Managing Working Capital and Capital Expenditure Quiz

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What are the main sources of long-term investment fund for small to medium sized companies?

Venture capital

What do venture capitalists generally expect in return for their investment?

A share of the future profits or a sizeable stake in the business

What is a rights issue?

When a company offers its existing shareholders the chance to buy additional shares for a reduced price

How long does the discounted price in a rights issue usually stand for?

A specified time frame, after which it is returned to normal

What is one advantage of debt finance over equity finance?

Ownership is not diluted

What is one advantage of equity finance over debt finance?

Equity finance is a permanent capital that never has to be repaid

What is the relationship between a company's level of indebtedness (gearing) and its chance of bankruptcy?

Due to increased level of indebtedness, debt finance becomes a lower proportion of the company's total long-term finance, increasing the chance of bankruptcy.

What is one advantage of debt finance over equity finance?

Interest is paid before corporation tax

What is one advantage of equity finance over debt finance?

Dividends do not have to be paid every year

What type of assistance do governments provide to small and newly formed businesses?

Government grants

Study Notes

Managing Working Capital

  • Managing working capital can be achieved by managing inventory, managing the cash cycle, and managing trade receivables
  • Amount of working capital required increases with the length of the cash cycle
  • Managing inventory includes managing raw materials, work in progress, and finished goods
  • Managing the cash cycle involves managing accounts payable and accounts receivable
  • Managing trade receivables involves managing debtors who owe the business money

Capital Expenditure and Revenue Expenditure

  • Capital expenditure is long-term spending on non-current assets that last more than one year (e.g., buildings, land, plant, machinery)
  • Revenue expenditure is short-term, day-to-day expenditure on costs and assets other than non-current assets (e.g., wages, salaries, insurance)

Sources of Finance for Limited Companies

Internal Sources of Finance

  • Retained profits: profits left after all additions and deductions from sales revenue, also known as the "bottom line"
  • Limitations: not available to newly formed businesses or those trading at a loss; requires shareholder consent
  • Sale of unwanted assets: selling off unwanted assets to raise finances
    • Limitations: may lead to decreased profitability in the long term
  • Reduction of working capital: lowering the amount tied up in working capital to free up money
    • Limitations: may negatively affect the company's liquidity position
  • Sale and leaseback of non-current assets: selling an asset and then leasing it back to continue using it
    • Limitations: may reduce long-term profit; requires cash to buy more profitable assets

External Sources of Finance

Short-term External Sources

  • Bank overdraft: a flexible short-term borrowing of money (a current liability)
    • Limitations: interest is calculated daily; banks can demand repayment on short notice; high interest rates
  • Trade credits: delaying payment for goods and services received
  • Debt factoring: selling accounts receivables to a third party at a discount

Medium-term External Sources

  • Medium-term loans: loans with a repayment period of 1-5 years
  • Hire purchase: a type of loan where the borrower pays for the asset over time
  • Leasing: renting an asset for a long period of time
  • Medium-term loan: a loan with a repayment period of 1-5 years

Long-term External Sources

  • Share capital: raising finance by issuing shares
  • Debentures: long-term debt securities with fixed rates of interest
  • Bank loans: long-term borrowing from a bank
  • Business mortgage: a long-term loan secured against a property
  • Venture capital: long-term investment fund for small to medium-sized companies
  • Government grants: available to small and newly formed businesses as part of government assistance

Test your knowledge on managing working capital which involves managing inventory, the working cycle, and trade receivables. Explore the concepts of capital expenditure including long-term spending and revenue expenditure.

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