Sources of Finance Overview
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Questions and Answers

What is a disadvantage of raising funds through shares?

  • It may require management to be more careful with funds.
  • It can deter potential investors. (correct)
  • It simplifies profit estimation.
  • Shareholders have fixed return expectations.
  • Which of the following is a characteristic of a bank overdraft?

  • Requires a fixed interest rate.
  • Must be arranged in advance.
  • Secures payment with real estate.
  • Repayable upon demand. (correct)
  • In what scenario may a term loan be appropriate?

  • For immediate cash flow needs.
  • To operate a negative bank balance.
  • When no security is available.
  • When borrowing for a specific purpose. (correct)
  • Which of the following is true regarding debt factoring?

    <p>It provides cash advances based on trade debtors. (B)</p> Signup and view all the answers

    What is a common disadvantage of using external sources of finance?

    <p>Higher rate of return expectations may be required by shareholders. (C)</p> Signup and view all the answers

    What can affect the variable interest rate on a bank overdraft?

    <p>The creditworthiness of the customer. (A)</p> Signup and view all the answers

    What is a significant risk of using debt factoring for a company?

    <p>It may lead to a negative impression of the company. (A)</p> Signup and view all the answers

    Which of the following sources of finance is NOT classified as short-term?

    <p>Term loan. (B)</p> Signup and view all the answers

    What is the primary function of the Official List on the London Stock Exchange (LSE)?

    <p>To list larger, established companies (A)</p> Signup and view all the answers

    Which of the following is NOT considered an advantage of stock market listing?

    <p>More control retained by shareholders (A)</p> Signup and view all the answers

    What is a major disadvantage of being listed on the stock market?

    <p>High flotation costs (A)</p> Signup and view all the answers

    Which market was established for smaller growing companies on the London Stock Exchange?

    <p>The Alternative Investment Market (AIM) (D)</p> Signup and view all the answers

    Which of the following is a potential risk for public limited companies (plcs)?

    <p>Increased market awareness among analysts (A)</p> Signup and view all the answers

    What is one way that public companies may attract and retain employees?

    <p>By offering shares as incentives (C)</p> Signup and view all the answers

    One of the disadvantages of being listed on the stock market includes the risk of being taken over. Why does this occur?

    <p>Shares are purchased more easily (B)</p> Signup and view all the answers

    What might happen to smaller firms on the stock market according to the disadvantages listed?

    <p>They may be ignored in favor of larger firms (C)</p> Signup and view all the answers

    What is a characteristic of ordinary shares?

    <p>They carry voting rights. (C)</p> Signup and view all the answers

    What is a potential drawback of leasing an asset?

    <p>It can be expensive. (B)</p> Signup and view all the answers

    Preference shares have which of the following features?

    <p>Fixed dividend percentage. (C)</p> Signup and view all the answers

    Which of the following is a characteristic of venture capital?

    <p>Investment usually occurs in shares or debentures. (D)</p> Signup and view all the answers

    Which situation does not typically receive venture capital funding?

    <p>Funding to cover operating losses. (B)</p> Signup and view all the answers

    What is a fundamental element regarding term loans?

    <p>Repayment can be interest only or principal plus interest. (A)</p> Signup and view all the answers

    In the context of bonds, which statement is true?

    <p>They can be secured or unsecured. (B)</p> Signup and view all the answers

    What does crowdfunding primarily involve?

    <p>Raising small amounts from a large number of people. (D)</p> Signup and view all the answers

    How are preference shares typically associated with dividends?

    <p>They have a right to dividends over ordinary shareholders. (A)</p> Signup and view all the answers

    Why might a firm seek venture capital?

    <p>To fund potentially risky projects or management buyouts. (D)</p> Signup and view all the answers

    Which of the following is a feature of ordinary shares?

    <p>They may have different categories. (B)</p> Signup and view all the answers

    What is a common platform used for crowdfunding?

    <p>kickstarter.com (B)</p> Signup and view all the answers

    Which characteristic is common to debentures and bonds?

    <p>They can be traded on the stock exchange. (C)</p> Signup and view all the answers

    What might affect a firm's ability to raise other forms of finance when leasing assets?

    <p>Leasing may affect the firm's leverage. (C)</p> Signup and view all the answers

    In venture capital, what is a participating interest usually involves?

    <p>Active involvement, such as a board seat. (B)</p> Signup and view all the answers

    What distinguishes a term loan from ordinary shares?

    <p>Term loans are secured with collateral. (D)</p> Signup and view all the answers

    What is a primary role of a financial manager in relation to fundraising?

    <p>To find the right type of finance at the right time (A)</p> Signup and view all the answers

    Which of the following is NOT a characteristic of internal sources of finance?

    <p>Requires consent from external parties (A)</p> Signup and view all the answers

    What is an advantage of tighter credit control?

    <p>Better cash flow (D)</p> Signup and view all the answers

    Which of the following is a disadvantage of reducing stock levels?

    <p>Possible loss of sales due to stock shortages (B)</p> Signup and view all the answers

    Why is it important for a financial manager to minimize loss of control in financing?

    <p>To maintain decision-making authority (B)</p> Signup and view all the answers

    What is one of the main goals of a financial manager when obtaining funds?

    <p>Maximizing the wealth of the owner (D)</p> Signup and view all the answers

    Which of the following is a long-term internal source of finance?

    <p>Retained earnings (D)</p> Signup and view all the answers

    What is a disadvantage of employing tighter credit control?

    <p>It risks losing customer goodwill (B)</p> Signup and view all the answers

    What is the primary advantage of a sale and leaseback arrangement for a business?

    <p>Immediate cash inflow without asset loss (A)</p> Signup and view all the answers

    What is one of the functions of the Stock Exchange?

    <p>To channel savings into investment opportunities (C)</p> Signup and view all the answers

    What happens to an asset in a sale and leaseback agreement after the lease period may end?

    <p>The financial institution may acquire the asset (D)</p> Signup and view all the answers

    Which market allows companies to raise new capital by selling shares to investors?

    <p>Primary Market (B)</p> Signup and view all the answers

    Which type of shares typically does not carry voting rights?

    <p>Preference shares (A)</p> Signup and view all the answers

    What is one characteristic of the Enterprise Securities Market (ESM) in Ireland?

    <p>It serves companies in earlier stages of development (D)</p> Signup and view all the answers

    Which of the following is not typically traded on the Stock Exchange?

    <p>Private equity shares (B)</p> Signup and view all the answers

    What could be a consequence of a building being sold in a sale and leaseback arrangement?

    <p>The company may lose potential capital appreciation (A)</p> Signup and view all the answers

    Flashcards

    Internal Finance

    Funds generated from within the company itself, often through operational decisions.

    External Finance

    Funds obtained from sources outside the company, like banks or investors.

    Short-term Finance

    Funding used for immediate needs, typically less than one year.

    Long-term Finance

    Funding used for longer-term projects or investments, typically lasting more than one year.

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    Tighter Credit Control

    A method to improve cash flow by rigorously managing accounts receivable and ensuring timely payments.

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    Reduce Stock Levels

    Minimizing inventory to free up cash and reduce storage costs.

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    Retained Earnings

    Profits kept by the company instead of distributed to shareholders.

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    Accrued Expenses

    Expenses incurred but not yet paid for, providing a short-term source of financing.

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    Sale and Leaseback

    A financing method where a business sells an asset (land or equipment) to a financial institution and then leases it back for a specific period. This allows them to raise cash immediately but continue using the asset.

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    Lease Payments

    Regular payments made by the business to the financial institution for the right to use the asset under the lease agreement.

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    Primary Market

    Where companies raise new capital by selling shares and bonds directly to investors. This is the initial sale of securities to the public.

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    Secondary Market

    Where existing shares and bonds are traded between investors. This market allows for the buying and selling of securities after the initial offering.

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    Ordinary Shares

    Represent ownership in a company and give holders voting rights and dividends.

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    Preference Shares

    Shares that offer a fixed dividend payment and priority over ordinary shares in case of company liquidation.

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    Debentures

    A type of debt security issued by a company to raise capital. They offer a fixed interest rate and are repaid on maturity.

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    Euronext Dublin

    Ireland's main stock exchange, providing a platform for trading shares, bonds, and other securities.

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    Retained Profits

    Profits that are kept within the business and used to finance future investment.

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    Disadvantages of Retained Profits

    Potential drawbacks of using retained profits for financing include: lack of manager scrutiny on spending, deterring potential investors, shareholder expectation of higher returns, difficulty in predicting profits, and lost opportunities from not using funds elsewhere.

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    Bank Overdraft

    A bank's permission for a company to temporarily spend more money than is in their account, subject to a limit and interest.

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    Characteristics of Bank Overdraft

    Key features include: flexible access to funds, ease of arrangement, variable interest, repayment on demand, preference for self-liquidating use, periodic review, potential security requirements, and potential for long-term use.

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    Term Loan

    A loan granted for a specific purpose with pre-determined terms and repayment plan, offering fixed or variable interest and potentially an arrangement fee.

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    Debt Factoring

    A finance company takes over managing a company's sales ledger, providing cash advances and potentially credit insurance and debt collection.

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    Factoring: With Recourse vs. Without Recourse

    With recourse means the finance company can recover from the original company if a customer doesn't pay. Without recourse means the finance company takes the full risk of bad debts.

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    Disadvantages of Debt Factoring

    Potential drawbacks of debt factoring include: high fees, higher interest rates than overdrafts, limited cash advance, and potentially giving a negative impression of the company.

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    London Stock Exchange (LSE)

    The primary stock market in the UK, offering two main markets: the Official List for established companies and the Alternative Investment Market (AIM) for smaller, growing companies.

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    Official List (Main Market)

    A market within the LSE for larger, more established companies, attracting investors seeking stable returns.

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    Alternative Investment Market (AIM)

    A market within the LSE specifically created for smaller, growing companies looking to raise capital and expand.

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    Advantages of a Stock Market Listing

    Benefits of listing on a stock market include access to capital, increased investor base, borrowing opportunities, and easier trading of shares.

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    Disadvantages of a Stock Market Listing

    Drawbacks of listing include high flotation costs, increased scrutiny from investors and analysts, potential for takeover, loss of control, and reporting requirements.

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    Increased Financial Standing

    Listing on a stock market enhances a company's reputation, attracting investors and lending institutions.

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    Easier to Acquire Companies

    Listed companies have a more accessible form of payment (shares) when acquiring other companies.

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    Market Price for Share Valuation

    Listing on a stock market provides a transparent and publicly recognized value for the company's shares.

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    What is a Term Loan?

    A loan with a fixed repayment schedule, usually for a specific purpose. The borrower typically receives a lump sum and pays back with interest over a set period.

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    Debentures/Bonds

    Long-term debt securities representing a loan to a company. These are usually issued in blocks with a fixed interest rate and a specific redemption date.

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    Nominal Value

    The face value of a share or bond, determined by the company and stated on the security certificate.

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    Market Value

    The current price at which a share or bond is traded on the open market, reflecting investor demand and company performance.

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    Secured Loan

    A loan where the lender holds a claim on specific assets of the borrower. This protects the lender in case of default, as they can seize the asset.

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    Unsecured Loan

    A loan where the lender's claim is not backed by specific assets. The lender relies on the borrower's creditworthiness and promises.

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    Leasing: What's the asset's fate?

    In a leasing agreement, the asset remains the property of the lessor (owner) even though the lessee (user) is using it. If lease payments aren't made, the lessor can repossess the asset.

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    Venture Capital: Who's it for?

    Venture Capital is a long-term source of finance for growth-oriented small and medium-sized businesses that need funding but can't access stock markets.

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    Venture Capital: The VC's Role

    Venture Capitalists typically take an active role in the companies they invest in, often joining the board of directors to ensure their investment is managed effectively.

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    Venture Capital: What's the goal?

    Venture Capital is provided for diverse business needs like initial startup funding, expanding operations, refinancing debts, and acquiring other companies.

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    Venture Capital: What's the return?

    Venture Capitalists invest in shares or debentures, expecting a significant return on investment when the company grows or is eventually sold.

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    Crowdfunding: How does it work?

    Crowdfunding involves raising small sums of money from a large number of people, usually online, to fund a project or venture.

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    Crowdfunding: What's the incentive?

    Crowdfunding platforms allow project organizers to set up campaigns where people can donate in exchange for rewards like early access to products or recognition.

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    Crowdfunding: Where's the money?

    Crowdfunding platforms like fundit.ie, kickstarter.com, and Indiegogo.com facilitate this process, connecting project creators with potential donors.

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    Study Notes

    Sources of Finance

    • Finance managers aim to find the right type of funding, at the right place, and at the right time.
    • Sources of finance can be categorized as short-term, medium-term, or long-term, based on repayment duration.
    • Each source affects a business in three ways: risk, income (cost of funds), and control.
    • Short-term funding is repaid within one year.
    • Medium-term funding is repaid in one to five years.
    • Long-term funding is repaid in more than five years.

    Internal Sources of Finance

    • Internal sources arise from management decisions.
    • Agreement is needed only from directors and managers, no need for external permission.
    • Internal sources are flexible and easily obtained quickly.
    • Short-term internal sources include tighter credit control, reducing stock levels, and delaying payments to creditors.
    • Long-term internal sources include retained earnings.

    Short-Term Internal Sources

    • Tighter Credit Control: Minimizing accounts receivable by handling customer payments promptly.
    • Reduced Stock Levels: Restricting inventory to release funds.
    • Delayed Payments to Creditors: Delaying payment to creditors to maximize available cash.
    • Accrued Expenses: Delaying the payment of incurred expenses to maximize funds.
    • Deferred Income: Collecting money from customers in advance.

    Advantages of Internal Short-Term Sources

    • Reduced risk of bad debts
    • Better cash flow

    Disadvantages of Internal Short-Term Sources

    • Risk of lost sales
    • Risk of loss of customer goodwill

    Long-Term Internal Source

    • Retained Earnings: Funds kept within the company, not distributed to shareholders.

    Advantages of Retained Earnings

    • No issue costs
    • Easy access
    • No effect on control
    • Helps reduce financial risk.

    Disadvantages of Retained Earnings

    • Management may not be as careful with funds as with external financing
    • May deter potential investors
    • Difficulty in planning profit timing and amount
    • Opportunity cost

    External Sources of Financing

    • External sources include short-term, medium-term, and long-term financing.
    • Short-term sources include bank overdrafts, term loans, debt factoring, and invoice discounting.
    • Medium-term sources include leasing.
    • Long-term sources include ordinary shares, preference shares, term loans, bonds, and debentures.

    Bank Overdrafts

    • Allow a business to operate a negative amount on its account.

    Advantages of Bank Overdrafts

    • Popular
    • Flexible
    • Easy and cheap to arrange
    • Bank may require forecast cash flows
    • Interest rates are variable; based on lending conditions and customer creditworthiness.

    Debt Factoring

    • A financial company takes over accounts receivable management, potentially offering insurance against bad debts and credit checks.
    • Factor may provide a cash advance.

    Invoice Discounting

    • Company gets immediate payment for invoices from a financial institution (a "factor").
    • Useful when an enterprise needs early payments on their invoices.

    Medium-Term External Financing Sources

    • Leasing: Contract where an asset owner (lessor) provides the asset to another entity (lessee).

    Advantages of Leasing

    • Financing when further borrowing is unavailable
    • Reduced risk for lessor
    • Flexibility with technology changes
    • Avoiding large upfront cash outflows

    Disadvantages of Leasing

    • Loss of capital appreciation
    • High effective interest rates

    Hire Purchase

    • Customers make installment payments to purchase an item.
    • Ownership (or title) of the item remains with the seller, who is often the financer, until the final installment is paid.
    • When the final installment is paid, the item becomes the property of the purchaser.

    Venture Capital (Private Equity)

    • Medium to Long-Term source of finance.
    • Provided to firms who need to grow and don't have access to the stock market.
    • Requires firms to have strong growth potential.

    Crowdfunding

    • Raising capital from a large number of people, typically through an online platform.

    Business Angels

    • Individuals who provide capital, but with more personal involvement in the enterprise's operation.

    Grants

    • Funds provided by organizations or government agencies for specific purposes.
    • Usually repayable based on certain conditions or the achievement of particular goals.

    Ordinary Shares

    • The foundation of a company's financial structure.
    • Typically non-redeemable.
    • Shares come with voting rights.

    Preference Shares

    • Have a nominal value and a market value.
    • Usually have a fixed dividend percentage.
    • No voting rights.
    • Lower-risk than ordinary shares.

    Term Loans

    • Fixed or variable interest rates.
    • Usually granted for specific purposes.
    • Loan agreements include conditions and/or payment schedule details.

    Debentures

    • Debt instrument issued by a company and backed by collateral.
    • Often traded on the secondary market of a stock exchange.

    Sale and Leaseback

    • A company sells an asset (e.g. building, equipment) and simultaneously leases it back.
    • Useful to raise capital without disposing of an asset.

    The Stock Exchange

    • Facilitates trading of securities to raise capital.
    • Primary Market: Companies get new capital.
    • Secondary Market: Existing investors swap shares.
    • Ireland's main stock exchange is Euronext Dublin (formerly known as the Irish Stock Exchange).

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    Description

    Explore various sources of finance, their classifications, and internal funding options in this concise quiz. Understand short-term, medium-term, and long-term funding along with their implications on risk and management. Ideal for finance students and managers alike.

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