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.</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.</p> Signup and view all the answers

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

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

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

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

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

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

    What is a characteristic of ordinary shares?

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

    What is a potential drawback of leasing an asset?

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

    Preference shares have which of the following features?

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

    Which situation does not typically receive venture capital funding?

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

    In the context of bonds, which statement is true?

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

    What does crowdfunding primarily involve?

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

    Why might a firm seek venture capital?

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

    Which of the following is a feature of ordinary shares?

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

    What is a common platform used for crowdfunding?

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

    Which characteristic is common to debentures and bonds?

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

    What distinguishes a term loan from ordinary shares?

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

    What is an advantage of tighter credit control?

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

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

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

    What is a disadvantage of employing tighter credit control?

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

    What is one of the functions of the Stock Exchange?

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

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

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

    Which type of shares typically does not carry voting rights?

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

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

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

    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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