finance.pdf

Finance -business income includes cash sales, credit sales, investment income, government grants, sale of fixed assets -household income includes wages, child benefit, social welfare, interest on savings -source of finance will differ based on purpose and time period as per the matching princip...

Finance -business income includes cash sales, credit sales, investment income, government grants, sale of fixed assets -household income includes wages, child benefit, social welfare, interest on savings -source of finance will differ based on purpose and time period as per the matching principle (Unit 4 Notes page 10) -sources of finance can be short, medium or long term Short Term Finance -finance available for a period of up to one year -should be repaid within twelve months -used for day-to-day business expenses (electricity, wages, stock) -eg bank overdraft, trade creditors, accrued expenses, factoring, credit cards Bank Overdraft -permission given by a bank to a current account holder to take out sums greater than they actually have in their current account up to an agreed limit -advantages = interest is only paid on overdraft money allowance used, interest payable is tax deductible for a business, no security guarantee needed -disadvantages = interest is charged, surcharged if agreed withdrawal limit is exceeded, account must be in credit (have positive balance) for at least 30 days before overdraft is possible -uses = purchase of stock, paying creditors, overheads -available to both households and businesses 2 Trade Creditors -trade credit means receiving goods from suppliers now and paying for them later -during this time period, the money that would have been used to pay the supplier can be used for other purposes -also known as ‘leaning on the trade’ -advantages = free source of finance, no interest, no security guarantee needed -disadvantages = interest may be charged on late/unpaid bills, discounts may be lost through not obtaining of early payment incentives, credit rating of purchases may be affected if payments late -uses = purchase of stock -available only to businesses Accrued Expenses -delaying the payment of bills -during this time period, the money that would have been used to pay the bills can be used for other purposes -eg tax in a business is paid in arrears (VAT is collected instantly by the business and remitted to the government at a later date) -advantages = free source of finance, no interest, no security guarantee needed -disadvantages = may be cut-off from services if payment is late/unpaid (eg electricity cut-off), interest may be charged on late/unpaid bills, discounts may be lost through not obtaining of early payment incentives -uses = paying for overheads -available to both households and businesses Factoring -involves selling debtors to a bank for cash, rather than waiting for debtors to pay, the business gets the money from the bank -two types of factoring (factoring with recourse and factoring without recourse) -factoring with recourse means the business must pay the bank if any debtors it sold don't pay the bank 3 -advantages = firm gets an immediate injection of cash (good for working capital), no security is needed, business doesn't have to give the bank any of its shares (retains control over the business), extra costly borrowing is avoided -disadvantages = expensive source of finance, only suited to well established businesses -available only to businesses Credit Card -used to buy goods now and pay at the end of the month -each credit card has a spending limit which is set by the bank -advantages = no interest if paid on full and on time, no security guarantee needed, safer to carry than cash -disadvantages = very high interest charged on unpaid/late bills, households must pay a government tax for every credit cards it holds -available to both households and businesses Medium Term Finance -finance available for a period of between 1 – 5 years -should be repaid within 1 – 5 years -used for mid-range expenses (eg computers, equipment, vehicles) -eg medium term loan, hire purchase, leasing Medium Term Loan -borrowing from a financial institution and repaying in fixed instalments over an agreed period -repayment periods and rates are arranged to suit the customers’ ability to repay -medium term loan for a household is called a personal loan -banks may demand security eg title deeds of premises, personal guarantor, share certificate -advantages = immediate ownership of asset, repayment amount and timeframe can be adapted to suit the re-payer, interest on the loan is a tax-deductible expense for a business 4 -disadvantages = interest must be paid, security may be lost if person defaults, if interest rates increase then repayment amounts increase -available to both households and businesses Hire Purchase -method of buying assets whereby an initial instalment is paid and the balance of the hire purchase price is paid in an agreed number of instalments -customer has immediate-possession and use of the asset but does not become the legal owner of the asset until the last instalment is paid -advantages = immediate use of the asset, payments are spread out over time, no security needed, if re-payer falls behind with payments but has already paid more than 1/3rd of the hire purchase then company must get a court order to take back the asset -disadvantages = interest must be paid, interest is charged on the initial hire purchase sum and not the reducing balance, expensive source of finance due to high APR (annual percentage rates) interest, risk of asset repossession if repayments are defaulted upon -available to both households and businesses Leasing -renting an asset -the business rents the asset from a finance company and pays a monthly lease payment for the use of the asset -business never owns the asset but obtains possession and use of it immediately -assets that have high rates of obsoletion (eg vehicles) are commonly leased by companies -at the end of the lease the asset is returned to the finance company -arrangements can be made with some leasing companies to buy the asset upon end of lease -advantages = business has the use of an asset without a large capital outlay, business can always have the most up to date-equipment, cost of leasing is a tax-deductible expense for a business, no security is needed, cheaper than hire purchase, leasing payments are regular so it is possible to plan expenditure 5 -disadvantages = never gain ownership of the asset (unless arrangement is made to buy after lease finishes), risk of asset repossession if repayments are defaulted upon -available to both households and businesses Long Term Finance -finance available for a period of more than 5 years -usually repaid after 5 years -used for expensive assets (eg premises, business expansion) -eg owner’s capital, share capital/equity, retained earnings, venture capital, government finance, long term loan/mortgage, debenture loan, savings Owner’s Capital -sole trader capital, money put into the business by the person setting it up -it’s left in the business as long as the business continues in operation -the owner’s personal savings -advantages = cheap source of finance, no interest payments, no security needed, sole trader can take out this invested capital tax free -disadvantages = sole trader may lose their savings upon business failure -available only to businesses Share Capital -equity for a company -provided by shareholders who purchase ordinary shares in the hope of a future dividend -share capital remains in the company as long as it exists and forms the permanent capital of the company -share capital is not repaid except on the winding up of the company -if the business fails the ordinary shareholders risk losing their money -advantages = no interest payments, no security needed -disadvantages = issuing shares assigns one vote to each share thus issuing shares dilutes company control, no dividend payment is guaranteed for ordinary shareholders (may become unhappy if profits consistently are used as retained earnings rather than 6 dividend payments and demand dividends), ordinary shareholders risk losing their money upon business failure, dividend payouts are not tax deductible -available only to businesses (not available to sole traders) Retained Earnings -business reserves/retained earnings are profits that are ploughed back into the business instead of being used as dividend payments -advantages = no interest payments, no security needed, company control is not diluted -disadvantages = retained earnings take a long time to build up thus not available to new businesses, ordinary shareholders may become unhappy if profits consistently are used as retained earnings rather than dividend payments -available only to businesses (not available to new businesses or sole traders) Long Term Loan -long term loans or mortgages are available from banks and building societies -usually used to buy houses and other properties -often secured against the asset for which they are purposed (eg mortgage secured against house) -advantages = company control is not diluted, interest is a tax-deductible expense for a business -disadvantages = interest must be paid, security may be lost if person defaults, if interest rates increase then repayment amounts increase -available to both households and businesses Debenture Loan -long term loan available to companies -advantages = company control is not diluted, interest is a tax-deductible expense for a business, fixed interest rates protect from rising interest rates and thus protects against rising repayments -disadvantages = interest must be paid, security may be lost if person defaults, fixed interest rates deny advantage of from decreasing interest rates and thus accessing cheaper repayments 7 -available only to businesses Government Finance -grant is a non-repayable source of finance -the Irish government and the EU provide grants to businesses for a variety of purposes -most grants are non-repayable but some are subject to conditions like agreed job creation targets -eg capital expenditure grants, feasibility grants, international expansion grants -advantages = free source of finance, company control is not diluted, no interest payments, no security needed -disadvantages = can be subject to conditions, often long and intricate application process with certain criteria to be met -available only to businesses Capital Choice Factors 1. Cost 2. Security 3. Reason 4. Taxation 5. Control 6. Risk 7. Business Status 8. Existing Financial Commitments