Need for Finance
What is meant by start-up capital?
Finance required to establish a new business, including purchasing essential equipment, premises and initial inventories.
State the formula for calculating working capital.
Working capital = Current assets − Current liabilities.
Identify two internal sources of finance.
Any two: retained earnings, sale of unwanted assets, owners' capital, sale and leaseback, or reducing working capital requirements.
A business withdraws more money than it has in its bank account, up to an agreed limit. Identify the source of finance.
Bank overdraft.
A clothing shop orders $5,000 of winter coats. The supplier allows it to pay 45 days after delivery. Identify the source of finance.
Trade credit. The shop obtains inventory without paying the supplier immediately.
Identify two reasons why an expanding business may require additional finance.
To purchase additional non-current assets such as machinery, and to finance additional working capital such as inventories.
A business has current assets of $84,000 and current liabilities of $59,000. Calculate its working capital.
$25,000.
What is meant by retained earnings?
Profits remaining in the business after tax and dividend payments that are retained for future use.
A supplier allows a manufacturer to pay for raw materials 60 days after delivery. Identify this source of finance.
Trade credit.
A street-food entrepreneur needs $600 to purchase cooking equipment. Traditional banks refuse to lend because the business has no financial history or collateral. Identify a suitable source of finance and explain why.
Microfinance, because it provides small loans to entrepreneurs who may not qualify for traditional bank finance.
A gift shop needs additional inventories for a one-month tourist festival. Is this a short-term or long-term financing need? Explain.
Short-term, because the additional inventory is needed only for a temporary increase in seasonal sales.
Explain how reducing the credit period offered to customers could improve working capital management.
Customers pay sooner, reducing cash tied up in trade receivables and making cash available earlier for daily expenses.
A restaurant sells an unused delivery vehicle. Identify one advantage and one limitation of this source of finance.
It raises cash without additional borrowing or interest payments, but is limited by the number and value of assets that the business can sell.
Identify the difference between leasing and hire purchase.
Leasing allows a business to use an asset for regular payments without necessarily acquiring ownership. Hire purchase involves instalment payments with ownership transferred according to the agreement, usually after the final payment.
A delivery company needs 10 new electric vans. It wants to spread the cost over four years and avoid owning vehicles that might become technologically outdated. Recommend one source of finance and explain why.
Leasing, because it avoids the large initial purchase cost and allows the vans to be used through regular payments without requiring ownership. The arrangement may also reduce the difficulties of replacing outdated vehicles.
A business buys goods for $9,000 cash and sells them for $14,000 on 60-day credit. Calculate its profit and net cash movement this month, ignoring other expenses.
Profit is $5,000. Net cash movement is −$9,000 because payment from customers has not been received.
A business experiences increasing sales but has insufficient cash to purchase more inventory. Explain why this might happen.
More cash may be tied up in additional inventory and trade receivables. If customers buy on credit, cash receipts may occur much later than the business's payments to suppliers.
A company sells its warehouse and then rents the same building from the buyer. Identify the method of finance and explain one drawback.
Sale and leaseback. The business receives cash immediately but loses ownership and incurs regular lease payments.
A furniture manufacturer sells $30,000 of outstanding customer invoices for $28,000. Identify the source of finance and explain why it receives less than the full amount.
Debt factoring. The factor purchases trade receivables at a discount, allowing the business to obtain cash immediately but at a cost.
A furniture manufacturer has $120,000 owed by customers who will not pay for another 90 days. It urgently needs $80,000 to pay wages and suppliers, but the bank refuses to increase its overdraft. Recommend a suitable source of finance and explain one drawback.
Debt factoring. It converts trade receivables into immediate cash, helping the manufacturer pay short-term expenses. However, the factor pays less than the full invoice value, reducing the amount ultimately received.
A business is profitable but cannot pay its employees because customers have not yet paid their invoices. Explain how this could lead to business failure.
The business has recorded revenue and profit from credit sales but has insufficient cash inflows. It may be unable to pay wages, suppliers or short-term debts, potentially resulting in insolvency.
A manufacturer increases the time it takes to pay suppliers from 30 to 60 days. Explain one advantage and one possible disadvantage.
It retains cash for longer, improving short-term liquidity. However, delayed payments may damage supplier relationships or cause the business to lose early-payment discounts.
A retailer reduces excessive inventory and uses the cash released to buy new shelving. Explain how this provides internal finance and one possible risk.
Lower inventory releases cash previously tied up in stock. However, reducing inventory too far may cause stockouts and lost sales.
Distinguish between microfinance, venture capital and share capital as sources of finance.
Microfinance provides small loans to entrepreneurs, often with limited access to traditional banks. Venture capital is risk capital invested in high-potential businesses, usually in exchange for equity. Share capital is raised when a limited company issues shares to investors.
A public limited company wants $40 million to build a new factory. It already has substantial bank loans and only $5 million in retained earnings. Recommend a suitable source of finance and justify why it may be preferable to a new bank loan. Identify one drawback.
Issuing new shares is suitable because it can raise substantial long-term capital without increasing debt or compulsory interest payments. Given the company's substantial existing borrowing, this could reduce financial pressure compared with a new loan. However, existing shareholders may experience dilution of ownership and control.