Sources of finance

explain retained earnings

• profits retained instead of distributed as dividends

• amount available each year is uncertain since future profits are unknown

how can earnings be retained

holding off dividend payments

how does reducing inventory levels improve efficiency of capital

reduces costs involved in holding inventory (e.g storage)

how does improved credit control help the business

minimises the risk of bad debts, cash received in a timely manner

how does improved credit control help the customer

maintains good customer relationships, gains new customers

credit control issues to be aware of

• which customers receive credit and how much?

• are there collection policies?

• are there discounts for prompt payments?

• how can we reduce the risk of non payment?

how can you tighten credit control proactively

• develop strong customer relationships

• publicise credit terms clearly

• issue invoices promptly

• answer queries quickly

how can you tighten credit control proactively

• have systems to deal with slow payers

• monitor outstanding debts

• produce an aged receivables schedule

how does deferring payments to suppliers help

makes the most of ‘interest free’ credit

what are some long term external sources of finance

• ordinary shares

• loans

• leases

what does issue of shares show as on the SFP

increased cash in assets, increased share capital in equity

what is a loan

a certain amount borrowed at an agreed rate of interest

what happens if a loan agreement is not kept

the lender is entitled to seize assets, sell it and recover the loan

what are the two types of interest rates

• fixed rates unchanged throughout the loan period

• variable rates change with the market

how is interest charge shown on the income statement

finance cost

advantages of financial leases

• ease of borrowing

• low cost

• flexibility

• help saving cash flow

if profits are falling, what gearing is best

low gearing. interest on debt must be paid still

short term external finance sources

• bank overdraft

• debt factoring

advantages of a bank overdraft

• very flexible

• cheap to arrange

• competitive interest rates

limits of bank overdraft

• overdraft limit must be approved by the bank

• banks usually ask for cash budget

• security may be required

• repayable on demand

what is debt factoring

• the company sells its trade receivable debts to a debt factor business at a discounted price

• company receives a portion of the receivables, immediate inflow of cash

• debt factor takes over the company’s trade receivables debts and collects them

• they charge a fee

what should short term borrowings be used for

a temporary need

what should long term borrowings be used for

supporting permanent operating base