Business Finance - M6

The term 'Hire-Purchase' is a UK term and is synonymous to '____________________' or '__________________' in various other countries.

'rent-to-own' or 'installment plan'

medium term sources of finance are

- Preference Capital or Preference Shares - Debenture / Bonds - Lease Finance - Hire Purchase Finance - Medium Term Loans from Financial Institutions, Government, and Commercial Banks

long term sources of finance are

- Share Capital or Equity Shares - Preference Capital or Preference - Shares Retained Earnings or Internal Accruals - Debenture / Bonds - Term Loans from Financial Institutes, Government, and Commercial Banks - Venture Funding - Asset Securitization - International Financing by way of Euro Issue, Foreign Currency Loans, ADR, GDR etc.

short term sources of finance are

- Trade Credit - Factoring Services - Bill Discounting etc. - Advances received from customers - Short Term Loans like Working Capital - Loans from Commercial Banks - Fixed Deposits (<1 Year) - Receivables and Payables

disadvantages of equity shares/share capital

- floatation cost - high cost of funds - no tax shield - underwriting of shares - dilution of control - no benefit of leverage

preference share is also known as

- hybrid financing instruments - preferred stocks - preferred share

Advantages of equity shares

- permanent source of finance - no obligatory dividend payments - open chances of borrowing - retained earnings - rights shares

Short term financing means financing for a period of less than ________.

1 year

Advantages of Leasing

1. Balanced Cash Outflow 2. Quality Assets 3. Better Usage of Capital 4. Tax Benefit 5. Off-Balance Sheet Debt 6. Better Planning 7. Low Capital Expenditure 8. No Risk of Obsolescence 9. Termination Rights

advantages of debt financing (term loans and debentures)

1. Benefit of Tax 2. Cheaper Source of Finance 3. No Dilution of Control 4. No Dilution in Share of Profits 5. The benefit of Financial Leverage 6. Disciplinary Effect 7. Low Issue Cost 8. Fixed Installments 9. No Harm in Communicating Critical Business Secrets 10. Callable Debentures / Bonds

disadvantages of preference shares

1. Costly Source of Finance 2. Skipping Dividend Disregard Market Image 3. Preference in Claims

Disadvantages of factoring

1. Factor collecting the money on behalf of the company can lead to stress in the company and the client relationships. 2. The cost of factoring is very high. 3. Bad behavior of factor with the debtors can hamper the goodwill of the company. 4. Factors often avoid taking responsibility for risky debtors. So the burden of managing such debtor is always in the company. 5. The company needs to show all details about company customers and sales to factor

Advantages of hire purchase

1. Immediate use of assets without paying the entire amount. 2. Expensive assets can be utilized as the payment is spread over a period of time. 3. Fixed rental payments make budgeting easier as all the expenditures are known in advance. 4. Easy accessibility as it is a secured financing. 5. No need to worry about the asset depreciating quickly in value as there is no obligation to buy the asset.

Advantages of factoring

1. It reduces the credit risk of the seller. 2. The working capital cycle runs smoothly as the factor immediately provides funds on the invoice. 3. Sales ledger maintenance by the factor leads to a reduction of cost. 4. Improves liquidity and cash flow in the organization. 5. It leads to improvement of cash in hand. This helps the business to pay its creditors in a timely manner which helps in negotiating better discount terms. 6. It reduces the need for the introduction of new capital in the business. 7. There is a saving of administration or collection cost.

Disadvantages of Leasing

1. Lease Expenses 2. Limited Financial Benefits 3. Reduced Return for Equity Holders 4. Debt 5. Limited Access to Other Loans 6. Processing and Documentation 7. No Ownership 8. Maintenance of the Asset 9. Limited Tax Benefit

features of term loan

1. Loan in any Currency 2. Secured Loan 3. Loan Installments 4. Maturity 5. Loan Agreement 6. Loan Covenant

There are three main terms of trade credit viz

1. Maximum Credit Limit 2. Credit Period 3. Cash Discount

advantages of preference shares

1. No Legal Obligation for Dividend Payment 2. Improves Borrowing Capacity 3. No dilution in control 4. No Charge on Assets

Disadvantages of Trade Credit

1. Opportunity Loss of Discount 2. Increase in Input Prices 3. Loss of Goodwill 4. The cost of Administration and Accounting 5. Loss of Suppliers

disadvantages of debt financing (debentures and term loans)

1. Rigid Obligation 2. Enlarge Leverage Ratios 3. Restrictive Covenants 4. Bad for Low Inflationary Conditions

four different things possible posttermination of the lease agreement.

1. The lease is renewed by the lessee perpetually or for a definite period of time. 2. The asset goes back to the lessor. 3. The asset comes back to the lessor and he sells it off to a third party. 4. Lessor sells to the lessee.

Disadvantages of hire purchase

1. Total amount paid towards the asset could be much higher than the cost of the asset due to substantially high-interest rates. 2. The long duration of the rental payments. 3. Ownership only at the end of the agreement. The hirer cannot modify the asset till then. 4. The addition of any covenants increases the cost. 5. If the hired asset is no longer needed because of any change in the business strategy, there may be a resulting penalty.

features of preference shares similar to equity shares

1. dividend from PAT 2. management discretion over dividend payment 3. no fixed maturity

the features of preference shares similar to debt are...

1. fixed dividends 2. preference over equity 3. no voting rights 4. no share in earnings 5. fixed maturity

Medium term financing means financing for a period of ___________ years and is used generally for two reasons.

3 to 5

A liability account used to record an amount received from a customer before a service has been provided or before goods have been shipped.

Advances Received from Customers

___________ raises the leverage of the business. High leverage means the high risk of _____________- is not the only risk but if the rate of return of the company declines below the debenture interest rate at a later stage after issuing the debentures, it can bring the whole project on a toss. The costs of projects may increase due to market conditions but interest payment would not change to compensate such increase in costs.

Debt financing; bankruptcy

A famous quote by _____________ says, "Why own a cow when the milk is so cheap? All you really need is milk and not the cow." The concept of __________ is influenced by this quote. We can compare 'milk' with the 'rights to use an asset' and 'cow' with the 'asset' itself. Ultimately, a person who wants to manufacture a product using machinery can get to use that machinery under a leasing arrangement without owning it.

Donald B. Grant; Lease

TRUE OR FALSE: Equity financing is not the permanent solution to financial needs of a company

FALSE: Equity financing is the permanent solution to financial needs of a company

Equity shareholders also have any right to ask for dividends, the dividends are paid at the discretion of the shareholder.

FALSE: Equity shareholders also DO NOT have any right to ask for dividends, the dividends are paid at the discretion of the MANAGEMENT OF THE COMPANY.

TRUE OR FALSE: Just like debt, preference shares also do not have fixed maturity date

FALSE: Just like debt, preference shares also have fixed maturity date

TRUE OR FALSE: Higher levered firms have higher chances of smooth borrowing of debt in times of need.

FALSE: LOWER levered firms have higher chances of smooth borrowing of debt in times of need.

TRUE OR FALSE: Like debt carries a fixed interest rate, preference shares do not have fixed dividends attached to them. But the obligation of paying a dividend is not as rigid as debt.

FALSE: Like debt carries a fixed interest rate, preference shares have fixed dividends attached to them. But the obligation of paying a dividend is not as rigid as debt.

TRUE OR FALSE: Opting for debentures over the equity as a source of finance keeps the profit-sharing percentage of existing shareholders unstable.

FALSE: Opting for debentures over the equity as a source of finance keeps INTACT the profit-sharing percentage of existing shareholders.

TRUE OR FALSE: The dividends distributed to the shareholders are a tax-deductible expense

FALSE: The dividends distributed to the shareholders are NOT a tax-deductible expense

TRUE OR FALSE: The payment of preference dividend is compulsory and is a decision of the management.

FALSE: The payment of preference dividend is NOT compulsory and is a decision of the management.

TRUE OR FALSE: The preference shareholders invest their capital with fixed dividend percentage but they do get control rights with them.

FALSE: The preference shareholders invest their capital with fixed dividend percentage but they do NOT get control rights with them.

TRUE OR FALSE: Internal accruals are used by corporate management for a minimal reasons.

FALSE: number of reasons

___________ is a financial service in which the business entity sells its bill receivables to a third party at a discount in order to raise funds.

Factoring

__________ involves the selling of all the accounts receivable to an outside agency. Such an agency is called a _________.

Factoring; factor

An agreement in which the owner of the assets lets them on hire for regular installments paid by the hirer. The hirer has the option to purchase and own the asset once all the agreed payments have been made. These periodic payments also include an interest component paid towards the use of the asset apart from the price of the asset.

Hire Purchase

______________ was very prominent for vehicle financing whether that is a personal car, commercial vehicle etc. but now equipment, machinery etc. are also financed with _________________ method.

Hire purchase

___________________ is a method of purchasing or financing capital goods whereby the goods are accessible for use almost instantaneously but the payment is made in smaller parts over an agreed period. The ownership is transferred only after the paying all installments. Technically speaking, it is an agreement between the buyer (or user) of the asset and the financing company whereby the financing company purchases the asset on behalf of the buyer and the buyer utilized it for business purpose and pays back to the financing company in small installments called hire charges.

Hire purchase

_____________ is the offer of shares which the company makes to the general public for the first time

IPO (initial public offer)

2 inventory financing

Inventory finance (asset-based loan) and floor planning

_____________ is a loan provided by a financial institution with the account receivables used as collateral. The quality and liquidity of the receivables will determine the exact amount and pricing of the facility.

Invoice discounting

The term loan is a long term secured debt extended by banks or financial institutions to the corporate sector for carrying out their long-term projects maturing between 5-10 years, which is normally repaid in monthly or quarterly equal installment

Medium Term Loans from Financial Institutions and Government

Preference shareholders can only claim two things which are the following..

One agreed on percentage of dividend and second the amount of capital invested

Amount and period of trade credit are dependent on two things

One, the customs and competition in the particular industry and second, the credibility of the buyer in terms of the liquidity position, profit making ability, past payment records etc.

Two reasons why medium term financing is used

One, when long-term capital is not available for the time being and second, when deferred revenue expenditures like advertisements are made which are to be written off over a period of 3 to 5 years.

most common loan structures

Receivable recourses Financing, Inventory Financing, Payables Financing

[___________________] Given that lease expenses reduce the net income without any appreciation in value, it means limited returns or reduced returns for an equity shareholder. In such a case, the objective of __________________ for shareholders is not achieved.

Reduced Return for Equity Holders; wealth maximization

______________ may also be described as sacrifices made by the shareholders. Companies generally retain 30% to 80% of their after-tax profit for the financial growth of the firm. The reserves and surplus representing the ______________________ constitute an important source of long term financing

Retained earnings; accumulated retained earnings

____________ is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs).

Securitization / Asset Securitization

TRUE OR FALSE: Asset securitization - Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).

TRUE

TRUE OR FALSE: Owning goods through hire and purchase lets companies improve their earnings performance. Not just beneficial to the hirer, this system is also the most effective and secure form of credit sales for the current owner of the asset.

TRUE

TRUE OR FALSE: 'Debt Financing' or 'Issuing of Debenture' results in interest expense for the borrower which is a tax-deductible expense

TRUE

TRUE OR FALSE: A company can get required capital via an issue of rights shares from its existing capital providers which have almost nil floatation cost

TRUE

TRUE OR FALSE: A company, majorly financed by equity, always has a controlled financial leverage ratio

TRUE

TRUE OR FALSE: Capital expenditures in fixed assets like plant and machinery, land and building etc of a business are funded using long-term sources of finance

TRUE

TRUE OR FALSE: Debenture holders or financial institutions do not share profits with the company. They are liable to receive the agreed amount of interest only. Therefore, the same number of hands share the profits before and after the new project.

TRUE

TRUE OR FALSE: Debt financing by term loan or debentures has fixed installments/coupon payments till the maturity of the loan

TRUE

TRUE OR FALSE: Equity finance is considered to be the costly source of finance especially in comparison to debt. The obvious reason is the higher required rate of return from equity share investors. Since equity share investment is a high-risk investment, an investor will always expect a higher rate of returns.

TRUE

TRUE OR FALSE: Equity finance provides that leverage to the management to continuously focus on fulfilling their core objectives. It keeps management away from the hassles of raising funds again and again like other sources of financing viz. debt.

TRUE

TRUE OR FALSE: Equity financing is one of the main funding options for any corporation

TRUE

TRUE OR FALSE: Equity mode of finance gives management a breathing space by having no fixed obligation to pay dividends.

TRUE

TRUE OR FALSE: In the case of a term loan, there is a comparatively lower cost of the issuance whereas in the case of equity financing, there is a huge cost of issuance

TRUE

TRUE OR FALSE: Issue of preference share does not lead to dilution in control of existing equity shareholders because the voting rights are not attached to the issue of preference share capital

TRUE

TRUE OR FALSE: Issuing of debentures or accepting bank loan does not dilute the control of the existing shareholders or the owners of the company over their business.

TRUE

TRUE OR FALSE: Non-payment of a dividend would not amount to bankruptcy in case of preference share

TRUE

TRUE OR FALSE: Percentage shareholding is reduced when new shareholders are introduced.

TRUE

TRUE OR FALSE: Preference share capital is not allotted any voting rights normally. They are similar to debenture holders and do not have any say in the management of the company

TRUE

TRUE OR FALSE: Preference shareholders enjoy a similar situation like that of an equity shareholder but still get a preference in both payment of their fixed dividend and claim on assets at the time of liquidation.

TRUE

TRUE OR FALSE: Preference shares become a part of net worth and therefore reduce debt to equity ratio. This is how the overall borrowing capacity of the company increases.

TRUE

TRUE OR FALSE: Skipping of dividend payment may not harm the company legally but it would always create a dent on the image of the company.

TRUE

TRUE OR FALSE: if the funds are utilized in projects with higher returns compared to what is available to the equity shareholders, the company effectively achieves its objective of shareholder's wealth maximization

TRUE

_____________ is also known as a spontaneous source of finance. It is a major source of working capital finance for most business whether small or big.

Trade credit

____________ is an important source of working capital extended or generated by the business itself. It can be defined as 'delay of payment' permitted by the creditor or supplier of raw materials, consumables etc. against the goods purchased from him. Any finance has three important parameters - ___________, _____________ and ________________. In this case, the amount of credit is the bill amount, the rate of interest is practically nil, and the period of credit is the credit period given in the terms of payment.

Trade credit; amount of loan, rate of interest and time period of a loan

______________ is a funding process in which the venture funding companies manage the funds of the investors who want to invest in new businesses which have the potential for high growth in future.

Venture funding

_____________ are financial products structured by financial institutions to help businesses fund their working capital needs and operating cycles.

Working Capital Loan

An ____________ is drafted between the borrower and the bank regarding the terms and conditions of the loans which are signed by the borrower and is preserved with a bank

agreement

This is an ____________ loan secured by the inventory or a part of the inventory such as work-in-progress or finished products. The amount will be determined by the realizable value of the inventory and pricing will be determined by the creditworthiness of the borrower and the quality of the inventory.

asset-based

It is the percentage of discount allowed by the creditor to the buyer to encourage him to pay as early as possible

cash discount

these shares are a ____________________ in the company by virtue of which investors are entitled to share the net profits and have a residual claim over the assets of the company in the event of liquidation.

certificate of ownership

_________________ is a form of security that charge on other assets of the borrower.

collateral security

If the investment is too large, several banks come together and finance it. Such type of term loan funding is also called as ________________

consortium loan

Lease expenses usually remain ____________ for over the asset's life or lease tenor or grow in line with inflation. This helps in planning expense or cash outflow when undertaking a budgeting exercise.

constant

The credit cannot be allowed for an infinite time period. It is the maximum period of time before which a buyer is expected to make payment. Beyond this period, the creditor may ask for interest on the amount at the rate mentioned in the terms of payment. The no. of days of credit is also determined in the similar fashion like the limit of credit amount.

credit period

____________________ are one of the common long-term sources of finance. They normally carry a fixed interest rate and a certain date of maturity. Also, issued to the general public and therefore the financier is the general public.

debentures

Although lease doesn't appear on the balance sheet of a company, investors still consider long-term lease as ______ and adjust their valuation of a business to include leases.

debt

_____________ are a part of a loan agreement. They are certain statements in the agreement which states certainly do's and dont's for the company.

debt covenants

debentures and term loans are what type of financing?

debt financing

Some managers have a tendency to _____________ till the last point possible. But, they are unaware of the problems posed by their suppliers in the absence of timely payment. Over a period of time, this idea impacts the goodwill of the firm in the market. All the suppliers will come to know about payment delays of the buying firm and will definitely entertain other buyers first. The firm may face problems like late supplies, no supplies in emergencies etc.

delay payments

The term ___________ refers to the capital expenditure allocation to various time periods for which the expenditure is expected to improve the financial condition of the firm

depreciation

The _____________ is considered an internal source of funds and is a non-cash charge.

depreciation charge

The seller makes the sale of goods or services and generates invoices for the same. The business then sells all its invoices to a third party called the __________. The _______ pays the seller, after deducting some discount on the invoice value.

factor

___________ the sale of account receivables to a third-party, or often a financial institution, at a discount.

factoring (recourse or non-recourse)

2 receivables financing

factoring (recourse or non-recourse) and invoice discounting

_________________ measures the ratio of financing to equity and debt

financial leverage ration

___________ is the cost incurred in raising funds.

floatation costs

A lender will purchase the inventory and, as the inventory is sold, the company will repay the debt. This method of financing is often used by a company with strong balance sheet such as car dealers.

floor planning

___________ can be defined as an option of financing or acquiring an asset for use whereby the financing company let the goods on hire to the buyer against small installments called hire charges and the buyer gets the right to use the asset with an option to purchase the asset by paying all such installments spread over a period of time.

hire purchase

IPO stands for

initial public offer

The _____________ of a business are the accumulation of retained earnings and depreciation charges.

internal accruals

A company develops an _____________ of finance by having equity finance on board

internal source

______________ and ______________ are the two sources of generation of capital.

internal sources and external sources

what is the special variant of shares that is immune to fixed maturity?

irredeemable preference shares

At the conclusion of the ______________, the asset goes back to the lessor (the owner) in an absence of any other provision in the contract regarding compulsory buying of the asset by the lessee (the user).

lease period

A __________ can be defined as an arrangement between the ________ (owner of the asset) and the _________ (user of the asset) whereby the lessor purchases an asset for the lessee and allows him to use it in exchange for periodical payments called lease rentals or minimum lease payments.

lease; lessor; lessee

____________ means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors

long term financing

Part of working capital which permanently stays with the business is also financed with __________________

long term sources of funds

On the basis of a time period, sources are classified as....

long-term, medium term, and short term

Leasing is an ideal option for a newly set-up business given that it means ________ initial cost and ________ CapEx requirements.

lower

It is the _______________________ which a customer is allowed. The limit is determined by the creditor based on the credibility of the customer, volume of its transactions, past payment track records, nature of business etc.

maximum amount of credit

_______________ or grace period is also given by banks in which no installment or very low installment is asked from the borrower

moratorium

NDA stands for

non-disclosure agreement

Although lease expenses get the same treatment as that of interest expense, the lease itself is treated differently from debt. Leasing is classified as an _______________ and doesn't appear on the company's balance sheet.

off-balance sheet debt

____________ and __________ classify sources of finance into owned capital and borrowed capital

ownership and control

The bank will pay the supplier promptly in cash when the invoice is issued and the company will repay the bank at a later date. The company will effectively stretch its payables and benefit from better payment terms. Payables facilities are usually provided on an unsecured basis but a bank could require a guarantee depending on the creditworthiness of the counterparty.

payables funding

payables financing

payables funding

_________________ are one of the special types of share capital having fixed rate of dividend and they carry preferential rights over ordinary equity shares in sharing of profits and also claims over assets of the firm; it is a long term source of finance

preference shares

Term loans come under the secured category of loans. Two kinds of securities are _____________ and ____________

primary and collateral securities

___________________ is the asset which is purchased using the loan amount

primary security

Control of the business is not weakened when it uses the _______________

retained earnings

Stock markets view _____________ in a more positive light than equities.

retained earnings

The ____________ are easily available to the business, requiring no need to consult its lenders or shareholders.

retained earnings

The _____________ make a portion of the equity earnings that are reinvested in the business

retained earnings

The extra equity infusion is effectively represented by the ______________. Unlike external equity, ______________ eliminate the losses and issue costs on account of under-pricing.

retained earnings

______________ fall under long-term sources of finance- category because legally they are irredeemable in nature

share capital or equity shares

The need for ___________ arises to finance the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank balance etc.

short-term finance

_________________ are an external source of finance paid in installments governed by loan agreement and covenants.

term loan

_____________________ is a long term secured debt extended by banks or financial institutions to the corporate sector for carrying out their long-term projects maturing between 5 to 10 Years which is normally repaid in monthly or quarterly equal installment

term loan

The job of an ______________ is to assume the risk of subscription. They would agree to subscribe the shares to the extent not subscribed by the general public and will charge a fee for that service.

underwriter

The _______________ firms provide the funds to start ups in exchange for the equity stake. Such a startup is generally one that possesses the ability to generate high returns. However, the risk for this is ________.

venture capital funding; high

A _________________ of a company is defined as the number of days it takes for a company to turn its inventory into cash. It is calculated as the number of days required to turn the inventory items into finished products and to collect the cash from the sale of these products

working capital cycle

The need for working capital arises due to the business cycle, commonly known as a ______________.

working capital cycle

Short term financing is also named as _________________.

working capital financing