Practice Flashcards
Define retained profit as a source of finance.
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All Flashcards in Topic 3.2
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3.2.125 cards
Define retained profit as a source of finance.
Retained profit is the portion of net profit kept in the business for reinvestment rather than paid out to owners/shareholders.
Profit kept inside.
Define internal sources of finance.
Internal sources of finance are funds raised from within the business itself, without using external lenders or investors.
From inside the business.
Internal finance comes from ______ the business.
Within.
Inside the business.
How does reducing stock levels raise finance?
Selling excess inventory frees up cash that was tied up in unsold goods.
Free cash from stock.
How does selling assets provide finance?
The business sells unwanted or underused assets to raise cash (e.g., old machinery or vehicles).
Sell assets for cash.
What is tighter credit control?
Improving the speed of collecting money owed by customers (trade receivables) to increase cash inflows.
Collect debts faster.
State one advantage of retained profit.
No interest is paid and ownership/control is not diluted.
No interest, no dilution.
State one disadvantage of raising finance by selling assets.
The business loses the asset permanently and may reduce capacity; it may also receive a low price in a quick sale.
Lose asset / low price.
Retained profit is the most common internal source for ______ businesses.
Established.
Needs profits.
State one advantage of internal finance.
It does not increase debt or interest payments and does not dilute ownership.
Low risk.
What are personal funds as a source of finance?
Personal funds are the owner’s own savings invested into the business (common for sole traders and partnerships).
Owner savings.
Selling assets raises cash but the business loses the ______ permanently.
Asset.
One-off source.
State one disadvantage of retained profit.
It is only available if the business is profitable and may be limited.
Needs profit.
State one method of improving credit control.
Send invoices promptly, set clear payment terms, and follow up late payments quickly.
Chase payments.
State one disadvantage of internal finance.
It is often limited in amount and may be insufficient for large investments.
Usually limited.
Why are internal sources often described as low-risk?
They do not increase debt/interest and do not dilute ownership or control.
No debt, no dilution.
Personal funds are especially common for ______ traders.
Sole.
Owner savings.
Why do many businesses prefer internal finance first?
Because it is cheaper and lower risk than external finance, and it avoids giving up control to outsiders.
Cheaper + control.
State one advantage of using personal funds.
No interest or repayments are required and it shows commitment to the business.
No repayments.
Why might shareholders dislike heavy use of retained profit?
It may reduce dividends paid to shareholders in the short term.
Lower dividends.
Which is usually larger: internal or external finance?
External finance usually provides larger amounts than internal finance.
External = bigger.
State one limitation of personal funds.
The amount is limited to the owner’s savings and increases personal financial risk.
Limited + personal risk.
Why can internal sources be insufficient for large projects?
Because the amounts raised internally are often limited and may not cover major capital investments.
Limited amounts.
Exam skill: Why can’t a start-up use retained profit?
Because it has not made profits yet, so there is no profit to retain.
No profits yet.
Can a start-up usually use retained profit?
No. Start-ups usually have no retained profit because they have not made profits yet.
No profits yet.
3.2.230 cards
Define external sources of finance.
External sources of finance are funds raised from outside the business, such as lenders, investors, or the government.
From outside the business.
What is a bank loan?
A bank loan is a fixed sum borrowed and repaid over an agreed period with interest.
Fixed sum, fixed term.
What is microfinance?
Microfinance provides small loans to entrepreneurs who cannot access traditional banking, often in developing countries.
Small loans.
What is share capital as a source of finance?
Share capital is money raised by a limited company by selling shares (ownership) to investors.
Sell ownership.
External finance comes from ______ the business.
Outside.
From lenders/investors.
Define trade credit.
Trade credit is when suppliers allow a business to buy now and pay later (e.g., 30–90 days).
Buy now, pay later.
How does trade credit help a business?
It improves cash flow by delaying payments to suppliers, freeing cash for other short-term needs.
Helps cash flow.
What is the main advantage of external finance?
It can provide larger amounts of funding than internal sources, supporting major investment or rapid growth.
Usually larger amounts.
Bank loans are suitable for large, ______ purchases.
Planned.
Longer-term, fixed.
What is a business angel?
A business angel is a wealthy individual who invests their own money in a start-up in exchange for equity, often providing mentoring.
Individual investor.
State one advantage of share capital.
It raises permanent finance with no repayment and can provide large sums for expansion.
No repayment.
State one advantage of a bank loan.
It provides a large lump sum for planned investment with a clear repayment schedule.
Planned + predictable.
State one advantage of a business angel.
They provide funding plus expertise, contacts and mentoring to help the start-up grow.
Money + advice.
State one disadvantage of a bank loan.
Interest increases total cost and the business must repay even if sales fall; security may be required.
Interest + repayments.
State one disadvantage of share capital.
It dilutes ownership/control and shareholders may expect dividends and influence over decisions.
Dilution.
State one disadvantage of external finance.
It has a cost (interest or sharing ownership) and can increase financial risk or reduce control.
Cost or control.
Define crowdfunding.
Crowdfunding is raising small amounts of money from many people, usually via online platforms.
Many small investors.
Overdrafts are best for short-term ______ flow gaps.
Cash.
Flexible short-term.
Define venture capital.
Venture capital is finance invested by specialist firms into high-growth, high-risk businesses in exchange for equity.
Equity + expertise.
External sources can be divided into which two main types?
Debt finance (borrowing) and equity finance (selling shares/ownership).
Debt vs equity.
What is a bank overdraft?
An overdraft allows a business to withdraw more money than it has in its account up to an agreed limit.
Flexible short-term.
Define a government grant.
A government grant is funding from the government that does not need to be repaid, usually for a specific purpose and with conditions.
Free but conditional.
State one disadvantage of using a business angel.
The owner gives up equity and may face investor influence over decisions.
Dilution + influence.
Selling shares raises permanent funds but dilutes ______.
Ownership.
Control reduced.
Business angel vs venture capitalist: state one difference.
A business angel is an individual investing their own money; a venture capitalist is an investment firm investing pooled funds (often larger amounts).
Individual vs firm.
Why might venture capital be attractive beyond the money?
Venture capitalists often provide expertise, contacts and strategic guidance, helping the business grow.
Money + support.
Which type of external finance requires repayment with interest?
Debt finance, such as bank loans and overdrafts.
Borrowed money.
Why is an overdraft considered risky?
The bank can withdraw the facility at any time and interest rates are often higher than loans.
Callable + high interest.
State one disadvantage of grants or crowdfunding.
Grants are competitive and come with conditions; crowdfunding may fail to reach the target and can take time to run.
Not guaranteed.
Exam skill: When recommending external finance, what must you always evaluate?
The advantages and disadvantages and how well the source matches the business context (purpose, amount, time period, control, risk).
Link to context.
3.2.325 cards
Short-term finance is for less than ______ year.
One.
< 1 year.
Define short-term finance.
Short-term finance is funding needed for less than one year, usually to cover day-to-day working capital needs.
Less than 1 year.
Define long-term finance.
Long-term finance is funding raised for more than one year, often to fund major investment and growth.
More than 1 year.
What does the matching principle in finance mean?
Match the time period of finance to the life of the asset or the duration of the need.
Time period must fit.
State two factors that affect the choice of finance.
Purpose of finance and cost (interest/fees or dilution). Other factors: time period, risk, business type, amount needed.
Purpose + cost.
Long-term finance is for more than ______ year.
One.
> 1 year.
Why is using an overdraft to buy a factory a problem?
It is short-term finance for a long-term asset; the bank can withdraw it, creating serious liquidity risk.
Short-term for long-term = risky.
Give two examples of long-term finance.
Bank loans and share capital (others include retained profit, leasing, mortgages, venture capital).
Loans + shares.
Give two examples of short-term finance.
Bank overdraft and trade credit (others include short-term loans and factoring).
Overdraft + trade credit.
Why does business type matter when choosing finance?
Sole traders/partnerships cannot issue shares, while limited companies can raise equity through share capital.
Some sources not available.
Give one example of matching finance correctly.
Using a long-term loan or mortgage to buy a building/factory that will be used for many years.
Long-term for long-life.
Why is a bank loan suitable for long-term investment?
Because it provides a large lump sum to buy long-life assets and can be repaid over several years to match the asset’s use.
Matches long-life assets.
How does risk tolerance affect the choice of finance?
More debt increases financial risk due to fixed repayments; more equity reduces repayment risk but can reduce control.
Debt = higher risk.
Matching principle: match finance term to the ______ of the asset/need.
Life.
Time fit.
Why is an overdraft suitable for short-term needs?
It is flexible: the business can borrow only what it needs up to a limit and repay quickly when cash comes in.
Flexible for cash gaps.
Why is the amount needed important?
Small short gaps may suit overdrafts/trade credit, while large investments may require loans, share capital or venture capital.
Small vs large.
Using short-term finance for long-term assets increases ______ risk.
Liquidity.
Cash squeeze.
What is leasing as a source of long-term finance?
Leasing is renting an asset for regular payments so the business can use it without buying it outright.
Use without owning.
Which source is often best to fund seasonal stock purchases?
Trade credit or an overdraft, because the need is short-term and the stock is used up quickly.
Stock = short-term need.
What is factoring?
Factoring is selling unpaid invoices (trade receivables) to a third party for immediate cash, usually for a fee.
Sell invoices for cash.
When asked to recommend a finance source, what should your final paragraph do?
Make a clear recommendation and justify it using purpose, time period (matching), cost, risk and control in the case context.
Recco + justify.
State one risk of relying too much on short-term finance.
It can be expensive and risky if lenders withdraw facilities; it may create cash flow pressure if repayments are due quickly.
Short-term pressure.
State one drawback of long-term finance (debt).
Interest increases total cost and long repayment commitments increase financial risk if revenue falls.
Long commitment.
What is the key exam skill when recommending a source of finance?
Justify why the source matches the purpose and time period, and evaluate cost, risk and control in context.
Justify + evaluate.
Exam tip: In finance recommendations, always evaluate cost, control and ______.
Risk.
Pros/cons in context.
3.2.420 cards
Define purchasing (as a way of acquiring an asset).
Purchasing means buying an asset outright so the business owns it completely.
Buy outright = own.
Define leasing (as a way of acquiring an asset).
Leasing means renting an asset for a set period by making regular payments, without owning it.
Rent, don’t own.
When is purchasing usually the better option?
When the business has strong cash reserves and expects to use the asset for a long time.
Cash + long-term use.
Purchasing means buying an asset outright. State the missing word: ______.
Outright.
Own it fully.
Leasing means renting an asset for regular payments. State the missing word: ______.
Renting.
Use but don’t own.
State one advantage of leasing an asset.
It avoids a large upfront cost and preserves cash flow through fixed regular payments.
Preserve cash flow.
State one advantage of purchasing an asset.
The business owns the asset and can use it long-term and potentially sell it later.
Own + can resell.
When is leasing usually the better option?
When cash flow is tight, the asset is needed short-term, or technology changes rapidly.
Tight cash or fast tech.
Which option usually preserves short-term cash flow better?
Leasing, because it avoids a large upfront payment.
No big upfront.
State one disadvantage of leasing an asset.
It is usually more expensive over time and the business never owns the asset.
Pay more, no ownership.
Why might a business lease vehicles rather than purchase them?
Leasing makes it easier to upgrade vehicles regularly and avoids large upfront payments.
Upgrade + no big upfront.
State one disadvantage of purchasing an asset.
It requires a large upfront payment, which can reduce cash flow.
Big upfront cost.
Purchased assets appear on the balance sheet. State the missing word: ______.
Balance.
Owned assets = balance sheet.
Leasing is especially suitable for assets that become outdated quickly, such as IT equipment. State the missing word: ______.
IT.
Fast-changing tech.
If an asset is needed for a limited time, leasing is often better than purchasing. State the missing word: ______.
Leasing.
Short-term need.
Which option is usually cheaper in the long run (if the asset is used for years)?
Purchasing, because the business owns the asset and can avoid ongoing lease payments.
Own = cheaper long-run.
Give one reason a business might still purchase technology equipment.
If it has strong cash flow and expects to use the equipment long-term, purchasing may be cheaper overall.
Cheaper long-term if stable.
In 6-mark evaluation questions on leasing vs purchasing, what should you compare?
Compare cost over time, cash-flow impact, flexibility/obsolescence risk, and link your recommendation to the business context.
Cost + cash flow + flexibility.
Give one reason leasing can reduce risk for a start-up.
It reduces the cash-flow strain from large purchases and makes budgeting easier with predictable monthly payments.
Lower upfront strain.
Why can purchasing be cheaper in the long run than leasing?
Because once the asset is paid for, there are no ongoing lease payments and the business can still sell the asset later.
No monthly payments later.
Topic 3.2 study notes
Full notes & explanations for Sources of finance
BM exam skills
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