Understanding Sources of Finance

What is the primary difference between internal and external sources of finance?

• Internal sources involve borrowing from banks, while external sources involve selling assets.

• Internal sources are funds raised from within the organisation, while external sources are obtained from outside the business.

• Internal sources require interest payments, while external sources do not.

• Internal sources are always short-term, while external sources are long-term.

Answer explanation

The correct choice highlights that internal sources of finance are funds generated within the organization, such as retained earnings, while external sources are funds obtained from outside, like loans or investments.

Which of the following is an advantage of owner's investment as a source of finance?

• It requires regular interest payments.

• It is limited by personal savings.

• It has no repayment obligation.

• It can lead to dissatisfaction among shareholders.

Answer explanation

The correct choice, 'It has no repayment obligation,' highlights a key advantage of owner's investment, as it allows businesses to use funds without the pressure of regular repayments, unlike loans or other financing options.

What is a disadvantage of using retained profit as a source of finance?

• It requires collateral.

• It can lead to opportunity costs associated with reinvestment.

• It involves high interest rates.

• It reduces ownership control.

Answer explanation

Using retained profit can lead to opportunity costs, as funds could be reinvested elsewhere for potentially higher returns. This means the business might miss out on better investment opportunities.

Which of the following is a characteristic of trade credit?

• It requires immediate payment for goods.

• It involves issuing new shares to the public.

• It allows businesses to defer payment for goods, aiding cash flow management.

• It is a form of long-term financing.

Answer explanation

Trade credit allows businesses to defer payment for goods, which helps manage cash flow effectively. This characteristic distinguishes it from immediate payment requirements and long-term financing options.

What is a disadvantage of using overdrafts as a short-term financing option?

• They are excluded from financial gearing calculations.

• They have fixed interest rates.

• Banks can withdraw overdraft facilities with little notice.

• They require collateral.

Answer explanation

A key disadvantage of overdrafts is that banks can withdraw these facilities with little notice, leaving borrowers without access to funds when they may need them most.

Which of the following is an advantage of using mortgages for business financing?

• They require immediate full payment for the property.

• They increase the business's gearing levels.

• They allow businesses to utilise the asset while making payments.

• They involve high interest rates compared to overdrafts.

Answer explanation

The correct choice is that mortgages allow businesses to utilise the asset while making payments. This means businesses can benefit from the property immediately, rather than waiting until the loan is fully paid off.

What is a disadvantage of issuing ordinary shares as a form of equity financing?

• It requires regular interest payments.

• It can lead to a loss of control due to changes in ownership structure.

• It involves high collateral requirements.

• It limits the amount of capital that can be raised.

Answer explanation

Issuing ordinary shares can dilute existing ownership, leading to a loss of control for current shareholders as new investors gain voting rights and influence over company decisions.

Which of the following is an advantage of using debentures as a source of finance?

• They provide voting rights to debenture holders.

• Interest payments on debentures are tax-deductible.

• They require no interest payments.

• They reduce the business's gearing levels.

Answer explanation

The correct choice is that interest payments on debentures are tax-deductible, which provides a tax advantage to the business. This reduces the overall cost of borrowing compared to other financing options.

What is a disadvantage of debt factoring?

• It requires collateral.

• It improves cash flow management.

• It involves costly fees that can impact profitability.

• It provides immediate cash access from unpaid invoices.

Answer explanation

A disadvantage of debt factoring is that it involves costly fees that can impact profitability, reducing the overall financial benefit of accessing immediate cash from unpaid invoices.

Which of the following is a characteristic of venture capital?

• It involves borrowing funds that must be repaid with interest.

• It is suitable for startups and businesses looking to expand or revitalise.

• It requires issuing debentures.

• It is a form of short-term financing.

Answer explanation

Venture capital is specifically designed to support startups and businesses aiming to grow or innovate, making it suitable for these purposes. The other options describe different financing methods.