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Finance and Accounting Solutions Paper 1

Start Up Capital, Capital for Expansion 💡

(a) Analyse the possible problems that a new business might experience when trying to raise finance. [8]

New businesses often require a high investment to start up. For example they must secure finance for hiring employees, finding premises, product development, marketing and cash flow until the revenue starts to flow into the business. This means that it can be difficult to find the loans, credit or sell enough equity to cover all of these costs.

New businesses may have to find many different sources of finance in order to raise the capital required which can be highly complex, and time consuming. A business plan can help to resolve these issues. 

Furthermore new businesses lack access to the same sources of finance of established businesses. For example, new businesses will not have a credit history, will be low in collateral and can’t use retained earnings. Often banks or lenders will require assets to secure a loan and suppliers may not offer goods on credit.

This can make it highly challenging to secure the high level of finance required to start a business. Often new businesses rely on wealthy investors to finance their enterprise.

New business owners are usually inexperienced and start up businesses have a high risk of failure.  So they lack the knowledge and skills to successfully manage cash flow in their business. This means that banks and other creditors may be unwilling to lend new businesses the capital they need to start a business.

Banks prefer to lend to businesses with a proven track record of financial management so they can be sure to get the capital back.  Undertaking a course in financial management may make banks more willing to finance a new business.

Other Acceptable Answers:

• Bank overdrafts may be available but usually at high rates of interest – this would increase costs
• If the new business is selling goods on credit and has to wait for its
customers to pay before it pays its suppliers, this could add significant
delay to the payment to suppliers – this might mean that suppliers will
not extend credit to the business until it is more established.
• Family and friends might offer to invest but this is not available for all businesses and may lead to a loss of control.

Legal Structure and Sources of Finance 💡

(b) Explain two reasons why a business may use equity finance. [3]

A  private limited company may wish to raise a large amount of capital by going public. 

For example Facebook raised $100 billion which it used for further expansion worldwide. It would have been very difficult to raise this level of capital from debt finance.

Interest rates may be very high.

This will mean it will be very costly to raise capital through debt finance due to high interest repayments. 

For example, 10% interest rates will mean the debt to be repaid rises one-tenth every year and it may be very difficult for the business to get out of high debt.

Other Acceptable Answers:

Business has high levels of debt.
Debt finance not available.

Short Term Finance and Long Term Finance 💡

(b) Briefly explain the distinction between short-term and long-term sources of business finance. [3]

Short term finance usually must be repaid in under a year, for example an overdraft or trade credit usually just lasts a few months. 

Long term finance usually is when a business requires a large sum for capital equipment like machinery or buildings. It is usually paid back over a number of years and examples include long term bank loans, long term leases or issuing shares. 

Other Acceptable Answers:

Short-term financing.
• Usually lower interest rates.
• Risk is lower so more accessible to smaller businesses.
• Used for to cover day to day cash flow shortfall

Long-term financing
• Spans a longer period of time, from over 1 year – 30 years.
• Banks often require collateral
• Examples are share issue, bonds, long-term bank loans, long-term leases, etc
• Often limited to large businesses

External Sources💡

 (a) Define the term ‘venture capital’. [2]

Long term source of finance available to entrepreneurs, often start ups.

(VC’s) invest in a businesses with high growth and profit potential in return for a percentage of the business. A good example is Dragon’s Den or Shark Tank.

Other Acceptable Answers:

• Risk capital invested in a business that has good profit potential
• Business that have difficulty in securing finance from other sources

(b) Explain two ways that venture capitalists might help a business. [3]

VC’s can provide long term finance for start-ups. Often new start-ups businesses find it difficult to raise capital as the don’t have collateral or a proven track record so may find it difficult to get finance from banks. 

VC’s can also give advice to start up’s on how to expand. They have access to valuable networks of contacts and may have experience helping other starts – ups so can be an invaluable guide through the challenges of starting a new business. 

Other Acceptable Answers:

• finance for small/medium-sized businesses that want to expand
• Provide funding for large investment in new technology, complex
machinery that other providers are not prepared to fund
• can rescue businesses from severe cash flow problems or save a business from liquidation

Uses of Cost Information 💡

(b) Briefly explain two reasons why cost information is useful for monitoring the financial performance of a business. [3]

Calculating profit margins. Without accurate cost information it is not possible to calculate how much profit is being generated from revenue. For example, if a business can’t take costs from revenue it will not know how much profit has been made.

For example, if a business can’t take costs from revenue it will not know how much profit has been made.

Making business decisions. With accurate cost information managers can make decisions based on which products or services are the most profitable. 

For example, if one product has a much higher cost of production the business may decide it is more profitable to focus on manufacturing another product with lower costs. 

Other Acceptable Answers:

• cost information also important for budgets, targets and benchmarking against competitors
• may show different production methods/pricing strategies are needed
• needed for break-even analysis
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