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20 Cards in this Set
- Front
- Back
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Sole Trader
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Solo person
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Partnership
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Two or more individuals working towards common aim
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Limited Liability Partnership (LLP)
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Losses Limited by amount invested by the partners
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Incorporation / Limited Company
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Must report performance to a regulator – completely separate from its owners
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Limited Company Advantages
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Advantages: Limited Liability(amount invested), Separate legal entity, Credibility because of Ltd., able to invite investers, Partners can be investors
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Limited Company Disadvantages
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Disadvantages: Compliance with regulators, Annual accounts must be kept, Director responsibility can be onerous, auditors may need to be employed, directors may have to pay income tax on their salaries, and corp. tax on profits
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Public Limited Company
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•Public shares sold and bought/sold on Stock exchange • i. Share: Interest of a shareholder in a company measured by a sum of money – share in a company entitles shareholder to equal share of dividends • ii. PLC must keep stock exchange informed
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Authorized and Issued Share Capital
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Obtaining capital through equity markets
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Steps for Obtaining Share Capital
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• i. Complete Memo of Association – incl company name, registered office, shareholders statement• ii. Article of Association – Company stipulates classes, costs, rights, powers of shareholders, and duties of directors/management – once signed, shares cane be issues• iii. Issue the Share Capital
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What are the different types of Share Capital
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•1. Authorised SC – max # and value of shares 2. Issued SC – number and value of shares actually issued 3. Called up SC - # and value of authorized shares for which cash has been paid for••
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Loan Capital
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• must be repaid and terms are agreed upon by borrower/lender – Equity / Loan balance affects capital structure and can jeopardise company••
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Basic Types of Loans
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• 1. Traded Loans: Bonds / Debentures bought and sold in secondary market• 2. Non-Traded Loans: Ordinary Bank Loans a. Both Traded/Non-Traded loans are collateralized against co. assets• 3. Other: Unsecured loans - higher interest uncollateralized loans or Convertibles – bonds which can be converted to ordinary shares
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Medium Term Company Finance
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two to five years
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Types of Medium Term Company Finance
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• a. Bank Loans: interest rates tied to banke rate and loans are secured against assets• b. Hire Purchase agreement: Obtain and use assets by depositing money and repaying capital over time (like mortgate)• c. Leasing: Making payments for use of an asset. At end of term asset is returned • d. Finance lease: Possession and payment can be converted to ownership • e. Credit Hire: similar to leasing, owner maintain and may provide additional services
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Short-term Company finance
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< 2 years
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Types of Short Term Company Finance
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• a. Overdraft: exceeding company deposits in a bank account (owing the bank $)• b. Factoring: selling accounts receivables for a fee• c. Credit: non-payment for a certain time period•d. Bill of exchange: written agreement to pay on a date through an intermediary (check) • e. Commercial Paper: prommisory notes, bank drafts, CD’s•
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In relation to business entities, explain the difference between a
sole trader and a partnership. |
A sole trader is the simplest form of business entity – a single person trading on their
own. The individual is responsible for all the liabilities that they might incur with their suppliers and will be bound by legislation to report their earnings to HM Revenue and Customs (HMRC) for income tax and value added tax purposes, plus PAYE (Pay As You Earn) if the sole trader takes on paid employees. The sole trader will need to show if they have made a profit or loss in the first year and report this to HMRC and, most probably, their local bank. Nonetheless, this is the simplest form of business entity that entails the minimum amount of legal formalities. The individual has no responsibility to let anyone else know how they are doing, which many sole traders believe is a distinct advantage. A partnership is formed if two or more individuals work together with a common aim. This business entity is governed by legislation (the first in the UK was the Partnership Act 1890) although partnerships may or may not need to be covered by their own legal agreement. In fact, some partnerships never have a written agreement and the law states that, when this occurs, profits and losses should be shared equally between the partners. However, the partnership is still required to report its performance to HMRC and the bank. |
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A friend, who knows that you are studying this course, has asked
for advice on setting up a limited company. What are the advantages and disadvantages of incorporation that you would include in that advice? |
The advantages of incorporation, that is, forming a limited company, are:
• Limited liability – your friend (and partners, if in a partnership) will become shareholder(s) and, in the event of a ‘winding-up’, will only be liable for the amount they have in shares • The company will become a separate legal entity, i.e. separate from your friend and partners • The ‘Ltd’ suffix will carry increased credibility with investors and suppliers • The company will also be able to invite new investors to become shareholders • Your friend and partners will become directors, who can be paid a salary as well as receive dividends as shareholders. However, your friend should also be advised that there will be a number of disadvantages of incorporation: • A limited company has to comply with the Companies Acts and file copies of accounts with Companies House • Preparing statutory annual accounts can be time-consuming and expensive • The responsibilities of directors cannot be taken lightly and can be onerous • If the company grows significantly, it may need to employ auditors • The directors will have to pay income tax on their salaries and the company will have to pay corporation tax on its profits. |
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In terms of long-term finance, what is the difference between
equity and loan capital? Illustrate your answer with a diagram. |
A company can secure initial share capital through equity markets, such as the
International Stock Exchange in London or the Alternative Investment Market (AIM), created in 1995 for smaller companies. Once the Memorandum and Articles of Association have been drawn up and signed, the company can create the shares. The maximum number and value of shares that the directors are allowed to issue is known as the authorised share capital, the equity in the diagram above. From this authorised amount, the directors issue shares to sell to the new shareholders. The number and value of new shares actually issued is known as the issued share capital. The directors may call upon the new shareholders to pay the full amount of the purchase price but it is possible for the purchaser to pay part now and part later. This is why the company records its called-up share capital, i.e. thenumber and value of the authorised and issued shares, for which cash has been paid. Apart from shares, the initial capital of a company can also include loans. Loan capital is for long-term investment rather than short-term needs. However, while equity (shares) does not have to be repaid and the payment of dividends is arbitrary, loan capital must be repaid and the interest paid as agreed between lender and borrower. Nonetheless, companies benefit from securing part of their capital in the form of loans as rates for such long-term borrowing are usually lower than their shortterm equivalents. The balance between equity and loan capital will affect a company’s capital structure and is constantly under review, as an over-reliance on borrowed funds can jeopardise a company’s long-term profitability. There are three basic types of loan capital: traded loans, non-traded loans and others. Traded loans include bonds and debentures, which can be bought and sold in the secondary capital markets. Non-traded loans are those which cannot be bought and sold, such as ordinary bank loans. The arrangement stays with the borrower and the lender until the debt is repaid. Like traded loans, however, the debt is secured against assets of the company. Other types of loan capital include unsecured loans and convertibles. It is not uncommon for a company to obtain unsecured loans for capital needs but they attract higher interest payments either on a fixed term or variable basis. Convertibles are bonds, which carry interest payments but give the bond owner the right to convert the bonds into ordinary shares at some stage in the future based on agreed terms. |
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Explain the difference between medium-term and short-term
company finance and list the ways or forms in which each can be obtained. |
In corporate finance, medium-term is generally understood to mean a period from
two to five years. Medium-term company finance, therefore, sits between capital or long-term needs of over five years and short-term needs, usually of less than two years. Medium term finance includes: • Bank loans, which are the major source of medium-term funds with characteristics similar to those of their long-term equivalents. Interest rates are usually tied to the bank rate and the loans are most often secured against assets, such as trading stock, property and debtors. • Hire purchase agreements, which are a way of obtaining and using assets. In this case, a deposit of money secures use of the asset and repayments of capital and interest are made over an agreed period of time. Only when the final payment is made does the ownership of the asset pass to the purchaser. • Leasing. One type of lease is the operating lease. Under this arrangement, a company takes possession of an asset for a payment, not strictly interest or repayment of capital, simply a payment for its use. At the end of the leasing agreement, the asset is returned to the lessor. A finance lease differs from an operating lease in that the possession and payment during the period of the lease is converted to ownership by the payment of an agreed sum at the end of theagreement. Taxation varies for each type of lease but directors will choose the most efficient type for their purpose. • Credit hire agreements are a development of the leasing principle. As the term implies, an asset can be obtained and used without the ownership and, in some cases, the encumbrances of ownership. The owner continues to maintain the asset and, in some arrangements, such as vehicle fleet management, will provide extras, such as replacement vehicles and even drivers within the hiring charge. Short-term finance includes: • Bank overdrafts – the most frequently used opportunity because of their inherent flexibility. Bank overdrafts arise when a current bank account goes into the ‘red’, that is, when the account ceases to be an asset and becomes a liability. Put another way, the company owes the bank, not the other way around. Overdrafts can be obtained relatively quickly and managed relatively easily. For these reasons, limits are usually placed on the amount by which a bank account can be overdrawn and the overdraft can be called in by the bank at short notice. Factoring - one of the challenges of managing the working capital of a business is the need to fund the fiscal drag that exists between a sale on credit and collecting the payment for the debt. To overcome this drain on cash resources, financial institutions have developed factoring. A company may choose to ‘sell’ part of its debt portfolio for cash, thus securing the use of the funds before they are normally paid. The Debt Factor institution, which could be a bank or a financial institution specialising in factoring of debts, will provide the funds and often collect the debt for a fee. Factoring, therefore, is a source of funding that is specific to, and appropriate for, those with large outstanding sales on credit. • Credit agreements - similar to factoring, but not involving payment when making significant purchases. A company may secure terms of payment with suppliers of up to, say, 90 days, particularly if the supplier wishes to keep the company’s business. For the company, this represents an easy short-term loan and, if managed carefully, can be very effective. Nonetheless, the company has to ensure that it does not take liberties with their suppliers’ credit by paying late - suppliers can withdraw supplies, putting pressure on production and sales. • Bills of exchange are written agreements to pay a particular sum of money on a specified date through an intermediary, usually a bank. The simplest example of a bill of exchange is the cheque. However, bills of exchange are used extensively in the short-term financing of international trade. • Commercial paper is a form of short-term borrowing available to businesses with a high credit rating. This means businesses with satisfactory payment records. Banks, which lend on commercial paper, consider it to be a low risk investment as the borrowers usually have high credit ratings and the duration of the loan is, typically, less than one year. The most common forms of commercial paper are promissory notes, bank drafts and certificates of deposit (CDs). |
