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Sources and Forms of Financing
Introduction to Finance (FIN2303)
Algonquin College
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Chapter 8
Sources and Forms of Financing
REVIEW QUESTIONS
- What is the difference between financial needs and financing requirements?
Financial needs are the items that need to be financed and the amounts needed to finance them, whereas financing requirements have to do with the sources of the financing and the forms the financing will take. 2. Differentiate between internal and external financing. Give several examples.
Internal financing consists of funds generated by the business itself such as profit for the year, depreciation/amortization, and reductions in working capital accounts such as inventories and trade receivables. External financing consists of funds obtained from outside sources such as shareholders and lenders, through the sale of additional share capital and loans, bonds, and mortgages. 3. How can working capital become a source of internal financing?
Turning over trade receivables and merchandise inventories faster will reduce the balance of these working capital accounts and produce a gain in cash available.
Increasing current liability accounts has a similar effect. 4. Discuss the concepts of business risk, financial risk, and instrument risk.
Business risk is the inherent risk in a business's operations arising from trying to protect the level of revenue and profit in an uncertain environment. Financial risk relates to the capital structure of a business with a greater risk of insolvency with greater levels of debt. Instrument risk has to do with the quality of security available to satisfy investors. 5. Differentiate between flexible and durable current assets.
Flexible current assets tend to vary as business conditions, such as the level of sales, fluctuate. Durable current assets, however, are necessary to operate the business and remain at the same level throughout the year. 6. Explain the meaning of the matching principle.
The matching principle means that the maturity of the financial needs should be matched to the period of time the funds are required to finance assets, taking into consideration the factors of cost and risk.
7. Identify the six C’s of credit.
The six C's of credit are: (1) character: the reputation and honesty of the borrower;
10. Is it easier for a big firm to obtain a loan than a small
business?
Explain. Answers may suggest that a big firm can obtain a loan more easily than a small firm. However, answers should also indicate that loans are obtained on the basis of creditworthiness and the purpose of the loan, which means that a worthy small firm is not at a disadvantage. A big firm may also have much larger financial needs than a small firm and thus find financing more difficult to obtain.
11. Why is it important for a business to understand the
nature of its assets before
approaching lenders?
A business must understand the nature of its assets (inventories, trade receivables, non-current assets) because the lender will be questioning this very nature. If the business does not find the assets creditworthy, a lender won't either.
Sources and Forms of Financing
Course: Introduction to Finance (FIN2303)
University: Algonquin College
