Sources of Finance

Why businesses need finance

Almost every business decision costs money before it earns money. Finance simply means the money a business raises and uses. Understanding where that money comes from is one of the most important skills in Edexcel IGCSE Business.

Businesses need finance at two key stages:

Start-up finance is the money needed to set up a new business before it makes any sales. It pays for premises, machinery, stock, a website, vehicles and initial wages.
Running and expansion finance is needed once the business is trading. This covers day-to-day costs (rent, wages, raw materials) and the cost of growing, such as opening a second shop or buying new equipment.

Key terms

Finance — the money a business raises to start up, run or expand.

Start-up capital — the initial money needed to set up a new business.

Working capital — the money used for day-to-day running costs.

Internal vs external sources

Sources of finance are split into two families. Internal sources come from within the business itself. External sources come from outside the business, usually from people or organisations that lend or invest.

Internal sources of finance

Owner's savings is money the owner puts in from their own pocket. There is no interest to pay and no loss of control, but the owner risks their personal money and may not have enough.

Retained profit is profit kept back in the business rather than paid out to owners. It is free to use and carries no interest, but a new business has no profit yet, and using it means owners receive less reward.

Selling assets means selling items the business no longer needs, such as old machinery or a spare vehicle, to raise cash. It avoids debt, but a new business may own little worth selling, and selling a useful asset can harm production.

Watch out

Retained profit is not the same as the profit for the year. It is profit kept after owners have taken their share. A brand-new business has no retained profit, so it cannot be a start-up source.

External sources of finance

Bank loan — a fixed sum borrowed and repaid in instalments with interest over an agreed period. Good for large, planned spending. The repayments and interest must be paid even if sales fall, and the bank may want collateral (security).

Overdraft — an agreed facility to spend more than is in the bank account, up to a limit. It is flexible and ideal for short-term cash gaps, but interest rates are high and the bank can demand repayment at short notice.

Trade credit — buying goods from suppliers now and paying later (often 30–90 days). It is interest-free and improves cash flow, but only delays payment and may mean losing early-payment discounts.

Share capital — money raised by selling shares in a company to investors, who become part-owners. It raises large sums with no repayment, but owners give up some control and share future profits as dividends. Only companies (not sole traders) can use this.

Venture capital — investment from specialists who put large sums into businesses they believe will grow fast, in return for a share of ownership. It brings money and expertise, but the owner gives up a slice of the business and some control.

Crowdfunding — raising small amounts from a large number of people, usually online. It can also test demand for a product, but the target must be reached and a strong campaign is needed.

Leasing — renting an asset (such as a vehicle) rather than buying it. There is no large upfront cost and the asset can be upgraded, but over time leasing usually costs more than buying, and the business never owns the asset.

Hire purchase — paying for an asset in instalments; the business owns it after the final payment. It spreads the cost, but the total paid (with interest) is higher and the asset can be repossessed if payments stop.

Government grants — money given by the government to support certain businesses, often in particular areas or industries. Grants usually do not have to be repaid, but they are competitive, may come with strict conditions and are often only for specific purposes.

Short-term vs long-term finance

Short-term finance is borrowed for under one year, to cover day-to-day cash flow gaps. Examples: overdraft and trade credit.
Long-term finance lasts more than one year and funds bigger items like premises and machinery. Examples: bank loans, share capital, leasing and hire purchase.

Exam tip

Match the time period of the finance to the life of the spending. Use short-term finance for short-term needs (paying a supplier) and long-term finance for long-term assets (buying a building). Funding a building with an overdraft, or stock with a 10-year loan, scores marks for poor judgement.

Comparing the sources

Choosing an appropriate source

There is no single "best" source — the right choice depends on the situation. Examiners reward answers that consider these factors:

1. Amount needed — large sums often mean a loan, shares or venture capital; small gaps suit an overdraft.
2. Purpose — long-term assets need long-term finance; short-term needs suit short-term sources.
3. Type of business — a sole trader cannot sell shares; only a company can use share capital or venture capital.
4. Cost — owners weigh interest charges and loss of profit or control.
5. Risk and existing debt — a business already in debt may struggle to borrow more.

Worked example

A new sole trader opening a small café has no profit, no shares and few assets. Realistic sources are owner's savings, a bank loan and trade credit from food suppliers. Share capital and venture capital are not available to a sole trader.

A large established company expanding into a new country has more options: it can issue share capital, take a large bank loan, use retained profit or lease vehicles. It can raise far larger sums and is seen as lower risk by lenders.

Exam tip

"Recommend a source of finance" questions need a justified judgement. State your choice, give two reasons it fits this business, and briefly say why a rejected option is less suitable here. Always link back to the case study.