Four reasons a business needs finance
Businesses need finance for four reasons: start-up capital (initial costs before revenue arrives), capital for expansion (new premises, machinery or markets), additional working capital (to fund day-to-day operations), and to cover a short-term cash-flow problem (a cash shortage). Working capital = current assets minus current liabilities; it pays day-to-day bills and is NOT profit — a profitable business can still run out of cash.
Internal vs external sources of finance
Internal sources come from within the business: retained profit (kept after tax and dividends; no interest), sale of surplus assets, and owner's savings. External sources come from outside: overdraft, bank loan, hire purchase, debentures, factoring, share issue, trade credit, government grants and crowdfunding. Internal sources carry no interest and keep control; external sources may cost interest, and a share issue dilutes ownership.
Short vs long term, and how to choose
Short-term finance (overdraft, trade credit, factoring) covers temporary needs cleared within a year; long-term finance (bank loan, hire purchase, debentures, share issue) funds major investment. Match the finance to the need. The choice of source depends on the amount required, the cost, the duration and purpose, the legal form (only companies issue shares or debentures), existing debt, and the effect on ownership.
Drawn from real examiner reports.
Start-ups cannot use these two sources
Asked for start-up finance, candidates often name retained profit and debentures — both unavailable to a new business. Retained profit needs previous years' profit, but a start-up has not traded yet; debentures need an established company with a credit record. A start-up's real options are owner's savings, a bank loan, a government grant, crowdfunding, or a share issue.
s22 P12 Q4(d).
Retained profit is not daily cash
Retained profit is profit kept after tax and dividends, then reinvested — for expansion or new equipment. It is NOT day-to-day operating cash; working capital pays wages, rent and supplier bills. Retained profit sits in equity, already deployed in the business's assets. Describe it as profit kept to reinvest without borrowing, not money for routine costs.
s22 P13 Q2(d).
Factors to choose are not the sources
Asked for the factors that influence the choice of source, candidates often just list sources (overdraft, loan, hire purchase) and score nothing. Factors are the criteria weighed before choosing: cost, amount needed, duration, legal form, existing debt, and the effect on ownership. Name the factor, then explain why it matters in the given context.
w23 P22 Q2(a).
Factoring means selling your invoices
Factoring is not the business chasing its own customers. It means selling outstanding sales invoices to a factoring company at a discount, so the business gets most of the cash immediately, and the factor then collects from the customers. It improves short-term cash flow, but the discount means the business receives less than the invoice value.
Overdraft is short-term, not long-term
An overdraft is short-term finance for a temporary cash gap; it can be recalled by the bank at short notice and charges daily interest, so it is unsuitable for a long-term project. A bank loan is the long-term counterpart. Match the source to the need: a temporary gap suits an overdraft or trade credit, a multi-year investment suits a loan or share issue.
s23 P21 general.
Only companies issue shares/debentures
Legal form limits the sources available. A sole trader or partnership cannot raise finance by issuing shares or debentures — those are open only to limited companies (Ltd or plc). Suggesting a share issue for a sole trader earns no marks. Check the legal form named in the case before recommending a source of finance.
Evaluate a source in context
On a 6-mark "Do you think...? Justify" about a source of finance, name your choice, apply a factor to the case (amount, cost, duration, legal form), then say why the alternative is less suitable. A bare choice, or a two-sided answer with no decision, earns no AO4.
Answer the question actually asked
If a question asks for the BENEFITS of a bank loan, give benefits — candidates who only say "it must be repaid" answer the opposite and score nothing. Read whether the command asks for advantages, disadvantages, or a judgement, and supply exactly that.
Develop the point, do not just state it
Stating that crowdfunding "needs no repayment" is knowledge; developing it — "so the start-up avoids interest and keeps cash for stock, though it may not reach its target" — earns analysis. Take each advantage or drawback one step further to a business consequence.
Match the command word
Read the command word. Define (2 marks) = a precise statement. Explain / Analyse = develop a chain of reasoning. "Do you think...? Justify" = weigh both options and give a supported judgement. A list for an analyse, or an evaluation for a define, wastes time.
Businesses need finance at different stages and for different reasons:
| Reason | What it covers | Example |
|---|---|---|
| Start-up capital | all costs before the business earns any revenue | buying equipment, fitting out premises, initial stock |
| Capital for expansion | growing into new markets, opening extra premises, buying new machinery | a bakery opening a second branch |
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