Sources of finance
A source of finance is where a business obtains the money it needs. Internal sources come from within the business itself, such as retained profit (profit kept back rather than paid out), the sale of unused assets, and the owner's own capital.
Method
- Decide whether the source of finance is internal (from within the business) or external (from outside it).
- For each source, learn one clear advantage and one clear drawback, rather than a vague description.
- Learn which sources suit a sole trader or partnership, e.g. owner's capital or loans, and which require a limited company, e.g. share capital.
- Learn which sources suit a short-term need, e.g. overdraft or trade credit, and which suit a long-term need, e.g. share capital, a long-term loan, or leasing.
- For a recommend question, name the source, give one advantage that fits the scenario, and give one drawback the business must accept.
- Where the question asks for a calculation, e.g. interest owed, show the formula and every step of the working.
Worked example
A business takes out a bank loan of 12,000 pounds at a simple interest rate of 6% per year, to be repaid in full after 3 years. Calculate the total amount of interest the business will pay, and the total amount it must repay at the end of the 3 years.
- Calculate the annual interest: 12,000 x 6% = 12,000 x 0.06 = 720 pounds per year.
- Calculate the total interest over 3 years: 720 x 3 = 2,160 pounds.
- Add the interest to the original loan to find the total repayment: 12,000 + 2,160 = 14,160 pounds.
- State the answer: the business pays 2,160 pounds in interest and repays 14,160 pounds in total.
Practice questions
Try each question, then tap to reveal the answer.
Q1Is retained profit an internal or an external source of finance?Show answer
Answer: Internal, because it comes from within the business itself, as profit kept back rather than distributed.
Q2Give one drawback of using retained profit to finance expansion.Show answer
Answer: It reduces the amount of profit available to pay out to owners or shareholders, and a new or loss-making business may not have any retained profit to use.
Q3State one advantage of an overdraft as a source of finance.Show answer
Answer: It is flexible, letting a business borrow only what it needs, up to an agreed limit, and only when it needs it.
Q4Why might a sole trader be unable to raise finance through share capital?Show answer
Answer: Because share capital requires selling shares in a limited company, and a sole trader's business is not structured as a company with shares to sell.
Q5Give one advantage and one drawback of trade credit.Show answer
Answer: Advantage: the business receives goods now and pays later, easing short-term cash flow. Drawback: suppliers may charge higher prices or refuse future credit if payment is late.
Q6What is crowdfunding?Show answer
Answer: Raising finance by asking a large number of people, usually online, to each contribute a small amount of money, often in return for a reward, equity, or early access to a product.
Q7A business leases a delivery van instead of buying it. Give one advantage of leasing over buying.Show answer
Answer: The business avoids the large upfront cost of buying the van, spreading the cost as smaller regular payments instead.
Q8A business borrows 5,000 pounds at a simple interest rate of 4% per year, repaid after 2 years. Calculate the total interest paid.Show answer
Answer: 5,000 x 0.04 x 2 = 400 pounds.
Exam-style questions
Written in the style of a GCSE Business exam paper, with a full mark scheme.
A small manufacturing business needs 20,000 pounds to buy new machinery. It is considering two options: Option A, a bank loan of 20,000 pounds at a simple interest rate of 5% per year, repaid after 4 years; Option B, an overdraft of 20,000 pounds used for the full 4 years at a simple interest rate of 9% per year. (a) Calculate the total interest paid under Option A. (2 marks) (b) Calculate the total interest paid under Option B. (2 marks) (c) State which option results in less interest being paid, and by how much. (2 marks)
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A sole trader wants to expand her cafe into a second premises and is deciding between a bank loan and finding a business partner who would invest capital in exchange for a share of the business. Evaluate which of these two sources of finance she should choose.
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See real GCSE Business past-paper questions, with official mark schemes →
Free printable worksheet
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