Growth, cash flow gaps, new equipment, a rainy day — every reason a business needs money has a different source of finance that genuinely suits it best.
This opens Topic 3.6, and it connects directly back to the business plan you met in 3.1.6 — a plan's financial forecasts identify exactly how much money a business needs and when, but they don't answer where that money should actually come from. That's the question this chapter tackles.
Every source of finance comes with its own cost, its own risk, and its own strings attached, and AQA wants you to be able to weigh those trade-offs for a specific business in a specific situation, rather than simply listing sources. Sources split into two broad groups: internal, generated from within the business itself, and external, coming from outside it.
Reinvesting past profit costs nothing in interest and doesn't hand any control to an outside lender or new shareholder — but it's only available if the business has actually made a profit, and using it means less is available to pay out to the owners themselves.
Raises cash without taking on any debt or giving up any ownership, but it's a one-off source that depends entirely on having suitable unused assets to sell in the first place, and relying on it repeatedly can be a warning sign of a business in genuine financial difficulty.
Often available on flexible, informal terms, sometimes interest-free, and can be quicker to arrange than a formal loan — but the amount available is usually limited, and a business struggling to repay can put real strain on a personal relationship that a bank loan simply wouldn't.
Can raise very large sums without creating any obligation to repay it like a loan — but this option only exists for private and public limited companies (see 3.1.2), and issuing new shares dilutes existing owners' percentage of the business and their share of future profit.
Provides a clear, predictable repayment schedule and can fund large investments a business couldn't otherwise afford — but comes with interest costs that rise and fall with the interest rate movements you met in 3.2.3, usually requires security or collateral, and has to be repaid regardless of how the business actually performs.
Highly flexible, since interest is only charged on however much is actually used, making it ideal for short-term cash flow gaps — but interest rates on overdrafts are usually higher than on a standard loan, and a bank can demand repayment or reduce the limit with little notice.
Improves cash flow by delaying when money actually has to leave the business, and typically costs nothing extra if paid within the agreed terms — but persistently paying late can damage a business's relationship with its supplier and its credit rating, and any early-payment discounts on offer are lost.
Lets a business start using an expensive piece of equipment straight away while spreading the cost over time — but the total amount paid is usually higher than buying outright, due to the interest and charges built into the instalments, and the asset can be repossessed if payments are missed.
Rarely needs repaying and carries no interest or loss of ownership at all, making it an extremely attractive source when available — but grants are usually highly competitive, restricted to specific purposes, regions or industries, and the application process itself can be slow and time-consuming.
There's no universally "best" source — the right choice depends on how much money is needed, how quickly, for how long, and what the business is willing to give up in exchange for it.
A short-term cash flow gap is usually better suited to an overdraft or trade credit than a long-term bank loan, while a major long-term investment usually needs a source designed to be repaid over years, like a loan or share issue.
Interest-bearing sources like loans, overdrafts and hire purchase all add to the total amount eventually repaid, while retained profit and grants avoid this cost entirely.
A new share issue raises money without creating debt, but dilutes existing owners' control and share of profit — a trade-off a sole trader or small partnership doesn't even have the option to make.
A new business usually can't rely on retained profit (it hasn't traded long enough to build any) and may struggle to secure a large loan without a trading history, often leaning more heavily on personal savings, family and friends, or smaller-scale borrowing than an established business would need to.
This is also where the legal structure you studied in 3.1.2 directly limits the options available. A sole trader can never issue new shares to raise finance, however attractive that source might otherwise look, simply because the structure doesn't allow it — while a well-established plc has access to every source on this page, including the ability to raise very large sums through the stock market that a small business could never realistically match.
Drag each source of finance into the correct category.
State two external sources of finance a business might use.
Structure guide: two correctly identified sources — 1 mark each, no explanation required.
State and explain two reasons why a bank loan might be more suitable than borrowing from his brother for financing Tomasz's new van.
Structure guide: state a reason grounded in the case study (1 mark), explain it (1 mark) — repeated twice over.
Analyse the benefits to Tomasz of using his bank overdraft rather than borrowing from his brother to cover his temporary £5,000 cash flow gap.
Structure guide: a single developed line of reasoning grounded in the case study (eg: the £5,000 gap is genuinely temporary, only needed until a large client payment arrives → an overdraft only charges interest for the short period it's actually used, matching this short-term need closely → whereas borrowing from his brother risks straining a personal relationship if repayment is delayed at all → making the overdraft a cleaner, more businesslike solution to a short-term problem).
Recommend whether Tomasz should use a bank loan or hire purchase to finance his new £15,000 van. Justify your answer using the case study.
Structure guide: a "recommend" question needs a justified judgement — weigh the predictable repayment and potentially lower total cost of a bank loan against hire purchase's ability to let Tomasz use the van immediately while spreading payments, before reaching a clear final recommendation.