Sources of finance — AQA GCSE Business
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Sources of finance explained
Businesses need finance for start-up, expansion, working capital and emergencies.
Read the full explanation
Methods include retained profit, net current assets, sale of assets, overdraft, trade credit, loan capital, share capital, venture capital, and crowd funding. Internal finance (retained profit, sale of assets, net current assets) avoids debt but is limited. External finance (overdraft, trade credit, loan capital, share capital, venture capital, crowd funding) provides outside funds but may add cost or loss of control. Short-term methods (overdraft, trade credit) suit cash-flow gaps; long-term methods suit assets. A bakery might use an overdraft for ingredients and loan capital for a new oven. Choosing depends on amount, time, cost and risk.
Appropriateness of sources of finance
Appropriateness means judging how well a source of finance fits a business's need. Consider amount required, time period, cost (interest, fees, dividends), impact on ownership and control, risk, cash-flow position and legal form. A sole trader needing £2,000 for stock might use an overdraft; a company raising £500,000 for a factory might issue shares. Short-term needs suit overdrafts or trade credit; long-term assets suit loans, leasing or share issue. Internal funds avoid debt but may be insufficient. The best choice balances cost, control, risk and availability, and is justified against the specific context.
understand the main internal and external sources of finance available (including family and friends, retained profit, a new share issue, obtaining a loan or mortgage, selling unwanted assets, overdrafts, trade credit, hire purchase and government grants)
Businesses need finance for start-up, expansion, or managing cash flow. Internal sources come from within the business: retained profit (profit kept after tax and dividends, reinvested) and selling unwanted assets (e.g., surplus machinery). External sources come from outside: family and friends (often informal loans), a new share issue (selling shares to raise equity, mainly for limited companies), obtaining a loan or mortgage (bank loan repaid with interest; mortgage secured on property), overdrafts (short-term bank borrowing allowing negative balances), trade credit (delaying payment to suppliers), hire purchase (paying in instalments while using the asset), and government grants (funding for specific projects, often not repaid). Each source has advantages and disadvantages depending on the situation.
analyse the advantages and disadvantages of each method for a given situation
For a given business situation, you must analyse the advantages and disadvantages of each source of finance. This means going beyond listing pros and cons: you need to develop chains of reasoning that link the source's features to consequences for the business. For example, a small business needing quick cash for stock might use an overdraft because it is flexible and fast, but the high interest rate could reduce profit. A profitable limited company expanding might issue shares to raise large sums without repayment, but the owners may lose control. Consider the business's size, legal structure, purpose (short-term vs long-term), cost, risk, and impact on cash flow and ownership. The best answer weighs up both sides and reaches a justified conclusion.
evaluate the suitability of sources of finance for new and established businesses.
Every business needs finance, but suitability depends on purpose, amount, time period, cost and the firm's age and risk profile. A new business (start-up) has no trading record, so lenders see high risk: owner's capital, family loans, retained profit (usually absent), bank overdraft, small business loan, grants, crowdfunding and, for larger ventures, business angels or venture capital may be considered. An established business has accounts, assets and cash flow evidence, so it can access retained profit, trade credit, bank loans, overdrafts, leasing, hire purchase, share issue (for a company) or debenture. Evaluate by weighing cost (interest, fees, dilution of control), availability, flexibility, repayment timing and risk against the specific need, such as buying a delivery van versus funding seasonal stock.
Your focus
- Identify and describe internal and external methods of raising finance.
- Explain how each method provides finance and one advantage or drawback.
- Select an appropriate method for a given business need and justify the choice.
Show all 15 objectives
- Apply criteria to judge the suitability of a source of finance.
- Compare sources and explain trade-offs between cost, control and risk.
- Recommend a source with a justified conclusion for a given business situation.
- Identify and classify the main internal and external sources of finance listed in the specification.
- Explain one advantage and one disadvantage of each source of finance.
- Apply knowledge of sources of finance to recommend an appropriate source for a given business situation, justifying the choice.
- Analyse the advantages and disadvantages of each source of finance in relation to a specific business situation.
- Compare and contrast different sources of finance to determine the most suitable for a given scenario.
- Justify a recommendation for a source of finance, taking into account the business's needs and circumstances.
- Identify and describe a range of internal and external sources of finance suitable for new and established businesses.
- Explain how the age, size and trading history of a business affect the suitability and availability of each source.
- Evaluate competing sources of finance and reach a justified recommendation for a given business context.
Sources of finance exam tips
Marking Points
- Classifies methods as internal or external and gives a valid example of each.
- Explains how a named method provides finance, such as loan capital paying a lump sum repaid with interest.
- Links a method to a suitable business need, such as an overdraft for a short-term cash-flow gap.
- Compares at least two methods using criteria such as cost, time, control or risk.
- Uses correct business terminology, for example retained profit, net current assets, trade credit, loan capital, share capital, venture capital and crowd funding.
- Applies criteria such as amount, time, cost, control and risk to a named source.
- Matches a source to a specific business need, for example trade credit for stock purchased on normal credit terms.
- Explains a drawback of a source in context, such as interest increasing costs or share issue diluting control.
- Compares two sources and reaches a supported judgement about which is more appropriate.
- Considers the legal form or size of the business when judging suitability.
- Internal sources: retained profit and selling unwanted assets; external sources: family and friends, new share issue, loan, mortgage, overdraft, trade credit, hire purchase, government grants.
- Retained profit is internal, avoids interest, but may be insufficient and has opportunity cost.
- A new share issue raises permanent capital but dilutes ownership and control; mainly available to limited companies.
- A loan or mortgage provides large sums but requires repayment with interest and may need security.
- Overdrafts are flexible short-term finance but have high interest rates and are repayable on demand.
- Trade credit delays payment to suppliers, improving cash flow, but may incur penalties or damage supplier relationships.
- Hire purchase spreads the cost of an asset but total cost is higher than outright purchase.
- Government grants do not need repayment but are competitive, time-consuming to apply for, and may have conditions.
- Develop arguments that explain how each advantage or disadvantage affects the business, not just state them.
- Consider the specific context: type of business, amount needed, duration, and existing financial position.
- Compare sources: e.g., a loan has fixed repayments but interest; an overdraft is flexible but expensive and repayable on demand.
- Evaluate trade-offs: e.g., share issue avoids debt but dilutes control; retained profit avoids interest but may be limited.
- Reach a justified recommendation that follows from the analysis, considering both pros and cons.
- Use business terminology accurately (e.g., 'dilution of control', 'security', 'cash flow').
- Identifies a range of internal and external sources: owner's capital, retained profit, sale of assets, bank loan, overdraft, trade credit, leasing, hire purchase, share issue, debenture, crowdfunding, grant, business angel and venture capital.
- Explains how business age and trading history affect access: a start-up lacks accounts and collateral, so lenders charge higher interest or refuse finance, while an established firm can borrow against assets and profit records.
- Links each source to a suitable purpose and time frame: short-term overdraft or trade credit for working capital, medium-term leasing or hire purchase for equipment, long-term loan or share issue for expansion.
- Analyses cost and control implications: interest and arrangement fees raise total repayment, while issuing shares dilutes ownership and voting control; retained profit avoids both but is limited.
- Evaluates by reaching a supported judgement that compares at least two sources for a stated business context, weighing risk, cost, flexibility and availability before recommending one.
- Uses business terminology accurately, for example distinguishing internal from external finance and short-term from long-term finance.
Examiner Tips
- 💡Name the method precisely, then state one advantage and one drawback in the context given.
- 💡Use the business situation in the question to justify why the method fits the need.
- 💡Use the data in the case to justify suitability, such as the amount, timescale or current cash position.
- 💡Give a balanced answer with at least one advantage and one drawback before judging.
- 💡Conclude with a clear recommendation and the main reason for it.
- 💡Learn at least one advantage and one disadvantage for each source, and be ready to apply them to a business context.
- 💡Use the business's situation (e.g., size, legal structure, purpose) to justify why a source is suitable or not.
- 💡For 'analyse' questions, develop chains of reasoning: source → benefit/drawback → impact on the business.
- 💡Avoid vague statements like 'it is good'; always explain why it is good or bad for that specific business.
- 💡Use connectives like 'because', 'therefore', 'however' to build chains of reasoning.
- 💡Refer explicitly to the business in the case study (e.g., 'for a small sole trader...').
- 💡Structure your answer: briefly outline the source, then analyse its pros and cons in context, then conclude.
- 💡For higher marks, consider alternative sources and explain why your recommendation is better than the alternatives.
- 💡Read the case study carefully and name the specific finance need, amount and time period before choosing sources.
- 💡Use connectives such as because, therefore and however to build chains of reasoning rather than isolated points.
- 💡For evaluation questions, compare at least two realistic options and finish with a justified recommendation that answers the question directly.
- 💡Apply the context: refer to the named business, its size, age and sector instead of writing generically.
Common Mistakes
- Treating an overdraft as long-term finance. Correction: explain it is repayable on demand and suited to short-term gaps.
- Confusing loan capital with share capital. Correction: state loan capital involves borrowing with interest, while share capital involves selling a stake in the business.
- Assuming all external finance is a loan. Correction: name other external methods such as share capital, venture capital, crowd funding and trade credit.
- Choosing a source without linking it to the amount or time period needed; correct by stating the sum and duration and matching the source.
- Ignoring the cost of finance; correct by explaining interest, fees or dividends and their effect on profit.
- Overlooking loss of control from share issue; correct by explaining that new shareholders may influence decisions.
- Classifying a new share issue as internal finance; it is external because it brings in money from outside investors.
- Assuming all external finance must be repaid; government grants and share capital do not require repayment, unlike loans.
- Confusing hire purchase with a loan; hire purchase is specifically for acquiring an asset through instalments, with ownership transferring at the end, whereas a loan provides cash.
- Thinking overdrafts are suitable for long-term investment; they are short-term and can be withdrawn by the bank at short notice.
- Listing advantages and disadvantages without linking them to the specific situation; always apply to the context given.
- Ignoring the disadvantages of a chosen source; a balanced analysis must consider both sides.
- Failing to make a clear judgement or recommendation; analysis should lead to a conclusion.
- Confusing short-term and long-term needs; e.g., using an overdraft for a long-term investment is usually inappropriate.
- Listing sources without linking them to the business's age or purpose; correction: always state why the source fits this business and this need.
- Treating all borrowing as equally risky or equally cheap; correction: compare interest, fees, security required and repayment schedule for each option.
- Assuming a new business can issue shares or debentures; correction: only limited companies can issue shares, and debentures are typically used by larger established firms.
- Ignoring the effect on ownership and control; correction: explain that external equity finance can dilute the owner's share and decision-making power.