What you'll learn
This revision guide covers all external sources of finance tested in the CIE IGCSE Business Studies specification. You'll understand how businesses raise capital from outside sources, distinguishing between debt and equity finance, and comparing short-term, medium-term and long-term funding options. The guide includes worked examples reflecting actual exam questions and mark scheme expectations.
Key terms and definitions
External sources of finance — money raised from outside the business, including funds from banks, investors, or the general public
Loan — a fixed amount of money borrowed from a financial institution that must be repaid with interest over an agreed period
Overdraft — a facility allowing a business to withdraw more money from its bank account than it currently holds, up to an agreed limit
Share capital — finance raised by selling shares (ownership stakes) in a limited company to shareholders
Debenture — a long-term loan certificate issued by a company, promising to repay borrowed money at a fixed rate of interest on specified dates
Leasing — paying regular amounts to use an asset (such as equipment or vehicles) without owning it
Collateral — an asset pledged as security against a loan, which the lender can seize if repayment fails
Microfinance — small loans provided to entrepreneurs in developing countries or low-income individuals who lack access to traditional banking services
Core concepts
Bank loans
Bank loans provide businesses with a lump sum of money that must be repaid in instalments over a fixed period, typically 1-25 years. The business pays interest on the loan, which represents the cost of borrowing.
Features of bank loans:
- Fixed repayment schedule with regular instalments
- Interest rate may be fixed (stays the same) or variable (changes with market rates)
- Secured loans require collateral; unsecured loans do not but charge higher interest
- Medium to long-term finance suitable for purchasing assets like machinery, vehicles or property
- The business retains full ownership and control
Advantages:
- Large amounts available for significant investments
- Repayment schedule is predictable with fixed-rate loans
- No loss of ownership or control of the business
- Interest payments are tax-deductible as business expenses
Disadvantages:
- Regular repayments required regardless of business performance
- Interest increases the total amount repaid
- Collateral may be required, putting business assets at risk
- May be difficult for new businesses without trading history to obtain
- Early repayment may incur penalties
Overdrafts
An overdraft is a flexible short-term borrowing facility attached to a business current account. The bank agrees a maximum overdraft limit, and the business can borrow up to this amount when needed.
Features of overdrafts:
- Only pay interest on the amount actually overdrawn
- Very flexible — can be used and repaid as cash flow requires
- Reviewed regularly by the bank (often annually)
- Typically used for short-term cash flow management
- Can be withdrawn by the bank with little notice
Advantages:
- Flexible borrowing — only use what you need
- Interest only charged on outstanding balance
- Helps manage short-term cash flow problems
- Quick to arrange
- No repayment schedule (though should be cleared regularly)
Disadvantages:
- Interest rates typically higher than loans
- Bank can demand full repayment on short notice
- Overdraft limit may be insufficient for large purchases
- Only suitable for short-term finance needs
- Charges apply if the limit is exceeded
Share capital
Share capital is raised by selling shares in a limited company. Shareholders become part-owners of the business and may receive dividends (share of profits).
Types of shares:
- Ordinary shares — give voting rights and variable dividends based on profit
- Preference shares — receive fixed dividends paid before ordinary shareholders, usually without voting rights
Features of share capital:
- Only available to limited companies (private limited or public limited companies)
- Private limited companies sell shares privately to invited investors
- Public limited companies can sell shares on stock exchanges
- No requirement to repay the capital
- Dividends only paid when the business is profitable
Advantages:
- No repayment required — permanent capital
- No interest payments — dividends only paid from profits
- Large amounts can be raised, especially by public limited companies
- No collateral required
- Improves the business's financial position (increases equity)
Disadvantages:
- Ownership is diluted — new shareholders gain control
- Shareholders may influence business decisions through voting rights
- Selling shares in a public limited company is expensive (legal and accounting fees, stock exchange listing fees)
- Profits must be shared through dividend payments
- Public limited companies face disclosure requirements
Debentures
A debenture is a long-term loan to a business, usually for 10+ years, where the lender receives a fixed rate of interest regardless of business performance.
Features of debentures:
- Formal loan certificates issued by larger companies
- Fixed interest rate paid annually or semi-annually
- Specific repayment date (maturity date)
- Often secured against company assets
- Can be traded (bought and sold) between investors
Advantages:
- Long-term finance suitable for major expansion projects
- Fixed interest rate makes planning easier
- Ownership and control remain with existing shareholders
- Interest rates typically lower than bank loans for established companies
- Interest is tax-deductible
Disadvantages:
- Regular interest must be paid regardless of profit
- Large amount must be repaid on maturity date
- Usually require security (collateral)
- Only suitable for established, larger businesses
- Adds to business debt, affecting credit rating
Leasing
Leasing allows businesses to use assets without purchasing them outright. The business (lessee) pays regular rental payments to the leasing company (lessor) for the right to use equipment, vehicles or property.
Types of leasing:
- Operating lease — short-term rental; asset returned at end of lease period
- Finance lease — long-term; business may have option to purchase at end
Features of leasing:
- Fixed regular payments, improving cash flow predictability
- Lessor remains the legal owner
- Maintenance may be included (especially operating leases)
- Tax advantages — lease payments are business expenses
Advantages:
- No large initial capital outlay required
- Preserves cash for other business uses
- Fixed costs aid budgeting and financial planning
- Equipment can be upgraded regularly (especially technology)
- Maintenance often included in agreement
- Does not appear as debt on balance sheet (operating leases)
Disadvantages:
- Never own the asset despite paying for years
- Total cost usually higher than outright purchase
- Ongoing payment commitment regardless of asset usage
- Early termination may be expensive or impossible
- Restrictions on asset use may apply
Microfinance
Microfinance provides small loans to entrepreneurs who cannot access traditional banking services, particularly common in developing countries and for start-up businesses.
Features of microfinance:
- Small loan amounts (often under $1,000)
- Simplified application process
- Targets low-income entrepreneurs
- Often provided by specialist microfinance institutions or NGOs
- May include business advice and training
- Group lending models where borrowers support each other
Advantages:
- Accessible to those rejected by traditional banks
- Small amounts suitable for micro-enterprises
- Flexible repayment terms
- Often includes business support and mentoring
- Helps financial inclusion and poverty reduction
- Lower collateral requirements
Disadvantages:
- Loan amounts too small for significant expansion
- Interest rates can be high (to cover administrative costs)
- Not available in all countries or regions
- Limited amounts restrict business growth
- May require group membership or guarantees
Crowdfunding
Crowdfunding raises finance by collecting small amounts of money from large numbers of people, typically through online platforms.
Types of crowdfunding:
- Donation-based — contributors give money without expecting return
- Reward-based — contributors receive products or perks
- Equity crowdfunding — contributors receive shares in the company
- Debt crowdfunding (peer-to-peer lending) — contributors lend money expecting repayment with interest
Features of crowdfunding:
- Uses online platforms (e.g., Kickstarter, Crowdcube, Funding Circle)
- Campaign sets funding target and deadline
- All-or-nothing model common (funds only released if target met)
- Requires compelling marketing and promotion
Advantages:
- Access to large pool of potential investors
- Tests market demand before full product launch
- Builds customer base and brand awareness
- May receive business advice from contributors
- No collateral required for many models
- Relatively quick compared to traditional finance
Disadvantages:
- Requires significant marketing effort and expense
- Success not guaranteed — many campaigns fail
- Platform fees reduce funds received (typically 5-10%)
- Equity crowdfunding dilutes ownership
- Public failure if target not met damages reputation
- Intellectual property may be exposed to competitors
- Time-consuming campaign management
Worked examples
Example 1: Calculate and Recommend (6 marks)
Question: Rashid wants to purchase equipment costing $50,000 for his manufacturing business. He is considering two options:
- Option A: Bank loan at 8% annual interest, repayable over 5 years
- Option B: Leasing at $950 per month for 5 years
(a) Calculate the total amount Rashid would pay under Option A. [2] (b) Calculate the total amount Rashid would pay under Option B. [2] (c) Recommend which option Rashid should choose. Justify your answer. [2]
Model answer:
(a) Annual interest = $50,000 × 8% = $4,000 [1] Total interest over 5 years = $4,000 × 5 = $20,000 Total repayment = $50,000 + $20,000 = $70,000 [1]
(b) Total lease payments = $950 × 12 months × 5 years [1] = $57,000 [1]
(c) Recommendation: Choose Option B (leasing) [1] Justification: Total cost is $13,000 less than the loan ($70,000 - $57,000), and leasing requires no initial capital outlay, improving cash flow. Additionally, maintenance may be included, and equipment can be upgraded at the end of the lease. [1]
Note: Accept Option A if justified by ownership benefits and lower long-term costs if equipment kept beyond 5 years.
Example 2: Explain and Analyse (6 marks)
Question: Explain two reasons why a new small business might choose an overdraft rather than a bank loan as a source of finance. [6]
Model answer:
One reason is flexibility [1]. An overdraft allows the business to borrow only the exact amount needed at any time, up to the agreed limit, and interest is only charged on the overdrawn amount [1]. This is particularly useful for a new small business because cash flow is unpredictable in the early stages, and the business may only need small amounts occasionally to cover temporary shortfalls [1].
A second reason is ease of arrangement [1]. Overdrafts are typically quicker and simpler to arrange than bank loans, requiring less documentation and fewer formalities [1]. For a new small business, this means they can access emergency funds quickly when unexpected expenses arise, such as a delayed customer payment or urgent equipment repair, without lengthy approval processes [1].
Example 3: Knowledge and Application (4 marks)
Question: Identify and explain two differences between share capital and debentures as sources of finance. [4]
Model answer:
One difference is ownership [1]. Share capital involves selling ownership stakes in the company to shareholders, whereas debentures are loans that do not give the lender any ownership or control of the business [1].
A second difference is repayment obligation [1]. Share capital does not need to be repaid to shareholders — it is permanent capital — whereas debentures must be repaid on the specified maturity date [1].
Alternative valid differences: payment obligations (dividends vs. interest), security (unsecured shares vs. often secured debentures), voting rights, tax treatment.
Common mistakes and how to avoid them
Confusing loans and overdrafts — remember that loans provide a lump sum for a specific period, while overdrafts offer flexible short-term borrowing up to a limit. In exam answers, be specific about which you mean.
Stating that share capital must be repaid — share capital is permanent finance; companies don't repay shareholders unless shares are bought back. Only dividends (which are optional) are paid to shareholders.
Forgetting the context — different sources suit different business situations. Always link your answer to the business size, age, legal structure and purpose mentioned in the question. A sole trader cannot raise share capital; a new business may struggle to get a large loan.
Treating all external finance as the same — examiners reward specific knowledge. Don't write vague answers about "getting money from banks" — specify whether it's a loan, overdraft, or other facility, and explain the features relevant to that specific source.
Ignoring the disadvantages — when "recommending" or "discussing," balanced answers that acknowledge both advantages and disadvantages score higher marks. Simply listing benefits without considering drawbacks suggests incomplete understanding.
Calculation errors with interest — when calculating loan costs, remember to multiply annual interest by the number of years. For monthly payments (e.g., leasing), multiply monthly payment × 12 × number of years. Show your working clearly for method marks.
Exam technique for external sources of finance
Command word awareness: "Identify" requires naming only (1 mark); "Explain" requires a reason or description (2-3 marks); "Analyse" requires examining causes, effects or connections (3-4 marks); "Recommend/Justify" requires reaching a conclusion with supporting reasoning (4-6 marks).
Link to business context: Always apply your knowledge to the specific business in the question. Consider the legal structure (sole trader, partnership, private/public limited company), size, industry sector, and whether established or start-up. This earns application marks.
Use business terminology precisely: Replace everyday language with business terms. Don't say "the company gets money from people buying bits of it" — write "the company raises share capital by issuing shares to investors who become part-owners."
Structure extended answers: For 6-mark "recommend" or "justify" questions, use point-evidence-explain structure. Make your recommendation clear, provide two developed reasons with evidence from the case, acknowledge counterarguments, then conclude. Aim for roughly 2 marks per well-developed point.
Quick revision summary
External finance comes from outside the business. Short-term options include overdrafts (flexible borrowing to an agreed limit). Medium/long-term debt options include bank loans (fixed sum repaid with interest), debentures (loan certificates with fixed interest) and leasing (paying to use assets without owning). Equity finance through share capital (selling ownership stakes) doesn't require repayment but dilutes control. Alternative sources include microfinance (small loans for entrepreneurs lacking bank access) and crowdfunding (raising small amounts from many people online). Choose sources based on business size, legal structure, purpose, and whether ownership dilution is acceptable.