What you'll learn
This revision guide covers all sources of finance you need to know for WJEC GCSE Business Studies. You will understand the difference between internal and external sources, when businesses use each type, and the advantages and disadvantages of different finance methods. This topic is essential for exam questions about business start-ups, expansion, and financial management.
Key terms and definitions
Internal sources of finance — money raised from within the business itself, such as retained profit or personal savings
External sources of finance — money raised from outside the business, such as bank loans or share capital
Retained profit — profit kept in the business after dividends and tax have been paid, used for reinvestment
Share capital — money raised by selling shares (part-ownership) in a limited company to shareholders
Loan capital — money borrowed from banks or other financial institutions that must be repaid with interest
Overdraft — a flexible short-term borrowing facility allowing a business to spend more than it has in its bank account
Trade credit — an agreement where suppliers allow businesses to buy goods now and pay later (usually 30-90 days)
Venture capital — large sums of money invested by specialist firms in return for a share of the business, typically for high-risk ventures
Core concepts
Internal sources of finance
Internal sources come from within the business and do not create debt obligations to external parties.
Owner's capital (personal savings)
The owner invests their own money into the business. This is particularly common when starting a new business.
Advantages:
- No interest to pay
- Owner retains full control (no outside shareholders)
- No need to meet loan repayment schedules
Disadvantages:
- Limited by how much the owner has saved
- Owner risks personal finances
- Opportunity cost — money could be used elsewhere
Retained profit
Profit generated by the business that is kept back rather than distributed to owners as dividends.
Advantages:
- No interest charges or repayment obligations
- Does not dilute ownership
- Flexible — can be used as needed
- Shows financial strength to potential investors
Disadvantages:
- Only available to established, profitable businesses
- May take years to accumulate sufficient funds
- Shareholders may prefer dividends to reinvestment
- Not available for start-up businesses
Sale of assets
Selling items the business owns, such as equipment, vehicles, or property.
Advantages:
- Can raise substantial funds quickly
- No debt created
- May improve efficiency if unused assets are sold
Disadvantages:
- Asset no longer available for business use
- May reduce productive capacity
- One-time source — asset can only be sold once
- May receive less than asset's value in a forced sale
External sources of finance
External sources involve raising money from outside the business. These are typically used when internal sources are insufficient.
Bank loans (loan capital)
A fixed amount borrowed from a bank, repaid with interest over an agreed period (typically 1-25 years depending on purpose).
Advantages:
- Large sums available for major purchases
- Repayments spread over time, making budgeting easier
- Interest rates may be fixed, providing certainty
- Ownership and control remain with existing owners
Disadvantages:
- Interest must be paid, increasing total cost
- Security (collateral) usually required — business risks losing assets if unable to repay
- Regular repayments required regardless of profit levels
- Application process can be lengthy and demanding
Overdrafts
A facility allowing a business to withdraw more money than it has in its account, up to an agreed limit.
Advantages:
- Flexible — only pay interest on amount used
- Quick to arrange
- Useful for short-term cash flow problems
- Can be repaid and reused as needed
Disadvantages:
- Higher interest rates than loans
- Bank can demand immediate repayment
- Only suitable for short-term finance
- Limit may be insufficient for major purchases
Share capital
Money raised by selling shares in a limited company. Shareholders become part-owners and may receive dividends.
Advantages:
- Large amounts can be raised, especially through public limited companies
- No repayment obligation — permanent capital
- No interest payments required
- Shares in successful businesses increase in value
Disadvantages:
- Ownership is diluted — original owners have less control
- Dividends expected by shareholders
- Selling shares publicly (flotation) is expensive and complex
- Financial information must be publicly disclosed
- Only available to limited companies
Venture capital
Investment from specialist firms or individuals who provide funding in exchange for equity (ownership stake) and often input into business decisions.
Advantages:
- Large sums available for high-growth businesses
- Expertise and business contacts often provided
- No monthly repayments unlike loans
Disadvantages:
- Significant loss of ownership and control
- Venture capitalists expect high returns
- May pressure business to grow too quickly
- Detailed scrutiny of business plans required
Trade credit
Suppliers allow businesses to receive goods immediately but pay later (typically 30, 60, or 90 days).
Advantages:
- No interest if paid within agreed terms
- Improves cash flow — sell goods before paying supplier
- Widely available from most suppliers
- No formal application process
Disadvantages:
- Only available for buying stock, not other expenses
- Late payment can damage supplier relationships
- Discounts for immediate payment are lost
- Relatively short-term solution
Hire purchase and leasing
Hire purchase involves paying for an asset in instalments and eventually owning it. Leasing means paying to use an asset without ever owning it.
Advantages:
- Spreads cost over time, protecting cash flow
- Equipment available immediately
- Leasing avoids obsolescence — can upgrade equipment
- No large initial capital outlay required
Disadvantages:
- More expensive overall than buying outright
- With leasing, the asset is never owned
- Regular payments required regardless of profit
- May include penalties for early termination
Grants
Money from government, EU (historically), or charitable organisations that does not need to be repaid, usually for specific purposes like job creation or environmental projects.
Advantages:
- Does not need to be repaid
- No interest or ownership dilution
- Often supports socially beneficial activities
Disadvantages:
- Highly competitive — difficult to obtain
- Strict conditions and reporting requirements
- Only available for specific purposes
- Application process lengthy and complex
Crowdfunding
Raising small amounts of money from large numbers of people, typically via online platforms like Kickstarter.
Advantages:
- Access to large pool of potential investors
- Tests market interest in product/service
- Marketing opportunity — builds customer base
- Various models available (donation, reward, equity)
Disadvantages:
- No guarantee of reaching funding target
- Platform fees reduce amount raised
- Equity crowdfunding dilutes ownership
- Requires significant marketing effort
Choosing appropriate sources of finance
The choice depends on several factors:
Purpose of finance
- Short-term needs (cash flow, stock purchase): overdraft, trade credit
- Medium-term needs (vehicle, equipment): hire purchase, bank loan
- Long-term needs (premises, expansion): share capital, long-term loans, retained profit
Size of business
- Sole traders and partnerships: limited to owner's capital, loans, overdrafts
- Private limited companies: can also use share capital (but shares sold privately)
- Public limited companies: can sell shares on stock exchange, raising substantial sums
Cost of finance
Interest rates and fees vary significantly. Overdrafts typically charge higher interest than loans. Share capital has no interest but shareholders expect dividends and capital growth.
Control considerations
Owners must decide if they are willing to share ownership and control. Loans maintain control but create debt. Share capital provides funds without repayment obligation but dilutes ownership.
Risk and security
Banks typically require security (collateral) for loans. If the business fails, secured assets can be seized. Personal guarantees may be required from owners of small businesses.
Worked examples
Example 1: Short-answer question (2 marks)
Question: State two internal sources of finance a business could use.
Model answer:
- Retained profit ✓
- Owner's capital / personal savings ✓
Examiner guidance: Simply naming two valid internal sources gains full marks. Sale of assets would also be acceptable. Ensure you distinguish internal (from within the business) from external sources.
Example 2: Application question (4 marks)
Question: Explain one advantage and one disadvantage to a start-up restaurant of using a bank loan to finance the purchase of kitchen equipment.
Model answer:
Advantage: A bank loan would allow the restaurant to spread the cost of expensive kitchen equipment over several years ✓, which would protect cash flow ✓ and allow the owner to use remaining cash for other start-up costs such as ingredients and marketing ✓.
Disadvantage: The restaurant would have to make regular repayments with interest ✓, increasing the total cost of the equipment ✓. This could be problematic for a start-up which may take time to become profitable ✓, potentially causing cash flow difficulties ✓.
Examiner guidance: Application means linking your answer to the context (restaurant, start-up, kitchen equipment). Generic answers about loans will score lower marks. Develop your points fully for higher marks.
Example 3: Analysis/evaluation question (6 marks)
Question: Analyse the suitability of using share capital to finance the expansion of an established private limited company.
Model answer:
Share capital could be suitable because the company could raise substantial finance ✓ without creating debt or repayment obligations ✓. This means the business does not face the pressure of regular loan repayments ✓ and can use its cash flow for expansion activities instead ✓.
However, selling shares would dilute the ownership of existing shareholders ✓, meaning they would have less control over business decisions ✓. New shareholders would expect dividends ✓, creating pressure to maintain profitability ✓. Additionally, as a private limited company, shares cannot be sold publicly on the stock exchange ✓, limiting the amount that could realistically be raised compared to a plc ✓.
Overall, share capital's suitability depends on whether existing owners are willing to sacrifice some control ✓ and whether they can find investors willing to buy shares in a private company ✓.
Examiner guidance: Analysis requires developed chains of reasoning (shown with multiple ticks). Evaluation means weighing up factors or reaching a judgement. Use words like "however," "although," and "overall" to structure evaluation.
Common mistakes and how to avoid them
Confusing internal and external sources — Remember internal means from within the business (owner's capital, retained profit, sale of assets); external means from outside (loans, shares, overdrafts). Owner's capital is internal even though it's the owner's personal money.
Thinking retained profit is available to start-ups — New businesses have no trading history, so cannot have retained profit. Only established, profitable businesses can use this source.
Believing overdrafts are interest-free — Overdrafts charge interest, often at higher rates than loans. They are convenient and flexible, not free.
Assuming all businesses can sell shares — Only limited companies can sell shares. Sole traders and partnerships cannot. Additionally, private limited companies sell shares privately, not on stock exchanges.
Failing to apply answers to the context — Generic advantages and disadvantages score lower marks than answers linked to the specific business scenario in the question. Always refer to the business type, size, purpose of finance, and any other relevant details.
Not considering the purpose of finance when recommending sources — Short-term needs require short-term sources; long-term needs require long-term sources. A 25-year mortgage for premises is inappropriate for buying stock that sells within weeks.
Exam technique for "Finance: Sources of Finance"
Command words matter: "State" requires brief answers (1-2 words). "Explain" requires reasons or causes. "Analyse" requires developed chains of reasoning. "Evaluate" or "Justify" requires weighing up factors and reaching a judgement.
Apply to context for higher marks: Always link your answer to the specific business in the question. Mention the business type (sole trader, plc, etc.), what the finance is for, and relevant circumstances. Generic textbook answers limit marks.
Structure longer answers clearly: Use paragraphs for different points. For evaluation questions, consider advantages and disadvantages, then reach a conclusion. Use connectives like "however," "therefore," and "this means that" to develop reasoning.
Know which sources suit which businesses: Sole traders cannot sell shares. Start-ups cannot use retained profit. Public limited companies can raise large sums through share capital. Match your answer to the business structure.
Quick revision summary
Sources of finance are either internal (owner's capital, retained profit, sale of assets) or external (loans, overdrafts, share capital, venture capital, trade credit, hire purchase/leasing, grants, crowdfunding). Internal sources avoid interest and maintain control but are limited in amount. External sources provide larger sums but create obligations—loans require repayment with interest while share capital dilutes ownership. Choose sources based on purpose (short/long-term), business size and type, cost, control implications, and risk. Apply knowledge to business contexts in exam answers.