Sources of Finance

Who else gets a say

Every business needs money, and this specification splits where it comes from into two: internal and external. That sounds like a filing exercise and it is not. The split matters because of one thing. Internal money is money the business already has, so there is nobody to ask, nobody to repay and nobody to share the profits with afterwards. External money always arrives with somebody attached to it. A lender wants repaying with interest whether trade goes well or badly. A new shareholder wants part of the ownership and a share of every future profit, for as long as the business exists. A supplier offering trade credit wants paying on time. A government grant comes with conditions to meet. So when you sort a source into internal or external, you are really answering the question of who else now has a claim on this business. That is why retained profit is usually the first thing a business reaches for, and also why there is never enough of it.

Words for the sources

Five of the sources this specification names. Each definition ends with what it costs, because that is the half students leave out.

Match the finance source

Inside the business or outside

A business arranges an overdraft with its bank and also sells a delivery van it no longer uses. How should each be classified?

• The overdraft is external and selling the van is internal
• The overdraft is internal and selling the van is external
• Both are internal, because the business arranged both itself
• Both are external, because both bring in cash

What you give up

There is no source that costs a business nothing. Setting the two sides against each other shows what the price actually is in each case.

Internal or external drill

Five quick questions on the split this specification expects you to have exactly. Three lives.

What that source costs you

Select the TWO statements that correctly describe what a source costs a business.

• A new share issue costs the owners part of the ownership and a share of future profits
• A loan must be repaid with interest whether or not the business trades well
• Retained profit costs nothing at all, so there is no reason not to use it
• A government grant costs nothing and carries no obligations

There is no free money

The most useful habit on this topic is to finish every sentence about a source with what it costs. Students lose marks by describing sources as though some of them were simply better than others, when what is really true is that each one charges a different price. A loan charges interest and a fixed obligation to repay. A share issue charges ownership and a permanent share of the profits. An overdraft charges a high rate for the convenience of being immediate. Trade credit charges nothing in money but only lasts weeks. A grant charges compliance with whatever conditions came with it. Even retained profit, which looks free, charges you the alternative: every pound kept in the business is a pound not available for something else, and there is only as much of it as the business has earned. Deciding which price is worth paying is a different job, and it is the next module on this topic. What this one asks is that you can say what each price is.

The sources in a paragraph

This specification names exactly _____ internal sources: retained profit and selling unwanted _____. Everything else it lists is _____, which means somebody outside the business gains a claim on it. A new share issue never has to be repaid, but the owners give up part of the _____. Trade credit is usually free if paid on time but only lasts a short while. And a government grant does not have to be repaid but comes with _____ attached.

The cost that is not there

Four statements about what a source costs. Select the ONE that claims a cost the source does not carry.

• A loan has to be repaid with interest even in a bad trading year.
• A new share issue means the original owners keep a smaller share of future profits.
• Retained profit has to be repaid to the business over an agreed period.
• Hire purchase means paying more in total than buying the equipment outright.

Two ways to raise the same money

Take an invented business for this example, a small bakery that has been trading for three years and wants to open a second shop. It can raise the money in more than one way, and here is what each would actually cost it, described rather than calculated. If it takes a loan, it keeps every share of the ownership and every pound of future profit, but it now owes fixed repayments with interest, and those repayments fall due in a quiet month exactly as they do in a busy one. If it issues new shares instead, there is nothing to repay and nothing falls due in a quiet month, but the original owners have permanently given up part of the ownership and a share of every future profit, including the profits from the second shop they are borrowing to open. If it uses retained profit, it owes nobody anything and gives nothing away, but the money is limited by what the bakery has earned so far, and whatever it spends here it cannot spend on anything else. Notice what this comparison does not do: it does not say which the bakery should choose. That is a judgement about this particular business, and it is the next module on this topic. What it does is name the price of each option, which is what you have to be able to do before any judgement is possible.

Name the source and its cost

Assemble the sentence pattern this topic rewards.

Costing the options

An invented café is looking at how it could fund new equipment. Your job here is to classify each option and say what it would cost, not to choose between them.

• The owner suggests using profit kept from previous years. How is that classified, and what does it cost?
• A supplier offers the equipment now with payment in three months. What is that, and what is the catch?
• The owner considers selling a spare oven that has not been used for a year. What is that?
• You are asked which option the café should actually take. What is the right response here?

Explain the sources and their costs

Explain the sources of finance available to a business and what each one costs it. You are not being asked to recommend one; that is a separate question about a particular business.

• Name the two internal sources this specification lists, and explain what makes them internal
• Explain why the internal and external split matters, in terms of who gains a claim on the business
• Name four external sources and say briefly what each one is
• Explain what a loan costs a business that a share issue does not
• Explain what a share issue costs a business that a loan does not
• Explain why retained profit is not actually free, even though it charges no interest
• Explain why a government grant is external even though it does not have to be repaid