5.2 Sources of finance
- Syllabus
- 9609–2026–2027
- Topic
- 5.2
- Level
- AS
Learning objectives
5.2.1Ownership and finance sources• Business ownership and sources of finance- the relationship between the form of business ownership and availability of sources of finance5.2.2Internal and external finance• Internal and external sources of finance- internal sources of finance: owners investment, retained earnings, sale of unwanted assets, sale and leaseback of non-current assets, working capital- external sources of finance: share capital, debentures, new partners, venture capital, bank overdrafts, leasing, hire purchase, bank loans, mortgages, debt factoring, trade credit, micro-finance, crowd funding and government grants5.2.3Finance source factors• Factors affecting the sources of finance- the factors influencing the choice of sources of finance in a given situation: cost, flexibility, need to retain control, the use to which it is put, level of existing debt5.2.4Selecting finance sources• Selecting the source of finance- the appropriateness of each possible source in a given situation
Ownership determines which equity sources a business can access
| Ownership form | Ownership-linked finance available | Key restriction/impact |
|---|---|---|
| Sole trader | Owner investment, retained earnings; may seek debt, trade credit, grant, microfinance or crowdfunding | Cannot issue shares; unlimited liability, limited collateral/record and owner resources may restrict borrowing |
| Partnership | Existing/new partner capital and retained earnings; may seek external debt/support | New partner can add money/skills but shares profit, control and decisions; cannot publicly issue shares |
| Private limited company | Private share capital from founders/existing or approved new investors, retained earnings, venture capital and debt | Cannot offer shares to the general public; new equity dilutes voting/control but limited liability may aid investor appeal |
| Public limited company | Public share issues, retained earnings, debentures and other borrowing | Can raise very large equity/debt but faces issue cost, disclosure, shareholder expectations and possible control dilution/takeover risk |
Legal availability is only the first screen. Lenders/investors still judge amount, credit history, collateral, cash flow, profitability, business plan, existing debt, risk and management. A new limited company is allowed to issue private shares, but that does not guarantee willing investors or affordable debt.
Changing ownership can unlock finance—adding a partner, incorporating or becoming public—but changes liability, governance, disclosure, profit sharing and control. Compare the funds gained with setup cost and the permanent ownership consequences.
A sole trader cannot issue shares, and a private company cannot sell shares to the public. Limited liability reduces owners' personal exposure but does not make lending risk disappear.
Internal and external finance differ in ownership, repayment and asset use
| Internal source | How it works | Main benefit / limitation |
|---|---|---|
| Owner's investment | Owner puts personal funds into business | Fast/control retained, but limited and personal opportunity/risk |
| Retained earnings | Profit kept instead of distributed | No interest/repayment or new owner; unavailable to start-ups/low-profit firms and has shareholder opportunity cost |
| Sale of unwanted assets | Dispose of idle non-current assets for cash | Releases funds/cuts upkeep, but one-off and may remove future capacity |
| Sale and leaseback | Sell a used asset, then lease it to retain use | Large/quick cash without stopping use; creates recurring lease cost and loses ownership/appreciation |
| Working-capital reduction | Collect receivables faster, reduce excess inventory or manage payables | Releases tied cash, but over-tightening can lose customers, supply or continuity |
| External ownership/support source | How it works | Main benefit / limitation |
|---|---|---|
| Share capital | Company sells ownership shares | No compulsory repayment; dividends/control dilution and issue conditions |
| New partner | Person contributes capital/skills for ownership/profit share | Adds funds/expertise; shared control/profit and possible conflict |
| Venture capital | Specialist investor funds a high-risk/high-growth business, usually for equity/control/return | Capital plus advice/network; substantial ownership/control and return pressure |
| Crowdfunding | Many contributors provide donations, rewards, loans or equity through a campaign | Tests/builds support; uncertain total, platform/promotion cost and disclosure |
| Government grant | Conditional government funding for an eligible activity, normally not repaid | No interest/debt/control dilution; restricted, competitive, slow and compliance-dependent |
| Microfinance | Small-scale finance for borrowers/businesses with limited conventional access | Enables start-up/inclusion; small amounts and repayment/fees still apply |
| External debt/asset-use source | How it works | Main benefit / limitation |
|---|---|---|
| Bank overdraft | Bank account can go below zero to an agreed limit; interest on amount used | Flexible short-term gap; high/variable cost, low limit and can be recalled |
| Bank loan | Fixed amount repaid with interest over agreed term | Predictable larger funding/control retained; repayment, interest, security and credit risk |
| Mortgage | Long-term secured loan for land/buildings | Matches property life/large amount; interest and asset repossession risk |
| Debenture | Long-term company borrowing from investors, paying interest; no voting ownership | Large long-term funds/control retained; fixed interest/repayment and possible security |
| Leasing | Pay to use asset owned by lessor | Low initial cash, maintenance/update possibilities; never owns asset and long-run payments may be high |
| Hire purchase | Deposit/instalments to use asset, owning it after final payment | Spreads cost and ends in ownership; interest raises total cost and repossession risk before completion |
| External trading source | How it works | Main benefit / limitation |
|---|---|---|
| Trade credit | Supplier allows later payment for inputs | Interest-free timing gap; not cash, limited to purchases, and late payment can lose discount/trust/supply |
| Debt factoring | Factor buys/advances against trade receivables for a fee | Immediate cash/collection support; fee, less receipt and possible customer-relationship impact |
Internal finance still has opportunity cost. External finance includes equity, grants and asset-use arrangements as well as debt. Leasing does not transfer ownership; hire purchase does after final payment; trade credit delays payment but does not put cash in the bank.
Five factors determine whether a finance source fits
| Syllabus factor | Questions to ask | Consequence for choice |
|---|---|---|
| Cost | Interest/dividend, fees, discount lost, lease/HP total, security, issue/monitoring cost and opportunity cost? | Compare total expected cash/economic cost, not headline rate; high cost can weaken cash flow/profit |
| Flexibility | Can amount/timing vary, repay early, renew, change asset or meet seasonal uncertainty? | Overdraft suits a temporary variable gap; inflexible long debt may burden a short need |
| Need to retain control | Does equity give votes, profit share, advice rights or influence? | Debt/internal funds preserve ownership but add repayment/opportunity risk; equity absorbs risk but dilutes control |
| Use of finance | Working capital, property, equipment, takeover, R&D or emergency—and for how long/what amount? | Match source term/mechanics to asset/use: mortgage to property, lease/HP to equipment, trade credit to inputs |
| Existing debt | Current repayments, gearing, collateral and cash-flow headroom? | More borrowing can raise lender risk, interest and failure exposure; equity/internal funds may rebalance risk |
These factors operate within availability: ownership form, business age/credit record, collateral, profitability/cash flow, amount/speed needed and grant/investor criteria may remove a source before comparison. A start-up with little cash and no record faces different terms from a mature profitable company.
Turn each factor into a consequence. Example: high existing debt + another large loan → larger fixed interest/repayment outflow → less cash buffer if expansion receipts are late → higher insolvency risk. The same loan may still fit if cash flows are stable, security is available and control is the priority.
Cost is broader than interest and control is broader than owning over 50%. No factor decides alone: its importance depends on the need, business and external conditions.
Select finance by screening, comparing and justifying the best fit
Use four steps. (1) Define exact amount, purpose, date needed, duration and repayment/cash pattern. (2) Remove legally or practically unavailable sources. (3) Shortlist at least two realistic sources and compare total cost, flexibility, control, use-fit, existing debt, security, speed and risk. (4) Recommend one source or mix, state its strongest reason, main drawback/mitigation and what the judgement depends on.
| Need | Realistic shortlist | Comparison focus |
|---|---|---|
| Seasonal inventory/temporary cash gap | Trade credit, overdraft, working-capital release/factoring | Amount/duration, supplier/customer terms, interest/fees and recall/relationship risk |
| Equipment | Lease, hire purchase, term loan, grant/internal funds | Ownership versus use, deposit/total payments, maintenance, asset life/obsolescence and cash certainty |
| Land/building | Mortgage, long loan, retained earnings/share capital | Long term, security/repossess risk, repayment capacity and control |
| High-risk growth/innovation | Venture capital, shares/new partner, crowdfunding/grant, retained earnings | Risk-sharing, expertise, dilution/control, eligibility and likelihood/amount |
| Large takeover/expansion | Long loan/debenture, share issue, retained earnings or a mix | Scale/speed, gearing and cash-flow stress versus dilution and shareholder approval |
Quantify where data permit. Hire purchase at 600permonthfor25yearscosts600 × 12 × 25 = $180,000 before comparing any deposit/other terms. For debt, test repayments/interest against forecast cash and existing debt; for equity, test ownership/voting/profit share given up.
One source need not fund everything. A furniture retailer might mortgage premises, lease display/IT equipment, use retained earnings for promotion and trade credit for inventory. Matching each component can reduce maturity mismatch and avoid concentrating repayment, control or supplier risk.
‘Bank loan because it provides money’ is not a selection. Appropriateness requires realistic alternatives, linked consequences and a conditional judgement; the cheapest headline source may be unavailable or create unacceptable control, cash-flow or security risk.