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3.1 Sources of business finance

Businesses need finance when required payments or investment exceed the funds currently available. The appropriate source should match how much is needed, when it is needed and how long the benefit or shortfall lasts.

Finance need	Typical purpose	Matching principle
short-term	bridge temporary cash shortages, buy inventory or meet immediate operating payments	use flexible finance that can be cleared as cash flows recover; avoid committing to long repayments for a brief gap
long-term	premises, machinery, product development or other assets/capacity used for years	spread funding over the period that generates benefits; larger, stable sources may be needed
start-up	premises/equipment, initial inventory, marketing and operating cash before sales receipts build	founders may lack trading history and retained profit, so affordability, risk and control are crucial
expansion	new branches, capacity, products, markets or employees	judge expected extra cash/profit against repayment, ownership and implementation risk

Use purpose and amount → duration/timing → affordability and cash-flow pattern → risk/control → source. A source is suitable only if the business can meet its conditions even when sales or project benefits arrive later than expected.

Short-term finance describes a temporary need or funding period, not a rule that the money must always be borrowed. Internal cash can meet a short-term need, while a long-term project should not normally depend on an overdraft that can be costly or withdrawn.

Internal finance comes from the owner or resources already inside the business, so it normally avoids interest and outside ownership—but availability is limited.

Internal source	How it raises finance	Benefits	Limitations
personal savings	owner invests their own accumulated money	quick, no interest/repayment to an external provider, owner keeps control	amount may be small; owner's personal security and emergency funds are at risk
retained profit	profit kept in the business rather than distributed to owners/shareholders	no interest or new owner; can be available quickly	only established profitable firms have it; using it reduces reserves/dividends and its alternative uses have an opportunity cost
selling assets	sell land, equipment, vehicles or other assets no longer needed	converts unused resources into cash with no repayment or ownership dilution	buyer/price may be uncertain; selling a useful asset can reduce capacity or require later replacement

Check whether the amount is sufficient and the resource is genuinely spare. Internal finance is not free: personal savings carry personal risk, retained profit sacrifices another use, and an asset sale gives up the asset's future service.

Sales revenue is not automatically an internal source available for investment: it must also cover operating costs and cash commitments. Retained profit is accumulated profit kept after costs and distributions, not every cash receipt in the bank.

External finance comes from outside the business. Compare not just the amount raised but repayment, interest/return, security, ownership, control, speed and suitability for the need's duration.

External source	Best fit / mechanism	Main benefit	Main cost or risk
overdraft	bank allows withdrawals beyond the account balance; flexible for a temporary cash shortfall	interest usually applies only while/where overdrawn and funds are quick to access within the limit	interest/fees may be high and the facility can be limited or withdrawn; poor fit for long-term assets
trade payables	supplier allows goods/services now and payment later	helps cash flow and may carry no explicit interest within agreed terms	late payment can lose discounts/supply trust and eventually disrupt supply
loan capital	fixed sum borrowed and repaid over an agreed period with interest	suitable for a known larger investment; ownership is retained	interest and repayments pressure cash/profit; lender may require security and approval
share capital / stock-market flotation	a company issues ownership shares; flotation lets a public limited company offer shares on a stock market	can raise substantial permanent capital without loan repayment	ownership/control and future profits are shared; flotation and reporting are costly/complex
venture capital	specialist investor funds a high-risk/start-up or growth business in return for ownership/return and often influence	can provide large funds, expertise and contacts when lenders will not	founders give up a share of ownership/profit and may face conflict over decisions
crowdfunding	many people contribute/invest through an online platform, sometimes for rewards/equity	reaches a wide pool, tests interest and may fund ideas without a bank loan	campaign may fail publicly; promotion/platform/reward costs apply and promises must be delivered

Match the source to the case. Temporary working-capital gaps favour overdraft or supplier terms; a long-lived asset favours long-term capital; a risky start-up may need venture capital or crowdfunding. Then test affordability, control and downside if forecasts are wrong.

Share capital is not debt: it is ownership finance and normally has no compulsory loan repayment, but shareholders gain claims and influence. Venture capital is not free expert advice; the investor expects a return and usually ownership/control rights.

3.2 Cash flow forecasting

Cash is money available to make payments now; profit is revenue minus costs for a period. A business needs enough cash at the right time even when its accounts show a profit.

Situation	Profit effect	Cash timing effect
sale made on credit	revenue and possible profit may be recorded	no customer cash arrives until payment is collected
inventory/equipment bought for cash	cost or asset treatment affects profit according to accounting rules	cash leaves immediately
bank loan received	not sales revenue or profit	cash rises now, but future interest/repayment creates outflows
owner/shareholder distribution or prior debt payment	may not be a current operating cost	cash leaves the business

Cash pays suppliers, overheads and employees. If the business cannot meet debts when due, operations or supplies may stop, employees may leave and creditors can take action. Persistent inability to meet obligations can make the business insolvent and cause failure.

A cash-flow forecast estimates future inflows, outflows and balances so managers can identify a shortage early, arrange suitable finance, change payment timing or reconsider spending. It supports planning but does not guarantee the forecast will occur.

A profitable business can become insolvent when receipts arrive after bills fall due. A cash-rich business is not necessarily profitable if its cash came from borrowing or owner investment.

Cash inflows are receipts such as cash sales, collected customer payments or finance received. Cash outflows are payments such as suppliers, wages, overheads, equipment and repayments. Add every relevant row before calculating the period totals.

$total cash inflow = sum of cash inflow rows; total cash outflow = sum of cash outflow rows; net cash flow = total cash inflow - total cash outflow; closing balance = opening balance + net cash flow$

February (£)	Amount	Calculation/meaning
opening balance	4,000	cash available at the start
total cash inflow	7,000	receipts during February
total cash outflow	3,000	payments during February
net cash flow	4,000	7,000 - 3,000
closing balance	8,000	4,000 + 4,000

The closing balance of one period becomes the next period's opening balance. To find a missing value, rearrange the same relationships; preserve the sign and currency/unit throughout.

Negative net cash flow means outflows exceed inflows in that period, but a positive opening balance may still leave a positive closing balance. A negative closing balance signals a forecast cash shortage. Managers can test changes to receipts, payment timing, costs or finance and consider their wider consequences.

Forecasts depend on estimates of sales, customer-payment timing, costs and unexpected events. Compare forecast with actual cash flow and update assumptions; a spreadsheet that balances mathematically can still be commercially unrealistic.

Do not add the opening balance when calculating net cash flow: it is brought forward from before the period. Revenue/cost figures belong in the forecast only when the related cash is expected to be received or paid in that period.

3.3 Costs and break-even analysis

Revenue is sales income; costs are resources used to operate/produce; profit or loss is the difference between total revenue and total costs for the same period and output.

Quantity	Meaning	Behaviour as output changes
fixed cost	cost that does not change with output within the relevant period/range, such as premises rent	total fixed cost remains constant even at zero output
variable cost	cost that changes with output, such as direct materials	total variable cost rises as more units are made/sold; variable cost per unit may be given
total cost	fixed cost plus all variable cost	starts at fixed cost and rises with output

$revenue = selling price per unit \times quantity sold; total variable cost = variable cost per unit \times quantity; total cost = fixed cost + total variable cost; profit = revenue - total cost$

200 bowls per day	Calculation	Result (£)
revenue at £12 each	12 × 200	2,400
variable cost at £3 each	3 × 200	600
total cost with £600 fixed cost	600 + 600	1,200
profit	2,400 - 1,200	1,200

If total cost exceeds revenue, the result is a loss: loss = total cost - revenue. Profit can rise if revenue increases by more than any added cost or costs fall without causing a larger fall in revenue.

Classify cost behaviour for the stated period and output range. A salary may be fixed when paid regardless of units, while piece-rate labour is variable; ‘fixed’ does not mean the amount can never change in the future.

Break-even is the output at which total revenue equals total cost, so profit is zero. Each unit's contribution first covers fixed cost; after fixed cost is covered, further contribution becomes profit.

$contribution per unit = selling price per unit - variable cost per unit; break-even output = fixed costs / contribution per unit$

Ice-cream case	Calculation
selling price per tub	£2.50
variable cost per tub	£1.10
contribution per tub	£2.50 - £1.10 = £1.40
fixed costs per day	£77
break-even output	£77 / £1.40 = 55 tubs

Below 55 tubs, total contribution has not covered fixed costs and the business makes a loss. At 55 it breaks even. Above 55, each additional tub contributes £1.40 toward profit, assuming price and unit variable cost stay unchanged.

Compare the calculated output with realistic demand and capacity. Managers can test how price, unit variable cost or fixed cost changes affect the target before deciding whether a product or expansion is viable.

If contribution per unit is zero or negative, selling more units cannot cover fixed costs under the formula. Break-even output is a number of units; break-even revenue is that output multiplied by selling price and is a different answer.

On a break-even chart, output is on the horizontal axis and money is on the vertical axis. The total-revenue line starts at zero; fixed cost is horizontal; total cost starts at fixed cost and rises with variable cost. Revenue and total cost intersect at break-even.

Change, all else equal	Line effect	Break-even effect
selling price rises	revenue line becomes steeper	break-even output falls
selling price falls	revenue line becomes flatter	break-even output rises
variable cost per unit rises	total-cost line becomes steeper	break-even output rises
variable cost per unit falls	total-cost line becomes flatter	break-even output falls
fixed cost rises	fixed-cost and total-cost intercept shift upward	break-even output rises
fixed cost falls	fixed-cost and total-cost intercept shift downward	break-even output falls

To the left of the intersection, total cost exceeds revenue: loss. To the right, revenue exceeds total cost: profit. The vertical gap between revenue and total cost at a chosen output shows the profit or loss amount on the chart's money scale.

A simple chart assumes constant selling price and unit variable cost, fixed costs unchanged over the range, straight-line relationships, all output sold and reliable demand/cost estimates. Discounts, capacity steps, waste, unsold inventory, competitors and uncertainty can make actual results differ.

Use break-even as one planning input: test alternative assumptions and combine it with demand, capacity, cash flow, quality and strategic evidence. A low break-even target is helpful only if the assumptions and expected sales are credible.

Break-even does not forecast demand or guarantee profit. Moving one line can have consequences elsewhere—for example, a higher price steepens revenue only if customers still buy the assumed output.

3.4 Financial documents

A statement of comprehensive income summarises a business's financial performance over a period by moving from sales revenue through costs to operating profit.

Feature	Meaning / relationship	Decision signal
sales	revenue earned from goods/services sold in the period	demand and price/output performance
cost of sales	direct cost of the goods/services sold	production/purchasing efficiency
gross profit	sales minus cost of sales	amount left to cover operating expenses and profit
operating expenses	other costs of running the business, such as administration or selling expenses	overhead/control burden
operating profit	gross profit minus operating expenses	profit generated by normal operations before items outside this syllabus calculation

$gross profit = sales - cost of sales; operating profit = gross profit - operating expenses$

Extract (£)	Amount
sales	90,000
cost of sales	11,000
gross profit	79,000
operating expenses	18,000
operating profit	61,000

Compare figures or margins over time, against targets or with a relevant business to identify changes in sales, direct cost or expenses. The evidence can inform pricing, cost control, product, investment or expansion decisions, but must be combined with cash, market and operational evidence.

Profit rewards owners, supports retained finance and provides a buffer for risk and future investment. Higher profit is not automatically better evidence if it came from unsustainable cost cuts or one unusual period.

This objective requires interpreting, not constructing, the statement. Profit is a period performance measure, not the cash balance and not proof that funds are immediately available for expansion.

A statement of financial position is a snapshot at a specific date of what the business controls (assets), what it owes (liabilities) and the long-term capital employed in the business.

Feature	Meaning	Typical interpretation
current assets	expected to be used, sold or converted into cash within 12 months, such as inventory, trade receivables and cash	resources available for near-term operations/obligations, though inventory and receivables are not immediate cash
non-current assets	resources kept for more than 12 months, such as premises, machinery or vehicles	long-term operating capacity; not normally available to pay immediate bills without sale/finance
current liabilities	amounts due within 12 months, such as short-term payables	near-term claims that current resources/cash flow must cover
non-current liabilities	debts due after 12 months, such as long-term loans	longer-term financing with future repayment/interest commitments
capital employed	long-term funds invested in/used by the business	scale of long-term finance supporting assets and a basis for judging returns

$capital employed = total assets - current liabilities$

Interpret composition and change: more non-current assets may support capacity but tie up funds; rising current liabilities may increase short-term pressure; changes in capital employed should be compared with the profit generated and with prior years or a suitable business.

Because the statement is dated, it can change soon after—for example when receivables are collected or suppliers are paid. Values may also depend on accounting estimates and do not necessarily equal current market prices.

This objective requires interpretation, not construction. An asset is not the same as cash, and a high asset total does not by itself prove liquidity, profitability or business success.

3.5 Accounts analysis

Accounting ratios turn financial-statement figures into comparable measures. First identify the ratio, select figures from the same business and period, calculate with the correct denominator, and state the unit. Then compare and explain the business reason for the difference.

$gross profit = revenue - cost of sales; operating profit = gross profit - other operating expenses$

Ratio	Calculation	What it measures	Unit
gross profit margin	gross profit ÷ revenue × 100	profit after cost of sales from each 100 of revenue	%
operating profit margin	operating profit ÷ revenue × 100	profit after operating expenses from each 100 of revenue	%
markup	profit per item ÷ cost per item × 100	profit added relative to item cost	%
ROCE	operating profit ÷ capital employed × 100	operating return generated by long-term capital	%
current ratio	current assets ÷ current liabilities	short-term asset cover for short-term debts	ratio, for example 1.50:1
acid test ratio	(current assets − inventory) ÷ current liabilities	short-term cover without relying on inventory	ratio, for example 0.90:1

Evidence	Calculation	Result	Initial reading
revenue £90,000; gross profit £22,000; expenses £4,000	operating profit = 22,000 − 4,000	£18,000	amount left after operating expenses
operating profit £18,000; revenue £90,000	18,000 ÷ 90,000 × 100	20%	£20 operating profit per £100 revenue
operating profit £60,000; capital employed £80,000	60,000 ÷ 80,000 × 100	75%	£75 operating return per £100 capital employed

A rise in a margin or ROCE may indicate stronger cost control, pricing or use of capital; a fall may reflect higher input costs, discounting, overheads or investment not yet producing returns. Test the explanation against the underlying figures and compare with previous years or a similar business.

Do not confuse markup with profit margin: markup divides by cost, while a margin divides by revenue. A higher ratio is not automatically better, and ratios with different definitions, periods, currencies or business models are not directly comparable.

Liquidity is a business's ability to meet short-term obligations when they fall due. A profitable business can still fail if cash and other liquid current assets are unavailable when suppliers, wages or tax must be paid.

$current ratio = current assets / current liabilities; acid test ratio = (current assets - inventory) / current liabilities$

Evidence	Useful interpretation	What to check next
acid test rises from 0.75 to 0.88	liquid-asset cover has improved, but remains below one unit per unit of current liabilities	cash-flow timing, access to short-term finance and whether creditors are due before customers pay
current ratio is much higher than acid test	inventory forms a large share of current assets	how quickly and reliably inventory can be sold without heavy discounting
ratio falls against last year or a similar competitor	short-term payment risk may have increased	whether this reflects deliberate working-capital choices, seasonality or unusual liabilities

Liquidity supports continuous trading: the business can pay urgent bills, retain supplier confidence and avoid emergency borrowing or asset sales. Managers can improve it by collecting receivables sooner, controlling inventory, negotiating payment timing or arranging suitable finance—but each action has costs and operational effects.

Make like-for-like comparisons over several years and with similar organisations. Explain both the direction and size of change, then connect it to the business's inventory cycle, customer-credit terms, seasonal cash flows and reliability of finance.

There is no universal ideal liquidity ratio. A very low ratio can signal payment risk, but a very high ratio may reflect idle cash, slow inventory or uncollected receivables. A ratio is a snapshot and does not show exactly when cash receipts and payments occur.

Financial documents help a business assess past performance and inform future decisions. Use a chain: identify relevant evidence, calculate or compare it, explain the business cause or consequence, and weigh it with other evidence before deciding.

Financial evidence	Performance question	Possible decision informed
revenue, gross profit and operating profit over time	are sales growing, and is growth becoming profit after costs?	pricing, promotion, supplier choice and operating-cost control
margins and ROCE against previous years or competitors	is efficiency or return improving on a comparable basis?	investment, expansion, closure or allocation of capital
current assets, current liabilities and liquidity ratios	can short-term obligations be met without disruption?	inventory, customer credit, supplier terms and short-term finance
several years of profit, position and liquidity	can the business afford and repay borrowing?	lender approval, loan size, interest terms and security

Example: if revenue rises but operating profit margin falls, sales growth alone does not prove stronger performance. Operating expenses or cost pressures may have grown faster than revenue. Managers could investigate costs before expanding; a lender would also examine liquidity, cash-flow timing and the multi-year pattern before judging repayment risk.

Managers use the evidence to plan and control; owners and shareholders judge return and risk; lenders assess repayment capacity; suppliers may consider creditworthiness. The same figure matters differently to each user, so the conclusion must match the decision being made.

Accounts are mainly historic and a statement of financial position is a snapshot. Accounting choices, inflation, one-off events and different business models can distort comparisons, while finance alone omits demand, competition, workforce capability and strategic fit. Use several documents, ratios, periods and non-financial evidence.

3 - Business finance

Exam analysis

Most tested topics

3.1 Sources of business finance

Match finance to timing and purpose

Compare internal sources before using outside finance

Choose external finance by obligation and control

3.2 Cash flow forecasting

Separate cash availability from profit

Calculate and interpret a cash-flow forecast

3.3 Costs and break-even analysis

Build revenue, cost and profit from units

Calculate the output where revenue equals cost

Read shifts and assumptions on a break-even chart

3.4 Financial documents

Read how sales become operating profit

Interpret assets, liabilities and capital employed

3.5 Accounts analysis

Calculate each ratio, then explain what changed

Judge liquidity through trend, context and asset quality

Turn financial documents into a reasoned decision