1.3.4 Sources of business finance — Edexcel GCSE Business revision notes

Short-term sources

Short-term finance covers a temporary shortfall — usually a cash-flow gap of weeks or months, of the kind seen in 1.3.3. The specification names two.

Overdraft. An arrangement with the bank allowing the business to spend more than it has in its account, up to an agreed limit. It is flexible and available quickly, and interest is only paid on the amount actually used. But interest rates are high, and the bank can demand repayment at short notice.

Trade credit. An agreement with a supplier to receive goods now and pay later, typically after 30 or 60 days. It is effectively an interest-free loan and improves cash flow immediately. But it has to be repaid on time or the supplier may refuse further credit, and businesses offering it sometimes give discounts for early payment that are lost by taking the credit.

Overdraft: an arrangement allowing a business to spend more than it has in its bank account, up to an agreed limit; flexible but expensive
Trade credit: an arrangement in which a supplier allows a business to pay for goods later, usually within 30 to 90 days

Long-term sources

Long-term finance pays for things that will benefit the business for years — premises, equipment, or the initial cost of starting up. The specification names six.

Figure: The six long-term sources

Source	What it is	Advantages	Disadvantages
Personal savings	The owner's own money	No interest, no repayment, no loss of control	Limited to what the owner has; they lose it if the business fails
Venture capital	Investment from an individual or firm in return for a share of the business	Large sums; investors bring expertise and contacts	The owner gives up part ownership and some control; investors expect high returns
Share capital	Money raised by selling shares in the company	No repayment required and no interest	Only available to companies; profits are shared as dividends and ownership is diluted
Loans	Borrowed from a bank and repaid in instalments	The owner keeps full ownership; repayments are predictable so can be budgeted	Interest must be paid; security may be required; repayments must be met whatever the sales
Retained profit	Profit from previous years kept in the business	Free — no interest and no loss of control	Only available to a business that has already made a profit; the money cannot also be taken by the owner
Crowd funding	Many people each contributing a small amount, usually online	Can raise large sums; tests demand and creates publicity at the same time	Fails if the target is not reached; needs a convincing campaign; the idea becomes public

Two distinctions run through the table and are worth naming in an answer.

Internal against external. Personal savings and retained profit come from inside the business or its owner; loans, venture capital, share capital, overdrafts, trade credit and crowd funding come from outside. Internal sources cost nothing in interest and involve no loss of control, but they are limited in size.

Ownership against debt. Venture capital and share capital give away part of the business, so the owner shares future profits and decisions permanently. Loans and overdrafts do not, but they must be repaid with interest whether or not the business does well. Which is better depends on whether the owner values control or wants to avoid fixed repayments.

Worked example

A sole trader needs £2000 to cover a two-month cash-flow gap, and separately £40 000 to buy a delivery van. Recommend a source for each.

Match the length of the finance to the length of the need — that is the principle these questions test.
The £2000 gap is short-term and temporary, so an overdraft fits: flexible, quick to arrange, and interest is only paid on what is used.
The van is a long-term asset that will be used for years, so short-term finance would be wrong — an overdraft would have to be repaid long before the van has paid for itself.
A bank loan suits: repaid in predictable instalments over several years, and the owner keeps full ownership.
Note why not share capital or venture capital here.

Answer: An overdraft for the £2000, because the need is short-term and interest is only paid on what is used. A bank loan for the van, because it is a long-term asset and the repayments can be spread over the years it will be used — and as a sole trader, share capital and venture capital would mean giving up ownership or are not available.

Common mistake

Share capital is not available to a sole trader or a partnership — only companies can sell shares. Check the type of business ownership in the question before recommending it.

Retained profit: profit from previous years kept in the business rather than paid out to the owners; an internal source of finance with no interest to pay
Crowd funding: raising finance from a large number of people, usually online, each contributing a small amount
Venture capital: finance provided by an investor in return for a share of the business, usually where the risk is too high for a bank

Before you practise

Short-term sources: overdraft and trade credit.
An overdraft is flexible with interest only on what is used, but expensive and repayable on demand.
Trade credit is effectively interest-free, but must be repaid on time and may cost early-payment discounts.
Long-term sources: personal savings, venture capital, share capital, loans, retained profit and crowd funding.
Internal sources — savings and retained profit — cost nothing but are limited in size.
Venture capital and share capital give away ownership; loans keep ownership but must be repaid with interest.
Match the length of the finance to the length of the need.
Share capital is only available to companies, not sole traders or partnerships.

Short-term sources

Long-term sources

Before you practise

Now practise it