Sources of finance - Business Management IB Study Notes
Overview
# Sources of Finance - Cambridge IB Business Management Summary ## Key Learning Outcomes Students examine internal sources (retained profit, sale of assets, owner's capital) and external sources (share capital, loan capital, overdrafts, trade credit, crowdfunding, leasing) of finance, evaluating their appropriateness for different business contexts. The lesson distinguishes between short-term and long-term finance, analyzing factors such as cost, control, flexibility, and risk when selecting funding methods. Understanding the relationship between gearing ratios, liquidity concerns, and financial strategy is essential for assessing business sustainability and growth potential. ## Exam Relevance This topic frequently appears in Paper 1 case studies and Paper 2 extended response questions, requiring students to recommend appropriate finance sources using contextual analysis and justify choices through stakeholder impact assessment. Evaluation skills are critical, as examiners expect balanced arguments considering both advantages and limitations of each financing method
Core Concepts & Theory
Sources of finance refer to the various methods businesses use to obtain funding for their operations, expansion, or other financial needs. These are categorized into internal and external sources, and further divided by duration (short-term, medium-term, long-term).
Internal Sources:
- Retained Profit: Earnings kept within the business after dividends are distributed. Formula: Retained Profit = Net Profit - Dividends Paid
- Sale of Assets: Converting non-essential assets into cash
- Personal Funds: Owner's savings invested into the business
External Sources: Short-term (< 1 year):
- Overdrafts: Flexible borrowing from banks allowing negative balances with interest
- Trade Credit: Delayed payment terms from suppliers (typically 30-90 days)
Medium-term (1-5 years):
- Hire Purchase: Acquiring assets through installment payments with eventual ownership
- Leasing: Renting assets without ownership transfer
Long-term (> 5 years):
- Share Capital: Equity funding from selling company ownership shares
- Debentures/Bonds: Fixed-interest loans with specified repayment dates
- Venture Capital: Investment from specialist firms in exchange for equity
- Bank Loans: Fixed-term borrowing with regular repayment schedules
Key Distinction: Equity finance (shares, venture capital) involves ownership dilution but no repayment obligation, while debt finance (loans, debentures) requires repayment with interest but preserves ownership control.
Gearing Ratio measures financial risk: Gearing = (Long-term Liabilities ÷ Capital Employed) × 100. High gearing (>50%) indicates greater financial risk.
Detailed Explanation with Real-World Examples
Think of business finance like funding a journey: internal sources are money already in your wallet (retained profit), while external sources require asking others for help—either borrowing (debt) or finding travel companions who share costs and decisions (equity).
Real-World Applications:
Startup Phase: A tech entrepreneur uses personal funds (£20,000 savings) and secures venture capital (£500,000 from Silicon Valley investors) for 30% equity. The VC brings expertise plus capital, perfect for high-risk, high-growth ventures like apps or biotech.
Established Business Expansion: Tesco purchasing new delivery vans might use hire purchase—paying £5,000 monthly over 3 years rather than £180,000 upfront. This preserves working capital for daily operations while spreading asset costs.
Cash Flow Management: A seasonal business like a ski resort faces summer revenue gaps. They negotiate trade credit (90-day payment terms) with suppliers and maintain a £50,000 overdraft facility for temporary shortfalls, paying interest only on amounts used.
Major Investment: When Amazon built warehouses across the UK, they issued corporate bonds worth £2 billion at 3% interest, repayable over 10 years. This avoided diluting Jeff Bezos's ownership while accessing massive capital.
Analogy: Retained profit is like saving birthday money—free but limited. Bank loans are like borrowing from parents—must repay with "interest" (chores). Selling shares is like getting roommates—they help with rent but now influence house decisions!
The appropriateness of each source depends on business size, risk tolerance, control preferences, and time horizons.
Worked Examples & Step-by-Step Solutions
**Example 1: Choosing Appropriate Finance [8 marks]** *Question:* Maya's bakery needs £80,000 for new ovens. She has £15,000 retained profit. Evaluate two suitable external sources. *Solution:* **Identification (2 marks):** Bank loan and hire purchase are suitable medium-term sources. **Analysis ...
Unlock 3 More Sections
Sign up free to access the complete notes, key concepts, and exam tips for this topic.
No credit card required · Free forever
Key Concepts
- Finance: The money a business needs to operate, grow, and achieve its goals.
- Sources of finance: The different places or methods a business uses to get money.
- Internal sources of finance: Money generated from within the business itself, like retained profits or selling old assets.
- External sources of finance: Money obtained from outside the business, such as bank loans, investors, or government grants.
- +6 more (sign up to view)
Exam Tips
- →Always identify if a source is internal or external, and short-term or long-term, as this helps you analyze its suitability.
- →When evaluating a source of finance, think about its advantages and disadvantages for the specific business in the case study.
- +3 more tips (sign up)
More Business Management Notes