Introduction: Why Choosing the Right Money Matters

Welcome! In this chapter, we are looking at where businesses get the money they need to survive and grow. Think of money as the "fuel" for a business. Just like a car can't run without fuel, a business can't pay its staff or buy stock without finance.

As a Business student, your job isn't just to list these sources, but to decide which one is best for a specific situation. Don't worry if it seems like a lot of terms at first—we’ll break them down using everyday examples to help you master them!

1. Internal vs. External Sources of Finance

The first thing to understand is where the money is coming from. We can split these into two main "buckets":

Internal Sources: This is money that already belongs to the business or is generated from within. It’s like using your own savings to buy a new phone.

External Sources: This is money that comes from people or organisations outside the business, like a bank or an investor. It’s like borrowing money from a friend or getting a loan from your parents.

Quick Review: The Main Sources We Need to Know
According to your AQA syllabus, you need to understand these specific sources:

  • Internal: Retained profits.
  • External: Debt factoring, overdrafts, share capital, loans, venture capital, and crowd funding.

2. Internal Finance: Retained Profits

Retained Profits are the profits a business has made in the past that have been kept (not given to owners) to reinvest back into the company.

Analogy: Imagine you have a Saturday job. You earn £50. You spend £30 on cinema and food, and you "retain" (keep) £20 in your drawer to buy a better bike later. That £20 is your "retained profit."

Advantages:

• No interest: You don't have to pay a bank back for using your own money.
• Total control: No outside investors get a say in how you spend it.

Disadvantages:

• Limited amount: You can only use what you’ve already made. New businesses usually don't have any retained profit yet!
• Unhappy shareholders: Owners might want that profit paid to them as dividends (cash rewards) instead of being reinvested.

3. External Finance: Short-Term Sources

Short-term finance is usually for money needed for less than a year, often to help with cash flow (paying day-to-day bills).

Debt Factoring

This is when a business sells its unpaid customer bills (invoices) to a third party (a "factor") for a small fee.

Example: A builder finishes a job and sends a bill for £1,000 to a customer who has 30 days to pay. If the builder needs cash today to buy bricks for the next job, they sell that bill to a debt factor. The factor gives the builder £950 immediately and takes the £1,000 from the customer later. The £50 difference is the factor's fee.

Overdrafts

A bank overdraft allows a business to spend more money than it actually has in its bank account, up to a certain limit.

• Pros: Very flexible; you only pay interest on the amount you actually use.
• Cons: Very high interest rates; the bank can take the facility away at any time.

Key Takeaway: Short-term sources are like "emergency cash" or "bridge money" to keep things moving while waiting for customers to pay.

4. External Finance: Long-Term Sources

Long-term finance is for big projects, like buying a new factory or launching a brand-new product line. These usually take many years to pay back.

Share Capital

This is money raised by selling a share (a piece of ownership) of the business to investors. This is only available to Limited Companies (Ltds or PLCs).

• Pro: You never have to pay the money back.
• Con: You lose some control because the new shareholders get a vote on how the business is run.

Loans

A bank loan is a fixed amount of money borrowed for a set period (e.g., 5 years). The business pays it back in monthly installments with interest added on.

• Pro: You know exactly how much to pay each month, which helps with planning.
• Con: If you miss a payment, the bank could take your business assets (like your van or office).

Venture Capital

Think of the TV show Dragons' Den. Venture capitalists are professional investors who put money into high-risk, high-growth businesses in exchange for a large share of the company.

• Bonus: They often provide expert advice and contacts, not just cash.

Crowd Funding

Raising small amounts of money from a large number of people, typically via the internet (like Kickstarter).

• Did you know? This is great for "niche" products because it also acts as a way to see if people actually want to buy the product before you make it!

Memory Aid: The "C.L.S.V." Mnemonic
To remember the main long-term external sources, think of Cars Love Speedy Vans:
Crowd funding
Loans
Share capital
Venture capital

5. Choosing the Best Source: The Decision Matrix

When you are writing an exam answer, don't just pick a source at random. Think about these three things:

1. The Purpose: Is it for a new printer (short-term) or a new warehouse (long-term)? Match the length of the finance to the length of the project.

2. The Cost: How much interest will we pay? \(Total Repayment - Original Loan = Cost of Interest\).

3. The Control: Does the owner want to keep 100% of the business? If yes, avoid Share Capital and Venture Capital.

Common Mistakes to Avoid:

• Confusing Loans and Overdrafts: A loan is for a fixed amount and time; an overdraft is flexible but much more expensive for long-term use.
• Thinking Share Capital must be repaid: It doesn't! Investors get dividends from profits, but they don't get their "loan" back unless they sell their shares to someone else.

Summary: Quick Review Table

Source Type Key Feature
Retained Profit Internal No interest, but limited amount.
Overdraft External (Short) Flexible for daily cash needs.
Share Capital External (Long) Permanent; lose some control.
Debt Factoring External (Short) Turning invoices into instant cash.

Final Tip: In your AQA exam, the "best" source is usually the one that matches the business's current objectives. If they want to grow fast and don't mind sharing control, Venture Capital is great. If they want to stay independent, Retained Profit or a Loan is better!