Where do businesses get their money, and how do they choose the right source?
Internal and external sources of finance; short-term and long-term finance; the distinction between capital and revenue expenditure; factors affecting the choice of finance; and the appropriateness of each source for a start-up versus an established firm.
A focused answer to the Eduqas A-Level Business statement on sources of finance. Covers internal and external sources, short-term and long-term finance, capital versus revenue expenditure, the factors affecting the choice of finance, and the appropriateness of each source for start-ups and established firms.
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What this theme is asking
Eduqas expects you to classify sources of finance into internal and external, and short-term and long-term, to distinguish capital from revenue expenditure, and to judge which source is appropriate for a given firm and purpose. The central idea is matching: the source should fit the use, so a long-lived asset is funded by long-term finance and a short-term cash gap by short-term finance.
Internal sources of finance
Internal finance is cheap (no interest), keeps control with the owners, and is quick to access. But it is limited by how much profit or spare asset the firm has, and a start-up with no trading history has little or none, which is why new firms rely more on external finance.
External sources of finance
Short-term versus long-term finance
Capital versus revenue expenditure
Capital expenditure is spending on long-lived (non-current) assets that will be used over several years, such as buildings, machinery and vehicles. It is usually funded by long-term finance. Revenue expenditure is day-to-day spending on running the business, such as wages, raw materials, rent and utilities; it is funded from sales revenue or short-term finance. The distinction matters because it affects which source of finance is appropriate and how the spending appears in the accounts.
Choosing a source of finance
The choice depends on:
- Purpose (capital asset versus short-term cash need),
- Amount needed (large sums often require loans or shares),
- Cost (interest, fees, or the dilution of selling shares),
- The firm's legal structure (only companies can issue shares),
- Risk and gearing (more borrowing raises financial risk),
- Control (loans keep control; shares and venture capital give some away),
- Speed and availability (a start-up with no history has fewer options).
Examples in context
A start-up with no profit relies on the owner's savings, a small bank loan, crowdfunding or a grant. A profitable established firm funds expansion from retained profit to avoid interest. A high-growth tech firm raises venture capital, accepting a stake and influence in return for the cash. A retailer uses trade credit and an overdraft to manage day-to-day cash.
Try this
Q1. State two internal sources of finance. [2 marks]
- Cue. Any two of: retained profit, sale of assets, reducing working capital.
Q2. Explain why a firm should fund a new factory with long-term rather than short-term finance. [3 marks]
- Cue. A factory is a long-lived asset, so long-term finance matches its life, spreading the cost over the years it earns money and avoiding the risk of a short-term facility being recalled before the asset pays for itself.
Exam-style practice questions
Practice questions written in the style of WJEC Eduqas exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Eduqas 20194 marksExplain the difference between internal and external sources of finance. (4)Show worked answer →
A short-answer question rewarding a clear contrast with examples.
Internal finance comes from within the business itself, such as retained profit, the sale of unused assets or reducing working capital. It is cheaper because it carries no interest and keeps control with the owners, but it is limited in size.
External finance comes from outside the business, such as bank loans, overdrafts, share issues, venture capital or trade credit. It can raise larger sums but usually carries a cost (interest or a share of ownership) and conditions.
Markers reward both definitions and an example of each. A one-sided answer caps the marks.
Eduqas 202110 marksEvaluate the most appropriate source of finance for a sole trader wanting to buy delivery vans costing . (10)Show worked answer →
A levels-of-response evaluation. The vans are capital expenditure (a long-term asset), so they should be funded by long-term finance to match the asset's life. Options: a bank loan (spreads the cost over several years, predictable repayments, the owner keeps control, but it carries interest and the lender may want security); leasing or hire purchase (lower upfront cost and the vans can be maintained or replaced, but total cost is higher and ownership may be delayed); retained profit if available (no interest, but a sole trader may lack enough). Evaluation: for a sole trader buying long-lived vans, a bank loan or leasing is more appropriate than an overdraft (which is short-term and could be recalled) or using all the cash; the best choice depends on whether the owner has security, wants to own the vans, and can meet the repayments. The top band reaches a justified judgement matched to the asset.
Related dot points
- The classification of costs into fixed, variable and total; the calculation of revenue, contribution and profit; break-even analysis and the margin of safety; the construction and interpretation of break-even charts; and the value and limitations of break-even analysis.
A focused answer to the Eduqas A-Level Business statement on costs and break-even. Covers fixed, variable and total costs, revenue, contribution and profit, the break-even point and margin of safety, break-even charts, and the value and limitations of break-even analysis, with worked calculations.
- The difference between cash and profit; the structure and use of a cash-flow forecast; the causes and solutions of cash-flow problems; working capital; budgets and budgetary control; and variance analysis.
A focused answer to the Eduqas A-Level Business statement on cash flow and budgets. Covers the difference between cash and profit, the cash-flow forecast, the causes and solutions of cash-flow problems, working capital, budgets and budgetary control, and variance analysis, with worked calculations.
- The income statement and statement of financial position; profitability ratios (gross and net profit margin, ROCE); liquidity ratios (current ratio, acid test); gearing; the calculation and interpretation of ratios; and their value and limitations.
A focused answer to the Eduqas A-Level Business statement on financial statements and ratios. Covers the income statement and statement of financial position, profitability ratios (gross and net margin, ROCE), liquidity ratios (current and acid test), gearing, the calculation and interpretation of ratios, and their value and limitations, with worked calculations.
- Financial objectives such as profit, cash flow, return on investment and cost minimisation; the calculation of profit and profitability; the use of financial data to set targets and judge performance; and the link between financial objectives and corporate strategy.
A focused answer to the Eduqas A-Level Business statement on financial objectives and performance. Covers financial objectives (profit, cash flow, return on investment, cost minimisation), the calculation of profit and profitability, the use of financial data to set targets and judge performance, and the link to corporate strategy, with worked calculations.
- Forms of business ownership: sole traders, partnerships, private and public limited companies, and not-for-profit and public-sector organisations; limited and unlimited liability; incorporation; and the factors affecting the choice of legal structure.
A focused answer to the Eduqas A-Level Business statement on forms of business ownership. Covers sole traders, partnerships, private and public limited companies, not-for-profit and public-sector organisations, limited and unlimited liability, incorporation, and the factors affecting the choice of legal structure.
Sources & how we know this
- Eduqas A Level Business Specification (A510) — Eduqas (2015)