What financial goals do businesses set, and how do they raise money?
Financial objectives including profit, cash flow, return and shareholder value, the distinction between internal and external sources of finance, short-term and long-term finance, and the factors that determine the most appropriate source for a given situation.
A focused answer to the OCR A-Level Business finance theme on objectives and funding, covering financial objectives, internal versus external sources of finance, short-term and long-term finance, and the factors that determine the most appropriate source for a situation.
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What this theme is asking
OCR wants you to explain the financial goals a firm sets and the sources of money it can raise, and to judge which source fits a given situation. This recurs across all three components, from a start-up's first funding in Component 1 to a multinational's capital raising in Component 3.
Financial objectives
Different firms emphasise different financial objectives. A start-up prioritises cash flow and survival; a mature plc prioritises profit and shareholder value; a firm planning investment focuses on return. The objective shapes which source of finance and which projects the firm chooses.
Internal and external finance
Short-term and long-term finance
Funding a long-term asset (a factory) with a short-term overdraft is dangerous, because the overdraft can be recalled before the asset has generated a return. Matching the term of the finance to the term of the need protects cash flow.
The main sources at a glance
- Retained profit (internal): no interest, no repayment, keeps control, but limited in size.
- Bank loan (external, long-term): a fixed sum repaid with interest over years; raises gearing.
- Overdraft (external, short-term): flexible borrowing up to a limit; expensive and repayable on demand.
- Share issue (external, long-term): raises large sums with no repayment, but dilutes ownership and control.
- Venture capital (external): investment plus expertise for high-growth firms, in exchange for a stake.
- Trade credit (external, short-term): paying suppliers later, easing cash flow at no direct cost.
- Grants (external): money from government or bodies that need not be repaid, but with conditions and limited availability.
What determines the best source
Examples in context
A tech start-up with high growth potential but no profit yet typically raises venture capital, accepting dilution in exchange for funding and expertise. An established plc funding a new factory issues shares or takes a long-term loan. A small retailer smooths a seasonal cash dip with an overdraft or trade credit. The choice in each case reflects the term, cost, risk and control trade-offs.
Try this
Q1. State one internal and one external source of finance. [2 marks]
- Cue. Internal: retained profit or sale of assets. External: bank loan, overdraft, share issue, venture capital, trade credit or grant.
Q2. Analyse why a long-term investment should be funded with long-term finance. [6 marks]
- Cue. Matching the term avoids funding a long-lived asset with short-term finance that could be recalled before the asset has paid for itself, developed as a chain in context.
Exam-style practice questions
Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
OCR H431/01 20194 marksExplain one reason why a start-up might use retained profit rather than a bank loan to fund expansion. (4)Show worked answer →
A Component 1 "Explain" rewards one developed point in context. Define retained profit as profit kept in the business rather than paid out. Build the chain: retained profit carries no interest and does not have to be repaid, so using it to expand avoids the fixed interest commitments and repayment pressure that a bank loan would add, protecting the start-up's cash flow. Therefore it is a cheaper, lower-risk source for a firm that wants to keep its finances flexible. Markers reward the link from a specific feature of retained profit (no interest, no repayment) to the benefit, anchored in the start-up context. A strong answer notes the limit: retained profit may be too small to fund a large expansion.
OCR H431/02 202112 marksAssess the most appropriate source of finance for an established UK company funding a major five-year investment. (12)Show worked answer →
A 12-mark "Assess" on a four-level grid. Consider the options against the purpose. A long-term investment should be matched with long-term finance: a bank loan or debenture (repaid over years, with interest) or a share issue (no repayment, but dilutes ownership and control). Chain: matching a five-year investment to a five-year-plus loan avoids the danger of funding a long-term asset with a short-term overdraft that could be recalled. Against each: a loan raises gearing and fixed interest commitments; a share issue dilutes control and is costly to arrange. Evaluation: the best source depends on the firm's existing gearing, the certainty of returns, and how much control the owners will give up. A judged conclusion, matching the term and risk of the finance to the investment, reaches the top band.
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Sources & how we know this
- OCR A-Level Business (H431) specification — OCR (2015)