Where do businesses get their money from, and how do they choose?
Sources of finance: internal and external sources, short-term and long-term finance, the suitability of each source, and the factors a business considers when choosing how to raise money.
A focused answer to OCR GCSE Business J204 topic 5.2, covering internal and external sources of finance, short-term and long-term finance, their suitability, and how a business chooses a source.
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What this topic is asking
OCR J204 topic 5.2 wants you to know the internal and external sources of finance, the difference between short-term and long-term finance, the suitability of each source, and the factors a business weighs when choosing. The exam often gives a business with a specific need and asks you to recommend or weigh a source. This links to the business plan and to cash flow.
Internal sources of finance
Internal sources avoid debt and interest and keep control, but the amounts are limited by what the business and owner have.
External sources of finance
Short-term and long-term finance
The golden rule is to match the term of the finance to the purpose: use short-term finance for short-term needs and long-term finance for long-term assets. Funding a building with an overdraft, or daily stock with a 10-year loan, is a poor match.
Choosing a source of finance
Try this
Q1. State one short-term and one long-term source of finance. [2 marks]
- Cue. Short-term: overdraft or trade credit. Long-term: bank loan, share capital or retained profit.
Q2. A business borrows at interest a year. Calculate the annual interest. [2 marks]
- Cue. .
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 J204/02 20183 marksExplain one internal source of finance a business could use. (Paper 2, Section A)Show worked answer →
A 3-mark AO1 and AO2 question. One internal source is retained profit, the profit kept in the business from previous years rather than paid out to owners. The business can reinvest it without borrowing, so there is no interest to pay and no loss of control, which means a cheaper way to fund growth. Other valid internal sources include selling unused assets and owners' own savings. One mark for naming a valid internal source, up to two more for explaining how it helps. A common error is to give an external source such as a bank loan.
OCR J204/02 20226 marksA small but growing manufacturer needs to buy new machinery and is deciding between a bank loan and issuing new shares. Analyse one benefit of each source for this business. (Paper 2, Section B)Show worked answer →
A 6-mark "analyse" needing a developed benefit of each source applied to the manufacturer. Bank loan benefit (keeps ownership and is predictable): a loan does not give away any share of the business, and repayments are fixed and known, so the owners keep full control and can budget for the cost, which suits funding a specific asset like machinery. Share issue benefit (no repayment or interest): selling shares brings in money that does not have to be repaid and carries no interest, so it does not strain cash flow, which means the manufacturer can invest without the burden of monthly repayments. Markers reward one developed benefit for each source, chained and applied to the manufacturer and its machinery purchase.
Related dot points
- The role of the finance function: the purpose of finance in a business, the difference between cash and profit, the use of financial information in decision-making, and profitability including profit margins.
A focused answer to OCR GCSE Business J204 topic 5.1, covering the purpose of the finance function, the difference between cash and profit, profitability and profit margins, and how financial information guides decisions.
- Revenue, costs, profit and loss: the definition and calculation of revenue, fixed, variable and total costs, the calculation of profit or loss, the importance of profit, and the difference between cash and profit.
A focused answer to OCR GCSE Business J204 topic 5.3, covering revenue, fixed and variable and total costs, the calculation of profit or loss, why profit matters, and the difference between cash and profit.
- Break-even: the concept of break-even, the calculation of break-even output using the formula, interpretation of a break-even chart, the margin of safety, and the usefulness and limitations of break-even analysis.
A focused answer to OCR GCSE Business J204 topic 5.4, covering the concept of break-even, the break-even output formula, the margin of safety, how to read a break-even chart, and the uses and limits of break-even analysis.
- Cash and cash flow: the importance of cash, the consequences of cash flow problems, the purpose of a cash flow forecast, the calculation and interpretation of inflows, outflows, net cash flow and opening and closing balances, and how forecasts aid decision-making.
A focused answer to OCR GCSE Business J204 topic 5.5, covering why cash matters, the consequences of cash flow problems, the purpose of a cash flow forecast, and how to calculate net cash flow and opening and closing balances.
- Business planning: the purpose and content of a business plan, the benefits and drawbacks of planning, and how a plan supports raising finance and reducing risk.
A focused answer to OCR GCSE Business J204 topic 1.2, covering the purpose and content of a business plan, its benefits and drawbacks, and how it helps a business raise finance and reduce risk.
Sources & how we know this
- OCR GCSE Business (J204) specification — OCR (2017)