Where does a business get the money it needs, and which source suits which purpose?
The main sources of finance available to a business (bank loan, overdraft, trade credit, hire purchase, leasing, mortgage, government grant, retained profit and owner's funds or share capital) and the advantages and disadvantages of each.
A focused answer to the SQA National 5 Business Management content on sources of finance, covering bank loans, overdrafts, trade credit, hire purchase, leasing, mortgages, government grants, retained profit and owner's funds or share capital, with the advantages and disadvantages of each.
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What this dot point is asking
The SQA wants you to know the main sources of finance a business can use and the advantages and disadvantages of each, and to recommend a suitable source for a given need. The key skill is matching the source to the purpose: short-term needs to short-term finance, large long-term purchases to long-term finance.
Short-term sources of finance
Short-term finance covers everyday running costs and temporary cash shortages.
Medium-term sources of finance
Medium-term finance usually funds equipment and vehicles.
- Bank loan: a fixed sum borrowed and repaid in regular instalments with interest over an agreed period. It spreads the cost of a purchase and the repayments are planned, but interest must be paid and the bank may want security.
- Hire purchase: the business pays for an asset in instalments and owns it after the final payment. It allows use of the asset without paying the full price at once, but the total cost is higher because of interest.
- Leasing: the business rents an asset (such as vehicles or machinery) for a regular fee and never owns it. It avoids a large upfront cost and the provider often maintains the asset, but the business has nothing to show for the payments at the end.
Long-term sources of finance
Long-term finance funds property, major expansion and start-up.
- Mortgage: a long-term loan secured on property, repaid over many years. It funds buying premises, but the property can be repossessed if repayments are not met.
- Share capital: a company sells shares to raise money from shareholders. It can raise large amounts that need not be repaid, but profit is shared as dividends and control is spread. Only limited companies can use this.
- Owner's own funds: the owner invests personal savings. There is no interest and no loss of control, but the amount is limited and personal money is at risk.
- Retained profit: profit kept in the business from previous years rather than taken out. It costs no interest and keeps control, but it is only available if the business has made and saved profit.
- Government grant: a sum of money from the government, often for a specific purpose such as creating jobs or locating in a certain area. It does not need to be repaid, but conditions usually apply and it may not be available to every business.
Matching the source to the need
The most important exam skill is choosing a suitable source. A short-term cash gap suits an overdraft or trade credit, not a 10-year loan; a large, long-term purchase such as a building suits a mortgage or share capital, not an overdraft. A justified recommendation that matches the source to the purpose and amount earns the marks.
Try this
Q1. Identify one short-term and one long-term source of finance. [1 mark]
- Cue. Short-term: overdraft or trade credit. Long-term: mortgage, share capital or retained profit.
Q2. Describe one advantage and one disadvantage of a bank loan. [2 marks]
- Cue. Advantage: the cost is spread over time in planned repayments. Disadvantage: interest must be paid and security may be required.
Q3. Outline why a government grant is an attractive source of finance. [2 marks]
- Cue. It does not have to be repaid, so it provides money without adding to the firm's debts, though conditions usually apply.
Exam-style practice questions
Practice questions written in the style of SQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
SQA-style Describe4 marksDescribe sources of finance a business could use to buy new equipment.Show worked answer →
Award 1 mark per source correctly described, up to 4. A bank loan provides a fixed sum repaid with interest over an agreed period, which spreads the cost of the equipment over time (1). Hire purchase lets the business pay for the equipment in instalments and own it after the final payment, useful when it cannot pay the full price at once (1). Leasing lets the business rent the equipment for a regular fee without owning it, which avoids a large upfront cost and includes maintenance (1). A government grant is a sum of money that does not need to be repaid, often for a specific purpose such as creating jobs (1). Other valid sources include retained profit and owner's own funds. Markers reward described sources suited to the purpose.
SQA-style Compare4 marksCompare a bank loan with a bank overdraft as a source of finance.Show worked answer →
Award marks for valid points of comparison, up to 4. A bank loan is a fixed sum borrowed and repaid in regular instalments over a set period, whereas an overdraft lets the business spend more than is in its account up to an agreed limit (1). A loan suits a large, one-off, long-term purchase such as machinery, whereas an overdraft suits short-term cash shortages such as paying a bill before customers pay (1). A loan has regular planned repayments and usually a lower interest rate, whereas an overdraft is flexible but the interest rate is higher and the bank can demand repayment at any time (1). Both are forms of borrowing from a bank on which interest is paid (1). Markers reward genuine comparison.
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Sources & how we know this
- National 5 Business Management Course Specification — SQA (2024)