O-Level Business: Sources of Finance

Q: What is Retained Profit?

Retained profit is the cash kept in the business after all taxes and shareholder dividends have been paid out. It is the best internal source of finance because it is 'free' (it carries zero interest).

Q: What is the difference between a Bank Loan and an Overdraft?

A Bank Loan is a massive, long-term injection of cash used to buy huge assets like buildings, repaid over many years. An Overdraft is heavily flexible short-term borrowing used simply to pay emergency wages when the business bank account hits zero.

Q: What is an internal source of finance?

Capital generated from completely inside the business, such as Retained Profit from previous years, or the Selling of Unwanted Assets (like selling off an old delivery van that is no longer needed).

Q: What is Share Capital?

An external source of finance where an Ltd or plc sells legal ownership stakes (shares) in the business to investors. It raises massive amounts of cash that never has to be repaid, but the original owners dilute their absolute control.

A scale weighing the heavy interest of a Bank Loan against the loss of control from selling Share Capital.

Which source of finance should a business choose to build a new factory?

To build a massive factory, a firm needs huge 'Long-Term' finance. An Overdraft is inappropriate because the bank can demand it back tomorrow. The firm must use Retained Profit (if they have enough saved up), secure a multi-year Bank Loan, or issue new Share Capital (if they are an Ltd or plc willing to give up some control).

1. Internal Sources (The 'Free' Money)
2. External Sources (Loans vs Shares)
3. Short-Term vs Long-Term Borrowing
4. Frequently Asked Questions

Every firm needs capital. In the Paper 2 exam, you will frequently be asked to evaluate how a company should fund its next expansion. Picking the wrong source (like using an overdraft to buy a Boeing 747) will cost you all the logic marks. This guide from our Ultimate O-Level Business Guide breaks down the exact trade-offs.

1. Internal Sources (The 'Free' Money)

Money generated from inside the physical business. This is always the best option if the company is healthy.

Retained Profit

The profit kept back from previous years after taxes and dividends are paid.
Advantage: It does not have to be repaid to anyone, and carries exactly ZERO interest.
Disadvantage: A massive new expansion will likely drain the entire bank account, leaving the business with zero cash if a sudden emergency strikes. New startup businesses almost never have retained profit available.

Selling Unwanted Assets

Selling an old factory building or idle delivery truck to raise quick cash.
Advantage: Frees up capital tied up in useless machinery.
Disadvantage: It takes a lot of time to find a buyer for a massive factory. You cannot rely on this if you need emergency cash tomorrow.

2. External Sources (Loans vs Shares)

When internal funds run dry, businesses must beg outside parties.

The Bank Loan

Borrowing a massive lump sum from a corporate bank.
Advantage: You can secure millions of dollars instantly. The owner does NOT lose any control of the business.
Disadvantage: You must pay it all back with heavy Interest. The bank will demand 'Collateral' (like the deed to your house) before lending to you.

Issuing Share Capital

Only available to Ltds or plcs. The business sells pieces of its ownership to outside investors on the stock exchange.
Advantage: It generates millions of dollars that NEVER has to be repaid. There is zero interest.
Disadvantage: Total loss of control. If someone buys 51% of your shares, they can legally fire you from your own company. You are also expected to pay regular profit Dividends to all these new owners forever.

💡 Tutor's Tip

Sole Traders cannot issue shares: If the case study business is a Sole Trader or a Partnership, do not suggest "Share Capital" as an answer! They are unincorporated. They would have to legally convert their business to a Limited Company first.

3. Short-Term vs Long-Term Borrowing

Examiners test your common sense. You must match the source to the specific need.

Short-Term: The Bank Overdraft

An agreement where the bank allows the business to spend more money than it actually has in its account, effectively going into negative balance. It is highly flexible.
Use case: Emergency liquidity. For example, if customers are late paying their bills and the firm suddenly has no cash to pay Friday worker wages. It is NOT for buying factory machinery!

Long-Term: Mortgages & Debentures

A mortgage is heavily secured on property, paid back over 25 years. Used exclusively to buy land and buildings. You cannot use a mortgage to pay for an advertising campaign.

📋 From the Desk of Sarah Miller

When asked for an evaluation: "While a massive bank loan allows them to keep absolute control (unlike issuing shares), the high interest payments will heavily damage their future net profit margins. Furthermore, as a relatively new business, they likely lack the collateral required by the bank to secure such a massive loan."

Frequently Asked Questions

What is Retained Profit?▼

Money saved up in the corporate bank account from previous successful trading years.

What is the difference between a Bank Loan and an Overdraft?▼

A loan is a long-term fixed sum to buy massive assets. An overdraft is a flexible negative bank balance used for short-term daily emergencies.

What is an internal source of finance?▼

Money found from within the business itself, carrying no interest and no debt.

What is Share Capital?▼

An external source where an Ltd or plc sells ownership to raise 'permanent' capital that does not need to be repaid.

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Sources of Finance: Fueling Business Growth