Sources of Finance
Why Businesses Need Finance
Every business, at some point, needs money. A start-up needs cash to rent premises, buy stock and pay its first wage packet. An established business needs money to fund expansion, replace worn-out equipment, launch new products or simply run day-to-day operations. OCR names five reasons: establishing a new business, funding expansion, running the business, recruitment and marketing. Finance is the fuel that keeps a business alive — and picking the wrong source can be the difference between growth and going bust.
The question is not just ‘where does the money come from?’ but ‘which source is the best fit?’ A brand-new sole trader with no trading history cannot issue shares. A plc like Tesco can raise hundreds of millions by selling new shares on the stock market — something a sole trader cannot legally do.
Internal Sources of Finance
Internal finance comes from inside the business. OCR names three main sources.
Retained profit — profit the business has made and kept back rather than paid out to owners. It is free: no interest, no repayment, no loss of control. The downside is that a new business has no profit yet, and using retained profit means the owners receive less income this year.
Sale of assets — a business sells off spare machinery, an old van or a property it no longer uses. This frees up cash quickly, but only works if the business actually owns something worth selling, and the asset cannot be recovered if needed later.
Owner’s capital — the entrepreneur puts personal money (savings) into the business. Cheap and quick, but risky for the owner: if the business fails they lose their savings as well as their income.
Internal sources — retained profit, sale of assets and owner’s capital — do not involve borrowing or outside investors. They cost nothing in interest, but the business has to already have the money or the asset to use them.
External Sources of Finance
External finance comes from outside the business. OCR names six main sources.
Loan — the bank lends a fixed sum to be repaid with interest over an agreed period. Good for large one-off purchases like a delivery van. The business must pay interest and may need to offer collateral.
Overdraft — the bank lets the business spend more than is in its current account, up to an agreed limit. Flexible for short-term cash-flow problems, but interest rates are high and the bank can demand repayment at any time.
Trade credit — a supplier delivers stock now and lets the business pay 30, 60 or 90 days later. Effectively an interest-free short-term loan, but late payment damages the supplier relationship.
New partner — a partnership brings in an extra partner who invests cash in exchange for a share of ownership. Brings in money and often new skills, but the original owners lose some control.
Share issue — a Ltd or plc sells new shares to investors in exchange for cash. Large amounts can be raised with no repayment date, but ownership is diluted and existing owners control a smaller slice of the business. Only limited companies can do this.
Crowdfunding — the business pitches to the public online (through platforms such as Crowdcube or Seedrs) and lots of small investors contribute. BrewDog famously raised millions this way in the 2010s through its ‘Equity for Punks’ campaigns, and Monzo used crowdfunding rounds to grow its customer base as well as its capital. Great for building a loyal community — but companies give away equity and face pressure from thousands of small shareholders.
Choosing the Right Source
The suitability of a source depends on four things: how much is needed, how quickly, for how long, and how established the business is. A £2,000 emergency tax bill might be covered by an overdraft. A £200,000 factory expansion needs a loan or share issue, not an overdraft.
Innocent Drinks is a classic UK example. Three Cambridge graduates started the business in 1999 with £500 of fruit at a festival. Early on they had no trading history — a bank would not lend them six-figure sums, so they relied on owner’s capital and small business loans. As the business grew, it could access bigger loans and eventually sold a stake to Coca-Cola — effectively a share issue on a huge scale. The right source changed as the business matured.
Share issues are only available to limited companies (Ltd and plc). Sole traders cannot sell shares — they rely on owner’s capital, retained profit, loans, overdrafts, trade credit and sale of assets instead.
New Businesses vs Established Businesses
OCR explicitly asks students to compare suitability for new versus established businesses. A brand-new start-up has no trading history, no retained profit and often no assets to sell. Its options are mostly owner’s capital, small loans, a new partner or crowdfunding. An established business has choices a start-up does not: years of retained profit to tap, a balance sheet to borrow against, a credible forecast to show investors, and (if it is a limited company) the ability to issue new shares. This is why the same business often raises money in very different ways at different points in its life — savings first, then loans, then shares at scale.
Another way of thinking about sources is how long the business needs the money. Short-term finance (under a year) covers temporary cash needs: an overdraft to bridge a quiet month, trade credit for a bulk stock order, or an owner’s capital injection to cover wages. Long-term finance (over a year) funds big projects that will pay back over time: a loan for new premises, a new partner’s investment for expansion, or a share issue for an overseas push.
Matching the length of the finance to the length of the need matters — paying for a 10-year factory extension with a 12-month overdraft is a recipe for disaster when the bank demands repayment.