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Edexcel A Level Business Your notes

2.1 Raising Finance

Contents
Internal Finance
External Finance
Liability
Planning

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Internal Finance
Your notes
An Introduction to Sources of Finance
All businesses need finance to get started, allow them to grow and fund their continuing activity
Finance may be needed for capital expenditure, which is spending on fixed assets such as equipment,
buildings, IT equipment and vehicles
Similarly, finance is required for revenue expenditure, which is spending on raw materials or day-to-
day expenses such as wages or utilities
Businesses have different sources of finance available to them
When the finance comes from inside the business, it is called an internal source of finance
When the finance comes from outside the business, it is called an external source of finance

Sources of Internal Finance

Internal finance comes from the owner’s capital, retained profit, or the sale of assets

Owner’s capital: personal savings

Personal savings are a key source of funds when a business starts up
Owners may introduce their savings or another lump sum e.g. money received from a redundancy
payment
Owners may invest more as the business grows or if there is a specific need, e.g. a short-term cash
flow problem

Retained profit
The profit that has been generated in previous years and not distributed to owners is reinvested back
into the business
This is a cheap source of finance, as it does not involve borrowing and associated interest and
arrangement fees
The opportunity cost of investing the money back into the business is that shareholders do not
receive extra profit for their investment

Sale of assets
Selling business assets which are no longer required (e.g. machinery, land, buildings) generates a
source of finance

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A sale and leaseback arrangement may be made if a business wants to continue to use an asset but
needs cash
Your notes
The business sells an asset (most likely a building) for which it receives cash
The business then rents the premises from the new owners
E.g. In early 2023, Sainsbury’s announced that it is in talks to sell the prime retail property for £500
million, which will then be leased back to them by the new owners, LXi Reit
A business can also generate additional finance internally by managing its working capital more
effectively
They can negotiate extended payment terms with suppliers
They can encourage customers to pay more promptly for credit purchases
The Benefits & Drawbacks of Using Internal Finance

Advantages Disadvantages

Internal finance is often free (e.g. it There is a significant opportunity cost involved in the
does not involve the payment of use of internal finance, e.g. once retained profit has
interest or charges) been used, it is not available for other purposes
It does not involve third parties who Internal finance may not be sufficient to meet the
may want to influence business needs of the business
decisions
Using an internal finance method is rarely as tax-
Internal finance can usually be efficient as many external methods, e.g. loan
organised very quickly and without repayments may be treated as a business cost and
significant paperwork offset against tax
Businesses that may fail credit checks
(necessary for a bank loan) can access
internal finance sources more easily

Examiner Tips and Tricks

Businesses that have been recently established or own few assets, as well as more established
businesses that have made modest profits in recent years, will struggle to raise internal finance.
Weighing up the circumstances of the business is very important when considering the
recommendation of internal finance.

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Carefully consider the financial information that is presented within the case study material (e.g.
cash flow forecasts, statements of financial position and statements of comprehensive income)
and look for clues in the body of the case studies text such as the personal circumstances of the Your notes
business owner or the nature of the business itself.
Then make justified assumptions about the likelihood of internal finance being suitable for the
intended purpose.

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External Finance
Your notes
Sources of External Finance
External finance is sourced from outside of the business

The external sources of finance available to a business

Sources of external finance include family and friends, banks, peer-to-peer funding, business angels,
crowdfunding, and other businesses

1. Family and friends

Small business owners approach close acquaintances to invest in or lend money to a business
The Advantages & Disadvantages of Family and Friends as a Source of Finance

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Advantages Disadvantages
Your notes
Usually a very cheap source of funds Relationships may be damaged if
the finance is not repaid
May have ‘no strings attached (e.g. a share of the business)
and can be provided to the business on very flexible terms

2. Banks
Banks provide several different kinds of loans to businesses, e.g. a small business loan
The Advantages & Disadvantages of Bank Loans

Advantages Disadvantages

May offer both short term finance (e.g. overdrafts) A business plan is usually required to
and long term finance (e.g. loans or mortgages) if a access bank finance
business qualifies
Banks can be cautious about lending to
Banks are often keen to provide free advice and new, untested businesses
guidance to businesses that use their services
Interest (and often an arrangement fee) is
Small sums may be borrowed from unsecured payable
Businesses must be customers of the
bank (i.e. hold a banking account) to
access some loans
For larger amounts, businesses may need
to provide security to be granted a loan

3. Peer-to-peer funding
Individuals with available savings pool it with others in a peer investment scheme such as Funding
Circle
The Advantages & Disadvantages of Peer-to-Peer Funding

Advantages Disadvantages

Loans can usually be made Borrowers are charged a small fee to access finance in this
available to businesses very way and have to pay interest in the same way as a bank loan

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quickly The individuals who made the money available in the first
Usually has ‘no strings attached place receive some of this interest as compensation
(e.g. a share of the business) Your notes

4. Business angels
Some individuals specialise in making investments in start-up or expanding businesses e.g. Dragons
Den investors
The Advantages & Disadvantages of Business Angels

Advantages Disadvantages

Business angels tend to be more Finding the ‘right’ business angel (e.g. with appropriate
willing to take a risk than banks experience, expertise or interest) can be challenging
Angels often offer advice and Networking is vital when entrepreneurs seek this
guidance to the businesses in which kind of investment
they invest
As business angels own a stake in the business, they
Investment is usually for a may be involved in decision-making and will receive a
determined period of time so owners share of business profits
regain shares in the future

5. Crowdfunding
Crowdfunding is finance provided by a large number of small investors on online platforms such as
Kickstarter
The Advantages & Disadvantages of Crowdfunding

Advantages Disadvantages

Creates an organic customer base Businesses need to provide a persuasive business plan
and the platform provides a form of to convince individuals to invest in their product as they
free marketing will be competing with many other projects online
A good credit rating is not required The potential for negative publicity if the project is not
so new businesses that lack a successful in attracting enough crowdfunding capital
trading record can attract funding

Investors are often attracted by incentives

Examples of incentives include samples or early access to a product
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E.g. In November 2022, well-known Twitter commentator Russ Jones published his long-
awaited book funded via Unbound, a crowdfunding publisher
6. Other businesses Your notes

It may be possible for a business to access finance via a joint venture with another business, such as a
key customer or supplier
Some large businesses buy shares in other companies as an investment or with the intention of a
takeover
E.g in 2018, Mike Ashley, owner of Sports Direct, acquired a stake of just under 30% of
Debenhams, a troubled British high street retailer, to eventually take over the company
The Advantages & Disadvantages of Finance from Other Businesses

Advantages Disadvantages

May provide access to business processes and market Profits need to be shared between
knowledge alongside finance businesses
Can access large amounts of finance Decisions will usually need to be
agreed by all businesses

Examiner Tips and Tricks

Recently, some sources of finance have been trickier to access. When assessing external sources
of finance in your answers, acknowledge that businesses may find accessing these sources more
challenging and expensive than in previous years. Many small to medium-sized businesses are often
undercapitalised in their early stages. This has restricted their ability to grow.
Peer-to-peer lending, Crowdfunding and sources such as Business Angels have been able to fill
some of the gaps left by changes in the banking industry.
Recognising that a business may not be able to achieve its objectives due to an inability to borrow
can be a useful evaluative point.

Methods of Finance

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Your notes

Businesses have many different methods of finance available to help them

Several methods of finance are available to businesses, including loans, share capital, venture capital,
overdrafts, leasing, trade credit and grants

Loans
A sum of money is borrowed and repaid (with interest) over a determined period of time
Bank loans are usually unsecured and are typically repaid over two to ten years
Mortgages are long-term secured loans
They are typically used by a business to purchase buildings, land or large items of capital
equipment
Debentures are long-term agreements between a business and a lender to repay a specified amount
(with a fixed rate of interest) by a certain date
Debenture holders are creditors rather than owners of a business and do not hold voting rights
Benefits and Drawbacks of Loans

Benefits Drawbacks

Interest rates are fixed for the term of the loan Interest rates depend on the businesses
credit rating
Repayments are made in equal instalments, helping
budgeting Non-current liabilities are increased in
the balance sheet
Businesses can purchase expensive equipment or
property without the need for large amounts of With a mortgage, missed payments may
capital lead to property being repossessed

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Control over decision-making is retained within the Failure to repay debentures may deter
business investors in the future
Your notes
With debentures, interest is fixed, aiding budgeting

Overdrafts
An arrangement for business current account holders to spend more money than it has in their
account
A limit is agreed and interest is charged only when a business ‘goes overdrawn’
Benefits and Drawbacks of Overdrafts

Benefits Drawbacks

A short-term source of finance that An overdraft may be ‘called in’ if the bank is
offers significant flexibility and aids cash concerned about a business's ability to repay what
flow it owes

Share capital
Share capital is finance raised from the sale of shares in a limited company
Shareholders are the owners of shares and they are entitled to a share of the company’s profit when
dividends are declared
Benefits and Drawbacks of Overdrafts

Benefits Drawbacks

Large amounts of capital can be Shareholders usually have a vote at a company’s Annual
raised, especially by public General Meeting (AGM) where they can have a say in the
limited companies composition of the Board of Directors
Interest is not payable on finance
raised in this way

Venture capital
Funds provided by specialist investors in small to medium-sized businesses that have significant
potential for growth, e.g. in the technology sector
Benefits and Drawbacks of Venture Capital

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Benefits Drawbacks
Your notes
Businesses that may have been refused finance Venture capitalists usually require a stake in
from other sources may be able to attract the business in return for finance and often
investment from less risk-averse venture expect to exert some control over the
capitalists business

Leasing
An asset such as a piece of machinery or a vehicle used by the business in return for regular payments
E.g. many businesses lease office equipment such as photocopiers and IT equipment
Benefits and Drawbacks of Leasing

Benefits Drawbacks

The business does not own the asset during the period of Leasing is usually more expensive
the lease and so is not responsible for maintenance or in the long run than buying an
repair costs asset

Trade credit
An agreement is made with suppliers to buy raw materials, components and stock which are paid for at
a later date, typically 30 to 90 days later
Benefits and Drawbacks of Trade Credit

Benefits Drawbacks

Trade credit is usually interest-free Discounts for early payment will not be available

Grants
Governments and industry trusts may offer grants to businesses that meet specific criteria
E.g. grants may be available for businesses that create jobs or improve infrastructure in a region
Benefits and Drawbacks of Grants

Benefits Drawbacks

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Grants do not need to be repaid The business must use the finance for its intended purpose
Your notes

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Liability
Your notes
Limited & Unlimited Liability
The most common forms of business ownership are sole traders, partnerships, private limited
companies, public limited companies, and franchises (see sub-topic 1.5)
When an entrepreneur starts a business, they need to consider what kind of legal structure they want
for their business
Sole traders and partnerships offer no legal protection to the owners in that the business assets and
the owner's personal assets are viewed as being the same (unlimited liability)
The other forms of business ownership offer limited liability in which the assets of the owners are
considered to be separate from those of the business
A Comparison of Unlimited & Limited Liability

Liability Description Implications

Unlimited Sole proprietors and partnership There is no legal distinction between

liability owners are fully responsible for all owners with unlimited liability and the
debts owed by the business business
Owners are also legally responsible for As a result, these business owners may
any unlawful acts committed by those have to use their own personal
connected to the business assets to pay debts or legal fees
E.g. a sole proprietor may need to sell
their home to pay creditors if their
business fails

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Limited Owners (shareholders) of private Companies are incorporated and

liability limited companies and public limited owners are considered a separate legal
Your notes
companies can only lose the original entity to the business
amount they invested in the business if
it fails This means that if a company fails, the
owners would lose their investment
Shareholders are not responsible for (shares) but would not have to use their
business debts assets to meet additional debts or legal
fees
In most cases, the shareholders cannot
be held responsible for unlawful acts E.g. In 2018 construction company
committed by those connected with Carillion entered liquidation and the
the business shareholders lost their investments

Appropriate Finance for Limited & Unlimited Liability

Businesses
Sources of finance for limited liability businesses
There are numerous factors that decide which is the most appropriate form of finance for limited and
unlimited liability businesses
More often than not there will be a range or blend of sources of finance that a firm can use

Methods of finance suitable for limited liability businesses

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Unlimited liability businesses usually access different sources of funding to limited liability businesses
Some sources of funding are suitable for both types of businesses, e.g. an unsecured bank loan Your notes
Sources of finance for unlimited liability businesses

Methods of finance suitable for unlimited liability businesses

Businesses need to consider a range of factors before selecting the most appropriate method(s) of
finance
Factors Affecting the Choice of Finance

Factor Explanation

Why is the finance needed? Capital expenditure on buildings and expensive equipment will
usually require a longer-term method of finance, such as a
mortgage or share issue
Revenue expenditure (e.g. purchasing raw materials or paying
business rates) is more likely to be funded through a short-term
method such as trade credit or overdraft

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For how long and how For quick, short-term finance, businesses may use methods such
quickly is the finance as overdrafts, trade credit, short-term loans or leasing
Your notes
needed?
If a business needs access to finance over the longer term,
methods such as a share issue, debentures, mortgages or grants
may be more suitable

Who will lend to the Start-ups or struggling businesses may find their choice of finance
business? limited and will often pay much more to access it than more
established, stable businesses
Businesses that present more of a risk to lenders may choose to
raise finance through venture capitalists, business angels or
crowdfunding
Unlimited liability businesses, as well as businesses that own few
assets, often struggle to raise finance as they’re seen as risky

How much will it cost, and Methods of finance that attract interest, e.g. loans, mortgages and
how easy is it to access the overdrafts, are less affordable for businesses when interest rates
finance? are high
Interest-free methods of finance are usually more complex to
access, e.g. share issues and grants

What is the legal status of Unlimited liability businesses often struggle to raise finance
the business?
They may be small, own few business assets (e.g. to use as
collateral) or have a limited trading record
Lenders (e.g. banks) prefer to lend to more established businesses
that own assets
Investors prefer to invest in limited companies as they are often
able to obtain a share in the business

Examiner Tips and Tricks

You are sometimes required to recommend a suitable source of finance to meet the needs of the
business presented in a case study.

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Whilst candidates are often able to effectively analyse the benefits and drawbacks of each of the
available methods and make a judgement, the very best responses take into consideration the
specific circumstances of the business. The table above provides some structure for that Your notes
discussion.

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Planning
Your notes
Using a Business Plan to Obtain Finance
A business plan is a document produced by the owner at start-up, which provides forecasts of items
such as sales, costs and cash flow
The main aim of producing a business plan is to reduce the risk associated with starting a new business
Producing a business plan forces the owner to think about every aspect of the business before they
start which should reduce the risk of failure
It shows potential lenders or investors that the business has done their research
Producing a business plan allows lenders (e.g. banks) and other investors to analyse the plan and make
an informed decision about providing a loan
Business Angels will analyse whether there is an opportunity to increase the value of their
investment and make a worthwhile profit
Having carried out research to support the plan, the business will be well-informed about the
potential problems and chance of success and can select the most appropriate source of finance
based on this information
Most high street banks can provide a detailed template for business owners to complete when
applying for finance

Interpreting Cash-flow Forecasts

A cash flow forecast is a prediction of the anticipated cash inflows and cash outflows, typically for a
six to twelve month period
A detailed business plan should include a cash flow forecast that allows the business owners to
identify its financial needs

Key terminology and an example

The net cash flow is calculated by subtracting total outflows from total inflows
The opening balance is the previous month’s closing balance carried forward
The closing balance is calculated by adding the net cash flow to the opening balance
An Example of a Start-up Six-month Cash Flow Forecast (£s)

Jan Feb Mar Apr May Jun

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Inflows
Your notes
Cash received from sales 2,600 2,800 3,100 4,600 4,800 5,200

Capital introduced 6,000 0 0 0 0 0

Total inflows 8,600 2,800 3,100 4,600 4,800 5,200

Outflows

Inventory 1,500 850 950 1,300 1,350 1,400

Wages 2,200 2,200 2,200 2,200 2,200 2,200

Utilities 840 840 840 882 882 882

Loan repayments 0 284 284 284 284 284

Miscellaneous 230 240 250 410 260 260

Total outflows 4,770 4,414 4,524 5,076 4,976 5,026

Net cash flow 3,830 (1,614) (1,424) (476) (176) 174

Opening balance 500 4,330 2,716 1,292 816 640

Closing balance 4,330 2,716 1,292 816 640 814

Analysis of the cash flow forecast example

Executive Summary
Overall, this cash flow forecast supports an application for the business to borrow £6,000 in January
to cover the initial low inflows, significant outflows and negative net cash flow
As sales increase from June, inflows are greater than outflows, and the business has positive cash
flow

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Should a loan be approved, the business will require any short-term sources of finance, such as
overdraft facilities
January Your notes
The cash flow forecast assumes that the bank approves a £6,000 loan in January (capital introduced)
The opening balance of £500 has been introduced by the owner
The business is expected to achieve sales of £2,600
Total inflows are therefore expected to be £8,600 (£2,600 + £6,000)
Total outflows are expected to be £4,770
The Net Cash Flow is expected to be £3,830 (£8,600 - £4,770)
January’s closing balance is expected to be £4,330 (£3,830 + £500)
February
The closing balance from January becomes the opening balance for February
Sales of £2,800 as expected to be the business total inflows
Total outflows are expected to be £4,414
The Net Cash Flow is expected to be -£1,614 (£2,800 - £4,414)
The closing balance is expected to be £2,716 (-£1,614 + £4,430)
March
The closing balance from February becomes the opening balance for March
The business expects to achieve sales of £3,100 as its total inflows
Total outflows are expected to be £4,524
The Net Cash Flow is expected to be -£1,424 (£3,100 - £4,524)
The closing balance is expected to be £1,292 (-£1,424 + £2,716)
April
The closing balance from March becomes the opening balance for April
Sales of £4,600 are expected as the businesses total inflows
Total outflows are expected to be £5,076
The Net Cash Flow is expected to be -£476 (£4,600 - £5,076)
The closing balance is expected to be £816 (-£476 + £1,292)
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May
The closing balance from April becomes the opening balance for May Your notes
The business expects to achieve sales of £4,800 as its total inflows
Total outflows are expected to be £4,976
The Net Cash Flow is expected to be -£176 (£4,800- £4,976)
The closing balance is expected to be £640 (-£176 + £816)
June
The closing balance from May becomes the opening balance for June
Sales of £5,200 are the business total inflows
Total outflows are expected to be £5,026
The Net Cash Flow is expected to be £174 (£5,200-£5,026)
The closing balance is expected to be £814 (£174 + £640)

Worked Example
Here is a simple three-month cash flow forecast for a small seaside café

March April May

Inflows

Sales 46,000 54,000 61,000

Outflows

Inventory 13,000 13,000 13,000

Wages 28,000 28,000 28,000

Miscellaneous 3,500 4,000 4,000

Total Outflows 44,500 45,000 45,000

Net cash flow 1,500 9,000 16,000

Opening balance 4,000 5,500 14,500

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Closing balance 5,500 14,500 30,500

Your notes
The café owner thinks that good weather will increase the volume of customers and decides to
appoint another full-time assistant in March. As a result, wages increase to an expected £31,000 per
month
Calculate the closing balances in the cash flow forecast resulting from the changes above (4)

March April May

Inflows

Sales 46,000 54,000 61,000

Outflows

Inventory 13,000 13,000 13,000

Wages 31,000 31,000 31,000

Miscellaneous 3,500 4,000 4,000

Total Outflows 47,500 48.000 48,000

Net cash flow (1,500) 6,000 13,000

Opening balance 4,000 2,500 8,500

Closing balance 2,500 8,500 21,500

Step 1: Insert the value of the new wages into the relevant space for each month
Step 2: Calculate the new total outflows for each month and insert them into the relevant space
for each month
March: £13,000 + £31,000 + £3,500 = 47,500
April: £13,000 + £31,000 + £4,000 = 48,000 (1 mark)
May: £13,000 + £31,000 + £4,000 = 48,000
Step 3: Calculate the new net cash flow for each month and insert it into the relevant space for
each month
March: £46,000 - £47,500 = -£1,500
April: £54,000 - £48,000 = £6,000 (1 mark)
May: £61,000 - £48,000 = £13,000
Step 4: Calculate and insert the new closing balance for March and carry it forward as the
opening balance for April
£4,000 + - £1,500 = £2,500 (1 mark)

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Step 5: Calculate and insert the new closing balance for April and carry it forward as the opening
balance for May
Your notes
£2,500 + £6,000 = £8,500 (1 mark)
Step 6: Calculate and insert the new closing balance for May
£8,500 + £13,000 = £21,500 (4 marks for the correct answer)
Note that this one change in the anticipated cost of wages impacts four other variables 1.Total
outflows 2. Net cash flow 3. Opening balance (except March) 4. Closing balance

Examiner Tips and Tricks

When calculating opening and closing balances, work through each month in turn.
Always double-check your calculations in cash flow forecasts, as one mistake will have a knock-on
effect elsewhere and, in some cases, lead you to make inaccurate judgements.

Evaluating Cash-flow Forecasts

The Uses & Limitations of Cash Flow Forecasts

Advantages Disadvantages

Cash flow forecasts can support an application for a Forecasts are usually based on
loan and are an integral part of the business plan estimates and in reality, inflows and
outflows may differ significantly from
They can help identify where the business may the estimates
experience cash shortfalls or cash surpluses so that
plans can be made to manage these periods (e.g. Cash flow forecasts require
arranging an overdraft) appropriate skills, insight, research
and time to prepare and update
Cash flow forecasts aid planning and help a business adequately
avoid costly mistakes
External factors that can impact inflows
and outflows may not be reflected in
the cash flow forecast

Examiner Tips and Tricks

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Look for clues in the case study about the reliability of the forecast and draw some judgements on
the reliability of the forecast presented.
Your notes
New entrepreneurs find it especially difficult to create accurate forecasts as they have little
experience to draw on. They do often make use of free advice and guidance (e.g. from banks) or
conduct significant research to support their forecasts. In these cases, the cash flow forecast is
likely to be an excellent tool for planning. Where the cash flow forecast is constructed without such
care, it can hinder business progress and undermine the business plan as a whole.

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