21

Business finance: needs

and sources
Revision answers
1 i) Finance needed to buy or rent premises and equipment.
ii) Finance needed to pay for inventories until these are sold and cash received
from customers.
2 Internal finance is obtained from the business’s own resources or assets, such as
selling assets no longer needed.
External finance is received from people or institutions outside of the business;
this will increase liabilities of the business.
3 Internal finance can be raised by:
i) Sale of inventories (reducing working capital) for cash. This will involve no
interest costs.
ii) Using retained profits if these are held in cash. This will not increase the debts
of the business.
4 Long-term finance is for over a period of at least one year, for example, a
long-term loan.
Short-term finance is required for a period of less than one year, for example, an
overdraft.
5 i) Arranging an overdraft: this is a flexible form of finance that can be varied to
meet business needs.
ii) Trade credit: obtaining supplies but delaying the payment for them. No
interest is payable on such finance.
6 Overdraft is flexible and the amount can be varied according to business
needs.
Interest is only payable on the amount overdrawn, not the full amount of a
pre-arranged bank loan.
7 Share capital is not repaid to shareholders – unless the company is sold – and is
therefore permanent finance, unlike long-term loans.
8 i) Share issues may dilute or change the ownership of the business. More
shareholders mean less control for the original shareholders. Bank loans do
not change ownership.
ii) Once a loan has been repaid the liabilities of the business fall and so do
interest charges. Shareholders will always expect dividends to be paid.
9 Leasing: asset is never owned by business and leasing charges can be expensive
but full purchase price does not have to be financed at once and maintenance is
paid for by leasing company.
Long-term loan: asset is owned by business; does not change ownership of
business; fixed interest rate might be possible. But interest costs can be high;
loan must be repaid.
Shares: ownership diluted; dividends expected by owners of new shares. BUT
asset owned by business, dividends can be reduced or suspended; share capital
does not have to be repaid.
10 i)  Share price and how the share price has varied in recent years (if the business
is a public limited company).
ii) The profits of the business over recent years and whether the prospects for
future profits are good.

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 21 Business finance: needs and sources

Answers to activities
Activity 21.1
Capital expenditure: building; computer; gym equipment.
Others are all revenue expenditure.

Activity 21.2
a) Buy or lease a car; pay for adverts (other answers possible).
b) Car purchase or leasing charge; advert costs; rent of office, for example, for
taking telephone calls; rent of garage for car; fuel for taxi.
c) Capital: Car purchase. Others are all revenue expenditure unless Paul actually
purchases premises or a lease on them.

Activity 21.3
a) Profit not available to new businesses as they have not made any yet!
b) Bank is most unlikely to finance all of the capital required so Paul’s savings will
be important to convince the bank to lend some of the capital required.
c) Paul’s business may hold some inventories of stationery, etc., but these would
be of very low value, unlike a manufacturing business. This service business does
not hold a high value of inventories.

Activity 21.4
a) Parveen is female (banks in some countries discriminate against women); she
is not employed and not an experienced entrepreneur; she probably has no
savings/capital of her own.
b) Helped her to start her own business; to become independent and eventually
offer jobs to others; some financial security.

Activity 21.5
a) If retained profits are sufficient and in a cash form, this source of finance has
the benefit of being obtainable immediately, with no interest costs and no
repayment necessary.
b) Paul might be advised to take out a bank loan when retained profits are not
sufficient to finance all of his expansion plans, when interest rates are low or
likely to fall and if the bank offers good ‘terms’, for example, long repayment
period.

Activity 21.6
Short term: overdraft and trade credit. Others all long term.

Activity 21.7
a) Company A: overdraft; bank loan; retained profits if in cash form.
b) Company B: share issue; debentures; retained profits if substantial enough and
in cash form.
c) Company A: profits if available in cash, if not an overdraft; a bank loan might be
for several years but an overdraft of $15 000 could, hopefully, be paid off quickly
and this will reduce total interest payments.
Company B: share issue if retained profits are insufficient as there will be no
interest costs and it already has a big bank loan; bank might be unwilling to lend
more.
d) Other information:
Company A: profitability; existing loans/overdraft; how quickly the managers
would hope to be able to pay back the $15 000.

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 21 Business finance: needs and sources

Company B: profitability; gearing ratio/size of existing loan; interest rates; share

prices and how this had changed recently; risk of losing control if many new
shares are issued.

Activity 21.8
a) Sole trader: partner would increase capital but reduce sole trader’s
independence. No interest payable on partner’s capital but share of profits will
be expected to be given. Student’s own conclusion.
‘Going public’ is a very big and expensive step to take; it can raise a very large
capital sum (which would be expensive to raise from a loan) but there is a risk
of takeover from other businesses; original owners will experience some loss of
control. Student’s own conclusion.
Plc: similar to above, except that company already has a stock exchange listing.
Potential loss of control/takeover, but share issue can raise large capital sum
which would be very expensive to borrow.
b) i) and ii)
Student’s own answer based on textbook guidance and the support given by
answers above.

Activity 21.9
a) Yes: share price could rise again; Stock Exchange seems to be rising, reflecting
rising investor confidence; company pays good dividends.
No: why has share price fallen even though share prices in general have
increased? High gearing and high interest costs: which will be made worse if
interest rates increase?
Student’s overall conclusion.
b) Company profits; management team – any recent changes?; economic
forecasts; share prices of other similar companies

Sample answers to Paper 1 style questions

(with mark annotations for Question 2)
1 a) Very small sums of capital provided to start or expand new enterprises.
b) i) Buying cloth to make clothes.
ii) Buying a sewing machine.
c) i)  She had no experience of owning and running a business: she was an
employee of another business.
ii) She may not have had any capital herself to invest in the business, she may
have had a low paid job in the factory.
d) i)  It is still a small business so the costs of external finance (interest) might
reduce profits too much: internal finance will have no interest cost.
ii) As Michelle is a sole trader, if she asked another person to invest in the
business, for example, a partner, then she might lose some control over
the business; internal finance does not change the ownership or control of
the business.
e) Yes: access to more capital for expansion by selling shares to friends/family;
higher status for dealings with other businesses; continuity – she will be able
to pass the business on to her family, for example. She will gain limited liability.
No: she will have legal formalities; she will have to publish the accounts
of the business; the other shareholders might influence the management/
control of the business so she will lose some independence.
Overall conclusion/judgement needed.

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 21 Business finance: needs and sources

2 a) Finance that is needed by a business for more than one year. [2K]
b) i) Overdraft
ii) Credit from suppliers (trade credit) [2K]
c) i) He could have saved up the small (retained) profit he makes each year to
buy the tractor. [1K; 1App]
ii) He could have sold some of the assets of the business, perhaps some land
from the farm. [1K; 1App]
d) i) The bank would want to see the income statement (profit/loss) of the
business to see whether it was profitable and able to afford the tractor
and the loan he needed for it from annual profits. [1K; 1App; 1An]
ii) The bank would want to see a cash-flow forecast to see if Akram had
forecasted for the loan interest and loan repayments, otherwise he might
face a cash-flow problem. [1K; 1App; 1An]
e) Yes: share capital will not have to be repaid. There will be no interest costs,
which is important to Akram as his annual profits are only small.
No: it will mean some loss of ownership and control and Akram might value
his independence; a loan should eventually be repaid and Akram would still
be the sole owner of the business.
Student’s overall conclusion. [1K; 1App; 2An] + [2Eval]

Answers to revision test

 1 4)
 2 1)
 3 4)
 4 2)
 5 4)
 6 1)
 7 4)
 8 4)
 9 3)
10 1)
11 3)
12 2)
13 4)
14 1)
15 4)

Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 4