Choosing Appropriate Sources of Finance (OCR GCSE Business)
Revision Note
The Choice of Finance
There are many factors that managers must consider before deciding upon the type and source of finance required
The business may need to use more than one source of finance at the same time
Finance managers frequently have to make recommendations to their CEOs about the most suitable form of financing to use
An Explanation of the Factors Affecting the Choice of Finance
Factor to Consider | Explanation |
|---|---|
What is the purpose of obtaining finance? |
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How long is the finance required, and when can it be paid back? |
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How much finance is needed? |
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What is the legal structure of the business? |
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How much risk is involved? |
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How much control and ownership does the company want to keep? |
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Examiner Tip
A business is likely to consider internal sources of finance before taking on the burden of making repayments with interest or sharing ownership by selling shares.
Available sources of finance differ according to whether a business is a start-up or is more established
Start-up businesses are likely to have limited sources of finance to fund initial costs
Owners' capital is often the only available source
Some suppliers may offer limited trade credit
Attractive business ideas may attract crowdfunding
Established businesses usually have access to a wider range of finance, though this will depend on legal structure and financial status
Case Study
ESTABLISHED SOLE TRADER
A small retail store selling fashion trainers has sold large quantities of stock since an influencer promoted the store on TikTok. It needs to quickly replenish its stock. The sole trader, Toby, is considering using his existing overdraft or trade credit.
Explain the most suitable source of finance for this business.
Key considerations
New stock is needed quickly so the existing overdraft facility on his bank account could be an instant source of finance
Trade credit means he would not have to pay for stock straight away, which would avoid cashflow problems as stock can be sold before payment to the supplier is due
Recommendation
An overdraft is a short-term source of finance and Toby will have to pay interest on the amount that he uses
Trade credit would ease financial pressure as stock is replenished and he may receive a discount when he sets up the agreement
Most finance managers would recommend to Toby that he first seek trade credit. If he is unable to secure that, then he should consider using his overdraft facility
Case Study
ESTABLISHED PRIVATE LIMITED COMPANY
A very successful private limited company manufactures and sells wooden tables and chairs. It has been running for 15 years and has an excellent reputation. It has previously reinvested profits to fund expansion. It now needs more finance to fund growth into new markets.
Explain the most suitable source of finance for this company.
Key considerations
The business is a limited company, so selling shares to family and friends is an option to raise a limited amount
With 15 years of success, it is less of a risk than a new start-up, so a bank loan could be obtained
The scenario indicates that reinvesting profits will not be enough to finance growth plans
Recommendation
A bank loan could be easy to obtain due to business success over the last 15 years. Repayments are spread over several years and interest must be paid
The business could issue new shares to existing shareholders, which may increase their investment due to business success as family and friends may want to be part of its exciting growth plans
The decision will depend upon how much control and ownership the business owner may lose by issuing more shares
Most finance managers would recommend obtaining a bank loan, as this is often preferable to losing ownership and a share of future profits
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