Finance: Sources of Finance and Cash Flow
Businesses need money to start, to operate day to day and to grow, and choosing the wrong source of finance can sink an otherwise healthy firm. For AQA GCSE Business 8132 you need to compare internal and external sources of finance, and explain why cash flow, not profit, is what keeps a business alive week to week.
Internal and short-term sources of finance
Internal sources come from inside the business. Retained profit is profit kept back rather than paid to owners; it costs nothing in interest and involves no outsiders, but it is limited to what the business has actually earned. Selling unused assets can also raise cash.
Short-term external sources cover gaps in day-to-day finances. An overdraft lets a business spend more than is in its bank account up to a limit, useful for brief shortfalls but expensive if used for long, since interest rates are high. Trade credit means buying supplies now and paying the supplier later, often after 30 or 60 days, which is effectively an interest-free loan, though missing payment dates damages the relationship and future terms. These sources suit temporary needs, not major purchases.
Long-term external sources
For big investments, businesses look to long-term sources. A bank loan provides a lump sum repaid with interest over several years; repayments are predictable, but the bank may demand security and start-ups can be refused. A share issue sells part-ownership of a company in exchange for capital that never has to be repaid, though new shareholders expect dividends and dilute the founders' control. Government grants sometimes support particular regions or activities and do not have to be repaid.
Crowdfunding raises money from many small investors online. BrewDog ran one of the UK's best-known examples: its 'Equity for Punks' scheme raised over £80 million from roughly 200,000 small investors between 2009 and 2021, funding breweries and bars while turning investors into loyal customers who promote the brand. The trade-off was thousands of shareholders and heavy public scrutiny of every business decision.
Cash flow and cash-flow forecasts
Cash flow is the movement of money into and out of a business. A business can be profitable on paper yet fail because cash runs out before customers pay their invoices; suppliers, staff and landlords all demand real money on time. This is why cash flow is often called the lifeblood of a business.
A cash-flow forecast predicts monthly inflows and outflows and the resulting bank balance, so problems appear on paper months before they happen. If March shows a negative balance, the owner can act early: arrange an overdraft, delay buying equipment, chase customer payments, negotiate longer trade credit or cut costs. Forecasts are only predictions and rest on assumptions about sales, but a business that forecasts badly is guessing, and lenders will not back a business that cannot show it understands its own cash position.
Key terms
Practice questions
State two short-term sources of finance available to a business. [2 marks]
Model answer guidance: One short-term source is a bank overdraft. Another is trade credit from suppliers. Both help a business cover temporary gaps in its cash flow.
Explain one difference between cash and profit. [3 marks]
Model answer guidance: Profit is revenue minus costs over a period, shown in the accounts. Cash is the actual money available to the business right now. A business can be profitable but still run out of cash if customers have not yet paid their invoices, which is why profitable businesses can still fail.
Analyse one benefit to a small business of using trade credit. [6 marks]
Model answer guidance: Trade credit lets the business receive and even sell goods before paying the supplier, often 30 or 60 days later. During that time the business can turn the stock into revenue, so it funds its purchases with customers' money rather than its own, easing cash flow without paying any interest. The benefit depends on paying on time, because late payment can lose the credit terms and damage the supplier relationship the business relies on.
Analyse how a cash-flow forecast could help a seasonal business such as a seaside hotel. [9 marks]
Model answer guidance: A seaside hotel earns most of its cash in summer but pays wages, maintenance and utilities all year, so winter months will show cash flowing out faster than it comes in. A forecast makes the size and timing of the winter shortfall visible months ahead, letting the owner arrange an overdraft in advance, spread annual costs, or set aside summer surpluses to cover the gap. Without the forecast the shortfall arrives as a surprise, forcing panic borrowing at worse rates or missed payments, so the forecast converts a predictable seasonal pattern into a plan rather than a crisis.
A small bakery needs £30,000 to buy a new oven. Recommend the best source of finance for this purchase. Justify your answer. [12 marks]
Model answer guidance: An overdraft is wrong for this purchase: it is designed for short gaps and its high interest would make a £30,000 purchase very expensive. Retained profit would be ideal if available, since it costs no interest, but few small bakeries hold £30,000 spare, and draining all reserves would leave nothing for emergencies. A bank loan matches the situation best, because the oven is a long-term asset that will generate revenue for years while the loan is repaid in predictable instalments, and the oven itself can act as security. Crowdfunding worked for BrewDog, but it suits businesses with a story that excites thousands of investors, not routine equipment. I recommend a bank loan, possibly combined with a deposit from retained profit to reduce the amount borrowed and the interest paid.
Examiner tips
- Match the source to the purpose: short-term sources for temporary gaps, long-term sources for equipment and expansion. Mismatching them is a classic error.
- Never write that profit and cash are the same thing; showing you know the difference earns credit across the whole finance topic.
- In cash-flow questions, name specific fixes such as arranging an overdraft, chasing payments or negotiating trade credit, not just spend less.
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