Key Idea: Topic 3.2 is about where finance comes from and which source best fits the business situation. At HL, students are expected to go beyond listing sources and judge suitability using context such as business size, risk, gearing, liquidity, ownership and borrowing capacity.
🏠 Internal finance: **Internal finance —** comes from inside the business. **Retained profit —** profit kept in the business. **Sale of assets —** selling business assets for cash. **Owner's savings —** personal funds invested.
🌍 External finance: **External finance —** comes from outside the business. **Loans —** borrowed money repaid with interest. **Overdraft —** short-term flexible borrowing. **Share capital —** selling shares for investment.
Short-term vs long-term
- Short-term finance — less than 1 year (overdraft, trade credit, factoring)
- Long-term finance — more than 1 year (loans, shares, retained profit, leasing)
- Matching principle — short-term for working capital, long-term for assets
- Suitability depends on purpose, risk, cost and control
High-yield facts examiners expect
- Retained profit is common for established businesses but unavailable to new ones
- Loans increase interest costs and financial risk
- Share capital raises long-term finance but dilutes ownership
- Overdrafts are flexible but usually expensive if used for too long
- Selling assets raises cash but may reduce future capacity
🧠 Match source to situation: **Short-term need —** overdraft or trade credit may fit. **Long-term expansion —** loan, shares or retained profit may fit. **Start-up —** owner's funds, loans, angels, crowdfunding. **Established company —** wider choice of sources.
⚠️ Common finance risks: Using short-term finance for long-term assets is risky. Too much debt increases gearing and interest burden. Too much equity may weaken control. Selling assets solves cash problems only temporarily.
Always match the source of finance to the purpose.
HL exam tip: The marks are usually in the justification, not the label. Do not just name a source of finance — explain why it is suitable for that business in that situation.
Past-paper tip: HL markschemes often reward answers that connect finance choice to wider financial position, especially liquidity, gearing and borrowing capacity.
Important: Common trap: recommending retained profit to a start-up or recommending overdraft for a major long-term asset purchase.
- Identify internal or external
- Decide short-term or long-term
- Explain one advantage and one drawback
- Apply to the business context
- Judge whether it strengthens or weakens liquidity, gearing, control or risk