December at the bakery: Every December, Lena's Bakery Ltd bakes twice as many cakes. For a few weeks, the bakery needs cash it has not yet received.
| In December | What happens |
|---|---|
| Flour | The Mill Lane bakehouse orders about $8,000 more flour from Valley Grain than in a normal month. |
| Customers | The cafés and hotels that buy on credit pay at the end of the month. |
| Staff | Priti's bakers and the counter staff are paid every week. |
| By January | The cakes are sold and the money is in. |
Money a business needs for less than a year is short-term finance. It is paid back within twelve months, often within weeks. It pays for the day-to-day running of the business: stock, wages and bills, the revenue expenditure you met in 3.1.2. The money comes back quickly, as the stock is sold and customers pay, so the finance can be repaid quickly too.
Three short-term sources at the bakery
Trade credit from Valley Grain
Valley Grain delivers the flour now and lets the bakery pay 30 days later. By then the Christmas cakes are sold. At the end of 2025 the bakery owed its suppliers $45,000 this way.
The bank overdraft
The bank lets the account go below zero, up to a limit of $30,000. When a hotel pays late and wages are due on Friday, the overdraft covers the gap. At the end of 2025 the bakery was using $15,000 of it.
A short-term loan
A fixed sum borrowed and repaid, with interest, within a year. It suits a need with an end date, such as the stock and extra hours for a one-year supply contract.
Short-term is about the need: Trade credit and an overdraft are short-term by nature: the supplier wants paying within weeks, and the bank can reduce or withdraw the overdraft at short notice.
So the first question is never 'which source?' but 'how long will the money be tied up?' For December's flour, the answer is about a month.
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The Mill Lane bakehouse: When Lena and Marco built the Mill Lane bakehouse (1.4.3), it cost $600,000. The building and its ovens will bake bread for decades.
How it is being paid for
- They borrowed $400,000 from the bank.
- They are paying it back in instalments, with interest, over many years.
- At the end of 2025, $350,000 was still owed.
- The bakehouse pays for itself slowly, a few thousand loaves at a time.
Money a business needs for more than a year is long-term finance. It pays for the things that earn money over many years: buildings, ovens, vans, a new shop, the capital expenditure from 3.1.2. Because the asset pays back slowly, the finance must give the business years to pay, or never ask for the money back at all.
| Source (3.2.1 and 3.2.2) | Usually | Why |
|---|---|---|
| Trade credit | Short-term | The supplier expects payment within weeks |
| Overdraft | Short-term | Flexible, but the bank can cut it at short notice and the interest is high |
| Loan capital (a bank loan, or a mortgage secured on property) | Long-term | Repaid in instalments over a fixed number of years |
| Share capital | Long-term | Never repaid: the investor owns part of the company |
| Business angels | Long-term | Money for shares, often with advice; the angel stays in for years |
| Crowdfunding | Long-term | Many small investors, usually for a project or for shares |
| Leasing | Long-term | Regular payments for the use of an asset over several years |
| Microfinance providers | Either | Small loans; judge by how long the loan runs |
| Personal funds, retained profit, sale of assets | Long-term | The money stays in the business with no date for paying it back |
The one-year line: Less than a year: short-term. More than a year: long-term.
Judge a source by how long the business has the money for, not by how big the sum is. A $5,000 loan over three years is long-term; a $40,000 overdraft is still short-term.
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The rule behind every choice is simple: the finance should last as long as the need.
The matching principle
- Money tied up for weeks comes from a short-term source.
- Money tied up for years comes from a long-term one.
- This is sometimes called the matching principle.
Here is how Lena's Bakery Ltd applies it.
| What the bakery needs | How long the money is tied up | A source that fits |
|---|---|---|
| Extra flour for December | About a month, until the cakes are sold | Trade credit from Valley Grain |
| Wages on Friday while a hotel pays late | A few days | The overdraft |
| Stock and hours for a one-year hotel contract | One year, paid back as the hotel pays | A one-year loan |
| A new oven for Mill Lane | About fifteen years of baking | A bank loan over several years, or leasing |
| A fourth shop | Ten years or more | A long-term loan, or new shares sold to an investor |
Short money for a long need
- Paying for the $45,000 deck oven with the overdraft
- The bank can reduce or withdraw the overdraft at short notice, long before the oven has paid for itself
- Overdraft interest is high and can change, so the oven costs far more than planned
Long money for a short need
- Paying for December's flour with a five-year loan
- The flour is sold in weeks, but the repayments and interest carry on for five years
- Money borrowed for longer than it is needed costs interest for nothing
Matched
- Trade credit for the flour: it is sold before Valley Grain is paid
- A loan over years for the oven: each year's bread helps pay that year's instalment
- The finance ends when the need ends
The overdraft trap: An overdraft is easy to use, so it is tempting to let it pay for everything. Using it for a building, machinery or a new shop is the classic mistake.
If the bank cuts the limit, the business must find the money at once, and it cannot sell half an oven. A cash problem becomes a crisis.
Matching narrows the list; it rarely leaves one answer. For a fourth shop, a long-term loan and new shares both last long enough. To choose between sources that both fit, the bakery asks a few more questions.
Questions that decide between sources that fit
- What does it cost? Interest on a loan; dividends and a share of every future profit for new shares.
- How much is needed? Trade credit cannot raise $120,000; a business angel can.
- Who will control the company? New shares dilute the owners; a loan does not, but the bank wants its instalments every month.
- Can the business afford the repayments? Compare them with its profit and cash, and with what it already owes. The bakery still owes $350,000 on Mill Lane.
- How fast, and what kind of business? An overdraft is ready today; shares take weeks to agree. A privately held company like Lena's Bakery Ltd cannot sell shares on the stock exchange (1.2.3).
Cost as a rate: When the bakery signed a one-year contract to supply a hotel group, it needed $10,000 up front for stock and extra hours. It took a one-year loan, repaid in 12 monthly payments of $900.
Was that cheap? Turn the interest into a rate, so it can be compared with other offers.
Worked example: the interest rate on a one-year loan
Add up everything repaid
12 payments x $900 = $10,800.
Take away the amount borrowed
$10,800 - $10,000 = $800. That is the interest.
Divide by the amount borrowed, times 100
Interest rate = interest ÷ amount borrowed x 100 = $800 ÷ $10,000 x 100 = 8%.
Say what it means
The loan cost 8% for the year. The contract's profit must cover that $800, and a rival offer at 6% would have been cheaper.
Show every line: Interest rate = (total repaid - amount borrowed) ÷ amount borrowed x 100.
Write each line of the working and finish with a % sign: 8%, not 8 and not 0.08.
Know your predicted grade
Take timed mock exams and get detailed feedback on every answer. See exactly where you're losing marks.
How this comes up: A case or a short stimulus describes something a business needs money for: a machine, a repair, a new site.
What you are asked
- Explain one suitable source, for two marks.
- Discuss two sources, or recommend one of two options, for ten.
- With a table, calculate the interest rate on a short-term loan, showing your working.
The ten-mark answer: In the ten-mark answer, a short-term source for a long-term need is simply not appropriate. The marks go to sources that fit, weighed with the case's own figures.
The recommendation pattern
- Match first. How long is the money tied up? Rule out any source that ends before the need does.
- Argue each option both ways. Cost, control and risk, each with a figure from the case.
- Test the repayments. Set them against the profit, the cash and the debt the business already has.
- Decide, with a condition and a limitation. Choose one, say what would change your mind, and name what the figures cannot show.
The trap: one option, no numbers: 'A loan means interest, shares mean losing control' is true of every business. Say how much interest, and whose control, in this case.
An answer that argues one option and ignores the other, or never uses the figures, stays in the middle marks however well written it is.
Using the information above, recommend whether Lena's Bakery Ltd should finance its fourth shop with Option 1 or Option 2.
Model answer plan
See the answer broken into clear points, with guidance on how each point earns marks.