IB Business Management HLTopic 3 — Sources of FinancePaper 1, 2 & 3Core skill~10 min read
Picking the Right Source of Finance
Knowing the sources is the easy half. The marks are in choosing between them and defending the choice. There is no source that is always best — the right answer depends on how much is needed, for how long, what it costs, and who ends up in charge afterwards.
📚 What you need to know
Most businesses use a combination of sources, not just one.
The main factors are amount, timescale, cost, legal structure, control and existing debt.
Match the finance to the purpose: short-term needs get short-term finance, long-term assets get long-term finance.
Not every source is available to every business. A poor credit history or a new trading record closes doors.
A business that is already highly geared (heavily in debt) will struggle to borrow more.
Raising money by selling shares means giving away ownership and control, which some owners will not accept.
The six factors
Use this as a checklist in Paper 2. Running through all six takes about thirty seconds and stops you writing a one-sided answer.
Amount needed
Small amounts can often come from savings, retained profit or trade credit. Large amounts usually need a bank or investors. If a firm needs $2 million, suggesting the owner uses personal savings is not a serious answer.
Timescale
Short-term needs are things like paying a supplier before customers pay you. These are small and rarely last beyond a year, so overdrafts and trade credit fit. Long-term needs are things like buying premises. These are large and tie money up for years, so loans, mortgages and share capital fit.
The matching principle. Fund a long-lived asset with long-term finance and a short-lived need with short-term finance. Examiners love seeing this idea applied, not just stated.
Cost
Interest is the obvious cost, but not the only one. Variable interest rates can rise during the loan, which makes planning harder. Fixed rates stay the same, which is safer, so lenders usually charge a bit more for them. Selling shares has costs too: flotation involves paying merchant banks, and a rights issue is normally priced at a discount.
Legal structure
Sole traders, partnerships and small private companies are seen as riskier borrowers. They tend to be offered smaller amounts at higher interest rates. Public limited companies can reach far more sources and usually have valuable assets to offer as collateral.
Control
Selling shares or taking money from a business angel means letting someone else into the decision-making. For a founder who has built the business from nothing, that can matter more than the interest rate. Debt keeps control but brings the obligation to repay.
Level of existing debt
A highly geared business already carries a lot of debt. Lenders see it as risky and either refuse or charge more. In that situation raising share capital is often more realistic than borrowing again.
1
PURPOSEWhat is the money actually for?
2
AMOUNTHow much, and can internal cover any of it?
3
SHORTLISTWhich sources are even available to this firm?
4
JUDGEWeigh cost against control, then decide
WORKED EXAMPLE
A short-term cash gap
Priya is a sole trader running a garden centre. Sales collapse over winter and she needs about $4,000 for two months to cover wages and a supplier bill. She has no savings left. Recommend a source of finance.
Step 1: Purpose and timescale
Working capital, needed for two months only.
Step 2: What is not availableShe is a sole trader, so share capital is impossible. She has no savings, so internal finance is out.Step 3: ShortlistOverdraft or trade creditStep 4: Judge
An overdraft charges interest only on what she uses, only for the days she uses it. A 5-year loan would still be costing her interest long after winter ended.
Recommend an overdraftrisk to mention: the bank can call an overdraft in at short notice
WORKED EXAMPLE
A large long-term project
Northgate Foods plc needs $2 million for a new factory. It already has $8 million of long-term loans and a family shareholding of 55%. Discuss how it should raise the money.
Step 1: Purpose and timescale
Capital expenditure on an asset that will last decades → long-term finance.
Step 2: The complicationIt is already carrying $8m of debt, so it is highly geared. More borrowing may be refused or priced high.Step 3: The two realistic optionsA mortgage secured on the factory, or a rights issue of sharesStep 4: The trade-off
A mortgage keeps the family’s 55% intact but adds to gearing. A rights issue reduces the debt burden but may push the family below 50% and cost them control.
Rights issue, given the existing debta fair conclusion could go either way — what earns the marks is naming the control cost
There is rarely a single correct recommendation in these questions. Examiners are marking your reasoning, not your opinion. A well-argued “loan” and a well-argued “share issue” can both score full marks on the same case study.
Situation in the case study
Sensible choice
Reason
Sole trader, small short-term gap
Overdraft or trade credit
Flexible, cheap for short periods, no shares to sell
