IB Business Management HLTopic 3 — Sources of FinancePaper 1, 2 & 3Core idea~11 min read
Raising Money From Outside the Business
When the money inside the business runs out, it has to be brought in from outside. There are a lot of options here and students often blur them together. The trick is to file each one under two headings: how long it lasts, and what it costs you — interest, ownership, or both.
📚 What you need to know
External finance comes from people or institutions outside the business.
Short-term sources include overdrafts and trade credit; long-term ones include share capital, bank loans and mortgages.
Share capital is raised by selling shares. Shareholders get dividends and a vote at the AGM, so the original owners lose some control.
Loans are repaid with interest over a set period; a mortgage is a long-term secured loan against property.
Leasing means renting an asset instead of buying it — cheaper now, more expensive over the whole period.
Newer options include crowdfunding, business angels and microfinance providers, which reach firms banks would turn away.
Sorting the sources by time
The first thing to do with any source of external finance is ask how long the money is for. Get this right and half the evaluation writes itself, because a short-term source used for a long-term purpose is almost always the wrong choice.
Learn the diagram as two columns rather than one long list. In an exam you will be picking a source for a specific problem, and the time frame narrows it down instantly.
Share capital
A limited company can raise money by selling shares. In a private limited company shares are sold to people the owners choose. A public limited company can sell to anyone, either through a flotation (its first public share sale) or a rights issue (new shares offered to existing shareholders, usually at a discount).
Shareholders become part-owners. They receive dividends when profits are shared out.
They usually get a vote at the AGM, which is where directors are appointed.
There is no repayment date and no interest, which makes it very different from a loan.
The cost is dilution of control: the more shares are sold, the smaller the original owners’ say.
Only limited companies can do this. If the case study is a sole trader or a partnership, share capital is not available to them. Saying “sell shares” about a sole trader loses marks instantly.
Loans, mortgages and overdrafts
These are all bank finance, but they behave completely differently and examiners like to see that you know the difference.
Source
How it works
Best used for
Main risk
Bank loan
A fixed sum, repaid in instalments with interest over an agreed period
Buying equipment or funding expansion
Repayments must be met whether trade is good or bad
Mortgage
A long-term loan secured against land or property, often 10 to 25 years
Buying premises
The property can be taken if repayments are missed
Overdraft
Permission to go below zero in the current account, up to an agreed limit
Short cash-flow gaps
Expensive rate, and the bank can call it in at any time
Interest on an overdraft is charged only on the amount you are actually overdrawn, and only for the days you are overdrawn. That flexibility is why firms use it for short gaps even though the rate looks high.
WORKED EXAMPLE
What a loan really costs
A firm borrows $50,000 over 5 years. Interest is charged at 8% per year on the full amount borrowed. Calculate the total interest, the total repaid, and the monthly repayment.
Step 1: Interest for one year$50,000 × 0.08 = $4,000Step 2: Interest over the whole loan$4,000 × 5 = $20,000Step 3: Total repaid$50,000 + $20,000 = $70,000Step 4: Spread over 60 months$70,000 ÷ 60 = $1,166.67$70,000 in total, $1,166.67 a monththe firm pays back 40% more than it borrowed — that is the real cost of the loan
Trade credit and leasing
Trade credit is an agreement to receive goods now and pay for them later, usually 30 to 90 days later. It is normally interest-free, which makes it one of the cheapest sources a business can use. The catch is that suppliers only offer it to firms with a track record, so new businesses often cannot get it.
Leasing means renting an asset rather than buying it. The business pays a regular amount and uses the asset, but never owns it. Maintenance and repair are usually the leasing company’s problem.
WORKED EXAMPLE
Lease or buy?
A print shop can buy a machine outright for $13,000, or lease it for $450 a month over 3 years. Compare the two options in money terms and comment.
Step 1: Total cost of leasing$450 × 36 months = $16,200Step 2: Compare with buying$16,200 − $13,000 = $3,200 more expensiveLeasing costs $3,200 more over 3 yearsbut the firm avoids paying $13,000 today, keeps its cash, and hands repair bills to the leasing company — worth it if cash is tight
The newer sources
Crowdfunding. Many small investors put money in through an online platform. It needs a convincing pitch because the business is competing with thousands of other projects. Backers are often rewarded with early access or a sample rather than a share of profits.
Business angels. Wealthy individuals who invest in start-ups in exchange for a stake. They accept more risk than a bank and often bring useful expertise and contacts, but they will want a say in decisions.
Microfinance providers. Small lenders who serve people and firms that no bank will touch, often in low-income countries. Formalities are minimal but the amounts are small.
Family and friends. Common for start-ups. Usually cheap and informal, but a business failure can damage the relationship badly.
The choice underneath every source
Debt → you keep control but must repay Equity → nothing to repay but you give away ownership
🧩 Building a full evaluation of an external source
Say what it is in one clear sentence.
Say why it fits this business — use a detail from the case study.
Give the cost — interest, rent, lost control or lost profits.
Give the risk — what happens if trade goes badly?
Compare with one alternative and then decide.
💡 Exam tip
Check the legal structure of the business before recommending anything. Share capital is only possible for limited companies.
Loans need collateral. If a case study firm owns very little, say that this makes borrowing harder or more expensive.
Small firms usually pay higher interest rates than large ones because lenders see them as riskier. That is a strong point in comparison questions.
Never recommend one source and stop. Compare at least two, then justify.
Use the numbers you are given. An answer that calculates the actual cost of the finance always beats one that only describes it.
⚠ Common mix-up
Muddling an overdraft with a loan. A loan is a fixed sum for a fixed period; an overdraft is a flexible limit that the bank can withdraw.
Thinking share capital has to be repaid. It does not. Shareholders get dividends and a vote instead.
Saying leasing is always cheaper. It is cheaper now, but usually more expensive over the whole period.
Assuming trade credit is available to everyone. New firms with no trading record are often refused.
Treating crowdfunding as easy money. Most campaigns fail, and running one takes real time and effort.
Forgetting that business angels want control as well as a return.
Up next: Picking the Right Source of Finance — the factors that decide which of all these options a business should actually choose.
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