IB Business Management SLTopic 3 — Sources of FinancePaper 1 & 2Core skill~11 min read
Picking the Right Source of Finance
This is the page the exam actually tests. Knowing what an overdraft is gets you two marks. Explaining why this business, with this history, needs an overdraft and not a mortgage gets you the rest.
📚 What you need to know
Most businesses use a combination of sources, not one.
Purpose comes first: what is the money buying?
Timescale: short-term needs get short-term finance; long-term assets get long-term finance.
Cost: interest, fees and the price of issuing shares.
Legal structure: only limited companies can sell shares; small firms face higher rates.
Control: selling equity means sharing decisions and profit.
Existing debt and credit history: highly geared firms and start-ups get refused.
Start with the purpose
Ask one question before anything else, and half the possible answers disappear straight away.
Answer this question in your first sentence and the examiner knows immediately that you understand the topic.
The seven factors
Factor
The question to ask
What it rules in or out
Purpose
What is being bought?
A mortgage for property; an overdraft for a cash gap
Timescale
How long is the money needed for?
Short need rules out long loans, and the reverse
Amount
How much is needed?
Microfinance and savings cannot fund millions
Cost
Interest, fees, dividends — what is the total?
High rates rule out borrowing for thin-margin firms
Legal structure
Sole trader, partnership or company?
Only companies can issue shares
Control
Is the owner willing to share decisions?
If not, equity is out and debt is in
Existing debt
How much is already borrowed?
Highly geared firms get refused or pay more
Timescale
Short-term finance covers unexpected costs and bills — small amounts, rarely needed beyond a year. Long-term finance buys non-current assets — large sums tied up for years. Mixing them up is the classic mistake.
Cost
Fixed interest rates stay the same for the whole loan, which makes planning easy, and are usually a bit higher for that reason. Variable rates move with the market, so repayments can rise unexpectedly. Selling shares has its own costs: flotation is expensive, and a rights issue is usually priced at a discount, so less is raised per share.
Legal structure and control
Sole traders, partnerships and small private companies are seen as a bigger lending risk, so they borrow smaller amounts at higher rates. Public limited companies can access far more sources and offer assets as security. And any equity raised means giving away a slice of ownership — smaller firms often have little bargaining power when negotiating those terms.
Existing debt and credit history
A highly geared business already carries a lot of debt, so lenders see more risk and either charge more or say no. A firm with a poor or non-existent borrowing record may fail credit checks entirely, which is exactly why crowdfunding, business angels and microfinance exist.
Use this as your conclusion structure: if the project is fairly certain, borrow; if it is risky, share the risk.
🧩 Answering a “recommend a source” question
State the purpose and the amount. Pull both from the stimulus.
Set the timescale. Long-lasting asset or short gap?
Rule things out. Legal structure, credit history and existing debt remove options fast.
Choose one source and say precisely why it fits this purpose and this firm.
Give the drawback of the source you chose. Never pretend it is perfect.
Conclude with a condition: “provided sales hold up”, “as long as the owner accepts a partner”.
Worked examples
WORKED EXAMPLE 1
Recommending a source [6 marks]
Amaya is a sole trader running a mobile coffee van. She needs a second van costing $28,000. She has $6,000 in savings, has traded profitably for four years and has never missed a payment. Recommend a source of finance.
Step 1: purpose and amount
A van — a long-lasting asset. $28,000 − $6,000 savings = $22,000 still needed.Step 2: rule things out
Sole trader, so no share capital. Long-term asset, so not an overdraft. Trade credit does not buy vans.
Step 3: what fits
A secured bank loan over 4 to 5 years, or leasing the van. Four profitable years and a clean record make a loan realistic.
Use the $6,000 savings plus a $22,000 bank loanStep 4: the drawback
Repayments become a fixed monthly cost, and as a sole trader she has unlimited liability if the second van does not earn.
a good alternative to mention: leasing avoids the deposit entirely and includes maintenance, but costs more over the van’s life
WORKED EXAMPLE 2
When the obvious source is not available [10 marks]
A three-year-old software firm needs $1.2m to launch in two new countries. It has never made a profit, owns no property, and already has a $400,000 bank loan. The founders want to keep control. Evaluate its options.
Step 1: what is ruled out immediatelyNo profit → no retained profit. No property → no security and no sale of assets.Step 2: test more borrowing
Already carrying $400,000 with no profits. A bank sees a highly geared, loss-making firm and will refuse or price it very high.
Step 3: what is left
Equity: business angels or venture-style investors, or equity crowdfunding.
Step 4: face the conflict
The founders want control, but the only realistic $1.2m comes from selling a stake. Something has to give.
Raise equity, or shrink the plan to one countrythe top-band move is exactly this: point out that the objective and the finance available do not match, so either the objective or the wish to keep control has to change
💡 Exam tip
Rule options out loud. “As a partnership it cannot issue shares” is a mark, not a wasted sentence.
Use the numbers. Subtract what the firm already has from what it needs, and finance the gap.
Recommend a combination where it fits — savings plus a loan is often the realistic answer.
Mention availability, not just suitability. A source the firm cannot get is not an answer.
Look for clues about the owner: their age, their attitude to risk, whether they want to retire or expand.
Finish with a condition. Unconditional recommendations rarely reach the top band.
⚠ Common mix-up
Recommending share capital for a sole trader. Check the legal structure before you write anything.
Using an overdraft to buy an asset. Wrong timescale, high interest, and it can be called in.
Ignoring existing debt. If the case gives you a gearing figure or an existing loan, it is there for a reason.
Treating “cheapest” as “best”. The cheapest source is no use if the business cannot get it.
Forgetting the owner’s aims. Someone who wants to stay in charge will not accept an investor.
Listing all nine sources. Choose, justify, and give the drawback. Lists score in the bottom band.
Up next: Fixed, Variable, Direct and Indirect Costs — once the money is raised, the next question is where it all goes.
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