Business finance: needs and sources · IGCSE Business

Explain one advantage and one disadvantage to Peter of using crowdfunding as a source of finance. Award 1 mark for identification of each relevant advantage/disadvantage (max 2) Award 1 mark for each relevant reference to this business (max 2). Award 1 mark for each relevant explanation (max 2). Points might include: Advantages:

• No/low interest charged [k] so does not increase cash outflows [an] for this sole trader [app]
• Can raise a large amount of finance [k]
• Can test public reaction [k] and decide whether to start the business [an]
• Builds customer relationship/create brand awareness [k] which could lead to more customers [an] for this small business [app]
• May not need to repay/permanent [k] so does not add to its liabilities/debt [an]
• No collateral/security/credit history needed [k]
• May get advice/feedback [k]
• Fast way to raise finance [k]
• Maybe available when other sources of finance are not available [k] Disadvantages:
• No guarantee can raise full amount / may not raise sufficient funds / not reliable source [k] must repay everyone if cannot raise full amount /so may need to find another source [an] for this new business [app]
• Crowdfunding site may reject the proposal [k] therefore the owner’s time has been wasted [an]
• Competitors may learn more about your business before launch [k] and use Peter’s ideas [an] for being a photographer [app]
• A lot of paperwork [k]
• Slow to organise [k] because media interest / publicity needs to be generated to increase chance of success [an]
• Site may take a percentage of the funds raised [k] Other appropriate responses should be credited.

Explain two external sources of finance KYX could use to fund the new factory. Award 1 mark for each relevant source (max 2). Award 1 mark for each relevant reference to this business (max 2). Award 1 mark for each relevant explanation (max 2). Points might include:

• (Long-term) bank loan [k] which is quick to arrange [an] OR can raise a large/full amount [an] which may be beneficial during periods of economic growth [app]
• (New) share issue [k] by this public limited company [app] which do not have to be paid back/permanent capital [an] OR can raise large amounts [an] OR no interest to pay [an]
• Grants/subsidies [k] as no interest to pay [an] OR no need to repay [an]
• Crowdfunding [k] especially as demand increased (by 30%) [app] as no initial fees need to be paid [an]
• Leasing [k] as do not need to find a large cash sum to purchase the asset [an] OR care/maintenance of asset is carried out by leasing company [an]. Other appropriate responses should be credited.

Explain two factors CPW should consider when deciding on a source of finance for the new vehicles. Award 1 mark for identification of each relevant factor (max 2). Award 1 mark for each relevant reference to this business (max 2). Award 1 mark for each relevant explanation (max 2). Points might include:

• Amount required [k] for the 10 (vehicles) [app] because this is a large amount a bank loan/selling non-current assets maybe required [an]
• Current level of borrowing/loans [k] as the bank might not be willing to lend extra finance [an] when have non- current liabilities of $75 million [app]
• Time period [k] as the vehicles may be needed for the long-term, the source needs to be long-term [an] to make deliveries [app]
• Cost of finance/is it affordable [k] as high interest rates could increase cash outflows/expenses [an] adding to its current liabilities of $110 million [an]
• Size/legal form of the business [k] of this private sector business [app]
• Security/collateral needed [k]
• Level of control [k]
• How urgently the funds are required [k] Other appropriate responses should be credited.

Do you think the advantages of using retained profits to fund business expansion are greater than the disadvantages? Justify your answer. Award up to 2 marks for identification of relevant points. Award up to 2 marks for relevant development of points. Award up to 2 marks for a justified decision as to whether the advantages of using retained profits to fund business expansion are greater than the disadvantages. Points might include: Advantages:

• No need to repay [k] so does not increase level of debt/liabilities [an]
• No interest to pay [k] so no additional cash outflows/expenses [an]
• Easy/quick to obtain [k] Disadvantages:
• Takes time to generate sufficient funds [k] which could delay the expansion [an]
• May not have sufficient/any funds [k] so must limit the size of expansion [an]
• (Keep more profit in the business) reduces payment/reward to owners [k] which may deter further investment [an] Other appropriate responses should be credited. Justification might include: An advantage is there is no interest to pay [k] so no additional cash outflows [an]. However, it may take time to generate these funds [k] delaying expansion [an]. The disadvantages are greater because expansion is likely to need a large amount of finance which the business may not have [eval]. Delay could mean the opportunity is missed [eval].

Do you think a bank loan is the best source of start-up capital for a new business? Justify your answer. Award up to 2 marks for identification of relevant points. Award up to 2 marks for relevant development of points. Award up to 2 marks for a justified decision as to whether a bank loan is the best source of start-up capital for a new business. Points might include: Bank loan

• Quick to arrange [k] so does not delay plans/so can pay bills on time [an]
• Must pay interest [k] increasing costs/expenses/cash outflows [an]
• Must repay [k]
• Able to obtain large/full amount [k]
• May need security/collateral [k] which may not be available for a start-up / so personal assets may be at risk [an] Other methods could include:
• Own savings [k] as no need to repay [an]
• Borrow from friends/family [k] as may give long time to repay [an]
• Overdraft [k] can arrange quickly/only pay interest when used [an]
• Government grant [k] which has no interest [an]
• Crowdfunding [k] but no guarantee can raise full amount [an] Other appropriate responses should be credited. Justification might include: One advantage of a bank loan is it is quick to arrange [k] so does not delay plans/ability to pay bills straightaway [an]. Another source is own savings [k] because there is no need to repay [an]. A bank loan is the best source because speed means they do not miss out on the opportunity whereas it can take time to build up enough savings [eval], and by the time they do, there may be insufficient demand [eval]. Answer

Identify two advantages to a business of using external sources of finance. Award 1 mark per advantage (max 2). Points might include:

• Able to raise funds quicker / quickly
• May be able to raise full / large(r) amount of finance
• Can use internal sources / profit for other purposes
• Provider may offer advice/support Other appropriate responses should be credited.

Explain two sources of finance Amir and Carla could use if they decide to expand. Award 1 mark for each relevant source of finance [max 2]. Award 1 mark for each relevant reference to this business [max 2]. Award 1 mark for each relevant explanation [max 2]. Points might include:

• Retained profits [k] from the hotel [app] as does not need to pay it back [an]
• Bank loans [k] to obtain a large amount of money/varying length of time to repay/quick to arrange [an] for the luxury service [app]
• Own(er) savings [k] from the 2 partners [app] as may be readily accessible/no interest to pay [an]
• Crowdfunding [k] as no interest to pay [an] Other appropriate responses should be credited.

Define 'working capital’. Award 2 marks for a full definition. Award 1 mark for a partial definition.

• The money available for a business to pay its day-to-day expenses/short-term debts. [2]
• Current assets - current liabilities. [2] Partial definition, e.g.
• Funds used to pay inventory/wages/electricity [1]

Consider the advantages and disadvantages of the following three 12 sources of finance Ashanti could use for the new equipment. Which source should she use? Justify your answer.

• owners’ savings
• bank loan
• leasing Level Description Marks 3 Sound application of knowledge and understanding of 9–12 relevant business concepts using appropriate terminology. Detailed discussion of two or more sources. Well-justified recommendation. Candidates discussing all three sources in detail, in context and with a well-justified recommendation, including why the alternative sources were rejected, should be rewarded with the top marks in the band. 2 Sound application of knowledge and understanding of 5–8 relevant business concepts using appropriate terminology. Detailed discussion of at least one source. Judgement with some justification / some evaluation of choice made. Candidates discussing two of more sources in detail and applying them to the case should be rewarded with the top marks in the band. 1 Limited application of knowledge and understanding of 1–4 relevant business concepts. Limited ability to discuss the sources with little/no explanation. Simple judgement with limited justification / limited evaluation of choice made. Candidates outlining all three sources in context should be rewarded with the top marks in the band. 0 No creditable response. 0 Notes:
• This question is looking at finance for a new piece of equipment so related to sales/retail and not a factory/production/ producing.
• Do not award mirror arguments (the advantage of using one method of finance may be a disadvantage of another, but this should only be credited once). Relevant points might include: Advantages Disadvantages Owners’ savings • Does not have to be • It may use all $20 000 repaid from Ashanti’s
• No interest paid on it savings – then there – making it a cheaper will be no reserves left source of finance than for any emergencies possibly 5% interest in the future on bank loans • Possible loss of 2% to
• No security needed 5% interest – as which would be money not left in a required with a bank savings account loan – Ashanti does (opportunity cost) not have to risk any personal assets as security for the loan due to being a sole trader
• Is available straight away if Ashanti has sufficient funds Bank loan • Usually quite quick to • It must be repaid with arrange compared to interest – increases some other sources costs/expenses – may
• Can be repaid over reduce profit in the various periods of short-term time – so if over a • As YC is a start-up longer period then the business then the repayments will be interest rate on the lower each month – loan may be quite more manageable to high relative to the repay interest rate for a
• Can be paid back in larger business – it monthly instalments may be harder to be as the clothes shop competitive with other gets established clothes shop
• businesses
• As a sole trader Ashanti will have her personal assets at risk if she does not repay the loan Advantages Disadvantages Bank loan Ashanti is more likely to • Security is often get the full amount required required when she applies • YC has not yet for the loan – as she has started so there will already prepared a not be any financial business plan statements available to take to the bank to support a loan application
• As interest rates are increasing from 2% to 5% the interest charged on the loan may increase if the terms allow for this Leasing • Allows YC to use the • Will be more shop equipment expensive than buying without a large sum of the equipment outright capital required to as total costs are purchase it likely to be higher
• Payments are made • YC does not own the each month so these equipment, so it is not spread out the an asset of the payments instead of clothing business one large sum at the • May have to return start – which can help the equipment at the the management of its end of the lease and cash flow will have to start again
• Maintenance of the to replace it shop equipment will be paid for by the lease company – lowers costs
• May be able to purchase the equipment at the end of the lease – so will become a non-current asset of the business
• Can replace the equipment more regularly when new models are brought out Recommendation Justification might include:
• Owners’ savings should be used because it has the lowest cost of the three sources which is important as YC will be incurring other expenditure when the clothes shop is first opened. Ashanti will not want additional costs from interest payments on bank loans if it can be avoided and leasing will not be beneficial as it will still mean regular cash outflows will have to be made.
• A bank loan will be the best choice because Ashanti needs to spread out the repayments for equipment for the new shop. As a sole trader Ashanti is likely to use her personal assets as security so the bank will be more willing to provide the loan.
• Leasing will be the best because no capital is required, and YC is only just starting up so is unlikely to have the security required to be able to get a bank loan. As Ashanti is unlikely to have the capital to purchase the equipment as well as cover all the other costs of starting up, leasing will allow her to use the equipment and just make monthly payments which she is likely to afford with revenue from selling clothes.

Explain one reason why CTD might need short-term finance and one 8 reason why CTD might need long-term finance. Award 1 mark for each reason (max 2). Award a maximum of 3 additional marks for each explanation of the reason why a business needs short-term / long-term finance – one of which must be applied to this context. Reasons for short-term finance might include:

• To pay for day-to-day expenses to operate the business – such as wages or cost of ingredients – if these costs are not paid the business will not be able to operate
• To help avoid / solve a cash flow problem – if sales fall at certain times of the year then cash inflows will reduce, and short-term finance may be needed to enable the business to keep operating
• To enable the business to purchase more raw materials if it is increasing its output – these raw materials may need to be paid for before the finished products are sold, and revenue is received. Reasons for long-term finance might include:
• To pay for expansion – when another location is opened to grow the business – to pay for the capital required for it to start operating
• To pay for new (non-current) assets – to replace old equipment that no longer works / has broken down – so that the business can meet its current demand
• To invest in new technology – so the business can become more efficient – reducing its average cost. For example: To pay for day-to-day expenses (1) such as wages or the cost of ingredients (1) to keep the cafe operating, (app) because if these costs are not paid the business will not be able to trade. (1) Application could include: café; 8 production employees; work in the kitchen; desserts; high-quality products; good reputation; food and drinks; set-up 4 years ago; tea / coffee; sole trader; 3 employees serving customers; cost-plus pricing; expand to a second café; interest rates increasing from 2% to 6%; create brand loyalty.

Consider the following two sources of finance which could be used for 12 working capital when FF’s new shop opens. Which would be the best source for Kathryn to use? Justify your answer.

• Bank overdraft
• Trade credit Level Description Marks 3 Sound application of knowledge and understanding of 9–12 relevant business concepts using appropriate terminology. Detailed discussion of both sources of finance. Well-justified recommendation. Candidates discussing in detail both sources of finance, in context and with a well-justified recommendation, including why the alternative source is rejected, should be rewarded with the top marks in the band. 2 Sound application of knowledge and understanding of 5–8 relevant business concepts using appropriate terminology. Detailed discussion of one or more sources of finance. Judgement with some justification / some evaluation of choice made. Candidates discussing both sources of finance in detail and applying them to the case should be rewarded with the top marks in the band. 1 Limited application of knowledge and understanding of 1–4 relevant business concepts. Limited ability to discuss the sources of finance with little/no explanation. Simple judgement with limited justification / limited evaluation of choice made. Candidates outlining both sources of finance in context should be rewarded with the top marks in the band. 0 No creditable response. 0 Relevant points might include: Advantages Disadvantages Bank overdraft • Can be quick to • Amount overdrawn will arrange – so finance have to be repaid with available straight interest – increases away expenses – may lead
• May be arranged for to higher prices for varying lengths of flower arrangements time for repayment – charged or reduced longer time to pay it profits back from the sale of • May need to provide wedding flowers – collateral – may lose helping to avoid a assets if overdraft cash flow problem cannot be repaid
• May have to pay a high interest rate due to it being a small business and may be seen as high risk – raises costs further
• Interest rate may be variable so if interest rates increase later FF will be affected – increased risks for FF Advantages Disadvantages Trade credit • Is effectively an • Supplier may refuse to interest-free loan – supply if payment is unless penalties for not made as agreed – late payment are may damage the made relationship with
• May be able to supplier – unable to receive revenue from meet orders spoiling sales of flowers FF’s good reputation before paying • Supplier may refuse to supplier as has a offer discounts for the good relationship flowers at all if with her supplier – payment is not made improves cash flow as agreed – may increase costs – which could lead to higher prices as FF may use cost-plus pricing Recommendation Justification might include:
• A bank overdraft is the best source of finance to use as a sufficient amount of capital may be arranged which will pay for all the operating costs for the new flower shop. Some suppliers may not be willing to provide FF with trade credit leaving them short of working capital.
• Trade credit is the best source of finance to use as FF can use it to purchase the flowers and then sell them to receive the revenue before payment is due. This is an interest free source of finance for the day-to-day running of the third shop.

Explain two advantages and two disadvantages to a business of using a 8 bank loan as a source of finance. Award 1 mark for each advantage/disadvantage (max 2 advantages/max 2 disadvantages). Award a maximum of 1 additional mark for each explanation of the advantage/disadvantage. There are no application marks for this question. Relevant advantages might include:

• Usually quick to arrange – if already a customer of the bank, then will already be familiar with the business’ bank records
• Can be for a varying length of time – the monthly repayment will be lower if a longer period of time is taken to repay the loan
• If interest rate is fixed when loan taken out, then this fixes the repayments / know repayments cannot be increased – expenses for loan repayments will not increase so easier to plan
• Paid back in instalments usually monthly – so can budget for the repayments in the cash flow forecast
• Keeps control of the business which will not be true if share capital is used instead to raise the finance required
• Lower interest rates may be offered to larger businesses – as lower risk of not repaying so repayments will be lower Relevant disadvantages might include:
• Interest will be added to the repayments – increasing expenses for the business
• Security/collateral may be required – may lose personal assets if the loan is not repaid
• The loan needs to be repaid – which could negatively affect cash flow / liquidity
• If variable rate agreed, then interest rate may be increased during the repayment period – increasing expenses for the business For example: The loan can be for varying length of time (1) so the monthly repayment will be lower if a longer period of time is taken to repay the loan and therefore easier to afford (1).

Explain four sources of external finance a business could use. 8 Award 1 mark for each source of external finance (max 4). Award a maximum of 1 additional mark for each explanation of the source of external finance. There are no application marks for this question. Sources of external finance might include:

• Bank loans
• Bank overdraft
• Grants (or subsidies) from government
• Sale of shares
• Hire purchase
• Leasing
• Trade credit
• Micro-finance
• Crowdfunding
• Mortgage For example: Bank loan (1) is a fixed sum of money borrowed for a set-period of time / repaid in monthly instalments (1).