External finance: loans, shares, overdrafts and more

Debt: loans and overdrafts

• Loan: a fixed sum borrowed for a set period (often 1 to 10 years) and repaid in instalments with interest. Suits long-term assets such as machinery or premises. Repayments are predictable but must be met even when sales are poor, and security may be needed.
• Overdraft: the bank lets the business take its current account below zero up to an agreed limit. Flexible, for short-term cash shortfalls, and interest is paid only on the amount overdrawn. But interest rates are high and the bank can withdraw it at short notice.

Equity: share capital and venture capital

• Share capital: money raised by selling shares in a limited company. It never has to be repaid and has no interest; shareholders may receive dividends. But ownership and control are diluted.
• Venture capital: finance from specialist firms that invest large sums in young, high-growth businesses in return for shares, usually planning to sell their stake later at a profit. They take high risks, expect high returns and often want a say in management.

Leasing, trade credit and grants

• Leasing: renting an asset (vehicles, equipment) for regular payments instead of buying it. Avoids a large upfront cost and maintenance may be included, but it costs more overall and the business never owns the asset.
• Trade credit: suppliers allow the business to pay for goods later, often 30 to 90 days. It is a free short-term source, but late payment damages relationships and early-payment discounts are lost.
• Grants: money from government or other bodies that does not need repaying, often to support jobs in particular areas or new technology. They are limited, competitive and come with conditions.

Matching method to need

Typical features of each method

Worked example

A firm borrows $60,000 for 5 years at 8% simple interest per year. Find the total repaid and explain why a loan suits buying a machine better than an overdraft.

1. Interest per year = 8% x 60,000 = $4,800
2. Total interest over 5 years = 4,800 x 5 = $24,000
3. Total repaid = 60,000 + 24,000 = $84,000
4. The machine earns money over several years, so a long-term loan with fixed repayments matches it; an overdraft is dearer and can be withdrawn at short notice.

Answer: $84,000 repaid in total; match long-term assets with long-term finance.

Check yourself

1. A business borrows $25,000 at 6% simple interest per year for 4 years. Calculate the total interest paid.
   Show answer

   $6000. 25,000 x 0.06 = $1,500 a year; x 4 = $6,000.

2. A business is overdrawn by $8,000 for one month. The overdraft interest rate is 18% a year. Calculate the interest for that month.
   Show answer

   $120. 8,000 x 0.18 / 12 = $120.

3. Leasing a van costs $450 a month for 3 years. Buying it costs $14,000. How much more does leasing cost over the 3 years?
   Show answer

   $2200. 450 x 36 = $16,200; 16,200 - 14,000 = $2,200 more.

4. Founders own all 100,000 shares of a company. A venture capitalist buys 25,000 new shares. What percentage of the company do the founders now own?
   Show answer

   80 %. Total shares = 125,000; founders own 100,000 / 125,000 = 80%.

5. Which method best suits a temporary cash shortfall while waiting for customers to pay?
   • Share capital
   • Venture capital
   • Overdraft
   • A ten-year loan
   Show answer

   Overdraft. Overdrafts are flexible short-term finance.

6. Trade credit is
   • a period allowed by a supplier before payment is due
   • a loan from a bank to buy stock
   • a government payment to exporters
   • a share issue to suppliers
   Show answer

   a period allowed by a supplier before payment is due. Goods now, pay later: a short-term source of finance.

7. Venture capitalists usually expect
   • fixed monthly interest payments
   • no involvement in the business
   • a share of ownership and a high return
   • repayment within one year
   Show answer

   a share of ownership and a high return. They take equity in high-risk firms, aiming to sell for a large gain.

8. Explain one disadvantage of raising finance through share capital rather than a loan.
   Show answer

   Selling shares dilutes ownership, so the original owners lose some control and must share future profits as dividends.. Shares bring new owners, so control and profits are shared.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.