Compare internal and external finance sources
Identify the syllabus-listed internal and external sources and explain their distinct cash, ownership, repayment and asset effects.
Section 5.2 · Sources of finance
Cambridge International AS & A Level Business 9609, 2026–2028 syllabus and 2029 syllabus, section 5.2.2. Cambridge states that both current versions have no significant changes affecting teaching. This lesson maps only its named section; other sections and full paper practice remain separate. Written practice is self-checked
Before you begin
- No previous business course is assumed. Use the lesson's definitions before applying them to the business context.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
What is retained earnings?
What you will learn
- Distinguish internal and external finance
- Explain common finance sources by mechanism
- Compare source-specific obligations and risks
Internal funds come from within the business or its owners
Internal sources include owners' investment, retained earnings, sale of unwanted assets, sale and leaseback of non-current assets, and working capital released by managing inventory, receivables or payables. They may avoid new lenders, but funds can be limited or needed elsewhere.
Sale and leaseback releases cash from an asset while the business rents it back; future lease payments and lost ownership matter. Retained earnings are not free: using them has an opportunity cost if they could support another purpose.
External sources differ in repayment, ownership and asset use
External sources in the syllabus include share capital, debentures, new partners, venture capital, bank overdrafts, leasing, hire purchase, bank loans, mortgages, debt factoring, trade credit, microfinance, crowdfunding and government grants. Equity (shares, partners or venture investors) can share control and returns; debt must be repaid under its terms.
A lease provides use of an asset for payments; hire purchase usually transfers ownership after the final instalment under the agreement. A mortgage is secured against property; a debenture is long-term debt that may carry interest and security. An overdraft is a flexible short-term facility; factoring advances cash against receivables for a fee. Crowdfunding can be donation, reward, debt or equity, so identify the model. Grants have eligibility and use conditions and are not guaranteed.
Pause and explain
What does debt factoring typically do?
Worked example
A company needs a delivery van but wants to preserve cash for inventory. Compare an outright purchase from retained earnings with leasing.
Show the worked solution
- Retained earnings avoid a new financing contract but reduce funds available for inventory.
- Leasing spreads payments and provides use of the van.
- Compare total payments, ownership, flexibility and cash timing.
Answer Using retained earnings avoids a lease contract but removes cash that may be needed for inventory. Leasing spreads payments and provides use of the van, but the company pays over time and may not own the asset. Compare total cost, terms, cash needs and expected use before choosing.
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Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Classify each as internal or external: retained earnings, trade credit, sale of an unused machine, a bank loan and working capital released by collecting overdue invoices.
Give me a hint
Ask whether the funds come from within the existing business or from another provider.
Compare my reasoning
- Retained earnings and sale of an unused asset use internal resources.
- Trade credit and a bank loan involve external providers.
- Collecting receivables releases existing working capital.
Internal: retained earnings, sale of the unused machine and working capital released by collecting invoices. External: trade credit from a supplier and a bank loan.
Look for these in your work
- All five sources are classified
- Provider finance is distinguished from internal funds
- Working capital release is understood
A firm is offered hire purchase for machinery or a lease. Explain one distinction and one comparison it should make.
Give me a hint
Check when ownership transfers and compare contract costs and flexibility.
Compare my reasoning
- Hire purchase usually transfers ownership after final instalments under its terms.
- A lease generally provides use for payments without the same automatic transfer.
- Compare total payments, maintenance obligations and end-of-contract options.
Under hire purchase, ownership usually transfers after the final instalment if contract terms are met; a lease provides use under a rental agreement and ownership may remain with the lessor. The firm should compare total payments, maintenance, flexibility and end-of-term rights.
Look for these in your work
- Ownership timing is distinguished
- Contract terms are acknowledged
- Relevant comparison factors are given
A start-up considers venture capital, crowdfunding or a government grant. Explain why it should identify the specific arrangement before comparing them.
Give me a hint
These labels can involve different ownership, repayment and eligibility terms.
Compare my reasoning
- Venture capital commonly exchanges investment for equity and influence.
- Crowdfunding may be reward, donation, debt or equity-based.
- A grant depends on eligibility and may include reporting or use conditions.
Venture capital may involve equity and investor influence; crowdfunding can mean reward, donation, debt or equity; and a grant may be restricted to eligible uses with reporting conditions. The start-up should compare the actual contract, eligibility, control and repayment terms rather than the label alone.
Look for these in your work
- Sources are not treated as interchangeable
- Control and repayment are considered
- Conditions are checked
Common mistakes
- Calling every external source a loan
- Confusing leasing with hire purchase ownership
- Treating grants or crowdfunding outcomes as guaranteed
What can you explain now?
What is retained earnings?
Compare with the explanation
Profit kept in the business rather than distributed
It is an internal source accumulated from past operations.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Which finance sources are internal or external, and how do equity, debt, leases, factoring, grants and crowdfunding differ?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.