Money is the language every business speaks
A brilliant product idea means nothing if the business behind it runs out of cash before the first unit ships. A profitable company on paper can still collapse if it cannot pay its suppliers on time. Finance is not just one section of the IGCSE Business Studies syllabus; it is the thread that connects every other topic. Marketing campaigns need budgets. New employees need salaries. Expansion plans need capital. Understanding where money comes from, how it moves through a business, and how to measure whether a business is financially healthy is essential for every exam paper you will sit.
This topic covers 12 subtopics and 29 learning objectives. Questions on sources of finance, break-even analysis and cash flow appear in almost every past paper session, making this one of the highest-return revision areas in the course.
Why businesses need finance
Businesses require finance at every stage of their life cycle, but the reasons shift as the business matures:
- Start-up capital: money needed to launch the business. This covers premises, equipment, initial stock, legal fees and marketing to attract the first customers.
- Working capital: the day-to-day funds a business needs to pay wages, buy raw materials and cover running costs while waiting for customers to pay. A business with strong sales but slow-paying customers can still face a cash crisis.
- Expansion capital: funds for growth. Opening a second branch, entering a new market or developing a new product line all require investment beyond normal operating revenue.
The type of finance a business chooses depends on the amount needed, the time frame and the level of risk the owners are willing to accept.
Sources of finance
Sources of finance divide along two axes: internal versus external, and short-term versus long-term. Getting these distinctions right is a frequent exam requirement.
| Source | Internal or External | Short-term or Long-term | How it works | Key advantage | Key disadvantage |
|---|---|---|---|---|---|
| Retained profit | Internal | Long-term | Profits kept in the business rather than distributed to owners | No interest charges; no loss of control | Only available if the business is already profitable |
| Sale of assets | Internal | Varies | Selling property, vehicles or equipment the business no longer needs | Raises cash without borrowing | The asset is gone permanently; may reduce capacity |
| Bank overdraft | External | Short-term | The bank allows the business to spend more than its account balance, up to an agreed limit | Flexible; interest only on the amount overdrawn | Can be recalled at short notice; interest rates are often high |
| Trade credit | External | Short-term | Suppliers allow the business to receive goods now and pay later (typically 30 to 90 days) | Improves short-term cash flow without borrowing | Late payment damages supplier relationships and credit rating |
| Bank loan | External | Long-term | A fixed sum borrowed from a bank, repaid in instalments with interest over an agreed period | Predictable repayments; ownership is not diluted | Interest must be paid regardless of business performance; collateral may be required |
| Share capital | External | Long-term | Selling shares in the company to raise funds (limited companies only) | No repayment obligation; large sums can be raised | Ownership is diluted; shareholders expect dividends and influence |
| Crowd-funding | External | Varies | Raising small amounts from a large number of people, usually via an online platform | Tests market demand before launch; no interest if reward-based | Success is not guaranteed; public exposure of the business idea |
| Micro-finance | External | Varies | Small loans provided to entrepreneurs in developing economies who lack access to traditional banking | Enables business creation where conventional finance is unavailable | Loan amounts are small; interest rates can be high relative to income |
Cash flow and cash-flow forecasting
Cash is not the same as profit
This distinction trips up more IGCSE candidates than almost any other concept in the finance section. Profit is the difference between revenue and costs over a period. Cash is the actual money available in the bank at a given moment. A business can be profitable on its income statement yet still run out of cash if, for example, it has sold goods on credit and customers have not yet paid. Equally, a business making a loss can still have cash in the bank if it recently received a large loan.
How a cash-flow forecast works
A cash-flow forecast predicts the money flowing into and out of a business over future months. It helps managers anticipate shortfalls and arrange finance before a crisis hits. The structure is straightforward:
- Cash inflows: all money expected to come in. This includes cash sales, credit sales receipts, loans received, capital injected by owners and any other income.
- Cash outflows: all money expected to go out. This includes raw materials, wages, rent, utility bills, loan repayments, equipment purchases and tax payments.
- Net cash flow: inflows minus outflows for the month. A positive figure means more came in than went out; a negative figure means the opposite.
- Opening balance: the cash available at the start of the month (which equals the previous month's closing balance).
- Closing balance: opening balance plus net cash flow. This is the cash the business carries into the next month.
Worked example
| January ($) | February ($) | March ($) | |
|---|---|---|---|
| Cash inflows | 8,000 | 12,000 | 15,000 |
| Cash outflows | 10,000 | 9,000 | 11,000 |
| Net cash flow | (2,000) | 3,000 | 4,000 |
| Opening balance | 5,000 | 3,000 | 6,000 |
| Closing balance | 3,000 | 6,000 | 10,000 |
In January, the business spends more than it earns, but the opening balance of $5,000 covers the shortfall. By March, cash has built up to $10,000. If January's outflows had been $14,000 instead, the closing balance would have been negative, signalling a need for short-term finance such as an overdraft.
Working capital
Working capital equals current assets minus current liabilities. Current assets are items the business expects to convert to cash within a year (stock, money owed by customers, bank balance). Current liabilities are debts due within a year (money owed to suppliers, overdrafts, short-term loans). A healthy business maintains positive working capital so it can meet its short-term obligations without selling long-term assets.
Break-even analysis
Break-even is the point at which total revenue equals total costs. Below this point, the business makes a loss. Above it, the business makes a profit. The formula is:
Break-even point (units) = Fixed costs / (Selling price per unit - Variable cost per unit)
The denominator (selling price minus variable cost) is called the contribution per unit because it represents how much each sale contributes toward covering fixed costs.
Worked example
A bakery has fixed costs of $6,000 per month (rent, insurance, loan repayments). Each cake costs $2 in ingredients (variable cost) and sells for $5.
- Contribution per unit = $5 - $2 = $3
- Break-even point = $6,000 / $3 = 2,000 cakes
The bakery must sell 2,000 cakes per month to cover all its costs. Every cake sold beyond 2,000 generates $3 of profit.
The margin of safety is the difference between actual (or expected) sales and the break-even point. If the bakery expects to sell 2,500 cakes, the margin of safety is 500 cakes. This tells managers how much sales can fall before the business starts making a loss.
Income statements
An income statement (sometimes called a profit and loss account) summarises a business's revenue, costs and profit over a specific period, usually one year. The key lines are:
- Revenue (also called turnover or sales): the total income from selling goods or services.
- Cost of goods sold (COGS): the direct costs of producing the goods sold (raw materials, direct labour).
- Gross profit: revenue minus cost of goods sold. This shows how much the business earns from its core trading activity before overheads.
- Expenses (overheads): indirect costs such as rent, marketing, administration, utilities and depreciation.
- Net profit: gross profit minus expenses. This is the profit left after all costs have been deducted.
In the Cambridge IGCSE exam, you will not be asked to construct an income statement from scratch, but you will be expected to read one, identify its components, and draw conclusions from the figures.
Statement of financial position
A statement of financial position (formerly called a balance sheet) is a snapshot of what a business owns (assets), what it owes (liabilities), and the value of the owner's stake (equity) at a specific date. It follows a fundamental equation:
Assets = Liabilities + Equity
- Non-current assets: items owned for more than one year (land, buildings, machinery, vehicles).
- Current assets: items expected to be converted to cash within one year (inventories, trade receivables, bank balance).
- Current liabilities: debts due within one year (trade payables, overdraft, short-term loans).
- Non-current liabilities: debts due after more than one year (long-term bank loans, mortgages).
- Equity: the owner's investment plus retained profits. It represents what would be left if the business sold all its assets and paid off all its debts.
As with the income statement, the IGCSE exam does not ask you to build a statement of financial position. It asks you to interpret one: identify how the business is financed, assess whether it holds enough current assets to cover current liabilities, and suggest actions if liquidity looks tight.
Financial ratios
Ratios convert raw numbers from financial statements into meaningful indicators. The IGCSE syllabus focuses on two families: profitability and liquidity.
Profitability ratios
| Ratio | Formula | What it tells you |
|---|---|---|
| Gross profit margin | (Gross profit / Revenue) x 100 | The percentage of revenue left after covering direct production costs. A higher figure suggests efficient production or strong pricing. |
| Net profit margin | (Net profit / Revenue) x 100 | The percentage of revenue left after all costs. A declining net margin with a stable gross margin points to rising overheads, not production problems. |
Liquidity ratios
| Ratio | Formula | What it tells you |
|---|---|---|
| Current ratio | Current assets / Current liabilities | Whether the business can pay its short-term debts. A ratio of 1.5 to 2 is generally considered healthy. Below 1 means current liabilities exceed current assets. |
| Acid test ratio | (Current assets - Inventories) / Current liabilities | A stricter test that excludes inventories (which may be hard to sell quickly). A ratio below 1 signals potential difficulty paying debts without selling stock. |
Why and how accounts are used
Different stakeholders use financial information for different purposes:
- Owners and shareholders: to assess profitability and decide whether to invest further or withdraw funds.
- Managers: to plan budgets, control costs and make decisions about pricing, staffing and expansion.
- Banks and lenders: to evaluate whether the business can repay a loan before approving finance.
- Employees: to judge job security and the fairness of pay relative to profits.
- Government: to calculate tax liabilities and ensure regulatory compliance.
- Suppliers: to decide whether to offer trade credit based on the business's ability to pay.
In many European and international jurisdictions, limited companies are legally required to publish their accounts. This transparency allows all stakeholders to make informed decisions, but it also means competitors can access the same information.
Common exam mistakes
- Confusing cash and profit. A business that is profitable can still go bankrupt if it runs out of cash. The income statement shows profit; the cash-flow forecast shows liquidity. They measure different things. If a question asks about a cash shortage, do not answer with profit figures.
- Recommending the wrong source of finance. Sole traders cannot issue shares. A start-up with no trading history cannot use retained profit. Always check the business type and stage before recommending a source.
- Forgetting to show working in break-even calculations. Writing "the break-even point is 2,000 units" without showing the formula and substitution loses method marks. Even a wrong answer with correct working earns partial credit.
- Stating a ratio without interpreting it. "The gross profit margin is 40%" is not analysis. "The gross profit margin fell from 45% to 40%, suggesting the business is paying more for raw materials or has reduced its prices to stay competitive" is analysis.
- Mixing up gross and net profit. Gross profit deducts only the cost of goods sold. Net profit deducts all expenses. If a question asks why net profit fell while gross profit stayed the same, the answer lies in rising overheads, not production costs.
- Ignoring the time dimension of finance. An overdraft is appropriate for a temporary cash shortage lasting weeks. A bank loan suits a multi-year investment. Matching the duration of finance to the duration of need is a basic principle that many candidates overlook.
Self-check questions
- Explain the difference between cash and profit. Give an example of a business that is profitable but has a cash-flow problem.
- A business has fixed costs of $10,000 per month, a selling price of $8 per unit, and a variable cost of $3 per unit. Calculate the break-even point and the margin of safety if expected sales are 2,500 units.
- Using the sources of finance table, recommend and justify two appropriate sources for a sole trader who needs $5,000 to buy new equipment.
- A company's current ratio has fallen from 2.0 to 0.9 over three years. Explain what this means and suggest two actions the business could take.
- Explain why a bank would want to see a business's cash-flow forecast before approving a loan.
A thorough guide to the financial section of the IGCSE Business Studies syllabus, covering sources of finance, cash-flow forecasting, break-even analysis, income statements, statements of financial position, and the profitability and liquidity ratios examiners test most often.
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