Sources of Business Finance

BST

Business Finance

is the requirements of funds by a business to carry out various activities.

Finance is significant for a business because

A business cannot function unless adequate funds are made available to meet its financial requirements. The initial capital contributed by the entrepreneur are not sufficient to carry out all its functions. A business person must have a clear assessment of the business's financial needs and information regarding the availability of sources of finance.

What are the two types of financial needs of a business?

Fixed Capital Requirement and Working Capital Requirement

Fixed Capital Requirement

The funds required for building, land, plant, machinery, machinery and fixtures, when starting a business are called fixed capital. The funds required in fixed capital remain invested in the business for a long time. The amount of fixed capital depends on the business unit concerned and the size of the enterprise.

Working Capital Requirement

The financial requirements of a business do not end after the procurement of fixed asset. The business still needs funds to carry out its day-to-day operations. These funds are called working capital. They are used to hold current assets such as stock, inventory, and bills receivable and to meet current expenses like salaries, wages, taxes, etc.

What can lead to increase in financial requirement?

Increase in financial requirement may be due to growth and expansion of the business, upgradation of technology, building higher inventories for festive seasons, to meet current debts, shift to a new location, etc.

Long Term Funds

equity shares, retained earnings, preference shares, debentures, loans from financial institutions, loans from banks

Short Term Funds

trade credit, factoring, banks, commercial paper

Medium Term Funds

loan from banks, public deposits, lease financing

Owners Funds

equity shares and retained earnings

Borrowed Funds

debentures, loans, public deposits, lease financing, commercial paper

Internal Sources of Funds

equity shares,

External Sources of Funds

financial institutions, banks (loans), preference shares, public deposits, debentures, lease financing, commercial papers, trade credit, factoring

What are Retained Earnings?

A company does not always distribute all of its profit among the shareholders as dividends. It sometimes retains its net earnings for future use. This is called retained earnings. It is and internal source of financing known as 'ploughing back of profits'. The availability of profit for ploughing back depends on net profit, dividend policies, age of the organization.

What is Trade Credit?

Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade
credit facilitates the purchase of supplies without immediate payment.

Lease Financing

A lease is a contractual agreement whereby one party i.e., the owner of an asset grants the other party the right to use the asset in return for a periodic payment. In other words it is a renting of an asset for some specified period. The owner of the assets is called the ‘lessor’ while the party that uses the assets is known as the ‘lessee’. The lessee pays a fixed periodic amount called lease rental to the lessor for the use of the asset.

What are Public Deposits?

The deposits that are raised by organizations directly from the public are known as public deposits. Rates
of interest offered on public deposits are usually higher than that offered on bank deposits. Any person who is
interested in depositing money in an organization can do so by filling up a prescribed form.

Commercial Paper

It is an unsecured money marketing instrument issued in the form of a promissory note. It is issued by a firm to raise funds for a short period, varying from 90-364 days. The amount raised is generally very large. Since the debt is unsecured, only firms with good credit scores can issue a CP. CPs are regulated by the RBI.

What are dividends?

A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-invested in the business.

Equity Shares

An equity share, normally known as ordinary share is where each member has partial ownership of the company. Payment of dividend to equity shareholders is not compulsory. Equity shareholders have voting rights.

Preference Shares

Preference shareholders hold a preferential position over equity shareholders. They receive a fixed rate of dividend out of the net profits, before dividend is declared for the equity shareholders. Preference shareholders typically do not have voting rights.

Debentures

A company can raise funds through issue of debentures, which bear a fixed rate of interest. The debenture issued by a company is an acknowledgment that the company
has borrowed a certain amount of money, which it promises to repay at a future date. Debenture holders are, therefore, termed as creditors of the company. Debenture holders are paid a fixed stated amount of interest at specified intervals say six months or one year. The difference between the face value of the debenture and its purchase price is the return to the investor.

Commercial Banks

Banks extend loans to firms of all sizes and in many
ways, like, cash credits, overdrafts, term loans, purchase/discounting of bills, and issue of letter of credit. The rate of interest charged by banks depends
on various factors such as the characteristics of the firm and the level of interest rates in the economy.
The loan is repaid either in lump sum or in installments.
It is not a permanent source of funds.