sources of finance

Business finance is the management and raising of funds by commercial organisations. The money required to launch, run, and expand a business is business finance. In addition to intangible assets like patents, technical expertise, and trademarks, funds are required to purchase tangible assets like furniture, machinery, buildings, offices, and factories.

The goal of every business endeavour is long-term financial success and societal benefit. Additionally, a business is founded on a going-concern principle, which calls for carrying out all operations with the expectation that they will last for a considerable amount of time and make a profit.

Entrepreneurs who engage in the activity invest a certain amount of money, known as capital. One must continually invest money in the company to support its growth, known as business financing. A company’s ability to raise the capital it needs to function is what is known as business finance.

Significance of Business Finance

The points below highlight the significance of Business Finance:

• A company with adequate business financing will launch its venture with fewer delays and hassles.

• With business financing, the owners can purchase raw materials as needed for production.

• With the aid of business finance, the business firm can easily make its dues and other payments.

• The right business finance will help manage uncertain risks and contingencies.

• A business with strong financial standing will be able to attract talented employees and access highly effective technology.

Financing Needs of the Business:

Fixed Capital Requirements:

Fixed capital requirements are the sums of money needed by a business to buy real estate, structures, equipment, furniture, and fixtures, among other things. Different amounts of fixed capital are required depending on the organisation’s size and the level of operations. Fixed capital remains invested in the business for a long period.

Working Capital Requirements:

The money needed to maintain the regular operations of a business is known as working capital. It holds current assets like material stock, debtors, and other liabilities. The amount of working capital needed depends on several variables, including the type of business, size, operational cycle, etc.

Classification of Sources of Funds

A. Basis of Period

1. Short Term: These funds are utilised for short-term projects that last one year or less. For example, trade credit, loans from commercial banks and commercial papers.

2. Medium Term: These funds are needed between one and five years. For example, public deposits, lease financing, and loans from financial institutions.

3. Long Term: These funds have been meeting the company’s needs for more than five years. For example, shares, debentures and long-term borrowings.

B. Basis of Ownership

1. Owners’ Funds: Owners’ funds are contributions from the organisation’s founders. It includes earnings that are put back into the company. These funds remain invested in the business for a longer duration and are not required to be refunded through the life of the business. The significant funding sources for owners have retained profits and released equity shares.

2. Borrowed Funds: These sums of money are acquired through borrowing and loans. A few examples of this source of funding are issues of debentures, bank loans, public deposits, trade credit, etc.

C. Basis of Generation

Internal Sources: An organisation’s funds are referred to as internal sources. However, this source can only meet temporary or small needs. For example, reinvesting profits, eliminating excess inventory, etc.

External Sources: External funding sources are used to meet large financial requirements. Compared to internal sources of funding, these are more expensive sources. These are carried out through bank loans from commercial institutions, receiving public deposits, raising debentures, etc.

Sources of finance:

Retained earnings:
a portion of net earnings that is retained in the business rather than being distributed to shareholders, allowing the company to reinvest in operations and growth.

Merits:
1. Permanent source of finance
2. does not involve explicit costs
3. funds are generated internally so there’s more freedom of operation.
3. may increase in market price of equity shares

demerits:
1. excessive ploughing back may lead to dissatisfaction among shareholders
2. uncertIN SOURCE OF funds because profits are fluctuation
3. opportunity cost is not associated with these funds which may lead to sub optimal use of the funds.

Trade credit:

credit extended by one trader to another for the purchase of goods and services.

• It allows businesses to manage cash flow more effectively by delaying payment for goods, thus providing short-term financing.

Merits:

• convenient and continuous

• helps promote sales of an organisation

• no asset charges
  

Demerits:

• risk of overtrading BCS easy and flexible credit facilities may lead to overtradin by increasing risks,

• limited funds

• costy source

Public deposits:

• funds directly fro the public

• offered at a higher interest rates than bank deposits.

• both medium and short term financing

Merits of Public Deposits

• It has a simple procedure.

• It leads to no loss of control.

• It is economical.

• It creates no change over assets.

Limitations of Public Deposits

• It is not suitable for new companies.

• It is not suitable for long term financing.

• It is not a reliable source.

• It can provide limited funds.

Equity Shares

Equity shares are those shares which do not carry any special or preferential rights in respect of payment of annual dividend and repayment of capital.

Merits of Equity Shares

• It is ideal for adventurous investors

• There is no obligation as to dividend

• It provides credit standard

• It is a source of fixed capital

• It creates no charge on assets

• It creates democratic management

• It has a small nominal value

Limitations of Equity Shares

• There is risk of fluctuating returns

• It leads to dilution of capital

• It has many legal formalities

• Equity shares capital has high cost of capital

• It suffers from the danger of over-capitalisation

Preference Shares

Preference shares are those shares, which enjoy preferential right in payment of dividend and repayment of capital.

Merits of Preference Shares

• It gives reasonable safety of returns.

• Repayment of principal amount is ensured.

• There is no interference in management.

• Trading on equity is allowed.

• It creates no charge on assets.

Limitations of Preference Shares

• It has limited appeal.

• It dilutes claim of equity shareholders.

• It is unreliable and gives low returns.

• It has no tax benefits.

Loans from Financial Institutions

These institutions provide finance to business organizations and are suitable to raise large funds for long-term.

Merits of Financial Institutions

• It provides medium and long-term finance.

• It gives assistance in business.

• It is a source of goodwill.

• It has easy repayment scheme.

• It provides finance even during depression.

Limitations of Financial Institutions

• It has difficult procedure.

• It has restrictive clauses.

• It creates interference in management.

Loans from Commercial Banks

Commercial bank is an institution which performs the function of accepting deposits, granting loans and making investments, with the aim of earning profits.

Merits of Commercial Banks

• It is economical.

• It maintains business secrecy.

• It has less formalities.

• It is a flexible source.

Limitations of Commercial Banks

• It provides short-term financing.

• It has difficult procedure.

• It has restrictive clauses.