Finding sources of business finance is of utmost importance for entrepreneurs and businesspersons embarking on a new venture. It requires dedicated effort and a strong commitment. The various sources of business finance can be elaborated based on ownership, time frame, duration, and control, among other factors.
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What is Business Finance?
Business finance refers to managing financial resources within an organisation to support its operations, expansion, and overall success. It includes various activities such as acquiring, allocating, and utilising funds to meet the business’s financial needs.
One fundamental aspect of business finance is the acquisition of funds. This involves identifying and securing sources of capital, which can be obtained from internal or external sources. Internal sources include personal savings, retained earnings, and the sale of assets, while external sources comprise bank loans, venture capital, angel investors, and government grants, among others. The choice of funding depends on factors such as the business’s size, stage of development, and financial requirements.
Business Finance: Sources
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Companies may acquire funds from a variety of funding sources, which can be divided into three groups.
Based on the time
- Long-term sources of funding are used by businesses to meet their financial needs for a duration of more than 5 years. These sources may include issuing shares and debentures, obtaining long-term loans, and seeking financial assistance from institutions.
- Medium-term finance options are chosen by companies when they require funds for a period longer than 1 year but less than 5 years. Such sources include borrowing from commercial banks, accepting public deposits, and similar avenues.
- Short-term funds refer to the financial resources needed for up to one year. Examples of short-term funds include trade credits, loans from commercial banks, and commercial papers.
Based on ownership
- Owner’s Fund refers to the capital provided by the owner(s) of the enterprise. It can include shares the owner(s) issued and retained earnings from the business.
- Borrowed Funds are the financial resources the business acquires through loans or borrowings from external sources.
Based on the source of generation
- Internal Sources of funds are the funds generated from within the business. Examples of internal sources include collecting receivables from customers and disposing of excess inventory.
- External Sources of funds encompass the financial resources obtained from entities outside the organisation. These sources include suppliers, lenders, and investors who fund the business.
Source of funds in Business Finance: Other factors
Sources of Business Finance can vary based on different factors such as the size of the business, its stage of development, the purpose of financing, and the risk associated with the company. Here are some familiar sources of business finance based on these factors:
Many small companies initially rely on personal savings to fund their operations. Owners may use their funds to start the business or contribute capital from personal savings.
Banks provide various types of loans to businesses, like term loans, lines of credit, and equipment financing. The availability and terms of bank loans depend on factors like the business’s creditworthiness, collateral, and business plan.
In exchange for stock, venture capital firms make investments in companies with great development potential. They typically target startups and early-stage companies with innovative ideas and significant growth prospects.
Crowdfunding platforms allow businesses to raise funds from many individuals who contribute small amounts. There are different types of crowdfunding, including donation-based, reward-based, and equity-based crowdfunding.
Some businesses, particularly in sectors like research, technology, and social enterprise, may be eligible for assistance from government agencies, foundations, or nonprofit organisations. These grants do not need to be repaid but often have specific requirements and reporting obligations.
Suppliers may extend credit to businesses, allowing them to purchase goods or services and defer payment until later. This can be a valuable source of short-term financing.
Factoring and Invoice Financing
Businesses can sell their accounts receivable to a factoring company, which provides immediate cash in exchange for a fee. Invoice financing allows businesses to borrow against their outstanding invoices.
Initial Public Offering (IPO)
Established companies with a strong track record may choose to go public by offering company shares on a stock exchange. This allows them to raise substantial capital from public investors.
Factors Affect Business Finance
Many underlying factors affect business finance; the most critical factors are discussed in this segment.
Type of the business
The financing requirements of a company largely depend on its nature. If the business involves substantial equipment and machinery, a significant amount of fixed capital will be necessary. Conversely, if the business focuses on manufacturing consumer goods, higher levels of finance will be required.
The size of a company also plays a crucial role in determining its financing needs. Larger businesses typically require more land, buildings, equipment, and machinery. Consequently, there is a greater demand for both fixed and working capital to meet these requirements.
Method of production
The choice of production method has a direct impact on the financial aspect. A labour-prone production process necessitates lower levels of financing. On the other hand, if machinery is extensively used instead of labour, particularly in complex production processes, higher financing becomes essential.
Cycle of Business
The business cycle significantly influences capital requirements. During a boom period, the need for capital may be relatively low. However, there is a simultaneous increase in the demand for working capital to support the expanding operations.
Factors Influencing the Choice of Business Financing
When it comes to selecting the right sources of financing for a business, several factors come into play. Here are some key considerations to keep in mind.
Cost of business
Businesses must carefully evaluate the cost involved in acquiring and utilising funds. For instance, debentures and term loans often offer relatively lower interest charges.
Sources of funds
Sources of funding depend on the type of company. Sole proprietors or businesses in partnership cannot issue debentures and shares, thus relying on short-term options such as hire purchase, leasing, or bank finance. On the other hand, businesses, cooperative organisations, and government organisations can access both long-term and short-term funding sources.
The duration for which a company requires financial assistance determines the appropriate source. Short-term funding needs can be fulfilled through bank overdrafts, cash credits or bill discounting. On the contrary, long-term funding requirements may be met through issuing shares, term loans, or debentures.
While utilising self-owned funds entails minimal risk for a business, borrowing funds introduces a significant level of risk. The interest charges associated with borrowing can potentially lead to business liquidation and reputation damage.
Newly established businesses often face challenges in mobilising business finance compared to well-established enterprises. In the initial stages, they may have to rely on internal sources. As the business grows and matures, it becomes more capable of borrowing funds and using assets as mortgages or security.
The sources of funds may require the business to pledge assets as collateral. However, this can negatively impact the creditworthiness of the business.
Businesses are involved in producing and distributing goods and services to fulfil societal needs. However, operating a business requires adequate funds. When the decision to start a business is made, the necessity for funding arises.
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