SummaryMeaning and Significance of Business Finance: Finance requisite by business to establish and carry out its activities is known as business finance. No business can function without sufficient amount of funds. The funds are mandatory to purchase fixed assets (fixed capital requirement), for carrying out its day-to-day operations (working capital requirement), and for undertaking growth and expansion plans in a business organisation.
Classification of Sources of Funds: A wide range of sources of funds available to a business can be classified according to three major basis, which are
- Time period (long, medium and short term),
- Ownership (owner's funds and borrowed funds), and
- Source of generation (internal sources and external sources).
Owner's Funds and Borrowed Funds: Owner's funds are referred to the funds that are provided by the owners of an enterprise. Borrowed capital, on the other contrary, refers to the funds that are generated through loans or borrowings from other individuals or institutions.
Internal and External Sources: Internal sources of capital are classified as those sources that are generated within the business from the profit gains. External sources of capital, on the other hand are those that are not within the business entity such as suppliers, lenders, and investors.
Sources of Business Finance: The sources of funds offered for a business include retained earnings, trade credit, factoring, lease financing, public deposits, commercial paper, issue of shares and debentures, loans from commercial banks, financial institutions and international sources of finance.
Retained eEarnings: Retained earnings can be defined as the portion of the net earnings of the company that is not distributed as dividends. The amount of retained earnings obtainable depends on the dividend policy of the company. It is basically used for growth and expansion of the company.
Trade Credit: The credit provided by one trader to another for purchasing goods or services is called as trade credit. Trade credit helps purchase of supplies on credit. The stipulations of trade credit vary from one industry to another and are mentioned in the invoice. Small and new firms are generally more dependent on trade credit, as they find it relatively difficult to obtain funds from other sources.
Factoring: Factoring has evolved as a popular source of short-term funds in recent years. It is a financial service wherein the factor is responsible for all credit control and debt collection from the buyer and gives protection against any bad-debt losses to the firm. There are two methods of factoringâ€” recourse and non-recourse factoring.
Lease Financing: A lease can be defined as a contractual agreement wherein the owner of an asset (lessor) grants the right to use the asset to the other party (lessee). The lessor charges a periodic payment for renting of an asset for some specified period called lease rent.
Public Deposits: A company can raise revenue by inviting the public to deposit their savings with their company. Pubic deposits are both long and short-term financial requirements of business. Rate of interest on deposits is generally higher than that offered by banks and other financial institutions.
Commercial Paper (CP): A Commercial paper can be defined as an unsecured promissory note issued by a firm to raise funds for a short period. The maturity period of commercial paper ranges from 90 days to 364 days. Being unsecured, only organizations having good credit rating can issue the CP and its regulation falls under the purview of the Reserve Bank of India.
Issue of Equity Shares: Equity shares represent the ownership capital of a company. Owing to their fluctuating earnings, equity shareholders are called risk bearers of the company. These shareholders enjoy higher returns during prosperity of the company and hold good control over the management affairs of the company by exercising their right to vote.
Issue of Preference Shares: These shares offer a preferential right to the shareholders regarding payment of earnings and the repayment of capital. Investors who look forward for steady income without undertaking higher risks opt for these shares. A company can issue different types of preference shares.
Issue of Debentures: Debenture can be defined as the loan capital of a company and the holders of debentures are called creditors. These are the fixed charged funds that carry a fixed rate of interest. The issue of debentures is appropriate under the circumstances when the sales and earnings of the company are relatively stable.
Commercial Banks: Banks grant short and medium-term loans to firms of all sizes. The loan is repaid either in lump sum or in equated instalments. The rate of interest charged by the bank depends on various factors including the characteristics of the borrowing firm and the level of interest rates in the economy.
Financial Institutions: Both central and state governments have recognized number of financial institutions all over the country to grant industrial loans to companies engaged in business. They are also called development banks. This source of financing is considered appropriate when large funds are required for expansion, reorganisation and modernization of the business entity.
International Financing: With internation collaborations and globalisation of the economy, Indian companies have started generating funds through international markets. The international sources for procuring funds include foreign currency loans from commercial banks, financial assistance provided by international agencies and development banks, and issue of financial instruments (GDRs/ ADRs/ FCCBs) in international capital markets.
Factors Affecting Choice: An effectual appraisal of various sources must be instituted by the business organisation to achieve its main objectives. The selection of a source of business finance depends on factors such as cost, financial strength, risk profile, tax benefits and flexibility in obtaining funds. These factors should be analysed collectively while taking a decision for the choice of an appropriate source of funds.