Sources of business finance can be studied under the following heads:
(1) Short Term Finance:
Short-term finance is needed to fulfill the current needs of a business. The present conditions may include payment of taxes, salaries or wages, repair expenses, compensation to creditors, etc. The need for short-term finance arises because sales revenues and purchase payments are not always the same. Sometimes, sales can be low as compared to purchases. Further sales may be on credit while purchases are on cash. So, short-term finance is needed to match this disequilibrium.
Sources of short-term finance are as follows:
(i) Bank Overdraft: Bank overdraft is widely used as a source of business finance. Under this, the client can draw a certain sum of money over and above his original account balance. Thus, it is easier for the businessman to meet short-term unexpected expenses.
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(ii) Bill Discounting: Bills of exchange can be discounted at the banks. This provides cash to the bill holder, which can be used to finance immediate needs.
(iii) Advances from Customers: Advances are primarily demanded and received the confirmation of orders. However, these are also used to finance the operations necessary to execute the job order.
(iv) Installment Purchases: Purchasing on installment gives more time to make payments. The deferred payments are used to finance small expenses that are to be paid immediately.
(v) Bill of Lading: Bill of lading and other export and import documents are used as a guarantee to take the loan from banks, and that loan amount can be used as finance for a short period.
(vi) Financial Institutions: Financial institutions also help business people avoid financial difficulties by providing short-term loans. Certain cooperative societies can arrange short-term financial assistance for business people.
(vii) Trade Credit: The business people usually buy raw materials, stores, and spares on credit. Such transactions increase accounts payable of the business, which are to be paid after a certain period. Goods are sold in cash, and payment is made after 30, 60, or 90 days. This allows some freedom to business people in meeting financial difficulties.
(2) Medium Term Finance:
This finance is required to meet the business’s medium-term (1-5 years) requirements. Such finances are necessary for the balancing, modernizing, and replacing machinery and plants. These are also needed for re-engineering of the organization. They aid the management in completing medium-term capital projects within the planned time. The following are the sources of medium-term finance:
(i) Commercial Banks: Commercial banks are the major source of medium-term finance. They provide loans for different periods against appropriate securities. At the termination of terms, the loan can be renegotiated if required.
(ii) Hire Purchase: Hire purchase means buying in installments. It allows the business house to have the required goods with payments to be made in the agreed installment future. Some interest is always charged on the outstanding amount.
(iii) Financial Institutions: Several financial institutions, such as SME Bank, Industrial Development Bank, etc., also provide medium and long-term finances. Besides providing finance, they provide technical and managerial assistance on different matters.
(iv) Debentures and TFCs: Debentures and TFCs (Terms Finance Certificates) are also used as a source of medium-term finances. Debentures are an acknowledgment of a loan from the company. It can be of any duration as agreed among the parties. The debenture holder enjoys a return at a fixed rate of interest. Under the Islamic mode of financing, debentures have been replaced by TFCs.
(v) Insurance Companies: Insurance companies have a large pool of funds their policyholders contribute. Insurance companies grant loans and make investments out of this pool. Such loans are the source of medium-term financing for various businesses.
(3) Long Term Finance:
Long-term finances are required permanently or for more than five years of tenure. They are desired to meet structural changes in business or for heavy modernization expenses. These are also needed to initiate a new business plan or long-term developmental projects. The following are its sources:
(i) Equity Shares: This method is widely used worldwide to raise long-term finance. The public subscribes to equity shares to generate the capital base of large-scale businesses. The equity shareholders share the profit and loss of the business. This method is safe and secured, in the sense that the amount once received is only paid back at the time of wounding up of the company.
(ii) Retained Earnings: Retained earnings are the reserves generated from the excess profits. In times of need, they can finance the business project. This is also called plowing back of profits.
(iii) Leasing: Leasing is also a source of long-term finance. With the help of leasing, new equipment can be acquired without any heavy outflow of cash.
(iv) Financial Institutions: Financial institutions, such as former PICNIC, also provide long-term loans to business houses.
(v) Debentures: Debentures and Participation Term Certificates are also used as sources of long-term financing.
These are various sources of finance. There is no hard and fast rule to differentiate between short-, medium-, and long-term bases. For example, a source can provide both a short-term and a long-term loan according to a client’s needs. However, all these sources are frequently used in the modern business world for raising finances.