Sources of Finance | Types of Business Finance

Sources of Finance

There are basically three types of business organizations and for every sort of business organization sources of finance are really important to have. Through these sources of finance, business meets its basic and day to day needs. Sole proprietorship and partnership form of business organization are mostly run on small scale basis. They generally meet their fixed and working capital requirements from their owned capital. It is only the company form of organization, which is run on large scale basis. It requires huge amount of funds to purchase fixed assets, meeting day to day expenses of business and for modernization and replacement of machinery. Let’s discuss the major joint stock company sources of finance in detail.

Sources of Finance in Business

There are two major sources of finance for meeting the financial requirements of any business enterprises, which are as under:

  • Owners Fund
  • Borrow Fund
  1. Owners Fund

Owners fund is also called as Owners Capital or owned capital. It consists of the funds contributed by the owners of business as well as profits reinvested in business. A company cans raise owner’s funds in the following ways:-

  • Issue of equity shares
  • Ploughed back profits
  1. Borrow Fund

The second source of funding to a business is the borrowed fund. Borrowed fund consists of the amount raised by way of loans or credit. It is also known as borrowed capital. The borrowed fund is procured from the following sources;-

  • Debentures
  • Bank Loans
  • Loans from specialized financial institutions
  • Other long term financial institutions

Types of Business Finance

All businesses require an adequate finance. They need money for investment in fixed asset such as land, building, machinery etc. Once business is in operation, money is needed for Working Capital, such as purchase of raw material, payment of wages, utility bills etc.. A going concern also requires extra capital to cover a temporary cash flow crisis, or purchase new improved machinery or simply to expand the business. The financial requirements of a business, on the basis of time duration, are usually classified under three heads which are as follow:

  • Short Term Finance
  • Medium Term Finance
  • Long Term Finance
  1. Short Term Finance

Short term Sources of  finance is defined as money raises for investment in business for a period of less than one year, it is also named as working capital or circulating capital or revolving capital.

The purpose and amount of obtaining short term capital varies with the nature and size of the business. Generally the short term capital is required for meeting the day to day expenses of business such as payment of utility bills, wages to the workers, unforeseen expenses, seasonal upswings in business, increasing inventories raw material, work in progress and finished goods etc.

The various sources of short term finance are as under:-

  • Trade creditor open book account
  • Advance from customers
  • Installment credit
  • Bank Overdraft
  • Cash credit
  • Discounting bills
  • Against bill of lading
  1. Medium Term Finance

Medium term sources of finance are required for investment in business for a medium period which normally ranges from one to five years. The medium term funds are required generally for the repair and modernization of machinery, renovation of the building, adoption of new methods of production, carrying advertisement campaign on large scale in newspapers, television etc. The various sources of medium term finance are as under:-

  1. Long Term FinanceLong term sources of finance refer to the funds, which are required for investment in business for a period exceeding up to five years. It is also named as long term capital or fixed capital. Long term sources of finance are mostly required for the purchased of fixed assets, such as land, building, machinery etc. modernization and expansion of business. The amount of long term finance varies with the nature of business, size of business, nature of the product manufactured, the number of goods produced, and the method of production etc. The various sources of long term finance are as under:-
    • Equity shares
    • Issue of right shares
    • Debentures
    • Loans from industrial and financial institutions
    • Leasing
    • Ploughing back of profits