What are the Sources of Finance?
Business Finance
Businesses require funds for various activities, including start-up, daily operations, and expansion. These funds can be obtained through internal or external sources.
- Internal Sources: These are funds generated within the business itself, such as retained profits or the sale of assets.
- External Sources: These are funds obtained from outside the business, such as loans, equity financing, or government grants.
- The appropriateness of different funding sources depends on factors like the business’s size, stage of development, and specific needs.
Internal Sources of Finance
Internal sources of finance are funds generated within the business itself. They can include:
- Personal Funds: This is the entrepreneur’s own money, often used to start a business. It’s common for sole traders and can be supplemented with other sources.
- Retained Profit: This is the portion of profits kept after paying taxes and dividends. It can be used for reinvestment in the business or to create a contingency fund.
- Sale of Assets: Businesses can sell unused or obsolete assets to raise funds. This can be especially helpful during relocation or financial difficulties.
External Sources of Finance
This section outlines various external sources of finance that businesses can utilize:
- Share Capital: Raising money by selling shares in the company. This is a major source for publicly traded companies and allows for a large amount of funding.
- Loan Capital: Borrowing money from lenders like banks for medium to long-term needs. Examples include mortgages and business development loans. Interest is charged, and repayment occurs over a set period.
- Overdrafts: A flexible short-term borrowing option from banks that allows businesses to temporarily withdraw more money than they have in their account. Interest is charged on the amount overdrawn.
- Trade Credit: Essentially “buying now, paying later” from suppliers. Businesses are given a grace period (usually 30-60 days) to settle payments for goods received.
- Crowdfunding: Raising smaller amounts of money from a large number of individuals online or through social networks. May involve donation or equity crowdfunding.
- Leasing: Renting assets like machinery or equipment from a leasing company instead of purchasing them outright. This frees up cash for other uses but can be more expensive in the long run compared to buying.
- Microfinance Providers: Institutions offering financial services to small businesses and low-income entrepreneurs, often with social development goals.
- Business Angels: Wealthy individuals who invest their own money in high-growth potential businesses. They may provide guidance and expertise but expect a high return on investment and may take a role in the business.
Short-Term and Long-Term Sources of Finance
The appropriateness of different finance sources depends on various factors, including:
Business Factors:
- Size and Type: Larger, established businesses have more options than sole traders.
- Time Scale: Short-term needs require immediate financing, while long-term investments demand sustainable sources.
- Purpose: Daily operations require short-term funds, while asset purchases necessitate long-term financing.
- Amount: Larger amounts may require IPOs or long-term loans, while smaller amounts can be covered by retained profits or overdrafts.
- Gearing Ratio: High debt levels can increase financial risk, affecting borrowing options and costs.
External Factors:
- Economic Conditions: Market volatility and interest rates influence investment decisions.
- Industry Trends: Fast-paced industries may have shorter planning horizons than slower ones.
- Strategic Considerations:
- Cash Flow: Businesses must ensure sufficient cash inflows to cover outflows.
- Collateral: Larger firms may offer better collateral for loans.
- Costs: Interest rates, fees, and maintenance charges vary by source and should be considered.
Control: Issuing shares or debentures can dilute ownership and control.
