Sources of business finance can be studied under the following headings:
(1) Short Term Financing:
Short-term financing is needed to meet the current needs of businesses. Current needs may include payment of taxes, wages or salaries, repair expenses, creditor payment, etc. The need for short-term financing arises because sales revenues and purchase payments are not perfectly equal at all times. Sometimes sales can be low compared to purchases. Other sales may be on credit while purchases are for cash. Therefore, short-term financing is needed to equalize these imbalances.
The sources of short-term financing are the following:
(i) Bank overdraft: Bank overdraft is a widely used source of business financing. Under this client can withdraw certain sum of money above the balance of his original account. This makes it easier for the entrepreneur to deal with unexpected expenses in the short term.
(ii) Discount of invoices: Bills of exchange can be discounted at banks. This provides the note holder with cash that can be used to fund immediate needs.
(iii) Customer Advances: Advances are requested and received primarily for order confirmation, however, they are also used as a source of financing for the operations necessary to execute the work order.
(iv) Installation purchases: Buying in installments gives more time to make payments. Deferred payments are used as a source of financing for small expenses that must be paid immediately.
(v) bill of lading: The bill of lading and other export and import documents are used as collateral to borrow from banks and that loan amount can be used as financing for a short period of time.
(vi) Financial Institutions: Different financial institutions also help entrepreneurs out of financial difficulties by providing short-term loans. Certain cooperative societies can arrange short-term financial assistance for entrepreneurs.
(vii) Trade Credit: It is common practice for businessmen to buy raw materials, warehouses and spare parts on credit. Such transactions result in an increase in the accounts payable of the business that must be paid after a certain period of time. Goods are sold for cash and payment is made after 30, 60 or 90 days. This allows entrepreneurs some freedom to deal with financial difficulties.
(2) Medium Term Financing:
This financing is necessary to meet the medium-term requirements (1-5 years) of the business. Such financing is basically required for the balancing, modernization and replacement of machinery and installations. These are also necessary for the reengineering of the organization. They help management complete medium-term capital projects within the planned time. The following are the sources of medium-term financing:
(i) Commercial Banks: Commercial banks are the main source of medium-term financing. They provide loans for different periods of time against appropriate values. At the end of the terms, the loan can be renegotiated, if necessary.
(ii) Installment purchase: Installment buying means buying on installments. It allows the business house to have the required goods with payments to be made in the future in agreed installments. It goes without saying that some interest is always charged on the outstanding amount.
(iii) Financial Institutions: Several financial institutions such as Banco PYME, Banco de Fomento Industrial, etc., also provide medium and long-term financing. In addition to providing funding, they also provide technical and managerial assistance on different matters.
(iv) Debentures and TFC: Debentures and TFCs (Terms Finance Certificates) are also used as a source of medium-term financing. Debentures is an acknowledgment of a company loan. It can be of any duration as agreed between the parties. The bond holder enjoys a return at a fixed interest rate. Under the Islamic mode of financing, bonds have been replaced by TFCs.
(v) Insurance Companies: Insurance companies have a large amount of funds contributed by their policyholders. Insurance companies make loans and make investments outside of this group. Such loans are the source of medium-term financing for various businesses.
(3) Long Term Financing:
Long-term finances are those that are required permanently or for more than five years. Basically they are desired to deal with structural changes in the business or for heavy modernization expenses. These are also needed to start a new business plan or for long-term development projects. The following are their sources:
(i) Capital Shares: This method is the most used worldwide to obtain long-term financing. Equity shares are subscribed for by the public to generate the capital base of a large-scale business. Equity shareholders share in the profits and losses of the business. This method is safe and secure, in the sense that the amount once received is only returned at the time of liquidation of the company.
(ii) Retained Earnings: Retained earnings are the reserves that are generated from excess earnings. In times of need they can be used to finance the business project. This is also called reinvestment of earnings.
(iii) Lease: Leasing is also a source of long-term financing. With the help of leasing, new equipment can be acquired without a large cash outflow.
(iv) Financial Institutions: Different financial institutions, such as the former PICIC, also provide long-term loans to business houses.
(v) Obligations: Negotiable Obligations and Term Participation Certificates are also used as a source of long-term financing.
Conclusion:
These are various sources of funding. In fact, there is no hard and fast rule to differentiate between short and medium term sources or medium and long term sources. A source, such as a commercial bank, may provide a short-term or long-term loan depending on the client’s needs. However, all of these sources are frequently used in the modern business world for fundraising.