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Sources of finance are the most explored area especially for the entrepreneurs about to start a new business. It is perhaps the toughest part of all the efforts. There are various sources of finance classified based on time period, ownership and control, and source of generation of finance.
The process of selecting right source of finance involves in-depth analysis of each and every source of finance. For analyzing and comparing the sources of finance, it is required to understand all characteristics of the financing sources. There are many characteristics on the basis of which sources of finance are classified.
On the basis of a time period, sources are classified into long term, medium term, and short term. Ownership and control classify sources of finance into owned capital and borrowed capital. Internal sources and external sources are the two sources of generation of capital. All the sources of capital have different characteristics to suit different types of requirements. Let’s understand them in a little depth.
ACCORDING TO TIME-PERIOD:
Sources of financing a business are classified based on the time period for which the Money is required. Time period is commonly classified into following three:
- Long Term Sources of Finance:
Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building etc of a business are funded using long-term sources of finance. Part of WORKING CAPITAL which permanently stays with the business is also financed with long-term sources of finance. Long term financing sources can be in form of any of them:
- Share Capital or Equity Shares
- Preference Capital or Preference Shares
- Retained Earnings or Internal Accruals
- Debenture / Bonds
- Term Loans from Financial Institutes, Government, and Commercial Banks
- Venture Funding
- Asset Securitization
- International Financing by way of Euro Issue, Foreign Currency Loans, ADR, GDR etc.
- Medium Term Sources of Finance:
Medium term financing means financing for a period of 3 to 5 years. Medium term financing is used generally for two reasons. One, when long-term capital is not available for the time being and second, when deferred revenue expenditures like advertisements are made which are to be written off over a period of 3 to 5 years. Medium term financing sources can in the form of one of them:
- Preference Capital or Preference Shares
- Debenture / Bonds
- Medium Term Loans from
- Financial Institutes
- Government, and
- Commercial Banks
- Lease Finance
- Hire Purchase Finance.
- Short Term Sources of Finance: Short term financing means financing for a period of less than 1 year. Need for short term finance arises to finance the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank balance etc. Short term financing is also named as working capital financing. Short term finances are available in the form of:
- Trade Credit
- Short Term Loans like Working Capital Loans from Commercial Banks
- Fixed Deposits for a period of 1 year or less
- Advances received from customers
- Creditors
- Payables
- Factoring Services
- Bill Discounting etc.
There are two main categories of sources from which the firm can get the required funds for their business. These are:
(1) Internal sources; and
(2) External sources.
When the businessman invests his own money (called owner’s capital), and retains a part of the profits earned in the business it constitute the internal sources of finance. It is an integral part of every business organisation and it is cost effective. But, this source has its own limitations. Hence the business houses have to resort to the external sources of finance. The various external sources from where businessmen can get the finance include, friends and relatives, banks and other financial institutions, moneylenders, Capital Market, manufacturers and producers, customers, foreign financial institutions and agencies, etc. It is observed that the scope of raising funds also depends upon the nature and form of business organisation.
The following are the usual sources of finance. (a) Capital Market (b) Financial Institutions (c) Public Deposits (d) Commercial Banks (e) Leasing Companies (f) Investment Trusts (g) Retained Profits,
Sources of Finance
There are many different sources of finance available to businesses, entrepreneurs, and individuals. The best source of finance will vary depending on the specific needs of the user.
Equity
Equity is a form of ownership in a company. When you buy shares in a company, you are buying a piece of that company. Equity is often used to finance new businesses or to expand existing businesses.
Debt
Debt is a loan that must be repaid with interest. Debt can be used to finance a variety of expenses, such as buying a car or a house. Debt can also be used to finance businesses.
Hybrid securities
Hybrid securities are a combination of equity and debt. They have some of the features of equity, such as the potential for capital appreciation, and some of the features of debt, such as the requirement to make interest payments. Hybrid securities are often used to finance businesses.
Venture capital is a type of equity financing that is provided to early-stage companies. Venture capitalists typically invest in companies that have the potential for high Growth.
Private equity is a type of equity financing that is provided to companies that are not publicly traded. Private equity firms typically invest in companies that are looking to grow or restructure.
Angel investment
Angel investors are individuals who provide financial backing to early-stage companies. Angel investors typically invest in companies that they believe have the potential to be successful.
Crowdfunding
Crowdfunding is a way of raising money from a large number of people, typically through the Internet. Crowdfunding can be used to finance a variety of projects, such as new businesses, creative projects, and charitable causes.
Government funding
Government funding is money that is provided by the government to businesses, individuals, and other organizations. Government funding can be used for a variety of purposes, such as research and development, job creation, and Economic Development.
Grants
Grants are a type of government funding that is provided to businesses, individuals, and other organizations without the expectation of repayment. Grants are typically awarded to organizations that are working to address a social or economic need.
Loans
Loans are a type of debt financing that is provided by a lender. Loans must be repaid with interest. Loans can be used to finance a variety of expenses, such as buying a car or a house.
Credit cards
Credit cards are a type of revolving credit that is provided by a credit card company. Credit cards allow you to borrow money up to a certain limit and repay it over time. Credit cards can be used to finance a variety of expenses, such as travel, shopping, and dining.
Personal Savings
Personal savings are money that you have set aside for future use. Personal savings can be used to finance a variety of expenses, such as a down payment on a house or a new car.
Retirement savings
Retirement savings are money that you have set aside for your retirement. Retirement savings can be invested in a variety of assets, such as stocks, bonds, and Mutual Funds.
Home equity
Home equity is the value of your home that is above the amount you owe on your mortgage. You can borrow against your home equity to finance a variety of expenses, such as home repairs, Education, or medical expenses.
Sale of assets
You can finance your expenses by selling assets that you own, such as stocks, bonds, or real estate.
Insurance proceeds
If you have insurance, you may be able to use the proceeds from a claim to finance your expenses.
Inheritance
If you inherit money or property, you may be able to use it to finance your expenses.
Divorce settlement
If you get a divorce, you may be able to use the proceeds from the divorce settlement to finance your expenses.
Lottery winnings
If you win the lottery, you may be able to use the winnings to finance your expenses.
Other sources
There are many other sources of finance available, such as family and friends, credit unions, and pawn shops.
The best source of finance will vary depending on your specific needs. If you are unsure of which source of finance is right for you, you should consult with a financial advisor.
What are the different types of sources of finance?
There are many different types of sources of finance, but some of the most common include:
- Debt finance: This is when a business borrows money from a lender, such as a bank or a credit card company. The borrower must then repay the loan, plus interest, over time.
- Equity finance: This is when a business sells shares in itself to investors. The investors then become part-owners of the business and share in its profits or losses.
- Internal finance: This is when a business uses its own cash flow to finance its activities. This can be done by reinvesting profits or by using cash reserves.
- Government finance: This is when a government provides financial assistance to businesses, such as through grants or loans.
- Private equity finance: This is when a private equity firm invests in a business. Private equity firms typically invest in businesses that are not publicly traded, and they often take an active role in managing the businesses they invest in.
- Venture capital finance: This is a type of private equity finance that is typically used to finance early-stage businesses. Venture capitalists typically invest in businesses that have the potential for high growth, but they also take on a higher level of risk.
What are the advantages and disadvantages of each type of source of finance?
Each type of source of finance has its own advantages and disadvantages. Some of the key factors to consider when choosing a source of finance include:
- The cost of finance: The cost of finance will vary depending on the type of finance and the terms of the loan or investment.
- The level of risk: Some types of finance are riskier than others. For example, debt finance is typically considered to be a lower-risk option than equity finance.
- The level of control: The level of control that a business has over its finances will vary depending on the type of finance. For example, a business that borrows money from a bank will typically have less control over its finances than a business that sells shares to investors.
- The flexibility of finance: The flexibility of finance will vary depending on the type of finance. For example, a business that borrows money from a bank may have to repay the loan over a fixed period of time, while a business that sells shares to investors may be able to sell shares whenever it wants.
How do I choose the right source of finance for my business?
The right source of finance for your business will depend on a number of factors, including the size of your business, your financial needs, and your risk Tolerance. It is important to speak to a financial advisor to get advice on the best type of finance for your business.
What are some common mistakes to avoid when financing a business?
Some common mistakes to avoid when financing a business include:
- Not planning ahead: It is important to have a clear plan for how you will finance your business before you start looking for funding.
- Not considering all of your Options: There are many different types of finance available, so it is important to consider all of your options before making a decision.
- Taking on too much debt: Debt can be a useful tool for financing a business, but it is important to make sure that you do not take on too much debt.
- Not understanding the terms of the loan or investment: It is important to understand the terms of any loan or investment before you agree to it.
- Not having a backup plan: It is always a good idea to have a backup plan in case your business does not generate enough cash flow to repay your loans or meet your financial obligations.
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Which of the following is not a source of finance?
(A) Equity
(B) Debt
(C) Government grants
(D) Crowdfunding -
Which of the following is a type of equity finance?
(A) Shares
(B) Bonds
(C) Loans
(D) Invoice discounting -
Which of the following is a type of debt finance?
(A) Shares
(B) Bonds
(C) Loans
(D) Invoice discounting -
Which of the following is a type of government grant?
(A) Regional development grant
(B) Research and development grant
(C) Start-up loan
(D) All of the above -
Which of the following is a type of crowdfunding?
(A) Equity crowdfunding
(B) Debt crowdfunding
(C) Reward crowdfunding
(D) All of the above -
Which of the following is the most common source of finance for small businesses?
(A) Equity
(B) Debt
(C) Government grants
(D) Crowdfunding -
Which of the following is the most expensive source of finance?
(A) Equity
(B) Debt
(C) Government grants
(D) Crowdfunding -
Which of the following is the most risky source of finance?
(A) Equity
(B) Debt
(C) Government grants
(D) Crowdfunding -
Which of the following is the most flexible source of finance?
(A) Equity
(B) Debt
(C) Government grants
(D) Crowdfunding -
Which of the following is the most common source of finance for start-ups?
(A) Equity
(B) Debt
(C) Government grants
(D) Crowdfunding