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What are the different Sources of Finance?

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Business is concerned with the production and distribution of goods and services to meet demands. Finance is required by businesses to carry out many activities. As a result, finance is said to as the “vital blood” of any business. Business finance refers to a company’s need for finances to carry out its numerous operations. Different sources of finance include Retained Earnings, Trade Credit, Factoring. Lease Financing, Public Deposits, Debentures, etc.

Sources of Finance

A company can raise capital from a variety of sources. Each source has distinct features that must be properly analyzed in order to choose the greatest accessible method of obtaining finances. For all organisations, there is no one optimum source of funding. A choice of the source to be used may be made depending on the situation, purpose, cost, and associated risk.

Finance is required at the point when an entrepreneur decides to launch a business. For example, funds are needed to buy furniture, equipment, and other fixed assets. Similar to this, funds are needed for regular operations, such as buying supplies or paying employees’ salaries. Additionally, a business needs funds to expand. For Example, if a company wants to raise funds to fulfil its fixed capital requirements, long-term finances may be necessary, which can be raised through either owned or borrowed funds. Similarly, if the goal is to meet the day-to-day needs of the business, short-term sources may be utilized.

Without sufficient funding, a business is unable to operate. The entrepreneur’s initial investment may not always be enough to take care of the company’s entire financial needs.  As a result, a businessman needs to look for various other sources where the need for funds can be satisfied. Running a business organisation, therefore, requires a clear understanding of the financial requirements and the identification of various sources of funding.

Different Sources of Finance

Different Sources of Finance

1. Retained Earnings:

In most cases, a company does not release all of its earnings or share its profits with its shareholders as dividends. A part of the net earnings may be retained in the company for future use. This is known as retained earnings. It is a source of internal finance, self-financing, or profit ploughing. The profit available for reinvestment in an organisation is dependent on a variety of factors, including net profits, dividend policy, and the age of the organisation.

2. Trade Credit:

Trade credit is credit given by one trader to another for the purchase of products and services. Trade credit facilitates the purchase of goods without the need for immediate payment. Such credit shows in the buyer of goods’ records as ‘sundry creditors’ or ‘accounts payable.’ Business organisations frequently utilise trade credit as a form of short-term finance.

It is granted to consumers that have a solid financial status and a good reputation. The amount and period of credit provided are determined by criteria, such as the purchasing firm’s reputation, the seller’s financial status, the number of purchases, the seller’s payment history, and the market’s level of competition. Trade credit terms might differ from one industry to another and from one person to another.

3. Factoring :

Factoring is a financial service in which the ‘factor’ provides a variety of services such as :

  • Bill discounting (with or without recourse) and debt collection for the client:  Under this, receivables from the sale of goods or services are sold to the factor at a certain discount. The factor takes over all credit control and debt collection from the buyer and protects the company against any bad debt losses.

    Factoring has basic two methods: Recourse and Non-recourse.
    The customer is not safeguarded against the risk of bad debts while using recourse factoring. Non-recourse factoring, on the other hand, involves the factor assuming the complete credit risk, which means that the full amount of the invoice is reimbursed to the client if the debt goes bad.
  • Factors retain vast volumes of information on the trading history of businesses, which they use to provide information about the creditworthiness of prospective clients, among other things. This can be beneficial to individuals that use factoring services, and therefore avoid doing business with consumers who have a bad payment history. Factors may also provide appropriate consulting services in areas, like finance, marketing, and so forth.

4. Lease Financing:

A lease is a contractually enforceable arrangement whereby a one party, the owner of an asset, grants the other party the right to use the asset in exchange for a monthly payment. In other terms, it is the rental of an asset for a certain amount of time. The party who owns the assets is known as the ‘lessor,’ while the party who utilises the assets is known as the ‘lessee.’ The lessee pays the lessor a predetermined periodic sum known as lease rental in exchange for the usage of the asset.

The lease contract includes the conditions and terms that regulate the lease arrangements. At the end of the lease agreement, the asset will be returned to the owner. Lease financing is a critical tool for the firm’s modernization and diversification.

5. Public Deposits:

Public deposits are deposits gathered from the public by organisations. Interest rates on public deposits are often higher than those on bank deposits. Anyone who wants to make a monetary contribution to an organisation can do so by filling a specified form.

In return, the organisation gives a deposit receipt as proof of payment. A business’s medium and short-term financial needs can be met through public deposits. Deposits are beneficial to both the depositor and the organisation. While depositors receive higher interest rates than banks, the cost of deposits to the corporation is lower than the cost of borrowing from banks. Companies often seek public deposits for up to three years. The Reserve Bank of India regulates the acceptance of public deposits.

6. Commercial Papers:

Commercial Paper (CP) is an unsecured promissory note. It was first created in India in 1990 to allow highly rated corporate borrowers to diversify their sources of short-term borrowings and to give investors an additional instrument.

Following that, primary dealers and all-India financial institutions were authorised to issue CP in order to cover their short-term funding needs for their operations. Individuals, banks, other corporate organisations (registered or incorporated in India), unincorporated bodies, Non-Resident Indians (NRIs), and Foreign Institutional Investors (FIIs), among others, can invest in CPs. CP can be issued in denominations of Rs.5 lakh or multiples thereof with maturities varying from 7 days to up to one year from the date of issue.

7. Issue of Shares:

A share is the smallest unit of a company’s capital. The firm’s capital is split into small units and issued to the public as shares. The capital gained via the issuance of shares is referred to as ‘Share Capital.’ It’s a kind of Owner’s Fund.

There are two kinds of shares that can be issued:

  • Equity Shares: These are shares that do not pay a fixed dividend, but do have ownership and voting rights. Owner of the firm refers to the company’s equity shareholders. They do not get a set dividend, but are paid dependent on the company’s profitability.
  • Preference Shares: Preference shares are shares that have a slight preference over equity shares. Preference Shareholders get a set dividend rate and have the right to receive their capital before equity shareholders in case of liquidation. They do not, however, have any voting rights in the company’s management.

8. Debentures:

Debentures are an effective instrument for raising long-term debt capital. A firm can raise capital by issuing debentures with a fixed rate of interest. A firm’s debenture is a recognition that the company has borrowed a specified amount of money, which it commits to repay at a later period. Debenture holders are part of the company as the company’s creditors. Debenture holders get a definite stated amount of interest at predetermined periods, such as six months or a year.

Debentures issued publicly must be assessed by a credit rating agency such as CRISIL (Credit Rating and Information Services of India Ltd.) on factors such as the company’s track record, profitability, debt payment capability, creditworthiness, and perceived risk of lending.

9. Commercial Banks:

Commercial banks play an important role in providing finances for a variety of purposes and time periods. Banks provide loans to businesses in a variety of ways, including cash credits, overdrafts, term loans, bill discounting and the issuance of letters of credit. The interest rate imposed on such credits varies depending on the bank as well as the nature, amount, and duration of the loan.

10. Financial Institutions:

The government has established many financial institutions in the country to give financing to businesses. They provide both owned and loan capital for long- and medium-term needs. These organisations are often known as ‘Development Banks’ since they aim to promote a country’s industrial development. In addition to financial help, these institutes conduct surveys and provide organisations with technical assistance and management services. Financial institutions provide funds for the expansion, reorganisation and modernisation of an enterprise. 

Last Updated : 19 Jan, 2024
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