FINANCE & ITS SOURCES- AN OVERVIEW:
Finance is very much essential for an organization for its daily business operations, development or diversification process. Finance, being a core limiting factor for most of the enterprises, it become important for a business to manage it properly.
There are various sources of finances which are classified on the basis of time period, ownership and source of generation. Having so many sources, it becomes a key challenge for every organization to choose a right source and right mix of finance. For doing that the business must require to do an in depth analysis of various sources of finance so that it can understand all the characteristics of financing resources.
SOURCES OF FINANCE ON THE BASIS OF TIME PERIOD:
It would be uncomplicated to classify the sources of finance on the basis of time period. It can be divided into the following three parts:
Short Term Sources:
Need for short term finance arises to meet the current assets requirement such as debtors or minimum cash or bank balance. It generally ranges for a period less than a year. The main sources of short term funds basically include the following:
- Trade credit: Under such arrangement, the suppliers supply the raw materials or unfinished products to the business on time but collect the due amount after some time. In this the credit worthiness of a business acts as security for trade credit.
- Factoring: In this the short term finance can be raised by partially or wholly discounting the bills and sales invoices of the customers. The institutions offering such service are known as factors.
- Commercial banks: Commercials banks are also a great source of short term finance. They provide finance by means of overdraft facility; cash credit facility etc. to meet the working capital requirements.
- Advances: Advances obtained from customers is one of the cheapest sources of finance and the firms usually takes advances from their customers and use them in meeting their short term needs of funds.
- Commercial papers: Commercial paper issued by the business which also includes promissory notes acts as a great as well as secure source of short term finance.
Medium Term Sources:
Need for medium term finance arises to meet both the current assets as well as fixed assets requirement. It ranges from 3 to 5 years. The medium term sources of finance include the following:
- Preference Shares: It is one of the important sources of medium term finance. These shareholders generally have preference over dividend as compared to other types of shares but have no say in the management. Preference shares are of various types such as cumulative, non-cumulative, redeemable, irredeemable, convertible, non-convertible etc.
- Debentures or bonds: Debentures are used as a tool for raising debt capital. A Debenture holder is a long-term creditor of the company. They receive a fixed rate of interest on the debt whether the company makes a profit or loss. Debentures are issued for fixed maturity and can be classified as secured, unsecured, fixed or floating.
- Public Deposits: Another important medium term source of finance includes raising money through public. The businesses generally offer high interest rates as compare to bank to attract more public. The cost of financing through public deposits is low.
- Term Loans: These loans are for a fixed period of time and a fixed amount of interest is paid on them. Its major sources include loans (for a term less than 5 years) from commercial banks as well as financial institutions.
Long Term Sources:
Long term finances are used to fund capitals expenditures in fixed assets such as plant & machinery, plant & building etc. and ranges from 5 years to 10,15 or 20 years. The long term sources of finance include:
- Equity Shares: It basically represents the owner capital of the company. These types of shares involve high risk and they cannot be redeemed during the company’s life time. The shareholders are provided with high interest and the repayment of capital is made after meeting all dues and liabilities.
- Retained Earnings: A Part of profit retained after distributing dividend is known as retained profits. These retained profits can be used to replace old assets or for the growth and expansion purpose.
- Lease Financing: Under this, an agreement is made between the two parties one is the lessor who lease the assets and other is the firm known as lessee. The agreement provides the firm with the facility to use and control over the asset without owing them. Hence the amount can be invested somewhere else.
- Term Loans: Loans for a period more than 5 years from various commercial banks and specialized financial institutions also acts as a reliable source of long term financing.