Sources of Business Finance

Business finance means the funds required by a business to carry out its activities. It is the money needed to establish and run the business.

Businesses need funds because they cannot function without adequate money. Funds are required for:
- purchasing fixed assets like land, building, plant, machinery, furniture, etc. (fixed capital requirements),
- day-to-day operations such as buying raw materials, paying salaries, wages, taxes and rent (working capital requirements), and
- growth and expansion, modernisation, higher inventories, or shifting to a new location.

So, business finance is essential for both starting a business and conducting it smoothly.

On the basis of period, sources of finance are classified as:

- Long-term sources: these provide funds for more than 5 years. They include shares, debentures, long-term borrowings, and loans from financial institutions.
- Short-term sources: these provide funds for not exceeding one year. They include trade credit, loans from commercial banks, and commercial papers.

So, the sources of raising long-term and short-term finance are as listed above.

The difference is based on where the funds come from:

- Internal sources of funds are generated from within the business. Examples are ploughing back of profits, acceleration of receivables collection, and disposing of surplus inventories.
- External sources of funds come from outside the business. Examples are suppliers, lenders, investors, issue of debentures, borrowing from commercial banks and financial institutions, and public deposits.

Internal sources can meet only limited needs, while external sources are used when a larger amount of money is required. External funds may also be costlier and may require security or mortgage of assets.

Preference shareholders enjoy a preferential position over equity shareholders in two ways:

1. Right to fixed dividend first: They receive a fixed rate of dividend out of the net profits of the company before any dividend is paid to equity shareholders.
2. Right to repayment of capital first at liquidation: At the time of liquidation, they receive their capital after the claims of creditors are settled, but before equity shareholders.

Thus, preference shareholders have a preferential claim over dividend and repayment of capital.

The chapter says financial institutions are established by the central and state governments to provide finance to business organisations and promote industrial development. Any three examples are:

- IFCI
- IDBI
- State Financial Corporations (SFCs)

Their objective is to provide owned capital and loan capital for long-term and medium-term requirements and to support expansion, reorganisation and modernisation of enterprises.