Sources of Business Finance

Article Summary show

(1) Short Term Finance:

Short-term finance is needed to fulfill the current needs of the business. The present conditions may include paying taxes, salaries or wages, repair expenses, payment to creditors, etc. The need for short-term finance arises because sales revenues and purchase payments are not salways the same. Sometimes, sales can be low as compared to purchases. Other deals may be on credit, while purchases are on cash. So, short-term finance is needed to match this disequilibrium.

Sources of short-term finance are as follows:

(i) Bank Overdraft: Bank overdraft is a widely used business finance source. Under this, the client can draw a certain sum of money over and above his original account balance. Thus, it is easier for the businessman to meet unexpected short-term expenses.

(ii) Bill Discounting: Bills of exchange can be discounted at the banks. This provides cash to the bill holder, which can be used to finance immediate needs.

(iii) Advances from Customers: Advances are primarily demanded and received to confirm orders. However, these are also used to finance the operations necessary to execute the job order.

(iv) Installment Purchases: Purchasing on installment gives more time to make payments. The deferred payments are used to finance small expenses to be paid immediately.

(v) Bill of Lading: Bill of lading and other export and import documents are used as a guarantee to take a loan from banks, and that loan amount can be used as finance for a short time.

(vi) Financial Institutions: Financial institutions also help business people avoid financial difficulties by providing short-term loans. Certain cooperative societies can arrange short-term financial assistance for business people.

(vii) Trade Credit: It is the usual practice of businessmen to buy raw materials, store, and spares on credit. Such transactions increase accounts payable of the business, which are to be paid after a specific period. Goods are sold in cash, and payment is made after 30, 60, or 90 days. This allows some freedom to business people in meeting financial difficulties. My Live Updates.

(2) Medium Term Finance:

This finance is required to meet the business’s medium-term (1-5 years) requirements. Such finances are necessary to balance, modernize, and replace machinery and plants. These are also needed for re-engineering of the organization. They aid the management in completing medium-term capital projects within the planned time. The following are the sources of medium-term finance:

(i) Commercial Banks: Commercial banks are the primary source of medium-term finance. They provide loans for different periods against appropriate securities. At the termination of terms, the loan can be re-negotiated if required.

(ii) Hire Purchase: Hire purchase means buying in installments. It allows the business house to have the required goods with payments made in agreed installments. Some interest is always charged on outstanding amounts.

(iii) Financial Institutions: Several financial institutions, such as SME Bank, Industrial Development Bank, etc., also provide medium and long-term finances. Besides providing finance, they provide technical and managerial assistance on different matters.

(iv) Debentures and TFCs: Debentures and TFCs (Terms Finance Certificates) are also used as a source of medium-term finances. Debentures are an acknowledgment of a loan from the company. It can be of any duration as agreed between the parties. The debenture holder enjoys a return at a fixed rate of interest. Under the Islamic mode of financing, debentures have been replaced by TFCs.

(v) Insurance Companies: Insurance companies have a large pool of funds from their policyholders. Insurance companies grant loans and make investments out of this pool. Such loans are the source of medium-term financing for various businesses.