Sources of Business Finance

To meet long-term, medium-term, and short-term financial requirements, companies can use various sources to raise funds for their business. This article provides an overview of the main methods used in today’s business landscape.

Methods For Raising Long-Term Funds

  1. Issue of shares
  2. Issue of debentures
  3. Loans from specialized financial institutions
  4. Plowing back earnings (for existing companies)

Methods For Raising Medium-Term (or Intermediate-Term) Funds

  1. Issue of preference shares
  2. Issue of debentures
  3. Public deposits
  4. Bank loans (term loans)
  5. Assistance from specialized financial institutions

Methods of Raising Short-Term Funds

  1. Credit purchases or trade credit
  2. Bank overdraft
  3. Cash credit
  4. Advances from customers

Sources of Raising Borrowed Funds

  1. Debentures
  2. Financial institutions
  3. Public deposits
  4. Commercial banks

Sources For Raising Long-Term Borrowed Funds

  1. Debentures
  2. Financial institutions

The Pattern of Capital Structure

A joint-stock company is free to choose its own capital structure. This may happen through:

  1. Issuing equity shares
  2. Issuing both equity shares and preference shares
  3. Issuing equity shares, preference shares, and debentures

Frequently Asked Questions

What are the advantages of issuing shares to raise long-term finance?

An advantage is that it involves passing on some risk to the shareholders. Additionally, new equity issues are generally regarded favorably by existing and potential investors, also providing access to additional sources of capital for diversification purposes.

What are the disadvantages of borrowing instead of raising funds through issuing equity shares?

The main disadvantage is that interest costs and debt servicing requirements may reduce the net income available for dividends or reserves, possibly adversely affecting earnings per share. It may also limit the companies’ growth potential.

What are the advantages of borrowing instead of raising funds through issuing shares?

It offers additional liquidity than other forms of funding because there is no voting rights, or claim to the company's assets. Moreover, by borrowing through the creation of a separate legal entity, it also allows companies to diversify their sources of finance and limit their exposure to market fluctuations.

What are the disadvantages of borrowing instead of raising funds through issuing shares?

Debt levels are typically much higher than for shareholder-funded companies. This means that portions of income must be reinvested in the business to pay interest on loans, rather than funding growth or paying dividends. However, as debt constitutes a fixed liability, it also makes the company susceptible to bankruptcy risk in the event of a downturn in business.

What is the difference between preference shares and debentures?

Preference shareholders have priority in receiving dividends before ordinary shareholders, but after debt holders. Additionally, it is also not possible for preference shareholders to receive unpaid dividends from earlier financial years because ordinary shareholders will already have received their dividend.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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