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Sources Of Finance

1. Importance of Finance in Business

Key Point:
Finance is the life blood of any business and is required to carry out various activities, including production and distribution of goods and services.

Elaboration:

  • Every business needs money to start and continue its operations.
  • The finance helps in buying raw materials, paying salaries, and managing all expenses.
  • Initial capital, or money brought in by the entrepreneur, is often not enough. Additional funds are needed from various sources.

Examples:

  1. Starting a bakery requires money to buy ovens, ingredients, and pay workers.
  2. A car manufacturing company needs a lot more capital to set up the factory and purchase machinery.
  3. A grocery shop may initially use the owner's savings, but as more customers arrive, more money is needed for stock.

2. Financial Needs of a Business

The financial needs of a business are mainly of two types: fixed capital requirements and working capital requirements.

(a) Fixed Capital Requirements

Key Point:
Fixed capital is needed to acquire fixed assets used for a long time.

Elaboration:

  • Fixed capital is used to purchase assets like land, buildings, machines, furniture, etc.
  • These assets stay in the business for many years.
  • The amount needed depends on the type and size of business.
  • Factories need more fixed capital than a small retail shop.

Examples:

  1. Buying a delivery van for a transport company.
  2. Setting up a factory with machines and buildings for a textile business.
  3. Purchasing furniture for a new restaurant.

(b) Working Capital Requirements

Key Point:
Working capital is needed for daily expenses and smooth running of business operations.

Elaboration:

  • Working capital is used for things like buying materials, paying salaries, water and electricity bills, and other day-to-day expenses.
  • It is also used to hold ‘current assets’ like cash, stock-in-trade, and bills receivable.
  • No matter how big or small, every business needs working capital.

Examples:

  1. Paying wages to factory workers every month.
  2. Buying flour, sugar, and eggs daily in a bakery.
  3. Paying shop rent and utility bills for a shop.

3. Classification of Sources of Funds

Sources of funds for a business can be classified on two bases: the period for which funds are required, and the ownership of funds.

(a) Period Basis

Key Point:
Sources of funds are classified by the time period for which funds are needed: long-term, medium-term, and short-term.

Elaboration:

  • Long-term sources: Needed for more than 5 years. Used for buying land, building and expensive equipment.
  • Medium-term sources: Needed for 1 to 5 years. Used for buying vehicles or doing repair or renovation.
  • Short-term sources: Needed for less than 1 year. Used for meeting daily expenses.

Examples:

  1. Building a new office (Long-term funding, like issuing shares or debentures).
  2. Renovating a shop (Medium-term funding, loan from bank).
  3. Buying raw materials for a festival rush (Short-term funding, trade credit).

Step by Step (Activity):
Let’s imagine a new company starting to manufacture notebooks.

Instructions:

  1. First, it needs a building and machines (Fixed Assets) – funds for more than 5 years (Long-term).
  2. Next, it wants to buy delivery vans for 3 years – needs funds for 3 years (Medium-term).
  3. Every month, it buys paper and pays staff – needs funds for one month (Short-term).

Observations:

  • Different needs require different sources of funds.
  • Planning is needed to match funds required with the right funding source.

(b) Ownership Basis

Key Point:
Sources can also be classified based on ownership, as owner's funds or borrowed funds.

Elaboration:

  • Owner’s Funds: Money contributed by the owners (sole trader, partners, shareholders).
    • Main sources are issue of shares and retained earnings (profits kept back in the business).
  • Borrowed Funds: Money borrowed from others.
    • Main sources are loans from banks, financial institutions, debentures, public deposits, and trade credit.

Examples:

  1. A shop owner uses his savings (Owner’s fund).
  2. A company issues shares to the public (Owner’s fund).
  3. Taking a bank loan to buy machinery (Borrowed fund).
  4. Issuing debentures to raise money from public (Borrowed fund).

Scenario Based Questions

  1. Scenario: You are starting an internet café and only have money for computers and tables.
    • Question: What type of finance do you need to buy snacks and pay the staff daily?
    • Answer: You need working capital, which is used for daily running expenses.
  1. Scenario: A company wants to expand by building a new factory that will be in use for 10 years.
    • Question: What kind of finance should it arrange?
    • Answer: It should arrange long-term finance, for example, by issuing shares or taking long-term loans.
  1. Scenario: A retailer needs to pay for extra stock before Diwali and will sell it within two months.
    • Question: What type of finance is best suited?
    • Answer: Short-term finance, such as trade credit or a loan from a commercial bank.
  1. Scenario: A group of friends pool their money to start a food truck.
    • Question: What is the source of funds they are using?
    • Answer: They are using owner's funds, as the money comes from the owners themselves.
  1. Scenario: A business owner wants to keep control of the company but needs extra funds to modernize equipment.
    • Question: Should he choose owner’s funds or borrowed funds, and why?
    • Answer: He should choose borrowed funds, like a bank loan, as it provides money without diluting ownership control.

Remember, understanding the different sources of finance helps businesses survive, grow and succeed! Making finance fun helps you remember it better!

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