When a company is formed, initially, the finance is made by the individuals privately or by the reinvested profits. Many of the investors are not willing to take risks connected with an unknown company. As the organization grows, the sources of finance made initially may become deficient in order to invest in heavy investments required to grow the business further, which are beyond the resources of a company or an individual. Thus, a need to finance from other sources arises.
There are three groups of sources of finance; Short-term finance (these finances are for the period up to one year), medium-term finance (which are from the period between one year to five years), and long-term finance (which are from the period of over five years).
Short-term Finance
Working Capital Finance
The working capital is calculated as the current assets of a company minus the current liabilities. The surplus amount shows how much a company has exceeding current assets in hand. The business’s current assets include stock held, debtors, short-term investments, and the cash in the bank. Whereas the current liabilities include the company’s short-term liabilities, which the company had to pay within one year. Consequently, a business’s working capital is an amount of capital the company can make available in the short term.
Bank Overdrafts
Banks are the most common source of finance and borrowings available to any business organization; the banks provide money as an overdraft or a loan. The overdraft is a source of finance offered by the clearing banks mainly. These sources have the advantage of being flexible in the sense that the company can draw the capital against the limit previously agreed. The interest in the overdraft is calculated on a daily basis over the outstanding amount and is usually 2 to 3 percent higher above the prime rate.
Medium-Term Finance
Finance Houses
The finance house operates as a business entity that extends funds to the commercial, industrial, and consumer segments in many forms, such as leasing, hire purchase, and loan agreements. Like other commercial banks, financial houses acquire capital by accepting capital deposits from customers, including commercial and industrial concerns. Financial institutions also borrow the amount from banks as well as from other financial houses.
Sale and Leaseback
When a business faces monetary difficulties or has the need for additional finances to invest in a future growth opportunity, it might become necessary for them to sell some of their assets. If the company possess freehold property or it has an extended leasehold, the company can raise their capital by selling or mortgaging of a property at a price of the market. A sale and leaseback is another way for the companies to avoid selling and mortgaging and still elevate as much finance as possible against the company’s property.
Bank Loans
The bank loans are considered the medium-term finance that is attained for situations, which require finance for more than one year and up to five years. The interest rates on the term loans are generally higher than the rates of overdraft. The cost of this source of finance is higher than the other sources as the bank charges interest on the capital provided and the set-up fee also charged by the banks, which can be 0.5% of the amount lent.
Long-Term Finance
The three long-term sources of finance are the issuance of shares, retained profits, and debentures.
Issuance of shares
Business organizations can raise added financed by the issuance of new shares; it can be done to the public or even to current shareholders. The procedure of the issuance of new shares can become an expensive process, and therefore it is restricted to raise only the amount that is large enough to offset the cost of financing.
Retained Earnings
One of the substantial sources of finance is the use of retained earnings. This finance source is considered most suitable if available as it does not require the payment of interest expense.
Debentures
The term debentures have two different significance due to the difference in the United States and the United Kingdom concept. In the US, debenture means an unsecured debt, whereas it refers to the secured stock in the UK. In any case, the debenture is an inscribed salutation of long-term debt with more than fifteen years of maturity periods.
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