What are the different sources of finance? How do they work?

25 October 2018

Three types of business organisation mainly exist. And every type of organisation requires a source of finance at some point. Allowing them to meet their day to day needs. Small scale partnerships generally come under the umbrella of proprietorships and partnerships. This type of business generally generates its own capital. Only the company form of an organisation is run on a larger scale. This is achieved through using funds to purchase a large amount of fixed assets. For example modernising or replacing machinery. In this article, I explain the main types of business financing in further detail.

What are the main sources of finance for businesses?

Generally, there are two main sources of finance that aim to meet the needs of financial aspects of an organisation. And these are either owners fund, or borrowers fund.

What is an owners fund?

Owners fund can take a number of names. For example owners capital or even owned capital. The current owners would add funds. In addition to other profits that have been added in. These types of fund can be raised through either the issuing of equity shares or ploughing back profits.

What is a borrow fund?

This is money that has been raised by methods such as loans and credit. Some people may also refer to it as borrowed capital. Borrowed funds can be derived from many different sources. For example, loans, debentures, financial institution loans or options from other financial institutions.

What types of business finance exist?

For a business to be successful, it must have a suitable source of finance. Major areas of a business that require practically constant investment are things such as buildings, machinery and land. And indeed, when a business is operating, it requires injection of working capital for day to day expenses. Such as purchasing materials, paying staff wages and covering necessary bills. Ad hoc requirement of money may also be needed. For example, relief of cash flow problems, replacing or repairing machinery, or even perhaps to expand the business.

Generally, three types of finance are available for a business. Including, short, medium and long term finance.

What is short term finance?

Short term finance refers to money raised over a period less than a year. The terms of working, circulating or revolving capital are other ones used.

The factors affect how much short term capital can be borrowed depends on two things. 1) size of the business 2) what it does. Short term capital generally allows cover of everyday capital. For example, payment of bills, purchasing of materials or seasonal variation in profit.

There are many sources of short term finance available. For example, open book accounts, customer advance, credit installment, overdraft, cash credit, bill discounts and against bill of lading.

What is medium term finance?

Medium term finance is generally for businesses that may be requiring finance between one and five years. Use of this finance option is normally used for things such as updating or upgrading machinery, modernising premises, updating production methods or even large scale methods of advertising.

Typical sources of finance include:

  • Commercial banks
  • Debentures
  • Loans from credit institutions
What is long term finance?

Long term finance is suitable for businesses that require investment for a period greater than five years. People may also refer to it as either long term or fixed capital. Purchase of new land or accommodation is a typical use of such capital. Or things such as buying new machinery or updating business premises. The amount of long term finance that a business may require can depend on what the business does, how big it is, types of product manufactured and the types of production, amongst many other things.

There are many sources of long term finance. Such as equity shares, shares of issue of right, debentures, loans from financial institutions, leasing and taking money back from business profits.

  • In this blog, we have discussed the main types of finance available for business. Which includes an owners fund and a borrow fund
  • We have also discussed the differences between short, medium and long term finance
  • If you need advice any other advice on types of business finance, contact Angelina Bell today for a 45 minute chat and see how she can help

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