To start a business someone will need to source for finance to establish the business in this article we will be looking into the sources of finance for business and the major way business organizations and individuals can acquire such money and support to run their various business firms. The sources of finance for business can be in the long term or in the short term source of finance and also the medium term source of finance.
Long term sources of finance for business:
This has to do with the funds, which a firms utilise, which is not required to repay back within the accounting period of year. They may include: ordinary shares, preference share, debentures, warrant and convertable securities.
Short term source of finances for business:
A short term finance is defined as "finance originally scheduled for repaymento liquidation within one accounting year or cycle . Short term sources of finance are made up of the following below:
Bank credit(bank overdraft);
Commercial banks sometimes allow their customer to overdraft their account up to a certain limit. Overdraft interest is charged on the day to day over drawn position,while the bigger customer may base rate. It is pertinent to note that banks may require collaterals and or evaluate the credit worthiness of customers before granting and overdraft. This main cost of bank overdraft is the interest charge.
Commercial paper;
This is the instrument used by large concerns to raise short term source of finance from the money market. It is usually on behalf of the company by an issuing house ( normally a merchant bank). This issuing house does not quarantee the notes but assists in finding investors buy them. The investors effectively lend directly to the company issuing the note. This issuing banks charge a commission for the service.
Trade credit;
The credit from suppliers is a major source of business finance, especially to small companies. This sources of finance for business could be very expensive if it include cash discount offer and such offer is not taking.
Factoring;
Factoring involvse raising finance on the security of the company s debt so that the cash is received earlier than if the company waited for the debtors to pay. There are two major types of factoring the are as follows;
- Services factoring where the factor buys from company it's invoiced and affect the company debt collection an debtors accounting. Payment to the company by the factor of debt is made on an average settlement date based in the maturity date of the debt.
- Service and finance factoring which involves not only the provision if accounting facilities but also of immediate finance since the factor on buying the debt makes an immediate payment to the company of up to 90% of the face value of the debt in addition to paying the service charge, the company must also pay the finance charges to the factor without recourse. Factoring with recourse attract 5% charge while factoring without recourse attracts a negotiated charge.
- In spite of the fact that by accepting a company a factor will thouroughly investigate the company s affairs in order to satisfy himself that the business is properly managed. There is still a fear that the use of a factor indicate financial instability. Consequently ,many potential users of debt factoring have refrained from the facilities available,this reluctance has given rise to a method of confidential invoice factoring which one has become known as involve discounting. Under this method debt are sold to the factor who makes an immediate payment of an agreed percentage of the face value of the debt sold.
Bills discounting;
A bill of exchange is normally prepared by the supplier of goods (creditor) for endorsement/acceptances by the customer (debtors). This is common with export sales . The suppliers (seller) can obtain immediate cash after the goods have been dispatched by discounting the bill with the bank ) discount house.
Accruals;
Deferment of tax payment and wages are the commonness example in this method . Tax laws provide that liabilities should be due for payment after one year . Also employees work for a period of one month before receiving their pay.
Acceptances credit/bankers acceptances;
This source of finance is similar to bills of exchange. The only difference is that it is a bank which qaurantees and undertake to liquidate the debt in maturity in case of a default. Such bill becomes readily discountable in the money market because a bank has accepted it. The evaluation is carried out by the providers of the finance (discount house) will normally cover the credit worthiness and reputable of the bank providing the quarantee/acceptances. Bankers acceptances (acceptances credit) are issued for period varying between 2 months and 12 month.
Medium term source of finance for business:
The major sources if medium term funds and finance are as follows;
Bank term loan:
This is similar to bank over draft except that it is available for a longer period. Also ,it carries a higher interest rate because of the longer period covered.
Venture capital;
Venture capital represent finance invested usually in a new enterprises. There are several stages involved in a venture capital finance funding. Seed money is needed to develop a concept product or service and a business plan.
Project finance;
This is a self liquidating facility with the following characteristics;
- The financial standing of the borrower is not important
- The proceeds from the project should be sufficient to reoay the capital together with the interest.
- The project/property financed will serve as security.
Equipment leasing:
This is a financial arrangements to finance the purchase of an asset through a finance company or a leasing company or a bank. There are two type of leasing namely , finance lease and operating lease.
Finance lease;
This is where the risk and benefit of ownership have been substantially transferred to the lease.
Operating lease;
A lease where the risk and benefit of ownership remain with the lessor.
Sale and leaseback:
This is a situation where an asset previously owned by a company is disposed off and immediately repossessed through a leasing contract.
Hire purchase (vendor credit);
This is an arrangement under which the hire , in return for the use of an asset undertakes to make periodic payment to the owner of the asset. He is expected to assume ownership of the asset after the payment of the last installment.
Mortgage;
An alternative to sale and lease back is mortgaging. It may be possible for a company that arrange to borrow money by means of a mortgage on freehold property.
This are the various sources of finance for business organizations and individuals. The goal of any business firm is to maximize profit and invest in the sources of finance that is capable of bringing growth and development of the organization.
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