Summary

Meaning and significance of business finance: The finance a business needs to establish and run its operations is business finance. No business can function without adequate funds — for fixed capital (fixed assets), working capital (day-to-day operations), and growth and expansion.

Classification of sources of funds: Sources can be classified on three bases — (i) time period (long, medium and short term), (ii) ownership (owner's funds and borrowed funds), and (iii) source of generation (internal and external sources).

• Long, medium and short-term sources: Long-term sources provide funds for over 5 years; medium-term for more than one but not over 5 years; short-term for not more than one year.
• Owner's funds and borrowed funds: Owner's funds come from the enterprise's owners; borrowed funds come from loans/borrowings from others.
• Internal and external sources: Internal funds are generated within the business (e.g. ploughing back profits); external funds come from suppliers, lenders and investors.

Sources of business finance include retained earnings, trade credit, factoring, lease financing, public deposits, commercial paper, issue of shares and debentures, loans from commercial banks, financial institutions, and international sources.

• Retained earnings: The portion of net earnings not distributed as dividend; the amount available depends on the dividend policy; used mainly for growth and expansion.
• Trade credit: Credit extended by one trader to another for buying goods/services; terms vary by industry and appear on the invoice; small and new firms rely on it more.
• Factoring: A financial service where the factor handles credit control and debt collection and protects against bad-debt losses; done via recourse or non-recourse factoring.
• Lease financing: The owner (lessor) grants the right to use an asset to the lessee for a periodic lease rent over a specified period.
• Public deposits: Funds raised by inviting the public to deposit savings with the company; interest usually higher than banks offer.
• Commercial paper (CP): An unsecured promissory note to raise short-term funds; only well-rated firms can issue it; regulated by the RBI.
• Issue of equity shares: Represent the ownership capital; equity holders are risk bearers with fluctuating earnings and voting rights.
• Issue of preference shares: Give a preferential right in dividend and repayment of capital; preferred by investors wanting steady income at low risk; several types exist.
• Issue of debentures: Represent the loan capital; holders are creditors; fixed-charge funds with a fixed interest rate; suitable when sales/earnings are stable.
• Commercial banks: Provide short- and medium-term loans to firms of all sizes, repaid in lump sum or instalments; interest depends on the firm and market rates. …