Q.Explain the classification of Sources of Finance on the basis of ownership and period, with examples of each.

This essay question asks a student to present the complete classification framework that opens this AP Board Intermediate Commerce chapter.

A full answer names both classifications and gives examples under each heading.

The various means by which a business raises money are together called sources of finance, and they are classified in two principal ways.

The first classification is on the basis of ownership. Owned funds are contributed by the owners of the business — a sole trader's own capital, a partner's capital, or, in a company, equity share capital, preference share capital and retained earnings. Owned funds carry no fixed obligation to pay a return every year and are generally not repayable during the life of the business. Borrowed funds, in contrast, are raised from outsiders who are not owners — through debentures, term loans from banks and financial institutions, public deposits, and trade credit — and they carry a fixed obligation to pay interest regardless of profit and must ordinarily be repaid within an agreed period.

The second classification is on the basis of period. Long-term sources, needed for more than about five years and used mainly to finance fixed assets, include equity shares, preference shares, retained earnings, debentures and long-term loans. Medium-term sources, needed for one to five years, include medium-term bank loans and public deposits issued for such a period. Short-term sources, needed for less than a year and used mainly to meet working capital needs, include trade credit, bank overdraft and cash credit.

In practice, a firm plans its total finance by choosing a suitable combination from both dimensions at once — deciding, for a given need, whether the source should be owned or borrowed, and whether it should be long-term, medium-term or short-term, so that the nature and duration of the source genuinely matches the nature and duration of the need.