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Chapter 8 Sources of Business Finance
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1. Introduction Finance is the key factor in the business that makes all other functions run smoothly. The term financing refers to the process making money available to a business. It should be done through the right channels at reasonable cost.
2. Nature and Significance of Business Finance Availability of adequate finance is one the most essential preconditions for starting any business. The amount of capital required depends on the nature and size of business. The sources of finance for a business can be essentially classified into owner’s finance and creditor’s finance. Finance is important to start, to operate and to expand the business.
A business requires finance for purchasing fixed assets such as plant machinery and buildings. These assets remain with the business for a longer period. These items are not purchased for sale. This area of investment is termed as fixed capital of the business. Since money will be locked up in fixed assets, financing for fixed assets should be planned from long term sources.
A business also needs working capital for buying raw materials of stock for sale and meet day to day expenses. It cannot generate revenue until the production process is completed. When this process is lengthy the firm needs more money. Even after the completion of production period there is a waiting period to complete the marketing process to convert the finished products into money. Thus finance becomes essential in business due the time taken in the process of production and marketing. If this cycle takes place in a short span of time, the finance requirement will also reduce accordingly.
The importance of finance increases along with the increase in business and industry. Large scale production and marketing involves huge investments as well. The management of finance remains significant segment of business activity. A business will need finance at various stages due to the need for expansion. With increased competition, it is essential to keep improving the techniques of management and finding out ways to put the available finance to best use. Without making wise investment in improving the business, survival of a business in the complex business world is difficult. Finance is often said to be the life blood of business. It should be available at the right time.
3. Types of Business Finance Business finance may be divided into three types depending upon the nature and purpose of finance, as follows: i) Long term finance ii) Medium term finance iii) Short term finance
i) Long Term Finance Funds that are required in the business for long period are termed as long term finance. This is usually required for a period exceeding five years. Long term finance is essential for investing in fixed assets such as land and buildings, plant, machinery etc. Requirement of long term finance depends on the size of business and the nature of business. Large organizations require large amounts to be invested in fixed assets, whereas small units need small amounts of capital investment. Nature of business also plays and important role in deciding the fixed capital needs. An engineering or capital intensive manufacturing unit will require more investment in fixed assets while trading concerns require more of their investments in the form of stock and other current assets. Long term finance is required in acquisition of assets and modernization of the business.
ii) Medium Term Finance Funds that are raised for a period between one and five years are termed as medium term finance. Medium term finance is used for modernization of machinery, large advertisement campaigns, launching of new products, opening of new branches or outlets. Manufacturing industries often require medium term finance.
iii) Short Term Finance This type of finance is required for a short period up to one year. Short term finance is utilized for meeting working capital requirements of the business. The investment in this area keeps on changing from stock to debtors and then to cash. Short term funds are used over and over again. The amount required in short term funds depends on
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