Sources of Business Finance

Finance is the most significant part for any business as entrepreneur’s need the funds for essential most functions like purchase of raw material, machinery, and other expenses. Businesses need to meet these expenses time to time and hence will require finances throughout the year. 

Therefore, determining the sources from where a business can acquire funds is essential so that they carry out different commercial operations seamlessly.

What is Business Finance? 

Business finance refers to the money or fund needed to perform various organisational operations like the purchase of raw material, goods, assets, etc.

Tangible assets like machinery, buildings, furniture, factories, as well as intangible assets like trademarks, patents, technical expertise, etc. are part of essential business operations. Business finance refers to the money which is required for purchase and maintenance of these assets along with other overhead expenses.  

Understanding Sources of Business Finance 

Now, to accumulate these finances, businesses rely on multiple sources so that they have ample amounts of funds throughout. To start a business and sustain it in the long run, entrepreneurs need various sources of finance. 

For example, a business named ABC enterprises has arranged for the initial capital investment amount with their savings. They have procured office, equipment, and raw material to start the production work. 

A few days later, they need more funds to pay wages regularly and to maintain the stocks of raw materials. To meet such day to day operational demands, businesses will require funds and they can’t depend upon savings solely. 

They need various Sources of Business Finance to accumulate funds at any point in time and keep the organisation running. However, there can be different sources of finance depending upon the nature of ownership, equipment, and sources. 

Multiple Choice Questions 

  1. The funds needed for buying current assets are 

  1. Lease financing. 

  2. Working capital requirement. 

  3. Fixed capital requirement. 

  4. Ploughing back of profits. 

Answer : (b) Working capital requirement. 

  1. What are internal sources of capital?

  1. Generated through issue of shares. 

  2. Generated through outsiders such as suppliers. 

  3. Generated within the business. 

  4. Generated through loans from commercial banks. 

Answer :  (c) Generated within the business.

Categories of Source of Funds 

There are several categories in which these sources of businesses finance can be classified. Have a look and get a brief idea about the same. 

  1. Based on Ownership 

Amongst the other Sources of Finance in Financial Management, this source is divided into two categories. 

Owner’s funds

Borrowed funds 

As the name suggests, the funds here are provided by the owner only to finance various business activities. 

Here, the funds are acquired by borrowing money or applying for a loan from outside for a predetermined tenor. 

The capital investment amount is arranged by the entrepreneur through equity shares, preference shares, retained earnings, etc. 

Here, entrepreneurs can borrow funds from financial institutions or non-banking financial companies. 

  1. Based on generation 

This source of financing business is categorised into two kinds 

Internal sources 

External sources 

In this case, funds are generated within the organisation through different means. 

Here, funds are arranged from the external resources. 

Entrepreneurs can use the retained earnings or sell the accumulated assets to arrange the funds. 

Debentures, bank loans, issuance of equity shares to the public are some external resources from where entrepreneurs seek funds. 

  1. Based on the period 

Depending upon the term or period of these funds, these are divided into three categories. These are mentioned below. 

Long term source of finance 

Medium-term source of finance 

Short term source of finance 

These funds are for the long term, usually more than 5 years. 

These funds are those that are accumulated for more than 1 year and less than 5 years.

These funds are for a shorter term, usually less than 1 year.

Funds accumulated from the capital market such as equity shares, debenture, etc. are examples of sources of long term finance. 

Loans from financial institutions, lease financing, public deposit, commercial papers etc. are examples of medium-term sources of finance. 

Trade credits, working capital borrowings from financial institutions etc. are a few examples of short term sources of finance.

Some Questions to Answer 

Medium-term source of finance is usually accumulated for what period?

Answer : More than 1 year and less than 5 years. 

Examples of Business Finance Source 

Like the structure of different sources of finance, the examples of such sources also follow the same structure. These fall under different categories depending upon time, the basis of ownership, or basis of source generation. 

Here are some examples of varied sources using which businesses can accumulate funds and utilise this money for various operations. 

  • Equity shares 

  • Debenture

  • Lease finance 

  • Venture funding

  • Bill discounting 

  • Preference capital or preference share

  • Receivables and payables 

  • Short term loans 

  • Term loans from financial institutions 

  • Advances from various customers

  • International financing 

  • Internal accruals 

  • Factoring services 

  • Short term deposits 

  • Asset securitisation, etc. 

These are a few examples of varied sources of businesses finance using which businesses arrange for funds. It is crucial to rely upon a single source as unavailability of funds through it can put your businesses operations into hold. 

Therefore, entrepreneurs are introduced with several sources so that they can make use of them as per their business demand. For instance, one may need limited funds to keep their inventories stocked up for a year and acquiring short term funds will help businesses get the same. 

Subsequently, entrepreneurs need to realise their business viability and demand for funds before deciding upon which sources of businesses finance they need. 

To learn more about sources of business finance, go through the study materials available in our website today. You can also install Vedantu’s app to participate in live classes and keep yourself updated.

FAQ (Frequently Asked Questions)

1. What is Business Finance?

It is the method wherein entrepreneurs have to finance their business using money accumulated from outside or inside. They accumulate funds and use these to carry various day to day business operations.

2. What are the Sources of Finance?

There can be several sources of finance depending upon ownership of funds, generation of funds, and period. These structures are again divided into subcategories. Generation of funds is divided into internal and external sources. Based on ownership, these are classified as owned and borrowed. And based on time, these are classified as short term, medium-term, and long term.