Sources and Methods of Finance

Businesses can access numerous sources and use different methods for raising finance. It is crucial to understand these in depth to make sound fiscal decisions that could determine the success or failure of the firm. Here are the main points to consider:

External Sources of Finance:

Bank loans: Banks provide short, medium, or long-term loans to businesses that have to be paid back with interest. The rate of interest may vary depending on the firm’s credit history and the length of the loan.
Overdrafts: Banks let companies borrow up to a maximum limit as and when required. It’s flexible but often has a high-interest rate.
Trade Credits: Suppliers can give extended credit terms or discounts for early payment.
Leasing: This involves renting a physical asset such as property or equipment from a leasing company.
Venture Capitals: They are firms or individuals who invest in innovative and high-risk projects in return for a stake in the business.
Share Capital: Funds raised by issuing shares in return for cash.
Grants: Non-repayable funds given by governments or organisations, usually for a specific project or purpose.

Internal Sources of Finance:

Retained Earnings: Profits that the firm has earned and re-invested into the business rather than distributing it to shareholders.
Sale of Assets: Selling unused or unnecessary assets can help raise funds.
Reduction in Working Capital: Reducing inventories or increasing payables can help free up cash.

Methods of Finance:

Equity Financing: This involves raising capital by selling a part of the business (shares). This doesn’t have to be paid back but shareholders will have a right to a percentage of profits.
Debt Financing: This includes obtaining loans or issuing bonds. Although interest must be paid, the lenders have no control over the firm.
Hybrid Financing: This is a mix of both debt and equity financing.

Factors to Consider when Choosing a Source of Finance:

The amount needed: Large sums might require equity or long-term loan financing.
Duration: Short term needs can be met with trade credits, bank overdrafts while long-term needs can be fulfilled by share capital, retained earnings.
Cost of Finance: High-interest rates or giving away parts of the business could be costly.
Risk: Debt financing is risky as the business is obligated to repay the amount irrespective of their financial standing.
Control: Issuing shares might dilute ownership and control over the company.
Legal Structure: Sole traders cannot issue shares whereas limited companies can.

It is crucial to weigh these considerations according to the specific context and objectives of the business.