Analysing a range of different sources of finance
Sources of finance
The nature of the business, risk appetite, and financing requirements determine the source of funding secured by a company. Before a business starts raising capital through debts, it considers several factors such as money required, funding terms, covenants, risk rating, and cost of that debt. There are short-term, medium-term and long-term sources of finance.
Short term sources
The business mainly uses short-term sources to obtain tiny amounts of money with fewer business credentials and credit history. Though, it can be a more expensive type of debt because of the high risk with debtholders. Leases. Supplier credits, loans, and overdrafts are examples of short-term sources of finance.
Trade credits ; Trade credit is the most significant form of short-term credit. A business customarily buys its materials and supplies on credit from other companies, accounting for the debt as an account payable. Predominantly, credit cards are expressed with a discount and maintaining the highest degree of commercial discipline. A seller may decide to give you a 2 percent discount if you make payment within ten days of the invoice issued. If no cash discount is taken, then the payment is due after 30 days from when the invoice was issued.
Positive: Trade credit has no interest and can be accessed by suppliers without immediate payment.
Negative: Trade credit requires to be quickly paid off and only a small amount can be given.
Commercial bank loans; It is the second important source of short-term financing in business from trade credits. Banks play a significant role in the intermediate-term money and short-term money markets. For a business to grow financially, it must borrow from commercial banks for additional funding. The loan obtained by the company from the banks has no different in principle from that obtained by an individual.
Positive: Commercial bank loans are quick and easy to access and a business can get any amount of money at a particular time.
Negative: it is usually difficult for new companies to access commercial bank loans due to high-interest rates.
Lease financing ; It means the business does not necessarily need to buy assets so that it can use them. For example, in United States, Airlines and Railroad companies have acquired many assets by leasing them. To determine if leasing is advantageous, you consider the tax advantages of the business to access funds. Leasing is an alternative method that a business can get finance. However, leasing has some disadvantages, such that the company will not own the asset or property; if the company fails to pay, the property is repossessed. It can also affect the credit rating of the guarantor and business.
Positive: Leasing lacks huge upfront payment and leasing companies are responsible for maintenance and repairs.
Negative: Leasing has a disadvantage in that the company or the business does not own the assets. Also, leasing can be an expensive way of obtaining properties.
Secured loan ; Most small business loans are unsecured, meaning that a continuing company qualifies credit terms for a loan. Ordinarily, any company should borrow unsecured loans, but frequently, the company's borrowing rates are not vital to be eligible for an unsecured loan. Inventories and receivable accounts are mainly used for short-term credit as insurance. Account receivables finance the company either by selling outright or by indemnification of receivables, and the process in the United States is referred to as factoring. When receivable is guaranteed, the company that borrowed maintains the risk that the firm or the person that owes accounts receivable might not pay, and when factoring is involved, the risk may be passed to the lender (Khan, 2015, p.7).When accounts inventory loans are secured, the firm or the person who lender the loan takes their title. The lender may or may not have to take physical possession of those loans. For instance, inventory accounts in a warehouse department will be physically controlled by a warehouse company, and the company only releases the inventory on lending institution orders. Standardized products like steel, canned goods, lumber, and coal are primarily types of goods commonly covered in warehouse departments.
Positive: A secured loan has collateral which makes it easier to be accessed. Some lenders offer secured loans with a lower interest rate and with a long time of repayment than those of unsecured loans.
Negative:Secured loans cause a higher risk to the borrower because of the risk of losing collateral.
Long-term sources of finance
Equity share capital ; Equity share is also commonly known as ordinary shares, and they represent the capital that the owner has in a means. The founders of the company or the real owners are the holders of the company's shares. Owner control and manages the operations of the company. The profit that a company makes determines the dividend rate be issued to the shareholders (Amornkitvikai, and Harvie,2018, p.92) When the company makes more profits, the rate of bonus will be higher. Shareholders can not get anything when a company makes an insufficient profit. It is when equity shareholders pay dividends to preference shareholders will receive the reward.
Positive: Equity share capital does not change fixed payments or fixed costs and there is deferment of dividends. Also, equity share capital has a lower risk and no repayment requirements.
Negative: Equity share capital loan requires a lot of effort and time to get. Also, even if equity has no interest payments, it typically has higher costs than debt capital.
Preference shares ; A preference share is a share with specific preferences in comparison with other shares.
Positive: Preference shares have no interference since lack voting rights. It is not a must for companies to pay dividends on preference shares to incase their profits are insufficient in that particular year.
Negative: Preference shares have limited appeal due to companies' wish of attracting more investors ending up offering a higher rate of dividends. Also, preference shares lack voting rights hence having no say in management
Debentures ; Debentures include bonds, debentures stock, or any company securities, whether not or consisting of assets charge. A company that holds debentures is a creditor to that organization. Debentures have a fixed rate of interest. Debentures have interest due, which is calculated in the profit and loss account of the company.
Positive: Debentures facilitate the growth of the businesses because it offers long-term funding.
Negative: Debentures lead a lender to lose voting rights.
Loans from financial institutions ; Loans from financial institutions are a more suitable source of finance to meet the demands of medium-term working capital. Life insurance corporations, commercial banks, state financial corporations, and industrial finance corporations of India are some of the financial institutions that provide these loans.
Positive: loans are flexible in that the financial institution does not follow up how the borrowed money will be spent.
Negative: Financial institutions are stricter about lending money to small businesses.