Notes On Soures of Finance
Notes On Soures of Finance
Notes On Soures of Finance
Finance is the life blood of any business. It is known that some amount of money is required to
start and run the business. Whether it is a small business or large, manufacturing or trading or
transportation business, money is an essential requirement for every activity. Money required for any
business activity is known as finance. A business unit cannot move a single step without sufficient
amount of finance.
Funds required for a business may be classified as long term and short term Funds required for a
business may be classified as long term and short term
SHORT-TERM FINANCE
Funds required to meet day-to-day expenses are known as short-term finance. This is required for
purchase of raw materials, payment of wages, rent, insurance, electricity and water bills, etc. The short-
term finance is required for a period of one year or less.
LONG-TERM FINANCE
The amount of funds required by a business for more than five years is called long-term finance.
Generally this type of finance is required for the purchase of fixed assets like land and building, plant
and machinery furniture etc. The long-term finance is also known as fixed capital as such need in fact
is, of a permanent nature.
Shares
Issue of shares is the main source of long term finance. Shares are issued by companies to the public.
A company divides its capital into units of a definite face value, say of Rs. 10 each or Rs. 100 each.
Each unit is called a share. A person holding shares is called a shareholder.
Characteristics of shares:
The main characteristics of shares are following:
1. It is a unit of capital of the company. 2. Each share is of a definite face value.
3. A share certificate is issued to a shareholder indicating the number of shares and the amount.
4. Each share has a distinct number. 5. Shares are transferable units.
Investors are of different habits and temperaments. Some want to take lesser risk and are
interested in a regular income. There are others who may take greater risk in anticipation of huge
profits in future. In order to tap the savings of different types of people, a company may issue different
types of shares. These are:
1. Preference shares, and
2. Equity Shares.
06 Retained Earnings
Like an individual, companies also set aside a part of their profits to meet future requirements
of capital. Companies keep these savings in various accounts such as General Reserve, Debenture
Redemption Reserve and Dividend Equalization Reserve etc. These reserves can be used to meet long
term financial requirements. The portion of the profits which is not distributed among the shareholders
but is retained and is used in business is called retained earnings or ploughing back of profits. As per
Indian Companies Act., companies are required to transfer a part of their profits in reserves. The
amount so kept in reserve may be used to buy fixed assets.
Merits :
Following are the benefits of retained earnings:
1. Cheap Source of Capital:
No expenses are incurred when capital is available from this source. There is no obligation on the part
of the company either to pay interest or pay back the money. It can safely be used for expansion and
modernization of business.
2. Financial stability :
A company which has enough reserves can face ups and downs in business.
3. Benefits to the shareholders:
Shareholders may get dividend out of reserves even if the company does not earn enough profit. Due to
reserves, there is capital appreciation, i.e. the value of shares go up in the share market .
Limitation :
Following are the limitations of Retained Earnings:
1. Huge Profit :
This method of financing is possible only when there are huge profits and that too for many years.
2. Dissatisfaction among shareholders :
When funds accumulate in reserves, bonus shares are issued to the shareholders to capitalise such
funds. Hence the company has to pay more dividends. By retained earnings the real capital does not
increase while the liability increases.
3. Mis-management of funds :
Capital accumulated through retained earnings encourages management to spend carelessly.
02 Customers’ Advances
Sometimes businessmen insist to their customers to make some advance payment. It is
generally asked when the value of order is quite large or goods ordered are very costly. Customers’
advance represents a part of the payment towards sale price of the product(s), which will be delivered
at a later date. Customers generally agree to make advance payment when such goods are not easily
available in the market or there is an urgent need of any goods. A firm can meet its short-term
requirements with the help of customers’ advances.
03 Trade Credit
Trade credit refers to credit granted to manufacturers and traders by the suppliers of raw
material, finished goods, components, etc. Usually business enterprises buy goods on 30 to 90 days
credit. This means that the goods are delivered but payments are not made until the expiry of the
period of credit. This type of credit does not make the funds available in cash but it facilitates
purchases without making immediate payment which amounts to funding it by suppliers. This is a very
popular source of short term finance.