Financing of Business: Types and Sources of Business Finance (For CBSE, ICSE, IAS, NET, NRA 2022)

Get unlimited access to the best preparation resource for competitive exams : get questions, notes, tests, video lectures and more- for all subjects of your exam.

Types of Business Finance

The type and amount of funds required usually differs from one business to another. For instance, if the size of business is large, the amount of funds required will also be large. Likewise, the financial requirements are more in manufacturing business as compared to trading business. The business need funds for longer period to be invested in fixed assets like land and building, machinery etc. Sometimes, the business also needs fund to be invested in shorter period. So, based on the period for which the funds are required, the business finance is classified into three categories.

Types of Business Finance
  • Short-term Finance.
  • Medium-term Finance; and
  • Long-term Finance.

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. This financial requirement for short period is also known as working capital requirement or circulating capital requirement. It may be noted that a part of the working capital requirement is of a long-term nature, as certain minimum amount of funds is always kept meeting the requirement of stock and regular day-to-day expenses.

Medium-Term Finance

Medium-term finance is utilised for all such purposes where investments are required for more than one year but less than five years. Amount required to fund modernisation and renovation, special promotional programmes etc. fall in this category.

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.

Table Of
Types of FinancePeriod of RepaymentPurpose
Short-termLess than a yearPurchase of raw materials, payment of wages, rent, insurance etc.
Medium-termOne year to five yearsExpenditure on modernisation, renovation, heavy advertising etc.
Long-termMore than five yearsPurchase of land and building, plant and machineries, etc.

Every organisation needs different types of finance i.e.. , long-term, medium-term as well as short-term. But the combination in which these are used differ from one business to another.

Sources of Finance

  • Having learnt about the need, importance and types of financial requirements, now we must know from where the businessmen get the required amount of funds to meet the short-term, medium term and long-term requirements. Who provides them the required amount? Let us learn about the various sources from which the businessmen generally arrange money for business purposes.
  • Broadly speaking, there are two main categories of sources from which the businessmen can get the required funds for their business. These are:
Sources of Finance
  • You know that to start a business the businessman either invests his own money or borrows from outsiders or uses both the sources. When the businessman invests his own money (called owner՚s capital) and retains a part of the profits earned in the business it constitutes the internal sources of finance. It is an integral part of every business organisation and it is cost effective. But this source has its own limitations. Hence, the business houses have to resort to the external sources of finance. The various external sources from where businessmen can get the finance include, friends and relatives, banks and other financial institutions, moneylenders, capital market, manufacturers and producers, customers, foreign financial institutions and agencies, etc.
  • It is observed that the scope of raising funds also depends upon the nature and form of business organisation. For example, a sole proprietorship form of business organisation has very limited sources from which it can arrange funds for the business. These are:
    • Own Savings
    • Friends and Relatives
    • Moneylenders
    • Commercial Banks
    • Finance Companies
    • Manufactures and Suppliers
    • Retained Profits
  • The same sources of financing are also available in case of partnership firms. In both sole proprietorship and partnership form of business organisation, long term capital is generally provided by the owners themselves by way of investing their own savings and retaining a part of the profits generated by the business and the rest of the above sources are mostly used for their short-term financial needs. However, in case of companies, the following are the usual sources of finance.
    • Capital Market
    • Financial Institutions
    • Public Deposits
    • Commercial Banks
    • Leasing Companies
    • Investment Trusts
    • Retained Profits

Developed by: