Sources of business finance
In starting a business, the major problem that arises is the sources of business finance requires is setting up the business, though an entrepreneur might have a great idea of how to manage and turn it ideology into a successful business. But one thing is raising the capital in starting up a business.
Business finance is a branch of economics concerned with resource allocation as well as resource management, acquisition and investment. Simply put, finance deals with matters related to money and the markets, it involves raising of money through the issuance and sale of debt and/or equity.
It is often referred to as one of the hardest part of starting a business because in raising finance for starting-up, The entrepreneur have to first of all answer these questions of:
- How much finance is required?
- When and how long the finance is needed for?
- What security (if any) can be provided?
- Whether the entrepreneur is prepared to give up some control (ownership) of the start-up in return for investment?
Moreover, one also have to take a look at the following aspects of start-up:
- Set-up costs (i.e costs that have been incurred before the business starts to trade)
- Starting investment in capacity (i.e the fixed assets that the business needs before it can begin to trade)
- Working capital (i.e the stocks needed by the business –e.g. raw materials and also allowance for amounts that will be owed by customers once sales begin)
- Growth and development (e.g. extra investment in capacity)
Read the Advantages and Disadvantages of the sources of business finance
Sources of business finance for a start-up is to divide them into:
- Internal sources
- External sources
Internal sources
The internal sources of a business include:
- Personal source: This is the most important source; it is the personal financial arrangements of the founders of a business. It could be borrowing from friends and family, entrepreneurs personal Savings and Credit cards.
- Retained profits or (earnings): This is the cash generated when the business is operated profitably it is another important source of finance for any business, be it large or small. (Note that retained profits could only be generated the moment trading has begun).
- Share capital (by the founder): The founder provides all the share capital of the company, the founding entrepreneurs may decide to invest in the share capital of a company, founded for the purpose of forming the start-up.
External sources
- Loan capital: In finance, a loan is the lending of money from one individual, organization or entity to another individual, organization or entity. A loan is a debt provided by an entity (organization or individual) to another entity, it usually attracts interest.
Read the Advantages and Disadvantages of the sources of business finance
Loan capital could also be in form of a bank loan and a bank overdraft.
A bank loan
This provides a long-term finance for a start-up, the bank would state the fixed period over which the loan provided is to be repaid (like say, 5 years or more), the rate of interest and the timing and amount of repayments.
The banks seek for loan security in form of personal guarantees provided by the entrepreneur (it could be a collateral or guarantor). Bank loans are good for financing investment in fixed assets and are generally at a lower rate.
A bank overdraft
This is a more short-term finance which is also widely used by start-ups and small businesses. An overdraft is a loan facility that enable banks to allow the business “owe it money” when the bank balance goes below zero, in return for charging a high rate of interest. It helps the business meet its short-term cash flow or working-capital.
- Share capital (by outsiders): This capital consists of all funds raised by a company in exchange for shares of either common or preferred shares of stock. It is the interest of share-holders in a company.
The amount of share capital or equity financing a company has can change over time. A company that wishes to raise more equity can obtain authorization to issue and sell additional shares, thereby increasing its share capital.
- Debenture: A debenture is a medium to long-term debt instrument used by large companies (usually incorporated companies) to borrow money, at a fixed rate of interest. It take the larger portion of a company’s finance.
Thus, debenture is like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure.
It is quiet different from share capital as debenture holders have a preference over shareholder in terms of dividend payment.