Sources of Business Finance

Business Finance refers to the money and credit employed in the business. It involves sourcing, planning, and managing the funds required for running a business effectively.

Need for Funds:

• Fixed Capital Requirement: To purchase fixed assets like land, building, and machinery for starting the business.
• Working Capital Requirement: To meet day-to-day expenses like buying raw materials, paying wages, and electricity bills.
• Growth and Expansion: To upgrade technology, increase production capacity, or enter new markets.

• Long-term Sources (More than 5 years): Equity Shares, Preference Shares, Debentures, Loans from Financial Institutions, Retained Earnings.
• Short-term Sources (Less than 1 year): Trade Credit, Commercial Paper, Bank Overdraft, Factoring, Inter-Corporate Deposits (ICD).

Internal Sources	External Sources
Generated from within the organization.	Generated from sources outside the organization.
Example: Retained Earnings (Ploughing back of profits).	Example: Loans from banks, Issue of Debentures, Public Deposits.
No security is required.	Assets are often mortgaged as security.

Preference shareholders enjoy two main rights over equity shareholders:

• Priority in Dividend: They have the right to receive a fixed rate of dividend before any dividend is paid to equity shareholders.
• Priority in Repayment: In the event of winding up the company, they have the right to receive their capital back before the equity shareholders.

• IFCI (Industrial Finance Corporation of India): Its objective is to provide medium and long-term finance to industrial concerns and assist in the development of backward areas.
• IDBI (Industrial Development Bank of India): Established to coordinate the activities of other financial institutions and provide direct financial assistance to industrial units.
• EXIM Bank (Export-Import Bank): Its main objective is to finance, facilitate, and promote foreign trade in India.

GDR (Global Depository Receipt)	ADR (American Depository Receipt)
Issued to investors outside the USA (e.g., Europe).	Issued to investors only in the USA.
Can be listed on any foreign stock exchange (e.g., London, Luxembourg).	Can be listed only on American stock exchanges (e.g., NYSE, NASDAQ).
Less stringent disclosure requirements compared to ADRs.	More stringent disclosure requirements as per US SEC norms.

Trade Credit:

• It is the credit extended by one trader to another for the purchase of goods and services.
• It facilitates the purchase of supplies without immediate payment.
• It is a spontaneous source of finance and its volume depends on the creditworthiness of the firm.
• Merit: Easy to obtain, promotes sales. Demerit: Can lead to overtrading or higher prices charged by suppliers.

Bank Credit (Commercial Banks):

• Banks provide short-term finance through loans, cash credits, and overdrafts.
• Overdraft: Allows a customer to withdraw more than their account balance up to a limit.
• Cash Credit: A loan arrangement where the borrower can withdraw up to a sanctioned limit against security.
• Merit: Flexible and maintains secrecy. Demerit: Requires security and involves detailed investigation by the bank.

For modernization and expansion, an enterprise needs long-term finance. The suitable sources are:

• Equity Shares: The most important source for long-term capital. It does not create a charge on assets but dilutes control.
• Retained Earnings: Reinvesting undistributed profits. It is the cheapest source (no explicit cost) and ensures total control.
• Debentures: Debt instrument acknowledging a loan. Best for companies with stable earnings as interest is tax-deductible.
• Loans from Financial Institutions: Institutions like IDBI or IFCI provide large loans specifically for expansion projects and also offer technical consultancy.

Debentures are preferred over equity shares because:

• No Dilution of Control: Debenture holders do not have voting rights, so the control of existing equity shareholders remains intact.
• Tax Benefit: Interest paid on debentures is a tax-deductible expense, whereas dividends on equity are paid out of post-tax profits.
• Fixed Cost: Debentures carry a fixed rate of interest. In times of high profit, the company pays only the fixed rate, leaving more surplus for equity shareholders (Trading on Equity).
• Certainty for Investors: Investors prefer debentures for regular fixed income and safety of investment.

A. Public Deposits (Unsecured deposits invited from the public):
Merits:

• Simpler procedure than issuing shares.
• Cost is generally lower than bank loans.
• No dilution of control (depositors have no voting rights).

Demerits:

• Unreliable source (public may withdraw funds).
• Collection is difficult during economic depression.

B. Retained Earnings (Ploughing back of profits):
Merits:

• Permanent source of funds.
• No explicit cost (interest/dividend).
• Enhances capacity to absorb unexpected losses.

Demerits:

• Dissatisfaction among shareholders due to lower dividends.
• Uncertain source (depends on fluctuating profits).

(Assuming the restaurant owner needs funds for renovation/expansion):

Recommended Options:

• Retained Earnings: If the restaurant has been profitable, reinvesting profits is the safest and cheapest option.
• Loan from Commercial Banks: A term loan can be taken for renovation, secured against the restaurant’s assets.
• Trade Credit: Negotiating longer credit terms with suppliers for raw materials (vegetables, meat) to manage working capital.
• Lease Financing: Instead of buying expensive kitchen equipment, the owner can lease them to reduce initial capital outflow.