Types and Sources of Funds for Business

Investment decisions need to consider and identify the various investment opportunities, comparison and evaluation of these opportunities such that the selection of these opportunities will be based on the availability, characteristic, and cost of sources of funds for the business which are based on the following short-term, medium-term and long-term sources.

 Short-Term Sources of Funds

Working capital as earlier mentioned is that money, which is used for the running the day-to-day activities of a business. Therefore, the short-term sources of funds are those funds needed to finance the shortages in the working capital of a business. This fund should not, if it can be avoided, be used for long-term investments. The main sources of short-term funds are:

• Loan from friends and relatives 
• Bank credit (bank overdraft) 
• Commercial or Trade credit 
• Inheritance 
•  Factoring 

Loans from Friends and Relatives

Good and reliable friends and relatives could assist their friend or relative to start a business by contributing to funds for the business, such funds is therefore invested in the business. However, these sources of funds might spell doom for the business, particularly if the business is successful. At times, at no notice these, friends or relations, out of jealousy, may demand the refund of their money, which might cause the closure of such business.

Bank Credit (Bank Overdraft)

This is another way of obtaining short-term funds. It involves borrowing from the bank. Overdraft arrangement is quite different from bank loans. A business can enjoy overdraft, depending on her relationship with the bank and operation of the business over time. The overdraft is a privilege, which the bank grants to its customers to enable account

holders withdraw over and above the balance to be paid to the bank normally within one to three months with an interest to be charged on a daily basis.

Commercial or Trade Credit

A business that has good reputation, human relations and connections could have goods and services rendered to it by bigger companies by supplying it with goods on credit or with part payments. In such cases, it is more like that more the bigger company has put money into the business. In advanced countries, there are more trade credit varieties such as trade acceptances and promissory note. Trade acceptance is a draft drawn by the seller against the buyer for an amount of credit extended to him to be paid at a specified date, which the buyer must accept by signing the draft. A promissory note is an unconditional promise to pay a specified sum of money to a specified person at a definite future date.

Inheritance or Donation

These are entitlement of materials (money inclusive), which a person receives as part of the properties of his parents or relatives who may (or may not) have died to serve as a source of fund for the start of his business. It is not incumbent on the benefactor to invest the said entitlement in business, but it is another way by which people could raise fund for starting a business.

Factoring

This is a situation where debtors of a company accounts could be bought over by a bank or it subsidiary at a percentage such that the company enjoys the advantage of about five per cent. The company will now enjoy her money owned her less the percentage before the maturity of the debt. For instance, if your debtors owe you a sum of 100million, you can factored this debt to a bank or its agent by collecting the value of the debt from the bank with five per cent reduction. This means that the bank will pay you 95million, take over the debtors and pursue to recover the debt from your debtors. These and so many other forms of financing business or raising funds to finance businesses are therein.

SELF-ASSESSMENT EXERCISE 2

• Discuss the different ways by which short-term sources of funds can be raised. 

Medium-Term of Sourcing Funds for Business

These are sources of fund in which a period is neither too short nor long enough for source of fund to mature for repayment. However, the period bridges the gap between short and long period to finance businesses that would not fit into short nor long gestation period. The sources of funds that fall under this period are as follows:

•  Bank Term loan 
• Venture capital 
• Project finance 
•  Equipment leasing 

Bank Term Loans

This is a bank loan, similar to bank overdraft, but has a long gestation period (that is long maturity period for repayment cum the interest). The interest charge on the bank term is higher than the overdraft and its security – collateral is also higher. The bank scrutiny of the business under this loan is more stringent that in the ordinary loan.

Venture Capital

These are monies used in venturing into a business with a high uncertainty of products at initial formulation and marketing of the products. This money could be called seed money because it is needed to develop a concept of the product or service. Just like planting seeds into the soil to produce the require grains after germinates. At times, these seeds might not or might, depending on the soil and other factors. Venturing money may not produce proceeds for the business; that is not to say you will not venture because of the probability. This is why it is regarded as highly uncertain.

Project Finance

Under this source of funds, the project is expected to sustain itself without considering the financial standing of the borrower of the fund. Once the fund is borrowed to start the business, the business that pays back the fund from the proceeds of the business with interest of the loan and profit to the owner of the business too.

Equipment Leasing

This method of financing business involves leasing out equipment to the user (Leasee) by the owner (Leasor) under an agreement, which requires the Leasee to pay the agreed value of the equipment to the Leasor the

sum of money for a determined period. Thus, leasing agreement is done in such a way that the business (Leasee) chooses the Leasor buys the equipment it wants to use for the business and these equipment. An agreement is therein drawn up between the Leasor and the Leasee indicating the terms of the contract and the amount of rent to be paid at a given period. This agreement allows the Leasor the legal title of the assets while the Leasee has a complete possession and use of the asset without having to pay for its purchase. The legal title of the equipment can only be transferred to the Leasee after a complete payment of the cost of the equipment at the end of the contract terms.

 Long-Term Sources of Funds

The long-term sources of funds could be for a period as long as five years or more. The long-term financing in most cases are used to finance fixed and current assets of the business. The main sources of long-term funds are:

• Equity capital 
• Ordinary share capital 
•  Debenture stock capital 

Equity Share Capital

The holders of these shares in a company are the owners of the business. Shareholders have rights to anything of value that the company may wish to share as well as the ultimate control of the company’s affairs. The liabilities of the company at the point of winding up or bankruptcy rest heavily on the equity shareholders.

Ordinary Shareholders

The ordinary shareholders have voting rights equals their investment in the company and cannot reclaim or redeem their shares except by rights of selling. Ordinary shares could be in form of preferred or deferred ordinary shares. The preferred ordinary share has a fixed rate of dividend and can also be entitled to a further share of profit after their fixed dividend. While deferred ordinary share is that who takes his share of the profit of the company last after all other claims must have be paid.

Debenture Stock Capital

These are long-term loans, which could be secured or unsecured that a business might obtain to finance long-term matured business. This debenture represents the document, which acknowledges the indebtedness to the company. Debenture could be redeemable or irredeemable. A redeemable debenture is that which on the other hand, an irredeemable debenture is one, which is repayable only in a situation of contingency, that is, when the business is winding-up or going bankrupt.

CONCLUSION

The discussions in this unit give different ways of financing a business, the need to identify sources of funds for the business such that you do not use then wrong sources of fund to finance your business. A wrong source of fund could cause the collapse or bankruptcy of the business. You should be able to use short-term fund to finance short-term yielding business while long-term fund could be used for both short-term and long-term yielding ventures. The discussions also shown how and where to source for funds to finance a business venture.

SUMMARY

This unit has highlighted the importance of financial need of a venture in relation to the nature of the business. It also identified the types of funds to be raised, and how to raise such funds for sustainability of the business.