Sources of business finance can be studied under the following heads:

(1) Short Term Finance:

Short-term finance is needed to fulfill the current needs of business. The current needs may include payment of taxes, salaries or wages, repair expenses, payment to creditor etc. The need for short term finance arises because sales revenues and purchase payments are not perfectly same at all the time. Sometimes sales can be low as compared to purchases. Further sales may be on credit while purchases are on cash. So short term finance is needed to match these disequilibrium.

Sources of short term finance are as follows:

(i) Bank Overdraft: Bank overdraft is very widely used source of business finance. Under this client can draw certain sum of money over and above his original account balance. Thus it is easier for the businessman to meet short term unexpected expenses.

(ii) Bill Discounting: Bills of exchange can be discounted at the banks. This provides cash to the holder of the bill which can be used to finance immediate needs.

(iii) Advances from Customers: Advances are primarily demanded and received for the confirmation of orders However, these are also used as source of financing the operations necessary to execute the job order.

(iv) Installment Purchases: Purchasing on installment gives more time to make payments. The deferred payments are used as a source of financing small expenses which are to be paid immediately.

(v) Bill of Lading: Bill of lading and other export and import documents are used as a guarantee to take loan from banks and that loan amount can be used as finance for a short time period.

(vi) Financial Institutions: Different financial institutions also help businessmen to get out of financial difficulties by providing short-term loans. Certain co-operative societies can arrange short term financial assistance for businessmen.

(vii) Trade Credit: It is the usual practice of the businessmen to buy raw material, store and spares on credit. Such transactions result in increasing accounts payable of the business which are to be paid after a certain time period. Goods are sold on cash and payment is made after 30, 60, or 90 days. This allows some freedom to businessmen in meeting financial difficulties.

(2) Medium Term Finance:

This finance is required to meet the medium term (1-5 years) requirements of the business. Such finances are basically required for the balancing, modernization and replacement of machinery and plant. These are also needed for re-engineering of the organization. They aid the management in completing medium term capital projects within planned time. Following are the sources of medium term finance:

(i) Commercial Banks: Commercial banks are the major source of medium term finance. They provide loans for different time-period against appropriate securities. At the termination of terms the loan can be re-negotiated, if required.

(ii) Hire Purchase: Hire purchase means buying on installments. It allows the business house to have the required goods with payments to be made in future in agreed installment. Needless to say that some interest is always charged on outstanding amount.

(iii) Financial Institutions: Several financial institutions such as SME Bank, Industrial Development Bank, etc., also provide medium and long-term finances. Besides providing finance they also provide technical and managerial assistance on different matters.

(iv) Debentures and TFCs: Debentures and TFCs (Terms Finance Certificates) are also used as a source of medium term finances. Debentures is an acknowledgement of loan from the company. It can be of any duration as agreed among the parties. The debenture holder enjoys return at a fixed rate of interest. Under Islamic mode of financing debentures has been replaced by TFCs.

(v) Insurance Companies: Insurance companies have a large pool of funds contributed by their policy holders. Insurance companies grant loans and make investments out of this pool. Such loans are the source of medium term financing for various businesses.

(3) Long Term Finance:

Long term finances are those that are required on permanent basis or for more than five years tenure. They are basically desired to meet structural changes in business or for heavy modernization expenses. These are also needed to initiate a new business plan or for a long term developmental projects. Following are its sources:

(i) Equity Shares: This method is most widely used all over the world to raise long term finance. Equity shares are subscribed by public to generate the capital base of a large scale business. The equity share holders shares the profit and loss of the business. This method is safe and secured, in a sense that amount once received is only paid back at the time of wounding up of the company.

(ii) Retained Earnings: Retained earnings are the reserves which are generated from the excess profits. In times of need they can be used to finance the business project. This is also called ploughing back of profits.

(iii) Leasing: Leasing is also a source of long term finance. With the help of leasing, new equipment can be acquired without any heavy outflow of cash.

(iv) Financial Institutions: Different financial institutions such as former PICIC also provide long term loans to business houses.

(v) Debentures: Debentures and Participation Term Certificates are also used as a source of long term financing.

Financing a small business can be most time consuming activity for a business owner. It can be the most important part of growing a business, but one must be careful not to allow it to consume the business. Finance is the relationship between cash, risk and value. Manage each well and you will have healthy finance mix for your business.

Develop a business finance plan and loan package that has a well developed strategic plan, which in turn relates to realistic and believable financials. Before you can finance a business, a project, an expansion or an acquisition, you must develop precisely what your finance needs are.

Finance your business from a position of strength. As a business owner you show your confidence in the business by investing up to ten percent of your finance needs from your own coffers. The remaining twenty to thirty percent of your cash needs can come from private investors or venture capital. Remember, sweat equity is expected, but it is not a replacement for cash.

Depending on the valuation of your business and the risk involved, the private equity component will want on average a thirty to forty percent equity stake in your company for three to five years. Giving up this equity position in your company, yet maintaining clear majority ownership, will give you leverage in the remaining sixty percent of your finance needs.

The remaining finance can come in the form of long term debt, short term working capital, equipment finance and inventory finance. By having a strong cash position in your company, a variety of lenders will be available to you. It is advisable to hire an experienced commercial loan broker to do the finance “shopping” for you and present you with a variety of options. It is important at this juncture that you obtain finance that fits your business needs and structures, instead of trying to force your structure into a financial instrument not ideally suited for your operations.

Having a strong cash position in your company, the additional debt financing will not put an undue strain on your cash flow. Sixty percent debt is a healthy. Debt finance can come in the form of unsecured finance, such as short-term debt, line of credit financing and long term debt. Unsecured debt is typically called cash flow finance and requires credit worthiness. Debt finance can also come in the form of secured or asset based finance, which can include accounts receivable, inventory, equipment, real estate, personal assets, letter of credit, and government guaranteed finance. A customized mix of unsecured and secured debt, designed specifically around your company’s financial needs, is the advantage of having a strong cash position.

The cash flow statement is an important financial in tracking the effects of certain types of finance. It is critical to have a firm handle on your monthly cash flow, along with the control and planning structure of a financial budget, to successfully plan and monitor your company’s finance.

Your finance plan is a result and part of your strategic planning process. You need to be careful in matching your cash needs with your cash goals. Using short term capital for long term growth and vice versa is a no-no. Violating the matching rule can bring about high risk levels in the interest rate, re-finance possibilities and operational independence. Some deviation from this age old rule is permissible. For instance, if you have a long term need for working capital, then a permanent capital need may be warranted. Another good finance strategy is having contingency capital on hand for freeing up your working capital needs and providing maximum flexibility. For example, you can use a line of credit to get into an opportunity that quickly arises and then arrange for cheaper, better suited, long term finance subsequently, planning all of this upfront with a lender.

Unfortunately finance is not typically addressed until a company is in crisis. Plan ahead with an effective business plan and loan package. Equity finance does not stress cash flow as debt can and gives lenders confidence to do business with your company. Good financial structuring reduces the costs of capital and the finance risks. Consider using a business consultant, finance professional or loan broker to help you with your finance plan.