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Sources Of Business Finance | Ways to Raise Capital

As a business promoter, lots of things need to be taken into consideration, but one of the most important aspect is raising investment capital.

This decision is important either at the start of the business (start -up capital) or for expansion of the business. In all cases,the type and sources of the business finance is an important factor that will not only affect other major business decisions,but will determine the success or failure of the business.

According to Adam Smith in Wealth of Nation in the year 1776,”Whatever a person saves from his revenue he adds to his capital and either employs it himself in maintaining an additional number of productive hands,or enables some person’s to do so….for a share of profits”. The point made here is that source of all capital funds is saving however generated. It could be savings internally by the business promoters or externally generated by outsiders.

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Sources of finance is divided into two and they are listed below:-

  1. Internal Sources Of Finance .
  2. External Sources Of Finance.

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Internal Sources Of Finance

This is a source of finance,where capital or money are raised from the business. Most businesses have various ways of generating funds to meet their operational needs. These include:-

  • Retained earnings / undistributed profits
  • Depreciation provisions
  • Taxation provisions

Retained Earnings /Undistributed profits

These are company earnings,which are retained or kept and are invested rather than distributed as dividends. As a source of finance to the business, undistributed profits are cheaper and surer than fund raised in the capital market. A company that is experiencing rapid growth generally needs all the funds it can get for reinvestment,also young companies especially those with retained earnings because they have limited borrowing powers.

Depreciation Provisions

Depreciation is a primarily a method of allowing for the decline in value of a company’s assets resulting from the use of assets over their life span. Although depreciation provision is charged against profit,it does not involve cash disbursement and is therefore retained in the company and used not only for replacement of the asset at the end of it’s economic or useful life,but could be used to enhance working capital position before the asset replacement becomes due.

Being deductible from profit before tax depreciation provision has considerable effect on tax liabilities. By reducing tax liabilities, depreciation makes available to the firm considerable effect on tax liabilities. By reducing tax liabilities, depreciation makes available to the firm considerably greater what is the system amount of cash. Fund realized from depreciation represents the last expensive kind of capital a company can obtain.

Taxation Provisions

Provision for business taxation not yet due for payment could be a cheap source of finance particularly to medium and large scale companies on short term basis. There is usually time lag sometimes up to 12 months between a company’s accounting period during which profit is earned and the period payment of the relevant tax becomes due. When profit is rising over a profit of time, the lag provides a veritable source of short term finance to companies.

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LIMITATIONS OF INTERNAL SOURCES OF FUND

  1. Retained profits are only available to a profit earning business. Where the company breaks even or operates at a loss,no profit can be accumulated so therefore there isn’t a way of funding the business.
  2. The amount gotten from depreciation provision is a function of the asset base of the company and the accounting method of depreciation. The smaller the company’s asset base the less that can be accumulate as provision of depreciation. Again since depreciation provision has direct effect on profit declared and it also affects the timing of amount accumulated.
  3. Finally taxes are quite inflexible and legislations are increasingly passed to reduce allowable time lag in payment of corporate taxation. Companies may be penalized for delayed payment of taxes.

As a result of these limitations on internal sources, businesses invariably resort to external sources to meet their financial needs as when required.

External Sources Of Business Finance

Under this board category are:-

  • Short Term Sources Of Finance
  • Medium
  • Long Term Financing

Short Term Sources Of Finance

Business debts that do not exceeds one year are generally classified as short term. Such debts are usually shown in the company’s account as current liabilities and are not considered part of the company’s capitalization. These include trade credits,money market credits (including commercial papers and banker’s acceptances),short term loan/credits, factoring, advance payment,accounts receivable financing and inventory loans.

Medium Term Sources Of Finance

Medium or intermediate finance refers to debt that extends between one and three years. Although intermediate financing, like short term financing is self liquidating,it satisfies more permanent fund requirements and can be used as interim substitute to bridge the gap until long term financing can be undertaken on favourable terms.

Time dimension is the most important basis of classification between short and medium term financing. If a short term debt is not repaid on schedule,it crystallizes into intermediate. Thus the short term facilities, which are renewed on expiration, easily become intermediate loans. The most common sources of medium term financing are:

  1. Term loan
  2. Revolving credits
  3. Equipment financing
  4. Hire purchase financing
  5. Leasing

Long Term Financing

For a publicly quoted company,fund for execution of the long term strategic and growth oriented plans can be sources either from equity or debt financing,unless otherwise provided from retained profit and other internally generated sources. Examples of long term financing are: Equity financing, ordinary shares, preference shares,debt financing, floating debenture, convertible debenture, income bond, guaranteed bond.

Decision on the type and source of business finance is critical for the survival and healthy growth of any business concern. However, availability of these sources depends on the ability to generate profit

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