- Sources of finance can be categorized as either short-term or long-term.
- Short-term sources of finance are those that are payable within a year, while long-term sources of finance have a longer repayment period.
- The choice of finance source depends on the business’s requirements, risk profile, and financial goals.
Short-term sources of finance:
- Bank Overdrafts – this involves borrowing from the bank where the business is allowed to withdraw more than it has in its account up to an agreed limit. This facility is usually available to current account holders.
- Trade Credit – this involves the supplier providing goods or services on credit for a specified period, allowing the business to sell the goods and generate cash flow before payment is due.
- Factoring and Invoice Discounting – this involves selling the business’s invoices to a third-party finance provider in exchange for immediate payment, freeing up cash flow.
- Short-term loans – this involves borrowing a specific amount for a short period, usually up to a year. These loans can be secured or unsecured, and the interest rates can be fixed or variable.
Ideal uses of short-term sources of finance:
- To finance short-term working capital requirements.
- To take advantage of trade discounts by paying suppliers promptly.
- To finance seasonal fluctuations in business activity.
- To finance unexpected or emergency expenses.
Long-term sources of finance:
- Bank loans – this involves borrowing a fixed amount of money from the bank over a long period, usually with fixed repayment schedules and interest rates.
- Debentures – this involves issuing a loan note to investors that can be bought and sold on the stock exchange.
- Equity – this involves selling shares in the business to investors in exchange for capital.
- Retained earnings – this involves reinvesting profits back into the business to finance its growth and expansion.
Ideal uses of long-term sources of finance:
- To finance long-term investment in fixed assets, such as land, buildings, and equipment.
- To finance the expansion of the business, such as opening new branches or entering new markets.
- To finance research and development projects.
- To finance acquisitions and mergers.
- Businesses can use a variety of short-term and long-term finance sources to fund their operations.
- Choosing the right finance source is critical to ensuring financial stability, managing cash flow, and achieving long-term growth and profitability.