Updated on July 6, 2024 – Added ten major sources of finance for business. Also FAQs for unanswered questions.
In this article, we will look at the 10 major sources of finance for business. We all dream of being our own bosses sometime. When its time, you will wonder about the 10 major sources of finance for your business. Therefore, in our article today, we will focus on discussing these sources.
Major Sources of finance for business
It is worth to note that sources of finance for businesses are mainly divided into two major parts. There are those that are short terms which facilitate day to day running of the business while there are those others that are long term. The long term sources are majorly used to facilitate business growth.
Therefore, today we will discuss the various sources of finance divided into these two major sections.
A) Long term sources of business finance
B) Short term sources of business finance
Short term sources of business finance have a repayment period of less than a year while long term sources have a repayment period of ten years and above.
Sources of Long term financing for business
There are various sources of long term finance for business. The major ones include equity shares, issuing debentures as well as acquiring secured loans from financial institutions.
Below is a list of some of the best sources of long term financing for a business.
Equity shares is the main source of long term finance for most business. Equity shares is also referred to as ordinary shares. A business owner raises capital for his/her business by selling a stake of ownership of their business. A person who has bought these shares becomes the owner of the business and can participate in making decisions.
2. Loans from financial institutions
Acquiring loans from financial institutions in order to fund your business is one of the major and mostly used sources of long term capital. A bank will always lend you money if you can clearly show that you are capable of repaying the loan back in time.
3. Retaining profits back into the business
If the business that needs financing already exists, then it may be possible to raise long term finance by retaining the profits you make in the business. You may decide to pay only a percentage of the profits to the investors and reinvest the whole chunk back into the business. When this happens it is referred to as the act of ploughing back profits.
4. Venture capital
Venture capital financing is the newest mode of long term financing for most start up. Instead of acquiring a loan from a bank, one may opt to offer a part of their equity stake for them to get funding. Despite the process of acquiring venture funding being long, this source of long term financing is still one of the best. Most times, an entrepreneur may also be mentored by some of industry leaders in his field if they opt to invest in his business.
Preference shares is the other source of long term finance for businesses in Kenya. These shares work the same way as equity shares only that they have fixed dividend rate and that have to be paid. In case the business goes into liquidation, these shares have to be paid first. Preference shares have a fixed term and they have to be paid back.
6. Debentures
Debentures are long-term securities issued by a company that are backed by the company’s general credit rather than by specified assets. They offer fixed interest payments to investors and are often used by companies to raise substantial amounts of capital.
7. Convertible Bonds
Convertible bonds are a type of debt instrument that can be converted into a predetermined number of equity shares of the issuing company. They offer the benefits of regular interest payments with the potential for capital appreciation if the company’s stock performs well.
8. Lease Financing
Lease financing involves a business leasing assets such as machinery, vehicles, or equipment from a leasing company for a specified period. It allows businesses to use the assets without purchasing them outright, thus preserving cash flow and credit lines for other uses.
9. Public Deposits
Public deposits are funds raised directly from the public, usually for a fixed period at a fixed rate of interest. These are similar to bank deposits but are directly solicited by the company, offering an alternative to traditional loans.
10. Development Financial Institutions (DFIs)
DFIs provide long-term capital for economic development projects, typically in sectors like infrastructure, manufacturing, and agriculture. These institutions offer loans, equity investments, and other financial products to support long-term growth.
Read more: Top 7 Long Term Sources of Finance
Just like there are a variety of long term sources of finance for business, there is also a number of short term sources of finance which a business can resort to using whenever it is in urgent need of cash and goods for business continuity.
Short Term Sources of Finance for business
These sources of finance for business include:
11. Trade credit
Trade credit is a major short of short term financing that happens during the normal course of business transaction. Most manufacturers have adopted this form as a result of the high competition being experienced all over. What this source of financing involves is that the supplier will offer to deliver goods or services to their customer on credit.
However, it is very important that as the buyer that you be very credit worthy for the buyer to trust that once you are able to repay you will do so without fail.
12. Deferred Income
Deferred income is a source of short term financing whereby a business receives payment in advance before delivering the agreed upon services or goods delivered. For instance if I deal with buying and selling of building materials and I lack enough funds to stock my business in order to complete some orders. If I’m using this method as a source of financing, I will go to one of my biggest customers, ask them to pay in advance, stock up my business and then pay later.
13. Accruals
Accruals are expenses which a company owes to another. These expenses however are not yet paid because they are not due. However, the company acknowledges that it has them and that they have to paid. Some of the major sources of business accruals include wages and salaries.
Moreover, accruals are interest free sources of short term financing for businesses.
14. Commercial banks loans
Most businesses are surviving this period with loans from commercial banks. Commercial loans are a huge source of short term financing in Kenya. Most commercial banks in Kenya have signed MOU’s with companies to either allow overdraft or extend loans to them as and when needed.
However, it is important to understand that commercial bank financing may come in many forms and shapes. It may be in form of a loan, discounting & Purchase bills or even in form of overdrafts as I had mentioned earlier.
15. Factoring
Factoring is the opposite of trade credit. Here a business sells its accounts receivable at a discount. It may sell it to a bank in order to receive financing to ensure continuity of business or any other institution.
16. Overdraft Facilities
An overdraft facility is an arrangement with a bank that allows a business to withdraw more money from its account than it has deposited, up to a specified limit. This provides a flexible source of short-term funding to cover immediate cash flow needs.
17. Short-Term Loans
Short-term loans are loans that must be repaid within a year. They are typically used to finance short-term needs such as inventory purchases, payroll, and other operational expenses.
18. Invoice Discounting
Invoice discounting is a financial arrangement where businesses sell their accounts receivable (invoices) at a discount to a financial institution to obtain immediate cash. This helps improve cash flow without waiting for customers to pay their invoices.
19. Commercial Paper
Commercial paper is an unsecured, short-term debt instrument issued by a company to meet its short-term liabilities. It is typically issued at a discount and matures within 270 days, providing a quick source of financing.
20. Line of Credit
A line of credit is a flexible loan from a financial institution that provides businesses with access to a specified amount of funds that they can draw upon as needed. It is an excellent option for managing short-term cash flow needs.
FAQs on Sources of Finance for Business
What is the difference between short-term and long-term sources of finance?
- Short-term sources: These are typically used to manage day-to-day operations and have repayment periods of less than a year.
- Long-term sources: These are intended for business growth and development, with repayment periods usually extending ten years or more.
What are equity shares?
Equity shares, also known as ordinary shares, involve raising capital by selling ownership stakes in the business. Shareholders gain ownership rights and can participate in decision-making.
How do loans from financial institutions work?
Banks and financial institutions lend money to businesses based on their ability to repay. These loans can be used for various business purposes and usually have structured repayment schedules.
What is venture capital?
Venture capital involves funding from investors in exchange for equity stakes in the business. This type of financing is common for startups and may also include mentorship from experienced industry leaders.
What are preference shares?
Preference shares are a type of equity with a fixed dividend rate and priority over ordinary shares in case of liquidation. They have a fixed term and must be paid back.
Conclusion
Understanding the various sources of finance is crucial for any business, whether it’s just starting out or looking to expand. Long-term sources like equity shares, loans from financial institutions, and venture capital are essential for growth and development. Short-term sources, including trade credit, deferred income, and commercial bank loans, help manage day-to-day operations and ensure business continuity.
