This topic is about sources of business finance. See we will in this topic we will learn what is the
importance of finance, why finance is required in the business okay, is it like the business or finance
is required at the start of the business only or is it something which is continuously required by the
businesses, what are the different sources of finance, what are their merits, what are their
limitations, we will understand that, we will also understand what are the various financial
institutions who provide finance in India okay, so let us begin.
See finance is known to be the lifeblood of the company or in other words finance is the soul of the
company, now what is the reason for that, what happens is when you start a company you would
require some kind of fixed capital right, see let us take an example if tomorrow Rama wants to open
a kitchen, now this kitchen will scattering to the needs of the people that is the eating needs of the
people, now for opening a kitchen I would require utensils, I would require various other things
which are required necessary for cooking the food okay, so a business requires fixed assets and to
buy the fixed assets we require finance okay, now is it that only finance is required at the start of the
business, no it is not, so let us understand that, the first thing is as I just told you business produces
goods and services, so in our example Rama is going to prepare food which needs to be supplied to
the consumer okay, so we require money to provide the same, now see in Rama's kitchen as I gave
you the example we would require the utensils, we would require all the materials that is the raw
materials which are required to prepare the food right, so because of that she needs finance, now.
As I already told you finance is the soul of the business, finance is the light blood of the business
right? Because imagine if Rama doesn't have any money what she will do? Would she be able to start
her business or would she be able to provide the food which she intends to do to the consumers?
No. Without finance she cannot go and buy the vegetables, she cannot buy the utensils, she cannot
buy the other ingredients which are required for cooking food and that is the reason it is said that
finance is the soul of the business.
Now what is business finance? See business finance is requirement of funds by business to carry out
its activities. As I gave you the example in Rama's kitchen she has to carry out the activities of
cooking food so she will require funds for doing that.
Now remember in business there are fixed work capital requirements and then there are working
capital requirements. What are these? Let's understand that. When it comes to fixed work capital
requirements, Capital requirements, see when you start your business you need to invest in certain
assets like you have to purchase the machinery, you need the requisite equipment to start your
business.
So, all this assets in which you are investing these are your fixed assets requirements, so you require
finance for that. Now, is it sufficient as I told you earlier? No, it is not sufficient. The need for finance
is also there when you are running your business for day to day operations also you require finance.
Now the question would arise why? See today when the customer places an order from that date till
the date I am able to realize the payment from him that is known as the working capital cycle. Okay?
Now in this working capital cycle there would be many stages where I will have to make a payment
but then I am going to realize the payment from my customer, I am going to receive the payment
from my customer only at the end.
Right? So, to meet these expenses which are coming in between from the date or from the day of
receiving the order till the day I receive the payment from the customer at this particular cycle we
require finance and to meet those requirements these are known as working capital requirements.
Okay? So, to meet those requirements of finance, to meet those requirements of business we also
require finance. Okay? Now let's understand the nature of business finance. Now remember before I
go further when it comes to your fixed capital requirements and your working capital requirements
the need varies from industry to industry.
For example if it is a trading company then the requirements for fixed capital would be lesser
compared to a manufacturing company where I will have to invest very heavily into machinery
equipment. For each of us fix your
where I will have to invest very heavily into machinery equipments, furniture, fixtures, etc. Now, whe
n it comes to working capital requirement, it purely depends upon the working capital cycle which I e
xplained you. So every industry has a different working capital cycle, for example, aviation industry. N
ow it would havea very large working capital cycle, the number of days till the time the payment is re
alized or released from the customer is very long, ok, compared to a normal production company, ok.
For example, a company manufacturing pens. So remember the requirements differ from industry to
industry. Again, whether youare a small company or whether you are a big company, you require mo
ney to run for your, you require money to run the operations of the company, ok. Now your efficienc
y would be to ensure that minimum points are used for the operations of the company, ok. Now let u
ssee the nature of business finance. See the concept is wide because as I explained you, it would con
tain all the requirements which are there, that is the fixed capital requirements and as well as the wo
rking capital requirements of the business. So it includes all the activities which are required
in the business, which has to be done in the business. Now every business require finance and that is
the reason we have been telling you that finance is the sole of the business. Without finance, I cann
ot do anything, ok. When it comes to business, money is the most important
thing and hence this is something which is used by every person in the business. Now this would incl
ude all types of funds and capital to run the business. As I explained you, you will have the fixed capit
al requirements, you have the working capital requirements. So all the means through
which you raise the finance would be included in this particular finance. When I am talking about bus
iness finance, everything gets included in that. So when an entrepreneur, let us say a sole proprietor l
ike Rama starts her kitchen, then she is investing her own personal savings. So even that is
a part of business finance later when she expands and her brand, she builds a brand, her company is
famous across the world and she starts doing other things also and she expands the company. At that
time, if she goes and raised the money from investor, even that is a
source of business finance, ok. So even that is a capital which would be included in business finance,
ok. Now the primary goal of the finance is to raise the corporate value. Corporate values are the valu
es or the ethics which we discuss for which you want to build the company.
helps you to get that goodwill get that name in the market okay now let's move further and understa
nd what are the significance of business finance see it is necessary to start a business now as I told yo
u certain businesses are started through savings for example to start a kitchen
as I gave you an example Rama's kitchen it is very easy you can start from your own savings but some
times certain industries certain setups need huge amount of money and in at that time you have to u
se the various sources of finance it helps to face economic cycle see
economic cycle I'm talking in perspective of the country so a country can see a growth period it can s
ee a recession or it can see a depression now what happens during recession and depression the de
mand goes down right and at that time it is the it is finance which
helps you to come over that okay so you're able to face depression or recession because you have fin
ance in hand what happens is when your money in recession when the demand is going down apart f
rom that the business condition also becomes stiff so people will not be willing to
give you an advance or you will require the sources of finance would dry up so if you have at that tim
e money in hand okay or if you have the finance in at that time it helps you to cater to those difficulti
es next it is necessary for growth now
tomorrow as I gave you example Rama's kitchen wants to expand from one city it wants to go to diffe
rent cities of India okay it wants to establish those branches when she is going to hire people like her
so she will require money to grow to expand so remember even
for growth and expansion finance is required necessary for payment of debt okay finance is necessar
y so that you get paying the debts which you have taken okay so you need to keep on earning finance
you need to keep on ensuring that you receive orders and you're getting money for
those orders so that you can pay your debts on time it is necessary for availing opportunities let's tak
e an example if Rama has been running her kitchen wherein the daily demand is only 10 different so
she has a working capital cycle set wherein she is able to cater to
demand of 10 different tomorrow suddenly she gets an demand of 100 that is a order comes in wher
ein they say they require 100 difference at a short notice okay now she it would be finance will will w
hich would help her to avail this opportunity and why would she avail
this opportunity because obviously she's in charge of premium and she'll get a double profit on that
and so remember finance helps you to avail opportunities which would would be in
and which would help your business to attain more profit this brings us to the end of the video.
Now this is all about the financial needs of business. So we are going to understand what are the
financial needs of business. Why would you require finance for your business? Now see we I already
discussed in the previous video about the fixed capital requirements and working capital
requirements. Okay. Now we are going to learn in detail what are the specific requirement when it
comes to fixed capital and working capital. See as I was telling you when it comes to fixed capital
requirements these are the requirements they arise because you need furniture, fixture, equipment,
machinery, building, land etc to run your business. So the requirement increases when it comes to
manufacturing companies which is quite obvious okay. Again the business who are operating on a
large scale will have more requirements. So as in when your business would grow the fixed capital
requirement starts increasing. For example you require an office right. Now when you start your
business your office would be only at one city. Now as you move further and you want to open up
your branches you will require offices in those cities also. So that means your scale of operations is
increasing you are becoming a large scale company and because of that the fixed capital
requirements are increasing. Similarly if you start opening up factories so more than one factory that
means you are expanding and because of that you require more machinery, more equipment to run
the business. Okay. Now always remember they should be financed by long term sources of finance.
What is long term sources of finance we will learn later in the video but remember that long term
sources of finance is the only way to finance the fixed capital requirements. Okay. Now the question
that could have come to your mind is why would a long term source of finance is necessary. See
when I am teaching you the long term source of finance I will also make you understand that why
fixed capital requirements should be met through these sources of finance. Okay. Now let us
understand what are the working capital requirements. I already explained you the working capital
cycle. Okay. Now remember the longer the working capital higher is the working capital required. I
gave you an example of aviation industry. Similarly a shipping company these all are companies who
would have a very long working capital cycle and hence the working capital required to run the
business would be very high compared to someone like a vegetable vendor. Okay. He gets cash every
day so is a daily basis of his working capital requirements are very less. Okay. Now remember
working capital requirements are met only through short term finances. When it comes to fixed
capital requirements they would be see met through long term sources of finance but when it comes
to working capital requirements these are met through short term sources of finance. Now if you are
selling the goods on credit that is now what happens is generally industry to industry the way the
operations are done are different. Okay. So if you are selling the goods on credit then you would have
higher requirement. Why because you remember I was telling you that from the time you start get
the order from the customer till the time you are releasing the payment that is your working capital
cycle okay. So if you are giving someone goods on credit you are increasing this life the life of this
working capital cycle and hence it becomes necessary that to understand that working capital cycle
gets prolonged or the number of days increases when the goods are sold on credit. Okay. Now again
the requirement would be very high when you have a slow sales turnover that is the amount of sales
are lesser. In that scenario also you will have to keep you will have to understand that the working
capital cycle would be on a larger basis. Now what happens is this requirement compared to fixed
capital requirement changes quite often okay. So you have to understand how the requirement
changes. The requirement would increase when there is a peak season. See every industry has a
peak season for example a garment manufacturing unit. The peak season is generally when the
market is at a high price. There are festivals, for example during Diwali, during Eid or during New Year
or during Christmas people go and buy new clothes.
So, at that time that would be the peak season for them, ok. Similarly, for a AC company that is an air
conditioner company, the peak season is the months of summer, ok. So, at that time the demand fro
m the customers for your goods is very high and because of
that the working capital requirement increases. What about festive season? I already gave you one e
xample that people buy a new clothes during the festive season. Now, remember the second thing lik
e even for eatables like mithai, that is any sweets when you go and buy those, ok. During festive seas
on
the demand for such sweets increases, the demand for gifts increases. So, the industries who are wor
king or the companies who are working under this industry, that is food industry, they would see a hi
gher requirement during the festive season. Expansion of business, if you want to expand your busin
ess, if
you want to take more orders. At that time your working capital requirement also increases, shifting t
o new location. Now, when you are shifting to new location, let us say if you are in city A, you want to
shift to city B, ok. So, the time of delivering the goods
may get delayed, ok. And then the time of setting up the business will also have to be considered. So,
that is the reason the requirement of working capital will increase. Then payment of current debts, a
lways remember that when we buy raw materials, we have to pay for the them,
right. So, we have to pay our creditors, we have to pay our debts. So, working capital requirement flu
ctuates on the basis of the amount of raw material which we have bought, amount of purchases we
have made. Sometimes in case if you have taken any kind of finance and you
have to pay an interest or you have to pay the installment, then again your working capital requireme
nt changes accordingly, ok. This brings us to the end of this. which we have bought, amount of purch
ases we have made. Sometimes in case if you have taken any kind of finance and
you have to pay an interest or you have to pay the installment, then again your working capital requir
ement changes accordingly, ok. This brings us to the end of this.
Now see we understood what is the need of finance, we understood the significance of finance, we
understood where is finance required that is fixed capital and working capital requirements of
finance. Now let us understand the sources of finance, okay. See there are classifications which are
being done for sources of finance. So this is the classification which is available to us. Don't get
confused if you see names appearing in all the three subheadings, okay. The reason is when it comes
to sources of classification, finance classification, it is either done on the basis of period or on the
basis of ownership or on the basis of sources of generation, okay. So on the time period when it
comes to the classification on the basis of period it would be long term and short term, okay. We will
understand this in the next slide as to what is long term and short term. For timing remember when I
am speaking about equity share capital, when I am speaking about retained profit, preferences,
debentures, these all will come under the long term source of finance, okay. Whereas if I need
finance for my working capital requirements then trade credit, factory, banks and commercial paper
will come under that, okay. Now remember there is a medium term source of finance also. What is
that? This is required for a medium term, neither it is a long term nor it is a short term as the name
suggests it is somewhere between these two and this is required, this can be taken from as a way of
loan from bank or as a public deposit or as way of lease financing, okay. Now on the basis of
ownership it would be either the owner's fund that is the person the proprietor investing in the
business itself. So these would be again equity shares and retained earnings. So you can see the
names are getting repeated out here. The same way the debentures loan from banks, loan from
financial institutions all this will come under borrowed funds. Now on the basis of sources of
generation you have the internal sources as well as you have the external sources. Internal that is
someone is bringing the money into his own business. So again the proprietor or the owner when he
brings the money so it would be equity share capital when you are taking the money from the
shareholders or it would be retained earnings. External it would be again financial institutions loan
from banks, referent shares, public deposits, lease financing all this will come under external sources
of finance. So these are the ways in which the classification of finance sources of finance is done.
Now let's understand each of them in detail. Now let's start with on the basis of time period, okay.
See long sources in case if I am talking about long term source of finance I am talking about finance
for more than five years. Now in the earlier video I had told you that when it comes to fixed capital
what happens is you are investing in assets, you are investing in machinery, equipment, computers,
fixed tools. So that kind when you have require finance that kind of finance would be long term
source of finance because the machinery equipment is needed by business for a long term. It is not
for a short term you require it continuously maybe till the time your business is in existence in hence
the finance for more than five years comes under long term source of finance. Now medium term is
somewhere between one and five so the finance which I require for more than one year but then it
is less than five years it will get classified as medium term source of finance. Now lease financing is
an example for that. Remember the terms I am using lease financing, commercial paper or
shareholders equity I will explain all this in detail later. For time being let's concentrate on
understanding what is long term, medium term and short term. Now coming to short term sources
of finance this is less than one year that is the reason it is used for financing working capital needs.
So whenever you are addressing the working capital needs the needs are only for less than one year
it is mostly for few months or at the most for an year and that is the reason these are known as short
term sources of finance. Now on the basis of ownership I gave you an example of Rama's kitchen so
in case if Rama wants to invest. She will bring her own funds so this would be the funds invested by
owner. So here if Rama invests her own funds these would be known as owner's
fund. They are not required to be paid back. See Rama will never take back that capital. She will not s
ay give me the money back. She will not go to the business and say I want my money back. All the onl
y things she would do is once the business
is up and running, she will start demanding a salary or a dividend. She will start earning a dividend on
it. Now remember this is a permanent source of finance because as I told you Rama will not go and s
ay I want my money back. So when it comes to
owner's fund, remember the owner of the business is investing in the money and that is known as o
wner's fund. We are not required to pay it back and it is a long permanent source of finance. When it
comes to borrowed funds, these are loans and credit. So as I
gave you an example, if Rama's kitchen wants to expand in different cities and open branches out the
re, she will have to borrow funds. So what she can do? She can go to bank. She can take the money f
or expansion of her business. The reason being because she doesn't have
that much of money to expand. So that would be a borrowed fund. So loans and credit which you tak
e come under borrowed fund. Now this is an external source of finance. That means when a party w
ho is not the party to business, that is an external party is helping
you out. Someone outside the business is helping you out to give you that finance. Now remember t
his is required to be paid back in stipulated time. Whenever you take a loan from bank, the bank will
give you a loan for a specific time period. For example, let's say five
years. So from the day you take the loan till the end of five years, you will have to pay regular install
ments. Apart from that you will have to pay interest to the banks. So as I said, interest is being charge
d by the bank. So it is a fixed rate
of interest which is being charged by the bank. So whenever you take credit from any person as a loa
n, they charge you an interest and you need to pay them. Now let's see the last source of finance tha
t was internal sources. Now see these are the funds which are
generated within the business. How can we do that? By accelerating accounts receivable. What is acc
ounts receivable? See when I give someone a credit, okay, so suppose a customer comes to me, he d
emands goods from me, but he says he will pay me in 60 days. Okay, so I have
to give him that 60 days. If I agree to that, then I'll have to wait for 60 days,s
after the delivery of goods to get payment from him. So, I can accelerate this cycle and these are kno
wn as accounts receivable. So, I can accelerate the cycle and increase the money by from the account
s receivable by realizing them at a faster rate. If I have inventory I can
ensure that the inventory is sold off as early as possible so that I can receive more funds. Now, if I am
earning profits then I can ensure the profits are flawed back in the business that is the money which
I have earned through profits I am again investing in
business. So, these become internal sources of finance ok. Now, remember these fulfill very limited n
eeds because the quantum is always less ok. So, they are able to only fulfill your let us say daily need
s compared to your bigger needs. For example, when you have a house so your daily
needs would be getting food right or electricity and other water etcetera. So, whatever charges are r
elated to that that would be you would be paying on a monthly basis ok. But when it comes to renov
ating a house that is a big demand you have for a house right. So,I am taking a hypothetical example
here when I am having a internal source of finance these would cater to these daily needs rather tha
n these bigger needs for example, renovating a office ok. So, for renovating my office or buying some
thing as a fixed assets or much new machinery these
resources are not useful. Now, external sources these are from outside the business. So, these are fro
m your bank loan these would come in form of your bank loan, lease financing or money from your s
uppliers wherein the suppliers agree to give you a longer term of credit that is you
do not pay your suppliers immediately you take the goods from them, but you pay them after a certa
in time period ok. Now, they are available at cost when it comes to loans. Obviously, I explained you t
hey come at a rate of interest you need to pay a rate of
interest the same applies to other sources of finance. This brings us to the end of the video.