Source Of Funds

Source Of Funds

Source Of Funds

A business cannot function without money, and the money necessary to make a firm work is referred to as business funds. Money is required consistently during the life of a firm. Funds are employed in business activities. 

Money can be obtained for a variety of reasons. Traditional areas of need may include the acquisition of capital assets, such as new machinery or the construction of a new building or depot.

The creation of new items may be quite costly, and cash may be necessary here as well. Typically, such advancements are funded domestically, although funding for machinery acquisition may come from outside sources.

A corporation may raise more funds from the following sources:

Retained Earnings

The amount of earnings maintained inside the firm has a direct influence on the amount of dividends paid by any corporation. The profit that has been re-invested as retained earnings is profit that might have been given as a dividend.

The following are the primary arguments for using retained earnings to finance new investments rather than paying larger dividends and then raising fresh stock for the new projects:

  • Many organizations’ management assumes that retained earnings represent free cash, which is not the case. However, it is true that using retained profits as a source of funds does not result in a cash payout.
  • In practice, the company’s dividend policy is established by the board of directors. Retained earnings are an appealing source of capital to them since investment initiatives may be done without engaging either the shareholders or any outsiders.
  • Using retained earnings instead of new shares or debentures saves money on issue charges.
  • Using retained earnings precludes the potential of a change in control as a consequence of the issuance of additional shares.

Another element to consider is the financial and tax situation of the company’s stockholders. If, for tax reasons, they would rather generate a capital profit (which will only be taxed when the shares are sold) than get current income, then financing through retained earnings is preferable to alternative options.

A firm must limit its self-financing through retained earnings because shareholders should be given a decent dividend in keeping with realistic expectations, even if the board would prefer to reinvest the cash.

At the same time, a corporation seeking more funds will not be expected by investors (such as banks) to pay large dividends or excessive wages to owner-directors.

Bank Lending

Bank loans are an essential source of funding for businesses. Bank financing is still mostly for the short term, while medium-term lending is becoming more popular.

Short-term loans can take the following forms:

  • An overdraft, which a corporation must stay within the bank’s limit. Interest is charged (at a variable rate) on the amount by which the firm is overdrawn from day to day.
  • A short-term loan with a repayment period of up to three years.

Medium-term loans are those with terms ranging from three to 10 years. The interest rate imposed on medium-term bank loans to major corporations will be a fixed margin, with the size of the margin determined by the borrower’s credit standing and riskiness. 

A loan may have a fixed or variable interest rate, which means that the rate of interest charged will be modified every three, six, nine, or twelve months in accordance with recent changes in the Base Lending Rate.

Lending to small businesses will be at a margin above the bank’s base rate, with either a variable or fixed interest rate. Overdraft lending is always at a variable rate. A loan with a variable interest rate is also known as a floating rate loan.

Longer-term bank loans are occasionally offered, mainly for the acquisition of real estate in the form of a mortgage. When a banker is approached by a business customer for a loan or overdraft facility, he will take various variables into account, which are frequently referred to by the mnemonic PARTS.

  • Purpose
  • Amount
  • Repayment
  • Term
  • Security

Equity Capital

Companies can raise public funds in return for a proportionate ownership stake in the form of shares distributed to investors who become shareholders after acquiring the shares.

Ordinary shares are issued to a company’s owners. They have a nominal or ‘face’ value, which is usually $1 or 50 cents. Except when ordinary shares are issued for cash, the issue price must be equal to or greater than the nominal value of the shares.

Private equity financing is another possibility if there are businesses or persons in the company’s or directors’ network willing to invest in a project or wherever the money is needed.

In contrast to debt capital funding, equity funding does not need the payment of interest to a borrower.

The long-term distribution of earnings among all shareholders is one disadvantage of equity capital investment. More crucially, when a corporation sells more shares, its ownership control is diluted.

What is the Purpose of Funding?

Seed Money: It is essential to get the business up and going; it can be used to purchase materials, websites, and office supplies. An investor, a small company loan, or the owner’s savings account can all provide seed capital.

Cash Flow:  A Company’s day-to-day costs must be fulfilled. Salaries, expenses, and insurance, to name a few, must be paid. The early stages of a firm create little money, necessitating capital.

Expansion:  As a company grows, additional locations, products, and market research may be necessary. These efforts increase existing costs and necessitate additional funding.

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