Sources of Finance
Source of finance is always a major problem to new firms and a big challenge for business firms wishing to expand their activities. Financial capital is a scarce resource that cannot be obtained with ease. It is however possible to get the capital through various channels, however there are benefits and also many challenges involved in every solution to the financing problem.
Sources of capital can be obtained externally or internally. Internal sources of finances include personal savings or savings from business partners who have interests in the business. The personal funding may be little but depending on the nature of need, personal savings can help solve financial problems of a firm. Personal savings can also be obtained in the form of cash given to owners of the organizations by friends and family members. The main challenge to this form of financing is that money generated is limited and may not support specific projects (Philip, Hermawan & David 2004). It is also good for start-ups and smaller businesses.
Another internal source of capital is the money ploughed in into the business as the business continues running. These funds are known as retained earnings which is the portion of profits re-invested into the business instead of sharing it out among the owners or shareholders. Retained earnings are a very prudent way to finance business activities since it has no costs of borrowing and helps the business sustain itself. It is however not a good source of finance for bigger projects since most companies may not make huge profits at a go to be able to finance every need. Share capital can also serve to finance the business by owners who may be the founders committing funds that will remain in the company permanently and only receives dividends periodically. This is also appropriate mostly for start-ups (Gerald & Joel 2005).
The second category in the sources of finance for business organizations is the external funding that originates from sources outside the organizations and their owners. A bank loan is one of external source of financing whereby funds are obtained from a bank or other lending institutions which have specific terms. These terms mostly includes repayment period, amount to be repaid every period and the interest charge on the principle. Bank loan is a common way to fund a business and is widely used in many ways. Loan is good for companies who wish to balance between debt and equity in their capital structure in order to take advantage of tax incentive in interest payments. The challenge to this financing option is that it has specific contractual obligations that must be honoured and an organization must provide collateral in order to obtain a loan (Philip, Hermawan & David 2004). Bank overdrafts can also be a source of capital for short term use by the business but is charged a high interest for the service.
Angel investors are also common external source of finance for young companies. The angel investors brings in money needed and waits for the business to grow and profit from them the angels are mostly skilled and talented entrepreneurs who upon availing the much needed cash, also provide expertise and knowledge crucial for business growth and success. A venture capital s also another form of capital that is mainly provided by professional investing bodies such as mutual funds, mortgage funds and other fund institutions. Angel investors however are rarely found and even if they avail their money, they will want huge returns or may even alter the ownership and control of the firm drastically (Philip, Hermawan & David 2004).
Governments and non government institutions may also provide capital to business and entrepreneurs through various ways. Such capital is cheap to obtain and are aimed at supporting enterprise in a country. This source is often good for smaller businesses and medium enterprises since such funds are not available in very large amounts.
Equity capital is one of the common and extensive forms of financing for already established corporations. Equity financing can be obtained for the first time through initial public offering where a company sells its shares for the first time in a stock exchange market. This has the ability of bringing in a lot of financial capital that will help the company undertake massive and capital intensive programmes and long term projects. The funds raised in this way are permanently with the company and cannot be withdrawn but its ownership can be changes through trading in the stock exchange. This form of financing is very good for long term horizons and shareholders get dividends for their investments. The challenge in this financing strategy is the heavy procedures and regulations that the process involves.
Preference shares is also a source of finance where the capital provided are used in the company and its owner (preference shares owners) are paid dividends before any other ordinary share dividends are paid. The preference shares have no voting rights and thus do not alter the ownership of the company. Its dividends can also be carried forward to next period in case profits are so low to be paid in dividends (Philip, Hermawan & David 2004).
Leasing is also a source of capital especially if capital was intended to purchase assets. Companies may need specific machinery or building and can lease it from other people or institutions. An operating lease is for short term purposes and finance lease is a long term contract that allows an asset to be used and maintained by the lessee over long periods of time and periodic payments to the lessor is made by the lessee. Franchising can also be a source of finance where a local business operates under the name and business model of the franchisor (Philip, Hermawan & David 2004). The franchisee pays the franchisor some amount periodically thus serving to expand the business with little problems of acquiring debt and other sources.