BUSINESS FINANCE

Introduction
Business is concerned with the production and distribution of goods and services for satisfaction
of needs of the society. For all these activities to happen, business requires money. Therefore,
business finance is the requirement of money by business to carry out the various activities. A
business cannot function unless adequate funds are made available to it.

Sources of business finance

The initial capital contributed by the entrepreneur is not always sufficient to take care of all
financial requirements of the business. The entrepreneur therefore has to look for other sources
of finance the will fund the business in its day-to-day operations. Finance can be obtained from
many different sources but the entrepreneur has to consider a number of factors before choosing
the sources. The factors affecting the choice of the source of finance include:

Cost
Financial strength and stability of the operation
Form of organization and legal status
Purpose and time period
Risk profile
Controls
Tax benefits
Flexibility and ease
Effects of credit worthiness

The sources of business finance include the following:

1: Bank loans

A bank loan is an amount of money borrowed for a set period within an agreed repayment
schedule. The repayment amount will depend on the size and duration of the loan and the rate of
interest. Banks may offer either short term loans or long term loans.
Many businesses use bank loans as a suitable part of their financial structure. In fact, bank loans
tend to be more available for well-established and growing businesses rather than start-up
businesses, this is because the borrower needs to provide some security or create a charge on the
assets of the firm before a loan is given and well-established business have an upper hand on
that.
Advantages of bank loans

The business is guaranteed the money for a certain period - generally three to ten years
(unless it breaches the loan conditions)

Loans can be matched to the lifetime of the equipment or other assets the loan is for

While interest must be paid on the loan, there is no need to provide the bank with a share
in the business

Interest rates may be fixed for the term, making it easier to forecast interest payments

Disadvantages of business loans

Lengthy application process banks need to verify all the credentials and details about the
business before sanctioning a loan. Therefore its application process is very long and its
review etc. takes a long time.

Cumbersome The prospect of getting into the detailing that banks require is really
cumbersome, and from the entrepreneurs point of view, totally unnecessary.

Risk of losing Collateral bank loans are generally sanctioned against some collateral,
often the entrepreneurs house and property. This stands the risk of being lost to the bank
should the business fail to take off.

Entire amount not granted banks are known to not agree to grant the whole amount
requested for a loan. They may grant 70 or 80 % of the sum applied for. This makes it
difficult for the entrepreneur to begin since he has to scout around for the remaining
balance and find agencies to funs that before he can start.

2: venture capital
Venture capital refers to financing that comes from companies or individual in the business of
investing in young, privately held businesses. They provide capital to young businesses in
exchange for an ownership share of the business. Venture capital firms are usually focused on
creating an investment portfolio of business with high growth rate potential resulting in high
rates of return.
Advantages of venture capital

Venture capital enables a company expansion that would not be possible through bank
loans or other methods. This is essential for start-ups with limited operating histories and
high upfront costs.
Repayment of venture capital investors isn't necessarily an obligation like it would be for
a bank loan. Rather, investors are shouldering the investment risk because they believe in
the company's future success.
Venture capitalists provide valuable expertise, advice and industry connections. A
stipulation of many VC deals includes appointing a venture capitalist as a member of the
company's board. This way, the VC firm has intimate involvement in the direction of the
company.
Disadvantages of venture capital

Securing a VC deal can be a difficult process due to accounting and legal costs a firm
must shoulder. The start-up company must also give up some ownership stake to the VC
Company investing in it. These results in a partial loss of autonomy that finds venture
capitalists involved in decision-making processes.
VC deals also come with stipulations and restrictions in composition of the start-up's
management team, employee salary and other factors

VC firm literally invested in the company's success, all business operations will be under
constant scrutiny. The loss of control varies depending on the terms of the VC deal.

3: leasing financing
A lease is a contractual agreement whereby one party i.e the owner of an asset grants the other
party the right to use the assets in return for a periodic payment. The lease pays a fixed periodic
amount to the leasor.
This method of financing is often used on equipment the business does not often use and it
makes money out of it. Once the contract ends, the assets is returned to the owner, the lease is
renewed or the assets is purchased.
Advantages of leasing finance

Balanced Cash Outflow: cash outflow or payments related to leasing are spread out over
several years, hence saving the burden of one-time significant cash payment. This helps a

business to maintain steady cash-flow profile.

Quality Assets: While leasing an asset, the ownership of the asset still lies with the lessor
whereas the lessee just pays rental expense. Given this agreement, it becomes plausible
for a business to invest in good quality assets which might look unaffordable or

expensive otherwise.
Better Usage of Capital: Given that a company chooses leasing over investing in an asset
by purchasing, it releases capital for the business to fund its other capital needs or to save

money for better capital investment decision.

Low Capital Expenditure: Leasing is an ideal option for a newly set-up business given
that it means lower initial cost and lower capex requirements.
.

Disadvantages of leasing finance

Reduced Return for Equity Holders: Given that lease expenses reduce the net income
without any appreciation in value, it means limited returns or reduced returns for an
equity shareholder. In such case, the objective of wealth maximization for

shareholders is not achieved.

Processing and Documentation: Overall, to enter into a lease agreement is a complex
process and requires thorough documentation and proper examination of asset being

leased.
In case the lessee makes a default in rental payment, the lessor is entitled to take over

the asset and the lessee has no right to prevent him from doing so.
Reduced Return for Equity Holders: Given that lease expenses reduce the net income
without any appreciation in value, it means limited returns or reduced returns for an
equity shareholder. In such case, the objective of wealth maximization for
shareholders is not achieved.

4: Issue of shares
The capital obtained by issue of shares is known as share capital. Shares are divided into two:
a) Equity share these are shares used to raise long term capital of the company.
b) Preference shares these are shares whose holders receive fixed rate of dividend out of
the net profit of the business.

Advantages of shares

Equity capital serves as a permanent capital as it is to be repaid only at the time of

liquidation of the company

Funds can be raised through equity issued without creating any charge on the assets of the
company. The assets of the company are therefore free from mortgaged for purpose of

borrowings,
They offer democratic control over management of the company due to voting rights of
equity shareholders thus the business is properly managed.

Disadvantages of shares

More formalities and procedural delays are involved while raising funds through issues of

equity shares
The dividend paid is not deducted from the profits as expenses thus there is no tax
savings as in the case of interest on loans.

References:
Rena Dietrich State university freelance writer
By Ed McLaughlin and Wyn Lydecker- Entrepreneur Magazines Martin Zwilling.
Startup Funding: The 7-Steps Angel Funding Process