Financing for Small Business

Finance is the life blood of every organization. It lubricates every organ and every functional area of the organization of maintains the health of an organization. At the moment the blood circulation in a human body stops, the human being collapses. Similarly the business organization also comes to a standstill, the moment the finances exhaust in it. It ultimately leads to the collapse of an organizational. Thus, we can easily understand the importance of finance in an organization.

Though a few of the critics observed that it is the money and finance which are instrumental for value erosion, in the society it is impossible in the modern business world, to carryout any business activity without finance. Finance is the root cause for the development of trade and industry. It is the money which gives practical shape to ones ideas. Right from the inception of a business organization to procure fixed assets, current assets, its sustenance expansion and growth, at every stage, finance is required. It deals with the meaning of business finance, types, ownership capital, types, characteristic merits and demerits, while the succeeding lesson deals with the borrowed capital.

Types of business finance:

On the basis of purpose for which the finance is put to use, the business finance can be broadly classified into two types:

1. Fixed capital and

2. Working capital

The capital raised by a company through issue of equity shares, preference shares, debentures and long term loans to meet its long term capital requirements is called capitalization.

1. Fixed capital The capital which is used to acquire fixed assets such as land and buildings, plant and machinery etc. is called the fixed capital. This type of capital is for setting up of a business organization without which it can neither carryout its activities not sustain. In other words, capital uses by business organization to meet the long term requirements is called fixed capital. The quantum of fixed capital is influenced by the nature of the business, the volume of business operation, production policy etc. For example, in manufacturing industries like iron and steel etc., the quantity of fixed capital is large while in a trading industry like garment shop etc., the size of fixed capital is minimum. Similarly the quantity of capital would be larger in large scale industries while it would be smaller in small scale industries.

2. Working capital The capital required by a business organization to run its day to day operations such as purchase of raw materials payment of wages, salaries, electricity charges etc, is called working capital. In other words the capital used in current assets is called working capital. Current assets are those which can be converted into cash within a period of one year. Therefore, it is also called as circulating capital or revolving capital.

Though the fixed capital is used for long term purposes and working capital for short term purposes, in practice it is very difficult to strictly adhere to this. For example, a part of the working capital which is called as permanent working capital should be financed from long term sources. Again long term or short term capital depends upon the nature of industry involved.

The level or size of working capital in business organization is not only market conditions, operating cycle, operating efficiency etc. For example, got trading concerns, the quantity of working capital will be more than the fixed capital.

Sources of finance:

Depending upon the purpose of use and the nature of the organization, business organization will choose different sources. A company chooses shares and debentures to meet its fixed capital requirements, while public deposits, bank loans etc. to meet medium and short term or current asset requirements. However sole proprietary concerns and partnership firms cannot make use of all the resources. The various sources through which companies generally, mobilize their capital requirements are exhibited as follows:

Capital requirements - It is clear that the methods of raising long term and medium term finances for a company are almost same with some exceptions. How much capital should be raised from which source depends on the necessity and time period. On the basis of time period the sources of finance can be broadly classified into three types:

1. Long term finance : The capital raised for a period ranging between seven years and 20 years is called long term capital. This type of capital is used to acquire fixed assets such as land and buildings, plant and machinery expansion and growth of the business etc.

2. Medium term finance : The capital raised for period ranging between one year and 7 years is called medium term finance. This type of capital is used to protect the assets of the company heavy replacements, advertisements, etc.

3. Short term finance : Capital raised for a period not exceeding one year is called short term finance. This type of capital is used to meet the day to day operating expenses of the business such as purchase of raw material, payment of wages, salaries etc.

Depending upon the capital requirements, the company has to choose different sources of finance. For efficient and effective use of finances, there should be a perfect match between the time period and the source of finance. Simply putting it, it is always better to use long term sources of finance for meeting long term capital requirements and short term sources for short term requirements. If this principle amount back or keeping the funds idle.

Now an attempt is made to discuss different types of sources of capital their characteristics, merits and demerits. For this purpose the sources of capital as already mentioned, are grouped broadly into two types:

1. Ownership capital : The capital raised by the company through the issue of equity shares, preference shares and retained earnings is called ownership capital.

2. borrowed or debt capital : Capital raised by the company through the issue of debentures and acceptance of public deposits, long term loans from the financial institutions is called borrowed or debt capital.

Among the different sources of capital used by the companies, equity shares are most common and popular. This provides base or cushion for raising capital through other sources. Since they enjoy voting power, they are called owners of the company. Equity shareholders are the last claimants with regard to dividend and also the assets in the event of liquidation.

Chasracteristic features:

Preference share capital is a hybrid form of financing. It possesses some of the features of ownership capital and some of debt capital. The preference shareholders enjoy preferential treatment with regard to payment of dividends and principal amount over the equity shareholders. On the basis of characteristic features possessed the preference shares can be classified into different types. They are:

a. cumulative and non-cumulative

b. convertible and non-convertible

c. redeemable and irredeemable

d. participating and non-participating preference shares

Retained earnings are an important source of internal finance. This is the best and most reliable source of finance provided companies have adequate amount of retained earnings. Every source of capital has got its own merits and limitations.

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