SOURCES OF FUNDS

Presented by
Yogeesh L N
Lecturer in Commerce and Management
Bangalore
 CONTENTS
This topic will introduce the major sources of funds for
businesses, including internal and external sources, as well as
the key factors affecting the choice of funds.
1. Explain the importance for a business to raise funds
2. Internal sources of funds for a business
3. External sources of funds for a business
4. Difference between ordinary shares, preference and
deferred shares
5. Factors affecting the choice of funds
 The need for funds:
No business can live without funds. Throughout the life
of a business, money is needed continuously. Firms raise
money mainly to meet the following three types of need:
1. To start a business as initial expenditure
2. To fund continuous business activities and money
flowing
3. To expand the business.
 Sources of funds
In general, a business may have two major
sources of funds which are needed for its
business operations. They are internal sources of
funds and external sources of funds.
Sources of Funds

Internal Sources External Sources

Short term:
Long-term:
Overdraft
Profit Depreciation Sales of assets Share Capital
Leasing
Loan Capital
Credit card
 Sources of Funds

Internal Sources External Sources

Short term:
Long-term:
Overdraft
Profit Depreciation Sales of assets Share Capital
Leasing
Loan Capital
Credit card
Internal Sources of Funds
The after tax profit earned and retained by a business is
an important and inexpensive source of finance, for
example, the retained earnings of the business. A large
part of finance is funded from profit.
Depreciation - The financial provision for the
replacement of worn-out machinery and equipment.
Nearly all businesses use depreciation as a source of
funds.
Sales of Assets- The activity that a business sells off
assets to raise funds for the business.
External Long-term Sources of Funds
Share capital:
The most important source of funds for a limited company.
It is often considered as permanent capital as it is not repaid
by the business, but the shareholder can have a share in the
profit, called dividend.
Three types of shares are:
1. Ordinary shares: The most common types of shares, and the
most riskiest shares since no guaranteed dividend. Dividend
depends on how much profit is made by the firm. But all
ordinary shareholders have voting rights.
2. Preference shares: The share owners receive a fixed rate of
return. They carry less risk because shareholders are
entitled to the dividend before the ordinary shares. But they
are not strictly owners of the company.
3.Deferred shares: These shares are often held by the founders
of the company. Deferred shareholders only receive the
dividend after the ordinary shareholders have been paid.
 Borrowed Funds
Loan capital
Definition:
Any money which is borrowed for a long period of time by a
business is called loan capital.
Types:
There are four major types of loan capital: Debentures,
Mortgage, Loan specialists funds, Government
assistance.
 Types of loan capital
1.Debentures: The holder of a debenture is a creditor of the
company, not an owner. Holders are paid with an agreed
fixed rate of return, but having no voting rights. The
amount of money borrowed must be repaid by the expiry
date.
2.Mortgage: These are long-term bank loans (usually over
one year period) from banks or other financial institutions.
The borrowers land or property must be used as a security
on such as a loan.
3.Loan specialists funds: These are venture capitalists or
specialists who provide funds for small businesses,
especially for high tech investment projects in their start-
up stage. There are also individuals who invest in such
businesses, which are often called business angels.
4. Government assistance: To encourage small businesses
and high employment, governments may be involved in
providing finance for businesses. In the USA, there is an
organization which is called the Small Business
Administration (SBA).
External Short-term Sources of Funds
Definition:
Short term sources of funds are usually the funds which are less
than one year for maturity. They are less stable sources of funds for
businesses.
Types:
The main types of external short term sources of funds include:
1. Bank overdraft
2. Bank loan
3. Leasing
4. Credit card
5. Trade credit
ETERNAL SHORT-TERM SOURCES OF LOANS

Major types Main characteristics

Bank This is a short term financing from banks.
overdraft The amount to be overdrawn depends on the needs of the business at
the time and its credit standing.
Interest is calculated from the time the account is overdrawn..
Bank loan This is a loan which requires a rigid agreement between the borrower
and the bank. The amount borrowed must be repaid over a certain
period or in regular installments.
Sometimes, banks change persistent overdrafts into loans, so
borrowers must repay at regular intervals.
Leasing Leasing allows businesses to buy plant, machinery or equipment
without paying large sums of money immediately.
The leasing company or bank hires or buys the equipment and for the
use of the hire company for a certain period of time. If the user can
never owns the equipment, it is an operating lease, while if it is given the
choice to own the equipment at the expiry time, it is a finance lease.
Lease payments are made by the hire company yearly or monthly, etc.
EXTERNAL SHORT-TERM SOURCES OF LOANS (CONT..)

Major types Main characteristics

Credit card Credit cards can be used to pay for hotel bills,
meals,
shopping and materials, etc. They are convenient,
and secure because it can avoid the use of cash and
the payment of interests within credit periods.
Cards may not be suitable for certain purchases,
especially a large sum of order because they have a
credit limit.

Trade credit It is a common method for businesses to buy

materials and to pay for them at a later date, usually
between 30 and 90 days. Such trade credit given by
the seller is usually an interest free way of short
term financing.
 Sources of Funds
Debt capitalfunds obtained through borrowing.
Equity capitalfunds provided by the firms owners
when they reinvest earnings, make additional
contributions, or issue stock to investors.
IPO- Initial public offer
FPO
American depository share(ADS)-US Dollar denominated
form of equity ownership in non US company.
ADR-( American depository receipts)-Evidence for ADS
Thank You!!