14 Sources of Finance for a Startup or Small Business Unit

Types of Sources of Finance for a Startup or Small Unit:

Sources of Finance or Sources of Funds are classified as Short-term sources of finance & Long-term sources of finance. The Sources of Business Finance help the company in expanding their business.

Finance is the lifeblood of any business organization. In the absence of sufficient finance in the business, it is difficult to manage most of the business transactions.

A business also needs to have some money or finance in hand to run day-to-day transactions in the business, this type of capital is known as Working Capital. So, to run a business very smoothly, one must have sufficient money or finance.



Generally, Startups or Small Business units look for acquisition of funds or money from various sources. By acquiring finance from different sources, these units invest in their business.

In a Startup, founder or owner of the business doesn't have the ability to acquire the money from self. There the founder looks for finance sources and chooses the best source with least interest/cost/charges.

Sources of Finance are classified into three:

• On the basis of Time Period
• On the basis of Ownership and Control
• On the basis of Source of Generation

Here in this article, we will discuss sources of funds on the basis of Source of generation for the Small business unit or Startup.

Internal Sources of Finance:

The finance or funds acquired inside of the company is known as Internal Sources of Finance. Below mentioned are some sources of funds acquired within the organization:

• Owner's Fund:

          Owner's Capital or money is that fund which is contributed by the business owner to make an investment and grow the business. Owner's fund is the internal source of finance unlike other sources such as the loan from the creditor, bank or from any institute.

• Sale of Stock:

           Stock means goods or merchandise available in the company or its warehouse and is ready for the sale or distribution. Regular sale of a certain proportion of the goods or stocks is very important in finance management.

           When a company makes the sale to its customers, the money comes in the company's hand. Sale of the stock is an internal source of financing in which, the business organization gets finance by selling their stocks.

• Retained Earnings:

         Retained Earnings are those earnings which are retained by the company every year for the intention to invest or fulfill business requirements in the future.

          Retained Earnings is also known as Ploughing back of Profit. Retained Earnings or Ploughing back of Profit simply means to retain a certain proportion of profit from the business unit to meet the business necessities in the business.

         Plowing back of Profit is one of the great sources of finance and that retained profit can be very useful when the market is suffering from recessions. 

         There is only one loophole in Retained Earnings is that there is no rule book for dividend and retained earnings ratio. This decision is in hands of the company that, what proportion to distribute as dividend and what proportion to retain.

• Collection of Debt:

            Collection of Debts from the Debtors is also one of the great internal sources of finance. Collection of debts means the recovery of money from the customers who have purchased the goods in debt.



       Collection of money from the debtors is used in various activities of business like purchasing of new stock, payment to employees, transportation cost and can be used as other working capital needs.

• Sale of Fixed Assets:

            A company may have another source of money by selling it's fixed assets. Fixed assets are those assets which are purchased after considering long-term use of that asset.

     The company purchases fixed asset after taking into consideration various factors because Fixed assets are costly in nature and after making a purchase these assets are not likely to be converted quickly in cash.

             So, the business organization could sell its fixed assets after proper usage or due to damage to that asset. Fixed assets include Land, Building, Plant, Machinery, Equipment etc.

• Depreciation Provisions:

              Depreciation is the expense for a company so, the amount of depreciation is not credited to the asset account and this amount is transferred to the depreciation provision account.

        The amount of depreciation of various fixed assets is calculated and transferred to the provision for depreciation account. Depreciation provision is one of the major sources of the funds which are generated internally.

External Sources of Finance:

The finance or money which is acquired externally i.e. sources outside of the company is known as External Sources of Funds. If the company faces scarcity of funds with its internal acquisition of finance, it may acquire funds outside from the company i.e. the general public.

So, here are some external sources of funds elaborated as below:

• Equity Shares:

               Equity Shareholders are the real owner of the company. Equity shareholders have equal right in the management of a company. They have a voting right and can interfere in the management of the company.

              The Issue of Equity Shares is one of the major sources of external financing in the company. Equity shares are for risk taker investors.



                For a new startup, issuing equity shares instead of taking a loan or acquiring money through debt is desirable because, in the case of equity shares, investors get their dividend only when the company makes the profit.

There are many advantages of issuing equity shares below mentioned are some advantages for both, the company & the investor:

• Limited liability
• Bonus Shares
• Dividend to the investors
• Capital Gain
• Shareholder's Control over management
• Liquidity

Just like benefits, there are various disadvantages of equity shares too for both i.e. the company and the investor:

• High risk for the investors
• The dividend is not fixed
• Limited control (on the company's side)
• Market Price Fluctuations

• Preference Shares:

              Preference Shareholders have preferential rights in the company. As the name suggests, preference shares are given more preference i.e. dividend is first paid to the preference shareholders and then to equity shareholders.

              Preference shares are for those investors who want to avoid risk factor in the investment of their funds i.e. risk-averse investors. As compared to equity shares, preference shares do not have any voting rights or participation in the management of a company.



                If the company faces bankruptcy, preference shareholders are entitled to be paid first from the company's assets. There are various benefits of preference share capital:

• The Company guarantees fixed dividend annually.

• Preferential rights in the company.

• Preference shareholders are entitled to be paid before ordinary or equity shareholders.

• No interference in the management of a company.

Preference shares do have some drawbacks for the company and for investors as well:

• Preference shares are rigid in the payment of dividend. There is a fixed amount of dividend to be paid every year to the preference shareholder.

• Preference shares have limited appeal. This kind of shares is for risk-averse investors not for risk taker investors.

• Preference shareholders do not carry any voting rights and can't interfere in the management of the company.

• As compared to equity shares, preference shares have low returns. The amount of dividend is fixed and shareholders are not entitled to be the part of excessive profits.

• Venture Capital:

               The company in its initial stage, need some huge amount of finance for the investment and growth of the business. Venture Capitalists like to invest in those startups which have a potential for the growth.

           Ventures involve high risk and having an uncertain outcome. Venture Capitalists invest in any startup or business by considering potential growth of that business on a long-term basis. Venture capital is of three types:

• Early Stage Financing
• Expansion Financing
• Buyout or Acquisition Financing

• The Issue of Debentures:

                Issuing Debentures is another important source of finance for the companies which are profit making. Because in the case of debentures, the company is liable to pay the amount of an investor (with interest) Debentures are for those investors who are risk-averse.



               Debentures are debt for a company and debt is considered as a less costly mode of financing for profit-making companies as compared with equity shares. Another reason why some companies prefer to issue debentures is that investors do not have any interference in the management of the company. (comparing with equity share capital)

               Various advantages of issuing debentures are mentioned below:

• No interference in the management of a company

• Cheap source of acquiring finance as compared to equity share capital.

• Preferable for risk-averse investors.

There are various disadvantages of issuing debentures are as below:

• A permanent burden on the earnings of the company.

• Return on investment is very low as compared to investing through share capital.

• Term Loan:

              The nature of Term Loan very common to debentures but it does not include the cost of issuing because the fund is given by the bank or a financial institution. In the case of debentures, the general public has involvement in the process.

            In Term Loan, the general public does not have involvement in the process because the loan is given by any institute or bank. The Term Loan is generally secured by some fixed assets of the company. Here are some advantages of Term loans:

• In term loans, there will be no interference in management or voting rights of the company by the lenders.

• Interest on the term loan is tax-deductible.

• An issue cost of the term loan is less expensive as compared to the issue of shares.

• Comparing it with equity shares, lenders are not entitled to the profits of a firm. They are only paid the principal amount with interest.

Here are some disadvantages of term loans:

• Term loans raise the financial leverage of the company, which raises the cost of equity to the firm.

• Legally, the firm is obliged to pay the principal amount with fixed interest whether the firm is suffering from loss or earning the profit.

• Leasing and Hire Purchase:

            Leasing and Hire Purchase is another great source of money for the company. There is a huge difference between leasing and hire purchase. In leasing the property or any machinery, the ownership lies with the lessor.

          While in hire purchase, the hirer becomes the owner of that property/machinery immediately after payment of the last installment.

• Bank Overdraft:

            Bank Overdraft (BOD) is one of the great short-term sources of finance. An Overdraft occurs when money is withdrawn from the bank and available balance becomes less than zero.

                  The money withdrawn through overdraft can be used for day-to-day expenses or payments in the company i.e. working capital. Payments like payment to employees, electricity bill payment, payment to suppliers etc.

• Trade Credit:

     Trade credit simply means the credit given by the creditors/suppliers to a business firm. Trade credit allows the business unit to delay the payment up to the period of trade credit given.

              Trade credit period depends upon the credit terms decided by a business firm and the supplier/creditor.


Conclusion:

            Sources of Finance play a very crucial role in the expansion and the growth of any company. If the Sources of Funds from which business is acquiring finance are high, the company has an opportunity to develop and expand the business.

There are numbers of other Short-Term Sources of Finance & Long-Term Sources of Finance. It is very important for the business to acquire from those sources which cost very low to the firm.


Suggested Articles:


The Scope of Finance Management

Ideal Management Styles for Business Excellence

Note on Finance Management

Enter your email address: