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
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
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
Sources of Funds
Sales of assets
Internal Sources of Funds
The after-tax profit earned and retained by a
business which 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
Sales of Assets- The activity that a business sells off
assets to raise funds for the business.
External Long-term Sources of
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
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
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.
Any money which is borrowed for a long period of
time by a business is called loan capital.
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 borrower’s 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
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
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.
The main types of external short term sources of funds
Eternal short-term sources of loans
This is a short term financing from banks.
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..
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 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 (continued)
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
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
Sources of Funds
Debt capital—funds obtained through borrowing.
Equity capital—funds provided by the firm’s owners when
they reinvest earnings, make additional contributions, or
issue stock to investors.
IPO- Initial public offer
American depository share(ADS)-US Dollar denominated
form of equity ownership in non US company.
ADR-( American depository receipts)-Evidence for ADS