Before starting a new business it is required of you to know the type of finance you will need to run the business if you really want to survive in that business.
This article is not just for startup businesses it is also for every entrepreneur who want to define their business financing sources and want to increase their business productivity.
Presently entrepreneur, startups, businesses must be aware of all types of finance available in the market. Also it’s their primary due to do research on; which type of financing technique is better to another, and where required funding can be found.
Before i talk about the types of financing i would like to explain what financing is all about.
So, What is financing?
Financing is the process of providing funds for business activities , making purchases or investing. Financial institutions such as banks are in the business of providing capital to businesses, consumers, and investors to help them achieve their goals. The use of financing is vital in any economic system, as it allows companies to purchase products out of their immediate reach.
In addition,financing is a way to leverage the time value of money (TVM) to put future expected money flows to use for projects started today. Financing also takes advantage of the fact on, at some will have a surplus of money that they wish to put to work to generate returns, while others demand money to undertake investment (also with the hope of generating returns), creating a market for money.
Now look at the main type of financing:
There are mainly two types of financing. They are broadly divided as debt finance and equity finance. which are further divided into various types like: short-term, medium- term and long-term. There are various options available for financing based on type of finance you required.
Detail Explanation On Type Of Financing:
Debt financing is essentially cash that you obtain to run or maintain your business. Debt financing does not give the moneylender ownership control, but rather the principal amount must be repaid along with the interest percentage agreed upon. Interest percentage is mostly determined based on duration, inflation rate, amount of loan and the purpose for which specified type of finance is been used. You can consider debt financing as being divided into three types of finance they are: short-term finance, medium-term finance and long-term finance.
A . Short – Term Types of Finance :
Loans usually for more than 1 to 180 days of period is known as short-term types of finance. This are made to cover occasional or temporary requirements and shortage of funds. Short-term financing most commonly applies to cash required for the everyday activities of the business, for example, obtaining raw materials or paying wages to their staff members. The amount to get a short-term credit is mostly dependably on the other source of income for repayment. Most common type of short-term finance is line of credit from their suppliers. Following are some of the types of short-term finance:
- Credit Cards .
- Trade Credit.
- Bank Overdraft.
- Bill Discounting.
- Small Business Loans.
- Working Capital Loans.
- Advances from customers.
- Short-term loans from Retail Banks.
B . Medium -Term Types of Finance :
Loans usually required for more than 180 to 365 days of period is known as medium-term types of finance. It mostly depends on business how the funds are utilized. The business will mostly repay from the cash-flow source of the business. Mostly such type of finance are chosen by business to buy fixed assets , equipment’s and so forth. Many times it is been observed that such types of financing are frequently used by startups or small business owners to fulfill the rotation of funds. As new businesses have to pay upfront to suppliers for all the required goods. For example: buying machinery, equipment, inventories etc. Following are some of the types of medium-term finance:
- Lease Finance.
- Hire Purchase Finance.
- Issue of Debenture / Bonds .
- Medium-term loans from Commercial Banks.
C . Long -Term Types of Finance :
Loans usually required for more than 365 days of period is known as long-term type of finance. Such financing for the most part is required for buying land, plant, restructuring buildings or offices, etc. for your business. Normally long-term types of financing options have better rate of interest when compare to short-term financing. Such type of finance are usually having repayment duration of 5, 10 or 20 years of period. For example: Home loans or Car loans are categories as types long-term of finance. Following are some of the types of long-term finance:
- Issue of Equity Shares.
- Issue of Preference Shares.
- Issue of Debenture / Bonds.
- Venture Funding or Finance from Investors.
- Long-Term Loans from Government,
- Investment Banks or Financial Services Institutions.
2. Equity financing
Equity financing is a typical route for businesses to raise capital by offering or issues shares of their company. This is a major difference of equity financing from debt financing. Equity financing option is ordinarily used for seed funding for new business and start-ups. Whereas raising additional capital for a business to expand for well-known companies. Equity financing is commonly raised by offering equity stocks of the business. Typically each stock is a unit of ownership for that particular organization.
“Equity” is another word for ownership in a company. For example, the owner of a grocery store chain needs to grow operations. Instead of debt, the owner would like to sell a 10% stake in the company for $100,000, valuing the firm at $1 million. Companies like to sell equity because the investor bears all the risk; if the business fails, the investor gets nothing.
At the same time, giving up equity is giving up some control. Equity investors want to have a say in how the company is operated, especially in difficult times, and are often entitled to votes based on the number of shares held. So, in exchange for ownership, an investor gives his money to a company and receives some claim on future earnings.
Honestly, If you are an owner of a company or you are managing organization finance then it became your primary goal to take knowledge on types of finance. Without finance a company cannot run its business operations. Also there will be lot of times where you will require funds for your organizational activities. It would then be easy for you to select a right types of financing option which will best suit your situation.
Borrowing money that is to be repaid over a period of time, usually with interest. Debt financing can be either short-term (full repayment due in less than one year) or long-term (repayment due over more than one year).
An exchange of money for a share of business ownership.
The lender does not gain an ownership interest in your business and your obligations are limited to repaying the loan
This form of financing allows you to obtain funds without taking on debt; in other words, without having to repay a specific amount of money at any particular time.
In smaller businesses, personal guarantees are likely to be required on most loans. If you have too much debt, lenders may consider your business to be overextended and risky for further investment. In addition, you may be unable to weather unanticipated business downturns, credit shortages, or an interest rate increase if you have an adjustable-rate loan.
The major disadvantage to equity financing is that you no longer have 100% ownership of your business, and must therefore share some degree of control of the business with additional investors.
In conclusion, there are other way to finance a business beyond Debt and Equity financing, you can also source for finance from friends and families.