UNIT III
CHOICE OF BUSINESS ORGANISATION
Which one among the different forms of business organizations an entrepreneur should go for, depends on a number of factors. The decision should be taken after taking into consideration the following factors:
I. Nature of Business: If the intent is to run a small venture and remain happy with the size of profits and quantum of business, proprietary concern is the best choice. Grocery shops, pharmacists, small garment shops, beauty clinics, tailoring units, restaurants usually go this way. The owners know the area. They are close to customers. They watch the trends. They know the gaps and try to bridge them.
If the objective is to pool resources and talent and establish a business in a promising line, partnership form is opted. Where the entrepreneur wants to set up a business with great potential and wants to do it in a big way, the corporation is a suitable option.
II. Scale of Operations: Big manufacturing units pick up the corporate form of business. They want to serve local, regional, national as well as international markets. The chosen field has lot of promise and potential (like cement, steel, sugar, aluminum, copper, construction, real estate development etc.). Partnership ventures have a limited audience and serve local markets well. Here the opportunity is lucrative but the partners do not have the strength to go beyond a point. So they try to limit their scale of operations to areas where they have strength. In a small proprietary concern, the capacity to bring in seed capital, get manpower, and reach out to customers in always limited to the capabilities of the owner. If the owner is dynamic, he can turn it into a successful venture, capable of growing into a big business.
III. Capital Requirements: If the venture requires heavy investments in the form of machines, equipment, a large factory supported by fairly number of skilled and unskilled hands, raw materials from different locations, and the company form of ownership is to be preferred. In a partnership firm, capital needs are relatively small. Whatever money and effort is needed to support the venture, the partners can bring in through their contacts. Proprietary concerns do not consume monetary resources in a big way. Where the need for funds is limited and the owners do not intend to grow big in the near future, sole proprietorship or partnership forms are preferred routes.
IV. Degree of Control: If owners want to oversee everything from close quarters, sole proprietary concerns or partnership firms need to be chosen.
V. Risk Taking Ability: If the intent is to diffuse risk, the company form of business is to be preferred. Risk is spread over a large number of shareholders. In case of proprietary concerns, risk is disproportionately high. The owner may get crushed by unexpected turn of events. Partners can deal with such negatives to a large extent.
VI. Division of Profit: If the owner wants to have everything for himself, then proprietary concern is the best option. If the intent to jointly share the gains arising out of joint contributions in the form of resources and effort, partnership venture is to be picked up. In a company form of business, the intent is to grow business, exploit the markets globally, make profits and share wealth with a large number of stakeholders.
VII. Stability of Business: The company form of business ensures stability, continuity and durability. Businesses in this format grow big, achieve economies of scale, venture into new fields and areas, and reach out to national as well as global audience through continuous improvements and innovations. To ensure survival and growth, every entity, even though they might be small when they started off, would always be interested in expanding and growing continually.
VIII. Talent Needs: Small firms do not depend on talent from outside. The owner has this in abundance. If the owner is dynamic and is able to understand the market well, he does not have to look back. Same is the case with partners. If they combine their skills well, the firm can survive, grow and flourish. So, where the intent is to hand over reins to professionals, the obvious choice falls on the company form of organization.
IX. Government Control: If the owners want to avoid interference and control from government, proprietary concern or a partnership venture is the option.
Key Takeaways
- Which one among the different forms of business organizations an entrepreneur should go for, depends on a number of factors such as the nature of operations, scale of operations, capital requirements, degree of control, stability of business etc.
Production planning and control is an important task of the Production Manager. Production process should be planned in advance and implemented efficiently. Production involves conversion of raw materials into finished goods. This process of conversion involves a number of steps. These decisions are part of production planning and control. An efficient system of production planning and control helps in providing better and more economic goods to customers at a lower investment. Both planning and control of production are necessary to produce better quality goods at reasonable prices and in the most systematic manner.
Key Takeaway
- Both planning and control of production are necessary to produce better quality goods at reasonable prices and in the most systematic manner.
The main objective of production planning and control is to ensure the co-ordinated flow of work so that the required number of products is manufactured in the required quantity and of the required quality at the required time at optimum efficiency. In other words, production planning and control aims at the following purposes:
i. Continuous Flow of Production: It tries to achieve a smooth and continuous production by eliminating successfully all sorts of bottlenecks in the process of production through well-planned routing and scheduling requirements relating to production work.
ii. Planned Requirements of Resources: It seeks to ensure the availability of all the inputs i.e. materials, machines, tools, equipment and manpower in the required quantity, of the required quality and at the required time so that desired targets of production may be achieved.
iii. Coordinated work Schedules: The production activities are planned and carried out in a manufacturing organization as per the master schedule. The production planning and control tries to ensure that the schedules to be issued to the various departments/ units/supervisors are in coordination with the master schedule.
iv. Optimum Inventory: It aims at minimum investment in inventories consistent with the continuous flow of production.
v. Increased Productivity: It aims at increased productivity by increasing efficiency and being economical. This is achieved by optimizing the use of productive resources and eliminating wastage and spoilage.
vi. Customer Satisfaction: It also aims at satisfying customers requirements by producing the items as per the specifications or desires of the customers. It seeks to ensure the delivery of products on time by coordinating the production operations with customers’ orders.
vii. Production and Employment Stabilization: Production planning and control aim at ensuring production and employment levels that are relatively stable and consistent with the number of sales.
viii. Evaluation of Performance: The process of production planning and control is expected to keep a constant check on operations by judging the performance of various individuals and workshops and taking suitable corrective measures if there is any deviation between planned and actual operations.
Key Takeaways
- The main objective of production planning and control is to ensure the co-ordinated flow of work so that the required number of products is manufactured in the required quantity and of the required quality at the required time at optimum efficiency.
The system of production planning and control serves as the nervous system of a plant. It is a coordinating agency to coordinate the activities of engineering, purchasing, production, selling and stock control departments. It is essential in all plants irrespective of their nature and size.
The principal advantages or importance of production planning and control are summarized below:
1. Better Service to Customers: Production planning and control, through proper scheduling and expediting of work, help in providing better services to customers in terms of a better quality of goods at reasonable prices as per promised delivery dates. Delivery in time and proper quality, both help in winning the confidence of customers, improving relations with customers and promoting profitable repeat orders.
2. Fewer Rush Orders: In an organization, where there is an effective system of production planning and control, production operations move smoothly as per original planning and matching with the promised delivery dates. Consequently, there will be fewer rush orders in the plant and less overtime than, in the same industry, without adequate production planning and control.
3. Better Control of Inventory: A sound system of production planning and control helps in maintaining inventory at proper levels and, thereby, minimizing investment in inventory. It requires a lower inventory of work-in-progress and less finished stock to give efficient service to customers. It also helps in exercising better control over raw-material inventory, which contributes to more effective purchasing.
4. More Effective Use of Equipment: An efficient system of production planning and control makes for the most effective use of equipment. It provides information to the management regularly about the present position of all orders in process, equipment and personnel requirements for the next few weeks. The workers can be communicated well in advance if any retrenchment, lay-offs, transfer, etc. are likely to come about. Also, unnecessary purchases of equipment and materials can be avoided. Thus, it is possible to ensure proper utilization of equipment and other resources.
5. Reduced Idle Time: Production planning and control help in reducing idle time i.e. loss of time by workers waiting for materials and other facilities; because it ensures that materials and other facilities are available to the workers in time as per the production schedule. Consequently, fewer man-hours are lost, which has a positive impact on the cost of production.
6. Improved Plant Morale: An effective system of production planning and control co-ordinates the activities of all the departments involved in the production activity. It ensures even flow of work and avoids rush orders. It avoids “speeding up” of workers and maintains healthy working conditions in the plant. Thus, there is improved plant morale as a by-product.
7. Good Public Image: A proper system of production planning and control helps keep systematized operations in an organization. Such an organization is in a position to meet its orders in time to the satisfaction of its customers. Customer satisfaction leads to increased sales, increased profits, industrial harmony and, ultimately, the good public image of the enterprise.
8. Lower Capital Requirements: Under a sound system of production planning and control, everything relating to production is planned well in advance of operations. Where, when and what is required in the form of input is known before the actual production process starts. Inputs are made available as per schedule which ensures even flow of production without any bottlenecks. Facilities are used more effectively and inventory levels are kept as per schedule neither more nor less. Thus, production planning and control help, in minimizing capital investment in equipment and inventories.
Key Takeaways
- The system of production planning and control serves as the nervous system of a plant.
- It is a coordinating agency to coordinate the activities of engineering, purchasing, production, selling and stock control departments.
- It is essential in all plants irrespective of their nature and size.
The following are the techniques of production planning and control:
A. Planning
B. Routing
C. Scheduling
D. Despatching
E. Follow-up and Expediting
F. Inspection.
A. Planning
It is the first element of production planning and control. Planning is given an important role in every business. A separate department is set up for this work. Planning is deciding in advance what is to be done in future. Control devices are also decided in advance so that all activities are carried on properly. An organizational set up is created to prepare plans and policies. Various charts, manuals and production budgets are also prepared. If production planning is defective then control will also be defective. Planning provides a sound base for control.
B. Routing
It is determining the exact path or route which will be followed in production. The stages from which goods are to pass are decided after a proper thought. Routing may be compared to a train journey for reaching a particular place. The passenger will decide the route only after taking into consideration various factors affecting his journey. Similar is the case with production routing. It is the selection of the path from where each unit has to pass before reaching the final stage. The path must have the best and cheapest sequence of operations.
According to James L. Lundy, “Production routing involves the planning of the exact sequence of work stations to be used in processing a part of product. Once a layout has been established the routing of an item is the determination of the path that item should follow as it is manufactured.”
The following steps are taken for a routing procedure:
1. Deciding what Part to be made or Purchased:
The product is thoroughly analyzed to find out which parts are required for it. The second decision is taken regarding the production or purchase of various components. Some components may be manufactured by the firm and others may be procured from the market. During slack periods most of the components may be manufactured by the firm but when industrial activity is at its peak then supplies from outside may be contracted.
These decisions are taken after considering factors such as:
(a) The relative cost involved;
(b) Purchase policies of the firm;
(c) Technical considerations; and
(d) Availability of equipment and personnel.
2. Determining Materials Required:
The analysis of the product will enable us to know the type of materials required for producing various components. The right type of quality, quantity, and time when needed should also be decided in advance.
3. Determining Manufacturing Operations and Sequences:
The manufacturing operations and their sequences can be determined from technical experience and layout of machines. A sound and economical operation is selected for manufacturing various components.
4. Determining of Lot Size:
A decision has to be taken about the number of units to be produced in one lot. If production is carried on the basis of orders then size of the lot depends upon the quantity ordered plus some units for possible rejections during the process. When production is done for the stock then lot is decided by considering various economies which may accrue.
5. Determining of Scrap Factors:
There may be some scrap during the course of manufacture. The finished products are generally less than the units introduced at the beginning. The scrap during manufacturing should be anticipated so that routing is facilitated. If products pass through three processes and a normal scrap is 5% of input at every stage then it will be easy to anticipate the units entering various processes and arrange equipments and manpower.
6. Analysis of Cost of the Product:
The determination of cost of products may be the duty of cost department but still production department makes records of direct materials, labour, direct and indirect expenses. These estimates are greatly useful to costing department also.
7. Preparation of Production Control Forms:
The carrying out of routing will be facilitated if forms are prepared to collect information for control purpose. The requirements are: job cards, inspection cards, move tickets, labour cards, tool tickets, etc.
C. Scheduling
Scheduling is the determining of time and date when each operation is to be commenced and completed. It includes the scheduling of materials, machines and all other requisites of production. A number of components are required to manufacture a product. The time and date of manufacturing each component is fixed in such a way that assembling for final product is not delayed in any way.
Scheduling can be compared to a railway time table which informs a passenger about his journey schedule. This time table shows the time when the train will start from a particular place, the time of its arrival at different stations and the time when it will reach its destination. Scheduling also gives exact information about the time-table of manufacturing process at all the stages.
Types of Schedules:
Following are the three types of scheduling:
1. Master Scheduling
2. Manufacturing or Operation Scheduling
3. Retail Operation Scheduling.
1. Master Scheduling:
Scheduling starts with the master schedule. This schedule is prepared by keeping in view the order or likely sales order in near future. Master scheduling is the breakup of production requirements. This may be prepared for a week, a fortnight, a month etc. If only one product is manufactured then scheduling is easy but it becomes complex when more products are required to be produced.
Master schedule has to be adjusted as per the new order received. If plant capacity is available then new requirements may be adjusted in the same schedule. But in case new orders may not be adjustable at present capacity, then either the schedule may be re-drawn or new plant and equipment may be acquired. No definite pattern may be suggested for master schedules because these may differ from industry to industry or in the same industry.
2. Manufacturing or Operation Scheduling:
Manufacturing schedule is used where production process is continuous. When same product is produced repeatedly or comparatively small number of products are required then operation schedules are useful. The name and number of the product and the quantity to be produced in a given time are required to prepare a manufacturing schedule. If the product to be produced is in a variety of sizes, colours, weights, types etc. then these things should also be mentioned in the schedule. The order of preference for the manufacture is also mentioned in the schedule for a systematic production planning.
3. Detail Operation Scheduling:
It indicates the time required to perform each and every detailed operation of a given machine or process.
D. Dispatching
The term dispatching refers to the process of actually ordering the work to be done. It involves putting the plan into effect by issuing orders. It is concerned with starting the process and operation on the basis of route sheets and schedule charts. A practical shape is given to the production plan. For example, putting oneself into train when the route to be followed and the train to be boarded have been selected, is termed as dispatching.
In the words of James L. Lundy, “The despatching function involves the actual granting of permission to proceed according to plans already laid down. This is similar in case of the traveller to his employer finally approving his vacation leave.”
Steps Followed in Dispatching:
The following steps are involved in despatching function:
1. The issuing or moving of materials from stores to first production process or from process to process.
2. Assigning of work to machines or work centres.
3. The issuing of required tools and equipment to production departments.
4. Issuing of job orders, authorizing operations in accordance with dates and times as per route sheet and schedule charts.
5. Issuing of time tickets and instruction cards to the persons involved in the work.
6. Recording of time taken from starting to completion of each job and also the total production time.
7. After the completion of work it should be ensured that all drawings, plans and tools are returned to their correct location of issuing departments.
8. Ensuring necessary changes in scheduling, etc. if changed situations so demand.
9. Having proper liaison with routing and scheduling sections for effective performance.
E. Follow Up and Expediting
Follow-up and expediting is related to evaluation and appraisal of work performed. This is an important function of production control. If goods are to be produced as per the plans then a proper follow-up of work is essential to see whether production schedule is properly adhered to or not. In case there are any bottlenecks then these must be removed in time. In the words of Bether and his associates, “follow up or expediting is that branch of production control procedure which regulates the progress of materials and part through the production process.” Follow up procedure. Progress may be assessed with the help of routine reports or communication with operating departments.
The following procedure is used for expediting and checking the progress:
(i) The progress should be checked continuously.
(ii) In case there are deviations between planned and actual work then the causes for these differences should be ascertained.
(iii) Helping in removing the causes of deviations.
(iv) Having a report with departments supplying materials and equipment to production centres.
F. Inspection
Inspection is also an important function of control. The purpose of inspection is to see whether the products manufactured are of requisite quality or not. It is carried on at various levels of production process so that pre-determined standards of quality are achieved. In case the products are not of proper quality then immediate steps are taken to correct the things. If inspection is not regularly undertaken then there may be a possibility of more rejections. Inspection is undertaken both of products and inputs. On the one hand work-in-progress and finished products are inspected, on the other hand the quality of materials issued, equipment’s used and machines employed is also taken into account. The final product will certainly be influenced by the quality of various inputs used in production. So inspection ensures the maintenance of predetermined quality of products.
Key Takeaways
- The techniques of production planning and control are Planning, Routing, Scheduling, Despatching, Follow-up and Expediting and Inspection.
- Planning is deciding in advance what is to be done in future.
- It is determining the exact path or route which will be followed in production.
- Scheduling is the determining of time and date when each operation is to be commenced and completed.
- Dispatching is concerned with starting the process and operation on the basis of route sheets and schedule charts.
- In the words of Bether and his associates, “follow up or expediting is that branch of production control procedure which regulates the progress of materials and part through the production process.”
- The purpose of inspection is to see whether the products manufactured are of requisite quality or not.
Financial planning is the process of estimating future needs of a business or project in terms of required investment, resources for generating funds, and efficient administration of these funds. Financial planning is usually done for long term projects whose estimated life is 4-5 years or more.
Financial planning includes:
- Planning for the amount of capital or investment required for a business to carry out its operations in a smooth way.
- Determining and comparing sources of funds both internally and externally.
- Making of suitable rules and policies for administration and utilization of funds.
- Identify risks and issues with all the estimations.
Key Takeaways
- Financial planning is the process of estimating future needs of a business or project in terms of required investment, resources for generating funds, and efficient administration of these funds.
The most prominent five objectives of financial planning are the following:
- Estimating the total capital required: The first step in financial planning is to determine the actual investment or capital required. The capital requirement can be further divided into two categories, i.e. short term requirements and long term requirements. Capital required depends on a number of factors like the requirement of current and fixed assets advertisement and operation expenses.
- Determining the sources, availability, and timing of funds: Determining the sources and timing of funds is as tricky as anything else. The required amount of funds should be available at the right time according to business needs. Financial planning helping in determine the inexpensive source of funds and make sure that funds are available at the right time.
- Determining the business capital structure: The capital structure of a business is considered as the composition of total external or internal debt to the shareholder’s capital. Financial planning includes the decision on debt to equity ratio and kind of investment required both in the short term and long term which doesn’t affect the capital structure of the company.
- Avoid excess generation of funds: Unnecessary excess and shortage of funds are always an expensive deal for businesses. One of the most important objectives of financial planning is to prevent the business from rising of unnecessary funds. Excess funds are just an idle asset of a business that cannot generate any revenue for the business but have their own cost.
- Counter strategies for Risks: Financial planning identifies the risks and issues associated with the business plan. Once the issues are identified at the planning stage, the counter strategies are prepared to counter the identified issues. This ensures the smooth completion of the project and saves a lot of money and time.
Key Takeaways
- Financial planning is done with the object of estimating the total capital required, determining the sources of funds, availability and timing of funds, determining the business capital structure, avoid excess generation of funds, counter strategies for risks etc.
Financial planning helps businesses to prepare a balanced plan for their short term and long goals. The most common importance is as follows:
- Arrange funds according to the project need at the right time.
- Financial planning helps to plan and execute long term development which plays a vital role in the growth of the business.
- Financial planning helps to prepare for any shortcomings and risks. This raise the chances of success for the project.
- Proper financial planning gives a competitive edge by arranging sufficient funds for every stage of the project.
Key Takeaways
- Financial planning helps businesses to prepare a balanced plan for their short term and long goals.
The following steps are followed in financial planning:
Step 1: Determining the Current Financial Situation
In this first step of the financial planning process, the current financial situation of the concern will have to be determined, with regard to income, savings, living expenses, and debts. Preparing a list of current asset and debt balances and amounts spent for various items gives a foundation for financial planning activities.
Step 2: Developing Financial Goals
Financial values and goals should be periodically analyzed. The purpose of this analysis is to differentiate the needs from wants. Specific financial goals are vital to financial planning.
Step 3: Identifying Alternative Courses of Action
Developing alternatives is crucial for making good decisions. Although many factors will influence the available alternatives, possible courses of action usually fall into these categories:
- Continue the same course of action.
- Expand the current situation.
- Change the current situation.
- Take a new course of action.
Not all of these categories will apply to every decision situation; however, they do represent possible courses of action. Creativity in decision making is vital to effective choices. Considering all of the possible alternatives will help in making more effective and satisfying decisions.
Step 4: Evaluating Alternatives
Possible courses of action should be evaluated. Every decision closes off alternatives. Opportunity cost is what one gives up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in terms of money. One needs to consider the lost opportunities that will result from such decisions.
Step 5: Create and Implement a Financial Action Plan
In this step of the financial planning process, an action plan is prepared. This requires choosing ways to achieve the goals of the enterprise.
Step 6: Reevaluation and Revision of Plan
Financial planning is a dynamic process that does not end when particular action is taken. Regular assessment of financial decisions is a must. Changing personal, social, and economic factors may require more frequent assessments.
Key Takeaways
- The steps involved in financial planning are: Determining the Current Financial Situation, Developing Financial Goals, Identifying Alternative Courses of Action, Evaluating Alternatives, Creating and Implementing a Financial Action Plan and Reevaluation and Revision of Plan.
All business concerns need funds for its establishment, workings, growth and expansion and diversification etc. Finance is the life- blood of business. Finance is required in each and every step taken by the business concern. Financial requirements may be broadly classified into two types, namely Fixed Capital and Working Capital.
Fixed Capital
Fixed capital is the investment done by the business for accruing long- term benefits and serves the business for a long time. It is mandatorily necessary for an enterprise during its primary stage, i.e., to begin the business concern or to administer the existing trade. It is that portion of the entire fund, which is not utilized for manufacturing but kept in trade for more than one accounting period. Fixed capital is used to acquire non-current assets of the business. It is not a t all liquid and cannot be converted into cash or kind immediately.
Working Capital
Working capital is the daily requirement pumped into the business. It is needed for the day-to-day operation of business. It is used to acquire the current assets of the business. It is Liquid and can be immediately converted into cash or kind. It serves the business for a concise period.
The requirement of finance in a business enterprise varies according to the size of the enterprise, type of enterprise, scale of operation, size of target market, financial stability of the owner/owners etc.
Financial requirements depend to a great extent on the external environment factors like the economic scenario of the country, the legal and political environment, government policies, natural causes etc.
Estimating financial needs for start-ups
To ensure that entrepreneurs have adequate funds, it is important to estimate the financial needs before starting a new business. The first step is to estimate the expenses. These can be divided into one-time start-up costs and recurring expenses.
1. One-time costs: One-time costs may include such items as legal and professional costs for incorporating or registering the business; starting inventory; licence and permit fees; office supplies and equipment; long-term assets, such as machinery, a vehicle or real estate; consulting services; and website design.
2. Recurring expenses: Recurring expenses will include such items as salaries, rent or lease payments, raw materials, marketing costs, office and plant overhead, financing costs, maintenance and professional fees.
Once the initial and follow-on expenses have been determined, the entrepreneurs will have to estimate how much money they have at their disposal.
Calculating financial resources:
How much starting capital is available must be determined and the amount of revenue that could be generated each month during the start-up period has to be estimated. To calculate the latter, the promoters should conduct research on the potential market and industry averages to come up with realistic numbers.
To meet any gap in funds, here are sources that could be tapped:
1. Personal investment- Most start-ups require some personal investment by the entrepreneur—either cash or personal assets used as collateral to secure financing.
2. Friends and family- Many new entrepreneurs rely on capital from family and friends (sometimes known as “love money”).
3. Debt financing- Lenders offer various types of debt financing including term loans and lines of credit. Some lenders offer loans specifically designed for new business ventures that come with flexible repayment terms.
4. Outside equity financing- Businesses with high growth potential may be able to secure start-up money from angel investors, business incubators (also known as accelerators) or venture capital funds. Funds from these sources are usually given in exchange for an equity position in the company.
5. Grants and subsidies- Some companies may be eligible for government grants and subsidies to help with start-up costs.
Thus, the financial needs of a new start-up can be estimated in the above mentioned manner.
Key Takeaways
- All business concerns need funds for its establishment, workings, growth and expansion and diversification etc.
- Financial requirements may be broadly classified into two types, namely Fixed Capital and Working Capital.
- Fixed capital is the investment done by the business for accruing long- term benefits and serves the business for a long time.
- Working capital is the daily requirement pumped into the business. It is needed for the day-to-day operation of business.
Sources of finance for business are equity, debt, debentures, retained earnings, term loans, working capital loans, letter of credit, euro issue, venture funding etc. These sources of funds are used in different situations. They are classified based on time period, ownership and control, and their source of generation. It is ideal to evaluate each source of capital before opting for it.
Sources of capital are the most explorable areas especially for the entrepreneurs who are about to start a new business. It is perhaps the toughest part of all the efforts. There are various capital sources, we can classify on the basis of different parameters.
On the basis of a time period, sources are classified as long-term, medium term, and short term. Ownership and control classify sources of finance into owned and borrowed capital. Internal sources and external sources are the two sources of generation of capital. All the sources have different characteristics to suit different types of requirements. Let’s understand them in a little depth.
1. According to Time Period
Sources of financing a business are classified based on the time period for which the money is required. The time period is commonly classified into the following three:
i. Long-Term Sources of Finance:
Long-term financing means capital requirements for a period of more than 5 years to 10, 15 or 20 years or maybe more depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building, etc of business are funded using long-term sources of finance. Part of working capital which permanently stays with the business is also financed with long-term sources of funds. Long-term financing sources can be in the form of any of them:
- Share Capital or Equity Shares
- Preference Capital or Preference Shares
- Retained Earnings or Internal Accruals
- Debenture / Bonds
- Term Loans from Financial Institutes, Government, and Commercial Banks
- Venture Funding
- Asset Securitization
- International Financing by way of Euro Issue, Foreign Currency Loans, ADR, GDR, etc.
ii. Medium Term Sources of Finance:
Medium term financing means financing for a period of 3 to 5 years and is used generally for two reasons- when long-term capital is not available for the time being and, when deferred revenue expenditures like advertisements are made which are to be written off over a period of 3 to 5 years. Medium term financing sources can in the form of one of them:
- Preference Capital or Preference Shares
- Debenture / Bonds
- Medium Term Loans from
- Financial Institutes
- Government, and
- Commercial Banks
- Lease Finance
- Hire Purchase Finance
iii. Short Term Sources of Finance:
Short term financing means financing for a period of less than 1 year. The need for short-term finance arises to finance the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank balance etc. Short-term financing is also named as working capital financing. Short term finances are available in the form of:
- Trade Credit
- Short Term Loans like Working Capital Loans from Commercial Banks
- Fixed Deposits for a period of 1 year or less
- Advances received from customers
- Creditors
- Payables
- Factoring Services
- Bill Discounting etc.
2. According to Ownership and Control
Sources of finances are classified based on ownership and control over the business. These two parameters are an important consideration while selecting a source of funds for the business. Whenever we bring in capital, there are two types of costs – one is the interest and another is sharing ownership and control. Some entrepreneurs may not like to dilute their ownership rights in the business and others may believe in sharing the risk.
i. Owned Capital
Owned capital also refers to equity. It is sourced from promoters of the company or from the general public by issuing new equity shares. Promoters start the business by bringing in the required money for a startup. Following are the sources of Owned Capital:
- Equity
- Preference
- Retained Earnings
- Convertible Debentures
- Venture Fund or Private Equity
Further, when the business grows and internal accruals like profits of the company are not enough to satisfy financing requirements, the promoters have a choice of selecting ownership capital or non-ownership capital. This decision is up to the promoters.
ii. Borrowed Capital
Borrowed or debt capital is the finance arranged from outside sources. These sources of debt financing include the following:
- Financial institutions,
- Commercial banks or
- The general public in case of debentures
In this type of capital, the borrower has a charge on the assets of the business which means the company will pay the borrower by selling the assets in case of liquidation. Another feature of the borrowed fund is a regular payment of fixed interest and repayment of capital.
3. According to source of generation:
Based on the source of generation, the following are the internal and external sources of finance:
i. Internal Sources
The internal source of capital is the one which is generated internally by the business. These are as follows:
- Retained profits
- Reduction or controlling of working capital
- Sale of assets etc.
The internal source of funds has the same characteristics of owned capital. The best part of the internal sourcing of capital is that the business grows by itself and does not depend on outside parties. Disadvantages of both equity and debt are not present in this form of financing. Neither ownership dilutes nor does fixed obligation/bankruptcy risk arise.
ii. External Sources
An external source of finance is the capital generated from outside the business. Apart from the internal sources of funds, all the sources are external sources.
Deciding the right source of funds is a crucial business decision taken by top-level finance managers. The usage of the wrong source increases the cost of funds which in turn would have a direct impact on the feasibility of the project under concern. Improper match of the type of capital with business requirements may go against the smooth functioning of the business. For instance, if fixed assets, which derive benefits after 2 years, are financed through short-term finances will create cash flow mismatch after one year and the manager will again have to look for finances and pay the fee for raising capital again.
Key Takeaways
- Sources of finance for business are equity, debt, debentures, retained earnings, term loans, working capital loans, letter of credit, euro issue, venture funding etc.
- These sources of funds are used in different situations.
- They are classified based on time period, ownership and control, and their source of generation. It is ideal to evaluate each source of capital before opting for it.
References:
- Tulsian, P.C. Business Organization and Management, Pearson Education, India (2002). Pp. 671.
- Wason, V. Textbook of Business Studies, S.Chand, New Delhi (2010)
