What is the basis of classification of sources of Business finance?
Answers
Answer:
Sources of Funds
Business simply cannot function without money, and the money required to make a business function is known as business funds. Throughout the life of business, money is required continuously. Sources of funds are used in activities of the business. They are classified based on time period, ownership and control, and their source of generation.
Learn more about Sources of Financing Business here.
Classification of Sources of Funds
Period Basis Sources
On the basis of the period, the different sources of funds can be classified into three parts. Which are:
Long-term sources fulfil the financial requirements of a business for a period more than 5 years. It includes various other sources such as shares and debentures, long-term borrowings and loans from financial institutions. Such financing is generally required for the procurement of fixed assets such as plant, equipment, machinery etc.
Medium-term sources are the sources where the funds are required for a period of more than one year but less than five years. The sources of the medium term include borrowings from commercial banks, public deposits, lease financing and loans from financial institutions.
Short-term sources: Funds which are required for a period not exceeding one year are called short-term sources. Trade credit, loans from commercial banks and commercial papers are the examples of the sources that provide funds for short duration.
Explanation:Ownership Basis Sources
On the basis of ownership, the sources can be classified into Owner’s funds and Borrowed funds. Owner’s funds mean funds which are procured by the owners of a business, which may be a sole entrepreneur or partners or shareholders of a business. It also includes profits which are reinvested in the business. The owner’s capital remains invested in the business for a longer duration and is not required to be refunded during the life period of the business.
This capital forms the base on which owners gain their right of control of management in the business. Some entrepreneurs may not like to dilute their ownership rights in the business and others may believe in sharing the risk. Equity shares and retained earnings are the two important sources from where owner’s funds can be obtained.
Borrowed funds refer to the funds raised with the help of loans or borrowings. This is the most common type of source of funds and is used the majority of the time. The sources for raising borrowed funds include loans from commercial banks, loans from financial institutions, issue of debentures, public deposits and trade credit.Generation Basis Sources
The way of classifying the sources of funds is whether the funds are generated from within the organization or from external sources of the organization. Internal sources of funds are those that are generated inside the business. A business, for example, can generate funds internally by speeding collection of receivables, disposing of surplus inventories and increasing its profit. The internal sources of funds can fulfil only limited needs of the business.
Whereas, External sources of funds are the sources that lie outside an organization, such as suppliers, lenders, and investors. When a large amount of money is needed to be raised, it is generally done through the external sources. External funds may be costly as compared to those raised through internal sources.
Answer:
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.
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