Sources Of Finance According To Ownership

sources finance

Sources of finance, categorized by ownership, can be broadly divided into two main groups: owner’s funds and borrowed funds. Each category represents a distinct approach to securing capital, with its own advantages and disadvantages.

Owner’s Funds

Owner’s funds, also known as equity or internal financing, represent investments made directly by the owners of the business or generated from the company’s own operations. This type of financing typically does not require repayment and provides a long-term, stable source of capital.

Equity Shares: These are the most common form of owner’s funds, representing ownership stakes in the company. Companies issue shares to raise capital from investors, who become shareholders and are entitled to a portion of the company’s profits (dividends) and assets. Equity financing dilutes existing ownership but does not create a debt obligation.
Retained Earnings: This represents the accumulated profits that a company has chosen to reinvest back into the business rather than distribute as dividends. Retained earnings are a cost-effective source of financing, as they do not incur interest or external costs. They indicate a company’s profitability and ability to self-finance future growth.
Preference Shares: These shares combine features of both equity and debt. Preference shareholders have a priority claim on dividends and assets compared to equity shareholders, but they typically do not have voting rights. Preference shares can be attractive to investors seeking a more secure return than common stock.
Owner’s Capital (for sole proprietorships and partnerships): In unincorporated businesses, the owner’s personal investment serves as the initial and ongoing source of funding. This includes personal savings, loans taken out in the owner’s name, and assets contributed to the business.

Borrowed Funds

Borrowed funds, also known as debt financing or external financing, involve obtaining capital from external sources with the obligation to repay the principal amount along with interest. This form of financing provides immediate access to capital but increases the company’s financial risk.

Loans from Banks and Financial Institutions: These are a traditional source of debt financing. Banks offer various types of loans, including term loans, lines of credit, and overdraft facilities, based on the company’s creditworthiness and the intended use of funds. These loans usually require collateral.
Debentures and Bonds: These are debt instruments issued by companies to raise capital from the public. Debentures are unsecured loans, while bonds are secured by specific assets. Investors purchase these instruments and receive periodic interest payments and the principal amount at maturity.
Trade Credit: This is a short-term financing option offered by suppliers. It allows businesses to purchase goods or services on credit and pay for them later, typically within 30 to 90 days.
Commercial Paper: This is an unsecured, short-term debt instrument issued by large, creditworthy corporations to finance their short-term liabilities.
Leasing: Leasing involves renting assets (e.g., equipment, vehicles) instead of purchasing them outright. This can be a cost-effective way to access assets without tying up capital.

The choice between owner’s funds and borrowed funds depends on various factors, including the company’s risk appetite, financial situation, stage of development, and the specific needs of the project being financed. Many companies utilize a combination of both types of financing to optimize their capital structure and achieve their financial goals.