Chapter 2. Sources of Finance

Chapter 2. Sources of Finance. Finance means fund collection, its management, and distribution. In this chapter, we will learn about the concept of the sources of finance for doing the fund collection activity efficiently. Different sources of finance have different features. For these different features, the fund should be collected from different sources suitable for different situations of the business. For example, to purchase a fixed asset fund should be collected through share selling. Again, to meet the daily needs such as raw materials purchase, credit purchasing can be used or short-term bank loans can be utilized.

Chapter 2. Sources of Finance

Chapter 2. Sources of Finance

Chapter 2. Sources of Finance

Chapter 2. Sources of Finance

The fund required for the purpose of starting any business or to conduct the daily activities of the business, selection of the sources of finance is one of the important decisions in financial management.  Because different sources have different costs of capital and the sources of different terms have different advantages and disadvantages. An institution collects funds by analyzing different sources to select that mixture of sources which will provide maximum benefit and minimum cost. The main objective of the investment is profit earning. We can get net profit by subtracting the cost of capital and tax from the total profit. So, the cost of capital should be reduced to maximize the profit of the business.

Sourcing money may be done for a variety of reasons. Traditional areas of need may be for capital asset acquirement – new machinery or the construction of a new building or depot. The development of new products can be enormously costly and here again, capital may be required. Normally, such developments are financed internally, whereas capital for the acquisition of machinery may come from external sources. In this day and age of tight liquidity, many organizations have to look for short term capital in the way of overdraft or loans in order to provide a cash flow cushion. Interest rates can vary from organization to organization and also according to the purpose.

Chapter objectives

This chapter is intended to provide:

  • An introduction to the different sources of finance available to management, both internal and external
  • An overview of the advantages and disadvantages of the different sources of funds
  • An understanding of the factors governing the choice between different sources of funds.

Structure of the chapter

This final chapter starts by looking at the various forms of “shares” as a means to raise new capital and retained earnings as another source. However, whilst these may be “traditional” ways of raising funds, they are by no means the only ones. There are many more sources available to companies that do not wish to become “public” by means of share issues. These alternatives include bank borrowing, government assistance, venture capital, and franchising. All have their own advantages and disadvantages and degrees of risk attached.

Ordinary shares are issued to the owners of a company. They have a nominal or ‘face’ value, typically of $1 or 50 cents. The market value of a quoted company’s shares bears no relationship to their nominal value, except that when ordinary shares are issued for cash, the issue price must be equal to or be more than the nominal value of the shares. 

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Chapter 2. Sources of Finance

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