Types of Business Finance

There are two types of business finance first one is “short term finance” and second one is “long term finance”.

Business finance is that activities which is concerned with the acquisition and conservation of capital funds in meeting the financial need and overall objective of business enterprise. Business finance can be divided into the following two types. Such as:

1. Short Term Finance:

Funds available for a period of one year or less are called short term finance. Short term finance is mainly used for purchasing current assets. Current assets are cash, inventories, sundry debtors, bills receivables, etc. For purchasing these assets, current liabilities are used.

Current liabilities are sundry creditors, accounts payable, trade credit, commercial paper, etc. In a financial year the difference between total current assets and total liabilities is called working capital.

Characteristics of short term finance:

  • Time This financing is made available for a period of one year or less. The funds may be used for procuring raw materials either in cash or credit. In purchasing the raw materials in cash any bank or financial institution may provide the loan for a short period of time.
  • Purpose: This financing is generally used to meet the working capital requirements of the organization like procuring raw materials, paying the wages of the workers, etc.
  • Costly and risky Since this fund is made available for short period of time, it is considered as costly and risky.
  • Security: In obtaining short term financing no security is generally required.  Sometimes bank loans are offered without any security based on relationships of the clients considered as costly and risky.
  • Recycling: Short term financing can be recycled. That is if we buy raw materials on credit, bill payable is created. If we pay the bill in time, creditors remain satisfied and they sanction this again.

2. Long Term Finance:

An organization requires long-term financing to meet its long-term capital asset requirements. Thus the funds raised for long-term investment is termed as long-term financing.

Characteristic of long-term finance:

  • types_of_business_finance

    Characteristic of long-term finance

    Size of the fund: It is generally very large and is usually invested in immoveable property.

  • Use of fund: The fund is used to procure land, machineries and equipments, preparing office building and residential building.
  • Nature of the fund: This fund can be either in domestic or foreign currencies.
  • Repayment method: Depends upon the contractual relationship between the lenders and the borrowers.
  • Security: Requires sufficient security against this loan. Generally the fixed assets of the business are used in this regard.
  • Claim on income: The creditors get first priority over the income of the borrowers.
  • Cost of Capital: Generally less than on short-term financing since the fund is used for a long-term ad the expected income is generally low.
  • Participation in management Shareholders can actively participate in management if the fund is raised through issuing shares. But if it is raised through the creditors, they can influence management indirectly.

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