Page 20 - DMGT409Basic Financial Management

Unit 2: Source of Finance

Introduction Notes

We all know that every business requires some amount of money to start and run the business.
Whether it is a small business or large, manufacturing or trading or transportation business,
money is an essential requirement for every activity. Money required for any activity is known as

finance. So the term ‘business finance’ refers to the money required for business purposes and the
ways by which it is raised. Thus, it involves procurement and utilisation of funds so that business

firms will be able to carry out their operations effectively and effi ciently.
2.1 Types of Business Finance

The type and amount of funds required usually differs from one business to another. For instance,
if the size of business is large, the amount of funds required will also be large. Likewise, the

financial requirements are more in manufacturing business as compared to trading business.

The business need funds for longer period to be invested in fixed assets like land and building,
machinery etc. Sometimes, the business also needs fund to be invested in shorter period. So

based on the period for which the funds are required, the business finance is classified into three

categories.
1. Short-term Finance: Funds required to meet day-to-day expenses are known as short-term
fi nance.

Example: Purchase of raw materials, payment of wages, rent, insurance, electricity and
water bills, etc.

The short-term finance is required for a period of one year or less. This fi nancial requirement

for short period is also known as working capital requirement or circulating capital
requirement.
2. Medium-term Finance: Medium-term finance is utilised for all such purposes where

investments are required for more than one year but less than fi ve years.

Example: Amount required to fund modernisation and renovation, special promotional
programmes etc.

3. Long-term Finance: The amount of funds required by a business for more than five years is
called long-term fi nance.

Example: The purchase of fixed assets like land and building, plant and machinery furniture
etc.

The long-term finance is also known as fixed capital as such need in fact is, of a permanent

nature.

Note Fixed vs Working Capital

Fixed capital refers to the total value of assets in a business, which is of durable nature
and used in a business over a considerable period of time. It comprises assets like land,

building, machinery, furniture etc. The capital invested in these assets is fixed in the sense
that these are required for permanent use in business and not for sale. Working capital
consists of those assets which are either in the form of cash or can easily be converted into
cash, e.g., cash and bank balances, debtors, bills receivable, stock, etc. These assets are
also known as current assets. Working capital is needed for day-to-day operations of the
business.

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