SOURCES AND

USES OF SHORT-TERM
AND LONG-TERM
FUNDS
CHAPTER 4
 Introduction:
Sources of finance are the most explored area
especially for the entrepreneurs about to start a new
business. It is perhaps the toughest part of all the
efforts.
There are various sources of finance classified
based on time period, ownership and control, and
source of generation of finance.
 Introduction:
On the basis of a time period, sources are classified into long
term, medium term, and short term. Ownership and control
classify sources of finance into owned capital and borrowed
capital. Internal sources and external sources are the two
sources of generation of capital.
All the sources of capital have different characteristics to suit
different types of requirements.
Short-term sources of finance
Short term financing means financing for a period
of less than 1 year. Need for short term finance
arises to finance the current assets of a business like
an inventory of raw material and finished goods,
debtors, minimum cash and bank balance etc.

Short term financing is also named as working

capital financing.
Short-term sources of finance:

• Trade credit • Customers’ advances

• Bank credit • Fixed Deposits for a period
• Loans and advances of 1 year or less
• Cash credit • Factoring services
• Overdraft • Instalment credit
• Discounting of bills • Loans from credit unions
 Trade credit
Trade credit refers to credit granted to
manufactures and traders by the suppliers
of raw material, finished goods,
components, etc. Usually business
enterprises buy supplies on a 30 to 90
days credit. This means that the goods
are delivered but payments are not made
until the expiry of period of credit. This
type of credit does not make the funds
available in cash but it facilitates
purchases without making immediate
payment.
 Bank credit
Commercial banks grant short-term
finance to business firms which is known
as bank credit.
When bank credit is granted, the borrower
gets a right to draw the amount of credit
at one time or in instalments as and when
needed.
Bank credit may be granted by way of
loans, cash credit, overdraft and
discounted bills.
Banks sometimes require securities on
credits granted.
Bank credit: Loans
When a certain amount is advanced by a
bank repayable after a specified period, it
is known as bank loan.
Such advance is credited to a separate
loan account and the borrower has to pay
interest on the whole amount of loan
irrespective of the amount of loan actually
drawn.
Usually loans are granted against security
of assets.
Bank credit: Cash credit
It is an arrangement whereby banks allow
the borrower to withdraw money up to a
specified limit. This limit is known as cash
credit limit. Initially this limit is granted
for one year.
This limit can be extended after review for
another year. However, if the borrower
still desires to continue the limit, it must
be renewed after three years. Rate of
interest varies depending upon the
amount of limit. Banks ask for collateral
security for the grant of cash credit.
Bank credit: Overdraft
When a bank allows its depositors or
account holders to withdraw money in
excess of the balance in his account up to a
specified limit, it is known as overdraft
facility.
This limit is granted purely on the basis of
credit-worthiness of the borrower.
In this system, the borrower has to show a
positive balance in his account.
Interest is charged only on the overdrawn
money. Rate of interest in case of overdraft
is less than the rate charged under cash
credit.
Bank credit: Discounting of bills
Banks also advance money by discounting
bills of exchange, promissory notes etc.
When these documents are presented
before the bank for discounting, banks
credit the amount to customer's account
after deducting discount.
The amount of discount is equal to the
amount of interest for the period of bill.
Sometimes it could be in the form of
invoice discounting. Taking a credit on the
face value of outstanding credit sales.
Types of securities required for bank credit

• Loans and advances are granted by bank on personal security of the

borrower as well as on the security of some tangible assets, besides
the standing of the firm. Securities against credit may be of two
types
1. Personal security
2. Security of tangible assets
 Types of securities required for bank credit

Personal security means Security of tangible assets

the credit-worthiness of • Moveable goods
the borrower. • Shares
• Documents of title to goods e.g.
Banks judge the credit-worthiness of the bills of lading
borrower on the basis of his or her financial • Fixed deposit receipts
soundness and past dealings with the bank. • Life insurance policies
• Precious metals
Customers advance
Sometimes businessmen insist on their
customers to make some advance payment.
It is generally asked when the value of order
is quite large or things ordered are very
costly.
Customers’ advance represents a part of the
payment towards price on the product(s) which
will be delivered at a later date.
Customers generally agree to make advances
when such goods are not easily available in the
market or there is an urgent need of goods.
A firm can meet its short-term requirements
with the help of customers’ advances.
Instalment credit
Instalment credit is now-a-days a
popular source of finance for consumer
goods like television, refrigerators as well
as for industrial goods.
Only a small amount of money is paid at
the time of delivery of such articles. The
balance is paid in a number of
instalments. The supplier charges interest
for extending credit. The amount of
interest is included while deciding on the
amount of instalment.
Loans from credit
unions
Credit unions are a good source to procure
short-term finance. Such unions have been
established at local, district and national levels.
These unions are usually formed among
workers in a particular organization. Some of
these unions or micro-finance institutions like
UT Financial Services was initially established
as a co-operative society and later converted
into a bank.
Factoring services

Factoring companies offer a range of

services in the area of sales administration
and the collection of amounts due from
trade receivables. A factor can take over
the administration of sales invoicing and
accounting for a client company, together
with collecting amounts due from trade
receivables and chasing up any slow
payers.
Factoring services
A factor can offer a cash advance against
the security of trade receivables, allowing a
company ready access to cash as soon as
credit sales are made. For an additional
fee, a factor can take on any bad debts
that may arise through non-payment. This
is called non-recourse factoring, since here
the factor does not have recourse to the
company for compensation in the event of
non-payment.
Long-term sources of finance
Long-term financing means capital requirements for a
period of more than 5 years to 10, 15, 20 years or maybe
more depending on other factors.
Capital expenditures in fixed assets like plant and
machinery, land and building etc. of a business are funded
using long-term sources of finance.
Part of working capital which permanently stays with the
business is also financed with long-term sources of finance.
Long-term sources of finance
The sources of long-term finance refers to the institutions
or agencies from which, or through which finance for a
long period can be procured.
In the case of sole traders and partnership firms, long-term
funds are generally provided by the owners themselves and
by retained profits. But in companies whose financial
requirement is rather large, the following are the sources
from, or through which long-term funds are raised.
 Long-term sources of finance:

• Capital markets • Venture capital

• Equity financing e.g. • Angel investors
shares • Government grants
• Debt financing e.g. • Special financial institutions
debentures and bonds • Mutual funds
• Leasing
• Mortgage
 Capital markets
Capital market refers to the organization and the
mechanism through which the companies, other institutions
and the government raise long-term funds.
So it constitutes all long-term borrowings from banks and
financial institutions, borrowings from foreign markets and
raising of capital by issuing various securities such as
shares, debentures, bonds, etc.
 Capital markets
The primary market deals with new/fresh issue of
securities and is, therefore, known as new issue market.
The secondary market on the other hand, provides a place
for purchase and sale of existing securities and is known as
stock market or stock exchange.
 Mutual funds
Mutual fund refers to a fund established in the form of a
trust by a sponsor to raise money through one or more
schemes for investing in securities.
It is a special type of investment institution, which acts as an
investment intermediary that collects or pools the savings of
a large number of investors and invests them in a fairly large
and well diversified portfolio of sound investments.
This minimizes their risk and ensures good returns to the
investors.
 Leasing companies
This method has become quite common among the
manufacturing companies. Leasing facility is usually
provided through the mediation of leasing companies who
buy the required plant and machinery from its manufacturer
and lease it to the company that needs it for a specified
period on payment of an annual rent.
 Special financial
institutions
A number of special financial institutions have been set up
by the central governments to provide long-term finance to
the business organizations.
They also offer support services in launching of the new
enterprises and also for expansion and modernization of
existing enterprises.
 Venture capital
Venture capital refers to financing that comes from
companies or individuals in the business of investing in
young, privately held businesses. They provide capital to
young businesses in exchange for an ownership share of the
business.
Venture capital firms usually don’t want to participate in the
initial financing of a business unless the company has
management with a proven track record.
 Angel investors
Angel investors are individuals and businesses that are
interested in helping small businesses survive and grow. So
their objective may be more than just focusing on economic
returns. Although angel investors often have somewhat of a
mission focus, they are still interested in profitability and
security for their investment. So they may still make many
of the same demands as a venture capitalist.
THANKYOU