Principles of

Commerce
Instructor: Mr. Abshir Gedi Idow
Faculty of Management Science and
Economics
Himilo University
Chapter 06: Basics of Commerce
Finance

Instructor: Mr. Abshir Gedi Idow

Faculty of Management Science Economics
Himilo University
Learning Objectives
 Meaning of Business Finance
 Nature of Business Finance
 Need for and Significance of Business Finance
 Classification of Sources of Funds
 Factors Determining the Choice of Sources of
Finances
Meaning of Business Finance

The requirement of funds by business firm to accomplish

its various activities is called ‘business finance’.
Finance is considered as the life blood of any organization.
The success of an industry depends on the availability of
adequate finance.
Cont….

To promote and operate the proposed enterprise

economically and efficiently, adequate finance is
necessary. Finance is a vital functional area of business. It
deals with procurement of funds and their effective
utilization. Finance is also labeled as capital of a company.
A business fundamentally requires identifying its sources
of finance from where it can procure funds. As soon as an
entrepreneur starts the business, the need for business
finance emerges.
Cont.….
Definitions
Howard and Upton “Business finance involves a set of
administrative functions in an organization which relate
with the arrangement of cash and credit so that the
organization may have the means to carry out its
objectives as satisfactorily as possible.”

B.O. Wheeler. “Finance is that business activity which is

concerned with the acquisition and conservation of capital
funds in meeting the financial needs and overall objectives
of a business enterprise.”
Nature of Business Finance
The financial needs of a business organization can be
categorized as follows:
A) Fixed Capital Requirements
B) Working Capital Requirements
Nature of Business Finance
A) Fixed Capital Requirements
In order to start business, funds are required to purchase
fixed assets like land and building, plant and machinery,
and furniture and fixtures. This is known as fixed capital
requirements of the business enterprise. The funds
required in fixed assets remain invested in the business for
a long period of time.
Nature of Business Finance
A) Fixed Capital Requirements
Different business units need varying amount of fixed
capital depending on various factors such as the nature of
business, etc. A trading concern for example, may require
small amount of fixed capital as compared to a
manufacturing concern. Likewise, the need for fixed
capital investment would be greater for a large business
enterprise, as compared to that of a small enterprise.
Nature of Business Finance
B)Working Capital Requirements
The financial requirements of a business enterprise do not
end with the procurement of fixed assets. No matter how
small or large a business is, it needs funds for its day-to
day operations. This is known as working capital of an
enterprise, which is used for holding current assets such
as Stock of material, bills receivables and for meeting
expenses like salaries, wages, taxes, and rent.
Nature of Business Finance
B)Working Capital Requirements
The amount of working capital required varies from one
business enterprises to another depending on various
factors. For example, A business unit selling goods on
credit, or having a slow sales turnover, would require
more working capital as compared to a concern selling its
goods and services on cash basis or having a high
turnover. The requirement for fixed and working capital
increases with the growth and expansion of business. At
times, additional funds are required for upgrading the
technology employed so that the cost of production or
operations can be reduced.
Need for and Significance of Business
Finance
Business needs finance mainly for acquiring various types
of assets and to meet various expenses on day to day
basis. There are also many other reasons for the
requirement of business finance.
 For establishing a new business:
1. To meet fixed capital requirement of business
2. To meet working capital requirements
3. For growth and expansion
4. For diversification
5. For survival
6. To meet Liabilities
7. For payment of expenses
Need for and Significance of Business Finance
 For establishing a new business:

1. To meet fixed capital requirement of business: To purchase fixed

assets like land and building, plant and machinery, furniture and
fixtures, etc., business requires finance.
2. To meet working capital requirements: Working Capital is used for
holding current assets such as stock of material, payment of wages,
transportation expenses, etc.
3. For growth and expansion: For growth and expansion activities, a
business requires finance. It may be required to increase production, to
install more machines, to set up a R&D centre, etc.
4. For diversification: Business finance is needed to start any new activity
in business. Entering into new businesses and new lines of activities is
known as diversification. Similarly main enterprises keep on grabbing
opportunities to start producing products of different segments.
Need for and Significance of Business Finance
For establishing a new business:
5. For survival: To carry out the various business operations
in continuity, business finance is needed. Without the
required finance, organizations cannot survive for long.
6. To meet Liabilities: To meet liabilities of business, be it
long-term or short, a business requires sufficient finance,
e.g., for payment of loan installments, creditors, etc.
7. For payment of expenses: For paying salaries, wages,
taxes, advertisements and rent, finance is needed.
Therefore, to execute the various plans of the business,
finance is needed
Classification of Sources of Funds
In case of Proprietary and Partnership concerns, the funds
may be raised either from personal sources or borrowings
from indigenous bankers or financial institutions etc,. In
case of company form of business organization, the
different sources of business finance are available in the
market. The sources of funds can be categorized using
different basis:
1. On the basis of the period,
2. On the basis of the ownership and
3. On the basis of source of generation.
Classification of Sources of Funds
1. On the basis of the period:
On the basis of period, sources of funds can be
categorized into three ways. They are
a) Long-term finance,
b) Medium-term finance and
c) Short-term finance.
Classification of Sources of Funds
1. On the basis of the period
a) Long-term finance:
The long-term sources fulfill the financial requirements of
an enterprise for a period exceeding five years and include
sources such as:
 Shares and debentures
 Long-term borrowings, and
 Loans from financial institutions
Such financing is generally required for the acquisition of
fixed assets such as land and buildings, equipment, plant
and machinery etc.
Classification of Sources of Funds

1. On the basis of the period

b) Medium-term finance:
Where the funds are required for a period of more than
one year but less than five years, medium-term sources of
finance are used. These sources include
 borrowings from commercial banks,
 public deposits,
 lease financing and
 loans from financial institutions.
Classification of Sources of Funds
1. On the basis of the period
c) Short-term finance:
Short-term funds are those which are required for short
duration i.e. a period not exceeding one year. Trade credit,
loans from commercial banks (bank credit), indigenous
Bankers, installment credit, advances, bank over drafts,
cash credits and commercial papers are some of the
examples of short –term sources.
Classification of Sources of Funds
2. On the basis of the ownership:
On the basis of ownership, the sources can be
classified into two types of funds:
a) owners’ funds
b) borrowed funds
Classification of Sources of Funds
2. On the basis of the ownership:
a) Owners’ funds: means funds that are provided by the
owners of an enterprise, which may be a sole trader or
partners or shareholders of a company. Apart from
capital, it also includes profits reinvested in the
business. The owner’s capital remains invested in the
business for a longer duration and is not required to be
refunded during the life period of the business. Such
capital forms the basis on which owners acquire their
right of control of management. Issue of equity shares
and retained earnings are the two important sources
from where owner’s funds can be obtained.
Classification of Sources of Funds

2. On the basis of the ownership:

b) Borrowed funds:

Borrowed funds’ on the other hand, refer to the funds

raised through loans or borrowings. The sources for raising
borrowed funds include loans from commercial banks,
loans from financial institutions, issue of debentures,
public deposits and trade credit.
Classification of Sources of Funds
3. On the basis of generation:
Sources of Finances can be generated from internal
(within the organization) or from external sources.
Internal sources of funds are those that are generated
from within the business. Such as ploughing back of
profits, retained earnings, collection of receivables,
disposing of surplus inventories and depreciation of funds
etc. External sources of funds include those sources that
lie outside an organization, such as shares, debentures,
public deposits, borrowing from commercial banks and
financial institutions, suppliers, lenders, and investors.
Factors Determining the Choice of
Sources of Finances
Financial needs of a business are of different types — long
term, short term, fixed and fluctuating. Therefore,
business firms resort to different types of sources for
raising funds.
Factors Determining the Choice of
Sources of Finances
The choice of selecting a better source of finance depends
on the following factors;
1. Cost
2. Financial strength and stability of operations
3. Form of organization and legal status
4. Purpose and time period
5. Risk profile
6. Control
7. Effect on creditworthiness
8. Flexibility and ease
9. Tax benefits
 Questions

Essay Type Questions

1. What is business finance? Explain its need and
significance in the business organizations.
2. What are the various factors that determine the
selection of sources of finance?
Short Answer Type Questions
3. What are the various types of capital required for
business enterprises?
4. Explain the classification of sources of finance.