Types of Business Finance

In every business activity money is an important as well as essential component. The type and amount of funds required usually differs from one business to another. For example, 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 needs funds for longer period to be invested in fixed assets like land and building, machinery etc. Sometimes, the business also needs funds to be invested for 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
2. Medium-term Finance
3. Long-term Finance

1. Short-term Finance

Funds required to meet day-to-day expenses are known as short-term finance. This is required for 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 financial requirement for short period is also known as working capital requirement or circulating capital requirement. A part of the working capital requirement is of a long-term nature, as certain minimum amount of funds are always kept to meet the requirement of stock and regular day-to-day expenses.

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 five years. Amount required to fund modernisation and renovation, special promotional programmes, etc. fall in this category.

3. Long-term Finance

The amount of funds required by a business for more than five years is called long-term finance. Generally this type of finance is required for 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.

Every organisation need different types of finance - long-term, medium-term as well as short-term. But the combination in which these are used differ from one business to another. For example, steel industry requires more long-term finance to be invested in land and building and machinery as compared to the manufacturing of leather goods or plastic buckets. Similarly, for manufacturing hosiery items, requirement of short-term finance would be more than that of long-term finance.

Concepts of Fixed and Working Capital

Capital of a business is invested in different types of assets like land and building, furniture, machines, raw material, stock of finished goods, etc. Some of these assets are used over a long period of time and hence are generally of a permanent nature.

Fixed capital refers to the total value of assets in a business, which are 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. However, a part of working capital is required at all times to maintain minimum level of stock and cash to pay wages and salaries etc. This part of working capital is called permanent working capital.