Financing Business

Financing is the process of providing funds for business activities, making purchases, or investing. It is a critical aspect of business setup, survival, and expansion. Understanding the sources, types of capital, calculations, and problems associated with financing is essential for any business enterprise.

1. Sources of Business Finance

Business finance can be categorized into three main categories based on duration: short-term, medium-term, and long-term sources.

• Short-term Sources (Under 1 Year): Used to run day-to-day operations (working capital). Examples include:
  • Bank Overdraft: An agreement allowing a business to withdraw more money than is in its current account up to a certain limit. Interest is charged on the daily overdrawn balance.
  • Trade Credit (Credit Purchase): Buying goods from suppliers on a 'buy now, pay later' basis, typically for 30 to 90 days.
  • Factoring: Selling trade debts (receivables) to a third party (a factor) at a discount for immediate cash.
• Medium-term Sources (1 to 5 Years): Used for purchasing equipment or vehicles. Examples include:
  • Leasing: An agreement where the owner of an asset (lessor) allows another party (lessee) to use the asset for a specified period in exchange for regular lease payments. Ownership does not transfer automatically.
  • Hire Purchase: Buying an asset by paying an initial deposit and the remaining balance in installments. Ownership transfers to the buyer upon paying the final installment.
• Long-term Sources (Over 5 Years): Used for major capital investments. Examples include:
  • Sale of Shares: Issuing shares to the public (or private individuals) in exchange for equity capital.
  • Debentures: Long-term loans raised by a company from the public, backed by a certificate indicating the rate of interest and date of redemption. Debenture holders are creditors, not owners.
  • Mortgages: Long-term loans secured by real estate/property.
  • Ploughing Back of Profit (Retained Earnings): Reinvesting accumulated profits back into the business instead of distributing them as dividends.
  • Personal Savings: The owner's personal money used to start or support a business (common in sole proprietorships).

2. Types of Capital

Capital is the wealth or wealth-producing tools used to set up and run a business. It takes several forms:

• Authorized (Registered/Nominal) Capital: The maximum amount of share capital a company is legally permitted to issue under its Memorandum of Association.
• Issued Capital: The portion of authorized capital that has actually been offered to the public for subscription.
• Called-up Capital: The portion of issued capital for which the company has requested payment from shareholders.
• Paid-up Capital: The actual amount of money paid by shareholders out of the called-up capital.
• Uncalled Capital: The portion of issued capital that shareholders have not yet been requested to pay.
• Capital Owned (Owners' Equity): The value of assets contributed by the owners. Formula: Capital Owned = Total Assets - Total Liabilities.
• Capital Employed: The total value of resources used by a company to generate profits. Formulas:
  • Capital Employed = Non-Current Assets + Working Capital, or
  • Capital Employed = Total Assets - Current Liabilities
• Working Capital: The capital used in the day-to-day trading activities of a business. Formula: Working Capital = Current Assets - Current Liabilities.
• Liquid Capital: Capital available in cash or assets that can be easily converted into cash. Formula: Liquid Capital = Cash + Bank + Marketable Securities.

3. Calculation of Capital, Profits, and Turnover

Calculations are crucial for assessing business performance. Key formulas include:

• Cost of Goods Sold (COGS): The direct cost of producing goods sold. Formula:
  COGS = Opening Stock + Purchases + Carriage Inwards - Closing Stock
• Gross Profit: The profit made before administrative and selling expenses are deducted. Formula:
  Gross Profit = Net Sales (Turnover) - Cost of Goods Sold
• Net Profit: The actual profit of the business after all operating expenses have been deducted. Formula:
  Net Profit = Gross Profit - Total Expenses
• Turnover: The total value of sales made by a business during a specific period (Net Sales). Formula:
  Turnover = Gross Sales - Sales Returns
• Rate of Stock Turnover (ROST): How many times a business replaces its stock in a period. Formula:
  ROST = Cost of Goods Sold / Average Stock, where Average Stock = (Opening Stock + Closing Stock) / 2

4. Problems of Sourcing Finance

Businesses, especially Small and Medium Enterprises (SMEs), face several hurdles when raising capital:

• High Interest Rates: Elevated cost of borrowing from commercial banks makes loans expensive and risky.
• Collateral Security Requirements: Banks demand valuable assets (e.g., land, buildings) as security, which many start-ups do not possess.
• Stringent Lending Conditions: Lengthy processes, strict documentation, and a requirement for audit histories scare off small businesses.
• Short Repayment Periods: Banks often prefer short-term lending, which is unsuitable for projects requiring long-term gestation periods.
• Economic Instability: High inflation rates and currency devaluations make lenders hesitant to provide long-term credit.

5. The Role of Bureau de Change (BDC) in the Economy

A Bureau de Change is a retail foreign exchange dealer licensed to buy and sell foreign currencies. Key roles in the economy include:

• Providing Access to Foreign Exchange: They facilitate access to foreign currencies for small retail buyers, tourists, and small-scale business importers.
• Stabilizing the Local Currency: By distributing foreign currency, they help meet retail demand, easing pressure on the official banking market.
• Reducing Black Market Activities: BDCs provide an official, regulated channel for exchange, reducing patronage of illegal currency hawkers.
• Facilitating International Trade: They allow small traders to quickly convert currencies to make payments for cross-border transactions.