Table of Contents
Introduction
Every business needs money to start, operate, and expand. The money used by a business comes from different sources and through different means.
These means are known as instruments of business finance. Understanding them helps us know how businesses raise and manage money.
Instruments of business finance are the various methods, tools, or means through which a business raises funds for its operations. They show how money is obtained to start a business, buy equipment, pay workers, and expand production. Examples include shares, debentures, loans, and retained profits.
Sources of Funds for Business
The sources of funds for business can be grouped into two main types:
a. Internal Sources
These are funds generated from within the business. Examples include:
- Personal Savings: Personal savings refer to money the business owner has saved over time and decides to invest in the business. It is a common source of finance for small businesses because it is easy to access and does not require paying interest. However, the amount available is usually small and may not be enough for large scale business activities.
- Retained Profits: Retained profits are profits made by a business that are not shared out to owners or shareholders but kept back for future use. This source of finance helps a business grow without borrowing money. The disadvantage is that it depends on how profitable the business is, and new businesses may not have enough profits to retain.
- Sale of Assets: A business can raise funds by selling old or unused assets such as land, machines, or vehicles. This provides quick cash without borrowing. However, selling assets may reduce the productive capacity of the business if the assets are still useful.
b. External Sources
These are funds obtained from outside the business. Examples include:
- Bank Loans: Bank loans are funds borrowed from commercial banks for a specific period and repaid with interest. They help businesses raise large amounts of money for expansion or operations. The main problem is high interest rates and strict conditions, which many small businesses find difficult to meet.
- Bank Overdraft: A bank overdraft allows a business to withdraw more money than it has in its bank account up to an agreed limit. It is useful for meeting short term financial needs. However, overdrafts attract high interest and must be repaid quickly.
- Shares: Shares are funds raised by selling ownership units of a company to the public. People who buy shares become part owners of the business. This source does not require repayment, but shareholders may demand dividends and have a say in how the business is run.
- Debentures: Debentures are long term loans raised by companies from the public, with a promise to pay interest. Unlike shares, debenture holders are creditors and not owners of the business. The disadvantage is that interest must be paid regularly, even when the business is not making profit.
- Loans from Friends and Relatives: Friends and relatives may provide funds to help start or support a business. These loans are usually easy to obtain and may have little or no interest. However, they are often limited in amount and may lead to personal conflicts if not repaid on time.
- Government Grants and Loans: Government grants and loans are funds provided by the government to support businesses, especially small scale and agricultural enterprises. Grants do not require repayment, while loans are usually given at low interest rates. Accessing them can be difficult due to bureaucracy and strict conditions.
Shares
A share is a unit of ownership in a company. When people buy shares, they become part owners of the business and are called shareholders. The money raised from selling shares is used to run and grow the business.
Types of Shares
- Ordinary Shares: These are the most common shares. Holders of ordinary shares receive dividends only after preference shareholders have been paid. They also have voting rights in the company.
- Preference Shares: Holders of preference shares receive dividends before ordinary shareholders. They usually receive a fixed rate of dividend and may not have voting rights.
Summary
Instruments of business finance explain how businesses raise funds. These include shares, capital, stock, and debentures. Understanding these concepts helps us know how businesses operate and overcome financial challenges.
Tags
Business finance, Instruments of business finance, Sources of funds, Internal sources of finance, External sources of finance, Personal savings, Retained profits, Bank loans, Shares, Ordinary shares, Preference shares, Shareholders, Dividend
