The Different Sources of Business Finance and Their Implications
1. Introduction
There are different types of business enterprises that operate in the economy. These businesses can be broadly classified into small-scale businesses and large-scale businesses. The term ‘business enterprise’ is defined as an entity that is engaged in commercial, industrial or other economic activity (European Commission, 2014). A business enterprise can either be a sole proprietorship, partnership, or a company.
The finance of a business enterprise refers to the capital that is required to start up or run a business enterprise. This capital can be in the form of cash, assets, or credit. Business finance is also concerned with the management of these funds and the decision-making process related to the use of these funds (Titman & Wessels, 1988).
The objective of this paper is to discuss the sources of business finance for small- and large-scale businesses and to assess the legal, financial, and control implications of external finance. The paper will also discuss bankruptcy as one of the consequences of poor financial management.
2. Sources of Business Finance
There are various sources of business finance available for small- and large-scale businesses. These sources can be classified into equity finance, debt finance, government grants, and leasing.
a. Equity Finance
Equity finance is the process of raising capital by selling shares in a business enterprise. The owners of the business enterprise sell a part of their ownership stake in the enterprise in exchange for cash. This cash can then be used by the business to finance its operations or expand its activities. The advantage of equity finance is that it does not require the business to repay the capital that has been raised. However, the downside of equity finance is that it dilutes the ownership stake of the existing owners and gives control over the enterprise to the new shareholders (Jensen & Meckling, 1976).
b. Debt Finance
Debt finance is the process of raising capital by borrowing money from financial institutions or investors. The business enterprise has to repay this borrowed capital along with interest at a later date. The advantage of debt finance is that it does not dilute the ownership stake of the existing owners. However, the disadvantage of debt finance is that it increases the financial obligations of the business enterprise and may lead to bankruptcy if not managed properly (Titman & Wessels, 1988).
c. Government Grants
Government grants are another source of business finance for small- and large-scale businesses. These grants are provided by national or local governments to encourage businesses to set up operations in their jurisdictions. The advantage of government grants is that they do not have to be repaid by the business enterprises. However, government grants are often awarded on a competitive basis and may not be available to all businesses (European Commission, 2014).
d. Leasing
Leasing is another source of business finance which involves renting equipment or machinery from another party for a fixed period of time. The advantage of leasing is that it helps businesses conserve their capital as they do not have to purchase equipment outright. However, leasing may tie up a significant amount of cash flow as periodic payments have to be made to the lessor (Brealey et al., 2016).
3. Legal, Financial, and Control Implications of External Finance
There are various legal, financial, and control implications of external finance which businesses have to consider before raising capital from external sources.
a. Debentures
Debentures are a type of debt security which can be issued by companies to raise capital. Debentures are normally issued for a fixed term and carry a fixed rate of interest. The advantage of debentures is that they provide a source of long-term finance for businesses. However, the disadvantage of debentures is that they are often subordinated to other creditors in the event of bankruptcy (Titman & Wessels, 1988).
b. Preference Shares
Preference shares are a type of equity security which gives the holder preference over ordinary shareholders in the event of liquidation. The advantage of preference shares is that they provide a source of long-term finance for businesses. However, the disadvantage of preference shares is that they often carry a higher rate of dividend than ordinary shares and may be subject to dilution if new ordinary shares are issued (Jensen & Meckling, 1976).
c. Share Capital
Share capital refers to the funds raised by a company through the issue of shares. Share capital can be either equity share capital or preference share capital. The advantage of share capital is that it provides a source of long-term finance for businesses. However, the disadvantage of share capital is that it gives the shareholders a stake in the company and may lead to conflict between shareholders and management (Titman & Wessels, 1988).
4. Bankruptcy
Bankruptcy is a legal process which allows businesses to be wound up in an orderly manner. The objective of bankruptcy is to distribute the assets of the business among its creditors. Bankruptcy may be filed voluntarily by the business or involuntarily by its creditors. The advantage of bankruptcy is that it provides relief from debts for businesses. However, the disadvantage of bankruptcy is that it damages the creditworthiness of businesses and may lead to the loss of jobs (Brealey et al., 2016).
5. Conclusion
In conclusion, business finance is a critical aspect of running a business enterprise. There are various sources of business finance available for small- and large-scale businesses. These sources can be classified into equity finance, debt finance, government grants, and leasing. Each of these sources has its own advantages and disadvantages which have to be considered before raising capital. There are also various legal, financial, and control implications of external finance which businesses have to consider before raising capital from external sources. Bankruptcy is a legal process which allows businesses to be wound up in an orderly manner. The objective of bankruptcy is to distribute the assets of the business among its creditors. Bankruptcy may be filed voluntarily by the business or involuntarily by its creditors.