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Sources of Finance Made Simple: How Businesses Raise Money

  • Writer: Collate Institute
    Collate Institute
  • Jun 20
  • 3 min read

Updated: Jun 21

Whether you're a CA student studying Financial Management or someone curious about how companies fund their growth, understanding Sources of Finance is essential. This blog breaks down complex topics like equity shares, loans, and venture capital in an easy, engaging way.

Introduction

Every business needs money — to start, to grow, to innovate. But where does this money come from?

In Financial Management, these are called Sources of Finance. Companies can either use their own funds or borrow from others. Let’s explore both in a way that’s easy to understand.

Classification of Sources of Finance


A. Based on Duration

  • Short-term: Less than 1 year (e.g., working capital loans)

  • Long-term: More than 5 years (e.g., equity, long-term loans)

B. Based on Ownership

  • Owned Funds: Provided by the owners or shareholders

  • Borrowed Funds: With a promise to repay in a fixed duration at fixed rate of interest

C. Based on Source

  • Internal Sources: From within the company (e.g., retained earnings)

  • External Sources: From outside (e.g., banks, investors)

Owned Capital / Equity Financing


🟢 Equity Shares

When a company issues equity shares, it's selling small pieces of itself to investors. These shareholders become part-owners.

Example Visual: A pizza divided into slices — each slice represents a share.

Pros for company:

  • No repayment obligation

  • Long-term capital

Cons:

  • Loss of control

  • Shareholders expect returns

Pros for investor:

  • Ownership

  • Dividends and capital gains

  • Voting Rights


🟡 Preference Shares

These shares get fixed returns and priority over equity shares in case of dividend or liquidation.

Hybrid: Like a mix between equity and debt. Usually, no voting rights.


🔵 Retained Earnings

Companies can reinvest their own profits instead of taking loans or issuing shares.

Example Visual: Piggy bank showing saved profits going back into business.

Borrowed Capital / Debt Financing


✅ Term Loans

Loans taken from banks or financial institutions for a fixed time (e.g., 5-10 years).

Features: Fixed interest, EMI-based repayment.

✅ Debentures / Bonds

Companies raise funds by issuing debentures — a form of loan from the public or institutions.

Investor earns: Fixed interest income.

✅ Bank Loans

Includes working capital loans, overdrafts, cash credit facilities.

Used for: Day-to-day business operations.

Short-Term Sources of Finance


  • Trade Credit: Buying now, paying later

  • Working Capital Loans: Short-term bank loans

  • Bill Discounting: Selling bills to banks before due date

  • Public Deposits: Direct money from the public for a short period

Government & Institutional Sources



New-Age & Alternative Sources


  • Venture Capital: High-risk funding for startups

  • Angel Investors: Wealthy individuals investing in early-stage ideas

  • Crowdfunding: Raising money from public via online platforms

Example Visual: Crowd raising hands with money toward a startup bulb icon.

Comparison Table

Source

Risk Level

Return Expectation

Ownership Dilution

Tenure

Equity Shares

High

High

Yes

Permamnent

Preference Shares

Moderate

Moderate

Limited

Medium-term

Term Loans

Low

Low

No

Long-term

Debentures

Low

Low

No

Long-term

Retained Earnings

None

None

No

Permamnent

Choosing the Right Mix

Companies mix different sources based on:

  • Cost of capital

  • Risk appetite

  • Need for control

  • Market conditions

Example: A startup may choose equity in the early stages, while a stable company might prefer loans.


Real-World Examples

  • Zomato: Raised funds via IPO (Equity shares)

  • Reliance: Issued debentures for capital

  • Startups: Raised angel funding and VC capital

Conclusion

Finance isn't just for big companies or CAs. Whether you're a student, business owner, or investor, knowing how businesses raise money helps you make smarter decisions.

Always remember: No one source is perfect. The key lies in balancing the mix of risk, return, and control.

FAQs


Q: What is the safest source of finance?A: Retained earnings – it's internal and has no repayment risk.

Q: Why do companies prefer equity sometimes?A: To avoid loan repayment pressure and interest burden.

Q: What is the main difference between equity and debt?A: Equity gives ownership; debt requires repayment with interest.

Want to learn more finance concepts the easy way? Stay tuned for our next blog on Capital Structure: How companies decide the right mix of debt and equity!\

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