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Business Finance Module 4

This document discusses sources and uses of short-term and long-term funds for businesses. It defines short-term funds as those used for day-to-day operations like working capital, while long-term funds are used for capital investments and permanent working capital needs. Sources of short-term funds include suppliers, stockholder advances, bank loans, and informal lenders. Sources of long-term funds include equity investors, internally generated revenue, banks, and bond markets. The document also examines challenges that small and medium enterprises face in obtaining financing, such as limited track records and collateral.

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CESTINA, KIM LIANNE, B.
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55 views

Business Finance Module 4

This document discusses sources and uses of short-term and long-term funds for businesses. It defines short-term funds as those used for day-to-day operations like working capital, while long-term funds are used for capital investments and permanent working capital needs. Sources of short-term funds include suppliers, stockholder advances, bank loans, and informal lenders. Sources of long-term funds include equity investors, internally generated revenue, banks, and bond markets. The document also examines challenges that small and medium enterprises face in obtaining financing, such as limited track records and collateral.

Uploaded by

CESTINA, KIM LIANNE, B.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

MODULE 4

Sources and Uses of Short-term and Long-term


Funds

Subject Objectives

After studying Module 4, you should be able to:


1. Understand the concept of financing.
2. Know the concept of debt and equity financing.
3. Understand and calculate the advantages and disadvantages of debt
and equity financing.
4. Know the sources and uses of short-term and long-term funds.
5. Identify and distinguish the problems faced by MSMEs in financing.
6. Determine borrowers’ duties to creditors.

Financing
Financing is the process of providing funds for business activities, making
purchases, or investing.

Debt Financing
Can be a form of borrowing from banks or other lending institutions or
issuance of debt securities like commercial papers and bonds. Debt financing
occurs when a firm sells fixed income products such as bonds, bills, or notes,
to investors to obtain the capital needed to grow and expand its operations.
The amount of investment loan, referred to as the principal, must be paid
back at some agreed date in the future.

Business Finance
Year Revised: 2020 Page 1 of 5
Table 4.1. Advantages and disadvantages of debt financing
Advantages Disadvantages
1) Interest expense provides tax shield 1) Payments have to made on time
because unpaid interest and principal
lead to penalties and more interest.
2) Creditors generally do not intervene 2) Too much debt can expose the
company to a bankruptcy risk and
may disrupt the operations of the
company. Suppliers may decide to
stop delivering merchandise,
managers’ executive time will be spent
fixing debt problem, and lenders have
higher claim on any liquidated assets
than shareholders.

Equity Financing
Equity financing is the process of raising capital through the sale of shares.
Companies raise money because they might have a short-term need to pay
bills or they might have a long-term goal and require funds to invest in their
growth. By selling shares, they sell ownership in their company in return for
cash.

Table 4.2. Advantages and disadvantages of equity financing


Advantages Disadvantages
1) If company is 100% financed by 1) Cash dividends are not tax-deductible.
equity or its leverage ratio is low, it
will be attractive to creditors.
2) Offering new shares to other investors
may dilute the ownership stake in terms of
percentage of existing stockholders.

Sources and Uses of Short-Term Funds


Short-term funds are normally used to finance day-to-day operations of the
company. It is used for working capital requirements such as accounts
receivables and inventories. It can also be used for bridge financing where a
company has some maturing obligations and does not have enough cash to

Business Finance
Year Revised: 2020 Page 2 of 5
pay such maturing obligations. There are occasions when the management of
a company decides to borrow short-term loan to address this problem.

The following can be sources of short-term funds:


1) Suppliers
2) Advances from stockholders
3) Credit cooperatives
4) Bank loans
5) Lending companies
6) Informal lending sources

Sources and Uses of Long-Term Funds


Long-term funds are used for long-term investments or sometimes called
capital investments. This includes expansion, buying new equipment. Or
buying a piece of land which will be site for future expansion. Long-term funds
can also be used to finance permanent working capital requirements.

The following are the different sources of long-term funds:


1) Equity investors
2) Internally generated funds
3) Banks
4) Bond market
5) Lending companies

Problems Faced by SMEs in Financing


While there seems to be an abundance of funds available for SMEs, the reality
is the SMEs are not able to avail most of these facilities for many reasons.

The following are reasons for the inability of SMEs to take advantage of
available financing:
1) Limited track record
2) Limited acceptable collateral
3) Inadequate financial statements
4) Lack of business plans

Business Finance
Year Revised: 2020 Page 3 of 5
According to potential creditors, the following reasons for rejecting loan
applications are:
1) Poor credit history
2) Insufficient collateral
3) Insufficient sales, income, and cash flows
4) Unstable business type
5) Poor business plans

Duties of the Borrower to Creditors


1) Pay the creditors based on the payment schedule agreed upon.
2) Provide the collaterals agreed upon in the loan negotiation with proper
documentation, if necessary and if applicable.
3) Comply with the provisions of the loan covenant such as maintaining
certain liquidity and leverage ratios.
4) Notify the creditor if the company is acquiring another company or the
company is now the subject of acquisition.
5) Do not default on the loans as much as possible.

Business Finance
Year Revised: 2020 Page 4 of 5
References

Cayanan, A.S & Borja, D.V. (2017). Business Finance. REX Book Store

Business Finance
Year Revised: 2020 Page 5 of 5

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