The role of finance is very crucial. It is the backbone of every activity. For example: suppose you’ve to purchase a car, you’ll start your planning only if your finances allow you. But there’s a huge difference between amount of capital required for purchasing a car and sanctioned by selecting different types of finance. What are the two main types of finance? There are mainly two types of financing. They are broadly divided as debt finance and equity finance. These categories are further divided into various types like: short-term, medium- term and long-term. There are various options available for financing based on type of finance you required.
Types of Finance:
Presently entrepreneur, startups, businesses must be aware of all types of finance available in the market. Also it’s their primary due to analyse it like, what they can do, which type of financing technique is better to another, and where required funding can be found. So here you can gain enough knowledge about it. What are the two main types of finance? Let us understand in detail:
1. Debt Financing:
Debt financing is essentially cash that you obtain to run or maintain your business. Debt financing does not give the moneylender ownership control, but rather the principal amount must be repaid along with the interest percentage agreed upon. Interest percentage is mostly determined based on duration, inflation rate, amount of loan and the purpose for which specified type of finance is been used. You can consider debt financing as being divided into three types of finance they are: short-term finance, medium-term finance and long-term finance.
A. Short-Term Types of Finance:
Loans usually for more than 1 to 180 days of period is known as short-term types of finance. This are made to cover occasional or temporary requirements and shortage of funds. Short-term financing most commonly applies to cash required for the everyday activities of the business, for example, obtaining raw materials or paying wages to their staff members. The amount to get a short-term credit is mostly dependably on the other source of income for repayment. Most common type of short-term finance is line of credit from their suppliers. Following are some of the types of short-term finance:
- Trade Credit.
- Bank Overdraft.
- Bill Discounting.
- Small Business Loans.
- Working Capital Loans.
- Advances from customers.
- Short-term loans from Retail Banks.
B. Medium-Term Types of Finance:
Loans usually required for more than 180 to 365 days of period is known as medium-term types of finance. It mostly depends on business how the funds are utilized. The business will mostly repay from the cash-flow source of the business. Mostly such type of finance are chosen by business to buy fixed assets, equipment’s and so forth. Many times it is been observed that such types of financing are frequently used by startups or small business owners to fulfill the rotation of funds. As new businesses have to pay upfront to suppliers for all the required goods. For example: buying machinery, equipment, inventories etc. Following are some of the types of medium-term finance:
- Lease Finance.
- Hire Purchase Finance.
- Issue of Debenture / Bonds.
- Medium-term loans from Commercial Banks.
C. Long-Term Types of Finance:
Loans usually required for more than 365 days of period is known as long-term type of finance. Such financing for the most part is required for buying land, plant, restructuring buildings or offices, etc. for your business. Normally long-term types of financing options have better rate of interest when compare to short-term financing. Such type of finance are usually having repayment duration of 5, 10 or 20 years of period. For example: Home loans or Car loans are categories as types long-term of finance. Following are some of the types of long-term finance:
- Issue of Equity Shares.
- Issue of Preference Shares.
- Issue of Debenture / Bonds.
- Venture Funding or Finance from Investors.
- Long-Term Loans from Government, Investment Banks or Financial Services Institutions.
2. Equity Financing:
Equity financing is a typical route for businesses to raise capital by offering or issues shares of their company. This is a major difference of equity financing from debt financing. Equity financing option is ordinarily used for seed funding for new business and start-ups. Whereas raising additional capital for a business to expand for well-known companies. Equity financing is commonly raised by offering equity stocks of the business. Typically each stock is a unit of ownership for that particular organization. For example: if the organization has offered 100,000 equity stocks to public investors. You being the investor buy 10,000 equity stocks of that company, which means that you hold 10% of ownership in that company.
Those who hold stocks of a company are known as shareholders. Shareholder gets ownership, dividend and voting rights in a company. Shareholders can sell their stocks at the higher price to other investors to gain profits from it. Usually large companies have various classes of equity stocks when offered to public investors. For example:
- A company can decide to offer equity stocks as an ownership along with dividend and voting rights.
- A company can also offer equity stocks as an ownership with neither dividend nor voting rights.
- A company can offer preferred stocks as an ownership with no voting rights but they will get dividend on stocks.
If you are an owner of a company or you are managing organization finance then it became your primary goal to take knowledge on types of finance. Without finance a company cannot run its business operations. Also there will be lot of times where you will require funds for your organizational activities. It would then be easy for you to select a right types of financing option which will best suit your situation.
- Tutorial Course - Basic Finance Concepts For Beginners Guide
» e-Learning Chapter 1: What is Finance with Examples?
» e-Learning Chapter 2: What is International Finance?
» e-Learning Chapter 3: Importance of Finance
» e-Learning Chapter 4: Features of Finance
» e-Learning Chapter 5: Source of Funds
» e-Learning Chapter 6: Types of Capital
» e-Learning Chapter 7: Types of Capital Market
» e-Learning Chapter 8: Types of Investment
» e-Learning Chapter 9: Short Term Sources of Finance
» e-Learning Chapter 10: Long Term Sources of Finance
» e-Learning Chapter 11: Finance Quiz – Finance Basics for Beginners