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 analyze 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:
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.
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. Example of short-term types of finance: 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:
- Credit Cards.
- Trade Credit.
- Bank Overdraft.
- Bill Discounting.
- Small Business Loans.
- Working Capital Loans.
- Advances from customers.
- Short-term loans from Retail Banks.
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. Example of medium-term types of finance: 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.
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. Example of long-term type of finance: 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.
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.
Example of equity type of financing: 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.
Seed Investors (Angel Investors)
In most cases, the amount of money invested by such investors is less than $0.5 million. This kind of equity financing consists of investors who are typically family members or close friends of the business’s founders or owners.
In addition, rich individuals or groups of wealthy persons that provide financial assistance to enterprises are referred to as “angel investors” as well. An angel investor will not be involved in the day-to-day operations of a company’s management.
IPOs (Initial public offerings)
An initial public offering (IPO) is a method of raising capital for companies that are more established (IPO). The initial public offering (IPO) allows businesses to raise cash by selling their stock to the general public for trading on the stock exchanges.
Venture Capital Firms
In the business world, venture capital companies are a collection of investors that make investments in enterprises that they believe will develop at a quick pace and will eventually be listed on stock markets. When compared to angel investors, they make greater investments in firms and earn a larger interest in the company as a result of their efforts. A venture capitalist is a person who makes investments in companies that are worth more than $1 million. Private equity financing is another term for this form of funding.
This kind of equity financing is comprised of huge groups of angel investors that provide capital to start-up and small- to medium-sized enterprises. A crowdfund investment might be as little as $1,000 per investor, depending on the size of the fund.
It is possible to establish an online crowdfunding “campaign” using one of the crowdfunding websites to raise funds for this sort of fundraising. Crowdfunding systems enable a large number of people from the general public to invest small sums of money in a firm.
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.
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Basic Finance Concepts For Beginners Guide
- Chapter 1: What is Finance with Examples?
- Chapter 2: What is International Finance?
- Chapter 3: Importance of Finance
- Chapter 4: Features of Finance
- Chapter 5: Source of Funds
- Chapter 6: Types of Capital
- Chapter 7: Types of Capital Market
- Chapter 8: Types of Investment
- Chapter 9: Short Term Sources of Finance
- Chapter 10: Long Term Sources of Finance
- Chapter 11: Finance Quiz – Finance Basics for Beginners
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