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Interactive Audio Lesson
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Short-Term vs Long-Term Finance
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Today, weβll discuss the types of business finance based on the time period. Can anyone tell me the difference between short-term and long-term finance?
Short-term finance is for immediate needs, right?
Exactly! Short-term finance is typically up to one year, used for things like trade credit or bank overdrafts. Long-term finance, on the other hand, is for periods over five years, like equity shares. Can anyone give me an example of short-term finance?
Like borrowing money from a bank to buy materials?
Precisely! Well done. Remember, short-term needs are like quick sprints, whereas long-term finance is like a marathon. Do you all understand the crucial differences?
Yes, but when should a business prefer long-term finance?
Good question! Businesses typically prefer long-term finance for major investments that require significant capital, like purchasing machinery. Now, let's summarize what we learned: Short-term finance is for immediate needs, while long-term finance is for investments lasting beyond five years.
Owned Capital vs Borrowed Capital
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Next, let's explore owned capital versus borrowed capital. Owned capital is funds from owners or shareholders. Can anyone name a type of owned capital?
Retained earnings, right?
Exactly! Retained earnings are profits kept in the business for reinvestment. Now, can anyone name a form of borrowed capital?
Loans from banks or other financial institutions?
Correct! Borrowed capital includes loans and debentures. Remember, using borrowed funds increases financial risk, as they need to be repaid with interest. Let's think about this: Why might a business choose borrowed capital over owned capital?
Maybe to avoid diluting ownership?
Spot on! Businesses often avoid equity to retain control. Great work, everyone! To summarize, owned capital comes from within the business, while borrowed capital involves external loans.
Internal vs External Sources
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Now, let's talk about internal and external sources of finance. Internal sources include retained earnings and personal funds. Can anyone provide examples of external sources?
Commercial banks and issuing shares?
Excellent! External sources are crucial for businesses needing more extensive funding. Why do you think a business might prefer internal sources?
It's cheaper because there are no interest payments?
Exactly, and since there's no need to repay, it reduces financial strain! Very insightful! To wrap up, internal sources tend to be low-cost and flexible, while external sources provide larger sums but come with repayment obligations.
Factors Influencing Finance Choice
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What factors influence the choice of finance for a business? Letβs discuss some of them.
The time period is one, right?
Absolutely! The necessity of grand financing depends on whether the need is short-term or long-term. What else?
Cost of finance?
Yes! Interest rates and costs of raising capital must be factored in. Are there any other considerations?
Control is important too, right?
Right again! Many business owners may avoid equity finance because they want to maintain control of their business. Excellent contributions! In summary, the choice of finance is influenced by time period needs, cost, control factors, and financial risks.
Introduction & Overview
Read a summary of the section's main ideas. Choose from Basic, Medium, or Detailed.
Quick Overview
Standard
The section outlines how business finance can be sourced based on different criteria, including time period (short-term, medium-term, long-term), ownership (owned vs borrowed capital), and whether the sources are internal or external. Additionally, it highlights the factors that influence the choice of financing options for different sizes of businesses.
Detailed
Sources of Business Finance
This section provides an overview of the various sources of business finance essential for operating and expanding a business. Businesses can source finance based on different criteria:
1. Based on Time Period
- Short-Term: Up to 1 year (e.g., trade credit, bank overdraft).
- Medium-Term: 1 to 5 years (e.g., bank loans, leasing).
- Long-Term: Over 5 years (e.g., equity shares, debentures).
2. Based on Ownership
- Owned Capital: Funds from owners/shareholders (e.g., equity capital, retained earnings).
- Borrowed Capital: Funds borrowed and repayable with interest (e.g., loans, debentures).
3. Based on Source
- Internal Sources: Retained earnings, sale of assets, owner's personal funds.
- External Sources: Commercial banks, financial institutions, issue of shares.
4. Factors Affecting Choice of Finance
Key factors influencing the choice of finance include time period needs, cost of finance, control considerations, financial risk, and availability of funds.
5. Relevance for Business Size
The choice of financing method varies depending on business size, with micro businesses relying on personal networks, small businesses considering bank loans, medium enterprises using venture capital, and large businesses accessing institutional finance.
By understanding these sources and their implications, businesses can make informed financial decisions that affect their growth and sustainability.
Audio Book
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Sources Based on Time Period
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A. Based on Time Period
| Type | Description | Examples |
|---|---|---|
| Short-Term | Up to 1 year | Trade credit, bank overdraft |
| Medium-Term | 1 to 5 years | Bank loans, leasing |
| Long-Term | Over 5 years | Equity shares, debentures, long-term loans |
Detailed Explanation
This chunk discusses the classification of business finance sources based on the duration for which the funds are needed.
- Short-Term financing is where businesses borrow money for a duration of up to one year. This is often used for immediate needs such as inventory purchases or managing cash flow. Examples include trade credit and bank overdrafts.
- Medium-Term financing lasts between one to five years. It's suitable for purchasing equipment or other investments that will eventually generate profits. Common forms include bank loans and leasing agreements.
- Long-Term financing is needed for more extended periods, usually over five years. This type of financing is ideal for significant investments like business expansion. Examples include equity shares and debentures.
Examples & Analogies
Imagine a bakery that needs flour to meet a sudden surge in demand due to a local festival. It might ask a supplier for trade credit (short-term) to pay for flour later. If the bakery plans to buy a new oven, it could take out a bank loan for five years (medium-term). And if it wants to open a second location, it might issue equity shares to raise funds (long-term).
Sources Based on Ownership
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B. Based on Ownership
| Type | Description | Examples |
|---|---|---|
| Owned Capital | Funds from owners/shareholders | Equity capital, retained earnings |
| Borrowed Capital | Funds borrowed and repayable with interest | Loans, debentures, public deposits |
Detailed Explanation
This chunk describes how sources of business finance can also be classified based on ownership.
- Owned Capital refers to funds that come directly from the owners or shareholders. This includes money the owners have invested into the business (equity capital) and profits that are reinvested back into the company (retained earnings).
- Borrowed Capital involves funds that are acquired through loans or debt securities that will need to be repaid with interest. It includes traditional bank loans, debentures (which are a type of bond), and public deposits.
Examples & Analogies
Consider a new coffee shop. The owner spends her savings (owned capital) to start the shop and reinvests profits from her first month into buying more equipment (retained earnings). If she decides to expand her seating, she might take out a bank loan or issue debentures to raise additional funds (borrowed capital).
Sources Based on Source
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C. Based on Source
Internal Sources
- Retained earnings
- Sale of assets
- Ownerβs personal funds
External Sources
- Commercial banks
- Financial institutions
- Issue of shares, debentures
Detailed Explanation
This chunk outlines the sources of business finance categorized into internal and external sources.
- Internal Sources are funds that come from within the business. These include retained earnings, which are profits not distributed to shareholders but reinvested in the business, sale of assets that the business no longer needs, and personal funds from the owner.
- External Sources are funds generated from outside the business. This category includes loans from commercial banks and financial institutions, as well as raising capital through issuing shares or debentures.
Examples & Analogies
Imagine a tech startup that has been successful enough to reinvest its early profits into further development (retained earnings). If it decides it needs new computers, it might sell off old equipment (sale of assets) to raise funds. To expand its team, it could also approach a bank for a loan (external source).
Definitions & Key Concepts
Learn essential terms and foundational ideas that form the basis of the topic.
Key Concepts
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Business Finance: Essential funds required for operation and growth.
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Short-Term Finance: Funds needed for immediate needs, typically under one year.
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Long-Term Finance: Funding for extended periods, typically over five years.
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Owned Capital: Money invested by the owners of the business.
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Borrowed Capital: External funds that need repayment.
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Internal Sources: Funds generated within the business.
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External Sources: Funds raised from outside the business.
Examples & Real-Life Applications
See how the concepts apply in real-world scenarios to understand their practical implications.
Examples
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A small bakery using personal savings for initial startup costs illustrates owned capital.
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A tech company obtaining a loan from a bank to finance a new software project serves as an example of borrowed capital.
Memory Aids
Use mnemonics, acronyms, or visual cues to help remember key information more easily.
π΅ Rhymes Time
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For finance you need, think first of time, short for quick fix, long for the climb.
π Fascinating Stories
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Imagine a baker who starts with personal savings (owned capital) for her small bakery and later borrows from the bank (borrowed capital) to expand her kitchen.
π§ Other Memory Gems
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Remember 'I BITE' for financing choices: Internal funds, Borrowed funds, Investment time, Terms of repayment, Expenses.
π― Super Acronyms
Use the acronym 'SLOPE' to remember financing types
- Short-term
- Long-term
- Owned capital
- Borrowed capital
- External sources.
Flash Cards
Review key concepts with flashcards.
Glossary of Terms
Review the Definitions for terms.
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Term: Business Finance
Definition:
Funds required for conducting business operations.
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Term: ShortTerm Finance
Definition:
Finance that is needed for a period of up to one year.
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Term: LongTerm Finance
Definition:
Finance required for periods exceeding five years.
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Term: Owned Capital
Definition:
Funds invested in a business from owners or shareholders.
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Term: Borrowed Capital
Definition:
Funds borrowed that must be repaid with interest.
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Term: Internal Sources
Definition:
Funds sourced from within the business, such as retained earnings.
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Term: External Sources
Definition:
Funds sourced from outside the business, such as loans or shares.