Last Updated : 03 May, 2023
Operating a business in this dynamic world is not an easy task. Every business requires funds to operate and carry out various activities, and without funds, there is no future for any organization. Therefore, finance is called the lifeblood of any business. There is always an initial amount of capital invested by the entrepreneur, which is not always sufficient to grow the business. So various sources of funds are required for running a business. There are various sources through which funds could be generated, but the correct knowledge of various sources is a vital part to make the correct decision because every source of the fund comes with a cost that needs to be compared and calculated before deciding which source is better for the organization. Therefore, every source of funds needs to be analyzed carefully. Funds can be classified on the Basis of Period (Long-term, Medium-term, and Short-term), Ownership (Owner’s Fund and Borrowed Fund), and Source of Generation (Internal Sources and External Sources).
Classification of Sources of Funds
A. Based on Period
1. Long-term Sources:
Long-term sources of funds fulfill the needs of any business for a long period that is for a period exceeding 5 years. Long-term funds are generally used for purchasing fixed assets. Examples of long-term sources of funds are shares, debentures, bonds, long-term loans from banks, etc.
2. Medium-term Sources:
The funds which are required for more than one year but less than five years. These include public deposits, borrowing from banks, lease financing, etc.
3. Short-term Sources:
The funds which are required for less than one year is termed short-term sources of fund. These kinds of funds are easily available and are easy to repay also. For Example, short-term loans from commercial banks, trade credit, factoring and commercial paper.
B. Based on Ownership
1. Owner’s Funds:
As the name suggests, owner’s funds are those which are provided to the firm by its owners. The owner can be a sole trader, a shareholder of the company, or a partner. The owners not only invest capital but also reinvest profits in the organization. The owner does not have to refund the invested amount during the lifetime of the organization. The investment made by the owners decides their control over the management. Issue of equity shares and retained earnings are the two most important sources of the owner’s fund.
2. Borrowed Funds:
As the name suggests, it is a fund which is borrowed from different financial institutions or raised through the issue of bonds debentures. These sources provide a firm with different sources of funds for a fixed period and come with a fixed amount of interest, which a company has to pay whether it is making a profit or not. Usually, the borrowed funds are provided to the firms by keeping some fixed assets as security. So this source of funds is a bit riskier as compared to the owner’s fund. For Example, public deposits, loans from a bank, debentures bonds, etc.
C. Based on the Source of Generation
1. Internal Sources:
Every business organization has some funds which are kept aside for future uncertainties and needs. When the funds are generated internally, then they are said to be internal sources of funds. Internal sources of funds have their own merits and demerits. The biggest advantage of internal sources is that these are a permanent source of funds that could be easily availed, and does not involve any explicit cost as it belongs to the business enterprises only. However, internal funds lead to various risks to the firm and can accomplish only the limited needs of the firm. For example, equity share capital, retained earnings, etc.
2. External Sources:
When a large amount of funds is required by a business enterprise, then it opts for external financing. Therefore, external sources of finance are the sources that are obtained from outside the business. The cost of raising funds from external sources is more than the cost from internal sources. Sometimes, an organization has to mortgage its assets as security. For example, lease financing, factoring, preference shares, Commercial papers, etc.
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FAQs
Funds can be classified on the Basis of Period (Long-term, Medium-term, and Short-term), Ownership (Owner's Fund and Borrowed Fund), and Source of Generation (Internal Sources and External Sources).
How will you classify the sources of funds on the basis of period? ›
On the basis of period, the different sources of funds can be categorised into three parts. These are long-term sources, medium-term sources and short-term sources.
What are the four primary sources of funds? ›
The four primary sources of funds are: Sales revenue Equity capital – money received from the owners orfrom the sale of shares of ownership in a business Debt capital – borrowed money obtained throughloans of various types Proceeds from the sale of assetsAll of the above.
What are the sources of funds and use of funds? ›
The main sources of funding are retained earnings, debt capital, and equity capital. Companies use retained earnings from business operations to expand or distribute dividends to their shareholders. Businesses raise funds by borrowing debt privately from a bank or by going public (issuing debt securities).
What is an example of a source of funds? ›
A legitimate example of a source of funds can include anything where the money was obtained through legal means, such as: wages, bonuses, dividends, and other income from employment. pension payments. interest from personal savings.
What are the different classifications of finance? ›
"Finance" is typically broken down into three broad categories: public finance, corporate finance, and personal finance.
How do you identify source of funds and source of wealth? ›
When assessing a person's SOW, factors like business ownership, real estate holdings, investments, and inheritances are taken into account. SOF refers to the origin of the funds used for a specific transaction or business relationship. SOW identifies the overall source of the client's wealth or asset base.
How do you classify financial assets? ›
Under IAS 39, financial assets are classified into one of four categories:
- Held to maturity (HTM)
- Loans and receivables (LAR)
- Fair value through profit or loss (FVTPL)
- Available for sale (AFS).
Liabilities and net worth on the balance sheet represent the company's sources of funds. Liabilities and net worth are composed of creditors and investors who have provided cash or its equivalent to the company in the past. As a source of funds, they enable the company to continue in business or expand operations.
What are the 2 most important sources of funds? ›
Debt and equity are the two major sources of financing. Government grants to finance certain aspects of a business may be an option. Also, incentives may be available to locate in certain communities or encourage activities in particular industries.
Debt and equity finance
Debt and equity are the two main types of finance available to businesses. Debt finance is money provided by an external lender, such as a bank. Equity finance provides funding in exchange for part ownership of your business, such as selling shares to investors.
What are the secondary sources of funds? ›
A second source of funds is borrowing through debt securities. A corporation may take out a debt security such as a loan, commonly evidenced by a note and providing security to the lender.
What is the most important financial statement? ›
Typically considered the most important of the financial statements, an income statement shows how much money a company made and spent over a specific period of time.
What is the source of funds? ›
Source of Funds (SOF) is the origin of an individual's funds upon the commencement of a business relationship/transaction. Businesses need to collect this information from their customers to ensure that the transactions aren't made with money laundering purposes.
What is source of fund verification? ›
Verifying the source of funds on a risk-sensitive basis involves confirming where those funds came from, how they were obtained by the customer and whether this is consistent with what you expect of the customer.
What do you mean by sources of funds? ›
What is Source of Funds? For growing their business units, companies seek for sources of funding. Funding, also known as the financing, is an act to contribute the resources to finance the project, or an investment or any cause related to the business. Funding is channelled out for long as well as short term purpose.
What are the five classifications of governmental funds list and define them? ›
Governmental fund reporting often has a budgetary orientation. Governmental funds are classified into five fund types: general, special revenue, capital projects, debt service, and permanent funds.
What is the other name for classification of borrowed funds? ›
(d) Borrowed funds are generally raised by issuing debentures through credit or loans. It is also termed as debt financing.
