ICAI Notes: Types of Financing | Financial Management & Strategic Management for CA Intermediate PDF Download

 Page 1


 
 
 
a
 
 
CHAPTER 
2 
 
 
 
 
 
   TYPES OF FINANCING 
 
 
 
 
After studying this chapter, you would be able to - 
? Describe the different sources of finance available to a 
business, both internal and external.  
? Discuss the various long term, medium term and short-term 
sources of finance. 
? Discuss in detail some of the important sources of finance, 
this would include Venture Capital financing, Lease 
financing and financing of export trade by banks. 
? Discuss the concept of Securitization. 
? Discuss the financing in the International market by 
understanding various financial instruments prevalent in the 
international market. 
 
 
 
 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
Page 2


 
 
 
a
 
 
CHAPTER 
2 
 
 
 
 
 
   TYPES OF FINANCING 
 
 
 
 
After studying this chapter, you would be able to - 
? Describe the different sources of finance available to a 
business, both internal and external.  
? Discuss the various long term, medium term and short-term 
sources of finance. 
? Discuss in detail some of the important sources of finance, 
this would include Venture Capital financing, Lease 
financing and financing of export trade by banks. 
? Discuss the concept of Securitization. 
? Discuss the financing in the International market by 
understanding various financial instruments prevalent in the 
international market. 
 
 
 
 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT 
2.2 
 
 
 
 1. FINANCIAL NEEDS AND SOURCES OF 
FINANCE OF A BUSINESS 
Financial Needs of a Business 
Business enterprises need funds to meet their different types of requirements. All 
the financial needs of a business may be grouped into the following three 
categories: 
(i) Long-term financial needs: Such needs generally refer to those 
requirements of funds which are for a period exceeding 5-10 years. All 
investments in plant, machinery, land, buildings, etc., are considered as 
long-term financial needs. Funds required to finance permanent or hard-
core working capital should also be procured from long term sources. 
(ii) Medium-term financial needs: Such requirements refer to those funds 
which are required for a period exceeding one year but not exceeding 5 
years. This might be needed for stores and spares, critical spares, tools, dies, 
moulds. 
Sources of Finance
Equity Share Capital
Preference Share Capital
Retained Earnings
Debentures/ Bonds
Loans from Financial 
Institution
Others
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


 
 
 
a
 
 
CHAPTER 
2 
 
 
 
 
 
   TYPES OF FINANCING 
 
 
 
 
After studying this chapter, you would be able to - 
? Describe the different sources of finance available to a 
business, both internal and external.  
? Discuss the various long term, medium term and short-term 
sources of finance. 
? Discuss in detail some of the important sources of finance, 
this would include Venture Capital financing, Lease 
financing and financing of export trade by banks. 
? Discuss the concept of Securitization. 
? Discuss the financing in the International market by 
understanding various financial instruments prevalent in the 
international market. 
 
 
 
 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT 
2.2 
 
 
 
 1. FINANCIAL NEEDS AND SOURCES OF 
FINANCE OF A BUSINESS 
Financial Needs of a Business 
Business enterprises need funds to meet their different types of requirements. All 
the financial needs of a business may be grouped into the following three 
categories: 
(i) Long-term financial needs: Such needs generally refer to those 
requirements of funds which are for a period exceeding 5-10 years. All 
investments in plant, machinery, land, buildings, etc., are considered as 
long-term financial needs. Funds required to finance permanent or hard-
core working capital should also be procured from long term sources. 
(ii) Medium-term financial needs: Such requirements refer to those funds 
which are required for a period exceeding one year but not exceeding 5 
years. This might be needed for stores and spares, critical spares, tools, dies, 
moulds. 
Sources of Finance
Equity Share Capital
Preference Share Capital
Retained Earnings
Debentures/ Bonds
Loans from Financial 
Institution
Others
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
TYPES OF FINANCING 
 
a
    
 
2.3 
 
(iii) Short-term financial needs: Such type of financial needs arise to finance 
current assets such as stock, debtors, cash etc. Investment in these assets 
are known as meeting of working capital requirements of the concern. The 
main characteristic of short-term financial needs is that they arise for a short 
period of time not exceeding the accounting period. i.e., one year. 
Basic Principle for Funding Various Needs 
The basic principle for meeting the short-term financial needs of a concern is that 
such needs should be met from short term sources, and medium-term financial 
needs from medium term sources and long term financial needs from long term 
sources. Accordingly, the method of raising funds is to be decided with reference 
to the period for which funds are required.  
General rule for financing of different assets would take place. These rules can be 
changed depending on the nature of borrower i.e. depending on the borrower’s 
level of operation Besides, the stage of development of the business and nature 
of business would also decide the type of borrowing. Generally, it can be as 
follows: 
Stage Nature of Business Sources of Fund 
Early stage 
High Uncertainty Equity; mainly Angel fund 
High to moderate 
Uncertainty 
Equity; Venture capital; Debt 
Growth Stage Moderate to Low 
Uncertainty 
Debt; Venture Capital; Private 
Equity 
Stable stage Low Uncertainty Debt 
 2. CLASSIFICATION OF FINANCIAL SOURCES 
There are mainly two ways of classifying various financial sources (i) Based on 
basic Sources (ii) Based on Maturity of repayment period. 
© The Institute of Chartered Accountants of India
Page 4


 
 
 
a
 
 
CHAPTER 
2 
 
 
 
 
 
   TYPES OF FINANCING 
 
 
 
 
After studying this chapter, you would be able to - 
? Describe the different sources of finance available to a 
business, both internal and external.  
? Discuss the various long term, medium term and short-term 
sources of finance. 
? Discuss in detail some of the important sources of finance, 
this would include Venture Capital financing, Lease 
financing and financing of export trade by banks. 
? Discuss the concept of Securitization. 
? Discuss the financing in the International market by 
understanding various financial instruments prevalent in the 
international market. 
 
 
 
 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT 
2.2 
 
 
 
 1. FINANCIAL NEEDS AND SOURCES OF 
FINANCE OF A BUSINESS 
Financial Needs of a Business 
Business enterprises need funds to meet their different types of requirements. All 
the financial needs of a business may be grouped into the following three 
categories: 
(i) Long-term financial needs: Such needs generally refer to those 
requirements of funds which are for a period exceeding 5-10 years. All 
investments in plant, machinery, land, buildings, etc., are considered as 
long-term financial needs. Funds required to finance permanent or hard-
core working capital should also be procured from long term sources. 
(ii) Medium-term financial needs: Such requirements refer to those funds 
which are required for a period exceeding one year but not exceeding 5 
years. This might be needed for stores and spares, critical spares, tools, dies, 
moulds. 
Sources of Finance
Equity Share Capital
Preference Share Capital
Retained Earnings
Debentures/ Bonds
Loans from Financial 
Institution
Others
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
TYPES OF FINANCING 
 
a
    
 
2.3 
 
(iii) Short-term financial needs: Such type of financial needs arise to finance 
current assets such as stock, debtors, cash etc. Investment in these assets 
are known as meeting of working capital requirements of the concern. The 
main characteristic of short-term financial needs is that they arise for a short 
period of time not exceeding the accounting period. i.e., one year. 
Basic Principle for Funding Various Needs 
The basic principle for meeting the short-term financial needs of a concern is that 
such needs should be met from short term sources, and medium-term financial 
needs from medium term sources and long term financial needs from long term 
sources. Accordingly, the method of raising funds is to be decided with reference 
to the period for which funds are required.  
General rule for financing of different assets would take place. These rules can be 
changed depending on the nature of borrower i.e. depending on the borrower’s 
level of operation Besides, the stage of development of the business and nature 
of business would also decide the type of borrowing. Generally, it can be as 
follows: 
Stage Nature of Business Sources of Fund 
Early stage 
High Uncertainty Equity; mainly Angel fund 
High to moderate 
Uncertainty 
Equity; Venture capital; Debt 
Growth Stage Moderate to Low 
Uncertainty 
Debt; Venture Capital; Private 
Equity 
Stable stage Low Uncertainty Debt 
 2. CLASSIFICATION OF FINANCIAL SOURCES 
There are mainly two ways of classifying various financial sources (i) Based on 
basic Sources (ii) Based on Maturity of repayment period. 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT 
2.4 
2.1 Sources of Finance based on Basic Sources 
Based on basic sources of finance, types of financing can be classified as below: 
 
2.2 Sources of Finance based on Maturity of Payment 
Sources of finance based on maturity of payment can be classified as below: 
 
Sources of Finance
External 
Sources
Share Capital
Equity Shares
Preference Shares
Debt or 
Borrowed 
Capital
Debentures
Loan from Financial 
Institutions
Others
Internal 
Sources 
Mainly 
retained 
earnings
Sources of Finance
Long-term  
1.  Share capital or 
Equity shares
2. Preference shares
3.  Retained earnings
4.  Debentures/Bonds 
of different types 
5.  Loans from financial 
institutions
6.  Loans from State 
Financial 
Corporations
7.  Loans from 
commercial banks
8.  Venture capital 
funding
9.  Asset securitisation
10.  International 
financing like Euro-
issues, Foreign 
currency loans
Medium-term   
1.  Preference shares
2.  Debentures/Bonds
3.  Public deposits/fixed 
deposits for duration 
of three years
4. Medium term loans 
from Commercial 
banks, Financial 
Institutions, State 
Financial 
Corporations
5.  Lease 
financing/Hire-
Purchase financing
6.  External commercial 
borrowings
7.  Euro-issues
8. Foreign Currency 
bonds
Short-term
1.  Trade credit
2.  Accrued expenses  
and  deferred 
income
3.  Short term loans like 
Working Capital 
Loans from 
Commercial banks
4.  Avances received 
from customers
6.  Various short-term 
provisions
© The Institute of Chartered Accountants of India
Page 5


 
 
 
a
 
 
CHAPTER 
2 
 
 
 
 
 
   TYPES OF FINANCING 
 
 
 
 
After studying this chapter, you would be able to - 
? Describe the different sources of finance available to a 
business, both internal and external.  
? Discuss the various long term, medium term and short-term 
sources of finance. 
? Discuss in detail some of the important sources of finance, 
this would include Venture Capital financing, Lease 
financing and financing of export trade by banks. 
? Discuss the concept of Securitization. 
? Discuss the financing in the International market by 
understanding various financial instruments prevalent in the 
international market. 
 
 
 
 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT 
2.2 
 
 
 
 1. FINANCIAL NEEDS AND SOURCES OF 
FINANCE OF A BUSINESS 
Financial Needs of a Business 
Business enterprises need funds to meet their different types of requirements. All 
the financial needs of a business may be grouped into the following three 
categories: 
(i) Long-term financial needs: Such needs generally refer to those 
requirements of funds which are for a period exceeding 5-10 years. All 
investments in plant, machinery, land, buildings, etc., are considered as 
long-term financial needs. Funds required to finance permanent or hard-
core working capital should also be procured from long term sources. 
(ii) Medium-term financial needs: Such requirements refer to those funds 
which are required for a period exceeding one year but not exceeding 5 
years. This might be needed for stores and spares, critical spares, tools, dies, 
moulds. 
Sources of Finance
Equity Share Capital
Preference Share Capital
Retained Earnings
Debentures/ Bonds
Loans from Financial 
Institution
Others
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
TYPES OF FINANCING 
 
a
    
 
2.3 
 
(iii) Short-term financial needs: Such type of financial needs arise to finance 
current assets such as stock, debtors, cash etc. Investment in these assets 
are known as meeting of working capital requirements of the concern. The 
main characteristic of short-term financial needs is that they arise for a short 
period of time not exceeding the accounting period. i.e., one year. 
Basic Principle for Funding Various Needs 
The basic principle for meeting the short-term financial needs of a concern is that 
such needs should be met from short term sources, and medium-term financial 
needs from medium term sources and long term financial needs from long term 
sources. Accordingly, the method of raising funds is to be decided with reference 
to the period for which funds are required.  
General rule for financing of different assets would take place. These rules can be 
changed depending on the nature of borrower i.e. depending on the borrower’s 
level of operation Besides, the stage of development of the business and nature 
of business would also decide the type of borrowing. Generally, it can be as 
follows: 
Stage Nature of Business Sources of Fund 
Early stage 
High Uncertainty Equity; mainly Angel fund 
High to moderate 
Uncertainty 
Equity; Venture capital; Debt 
Growth Stage Moderate to Low 
Uncertainty 
Debt; Venture Capital; Private 
Equity 
Stable stage Low Uncertainty Debt 
 2. CLASSIFICATION OF FINANCIAL SOURCES 
There are mainly two ways of classifying various financial sources (i) Based on 
basic Sources (ii) Based on Maturity of repayment period. 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT 
2.4 
2.1 Sources of Finance based on Basic Sources 
Based on basic sources of finance, types of financing can be classified as below: 
 
2.2 Sources of Finance based on Maturity of Payment 
Sources of finance based on maturity of payment can be classified as below: 
 
Sources of Finance
External 
Sources
Share Capital
Equity Shares
Preference Shares
Debt or 
Borrowed 
Capital
Debentures
Loan from Financial 
Institutions
Others
Internal 
Sources 
Mainly 
retained 
earnings
Sources of Finance
Long-term  
1.  Share capital or 
Equity shares
2. Preference shares
3.  Retained earnings
4.  Debentures/Bonds 
of different types 
5.  Loans from financial 
institutions
6.  Loans from State 
Financial 
Corporations
7.  Loans from 
commercial banks
8.  Venture capital 
funding
9.  Asset securitisation
10.  International 
financing like Euro-
issues, Foreign 
currency loans
Medium-term   
1.  Preference shares
2.  Debentures/Bonds
3.  Public deposits/fixed 
deposits for duration 
of three years
4. Medium term loans 
from Commercial 
banks, Financial 
Institutions, State 
Financial 
Corporations
5.  Lease 
financing/Hire-
Purchase financing
6.  External commercial 
borrowings
7.  Euro-issues
8. Foreign Currency 
bonds
Short-term
1.  Trade credit
2.  Accrued expenses  
and  deferred 
income
3.  Short term loans like 
Working Capital 
Loans from 
Commercial banks
4.  Avances received 
from customers
6.  Various short-term 
provisions
© The Institute of Chartered Accountants of India
 
TYPES OF FINANCING 
 
a
    
 
2.5 
 
 3. LONG-TERM SOURCES OF FINANCE 
There are different sources of funds available to meet long term financial needs of 
the business. These sources may be broadly classified into: 
? Share capital (both equity and preference) & 
? Debt (including debentures, long term borrowings or other debt 
instruments). 
The different sources of long-term finance have been discussed as follows: 
3.1 Owners Capital or Equity Capital 
A public limited company may raise funds from promoters or from the investing 
public by way of owner’s capital or equity capital by issuing ordinary equity 
shares. Some of the characteristics of Owners/Equity Share Capital are: 
? It is a source of permanent capital. The holders of such share capital in the 
company are called equity shareholders or ordinary shareholders.  
? Equity shareholders are practically owners of the company as they 
undertake the highest risk.  
? Equity shareholders are entitled to dividends after the income claims of 
other stakeholders are satisfied. The dividend payable to them is an 
appropriation of profits and not a charge against profits. 
? In the event of winding up, ordinary shareholders can exercise their claim on 
assets after the claims of the other suppliers of capital have been met.  
? The cost of ordinary shares is usually the highest. This is due to the fact that 
such shareholders expect a higher rate of return (as their risk is the highest) 
on their investment as compared to other suppliers of long-term funds.  
? Ordinary share capital also provides a security to other suppliers of funds. 
Any institution giving loan to a company would make sure the debt-equity 
ratio is comfortable to cover the debt. There can be various types of equity 
shares like New issue, Rights issue, Bonus Shares, Sweat Equity.  
© The Institute of Chartered Accountants of India