Financing is a process which is linked to the financial activity of a subject. The activities include investing, buying something or providing money for a particular purpose. The main function of financing is to help businesses or consumers to achieve their goals with additional capital.
The process of making a financial decision requires the presence of financial institutions, also known as banking institutions. In the broadest sense, these institutions may be divided into three categories:
- Depository institutions, which manage deposits and provide loans (banks, credit unions, trust companies, mortgage loan companies);
- Contractual institutions (insurance companies and pension funds);
- Investment institutions (investment banks, underwriters and brokerage firms).
Generally speaking, financial institutions give money to businesses, consumers, and investors.
While consumer financing is easier to understand because you probably face these words in your everyday life in the form of consumer credits, business financing is more complex because it combines many sources a business can rely on. The types of financial sources for businesses may be divided based on period, ownership and sources of generation.
We may distinguish three groups of the financial sources based on the period for which the money is required. Long-term sources of funds are equity (equity shares), bonds (debenture), long-term loans from financial institutions and the government, venture funding and international financing (euro issue, foreign currency loans, ADR). Medium-term sources include medium-term loans and lease financing. Short-term sources are short-term loans, such as credits.
The sources of finance may be also divided into two groups based on ownership and control. According to these characteristics, there are owned (equity) and borrowed (debt) types of capital. Also, we can separate financial sources based on the source of generation to internal and external. Internal financing is generated within the business. It includes, for example, retained profits and sale of assets. External sources are generated outside of the business.
Below we provided a detailed explanation of the most used sources of finance.
Equity financing is a form of attracting money to businesses, which involves the company’s stock sale and providing a part of the company’s ownership in exchange for cash. The proportion of equity financing depends on the size of investment by the owner.
Debt is the financing that must be repaid. The other specific issue of this type of capital source is that lenders require a rate of interest to be paid in exchange for their money.
In this type of financing, the owner of assets (the lessor) gives another person (the lessee) the right to use the asset for a regular, for example, monthly, payment. We can mention vehicles, equipment, and software as the assets, which attract lease finance.
Governments are also deeply involved in the financing process by structuring the government budget. The government structures often face the situation when they spend more money than receive as revenue by borrowing new funds. This situation is called deficit financing.