1.0 INTRODUCTION
Finance is one of the major areas of any enterprise usually given
much attention. This is because Money is an essential part of an Organization. It
even becomes an important consideration when the
case of small-scale enterprises
is considered. This is because they need little cash (compare to the
large-scale), to finance their activities, the sources are limited with bottlenecks
or constraints.
2.0 OBJECTIVES By the end of this note, you should be able to:
discuss various sources of finance
identify the difference between short-term and long-term capitals.
3.0 MAIN CONTENT
3.1 Sources of Short-Term Finance
Most small businesses will, at some stage seek funding or
investment – for growth, starting up, or to see them through a transitional
period (or a downturn). Enterprises need short-term finance to start-up a
business or to cover day-to-day running costs. This short-term finance, which
is repaid over a short period, provides the firm with working capital, which is
paid back over a number of years. We shall discuss the sources of funds
available to small-scale enterprise under these two types of capital.
1. Short-Term Capital
2. Medium-Term Capital
Short-Term Short-term finance is usually taken to be for a period of one
year.. These sources of finance include the following:
i. Loans from friends and relatives: A large number of
start-up enterprises are self-financed either through, loans from friends or through
existing sources of personal borrowings. Sometimes it can be difficult to raise
funds from other sources especially, if third party does not easily understand
your business plan. In a typical society like Nigeria, family and friends that
are well placed and who share the vision of the entrepreneur, can tender considerable
financial assistance to finance the business. It could either be a loan, which
will be repaid with or without interest, or as a gift that will not required
payment.
ii. Borrowing from Banks: Banks lending is a common source of financing
business on a short-term basis. Overdraft and loans are forms of bank lending
to small-scale enterprise. Overdraft is simple, flexible and cheap form of
borrowing. The overdraft is an obligation or privilege granted to a familiar
and regular customer of a bank to withdraw money above the deposit in his
current account with the bank. Such withdrawn amount usually attracts an
interest rate, which is calculated on daily basis. Loans from banks are mostly
obtained on a short-term basis usually one year. This is because of the need to
promptly satisfy the cash needs of their depositor. Loans are payable within a
year and interest is paid for the full period of the loan.
iii. Trade Credit
Facility: When a business is experiencing temporary difficulty in
connection with cash resources, it can improve its situation by the employing
credit facilities. With good human relations, a supplier on credit could give
an entrepreneur a supply of good/services. In this case, goods are to be paid
for at the end of the month following the month in which goods are received. Many
companies and small businesses depend on trade credit facility at the early
stage of growth when capital from normal sources is virtually unobtainable.
iv. Personal Savings: Most prospective entrepreneurs often solely back on personal
savings when starting a business. It is important for the entrepreneur to
commit a substantial portion of the needed finance to convince lenders and
investors that the business idea is worth the trial.
v. Retained Earnings: This is the part of the ploughed back into the business for future
use. Profit re-invested as retained earnings is profit that could have been
paid to owners. The amount of earnings retained has a direct impact on the
profit that could have been distributed. The major reason why enterprises uses
retain earnings is that, it is a cheaper source of financing developments in a
business since they will not have to look out for funds to developed projects.
The management of an enterprise believes that retained earnings are funds,
which do not cost anything (though this is not true). An enterprise must
however control its self-financing through retained earnings to allow for
payment of profit to the shareholders for their investment.
vi. Factoring: This involves raising funds on the security of the debt due to an
enterprise so that the cash is received earlier than when the organization could
have expected the debtor to pay. A financial institution offers to buy the
debtor’s account at a discounted rate for instance; a bank may approach Wazobia
PLC to buy its debt at a discounted rate of 10 per cent. This is to say, if Wazobia
debtor’s account is N100 million, the bank will buy the account for N90million.
It will now be the responsibility of the bank to pursue the
debtors to pay up their debt. This is a source of finance since the factor (the
bank) will make an immediate payment of 90 per cent of the first value of the
debt on buying the account. Generally, the circle of factoring is that, client
sells good to debtors, client sells debt to factor, the factor now makes immediate
payment to the company at the agreed discounted rate of the first value of
debt, and finally, the debtor makes payment to the factor.
vii. Loans from Government Agencies: Small-scale
enterprises have been recognised as a catalyst towards economic development.
Because of this, various government (both state and federal) have come up with
policies and schemes to aid in the financing of such enterprises. Soft loans
are usually given to small-scale entrepreneurs without interest. These loans
are usually repayable within a short period so that loan can be given to others
other entrepreneurs. Examples of such government agencies include National
Directorate of Employment (NDE), Small and Medium Enterprise Development Agency
of Nigeria (SMEDAN).
3.2 Medium Term Finance
Medium term finance is usually taken to be for a period of more
than one year. For a small-scale enterprise, it is usually between the periods of
one and three years. These sources of finance include the following:
i. Equipment Leasing: Leasing is an agreement between two parties, the ‘lessor’ and the
‘lessee’. The lessor owns a capital asset, but allows the lessee to use it. The
lessee makes payment under the terms of the lease to the lessor, for a
specified period. Leasing is, therefore, a form of rental. Leased assets
usually include plant and machinery, car and commercial vehicles, but may also
include computers and office equipments. Under the lease agreement, the lessor
has a complete legal title of the asset.
However, the lessee, who has possession of the asset, has a
complete use of the asset. Under a finance lease, a finance company will agree
to act as lessor in a finance leasing agreement, purchase the required equipment
from the dealer, lease it to the entrepreneur who will take possession of the
equipment and make regular payment to the finance company under the terms
agreed in the lease.
ii. Hire Purchase: This
is a form of indirect financing. It is an arrangement under which the hirer, in
return for the use of the asset makes periodic/installment payments to the
owner of the asset. The ownership of the asset does not pass on to the hirer immediately
until the payment of the final credit installment. The hire purchase agreement
usually involves a finance company and the hirer. A company uses hire purchase
as a source of finance because it is a useful and simple method of obtaining
finance since the enterprise can get the equipment needed without outright payment
of the equipment price. However, a finance company will always insist that the
hirer pay a deposit towards the purchase price.
iii. Venture Capital: This has become a vital aspect of the sources of finance. This is
the contribution put in the early stage of a business which may all be lost if
the enterprise fails but also have a significant chance of providing above
average returns, An entrepreneur starting up a business will invest venture
capital of his own, but he will probably need extra funding from another source.
Venture capital is more specifically associated with putting money in return
for an equity stake, into a new business or a major expansion scheme. A venture
capital organization recognises the high risk of loss involved in an investment
if the enterprise fails; as a result of such gamble, the organization will
require a high-expected rate of return on investments to compensate for the
high risk. When an enterprise seeks for financial assistance from a venture
capital institution, it must recognise that:
a. The institution will
want an equity stake in the company.
b. It will need to be convinced that the company will succeed.
c. It may want to have a representative appointed to the company’s
board of directors, to look after its interests.
iv. Franchising:
This is a method of expanding business on smaller capital than
would otherwise be needed. It is an alternative to raising extra capital for
growth. Under a franchising agreement, a franchisee pays a franchisor for the
right to operate a local business under the franchisor trade name. the
franchisor must bear certain costs (possibly for architect’s work establishing
cost, legal cost, marketing costs and the cost of other support services) and
will charge the franchisee an initial franchise fee to cover setup costs,
relying on the subsequent regular payment by the franchisee for an operating
profit.
These regular payments will usually be a percentage of the
franchisee’s turnover. The franchisor will probably pay a large part of the
initial investment but the franchisee will also be required to contribute his
share of the investment. The franchisor may also help the franchisee to obtain
loan capital to pay for his share of the investment cost. The advantage of a
franchise to a franchisee is that he obtains ownership of a business for an
agreed number of years (including stock and premises) together with the support
of a large Organization’s marketing effort and experience.
The franchisee is able to avoid some of the mistakes of many small
businesses, because the franchisor has already learned from its own past
mistakes and develop a scheme that works.
4.0 CONCLUSION
The discussion above showed that finance is an important
ingredient to the survival of an enterprise. An entrepreneur has various
sources of finance open to him from which he can obtain funds for his business.
It is important that to note that a business idea without a means of financing
will die in no time. These various sources of financial assistance help an
entrepreneur and owner of small-scale business in Nigeria to bring business
ideas to reality.
5.0 SUMMARY
In this note, we have discussed how enterprises can raise funds by
way of short-term and medium term borrowing. This note identified and explained
various sources of finance including factoring and leasing.
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