Types of Finance with Explanation
Evidence proved that the origin of finance is also old like human life on this earth. Originally, the word finance is a French word. In the eighteenth century, it was adopted by the English to mean “the management of money.” Finance is the management of funds or money and involves activities such as budgeting, borrowing, forecasting, investing, lending and saving. In other words, finance is the study of managing funds and the process of acquiring the required funds.
Types of Finance
There are mainly two types of finance:
The other types of finance are
- Public Finance,
- Personal Finance,
- Corporate Finance and
- Private Finance.
Each of the types is explained below with definition and explanation.
1. Debt Finance:
Basically, the cash which you acquire to maintain or run your business is known as debt finance. Debt finance does not provide ownership control to the moneylender; the borrower must repay the principal amount along with the agreed upon interest rate. Mostly, the interest rate is determined based on the loan amount, duration, the purpose for borrowing the specific type of finance and inflation rate.
Debt finance can be classified into three types:
- Medium-term and
Short-term Debt Finance:
Loans generally needed for a period of more than one to one hundred and eighty days is called short-term debt finance. These loans are borrowed for covering the shortage of finance and temporary or occasional requirements. Short-term finance is basically required for daily business activities such as paying wages to the staffs or getting raw materials. The amount of getting a short-term loan is dependent mostly on the other sources of income for repaying. The lines of credit from the business’s suppliers are the most common forms of short-term debt finance.
Trade credit, credit cards, bill discounting, bank overdraft, working capital loans, small business loans, short-term loans from retail banks and advances from customers are some other forms of short-term finance.
Medium-term Debt Finance:
Loans generally required for a period of more than one hundred and eighty to three hundred and sixty-five days is called medium-term debt finance. The way of utilizing the funds are mostly dependent on the type of business. The businesses generally, repay the loan from the sources of cash-flow of the businesses. Businesses choose this type of finance to purchase equipment, fixed assets and the like.
Sometimes small business owners or startups use medium-term debt finance for fulfilling the fund’s rotation. Because new businesses must pay beforehand to suppliers for every required good such as buying equipment, machinery, inventories and the like. Hire purchase finance, lease finance, medium-term credits from commercial banks and issue of bonds/debentures are some examples of medium-term debt finance.
Long-term Debt Finance:
Loans generally required for a period of more than three hundred and sixty-five days is called long-term debt finance. This type of finance is mostly needed for buying plant, land, restructuring offices or buildings, etc. for a business. Long-term finance has a better interest rate than short-term finance. This debt finance usually has a repayment duration of five, ten or twenty years.
Car loans or home loans are two popular examples of long-term finance. Issue of bonds/debentures, Issue of preference shares, issue of equity shares, long-term loans from government, financial services institutions or investment banks, venture funding or funds from investors, are other examples of long-term debt finance.
2. Equity Finance:
Equity finance is a classic way of raising capital for businesses by issues or offering shares of the company. This is one of the major differences in equity finance from debt finance. This finance is generally applied for seed funding for start-ups and new businesses. Well-known companies apply this finance to raise additional capital for the expansion of their business.
Equity finance is generally raised by issues or offering equity shares of the business. Basically, each share is an owner’s unit for that specific company. For instance, if the company has offered 10,000 equity shares to public investors. An investor buys 1000 equity shares of that company, means s/he holds 10% of ownership in the company.
The other types of finance are discussed below:
Public finance deals with the study of the state’s expenditure and income. It considers only the government’s finances. The scope of public finance includes the fund’s collection and its allocation among different sectors of state activities that are considered as essential functions or duties of the government.
Public finance can be classified into three types:
- Public Expenditure
- Public Revenues
- Public Debt
i. Public Expenditure:
Public expenditure means the expenses incurred by the government for its maintenance and for the welfare and preservation of the economy, society, and the nation.
ii. Public Revenues:
Broadly public revenues include all the receipts and income irrespective their nature and source, which the government acquires during any given period. It will also include the loans raised by the government. Narrowly, it will include only the income from revenue resources which include taxes, price, fees, penalties, fines, gifts, etc.
iii. Public Debt:
Public debt means the loans raised which is a source of public finance carrying with it the repayment obligation to the individuals and the interest.
Personal finance denotes the application of finance’s principles to the monetary decisions of a family or an individual. It includes the ways in which families or individuals get, budget, spend and save monetary resources over a period, considering different future life events and financial risks. Financial position is focused on understanding the available personal resources by examining the household cash flows and net worth. Net worth is an individual’s balance sheet, derived by summing up all assets under that individual’s control, minus the household’s all liabilities at a time.
Corporate finance includes financial activities pertaining to running a corporation. It is a department or division which oversees the financial functions of a company. The primary concern of corporate finance is the maximization of shareholder value through short-term and long-term financial planning and different strategies’ implementation.
Private finance denotes an alternative method of corporate finance helping a company raise fund to avoid monetary problems with a limited time frame. Basically, this method helps a company which is not listed on a securities exchange or is incapable to obtain finance on such markets. A private financial plan can also be suitable for a nonprofit organization.