Finance is the backbone of every business. Though short-term funding is essential to manage day-to-day activities, long-term sources of finance are vital for sustaining and expanding any business. Long-term sources of finance are the funds secured by businesses for a long period, usually more than one year, to finance large-scale operations or projects such as infrastructure, plant setup, acquisitions, and modernization. These funds can be sourced from equity, loans, or debentures to ensure steady growth and business development.
What are Long Term Sources of Finance?
It is essential to understand the meaning of long term sources of finance. Sources are financial resources provided to companies in order to raise funds for investments for a long time or to accomplish strategic objectives. Long term financing helps stabilize a business by lowering the reliance on short-term borrowings. A few examples are equity shares, retained earnings, long term loans, and debentures. It not only facilitates acquiring fixed assets but also manages the stability of funds.
Features of Long Term Sources of Finance
Long-term sources of finance have characteristics that distinguish them from short-term financing options. These features make them suitable for sustainable growth:
- Extended Repayment Period: Long-term finance offers a repayment period of more than one year, which gives businesses enough time to generate returns on investments made using these funds.
- Higher Capital Availability: Since long-term finance usually encompasses large-scale funding, businesses can raise a considerable amount of money to finance projects such as establishing new plants or venturing into new markets.
- Operational Stability: Funds from long-term sources give stability to businesses so that they can concentrate on growth without worrying about short-term liabilities.
- Diverse Sources: Long term financing sources include equity, retained earnings, loans, debentures, and venture capital. Each has flexibility depending on the needs of the company.
- Cost Implications: The cost of long-term of finance is normally lower than that of short-term loans because the risk perception by lenders is lower. However, equity financing may dilute ownership.
Sources of Long Term Finance
Business enterprises utilize various sources of finance for obtaining long-term financing. The following are in-depth looks into the primary sources.
- Equity Shares: Equity shares form the chief source of long-term finance for a business enterprise. Through public issues of shares, businesses can raise considerable funds without having the liability of re-paying.
- Retained Earnings: Retained earnings are the profits that are reinvested in the business rather than being paid out as dividends. This is a self-financing method that does not incur additional debt and is cost-effective.
- Debentures: Debentures are long-term debt securities issued to raise funds from the public. They carry a fixed rate of interest and a predetermined schedule of repayment.
- Long-term Loans from Financial Institutions: Banks and other financial institutions offer long-term loans to cater to the capital expenditure needs of businesses. Such loans are accompanied by structured repayment terms.
- Venture Capital: Venture capitalists are the long-term sources of finance for start-ups and small businesses. Venture capitalists also provide advice and mentorship.
- Lease Financing: Lease financing is a source of finance that allows businesses to utilize assets without ownership, thus eliminating significant upfront costs while ensuring long-term operational efficiency.
Benefits of Long Term Sources of Finance
Long term sources of finance benefit businesses in numerous ways that result in sustained business growth. These include:
- Lesser Repayment Burden: A longer repayment period means less pressure on the financials of a business, which can now be utilized towards operational efficiency.
- Supports Growth and Expansion: It helps in making heavy investments, as the business entity can scale up the operations and meet the strategic targets.
- Cost Efficient: Long term finance is cost-effective as interest rates are much lesser than those in short-term financing.
- Creditworthiness: Timely servicing of long-term finance develops a company’s creditworthiness and increases its possibility of receiving funding in the future.
- Ownership Retention: Some sources, such as retained earnings, do not dilute ownership, unlike equity financing.
Disadvantages of Long Term Finance
Long term finance is not without its limitations:
- High Initial Costs: The underwriting and administrative costs associated with arranging long-term finance, especially through equity or debentures, can be very high.
- Ownership Dilution: Equity financing dilutes ownership among shareholders, potentially reducing decision-making control for existing owners.
- Risk of Over-Leverage: Heavy dependence on debt as a source of long-term financing is likely to raise financial leverage, which may be hazardous in case of an economic downturn.
- Regulatory Compliance: Long-term financing techniques such as debentures and equity demand rigid adherence to regulatory norms, which is a time-consuming process.
- Fixed Financial Commitments: In case of loans or debentures, organizations have to pay interest and capital periodic repayments without considering their economic situations
Difference between Long and Short Term of Finance
Finance can be broadly categorized into long-term and short-term based on the duration of funds’ usage and repayment. Long-term finance supports extensive investments like infrastructure and business expansions, while short-term finance caters to immediate operational needs like inventory and payroll management. Organization sources both long term and short-term finances according to their need. The following is a side-by-side comparison:
| Aspect | Long Term Sources of Finance | Short Term Sources of Finance |
| Duration | Exceeds one year | Less than one year |
| Purpose | Capital expenditure | Working capital needs |
| Examples | Equity shares, debentures, loans | Bank overdrafts, trade credit, short-term loans |
| Cost | Lower due to extended repayment | Higher due to short tenure |
| Repayment Schedule | Long-term and structured | Immediate or within a year |
Long Term Sources of Finance FAQ
What are long-term sources of finance?
Long-term sources of finance are funds raised for more than one year to finance capital-intensive projects or expansion activities. Some examples include equity, retained earnings, and debentures.
What are the benefits of long-term sources of finance?
These sources offer capital stability, lower interest costs, and allow businesses to focus on growth by reducing short-term repayment pressure.
What is the difference between long-term and short-term sources of finance?
Long-term financing is for large-scale projects with extended repayment schedules, while short-term financing addresses immediate operational needs with shorter repayment periods.
Why do businesses prefer retained earnings?
Retained earnings are cost-effective as they don’t involve borrowing costs or ownership dilution, making them a preferred long-term financing source.
What are the disadvantages of relying heavily on long-term finance?
Heavy reliance can lead to high fixed costs, regulatory burdens, and dilution of ownership in the case of equity financing.
