Types of Finance: Concepts with Explanation

Types of Finance: Concepts with Explanation

Types of Finance Overview:

Finance has been around for decades; however, it has changed its shape, basis, concept, and purpose of existence now and then. Today, it is nothing closer to what it used to be a decade ago, but one thing has never changed- Finance is the key to money management. It enables parties to acquire funds in one way to another. It is actually a broad term that revolves around the creation, study, oversight of money, banking, assets, liabilities, and investments i.e. everything that develops the financial system. Before we move to discuss the types of finance, let’s go through its origin.

Origin of Finance Concepts

Although finance is a huge topic, its basic concepts originate from macro and microeconomics. These two areas help to study money management based on several activities like lending, saving, forecasting, borrowing, budgeting, and investing. It is nearly impossible to ensure the effective management of funds without any of the factors.

 

Types of Finance

Considering its scope, the term finance is divided into two main types:

  1. Debt Finance
  2. Equity Finance

To get to know them better, let’s understand the types of finance in depth.

Debt Finance

As the name suggests, debt finance refers to the funding that a person acquires for commercial purposes from a financial institution. Since the money that has been lent at a particular interest rate, it doesn’t create ownership of the person and he/she will have to repay the total amount (principal + interest) within the agreed time period. This debt is usually granted after a contract that explains the amount, purpose of borrowing, and duration to repay to avoid conflicts in the future. 

Debt finance has the following classification based on the time:

  • Short-term: Financing for a maximum of 180 days is referred to as short-term debt financing. They are intended to meet immediate financial needs- either occasional or temporary- so that the business can continue daily operations to meet their deadlines. Other than that, working capital loans, trade credit, bank overdraft, advance from customers, small business loans, bill discounting, and short-term retail loans are other forms of this financing.

 

  • Medium-Term:  We classify it as the medium-term finance when the finance is granted for 180 to 365 days. Its utilization depends upon the purpose or type of business. It is commonly used to pay-off loans from cash-flow sources or for the purchase of fixed assets, equipment, etc. Other forms of medium-term debt finance include the issuance of debentures/bonds, medium-term credits by commercial banks, hire purchase finance, lease finance, etc.

 

  • Long-Term: We classify it as the long-term finance when the finance is granted for more than 365 days. We usually prefer it for buying buildings, land, plants, or re-structuring office premises. The interest rate applied to them is far better than the short-term as it enables borrowers to pay-off loans in 5, 10, or 20 years. Other forms of this loan are – Home or car loans, issuance of preference shares, venture funding, long-term governmental loans, investment banks, etc. 

 

Equity Finance

Equity finance offers the company’s shares to the public for investment. A business with short of money introduces their share in the stock market and let people invest money. We call this process as equity financing, as it is the major element that differentiates it from debt financing. Big-scale companies prefer this type of financing when they have plans of expansion or re-structuring of their premises. 

Other Types of Finance

Yes, it’s true that finance has more types apart from the above mentioned. Let’s have a look at them as well:

Public Finance

This type of finance has been derived from the government’s study on the income and expenditures for their public. It involves the collection and allocation of funds among various sectors/departments who are held responsible to carry out governmental duties or obligations for the general public. We can further divide this type into:

  • Public Expenditure: Maintains a record of government spending on the welfare of the public and betterment in the economy, nation, and society.
  • Public Revenue: All income and receipts so collected or acquired by the government- Taxes, penalties, gifts, price, fines, fees, etc. 
  • Publics Debt: Loans received from any source of public finance with the obligation to pay-off with some interest.

 

Personal Finance

Among the types of finance, personal finance refers to how an individual or a family makes monetary decisions under the guidance of finance principles. Since the individual or family receives, spends, budgets, or saves their monetary resources, they always have something at hand to deal with financial risks and difficult life events. 

 

Corporate Finance

All financial activities performed to operate a business/company are referred to as corporate finance. It is a division or department within the company responsible to monitor, manage, and ensure effective utilization of financial resources. The aim is to maximize shareholder value with the help of long-term and short-term financial planning along with strategic implementation. 

 

Wrapping Up

Finance is such a broad term that nobody would ever claim to know everything about it. There is a new concept coming every day that requires study and analysis from a new perspective to ensure proper implementation of the concept. 

 

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