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Funds that a business borrows from outside the company to provide capital to the business is known as borrowed funds. This fund is different from that of the money introduced in the business, called equity funds. Borrowed funds can take the form of Loans, Bonds, Overdrafts, Credit Cards. Most of these funds are charged with an interest rate calculated on the amount of the Borrowed Capital. Typically, most small businesses prefer these funds as they are only entitled to pay a fixed rate of interest. Though this is easy, the borrowers must pay interest irrespective of their profits or losses.
An Overview of Borrowed Capital
Wealth generation is the ultimate goal of most businesses, and for this, capital is of paramount importance. Capital can be in properties, assets, inventories, cash etc. To acquire these, the company requires either equity funding or debt funding. Equity funding is the money raised from potential investors for a particular equity share to their part.
Debt funding involves the amount of money borrowed from financial institutions, individuals or the bond market. Several ways can constitute Borrowed Capital. Some of them include Credit Cards, Bonds, Loans, Overdrafts.
Most of the borrowed funds involve payment of interest regularly. Though it has the upside of enjoying the benefit of the profitable gains from the company, the loan amount and the interest has to be repaid in full no matter what the returns of the company are. An overview of borrowed fund meaning and its concepts could be understood with the help of various examples.
Salient Features of Borrowed Capital
The salient features of borrowed capital include:
Borrowed capital entails a certain percentage of interest on the capital involved and is usually fixed for a certain period, usually until repayment.
It involves the full repayment of the principal amount and the interest amount.
Borrowed funds are procured based on the requirements of the business. It might be short term, medium-term or long term depending upon the situation.
They are mostly charged against the company’s assets except for debentures, wherein sometimes they can be secured or unsecured debentures.
Lenders of such funds have no say in the business’s operations and are also barred from taking part in any of the meetings or voting at such meetings.
Various sources of borrowed funds
Financial Institutions
Generally, loans are the most common form of borrowed funds. Many public and private institutions are providing loans at fixed rates, usually by securing their loans by charging the borrower’s assets.
Debentures
Debentures are of many types. Usually, they have one thing in common – they are charged with a fixed rate of interest that a company is entitled to pay regularly irrespective of the company’s profits or losses. Most are secured by charging the assets, and some remain unsecured but for a higher interest rate.
Public Deposits
These are deposits that are accepted by the public, usually on a larger scale. They do not create any charge on the company’s assets and are helping to cater to the short term and medium-term needs of the company.
Commercial banks
Many nationalized and general banks offer timely assistance to borrowers by providing them with the funds required. Here too, they are entitled to fixed interest and most times are secured by charging the borrower’s assets.
Bonds
A fixed interest loan is issued by the borrower; these are instruments that are generally financed by the public when a company or the government wants to raise capital from the public. A fixed interest-bearing instrument, this type of borrowed capital can prove to be a very safe investment option for the public to invest in.
The other sources like personal savings, business loans, angel investors, friends and family, etc., are the resources of borrowed funds classified into long-term, medium-term, and short-term resources, respectively.
Conclusion
A proper source of funding is required in the process of obtaining borrowed capital. The capital use has to be maximized while the interest rates should be par or below par to maintain equilibrium in the borrowings and repayment and interest rates. Since this forms a part of debt financing, borrowed funds can take the form of loans, credit cards, bank overdrafts, bonds, etc. An increase in the borrowed capital leads to a decrease in the lender’s wealth, leading to a loss for the lender. Collaterals secure these funds to utilize them if the repayment is not made within the specified period. An understanding of borrowed funds’ meaning and their advantages and disadvantages have to be analyzed thoroughly to get a clear picture.
