Every business needs money — to buy machines, pay salaries, or stock inventory. The big question in Financing Decisions is: where do you get that money, and for how long do you need it? ICAI splits this cleanly into long-term finance (needed for 1 year or more) and short-term finance (needed for less than 1 year). Getting this match right is what separates well-run firms from cash-strapped ones.
Long-term sources fund fixed assets — land, plant, machinery, brand-building. The main options are: Equity shares (owners' capital, no mandatory repayment, but shareholders expect dividends and growth), Preference shares (fixed dividend, priority over equity in liquidation), Debentures/Bonds (debt with fixed interest — tax-deductible, making it cheaper than equity on an after-tax basis), Term loans from banks/FIs (e.g., a ₹5 crore machinery loan from SBI for 7 years), and Retained earnings (ploughing back profits — zero flotation cost, but limited by profitability). Newer options like Venture Capital and Private Equity matter for start-ups and growth-stage firms.
Short-term sources fund working capital — raw materials, debtors, day-to-day expenses. Key ones: Trade credit (buying on credit from suppliers — free if paid within the discount period), Bank overdraft / Cash Credit (CC) (flexible, interest only on amount used — most common for Indian SMEs), Commercial Paper (CP) (unsecured, issued by creditworthy companies, maturity 7–364 days), Bills discounting (sell your receivable bill to the bank at a discount and get cash now), and Factoring (sell your entire book of debtors to a factor who collects on your behalf).
The golden rule ICAI tests heavily: match the tenure of finance with the tenure of the asset. Fixed assets → long-term finance. Current assets → short-term finance. Using short-term overdraft to fund a 10-year factory is dangerous — you risk a liquidity crisis if the bank recalls the loan. This matching principle is called the Hedging (or Maturity Matching) Approach. The Conservative approach uses more long-term funds even for current assets (safe but costly); the Aggressive approach uses more short-term funds even for fixed assets (cheap but risky). This is asked frequently as a 4-mark or 8-mark theory/case question.