The Main Sources & Uses of Funds for Finance Companies

On the surface, finance companies work much the same as banks do. Clients apply for loans, credit or lease financing and are charged interest for the money they receive. Below the surface, however, finance companies are quite different. Much of this is due to the fact that finance companies can't accept deposits, like banks do whenever someone opens a savings account, so they have to get their money elsewhere. Additionally, finance companies normally specialize in a specific market. Where the money that's borrowed from a finance company is used depends on which market it specializes in.

When you borrow money from a bank, the bank can use the money other people have deposited to finance your loan. Finance companies can't accept deposits, so they don't have this option. Instead, the finance company borrows money itself to finance the money it is giving you, like by offering corporate bonds or other types of loans. As long as the interest the finance company pays on its loans is less than the rates it charges its customers, it can make a profit.

Because finance companies carry a lot of debt and don't have the ability to accept deposits as banks do, they generally need to carry a lot of equity in order to prove their solvency to investors and creditors. On the other hand, the inability to accept deposits also means that they are less regulated than banks. Overhead is also lower. Because finance companies typically specialize in their own market, often, they can take on somewhat riskier debts than a bank can.

There are basically three different kinds of finance companies: sales-based companies, business credit and personal credit companies. Sales-based finance companies lend money to customers of specific retailers or other companies, like General Motors Acceptance Corporation (GMAC), which lends money to GM customers buying its vehicles. Business credit companies provide financing to companies, such as a company that is leasing computers or office equipment, and factoring. Factoring is when the finance company buys outstanding accounts receivable at a discount from other companies, with the intention of collecting those debts. Personal credit companies offer loans and leases to consumers, such as people who are buying furniture on credit, or buying a used car.

For the past several years, tech companies have been having a significant impact on many different industries, and have been changing how business is conducted. The finance sector has been no exception. One example of this is the emergence of peer-to-peer financing. People and companies can now borrow and lend each other money at virtually no cost, usually through an app or a website. Because overhead is extremely low, investors can get a good return on their money, while borrowers are charged relatively low interest rates. In this scenario, the app's users are the source of funds and the recipients of the loans.