Meaning of Business Finance

Business finance refers to capital and credit funds invested in the business .financing means making available when its needed. Business finance may be defined as planning,raising,managing and controlling all the money used or capital funds of any kind used in connection with business

Definitions by different authors

“Finance is that business activity which is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of business enterprise”.

-B.O Wheeler.

“Business finance involves a set of administrative functions in an organization which relate with the arrangement of cash and credit so that the organization may have the means to carry out its objectives as satisfactory as possible”.

- Howard and Upton

Nature and significance

No one can start the business or run an enterprise without adequate

funds. Every business requires some money which is called initial

capital . The amount of capital required depends upon the nature

and size of business.

Business enterprise requires capital and finance for the

following purposes

While starting a business ,finance is required to procure fixed assets and also for meeting day – to – day expenses .

To meet the working capital requirement when production process is lengthy.

To finance the growth and expansion projects of the company .

Adequate finance provide the following benefits to a business

concern

The firm can meet its liability on time .

The firm can carry on its business smoothly.

The firm can adopt latest technology and new innovative methods of production.

The firm can make use business opportunities.

The firm can replace its assets and machinery whenever necessary.

The firm can face recession and depression period of trade cycle.

The firm can face completion more

strongly.

A business enterprise needs finance at every stage . It must be available in an adequate

amount at the right time for smooth functioning of an enterprise .Is short we can say that finance is the blood of the business

The financial needs of a business can be classified into two categories

Fixed capital requirement.

Working capital

requirement

Fixed capital requirement

In order to start a business finance is required to buy fixed assets such as land ,buliding,plant etc.this is known as fixed capital .the fixed capital remains invested in the company for the long term ,that is , the company should prefer long term sources of finance to meet the requirement.

Working capital requirement

The finance required to carry on operating and day to day activities is known as working capital . Generally working capital is used to buy current assets which get converted into cash in one year. Generally firm prefers short sources of finance to meet working capital requirement .

CLASSIFICATION OF SOURCES OF FUNDS

The various sources of funds can be broadly classified on the basis of following 3

categories

Period basis

Ownership basis

Sources of generation

basis

PERIOD BASISOn the basis of time period, a business

finance can be classified in three categories:-

Long Term Finance

Medium Term Finance

Short Term Finance

Long Term Finance

Funds which are required to be invested in a business for a long period of time, that is, more than 5 years are known

as long term finance.

FEATURES

This type of fund is used for acquiring fixed assets. For example, land, plant etc .

Small factory, retailers, traders etc.

require smaller long term finance.

MEDIUM TERM FINANCE

The finance required by business enterprises for more than one year but less than five years is known as

medium term finance.

FEATURES

Generally manufacturing industries require medium term finance.

Common sources of raising medium term

finance are: accepting public deposits, medium term loans etc.

SHORT TERM FINANCE

The finance required for a short period up to 1 year is known as

short term finance.

FEATURES It is more often called working capital.

Generally trading companies require more

of short term finance as compared to manufacturing companies.

For every business enterprise , there are two sources of business

finance. These are

Owner’s Fund

Borrowed Fund

OWNER’S FUND

Owners Fund refers to the funds contributed by owners as well as the accumulated profit of the company. This fund remains with the company and it has no liability to return this fund. For Example:-Equity shares,

retained earnings.

FEATURES

No security required- No security has to be offered against

ownership capital.

Sources of owner’s fund- The owner’s fund comprises of

share capital, retained earnings.

Merits

Permanent capital – The owner’s fund remains with the

business permanently. It is the most suitable fund to meet problems.

Right to control – The final decision in the business is taken by the owners. By contributing to owner’s fund, share holders acquire the right to control and supervise over the management of the company

DEMERITS

Under Utilization of capital- Ownership funds cannot be reduced

easily as these are a permanent source of capital. If company has no expansion of growth projects then a part of this fund may remain idle.

Diffusion of control- By purchasing the equity shares of the

company a large number of persons can get ownership rights of control over management. This may reduce the control and powers of the real owners who have promoted the company.

BORROWED FUND

Borrowed fund refers to the borrowing of the firm. It includes

all funds available by way of loans or

credit.

FEATURES

Fixed time – The borrowed fund is raised by business firms for

specified periods. These funds may be raised for short term, medium term or long term.

Security- Generally firms can get borrowed funds against the securities of assets. Banks are financial institutions offer loans on different

terms against the security of assets.

MERITS

Flexibility- The amount of borrowed fund can

be increased by raising more and can be decreased by paying them back. So finance can be raised or repaid according to convenience and needs of the company.

No interference – Borrowed funds security holder

do not get any right to control. It does not affect owner’s control over management.

DEMERITS

Adequate security- The borrowed funds are usually available up to

80% of the value of assets. Companies are required to offer adequate securities against loans.

Fixed liability- Payment of interest and repayment of principal

amount of borrowed fund is a fixed liability of a company. Default in payment may lead to serious effects such as decrease in the credit-worthiness of the company and insolvency.

Sources of generation basis

On the basis of generation. It can be classified into two categories

Internal sources External

sources

Internal sources

It include all those sources which are

generated within the business

External sources

It include all those sources that lie

outside

an organization

Methods of raising finance

Retained earningTrade credit

FactoringLease financingPublic deposits

Commercial papersEquity shares

Preference sharesDebentures

Commercial banks Financial institutions

International financing

Retained earning

These are also known as ploughing back of profit ,retained earnings, self financing or

internal financing ,reserves or surplus. It refers to undistributed profits after

payment of dividend and taxes provides the basis of expansion and growth of

companies. It is considered the most important source of

finance since its internally generated this method of financing is known as self–

financing.

Features

Funds for new innovative projects – The retained earnings are common source of funds for financing risky

and innovative projects . This fund is generally used for research work expansion projects etc.

Medium and long term finance – Retained earning is considered as an ownership fund . It serves the

purpose of medium and long term finance.

Conversion into ownership fund- The supplies retained earnings can be converted into share

capital by issue of bonus shares . In issue on bonus shares there is no outflow of cash . Investors to are benefited by the issue of shares fr of cost.

Merits

Most dependable source- As an internal source this is more dependable than the external

source of finance . The external source depends upon the preference

of investors market condition etc.

No fixed liability – There is no fixed commitment to pay dividend or interest on

this source of fund as retained profits are a company's own money.

No security – Unlike debentures no change is created against the assets .

The company is free to use its assets for raising loans in future.

Demerits

Careless use- The retained earnings are available easily at no cost. The management of the company not always use the retained earnings in the best interest of the shareholders. it may misuse them by investing in unprofitable or undesirable investment proposals.

Over- capitalization – large amount of retained earning results in the issue of bonus shares to equity shareholders .frequent capitalization of reserves may result in over-capitalization.

Dissatisfaction among shareholders – Large retained earnings may cause dissatisfaction among the equity shareholders as they do not receive high rate of dividend if a large amount of surplus profit is kept aside in the form of reserves.

Trade credit

Trade credit is a credit extended by one trader to another

for purchase of goods and services trade credit facilitate the purchase of supplies

without immediate payment it is also known as mercantile credit

terms of trade credit may vary from one industry to another and from one person to

another . firm may offer different credit terms to different

credit customers.

The availability of trade credit depends on:

Nature of the firm. Size of the firm. Status of credit worthiness of the firm

MERITS

READILY AVAILABLE Trade credit is available without any special efforts

on the part of a manufacturer or trader

FLEXIBLITY There are no rigid rules and regulations

involved in trade credit .it can be easily adjusted with the changing needs of purchases as time of payment is generally adjusted in view of past dealings.

Demerits

Increases in prices- Sometimes the supplier may increase the price of

commodity or raw material supplied if he is selling

Legal action- In trade credit the buyer generally issues a promissory note and incase he fails to meet his commitment, the supplier can take legal action. goods on credit

FACTORING

It is a financial service under which the factor renders the following services.

Following services are

Discounting of bills and collection of client debts

Discounts bills of exchange and also collects the debts of clients the client sell their receivable on accounts of credit sale or the factor of certain discount the factor become responsible for all credit control and debt collection from a buyer and provide protection against any bed debt losses to the firm

Providing information about credit worthiness of prospective client

Factors hold detailed information about the trading

history of the firm. with the help of the such information

firms using factoring services are saved from doing

business with customers with poor payment record

besides this factors also provide consultancy services in

area of finance marketing etc. the factor charges fees for

the services rendered and these services are provided by

the organization SBI factors, commercial services limited etc.

MERITS

Obtaining funds from factoring is cheaper

than any other sources of finance.

No claims over the asset of the company.

It provides a kind of security for a debt which

the company otherwise might not be able to pay.

DEMERITS

Factors generally charge a high rate of interest.

By involving a factor the company is inviting a

third party between customer and company the

customer may not like it.

LEASE FINANCING

A lease is a contractual agreement in which the owner of the asset grants the other party the right to use the asset in written of a periodic payment retains

title over the property

MERITS

With low financial investment the lessee can use

assets which require huge investment.

Not much of legal formalities is required.

Lease rent is deducted from the income of lessee before calculating the income tax.

Lessee has no risk of obsolescence.

Lessee has no claim over the assets of the company.

Demerits

Lesser may put certain restrictions on use of the assists.

Lessee never become owner of the asset.

The business operations may get affected if lessor terminates the agreement before maturity date or does not renew the lease contract.

PUBLIC DEPOSITS

These are the deposits raised by an organization directly from the public .under this method

company is inviting public deposit. public deposit are required to advertise publically along with it

financial position .public deposit can take care of medium and short term financial requirements of the business such deposits are beneficial to both

depositor as well as organization.

Features

Unsecured – Companies mortgage no asses against the

public deposits raised from general public.

Finance of working capital – The amount raised from public

deposits is generally used by the company for meeting the requirements of working capital. though they are a primary source of short term finance but by renewing these can be used for medium term also.

Time period –

Public deposit can be invited by companies for a period of 6 months to 3 years.

Repayment –

A company which has public deposits is required to set aside 10 percent of the deposits maturing by the end of the year . The amount so set aside can be used for repaying the public deposits.

MERITS

NO SECURITY

Public deposits are unsecured so the assets of the company are free to be used as mortgage in future.

REDUCTION IN TAX LIABILITY.

Interest paid on public deposits is deducted from the total income of the company. hence it helps in bringing down the tax liability.

.

Flexibility

Public deposits can be repaid when they are not required . their for public deposits introduce flexibility in the financial structure of the company

NO DILUTION OF CONTROL

Public depositors have no voting rights they cannot influence the decisions of the company their is no dilution of share holders control.

DEMERITS LIMITED AMOUNT

The amounts of funds that can be raised by way of public deposits is limited because of legal restrictions. public deposits cannot exceed 25% of share capital and free reserves.

UNCERTAINITY

Public deposits are an uncertain and unreliable source of finance. during depression period the depositors may not respond .also deposits may be withdrawn when ever the financial position of the company is not stable.

Not suitable for new concerns

New companies don't have enough goodwill in the market. The advertisements given by new companies do not attracts many people to invest money in their public deposits.

Suitable for conservative investors

Public deposits do not attract bold and adventurous

investors who want capital gains .only cautious and conservatives investors prefers to invest in 6the public deposits.

Commercial papersCommercial papers is source of short term finance. The

commercial paper was introduced in India for the first time

in 1990 . It is an unsecured promissory note issued by public and private sectors companies with a fixed maturity

period ,which varies from 3-12 months . Since these are unsecured that’s why these are generally issued by companies

having a good reputation .

Merits

Commercial papers are unsecured so no asset of the company is mortgaged.

Commercial papers are freely negotiable instrument.

Cost of issuing commercial paper is low.

Its continuous source of funds as its maturity can be changed according to the requirement of the company .

Companies can also invest their excess money in discounting the commercial and earn a good amount of return.

Demerits

Only financially sound companies with a good reputation can issue this security .

The size of money that can be raised through commercial papers is limited.

Commercial papers is an impersonal method of financing.

SHARES

Share is the smallest unit in which owners capital of the company is divided .A share

is the interest of the shareholder in the company measured by a sum of money for the purpose of liability and interest. A share may also be defined as a unit of measure of

share holder's in the company.

TYPES OF THE SHARES

Equity shares

Preference shares

Equity shares

They are the most important source of raising long term capital by company .Equity share are those shares which don't carry any special or preferential rights in respect of payment of annual dividend and repayment of capital the money issued by the issue of equity shares is limited as equity share capital .it represents as the owners capital as equity share holders as are real owners of the company thus the capital raised by issue of such share is common as ownership capital or owners fund.

Features

Risk bearing capital - They are the primary risk bearers they enjoys the reward as

well as bear the risk of ownership ..

Maturity -

Equity shares provide permanent capital to the company and cannot be redeemed during the life time of the company.

Returned The returned earned by equity share

holder is known as dividends which varies with the earning of the company.

Claim on residual income Equity share holders are

referred to a individual owners, as they get dividend only

after all other claims on the companies income

and asset have been settled voting rights.

Voting rights Equity share holders have voting rights

in proportion to the share held by the share

holders .they have a right to participate in the companies management.

Limited liability-

The liability of equity share holders is limited

to the extent capital contributed by the company.

Merits

IT IS IDEAL FOR ADVENTOROUS INVESTORS Equity share are suitable who are willing to assume

risk for higher returns.

NO OBLIGATION AS TO DIVIDENDS There is no burden or obligation on the company to

pay dividend as it depends on the profit available and the decision of

members

PROVIDES CREDIT STANDING Equity capital provide credit worthiness

to the company and confidence to prospective loan providers

No charge on asset Equity shares do not carry any

charge on asset of the company as a result asset can be freely mortgaged purpose of borrowing.

Democratic management Equity shares holders enjoys voting

rights which ensure democratic management of the company.

Small nominal value An equity share is generally low price

as a result ,even person with limited means can buy equity shares.

DEMERITS

Risk of fluctuating return- Equity shares are not suitable

for investors who desire to earn stable return on the investments as equity

share get fluctuating results.

High cost of capital The cost of equity shares is generally more as

compared to the cost of raising funds through other sources.

Legal formalities A company has to comply with no legal formalities

before issue of equity shares to the general public.

Danger of over capitalization Equity share capital is a permanent source of capital

if the company has raised excess equity capital due to faulty financial planning then company may get into a

state of overcapitalization. in such a situation equity capital may become idle and under utilized.

PREFRANCE SHARE

Preference share are those shares which enjoy certain priorities

regarding the payment of dividend under fixed rate and return of

investment the capital raised by issue of preference share is called preference share capital the preference share holders enjoy

preferential rights over equity share holders

Right to receive fixed rate of dividend before any dividend is paid to equity share holders

Right to receive repayment of capital on binding up of company before the capital of equity share holders is a returned.

FEATURES

FIXED RATE OF DIVIDENT :

Preference share holders receive dividend

at a fixed rate before any dividend is paid to equity share holder.

REPAYMENT OF CAPITAL Preference share holders have the

preferential rights as to the redemption of capital at the of time binding up of a company

NO VOTING RIGHTS:

Preference shareholders generally do not enjoy any

voting rights.

NO CHARGE ON ASSET

Preference shares are also used without creating any charge on the fixed assets of the company

TYPES OF PREFRANCE

CUMULATIVE PREFRANCE SHARES

The preference shares which carry the right to accumulate unpaid dividend in future years in case the same is not paid the current year are termed as cumulative preference shares example: if a company is having a loss for 2 years and if the 3 year the company earns the profit than the cumulative preference shares holder with get dividend for 3 years

NON CUMALATIVE PREFRANCE SHARES The preference shares on which the dividend does not get

accumulated are termed as non cumulative preference shares. if the company does not declare dividend for any year right of dividend of such shares holders in respect of that year will be lost.

PARTICIPATING PREFRANCE SHARES

The preference share in which share holder are granted the right to share or participate in the surplus profit of the company after paying dividend in equity shares are termed as participating preference shares

NON PARTICIPATING PREFRANCE SHARES

The preference share in which share holder don't carry the

privilege participation of surplus profit along with equity shares

are termed as non participating preference shares

CONVERTABLE PREFRANCE SHARES The preference shares that can be converted into equity

shares within specified period of time are known as convertible preference shares

NON CONVERTABLE PREFRANCE SHARES

Preference shares that cannot be converted into equity shares are known as non convertible preference shares

MERITS

REASONABLE SAFETY OF RETURN Preference share are useful for those investors

who want steady income in the form of fixed rate of

return and safety of investment.

NO INTERFERENCE IN THE MANAGMENT Preference shares don't affect the control of equity share holders over the management as preference share holders don't carry voting rights.

TRADING ON EQUITY

The preference shares are entitled to a fixed rate of dividend .It enables the company to declare higher dividend to equity share holders during prosperity to take advantages of trading on equity

NO CHARGE ON ASSET

Preference capital does not create any short of charge against a asset of a company . so ,assets may be used as

security for raising loans in future.

Demerits LIMITED CAPITAL Preference shares are not suitable for adventures or bold investors who are willing to take risk &are interested in higher returns .

DILUTE CLAIM OF EQUITY SHARES HOLDERS: Preference capital dilutes the claim of equity share holders over the asset of the company.

UNRELIABLE AND LOW RETURN

Preference shares carry a fixed but low return of dividends even during bumper profits preference share holders have to be satisfied with a fixed dividend while equity shares holders get more share in profit. More over their is no assured return for the

preference share holders as dividend is paid only when the company earns profit.

NO TAX BENEFITS:

Their is no tax saving in case of dividend on preference shares as they are not deductible from profits as expenses.

Debentures Debentures are the common security issued

under borrowed fund capital. Debentures are instrument for raising long term debt

capital . Debentures are called creditorship securities because debentures holders are

called creditors of the company.A debenture can be defined as “a documenter

a certificate “ issued by a company under its seal as an acknowledgement of its debt . Holder of debenture certificate is debenture

holder.

FeaturesBorrowed fund-

Debentures are part of borrowed fund capital as debenture holders are considered as the creditor of the company .

Fixed rate of interest-

The interest on debentures is paid at a fixes rate. The rate of interest is decided in the annual general meeting of the company .

Compulsory payment of interest-

Payment of regular and fixed rate of interest is a legal obligation of the company. company has to pay interest to its debentures –holders irrespective of its profit earning capacity.

Security –

Most of the time debentures are issued against the charge of some fixed assets of the company.

No voting rights-

Debenture holder have no say in the management as

they are never granted voting rights in the company.

Types

Secured debentures

Unsecured debentures

Convertible debentures

Non -convertible debentures

Secured debentures

Debentures which are secured by a charge on the immovable property of the company are known as secured

debentures. In case of default by the company ,debenture-holders can

recover money from the mortgaged property.

Unsecured debentures

Debentures which are unsecured and do not carry a charge on the fixed assets of the company . No property is mortgaged with the debentures holder. In case of default

they can file a case in the court but can not recover money by selling a asset of the

company.

Convertible Debentures

The debentures which get converted into equity shares on expiry of fixed of time are

known as convertible debentures.The ratio and period of conversion is specified

at the time of issue of debentures.

Non –Convertible Debentures

The debentures which do not get converted into equity shares are known as Non- Convertible Debentures. They always remain the creditor of the company.

Merits of Debentures

Low cost -

The cost of raising debentures is less than the cost of raising preference shares. It’s a cheaper source of finance.

Interest is treated as expense-

The interest paid to debenture holder is considered as an expense of the company. Interest is deducted from the total income of the company before calculating income tax . So the liability of the tax reduces.

Attract large number of investors-

The company offers a fixed rate of interest on

debentures. The fixed returns appeals and attracts many investors in invest in debentures. Hence the company can collect a large amount of funds by issue of debentures.

No dilution of control-

Debenture holder do not get any voting rights. They are not allowed to participate in decision – making so debentures financing does not result in the dilution of control of equity share holder.

Demerits

Fixed obligation –

Payment of interest is a fixed commitment of the organization whether its earning profit or not. sometimes companies have to borrow funds for payment of interest to debenture holder.

Reduction in credibility-

Financial institution and lenders hesitate to lent funds in the company more of debentures. The credit worthiness of the company which has issued a large number is low.

Charge on assets- Usually debentures are issued against securities of fixed asset . During the time of depression , if the company is unable to pay the regular amount of interest and finds its difficult to repay the amount , in this situation the debentures holder can have claim over the assets of the company.

No voting rights- Debentures holder are not allowed to vote in the management of the company . All the decision regarding interest rate for debentures are taken by the share holder only . Therefore they remain at the mercy of equity shareholder.

Commercial bank

Commercial banks occupies a very important position as they provide funds

for different purpose and different periods .firms of all size can approach

commercial banks generally commercial banks can provide short and medium term loans but nowadays they have

started giving long term loans against security.

Merits

Banks provide funds to firm as and when required .

The banks keep the information of borrower confidential and the business can maintain

its security.

No formalities of issue of prospects etc. are required so its very easy and economical source of funds.

It’s a flexible source as loan amount can be increased as well as decreased .

Demerits

Funds are generally available for a short period .

Banks make detailed investigation of the company's affairs and financial structure before issue of loans.

In some cases bank may put restrictions and difficult terms and condition.

Financial institutions

Public financial institution are referred to as lending institutions ,development banks or financial institutions . After

independence the government of India realised that economical development

of a country only commercial banks are not sufficient . There must be financial

institution to provide financial assistance and guidance to industries

and business enterprises . The need for public financial institution was felt due

to the following reasons:

Merits

Long term finance – Financial institution provide long term finance.

Managerial advice- Financial institution provide managerial as well as financial advice

on various matters.

Medium and long term finance-

Public financial institutions provide medium and long term finance to industrial enterprise at a reasonable rate of interest

Demerits

Too many formalities have to be fulfilled for taking loans from financial institution .

They may put certain restriction such as restriction on dividend payment etc.

Sometimes financial institution may appoint there nominees as board of directors to restrict the power of a company.

International source of finance

Prior 1991,indian companies were not allowed to raise finance from abroad or from companies .the source

of finance were restricted within India .after the new policy of liberalisation ,the doors of foreign companies and investors were opened to invest in

Indian companies .after 1991 the Indian companies can tape international source of finance for both

debt and equity .the main securities used by Indian companies to tap international source of finance are

given below:

Loans from commercial banks.

International agencies and

development banks.

International capital market

Loans from commercial banksCommercial banks are very popular and common source of medium term finance for companies . Medium term

loans can be raised by companies against the security of assets . The rate of interest of loans is generally

fixed by R.B.I.nowadays with the entry of foreign banks and private

banks .taking loans from commercial banks has become very simple

task .banks don't interfere in the management of companies and such

loans can be repaid in parts and interest can be saved to that extent.

International agencies and development banks

A number of international agencies and development banks have emerged over

the years to finance international trade . These bodies provide long term and medium term loans to promote the

development of economically backward areas in the world . These bodies are set

up by the government of developed countries . For example .international finance corporation ,EXIM.banks.asian

development banks.

International capital market

Modern big and multinational organizations get themselves

listed in the foreign stock exchange and the commercial financial instruments used for

this purpose are:

Global depository receipt [GDR].

American depository receipt [ADR]

Foreign currency convertible bonds [FCBs]

GDR

GDR receipts are issued against issue of equity shares in the global market . These are indirect

equity offerings. The equity shares issued against GDR are held by an international banks called depository. Companies issue dividend

notices ,reports etc. regarding these shares do not get voting rights . The capital contributed by these shares is in dollars . That’s is why these

are called dollar –denominated instruments. The global depository receipts were introduced by

the Citi bank in the year 1990.

ADR

An ADR is just like a GDR except that it can be issued to a citizen of USA only and it can be listed in the US stock exchange . Shares issued by the company are held by an international bank called depository ,which receives dividend notices and reports . ADRs are subject to much strict disclosure requirements than GDRs . Because regulation of us stock exchange are very strict . Annual legal and accounting cost of maintaining an ADR are much higher than GDR.

Fcbs

These are the foreign currency bonds which get converted into equity shares on equity shares on expiry of a fixed period of time .

The holders of FCB have the option of either convert the FCB in equity shares at a

predetermined price or at the exchange rate at that time . FCB get rate of interest and

these are traded by listing in foreign stock exchange.

Factors kept in mind before selecting a suitable source of

business finance

No source of business is free from limitation so we cant say which is the best source of finance . Before

deciding the source of finance to meet financial requirements.

Cost involved

Before finalizing any source of finance the company must find out the cost involved in procurement and using the funds . Both

the cost must be less than the benefit which they get by using that source of

funds

Financial capacity of the firms

If the firm is financially sound then it may prefer borrowed funds and can easily pay the interest amount . But is the firm is not

financially stable then it must depend upon the owners fund securities

Form of business organization

Sole proprietorship and partnership firm can not raise funds by issue of shares

/debentures .they have to depend upon factoring ,leasing,loan,trade credit

etc.whereas joint stock company prefer issue of shares and debentures to raise

funds.

Time period

Another factor which help in deciding the source of funds in the duration for which the firm require funds as for a short period trade

credit , factoring,short term loans etc.are suitable whereas for a long term

shares ,debentures are suitable debentures are suitable for medium term public deposits,

loans are suitable.

Risk involved

Owners fund securities involve no risk whereas borrowed fund securities are risky securities . If a business firm can bear the risk then only it should to go for borrowed funds otherwise it should prefer owner's

fund securities

Control

Equity shareholder are consider as the real owner of the business as they have

complete control over the business . If existing equity shareholder do not want to lose the control , then they must not issue

more equity shares to reuse additional capital as it may result in dilution of control.

Flexibility

Sometimes the financial institution which provide long term debt to companies put

certain restrictions on the companies which restricts the flexibility of company .so if other option are easily availed then firm

don’t prefer loan from financial insitution and bank put restriction .

Claim over assets

Some source of finance mortgage the assets of the firm and reduce its

creditworthiness ,for example debentures , secured loans.wheras some source such as shares ,unsecured loans etc. don’t put claim over the assets, hence result in no reduction

in creditworthiness.

Tax benefits

Interest on debentures ,loans is deducted from the total income of the company before

calculating income tax whereas dividend paid to equity shareholder is not deducted from

the total income . So if a firm wants to get tax benefit it should issue debentures,

preference shares,loans,

public deposits etc.