SOURCES OF FINANCE (LONG-TERM)

Categories of Financial Requirement

i) Long-term Financial Requirements

ii) Medium-term Requirements

iii) Short-term Requirements

Sources of Finance:-1) Long-term Sources of Finance: i) Owned Capital:- It includes equity shares,

preference shares and ploughing back of profits. ii) Borrowed Capital:- It includes debentures,

loans from F.I’s ,leasing etc.2) Medium term Sources of Finance:- It includes

Public deposits, medium-term loans from commercial banks etc.

3) Short-term Sources of Finance:- It includes short-term advances from commercial banks, trade credit, commercial papers, advances from customers, accrued expenses etc.

EQUITY SHARES:

Equity Shares, also known as ordinary shares, represent the ownership capital in a company. The holders of these are the legal owners of the company. The rate of dividend is not fixed and depends upon the availability of divisible profits and the intention of the directors.

Features:-

Residual Claim on Income Residual Claim on Assets Right to Control Pre-Emptive Rights Limited Liability

Advantages to the Company:-

Permanent Source of Funds Increase in the Borrowing Capacity Not Bound to Pay Dividend No need to Mortgage the Assets

Advantages to Investors:- Right to Control Increase in Rate of Dividends Increase in Market Value Bonus Shares Right Shares Easy to Sell

Disadvantages to the Company:- High Cost of Funds

No Advantage of Trading on Equity

Manipulation by a Group of Shareholders

Disadvantages to Investors:-

Irregular Dividend Fall in the Market Value of Shares No real Control Over the Company Ownership Dilution Loss on Liquidation

PREFERENCE SHARES:-

As the name suggests, these shares carry preferential rights over equity shares both regarding the payment of dividend and the return of capital.

Characteristics:-

Claim on Income Claim on Assets Controlling Power Fixed Dividend Cumulative Dividends Redemption Participation Feature Convertibility

Types: Cumulative Preference Shares Non-cumulative Preference Shares Redeemable Preference Shares Irredeemable Preference Shares Participating Preference Shares Non-Participating Preference Shares Convertible Preference Shares Non-Convertible Preference Shares

Advantages to the Company:-

Popular among less adventurous Investors Permanent Source of Funds No need to Mortgage the Assets Benefit of Trading on Equity Not Bound to Pay Dividend Increase in Borrowing Capacity No Interference in Management Flexibility in Capital Structure

Advantages to the Investors:- Fixed Rate of Income Prior Claim over Income and Assets of the

Company Voting Rights Benefit of Conversion Right of Participation in surplus Profits

Disadvantages to the Company:- High Cost of Funds Permanent Burden of Dividend Harmful in Case of Low Earnings Fear of Loss of Control

Disadvantages to the Investors: No Certainty of Payment of Dividends No Right to Vote No Right to Participate in Increased Earnings No Certainty of Redemption

Ploughing Back of Profits:-

An existing company can also generate finance through its internal sources, i.e., retained earnings. When a company does not distribute whole of its profits as dividend but reinvests a part of it in the business, it is known as retention of earnings.

Factors Influencing Retained Earnings Earning Capacity Desire and Type of Shareholders Future Financial Requirement Dividend Policy Taxation Policy

Advantages to the Company:

i. Economical Methodii. A Cushion to Absorb the Shocks of the

Businessiii. Helpful in following a Balanced Dividend

Policyiv. Helpful in making the Company Self-

Dependentv. Increase in Credit Worthinessvi. Helpful in Repayment of Long-term

Liabilities

Advantages to the Shareholdersi. Increase in the value of shares

ii. Safety of Investment

iii. No dilution of Control

iv. Enhanced earning Capacity

Disadvantages or Dangers of Excessive Ploughing Back:- Misuse of Retained Earnings Over-Capitalization Creation of Monopolies Manipulation in the Value of Shares Dissatisfaction among the Shareholders Hindrance in the Free Flow of Capital

DEBENTURES:-

Funds acquired by issue of debentures represent loans taken by the company and are also known as ‘debt capital’.

A debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holders

Characteristics:-

i. Maturity

ii. Claims on Income

iii. Claim on Assets

iv. Controlling Power

v. Buy-Back Provision

Types:-i. Simple, Naked or Unsecured Debentures

ii. Secured or Mortgaged Debentures

iii. Bearer Debentures

iv. Registered Debentures

v. Redeemable Debentures

vi. Irredeemable Debentures

vii. Convertible Debentures

viii. Zero Interest Bonds/ Debentures

ix. First Debentures and Second Debentures

Advantages to the Company

i. Cheaper Source of Finance

ii. Availability of Finance for a fixed period

iii. Benefit of Trading on Equity

iv. No Interference in the Management

v. Flexibility in Capital Structure

vi. Easy to issue During Depression

vii. Helpful in Removing Over-capitalization

Advantages to the Investors:

i. Fixed and Regular Income

ii. Minimum Risk

iii. Definite Maturity Period

iv. Liquidity

v. Benefit of Conversion

Disadvantages to the Companyi. Legal Obligation of Paying Interest and

Principal

ii. Mortgaging of Assets

iii. Higher Rate of Interest

iv. Cash Outflows

v. Restrictive Conditions in the Debenture Trust Deed

Disadvantages to Debenture holdersi. No voting rights

ii. Do not have Claim on Surplus Assets and Profits

iii. No certainty of regular payments in case of financial difficulties

Loans from Financial Institutions:- In India, a number of special financial

institutions have been established by the Government at the national level and state level to provide medium-term and long term loans to industrial undertakings. These are IDBI, IFCI,ICICI,UTI, LIC, GIC etc.

Characteristics:-

Maturity

Direct Negotiation

Security

Restrictive Conditions

Convertibility

Repayment Schedule

Advantages and Disadvantages: Such loans offer all the advantages and

disadvantages of debenture financing.

LEASE FINANCING:-

Lease is a contract between the owner of an asset and the user of such asset. Owner of the asset is called ‘Lessor’ and the user is called ‘Lessee’.

Under the lease contract, the owner of the asset surrenders the right to use the asset to another party for an agreed period of time for an agreed consideration called the “lease rental”

Advantages to the Lessee:-i. Additional Source of Finance

ii. Simplicity

iii. Free from Restrictive Conditions

iv. Flexibility in Fixing the Rentals

v. Safety from the Risk of Obsolescence

vi. Benefit of Maintenance

vii. No effect on Debt-Equity Ratio

viii. Tax Benefits

Advantages to the Lessor:

i. Fully Secured

ii. Tax Benefits

iii. High Profitability

Limitations of Leasing:-

i. Costly Source of Finance

ii. Restriction on the use of Asset

iii. Consequences of Default

iv. Excessive Penalties