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Business Financing Information Small
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Business Finance Information Small:
Finance Information Sources of Long Term and Medium Term Finance
The various sources from which a company may meet its long term and medium term requirement of funds are as follows:
a) Shares b) Debentures c) Term Loans d) Public Deposits e) Lease Financing f) Retained Earnings
Shares:
A share indicates a smaller unit into which the overall requirement of capital of a company is subdivided. E.g. If the capital required by a company is Rs.100 millions, it can be subdivided into 10 million smaller units called Shares, each one of the units having the value of Rs.10 each, which in technical terms is referred to as Face Value or Nominal Value. In the Indian circumstances, the face value or nominal value can be decided by the company on its own. Generally found face value or nominal value is Rs.10 or Rs.100 each share.
In the Indian circumstances, a company can raise the long term funds by issuing two types of shares.
a. Equity Shares b. Preference Shares
Equity Shares:
These are the corner stones of the financial structure of the company. On the strength of these shares, the company procures other sources of capital. Equity shares as a source of long term funds for the company has the following characteristic features:
1. Investors in the equity shares are the real owners of the company. As such, the investors in equity shares are entitled to the profits earned by the company or the losses incurred by the company. 2. Funds raised by the company by way of equity shares are available on permanent basis. In other words, funds raised by the company by way of equity shares are not required to be repaid by the company during the lifetime of the company. They are required to be repaid only at the time of closing down of the company, i.e. winding up of the company. 3. Funds raised by way of equity shares are available to the company on unsecured basis, i.e. the company does not offer any of its assets by way of security to the investors in equity shares. 4. Return which the company pays on equity shares is in the form of dividend. The rate of dividend is not fixed. It generally depends upon the profits earned by the company. However a profit making company is under no obligation to pay dividend on equity shares. 5. Equity shares as a source of raising the long term funds is a risk free source for the company, as the company does not commit anything on equity shares. 6. Equity shares as an investment is very risky for the investors. As such the investors are granted the voting rights. By exercising the voting rights, the investors can participate in the affairs regarding the business of the company. These voting rights are generally proportionate voting rights, in the sense the voting rights of the investors are in proportion to their investment on the overall capital of the company. However, it should be noted that due to some recent amendments to the Indian Companies Act, 1956, it may be possible for the companies to issue the equity shares with disproportionate voting rights. 7. In financial terms, equity shares as a source of raising the funds is a costly source available to a company.
Disadvantages of Equity Shares:
a) As the investors in equity shares enjoy the voting rights to control the affairs of the company, the management of the company is always under constant danger of getting interfered and disturbed in the regular administration. b) The cost associated with the equity shares is on the higher side as compared to the borrowed capital. By issuing more and more equity shares, the company loses the cost advantage. c) Many categories of investors, i.e. institutional investors may not be able to invest in the equity shares due to various statutory restrictions. d) The excessive issue of equity shares may result in over capitalization to be realized in future.
Preference Shares:
These are the shares which enjoy preferential treatment as compared to the equity shares in respect of the following factors:
a) Unlike in case of equity shares, the preference shares carry the dividend at a fixed rate which is payable even before any dividend is paid on equity shares. b) In the case of winding up of the company, preference shareholders are paid back their investment even before the investment of the equity shareholders is paid off.
Features of Preference Shares:
1. Investors in Preference shares are not the absolute owners of the company. 2. Funds raised by the company by way of preference shares are required to be repaid during the existence of the company. 3. Like in case of equity shares, funds raised by the company by way of preference shares are available to the company on unsecured basis. 4. Unlike in the case of equity shares, the rate of dividend in the case of preference shares is prefixed and pre-communicated to the investors. 5. As compared to equity shares, the risk on the part of the company is more in case of preference shares. 6. Preference shares as an investment is comparatively less risky for the investors. As such, the investors do not have any voting rights and hence they do not have any say in controlling the affairs of the company. 7. If any resolution directly affecting the rights of the preference shareholders is discussed by the equity shareholders, the preference shareholders can vote on such resolutions.
Debentures:
Debenture means a document containing an acknowledgement of indebtedness issued by a company and giving an undertaking to repay the debt at a specified date or at the option of the company and in the meantime to pay the interest at a fixed rate and at the intervals stated in the debenture.
Features of Debentures:
1. Investors who invest in the debentures of the company are not the owners of the company. They are the creditors of the company or in other words, the company borrows the money from them. 2. Funds raised by the company by way of debentures are required to be repaid during the life time of the company at the time stipulated by the company. As such, debenture is not a source of permanent capital. It can be considered as a long term source. 3. In practical circumstances, debentures are generally secured i.e. the company offers some of the assets as security to the investors in debentures. 4. Return paid by the company is in the form of interest. Rate of interest is predetermined, but the same can be freely decided by the company. The interest on debenture is payable even if the company does not earn the profits. 5. In financial terms, debentures prove to be a cheap source of funds from the companys point of view.
Disadvantages of Debentures:
a) By issuing the debentures, the company accepts the risk of two types. These are payment of the interest at a fixed rate, irrespective of the non-availability of profits and repayment of principal amount at the pre-decided time. If earnings of the company are not stable or if the demand for the products of the company is highly elastic, debentures prove to be a very risky proposition for the company. Any adverse change in the earnings or demand may prove to be fatal for the company. b) Debentures are usually a secured source for raising the long term requirement of funds and usually the security offered to the investors is the fixed assets of the company. A company which requires less investment in fixed assets, such as a trading company, may find debentures as a wrong source for raising the long term requirement of funds as it does not have sufficient fixed assets to offer as security.
Term Loans:
Term loans indicate liabilities accepted by the company which are for the purpose of purchasing the fixed assets and are repayable over a period of 3 to 10 years. The term loans may be granted by the Banks (Nationalized, Co-operative or Rural) or the Financial institutions like Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Industrial Finance Corporation of India (IFCI), etc.
Features of Term Loans:
1. Banks or Financial institutions granting the term loans are not at all the owners of the company. They are the creditors of the company. They lend the funds to the company. 2. Term Loans are required to be repaid during the life time of the company at the pre-decided intervals say monthly, quarterly, yearly, etc. The initial gap after which the repayment of term loan starts (technically referred to as the moratorium period) also depends upon the agreement between the borrowing company and the lending bank or financial institution. 3. The term loans may be secured or unsecured, though normally all the term loans are secured. The security which is offered for the term loans is the hypothecation or mortgage of the fixed assets purchased with the help of term loans. 4. Return payable by the company on term loans is in the form of interest which may be calculated on monthly or quarterly or half yearly basis at a pre-decided rate on the outstanding balance of the term loan. 5. Term loans as a source of raising long term funds is very risky from the companys point of view. These are payment of the interest at a pre-decided rate, irrespective of the non-availability of profits and repayment of principal amount at the pre-decided time. 6. In financial terms, as in case of debentures, term loans also prove to be a cheap source of funds from the companys point of view.
Public Deposits:
In the recent past, Public Deposits have become one of the most important sources available to the companies for meeting the medium term requirement of funds. The companies find public deposits as an attractive source mainly due to following reasons:
a) Raising the funds in the form of public deposits is more convenient than borrowing the funds from banks and financial institutions. Borrowing the funds from banks or financial institutions is a tedious job involving the compliance with many procedural requirements like margin money stipulations, security requirements, submission of periodical statements, etc. None of these procedural requirements are required to be complied with in case of public deposits. b) The rate of interest which the company is required to pay on public deposits is comparatively less than the rate of interest payable on the funds borrowed from banks or financial institutions. c) Public deposits are unsecured borrowings for the company. d) The company can raise the funds in the form of public deposits which can be used for any purpose. The end use of the funds raised in the form of public deposits is not committed by the company. e) In the situations of credit squeeze introduced by the banks, public deposits play a very important role.
Lease Financing:
In the recent years, the lease financing has emerged as one of the most important sources of long term financing. Under the leasing agreements, the company acquires the right to use the asset without holding the title to it. Thus it is the written agreement between the owner of the assets, called the lessor, and the user of the assets, called the lessee whereby the lessor permits the lessee to economically use the asset for a specified period of time but the title of the asset is retained by the lessor. This economical use of the asset is permitted by the lessor on the payment of periodical amount which is in the form of lease rent.
Advantages of Leasing for the Lessee:
1. Risks of ownership: Leasing facilitates lessee to avoid the risks attached with the ownership of the equipments, say risk of obsolescence in the area of over changing technologies. 2. Saving of capital outlay: Leasing enables lessee to make full use of the asset without making immediate payments of the purchase price which otherwise would be payable by him. Some lessor may also finance to the extent of 100% of the cost of the equipment where lessee is not required to make any provision for asset acquisition. 3. Tax Advantages: Under the leasing propositions, the payment of lease rents is the tax deductible expenditure. On the other hand, if the company decides to own the same asset by resorting to the borrowing, the expenses which are available for deduction for tax purposes are in the form of depreciation and interest on borrowing. 4. Structuring of lease rents: Lessor may structure the payments of lease rents in such a way that it matches the revenue expectations of the lessee from the equipments, which may not be possible if lessee resorts to borrowing for owning the asset. 5. No effect on borrowing power: As the obligations accepted by the lessee under the lease deed appear nowhere on the balance sheet as debt, the borrowing power of the lessee still remains unaffected. The lessee may still resort to debt capital provided equity base of the company permits further borrowing. 6. Convenience: Leasing is the quickest method of financing the requirements of long term capital and lessee is relieved from the rigid and time consuming procedures and terms and conditions involved in other forms of term borrowings say term loans.
Retained Earnings:
Retained earnings or ploughed back profits are one of the best sources of raising long term funds for the company. It indicates that whatever profits are earned by the company is not distributed by it by way of dividend but is kept aside for being used in future for expansion or other purposes. If the company follows a regular policy of plough back of profits, i.e. keeping aside profits without distributing them, the shareholders may resent to this policy. As such, while deciding the amount of profits to be retained, the company has to be very careful, about its consequences on the expectations of shareholders and also on the prices of the shares.
Related Topics:
1. Marketable Securities 2. Cash Management
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