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 Method
ii. A Cushion to Absorb the Shocks of the
Business
iii. Helpful in following a Balanced Dividend
Policy
iv. Helpful in making the Company Self-
Dependent
v. Increase in Credit Worthiness
vi. Helpful in Repayment of Long-term
Liabilities
Advantages to the
Shareholders
i. 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
Company
i. 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
holders
i. 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