Unit 2

SOURCES OF FINANCE

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 Introduction
It is rightly said that finance is the life-blood
of business.
No Business can be carried on without source
of finance.
There are several sources of Finance and as
such the finance has to be raised from the
right kind of source.
 Why do we need to study
finance?

Almost half of all new

ventures fail because
of poor financial
management

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 Two Types of Finance
1. Long Term
2. Short Term
 Sources Of
Finance

Short Term
Long Term

Equity Shares Trade

Credit
Preference Shares

Debentures
Bank
Retain Earning
Finance

Public Deposit
Other
Term Loan
Sources of Long
term finance
 Long Term Source of Finance
Long term sources of finance are those that are
needed over a longer period of time - generally
over a year.
Long term finance may be needed to fund
expansion projects
It's Types Are:-
Share, Debenture,Venture Capital, Government
Grant, Bank Loan, Mortgage, Owner Capital, Internal
Accrual.
 Need for long term Finance
For modernization, expansion, diversification;
requirement of huge quantities., irreversible
decision
Asset-liability mismatch, interest rate risk,
liquidity risk.
 What is Share?
The capital of the company can be divided into
different units with definite value called
shares. Holders of these shares are called
shareholders or members of the company.
 Characteristics of shares
1. It is a unit of capital of the company.
2. Each share is of a definite face value.
3. A share certificate is issued to a shareholder
indicating the number of shares and the amount
(Demat Account).
4. Each share has a distinct number.
5. The face value of a share indicates the interest of a
person in the company and the extent of his liability.
6. Shares are transferable units.
 Types of Shares
Two types of shares which a company may issue
(1) Equity Shares
(2) Preference Shares
Equity Shares
Will get dividend and repayment of capital after
meeting the claims of preference shareholders.
No fixed rate of dividend and this rate may vary form
year to year and determined by directors
Dividend proportionate to profit.
 Preferences Shares
Shares which enjoy the preferential rights as to dividend
and repayment of capital in the event of winding up of the
company over the equity shares are called preference
shares. The holder of preference shares will get a fixed rate
of dividend.

Types Preference shares

(a) Cumulative Preference Share
(b) Non-cumulative Preference Shares
(c) Redeemable Preference Shares
(d) Participating or Non-participating Preference Shares
(e) Convertible and Non Convertible Preference Shares
 Debentures
Just like shares, DEBENTURES are also instruments
for raising long term finance
Debenture is a document that either creates a debt or
acknowledges it, & is a debt without collateral
Attributes:-
Interest rates
Convertibility
Redemption
Credit rating & Trustee
Debenture redemption reserve
 Types of Debentures
1. Simple or Unsecured Debentures
2. Secured or Mortgaged Debentures
3. Bearer debentures: Easily Transferable
4. Registered debentures: Transferred only after
following a specific procedure
5. Non-convertible Debentures
6. Convertible Debentures
7. Redeemable Debentures
8. Irredeemable Debentures
 Retained Earnings
The portion of the profits which is not distributed
among the shareholders
As per Indian Companies Act., companies are
required to transfer a part of their profits in reserves.
Companies keep these savings in various accounts
such as General Reserve, Debenture Redemption
Reserve and Dividend Equalisation Reserve etc.
The amount so kept in reserve may be used to buy
fixed assets. This is called internal financing.
 Public Deposits
An undertaking which wants to raise funds through
public deposits.
It declares the rate of interest which may vary
depending upon the period for which money is
deposited.
It also declares the time and mode of payment of
interest and the repayment of deposits.
A depositor may get his money back before the date
of repayment of deposits for which he will have to
give notice in advance.
 Features of Public Deposits
1. These deposits are not secured and mainly used for
the working capital requirements.
2. They are available for a period ranging between 6
months and 3 years.
3. They carry fixed rate of interest.
4. They do not require complicated legal formalities as
are required in the case of shares or debentures
 Term Loan
Obtained from banks and financial institutions
Generally available for a period of 6 to 10 years but
maturity could be as long as 25 years
Interest on term loan is tax deductible
Term loans are secured through an equitable
mortgage on immovable assets
Sources of Short
term finance
 Trade Credit
Trade credit refers to the credit extended by supplier
of goods and services in the normal routine of the
business
Deferral of payment is called trade credit
In India it contributes nearly 40% of the short term
finance.
 Bank Finance
Main source of working capital finance in India
Amount approved by the bank for working capital is
called credit limit
Credit limit is the maximum funds which a firm can
obtain from the bank
Bank deduct margin money to ensure security
E.g. : If margin requirement is 20%, bank will give only
80% of the value of assets kept as security
 Forms of Bank Finance
a. Cash credit
b. Overdraft
c. Purchasing/Discounting of the bill
d. Letter of credit
e. Working capital loan
Other
Overdraft facilities the right to be able to
withdraw funds you do not currently have
Provides flexibility for a firm
Interest only paid on the amount overdrawn
Overdraft limit the maximum amount allowed
to be drawn - the firm does not have to use all of
this limit
Factoring the sale of debt to a specialist firm who
secures payment and charges a commission for the
service.
Leasing provides the opportunity to secure the use
of capital without ownership effectively a hire
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