Sources of Finance

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Basically there are three sources of finance:

Þ Long term

ÞMid term

Þ Short term

Short-Term FinancingShort-term financial needs: • Short term financial needs are for

fulfilling the working capital requirements.

• In this, we manage to get short term loan which will be repayable within one year.

The important sources of STF are :-Þ Advances received from customers Þ BanksÞ Trade creditÞ Installment credit

Medium-Term FinancingMedium-term financial needs: • Such requirements refer to funds for a period

exceeding one year but not exceeding 5 years.• It involves financing certain activities like

renovation of buildings, modernization of machinery, heavy expenditure on advertising, etc.

The important sources of MTF are :-Þ Preference sharesÞ Debentures/BondsÞ Public deposits/fixed deposits for a duration

of three/five yearsÞ Financial institutions

Long-Term FinancingLong-term financial needs: • For starting business, business needs

fund for buying fixed assets like machinery, land, plant and building

• This requirement may be of 10 to 15 years.

The important sources of LTF are :-Þ Issue of sharesÞ Issue of debenturesÞ Loans from financial institutionsÞ Reinvestment of profits

Long Term Sources of Finance

Owner’s Capital or Equity:

Þ A public limited company may raise funds from promoters or from the investing public by way of owners capital or equity capital by issuing ordinary equity shares.

Þ Ordinary shareholders are owners of the company and they undertake the risks inherent in business.

Þ In other word, Owner’s equity, often just called equity, represents the value of the assets that the owner can lay claim to.

Long Term Sources of Finance

Preference Share Capital:

Þ The money or capital that a company raise from selling preference shares.

Þ Shareholders with these shares must be paid before those with ordinary shares when a company is paying dividends or if it goes bankrupt.

Þ The rate of dividend on preference shares is normally higher than the rate of interest on debentures, loans, etc.

Long Term Sources of Finance

Debentures or Bonds:

Þ Debenture is a document of loan taken by the company.

Þ A debenture is a written acknowledging a debt containing provisions as regarding the repayment of principal and payment of interest at fixed rate.

Þ Debenture includes debenture stock, bonds and other securities of a company.

Long Term Sources of Finance

Types of Debentures1. Bearer Debenture: The names of the holders of such debenture are not registered in the company’s book. Such debentures are transferable merely by physical delivery of the document.2. Registered Debenture:The names and addresses of such debenture holders are registered in the company’s book. Such a debenture is not transferable by mere delivery. The transfer of debentures in this case requires the execution of proper transfer deed.

Long Term Sources of Finance

3. Naked Debenture: The debenture which does not have security is known as naked debenture. It is also called as unsecured or simple debentures.4. Secured Debenture: The debenture which is secured either on a particular assets or on the whole assets of the company is known as secured debenture.

Long Term Sources of Finance

5. Redeemable Debenture:The debenture which is issued for a particular fixed period is known as redeemable debenture. On the expiry of the fixed period, the principal amount of debenture is paid off to the debenture holder.6. Irredeemable Debenture:It is also known as perpetual debenture, which is not redeemable during the life time of the company. It is redeemable only at the time of liquidation of company.

Long Term Sources of Finance

7. Convertible Debenture:The debenture which is convertible into shares of the company, after some time at the option of debenture holder is termed as convertible debenture.8. Non-Convertible Debenture:The debenture which is not convertible into shares of the company is termed as non-convertible debenture.

Long Term Sources of Finance

Loans From Financial Institution: Þ The specialized institutions provide long-term

financial assistance to industry i.e. term loan.Þ Term loan is a loan made by bank/financial

institution to a business having an initial maturity of more than one year.

Þ Term loans represent secured borrowings and at present it is the most important source of finance for new projects.

Þ They generally carry a rate of interest inclusive of interest tax, depending on the credit rating of the borrower, the perceived risk of lending and the cost of funds.

Þ These loans are generally repayable over a period of 6 to 10 years in annual, semi-annual or quarterly installments.

LTF : Issues of SecuritiesPublic Issue: Þ Companies issue securities in the public in the primary

market and get them listed in the stock exchange.Þ Initial public offerings are used by companies to raise

expansion capital, to possibly monetize the investments of early private investors, and to become publicly traded enterprises.

Þ The issuer obtains the assistance of an underwriting firm, which provide a valuable service, which includes help with correctly assessing the value of shares (share price), and establishing a public market for shares (initial sale).

Private Placement:Þ The sale of securities to a relatively small number of select

investors as a way of raising capital.Þ Investors involved in private placements are usually large

banks, mutual funds, insurance companies and pension funds.

Þ Private placement is the opposite of a public issue, in which securities are made available for sale on the open market.

LTF : Issues of SecuritiesRight Issue: Þ A rights issue is an issue of rights to buy

additional securities in a company made to the company's existing security holders.

Þ A rights issue is directly offered to all shareholders of record or through broker dealers of record and may be exercised in full or partially.

Þ Subscription rights may either be transferable, allowing the subscription-rights holder to sell them privately, on the open market or not at all.

Þ A rights issue to shareholders is generally made as a tax-free dividend on a ratio basis (e.g. a dividend of one subscription right for one share of Common stock issued and outstanding).