Equity shares offer the following advantages to the company: (i) Permanent Source of Funds Equity capital is a permanent capital, and is available for use as long as the company continues. Lease is a contract between the owner of an asset and the user of such asset. Equity and other types of share capital except Redeemable Preference Share Capital can only be Re-paid only in the event of winding up or liquidation of the company. CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. Preference shares give preferential rights to their holders in comparison to equity shares. ii. Term loans differ from short-term loans which are employed to finance short-term working capital need and tend to be self-liquidating over a period of time usually less than a year. Equity Shares 2. Hence, if the company desires to raise further finance from other sources, it can easily do so by mortgaging its assets. Lower debt improves a companys debt capacity and creditworthiness, as well. (iv) Flexibility in Fixing the Rentals Lease rentals are fixed in such a way that the lessee is able to pay them from the cash flows generated from his business operations. Rate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. (b) Like other sources of debt financing, the lenders of term loans do not have any right to have direct control over the affairs of the company. (i) Fully Secured The lessors interests are fully secured because he is the owner of the leased asset and can take possession of the asset in case the lessee defaults. There exists a controversy whether depreciation should be taken as a source of finance. These funds are normally used for investing in projects that will generate synergies for the company in the future years. The total value of retained profits in a company can be seen in the equity section of the balance sheet. Make it difficult to repay funds raised by issuing equity shares during the lifetime of an organization, even if these funds are not in use. (b) They are very flexible as the management has complete control over how they are reinvested and what proportion is kept rather than paid as dividends. Let us start the discussion with the equity shares. Following points explain the type of debentures in brief: i. However, the use of internal accruals as opposed to new shares or debentures avoids costs that are associated with fresh issues. The capital procured by issue of equity shares is a permanent source of funds to the company as it need not be redeemed during the lifetime of the company. (vi) Easy to Sell In comparison to investment in fixed properties, the investment in equity shares is much liquid because the shares can be sold in the market whenever needed. vi. The disadvantages of term loans are as follows: i. Bind an organization to pay interests even in case of loss, ii. (vi) Helpful in the Repayment of Long-Term Liabilities It enables the company to repay its long-term loans and debentures and thus relieves the company from the burden of fixed interest payments. These shares carry a fixed rate of dividend and such dividend must be paid in full before the payment of any dividend on equity shares. (ii) Increase in Rate of Dividends In case of higher profits in the company, these shareholders are handsomely rewarded in the form of higher dividends. In return, investors are compensated with an interest income for being a creditor to the issuer.read more certificates under the companys common seal? The amount of capital decided to be raised from members of the public is divided into units of equal value. Financial institutions established at the national level include Industrial Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI), Industrial Credit and Investment Corporation of India (ICICI), Industrial Reconstruction Corporation of India (IRCI), Unit Trust of India (UTI), Life Insurance Corporation of India (LIC), General Insurance Corporation (GIC) etc. These sources are particularly important for small businesses which may find it difficult to get external finance. Short-Term Sources of Finance Short-term sources of funds: Money acquired must be paid back within one year. Convertible Debentures Refer to the debentures that have right to get converted into the equity shares after a specific period of time. You have learnt about short term finance in the previous lesson. iv. A new company can raise finance only from external sources such as shares, debentures, loans etc. However, they may be rescheduled to enable corporate borrowers to tide over temporary financial exigencies. Tax liability on dividends differs in different zones, states, and countries. These are the companys free reserves, which carry nil cost and are available free of charge without any interest repayment burden. This led to the deregulation and liberalization of the Indian economy and also increased the flow of foreign capital into the country. ii. Interest is computed on the amount of the unpaid balance of the loan at each payment period. A company can also raise funds through issue of preference sharesa special type of share capital. Therefore, it has become essential for the issuer to innovate and introduce new financial instruments to cater to the different needs of the issuers and investors. 3.6 Efficiency ratio analysis. As the foreign capital plays a constructive role in a countrys economic development, it has led to a progressive reduction in regulations and restraints that had earlier inhibited the inflow of foreign capital. (iii) Consequences of Default Since the lessee is not the owner of the leased asset, the lessor may take over the possession of the same, in case of default in payment of lease rentals. Although depreciation is meant for replacement of particular assets but generally it creates a pool of funds which are available with a company to finance its working capital requirements and sometimes for acquisition of new assets including replacement of worn out plant and machinery. The rate of interest is high for overdrafts compared to bank loans. This chapter deals with the major vehicles of both types of financing. Long-term finance Personal savings. The subscription price at which the right shares are offered to them is generally much below the shares current market price. Long-term finance Personal savings Personal savings is money that has been saved up by an entrepreneur. There is a lock-in period for SPN during which no interest will be paid for an invested amount. But an amendment in the Companies Act, 2000 permitted companies to issue equity shares with differential voting rights. Internal finance is also known as self-financing by a company. Equity shares are one of the most important financial instruments to raise long-term funds needed for the incorporation, expansion, and growth of an organization. This residual income is either directly distributed to them in the form of dividend or indirectly in the form of bonus shares. High gearing on the company may affect the valuations and future fundraising. The disadvantages of preference shares are as follows: i. Overall, long-term finance may have its advantages and disadvantages. As assets are depreciated, tax liability decreases. In case the SPN holder holds it further, the holder will be repaid the principal amount along with the additional amount of interest/premium on redemption in installments as decided by the company. The common practice in India is the repayment of principal in equal instalments and payment of interest on the outstanding loan. Companies can also raise internal finance by selling off assets for cash. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders. Australia and China have adopted more assertive strategies for security cooperation with Pacific countries during the previous year, with significant efforts concentrated on the Solomon Islands, reported Financial Post. Capital Markets 6. In fact, the foremost objective of a company is to maximise the value of its equity shares. Allow the debenture holders of an organization to transfer bearer debentures to other individuals, v. Increase the liability of an organization. In India, the two terms, bonds and debentures are used interchangeably. (iii) Helpful in Following a Balanced Dividend Policy Such a company can follow the policy of paying regular and balanced dividends because it can use retained earnings for paying dividends in the years when there are inadequate profits. These are also known as preferred stock or preferred shares. (c) In addition to collateral security, restrictive covenants are also imposed by the lenders which lead to unnecessary interference in the functioning of the business concern. Refer to the shares that are issued to the employees of an organization. This is one of the important sources of internal financing used for fixed as well as working capital. The value of equity capital is computed by estimating the current market value of everything owned by the company from which the total of all liabilities is subtracted. iii. (iii) Security Such loans are always secured. Bonds 7. International Sources. 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 ploughing back of profits or retention of earnings. This article shall discuss major sources of long-term debt financing for most corporations. (b) Like any other form of debt financing, term loans also increase the financial risk of the company. Involve less cost in raising funds than equity shares, ii. Investors have also become more aware, selective and demanding. The control of the company may change to new shareholders who may reap the benefits of the companys prosperity and progress. The rate of dividend on these shares is not fixed and depends upon the availability of divisible profits and the intention of the directors. Investors who desire to invest in safe securities with a regular and fixed income have no attraction for such shares. (v) Not Entitled to Tax-Benefits Lessee is not entitled to certain tax benefits like depreciation and investment allowance because he is not the owner of the asset. Long term sources of finance are those, which remains with the business for a longer duration of time. Medium term finance One to three years. Long-term finance can be defined as any financial instrument with maturity exceeding one year (such as bank loans, bonds, leasing and other forms of debt finance), and public and private equity instruments. Bank loan/financing from financial institutions. Let us have a look at the following disadvantages of equity shares: i. The capital profits emerging out of retained earnings may be preferred because of taxation considerations. Leasing is, thus, a device of long term source of finance. At the end of lease period, the lessee is usually given an option to buy or further renew the lease contract for a definite period. The following sources are considered major sources of finance for major corporations. Ploughing Back of Profits 4. In case of sole-proprietary concerns and partnership firms long term funds are generally provided by the owners themselves or by their retained profits. These shares are a kind of award for employees for the work rendered by them to organization. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance. In other words, the extent of profitability after tax, the size of dividend payments and the amount of depreciation provided for along with the reserves and surplus all contribute to the sources of internal funds. There are two sources of finance: internal and external. and is accumulated from the capital market. It is faster than the companys equity or preference shares issue as there are fewer regulations to abide by and less complexity. Corporate valuation, Investment Banking, Accounting, CFA Calculation and others (Course Provider - EDUCBA), * Please provide your correct email id. This has been a guide to what external sources of finance are. Paying dividend on equity shares is not an obligation for an organization when there is less profit or loss, ii. This source of finance does not cost the business, as there are no interest charges. (iv) No Need to Mortgage the Assets The company need not mortgage its assets to secure equity capital. His position is akin to that of a person who uses the asset with borrowed money. In the event of the company going for rights issue prior to the allotment of equity to the holders of FCDs, FCD holders shall be offered securities as may be determined by the company. There, the term bond refers to an instrument which is secured on the assets of the company whereas the debentures refer to unsecured instruments. However, unlike the sole proprietor or the partner of a firm, the risk of the shareholders in case of insolvency is limited to their capital contribution. The warrant gives a right to the debenture holder to obtain equity shares specified in the warrant after the expiry of a certain period at a price not exceeding the cap price specified in the warrant. Do not require any security from the organization. Some of the long-term sources of finance are:- 1. The fund is arranged through preference and equity shares and debentures etc. Customers' advances 4. Equity Share Capital: Equity shares, also known as ordinary shares or common shares represent the owners' capital in a company. Long term finance can be said as an investment or financing that is bound to be kept continue for a period exceeding one year. (vi) Benefit of Maintenance Lessee gets the benefit of maintenance and specialized services provided by the lessor. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. It is usually done for big projects, financing, and company expansion. The term loans carry a fixed rate of interest, but this rate is negotiated between the borrowers and lenders at the time of disbursing of loan. Long term Sources of Finance Long-term Financing involves long-term debts and financial obligations on a business which last for a period of more than a year, usually 5 to 10 years. Account Disable 12. Shares are a part of stocks that consist of fixed assets and current assets, which may change at different situations. Generally, the financial institutions charge an interest rate that is related to the credit risk of the proposal, subject usually to a certain minimum prime lending rate (PLR) or floor rate. A term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment. Equity warrant is generally attached to non-convertible debentures as a sweetener to improve their marketability. Sources of Long-Term Finance for a Company, Firm or Business, The main characteristics of retained profits are that there is no compulsory maturity like term loans and debentures and they are not characterized by fixed burden of interest or installment p, Essays, Research Papers and Articles on Business Management, Raising of Finance for a Company: 12 Methods, Sources of Industrial Finance in India | Financial Management, Essay on the Sources of Business Finance | Finance | Financial Management, Human Resource Planning: Meaning, Objectives, Purpose, Importance and Process, Long-Term Sources of Finance Equity Shares, Preference Shares, Ploughing Back of Profits, Debentures, Financial Institutions and Lease Financing, Long-Term Sources of Finance Shares, Debentures and Term Loans, Long-Term Sources of Finance Equity Capital, Preference Capital, Debt Capital, Internal Sources and Foreign Capital. Allow debenture holders to receive payment before equity and preference shareholders even at the time of liquidation of an organization. Most of the new instruments are simply old conventional instruments with some added features. An organization pays interest on the irredeemable debentures till its existence. (Nickels, McHugh, McHugh, N.D.) Long-Term Finance Ltd. via private equity routes from LeapFrog Investments amounting to 300 crores ($43 million). The holders of these shares are the legal owners of the company. Preference share capital is another source of long-term financing for a company. For example, in India, dividends are free from tax liability for shareholders; however, the organization pays tax on dividend before its distribution at the rate of 12.5%. Firstly, as compared to interest, dividends cannot be deducted from the income of the company while calculating taxes. Make the repayment of preference shares possible during the existence of the organization, iii. 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. Equity shares have many advantages but it also have some disadvantages. Financial Institutions may also restrict the payment of dividend, salaries and perks of managerial staff. Besides asset security, the lender of the term loans imposes other restrictive covenants to the borrower depending upon the nature of the project and the financial condition of the borrowing company. The objective of charging depreciation is to spread the cost of the fixed asset over its useful life for the purpose of ascertaining the result of operations as well as accumulation of funds for replacement of asset. Financial institutions impose a penalty for defaults on the payment of installment of principal and/or interest. It is computed by dividing the amount of the original loan by the number of payments. Allows the equity shareholders to interfere in the internal affairs of an organization. These are issued for a fixed period of time. However, for obtaining further finance in case of any existing company, the management should, as far as possible, avoid issuing equity shares. It is also referred to as ploughing back of profit. If a company wants to raise money privately, it may approach the major debt investors in the market and borrow from them at higher interest rates. ii. Content Filtration 6. The foreign capital may be provided by foreign government, institutions, banks, business corporations or individual investors. (ii) Increase in the Borrowing Capacity The equity capital increases the companys shareholders funds. They do not carry voting rights and are secured against the companys assets. The recipient of a long-term bank loan incurs a debt and is liable to pay interest . The holders of convertible preference shares have to pay conversion price at a given date for converting their shares into equity shares. ii. SBA loans offer competitive rates and repayment periods of up to 25 years. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. Align specifically to the long-term capital objectives of the company, Effectively manages the asset-liability position of the organization, Provides long-term support to the investor and the company for building synergies. Facilitate debenture holders to be paid back during the lifetime of an organization, iv. long term finance is required for purchasing fixed assets like land and building, machinery etc.The amount of long term capital depends . (ii) Simplicity Borrowing from banks and financial institutions involve time consuming and complicated procedures whereas a leasing contract is simple to negotiate and free from cumbersome procedures. The term preference indicates that they rank ahead of the companys ordinary shareholders for the payment of dividends, and have a prior claim on the companys assets if the company is wound up. Public Deposits 4. A debenture is a form of financial instrument that provides long-term debt to an organization. In addition, long-term financing is required to finance long-term investment projects. Help in raising funds from investors who are less likely to take risks, iii. It is a source of internal financing which does not affect the working capital of the concern as it does not involve outflow of any cash like other expenses. When the organization has sufficient profit, the accumulated dividend of these preference shares is paid. The saved taxes are allowed to accumulate as reserves. They may be paid a higher rate of dividend in times of prosperity and also run the risk of no dividends in the period of adversity. Such short-term sources of working capital help in assisting the seasonal fluctuations and short-term liquidity crisis. (iii) Free from Restrictive Covenants Lease financing is free from restrictive covenants whereas the financial institutions often put a number of restrictions on borrowers, such as, conversion of loan into equity, appoint nominee directors, restrictions on payment of dividend, and so on. The advantages of preference shares are as follows: i. Funds required for a business may be classified as long term and short term. It includes clauses and conditions, which are as follows: iv. Borrowing for long-term means that the business does not expect to repay this debt in less than five years. For this reason, they are also called hybrid financing instruments. Internal finance includes the funds generated within the corporate unit irrespective of the nature of source. Issue of Shares. The main advantage is that it is not been paid immediately or within shorter time duration. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. If the firm finds an asset-based lender, who owns those assets which are required by the firm, then upon a default, the lender as part of the agreement may acquire control of the firm in lieu of seizing the assets and causing a shutdown. Internal and external sources of finance (AO2) Short-term and long-term external sources of finance (AO1) The appropriateness of sources of finance for a given situation (AO3) 3.2 Costs and revenues. Funds acquired by issue of debentures represent loans taken by the company and are also known as debt capital. Less likely to take risks, iii overall, long-term financing for a longer duration of time fund arranged. 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