long term source of finance
TRANSCRIPT
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SOURCES OF FINANCE (LONG-TERM)
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Categories of Financial Requirement
i) Long-term Financial Requirements
ii) Medium-term Requirements
iii) Short-term Requirements
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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.
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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.
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Features:-
Residual Claim on Income Residual Claim on Assets Right to Control Pre-Emptive Rights Limited Liability
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Advantages to the Company:-
Permanent Source of Funds Increase in the Borrowing Capacity Not Bound to Pay Dividend No need to Mortgage the Assets
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Advantages to Investors:- Right to Control Increase in Rate of Dividends Increase in Market Value Bonus Shares Right Shares Easy to Sell
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Disadvantages to the Company:- High Cost of Funds
No Advantage of Trading on Equity
Manipulation by a Group of Shareholders
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Disadvantages to Investors:-
Irregular Dividend Fall in the Market Value of Shares No real Control Over the Company Ownership Dilution Loss on Liquidation
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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.
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Characteristics:-
Claim on Income Claim on Assets Controlling Power Fixed Dividend Cumulative Dividends Redemption Participation Feature Convertibility
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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
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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
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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
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Disadvantages to the Company:- High Cost of Funds Permanent Burden of Dividend Harmful in Case of Low Earnings Fear of Loss of Control
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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
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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.
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Factors Influencing Retained Earnings Earning Capacity Desire and Type of Shareholders Future Financial Requirement Dividend Policy Taxation Policy
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Advantages to the Company:
i. Economical Methodii. A Cushion to Absorb the Shocks of the
Businessiii. Helpful in following a Balanced Dividend
Policyiv. Helpful in making the Company Self-
Dependentv. Increase in Credit Worthinessvi. Helpful in Repayment of Long-term
Liabilities
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Advantages to the Shareholdersi. Increase in the value of shares
ii. Safety of Investment
iii. No dilution of Control
iv. Enhanced earning Capacity
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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
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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
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Characteristics:-
i. Maturity
ii. Claims on Income
iii. Claim on Assets
iv. Controlling Power
v. Buy-Back Provision
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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
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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
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Advantages to the Investors:
i. Fixed and Regular Income
ii. Minimum Risk
iii. Definite Maturity Period
iv. Liquidity
v. Benefit of Conversion
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Disadvantages to the Companyi. 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
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Disadvantages to Debenture holdersi. No voting rights
ii. Do not have Claim on Surplus Assets and Profits
iii. No certainty of regular payments in case of financial difficulties
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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.
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Characteristics:-
Maturity
Direct Negotiation
Security
Restrictive Conditions
Convertibility
Repayment Schedule
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Advantages and Disadvantages: Such loans offer all the advantages and
disadvantages of debenture financing.
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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”
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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
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Advantages to the Lessor:
i. Fully Secured
ii. Tax Benefits
iii. High Profitability
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Limitations of Leasing:-
i. Costly Source of Finance
ii. Restriction on the use of Asset
iii. Consequences of Default
iv. Excessive Penalties