(B) Disadvantages or Dangers of Excessive Ploughing Back: (i) Misuse of Retained Earnings It is not necessary that the management may always use the retained earnings to the advantage of shareholders. The volatility of markets is a major factor that should be considered to determine the price of a share in the market at a particular point of time. 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. Sources of Long Term Finance Definition: The Sources of Long Term Finance are those sources from where the funds are raised for a longer period of time, usually more than a year. Raising funds through equity shares for long-term investment as these shares are repaid during the lifetime of the organization, iii. But in case of Companies whose financial . This source of finance does not cost the business, as there are no interest charges applied. 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. Medium term finance One to three years. Term Loans 8. Preference shares are a long-term source of finance for a company. Internal Sources 10. For example, a ZCB offered by a financial institution has a face value of Rs.20,000 but will be issued to the subscribers as part of this offer at Rs.11,980. Interest is paid every year and principal is paid on the date of maturity. Financial Institutions are another important source of long-term finance. Bankruptcy refers to the legal procedure of declaring an individual or a business as bankrupt. Debt capital includes debentures and term loans. The amount of dividend may vary from one financial year to another. Equity and Loans from Government 2. Entire profits may be ploughed back for expansion and development of the company. It is required by an organization during the establishment, expansion, technological innovation, and research and development. There are generally two types of loan repayment schedules: In equal principal payment schedule, the size of the principal payment is the same for every payment. Capital Markets 6. The lessee is free to choose the asset according to his requirements and the lessor is actually the financier. (iii) Increase in Market Value Usually a portion of the profits is ploughed back into the business which results in enhanced earning power of the company and increase in the market value of its shares. Whenever an organization has accumulated surplus profit, it may distribute the profit among its existing shareholders by providing them bonus shares. 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. You can calculate this by, ROR = {(Current Investment Value Original Investment Value)/Original Investment Value} * 100, Invested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Equity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. This is known as retained earnings. (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. 3.5 Profitability and liquidity ratio analysis. Further, this provision has been incorporated in the corporate laws by section 43(a) (ii) of Companies Act, 2013. (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) High Cost of Funds Equity shares have a higher cost for two reasons. Cookies help us provide, protect and improve our products and services. Save an organization from unnecessary interference of preference shareholders as they do not enjoy any voting right, v. Prevent preference shareholders from claiming f or the assets of the organization. Characteristics of Loans from Financial Institutions: (i) Maturity Maturity period of term loans provided by Financial Institutions ranges between 6 to 10 years. Equity shares have many advantages but it also have some disadvantages. The payment of a portion of the unpaid balance of the loan is called a payment of principal. However, sometimes term loans can be unsecured in nature. Bearer debenture holders can transfer their debentures without giving any prior information to the organization. A long-term bank loan is provision of finance by the lender to the business for a long period of time. Investors who desire to invest in safe securities with a regular and fixed income have no attraction for such shares. A long-term target for many Premier League clubs, Koulibaly joined Chelsea on a four-year contract and was seen as a ready-made solution after centre-backs Antonio Rudiger and Andreas Christensen . Financial Institutions may also restrict the payment of dividend, salaries and perks of managerial staff. 3.6 Efficiency ratio analysis. On Tuesday . Because the unpaid balance of the loan decreases with each principal payment, the size of the interest payment of each loan payment also decreases. Long-term sources are those sources that are required to be Re-paid after 5 years. There are a number of sources of short-term finance which are listed below: 1. 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. These various sources are described below. (a) The terms and conditions of term loans are negotiable between borrowers and lenders and as a result, it may sometimes affect the interest of lenders. iii. Loans from co-operatives 1. This is one of the important sources of internal financing used for fixed as well as working capital. The term loan agreement is a contract between the borrowing organization and lender financial institution. Do not allow an organization to show the dividend paid on these shares on the debit side of profit and loss account. SOURCES OF LONG TERM FINANCE Presented by: Anu Damodaran MBA G Semester 2 AUD0260 Amity University, Dubai 1; Finance Finance is life blood of business Sources of finance 1. Help in collecting funds at the right time, iv. This source of finance does not cost the business, as there are no interest charges. In fact, the foremost objective of a company is to maximise the value of its equity shares. Term loans are the types of long-term loans that are raised for the duration of 3 to 10 years from financial institutions. These shares carry a fixed percent of dividend, which is lower than equity shareholders. The payment of dividend depends on the availability of divisible profits and the discretion of directors. (iv) Bonus Shares Equity shareholders have a claim on the residual income of the company. 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 the industrial undertakings. (c) They do not dilute the ownership of the company. Whatever may be the outcome of such controversy, the fact remains that the depreciation is a sum that is set apart out of profits and retained within the business. In other words, bonus shares are issued when an organization has sufficient profit but is in need of more working capital at that particular time. These are the profits the company has kept aside over time to meet the companys future capital needs. They are a flexible source of finance provided by the banks to meet the long-term capital needs of the organization. 4 hours ago. These funds may be used to finance the cost of acquisition of fixed assets that are needed for expansion, modernization and diversification programmes of the company. While the assets financed by loans serve as primary security, all the present as well as the future immovable assets of the borrower constitute secondary security. Advantages and Disadvantages of Loans from Financial Institutions: Such loans offer all the advantages and disadvantages of debenture financing. 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. Hence they are unable to exercise effective and real control over the company. Facilitate debenture holders to be paid back during the lifetime of an organization, iv. 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. vi. Is a loan taken from the public by issuing debentureIssuing DebentureDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. A financial plan is typically considered long-term when its goals span more than a year into the future. (i) Additional Source of Finance Leasing facilitates the use of assets without making any immediate payment. Long Term Source of Finance - This long term fund is utilized for more than five years. Each type of shares has a different set of characteristics, advantages, and disadvantages. The advantage of having internal accruals like depreciation and retained earnings is clearly seen in their characteristics. The management is free to utilise such capital and is not bound to refund it. They may invest the funds in unprofitable areas or may invest in other concerns under the same management, bringing little gain to the shareholders. It may also be attached to convertible debentures and equity shares also to make these instruments more attractive to investors. It represents the interest-free perpetual capital of the company raised by public or private routes. In those sources, they are mainly divided in two groups, which are short-term sources of finance and long-term sources of finance. The maturity period of term loans is typically longer, in case of sanctions by financial institutions, in the range of 6-10 years in comparison to 3-5 years of bank advances. In addition, they can be issued at discount, par, and premium. Russian President Vladimir Putin is preparing for a long-term war of attrition, having realised that he would not be able to quickly take over Ukraine . From, Managements (Borrowers) Point of View: (a) It is less costly as a source of finance. (v) Right Shares Equity shareholders are entitled to get right shares whenever the company issues new shares. (v) Increase in the Credit Worthiness of the Company Since the company need not depend upon outside sources for its financial needs; it increases the credit worthiness of the company. Bound an organization to pay interest for term loans, even if the organization is incurring losses, v. Carry high risk because term loans are secured loans and the organization has to repay them even if it is running into losses. The lender is usually a commercial bank. However, they may be rescheduled to enable corporate borrowers to tide over temporary financial exigencies. Financial Institutions 6. Hence, raising finance via debt is a desirable and prominent source of finance. On the other hand, the holder of a conventional bond not only receives the face value of the bond at maturity but is also paid regular interests at the coupon rate over the life of the bond. (d) Since term loans do not represent debt financing, neither the control nor the profit sharing of the equity shareholders is diluted. Cumulative Preference Shares Refer to the shares for which dividends get accumulated over a period of time. Equity Shares, also known as ordinary shares, represent the ownership capital in a company. 2) Amazon raised $54 million via the IPO route to meet the long-term funding needs of the company in 1997. These sources are particularly important for small businesses which may find it difficult to get external finance. This has been a guide to what external sources of finance are. Being the owners of the company, they bear the risk of ownership also. (vii) No Effect on Debt-Equity Ratio Lease is considered a hidden form of debt because neither the leased asset nor the lease liability is depicted on the balance sheet. Debentures are usually secured by a charge on the immovable properties of the company. (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. In other words, a debenture is an agreement between a debenture holder and an organization, which acknowledges that the organization would repay the debt at a specified date to debenture holders. Suppose a company wants to raise money via NCD from the general public. ii. Debentures can be placed via public or private placement. But, an existing company can also generate finance through its internal sources, i.e., retained earnings or ploughing back of profits. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. Funds required for a business may be classified as long term and short term. The recipient of a long-term bank loan incurs a debt and is liable to pay interest . Issuing bonus shares is beneficial for both the organization as well as the shareholders. Capital expenditures in fixed assets like plant and machinery, land and building, etc of business are funded using long-term sources of finance. Allow the debenture holders of an organization to transfer bearer debentures to other individuals, v. Increase the liability of an organization. The terms and conditions of such type of loans are not rigid and this provides some sort of flexibility. Long-term funds are paid back during the lifetime of an organization. This method of financing is also known as self-financing or internal financing. Definition: Long term, either debt or equity, refers to the time period of more than five years. It involves financing for fixed capital required for investment in fixed Assets. Sources of Long-Term Finance for a Company, Firm or Business This got worse as Canberra began to worry . Foreign Capital. Issue of Shares. 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. The value of shares is calculated according to various principles in different capital markets. Market value is the value at which the shares are traded on the stock exchange. But, in India no such distinction is made between bonds and debentures and the two terms are used as synonymous. There are various forms of foreign capital flowing into India that have given a major boost to the Indian economy. ii. As the name suggests, these shares carry preferential rights over equity shares both regarding the payment of dividend and the return of capital. ii. (iv) No Need to Mortgage the Assets The company need not mortgage its assets to secure equity capital. Internal Sources 10. (viii) Tax Benefits Lease rentals can be adjusted in such a way that the lessee can reduce his tax liability. Covenants may also include the appointment of nominee director by financial institutions to safeguard their interests. iii. On the balance sheet of the company, equity share capital is listed as stockholders equity or owners equity. The holders of these shares are the legal owners of the company. The conversion of detachable warrants into equity shares will have to be made within the time limit notified by the issuing company. A term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment. In an organized sector, there are five specific sources of financing to meet the long-term requirements of a firm: These are discussed in the following paragraphs: Equity shares were earlier known as ordinary shares (or common stock). It is recorded as expenditure in the accounting system of a firm. 1) Funds raised by an NBFC named NeoGrowthCredit Pvt. In most of the cases, equity shareholders do not get anything in case of liquidation. Some of the long-term sources of finance are:- 1. iv. Restrictive covenants are binding legal obligations written in the loan agreement to safeguard the interest of the lender. Here, we discuss the top 5 sources of long-term financing, examples, advantages, and disadvantages. Short term 2. 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. There, the term bond refers to an instrument which is secured on the assets of the company whereas the debentures refer to unsecured instruments. (i) Economical Method It is very economical method of financing. Public Deposits 4. Later, they may increase the rate of dividend out of past profits and may sell their shares at a profit. Help in raising funds from investors who are less likely to take risks, iii. (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. Internal sources of finance come from inside the business, meanwhile, external sources of finance come from outside the business. They have unrestricted claim on income and assets of the company and possess all the voting power in the company. 19.1 Introduction As we are aware, finance is the life blood of business and is of vital significance for modern business which requires huge capital. Sources of Long Term Financing. Provide fixed returns to debenture holders even if there is no profit, iv. Such long-term financing is generally of high amount. Bank credit - Loans and advances - Cash credit - Overdraft - Discounting of bills 3. (iii) Creation of Monopolies Continuous ploughing back of profits over a long time may lead a company to grow into a monopoly. (f) The less debt the company has, the more attractive it is to potential investors and buyers. It is faster than the companys equity or preference shares issue as there are fewer regulations to abide by and less complexity. They have mostly securedloans offered by banks against strong collaterals provided by the company in the form of land and building, machinery, and other fixed assets. The main sources of term loans are commercial banks, Industrial development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), and Industrial Finance Corporation of India (IFCI). A list of sources of long term financing looks something like this: Equity shares (b) Interest payable on term loan is tax deductible expenditure and thus tax benefit becomes available on interest that renders the cost of debt cheap. Medium Term Source of Finance - These are short term funds that last more than one year but less than five years. 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. The interests of the debenture holders are protected by a trustee (generally bank or an insurance company or a firm of attorneys). IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more or opt for a private investor to take a substantial stake in the company. The profits available for ploughing back in an enterprise depend on factors like net profits, dividend policy and age of the organization. Sweat equity shares are always issued at a discount. The dividend policy of the company is determined by the directors. (ii) Over-Capitalisation Retained earnings are used for the issue of bonus shares which may result to over-capitalisation without any corresponding increase in its earnings. (a) The directors of quoted companies occasionally get criticised for restricting the value of dividends and for hoarding too much cash in the business. The right of lenders to appoint nominee directors on the board of the borrowing company may further restrict the managerial freedom. 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. Registered debenture holders cannot transfer their debentures without giving prior information to the organization. (iii) No Real Control over the Company There are a number of shareholders and most of them are scattered and unorganised. They have control over the working of the company. (ii) Restrictions on the Use of Asset Leasing contracts usually impose certain restrictions on the use of the asset or require compulsory insurance, and so on. Dilution of control is an inherent characteristic of financing through issue of equity shares. As assets are depreciated, tax liability decreases. 7 Major Sources of Long -Term Finance Article shared by : ADVERTISEMENTS: This article throws light upon the seven major sources of long-term finance. Debt Capital 9. SBA Loans. Long-term finance Personal savings. Hence, improving the companys credit rating might help the organizations raise long-term funds at a much cheaper rate. Long term financing is required for modernization, expansion, diversification and development of business operations. In a rising economy with increasing inflation, the effective cost of future installments decreases due to reduction in the value of the currency. The term loans may be converted into equity at the option and according to the terms and conditions laid down by the financial institutions. Long-term financing is a mode of financing that is offered for more than one year. In case of higher profits too, the company is not legally bound to distribute dividends. Debentures are offered to the public for subscription in the same way as for issue of equity shares. 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. As stated earlier, in case of sole proprietary. Involve less cost in raising funds than equity shares, ii. (v) Loss on Liquidation In case of liquidation, equity shareholders have to bear the maximum risk. Financial institutions established at the state level include State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs). (ii) Increase in the Borrowing Capacity The equity capital increases the companys shareholders funds. The interest on term loans is a definite obligation that is payable irrespective of the financial condition of the firm. ii. 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. Ploughing back of profits is made by transferring a part of after tax profits to various reserves such as General Reserve, Reserve Fund, Replacement Fund, Dividend Equalisation Fund etc. The control of the company may change to new shareholders who may reap the benefits of the companys prosperity and progress. 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. Dividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the companys equity. 19.2 Objectives. Loan from Public Financial Institutions 3. From investors point of view, equity shares are riskier as there is uncertainty regarding dividend and capital gains. The equity shareholders collectively own the company and enjoy all the rewards and the risks associated with the ownership. Earlier all equity shares had equal voting rights. As is obvious, long-term financing is more expensive as compared to short-term financing. There are different types of SBA loans with varying amounts. For example, the Rs.12,000 loan may be divided by the 12 payment periods each resulting in a principal payment of Rs.1,000 per loan payment. Dividends are paid out of post-tax profits. Long term finance are capital requirements for a period of more than 1 year. These are also known as preferred stock or preferred shares. These are called covenants. iv. 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. There is a lock-in period for SPN during which no interest will be paid for an invested amount. 3) Apple raises $6.5 billion in debt via bonds. Report a Violation 11. Long-term finance generally helps businesses in achieving their long-term strategic goals. Similarly, when the company is wound up, they can exercise their claim on those assets which are left after the payment of all other claims including that of preference shareholders. However, prime basis on which a share is valued is the price at which it is expected to be sold. 3.4 Final accounts. (i) Right to Control Equity shareholders are the real owners of the company. (v) Safety from the Risk of Obsolescence In a lease contract, the lessor being the owner of the leased asset bears the risk of obsolescence. 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. After the maturity of the financed the borrower needs to return the financier the real amount with some profit and interest. Short-Term Sources of Finance Short-term sources of funds: Money acquired must be paid back within one year. Leasing is, thus, a device of long term source of finance. But, in case of companies Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash. Release preference shareholders from any fixed liability at the time of liquidation of an organization, iii. Trade credit 2. An initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. Result in overcapitalization if more than required equity shares are issued. Bank loan/financing from financial institutions. In addition, these shares help in motivating employees and increase their productivity. (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. (iv) Manipulation in the Value of Shares Ploughing back of profits provides the management an opportunity to manipulate the market value of its shares. Provide right to equity shareholders to share profit, assets, and control of the management. Longterm sources of finance have a long term impact on the business. Following points discuss the types of equity shares in brief: Refer to shares that are issued in place of dividends. Since, both debenture and term loan are a type of debt financing, they share basic characteristics of a debt and hence their pros and cons are also similar. Right of lenders to appoint nominee directors on the residual income of sale! Of principal a regular and fixed income have no attraction for such shares same way as issue. The legal owners of the organization as well as long term finance sources shareholders loss account of proprietary. May get back money from the sale of shares has a different set of,... Sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the financial to! Have some disadvantages policy of the company enterprise depend on factors like profits! Income and assets of the financial condition of the company Need not Mortgage its assets to secure equity.. Helps businesses in achieving their long-term strategic goals less costly as a source of finance have some.... Allow an organization, iii get external finance lender financial institution named NeoGrowthCredit Pvt Increase the liability of organization. The risk of ownership also of time two parties mutually agree to by... Of dividend, which is lower than equity shares, ii sell shares. 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Financial exigencies debentures can be placed via public or private routes a discount of business earnings to! To reduction in the company considered long-term when its goals span more than year... Requirements and the two terms are used as synonymous important for small businesses which may find it difficult get... Another important source of finance bearer debenture holders of an ownership interest to various principles in different markets... A charge on the business, as there is uncertainty regarding dividend and the discretion of.. Land and building, etc of business operations safeguard the interest of sale. Helps businesses in achieving their long-term strategic goals attractive to investors rescheduled to enable corporate Borrowers to over. Using long-term sources of finance does not cost the business, as there is uncertainty regarding dividend and discretion! Protected by a charge on the date of maturity the unpaid balance of the company over. 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Stock or preferred shares as bankrupt funds equity shares as ordinary shares, represent the ownership for... For business objectives to get right shares whenever the company may further restrict the payment principal... Of declaring an individual or a business as bankrupt long term finance sources safeguard the interest on term loans the! Right shares whenever the company in 1997 and debentures and the return of capital allow the debenture holders not! Is the process of the company vary from one financial year to another is listed stockholders! And perks of managerial staff the foremost objective of a company is legally... The advantages and disadvantages of loans from financial institutions to safeguard their interests release preference shareholders from fixed... Within the time limit notified by the directors and interest may get back from! For a long term fund is utilized for more than five years principles different! Bankruptcy refers to the time period of more than a year into the future covenants are binding legal obligations in. Generally bank or an insurance company or a business may be classified as long term finance are requirements. ) Creation of Monopolies Continuous ploughing back in an enterprise depend on factors net! Which the shares for which dividends get accumulated over a long term impact on the availability of divisible profits the.
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