Therefore, it can be used to finance the capital needs in the normal business routine, and as such depreciation in true academic sense can be deemed as a source of internal finance. The law treats them as shares but they have elements of both equity shares and debt. Allow an organization to raise secured loans. Issue of debentures. vi. Characteristics of Loans from Financial Institutions: (i) Maturity Maturity period of term loans provided by Financial Institutions ranges between 6 to 10 years. Both convertible and non-convertible debentures may be issued along with a detachable warrant. An additional disadvantage from borrowers viewpoint is that the loan contracts contain certain restrictive covenants which restrict the managerial freedom. A long-term bank loan is provision of finance by the lender to the business for a long period of time. Thus flexibility is not available in case of loans from financial institutions where the loans are repaid in instalments resulting in heavy burden in the earlier years of a project, whereas the project may actually generate substantial cash flows in later years. Preference shares give preferential rights to their holders in comparison to equity 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. Registered debenture holders cannot transfer their debentures without giving prior information to the organization. The total value of retained profits in a company can be seen in the equity section of the balance sheet. Do not require any security from the organization. Here we discuss the two types of external sources of finance: long-term financing (equity, debentures, term loans, preferred stocks, venture capital) and short-term financing (bank overdraft and short-term loans). A debenture is a form of financial instrument that provides long-term debt to an organization. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance. Make it difficult for an organization to provide security against debentures if an organization has insufficient fixed assets. Short-Term Sources of Finance Short-term sources of funds: Money acquired must be paid back within one year. A term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment. (e) Secured Premium Notes (SPN) with Detachable Warrants: SPN which is issued along with a detachable warrant, is redeemable after a notice period, say four to seven years. 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. In addition, the lessee is not free to make alterations to the leased asset. This makes employees feel that they are owners of the organization and motivate them to demonstrate dedication in their work. The amount of long-term finance needed for buying Fixed Assets, or Non-Current Assets, with a relatively low value such as vehicles will be small. 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. Provide right to equity shareholders to share profit, assets, and control of the management. This source of finance does not cost the business, as there are no interest charges. 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. 4 Sources of Long Term Financing 4.1 External sources of finance 4.2 Equity Shares 4.3 Preference Shares 4.4 Debentures and Bonds 4.5 Venture capital 4.6 Term Loans 4.7 Lease financing 5 Internal Sources of finance 5.1 Retained earnings 5.1.1 Advantages of Retained Earnings 5.2 Sale of assets Long Term Financing Needs of a Business (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. This chapter deals with the major vehicles of both types of financing. Do not bind an organization to offer any asset as security to preference shareholders, v. Carry less risk for investors as compared to equity shares. Similarly, at the time of liquidation, the whole of preference capital must be paid before any payment is made to equity shareholders. Hence, a group of shareholders may control the company by purchasing shares and they may use such control for their personal advantage at the cost of companys interests. This is more likely to occur when other companies find it difficult to procure finance from the market whereas an existing concern continues to grow through its retained earnings. Long-term finance Personal savings. Long term finance can be said as an investment or financing that is bound to be kept continue for a period exceeding one year. As assets are depreciated, tax liability decreases. They are entitled to receive dividend out of the profit generated at the end of every financial year. A repayment schedule is a complete table of periodic loan payments that includes an interest amount computed on the unpaid balance of the loan plus a portion of the unpaid balance of the loan. Facilitate debenture holders to be paid back during the lifetime of an organization, iv. Let us have a look at the following disadvantages of equity shares: i. They are issued under the common seal of the company acknowledging the receipt of money. Some of the long-term sources of finance are:- 1. Financial Institutions may also restrict the payment of dividend, salaries and perks of managerial staff. 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. Trade Credit Issuing bonus shares is beneficial for both the organization as well as the shareholders. Equity shareholders are considered as the real owners of the organization. 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. Account Disable 12. Long-term finance Personal savings Personal savings is money that has been saved up by an entrepreneur. Term loans, also referred to as term finance, represent a source of debt finance, which is generally repayable in less than 10 years. From, Managements (Borrowers) Point of View: (a) It is less costly as a source of finance. Increase the chances of government interference in the functioning of organization, as these loans are mainly provided by financial institutions, which are owned by the government. v. Redeemable Preference Shares Refer to the shares that are repaid by the organization. Long-term financing is a mode of financing that is offered for more than one year. In those sources, they are mainly divided in two groups, which are short-term sources of finance and long-term sources of finance. The amount of dividend may vary from one financial year to another. For example, In Haryana, Haryana State Financial Corporation (HFC) and Haryana State Industrial Development Corporation (HSIDC) have been established. They are employed to finance acquisition of fixed assets and working capital margin. There are other functional differences between the two- bonds carry lower rate of interest and lower risk as compared to debentures, are generally secured by collateral and are paid prior to debentures in case of liquidation. Internal Sources 5. This includes short-term working capital, fixed assets, and other investments in the long term. (iv) Ownership Dilution If the new shares are issued to the public, it may dilute the ownership and control of the existing shareholders. (iii) Not Bound to Pay Dividend A company is not legally bound to pay dividend to its equity shareholders. These sources are particularly important for small businesses which may find it difficult to get external finance. Preference Shares 3. Such debentures provide many options to debenture holders. The main advantage is that it is not been paid immediately or within shorter time duration. iv. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. The less the firm relies on external sources of funding, more is the retention of the ownership of the firm. Ltd. via private equity routes from LeapFrog Investments amounting to 300 crores ($43 million). The firms that choose to finance through the external sources can retain internal funds to cover the company in an emergency. However, term loan providers are considered as the creditors of the organization. Bonds 7. International Sources. Lessee gets the right to use the asset without buying them. Equity and Loans from Government 2. Long-term financing means financing by loan or borrowing for more than one year by issuing equity shares, a form of debt financing, long-term loans, leases, or bonds. Failure to meet these payments raises a question mark on the liquidity position of the borrower and its existence may be at stake. Long term 2; Basics Long term finance - Funding obtained exceeding three years in duration. Internal Sources 10. Entire profits may be ploughed back for expansion and development of the company. Covenant refers to the borrower's promise to the lender, quoted on a formal debt agreement stating the former's obligations and limitations. Make organizations more focused on profitable projects, as they have to pay interests on quarterly, half yearly, and annual basis, vi. However, sometimes term loans can be unsecured in nature. Terms of Service 7. This led to the deregulation and liberalization of the Indian economy and also increased the flow of foreign capital into the country. Huge Collection of Essays, Research Papers and Articles on Business Management shared by visitors and users like you. Financial institutions established at the state level include State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs). The control of the company may change to new shareholders who may reap the benefits of the companys prosperity and progress. 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. In addition, these shares help in motivating employees and increase their productivity. Each type of shares has a different set of characteristics, advantages, and disadvantages. This led to the business, as there are no interest charges ( borrowers ) Point View... 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