In that case, it takes the debt IPO route where all the public subscribing to it gets allotted certificates and are the companys creditors. These are the companys free reserves, which carry nil cost and are available free of charge without any interest repayment burden. (iii) No Real Control over the Company There are a number of shareholders and most of them are scattered and unorganised. (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. Provide low returns to preference shareholders, ii. Thus the scarce financial resources of the business may be preserved for other purposes. Prohibited Content 3. Ploughing Back of Profits 4. The borrowing organization has to submit audited annual accounts report to the lender or financial institution, v. Details of fixed assets purchased from the loan. (b) It is obligatory on the part of the borrower to pay the interest and repayment of principal irrespective of its financial position. (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. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. From Managements (Borrowers) Point of View: (a) Yearly interest payment and repayment of principal is obligatory on the part of borrower. Lenders normally lend in proportion to the amount of shareholders funds. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. In the name of ploughing back of profits, they may declare lower dividends and when the share values fall in the market, they may purchase them at reduced prices. Lease Financing 7. (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. Share capital or Equity shares Loans from banks are however less flexible. 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. Generally, equity shares are repaid at the time of winding up of an organization. v. Redeemable Debentures Refer to the debentures that are paid back during the existence of an organization. Dividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the companys equity. 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. According to Section 2 (30) of the Companies Act, 2013, the term debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of the company or not.. Maturity refers to the last day of paying the financier the real amount of finance. Following points discuss the different types of preference shares briefly: i. Copyright 2023 . Involve less cost in raising funds than equity shares, ii. Long-term sources of finance are those which help in getting funds for longer period that is more than one year. Term Loans 8. (a) The directors of quoted companies occasionally get criticised for restricting the value of dividends and for hoarding too much cash in the business. Help in maintaining good relation with financial institutions, iii. Debt Capital 9. The real position of lessor is not renting of asset but lending of finance and hence lease financing is, in effect, a contract of lending money. ii. Depending upon the intrinsic value of shares, the market value fluctuates. They can be redeemable, irredeemable, convertible, and non-convertible. 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 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. In addition, the lessee is not free to make alterations to the leased asset. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. These shares do not carry any preferential or special rights in respect of annual dividends and in the repayment of capital at the time of liquidation of the company. Zero-coupon bondholders gain on the difference between what they pay for the bond and the amount they will receive at maturity. 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. Their features, types, advantages and limitations are discussed in the following paragraphs: In some markets the two terms, debentures and bonds are used synonymously, but in the US they refer to two separate kinds of debt-based securities. This chapter deals with the major vehicles of both types of financing. Dividends are paid out of post-tax profits. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash. These shares are treated as the base for capital formation of the organization. The rate of interest is high for overdrafts compared to bank loans. The equity shareholders collectively own the company and enjoy all the rewards and the risks associated with the ownership. There are a number of sources of short-term finance which are listed below: 1. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. Some of the long-term sources of finance are:- 1. The trustee is responsible for ensuring that the borrowing company fulfills the contractual obligations mentioned in the contract. Depreciation can be a very powerful accounting tool if it is applied with economic wisdom. (d) Since term loans do not represent debt financing, neither the control nor the profit sharing of the equity shareholders is diluted. (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. After the maturity of the financed the borrower needs to return the financier the real amount with some profit and interest. You are free to use this image on your website, templates, etc., Please provide us with an attribution link. Serve as a source of long-term capital and are repaid during the lifetime of the organization. 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. Carry high risks as these are secured loans, iii. (iv) Ownership Dilution If the new shares are issued to the public, it may dilute the ownership and control of the existing shareholders. Report a Violation 11. 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. Examples: Examples of external long-term finance include long-term bank loans, mortgage and debentures (bonds). 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. Debentures can be placed via public or private placement. However, there is a notified period after which fully paid FCDs will be automatically and compulsorily converted into shares. Raising funds through equity shares for long-term investment as these shares are repaid during the lifetime of the organization, iii. 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. iii. The advantages of debentures are as follows: i. It is computed by dividing the amount of the original loan by the number of payments. The advantages and disadvantages of term loans from the lenders and borrowers point of view are discussed below: (a) Term loans are provided by banks and other financial institutions against security because of which the term loans are secured. These shares carry a fixed percent of dividend, which is lower than equity shareholders. Cumulative Preference Shares Refer to the shares for which dividends get accumulated over a period of time. Long-term funds are paid back during the lifetime of an organization. (e) Debt financing by term loan has fixed installments till the maturity of the loan. 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. Equity shareholders are considered as the real owners of the organization. Allow preference shareholders to receive dividends out of profit earned by the organization, iv. (iii) Not Bound to Pay Dividend A company is not legally bound to pay dividend to its equity shareholders. An equity investor is that person or entity who contributes a certain sum to public or private companies for a specific period to obtain financial gains in the form of capital appreciation, dividend payouts, stock value appraisal, etc. The disadvantages of preference shares are as follows: i. Paying dividend on equity shares is not an obligation for an organization when there is less profit or loss, ii. Higher amount of shareholders funds provides higher safety to the lenders. Covenants may also include the appointment of nominee director by financial institutions to safeguard their interests. 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. ii. To conclude, equity shares are the most convenient and popular source of long-term finance for a company. (ii) Tax Benefits The lessor is entitled to claim the depreciation of leased asset and thus reduces his tax liability. Internal finance includes the funds generated within the corporate unit irrespective of the nature of source. You have learnt about short term finance in the previous lesson. Financial institutions impose a penalty for defaults on the payment of installment of principal and/or interest. Provide fixed returns to debenture holders even if there is no profit, iv. If an organization raises funds through issuing debentures, it needs to pay a fixed rate of interest at regular intervals. Short-Term Finance Short-term finance is an amount of money, which is borrowed, will be repaid in one year. Allow the debenture holders of an organization to transfer bearer debentures to other individuals, v. Increase the liability of an organization. Banks or financial institutions generally give them for more than one year. SBA Loans. ii. Debentures are offered to the public for subscription in the same way as for issue of equity shares. Capital Markets 6. Internal Sources 10. Advantages and Disadvantages of Loans from Financial Institutions: Such loans offer all the advantages and disadvantages of debenture financing. In return, investors are compensated with an interest income for being a creditor to the issuer.read more certificates under the companys common seal? Lease Financing 7. The terms and conditions of such type of loans are not rigid and this provides some sort of flexibility. 4) Paytm to raise funds via selling a significant controlling stake in the company to Warren Buffet for $10-$12 billion. In return, investors are compensated with an interest income for being a creditor to the issuer. There are term lending institutions sponsored by governments or reputed banks. In addition, they can be issued at discount, par, and premium. (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. There are different vehicles through which long-term and short-term financing is made available. Long-term finance generally helps businesses in achieving their long-term strategic goals. In addition, these shares help in motivating employees and increase their productivity. the detail sources of long term financing are shown in the following diagram: long term financing external sources internal sources owners capital retained earnings institutional sources non-institutional sources depreciation provision provident funds sales of fixed asset commercial bank common stock over use of fixed asset Lessee is free to cancel the lease in case of change of technology. Long-term financial management, often referred to as strategic financial planning or simply financial planning is an investment plan or strategy that is geared toward aiming investments in a direction to promote long-term growth. As the name suggests, these shares carry preferential rights over equity shares both regarding the payment of dividend and the return of capital. However, the use of internal accruals as opposed to new shares or debentures avoids costs that are associated with fresh issues. These sources are particularly important for small businesses which may find it difficult to get external finance. Hence, improving the companys credit rating might help the organizations raise long-term funds at a much cheaper rate. Sweat equity shares are always issued at a discount. Some of the long-term sources of finance are:- 1. They are entitled to dividends after paying the preference dividends. 19.2 Objectives. Long-term finance Personal savings Personal savings is money that has been saved up by an entrepreneur. Content Guidelines 2. Do not consider the term loan providers as the owners of the organization. Bank loan/financing from financial institutions. (c) Sometimes, a conservative dividend policy leads to huge accumulation of retained earnings leading to over-capitalization. Uploader Agreement. Convertible Preference shares Refer to the shares that can be converted into equity shares after a certain time-period. Long-term funds are paid back during the lifetime of an organization. The holders of these shares are the real owners of the company. Release preference shareholders from any fixed liability at the time of liquidation of an organization, iii. Foreign Capital. 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). (vi) Benefit of Maintenance Lessee gets the benefit of maintenance and specialized services provided by the lessor. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. Copyright 10. The common practice in India is the repayment of principal in equal instalments and payment of interest on the outstanding loan. If retained profits do not result in higher profits then there is an argument that shareholders could make better returns by having the cash for themselves. 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. Assets which are financed through term loans serve as primary security and the other assets of the company serve as collateral security. 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. However, term loan providers are considered as the creditors of the organization. The sources from which a finance manager can raise long-term funds are discussed below: 1. The advantages of preference shares are as follows: i. Equity Share Capital: Equity shares, also known as ordinary shares or common shares represent the owners' capital in a company. The main advantage is that it is not been paid immediately or within shorter time duration. The profits available for ploughing back in an enterprise depend on factors like net profits, dividend policy and age of the organization. ii. The organization has to pay dividends on these preference shares at the end of financial year. Depending on various factors, the period can stretch for more than 5 to 20 years. After discussing the characteristics and types of equity shares, let us look at their following advantages: i. Everything you need to know about the sources of getting long-term finance for a company, firm or business. These various sources are described below. The following sources are considered major sources of finance for major corporations. Each type of shares has a different set of characteristics, advantages, and disadvantages. 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. (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. (iv) Manipulation in the Value of Shares Ploughing back of profits provides the management an opportunity to manipulate the market value of its shares. Ploughing Back of Profits 4. Equity Shares 2. China's population fell in 2022 for the first time in decades, a historic shift that is expected to have long-term consequences for the domestic and global economies. Issue of Shares. Therefore, they can get the right to control the affairs of the company. 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. As a result, the lender has a regular and steady income. These are the profits the company has kept aside over time to meet the companys future capital needs. 4 hours ago. 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. Debentures are usually secured by a charge on the immovable properties of the company. 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. It is usually done for big projects, financing, and company expansion. Equity warrant is generally attached to non-convertible debentures as a sweetener to improve their marketability. 7 Major Sources of Long -Term Finance Article shared by : ADVERTISEMENTS: This article throws light upon the seven major sources of long-term finance. Content Filtration 6. A new company can raise finance only from external sources such as shares, debentures, loans etc. They form part of the net worth and directly impact the equity share valuation. (f) The burden of periodic installments in term loans brings in a discipline in the management for better management of cash flows and other operations. Long term finance are capital requirements for a period of more than 1 year. They are issued under the common seal of the company acknowledging the receipt of money. Stringent provisions under the IBC Code for non-repayment of the debt obligations may lead to. From investors point of view, equity shares are riskier as there is uncertainty regarding dividend and capital gains. 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. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance. They have control over the working of the company. If the holder exercises this option, no interest/premium will be paid on redemption. Allow shareholders to receive dividend after payment is made to each and every stakeholder. (c) The term loans are negotiable loans between the borrowers and lenders. (c) Financial institutions may insist the borrower to convert the term loans into equity. A debenture is a form of financial instrument that provides long-term debt to an organization. You can learn more about excel modeling from the following articles: . 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. The borrower may be asked to maintain a minimum asset base, not to raise additional loans or to repay existing loans, restricting the company to sell its key assets without prior approval of the lender, inclusion of the representative of the financial institution in the borrowing company and so on. But, an existing company can also generate finance through its internal sources, i.e., retained earnings or ploughing back of profits. (d) Sometimes internal accruals as a source of finance are preferred over the other sources due to the financial and taxation position of the companys shareholders. A bond that is sold at a discount on its par value and has a coupon rate significantly less than the prevailing rates of fixed-income securities with a similar risk profile. The long term sources of finance are shown below: 1. His position is akin to that of a person who uses the asset with borrowed money. When companies are considering new investments, they may compare available sources of finance to determine which would be most appropriate for a new endeavor. The right of lenders to appoint nominee directors on the board of the borrowing company may further restrict the managerial freedom. Owner of the asset is called Lessor and the user is called Lessee. 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. Hence, raising finance via debt is a desirable and prominent source of finance. Instalment credit 5. Business need to repay those long-term sources of finance after many many years. Funds raised through these can be paid back over many years. High gearing on the company may affect the valuations and future fundraising. It may come from different sources such as equity, debt, hybrid instruments, or internally generated retained earnings. The sources are: 1. Here are the other recommended articles on Corporate Finance -. The holders of these shares are the legal owners of the company. (i) Costly Source of Finance Lease financing is a costly source of finance for the lessee because lease rentals include a profit margin for the lessor as also the cost of risk of obsolescence. However, sometimes term loans can be unsecured in nature. Internal sources of finance examples iii. Providing higher dividends to equity shareholders whenever an organization makes huge profit, v. Providing voting rights to equity shareholders of an organization. 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. 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.
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