- \n
- Meaning, Nature and Significance of Business finance<\/li>\n
- Equity shares – Features -Merits – Demerits<\/li>\n
- Preference shares – Features – Types – Merits – Demerits<\/li>\n
- Retained earnings – Features – Merits – Demerits<\/li>\n
- Debentures – Features – Types – Merits – Demerits<\/li>\n
- Public deposits – Features – Merits – Demerits<\/li>\n
- Commercial Banks – Features – Merits – Demerits<\/li>\n
- Financial institutions – Features – Merits – Demerits<\/li>\n
- Trade credit – Features – Merits – Demerits<\/li>\n
- Factoring – Features – Merits – Demerits<\/li>\n
- Lease financing – Features – Merits – Demerits<\/li>\n
- Commercial paper – Features – Merits – Demerits<\/li>\n
- International financing – ADR – GDR – FCCB<\/li>\n
- Factors affecting the choice of the source of fund Finance is the life blood of any business. The requirements of funds by business to carry out its various activities are called business finance.<\/li>\n<\/ul>\n
Nature of Business Finance:<\/span>
\n1. Fixed capital requirements:
\nIn order to start a business funds are needed to purchase fixed assets like land and building, plant and machinery. This is called fixed capital requirement.<\/p>\n2. Working Capital requirements:
\nA business needs funds for its day to day operation. This is known as working Capital requirements. Working capital is required for purchase of raw materials, to pay salaries, wages, rent and taxes.<\/p>\nClassification of Sources of Funds:<\/span>
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\n1. Period Basis:
\nOn the basis of period, the different sources of funds cari divided into 3. They are long-term sources, medium-term sources and short-term sources.
\n(a) Long Term Sources:
\nThe amount of funds required by a business for more than five years is called long-term finance. Generally this type
\nof finance is required for the purchase of fixed assets like land and building, plant and machinery furniture etc. It include sources such as shares and debentures, long-term borrowings and loans from financial institutions.<\/p>\n(b) Medium Term Sources:
\nWhere the funds are required for a period of more than one year but less than five years, is called medium-term sources. These sources include borrowings from commercial banks, public deposits, lease Financing and loans from financial institutions. This type of finance is required for modernization, renovation, special promotional programmes etc.<\/p>\n(c) Short Term Sources:
\nShort-term funds are those which are required for a period not exceeding one year. These sources include Trade credit, loans from commercial banks and commercial papers, etc. Short-term finance is used for financing of current assets such as accounts receivable and inventories.<\/p>\n2. Ownership Basis:
\nOn the basis of ownership, the sources can be classified into \u2018owner’s funds\u2019and \u2018borrowed funds\u2019.
\n(a) Owners Fund:
\nIt represent the amount of capital provided by owners and the amount of profit retained in the business. It is a permanent source of capital. Equity shares and retained earnings are the two important sources of ownership capital.<\/p>\n(b) Borrowed Funds:
\nIt refers to funds mobilized from outsiders. It include loans from commercial banks, loans from financial institutions, issue of debentures, public deposits and trade credit.<\/p>\nSuch sources provide funds for a specified period, on certain terms and conditions and have to be repaid with interest after the expiry of that period. Borrowed funds are provided on the security of some fixed assets.<\/p>\n
3. Source of generation:
\nAnother basis of categorising the sources of funds can be whether the funds are generated from within the organisation or from external sources.
\n(a) Internal sources:
\nInternal sources of funds are those that are generated from within the business. eg: ploughing back of profit, disposing of surplus stock etc.<\/p>\n(b) External sources:
\nExternal sources of funds are those that are generated from outside the business. eg: issue of debentures, borrowing from commercial banks and financial institutions and accepting public deposits.<\/p>\nSOURCES OF FINANCE:<\/p>\n
- \n
- Issue of shares- (Equity and Preference Shares)<\/li>\n
- Ploughing Back of Profit<\/li>\n
- Issue of debentures<\/li>\n
- Loan from Commercial bank<\/li>\n
- Loan from Financial institutions<\/li>\n
- Public deposits<\/li>\n
- Lease Financing<\/li>\n
- Long Term and Medium Term Sources of Finance<\/li>\n
- Short Term Sources of Finance International Sources of Finance.<\/li>\n<\/ul>\n
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\nA business can raise funds from various sources. They are:<\/p>\nIssue of shares:<\/span>
\nThe capital of a company is divided into smaller units called share. Those who subscribe the shares of a company are known as \u2018shareholders\u2019. Two types shares may be issued by a company to raise capital. They are:<\/p>\n- \n
- Equity Shares<\/li>\n
- Preference Shares<\/li>\n<\/ol>\n
1. Equity Shares:
\nEquity shares represents the ownership capital of a company. They do not enjoy any preferential right in the matter of claim of dividend or repayment of capital. Equity share holders do not get a fixed dividend but are paid on the basis of earnings by the company. They bear the maximum risk. Equity shareholders are the owners of the company. They have right to vote and participate in the management.
\nMerits:<\/p>\n- \n
- Equity shares are suitable for investors who are willing to assume risk for higher returns<\/li>\n
- Payment of equity dividend is not compulsory.<\/li>\n
- Equity capital serves as permanent capital as it is to be repaid only at the time of liquidation of a company.<\/li>\n
- Equity shares do not carry any charge on the assets of the company.<\/li>\n
- They have right to vote and participate in the management.<\/li>\n
- Equity capital provides credit worthiness to the company<\/li>\n<\/ul>\n
Limitations:<\/p>\n
- \n
- Investors who want steady income may not prefer equity shares.<\/li>\n
- The cost of equity shares is generally more as compared to the cost of raising funds through other sources.<\/li>\n
- Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders.<\/li>\n
- Issue of Equity shares is time consuming.<\/li>\n<\/ol>\n
2. Preference Share:
\nThe capital raised by issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential right over equity shareholders in two ways:<\/p>\n- \n
- The right to get a fixed rate of dividend.<\/li>\n
- The right to claim repayment of capital in the event of winding up of the company.<\/li>\n<\/ul>\n
Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.<\/p>\n
Types of Preference Shares:
\n1. Cumulative and Non-cumulative Preference Share:
\nin cumulative preference shares, the unpaid dividends are accumulated and carried forward for payment in future years. On the other hand, in non- cumulative preference share, the dividend is not accumulated if it is not paid out of the current year\u2019s profit.<\/p>\n2. Participating and Non-participating Preference Share:
\nParticipating preference shares have a right to share the profit after making payment to the equity shares. The non-participating preference shares do not enjoy such a right.<\/p>\n3. Convertible and Non-convertible Preference Share:
\nThe preference shares which can be converted into equity shares after a specified period of time are known as convertible preference share. Non-convertible shares cannot be converted into equity shares.<\/p>\n4. Redeemable and Irredeemable Preference Share:
\nRedeemable preference shares are those where the company undertakes to repay it after a specified period. Where the amount of the preference shares is refunded only at the time of liquidation, are known an irredeemable preference shares.
\nMerits:<\/p>\n- \n
- Preference shares provide reasonably steady income in the form of fixed rate of return and safety of investment.<\/li>\n
- Preference shares are useful for those investors who want fixed rate of return with comparatively low risk<\/li>\n
- It does not affect the control of equity share holders because they have no voting right.<\/li>\n
- Preference shares do not create arty charge on the assets of the company.<\/li>\n
- They have a preferential right of repayment of capital over equity shareholders in the event of liquidation of a company.<\/li>\n<\/ol>\n
Limitations:<\/p>\n
- \n
- Preference shareholders have no voting right.<\/li>\n
- The dividend paid is not deductible from profit for income tax.<\/li>\n
- These shares may not attract investors who are expecting higher returns.<\/li>\n
- The rate of dividend on preference shares is generally higher than the rate of interest on debentures.<\/li>\n<\/ol>\n
Differences between Equity shares and Preference shares:<\/span><\/p>\n
\n\n
\n Equity Shares<\/td>\n Preference Shares<\/td>\n<\/tr>\n \n It is compulsory to issue these shares.<\/td>\n It is not compulsory to issue these shares<\/td>\n<\/tr>\n \n Rate of dividend varies according to the profits of the company<\/td>\n Rate of dividend is fixed<\/td>\n<\/tr>\n \n Face value is lower<\/td>\n Face value is higher<\/td>\n<\/tr>\n \n No priority in dividend and repayment of capital<\/td>\n Priority in dividend and repayment of capital<\/td>\n<\/tr>\n \n It cannot be redeemed<\/td>\n It can be redeemed<\/td>\n<\/tr>\n \n Risk is high<\/td>\n Risk is low<\/td>\n<\/tr>\n \n They have voting rights<\/td>\n They do not have voting rights<\/td>\n<\/tr>\n \n They can participate in the management<\/td>\n They can not participate in the management<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n Retained Earnings (Ploughing Back of Profit):<\/span>
\nA company generally does not distribute all its earnings amongst the shareholders as dividends. A portion of the net earnings may be retained in the business for use in the future. This is known as retained earnings. It is a source of internal financing or self financing or ‘ploughing back of profits\u2019.
\nMerits:<\/p>\n- \n
- It is a permanent source of funds available to an organization<\/li>\n
- No costs in the form of interest, dividend or flotation cost.<\/li>\n
- It is more dependable than external sources.<\/li>\n
- There is no commitment to pay dividend.<\/li>\n
- It increases the financial strength and earning capacity of the business.<\/li>\n
- Control over the management of the company remains unaffected.<\/li>\n
- It does not require the security of assets.<\/li>\n
- It may lead to increase in the market price of the equity shares of a company<\/li>\n<\/ol>\n
Limitations:<\/p>\n
- \n
- Retained profits cause dissatisfaction among the shareholder because they get low dividend.<\/li>\n
- It attract competition in the market<\/li>\n
- It may attract government regulations.<\/li>\n
- It leads the management to manipulate the value of shares<\/li>\n
- It is uncertain source of fund because it is available only when profits are high.<\/li>\n<\/ol>\n
Debentures:<\/span>
\nA debenture is a document issued by a company under its seal to acknowledge its debt. Debenture holders are, therefore, termed as creditors of the corrfpany. Debenture holders are paid a fixed rate of interest.
\nTypes of Debentures:
\n1. Secured and Unsecured Debentures:
\nSecured (Mortgaged) debentures are debentures which are secured by a charge on the assets of the company. Unsecured (Simple or naked) debentures do not carry any charge or security on the assets of the company.<\/p>\n2. Registered and Bearer Debentures:
\nIn the case registered debentures, the name, address and other details of the debenture holders are entitled in the books of the company. The debentures which are transferable by mere delivery are called bearer (Unsecured) debentures.<\/p>\n3. Convertible and Non-convertible Debentures:
\nConvertible debentures are those debentures that can be converted into equity shares afterthe expiry of a specified period. On the other hand, nonconvertible debentures are those which cannot be converted into equity shares.<\/p>\n4. First and Second:
\nDebentures that are repaid before other debentures are repaid are known as first debentures. The second debentures are those which are paid afterthe first debentures have been paid back.
\nMerits:<\/p>\n- \n
- It. is preferred by investors who want fixed income at lesser risk<\/li>\n
- Debenture holder do not have voting right<\/li>\n
- Interest on Debentures is a tax deductable expense<\/li>\n
- It does not dilute control of equity shareholders on management<\/li>\n
- Debentures are less costly as compared to cost of preference shares.<\/li>\n
- They guarantee a fixed rate of interest<\/li>\n
- It enables the company to take the advantage of trading on equity.<\/li>\n
- The issue of debentures is suitable when the sales and earnings are relatively stable<\/li>\n<\/ol>\n
Limitations:<\/p>\n
- \n
- It is not suitable for companies with unstable future earnings.<\/li>\n
- The company has to mortgage its assets to issue debentures.<\/li>\n
- Debenture holders do not enjoy any voting rights.<\/li>\n
- In case of redeemable debentures, the company has to make provisions for repayment on the specified date, even during periods of financial difficulty.<\/li>\n
- With the new issue of debentures, the company\u2019s capability to further borrow funds reduces.<\/li>\n<\/ol>\n
Differences between Shares and Debentures:<\/span><\/p>\n