SOURCES OF FINANCE

By

Dr. P. D. Das
CIME, Bhubaneswar

1
 EQUITY SHARES

• Equity shares represent the ownership position in the

organization and are a source of permanent capital for the
firm.
• FEATURES OF EQUITY CAPITAL
• Claim on income
• Claim on assets
• Right to control
• Pre-emptive right
• Limited liability

2
 EQUITY SHARES

• ADVANTAGES OF EQUITY SHARES TO THE FIRM

• Permanent Capital
• No legal obligation to pay dividends

• DISADVANTAGES OF EQUITY SHARES

• Costlier source of finance
• Perceived as a risky investment by the investor due to
uncertain dividends and capital gains.
• Dilution of ownership

3
 DEBENTURES
• Debenture: A long-term promissory note for raising loan
capital.
• FEATURES
• Fixed interest payment
• Fixed maturity period
• Indenture
• Security
• Yield
• Claims on assets and income
• Types of debentures:
• Non-Convertible Debentures (NCDs)
• Fully-Convertible Debentures (FCDs)
• Partly-Convertible Debentures (PCDs) 4
 DEBENTURES
• ADVANTAGES OF DEBENTURES TO THE ISSUING
FIRM
• Lower cost and lower risk compared to equity capital
• No dilution in ownership
• Debenture-holders do not participate in the extraordinary
earnings of the company
• Useful in periods of inflation due to reduced obligation in real
terms.
• DISADVANTAGES
• Payment of interest is a legal obligation
• Increases the financial risk of the firm
• Results in substantial cash outflows on redemption.
• Inclusion of restrictive covenants may limit firm’s flexibility
5
 PREFERENCE SHARES
• Preference shares: A hybrid security having features of
both equity shares and debentures.
FEATURES SIMILAR TO EQUITY SHARES
• Payment of dividends is not a legal obligation
• Dividend payments are not tax-deductible.
• No maturity period for irredeemable preference shares
FEATURES SIMILAR TO DEBENTURES
• Fixed dividend payment
• No share in the residual earnings
• Prior claim on income and assets relative to equity shares.
• Creation of sinking fund for redemption
• Convertibility
6
 PREFERENCE SHARES
• ADVANTAGES TO THE ISSUING FIRM
• Preference dividend payment is restricted to the stated
amount.
• No dilution of ownership
• Dividend payment can be postponed in case of cumulative
preference shares.
• DISADVANTAGES TO THE ISSUING FIRM
• Preference dividends are not tax-deductible
• Non-payment of preference dividends may adversely affect
the image of the company.

7
 METHODS OF ISSUING SECURITIES

• PUBLIC ISSUE
• RIGHTS ISSUE
• PRIVATE PLACEMENT
• BOUGHT-OUT DEALS
• EURO-ISSUES

8
 TERM LOANS
• Long-term debt with a maturity of more than one year,
obtained from banks and financial institutions.
• FEATURES
• Maturity period > one year
• Lower costs of financing
• Security
• Presence of restrictive covenants
• Repayment schedule

9
 TERM LOANS
• ADVANTAGES TO THE FIRM
• Lower post-tax cost of funds.
• No dilution of control

• DISADVANTAGES TO THE FIRM

• Payment of interest charges and principal is legal
obligation.
• Restrictive covenants hinder firm’s flexibility.

10
 RETAINED EARNINGS

• A 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’. The profit available for
ploughing back in an organization depends on many
factors like net profits, dividend policy and age of the
organization.
11
 OTHER LONG-TERM SOURCES OF
FINANCE

• INTERNAL ACCRUALS
• GOVERNMENT SUBSIDIES
• DEFERRED CREDIT
• SALES TAX DEFERMENTS AND EXEMPTIONS
• LEASING AND HIRE PURCHASE

12
 SHORT-TERM SOURCES

• Funds which are required for a period not

exceeding one year are called short-term
sources.
• Trade credit, loans from commercial banks
and commercial papers are the examples of
the sources that provide funds for short
duration.

13
• Short-term financing is very common for the
financing of present assets such as inventories and
account receivables.
• Seasonal businesses that must build inventories in
terms of future prospects of selling requirements
often need short-term financing for the interim
period between seasons.
• Wholesalers and manufacturers with a major
portion of their assets used in inventories or
receivables also require a large number of funds
for a short period.
14
 TRADE CREDIT
• Trade credit is the credit extended by one trader to another for
the purchase of goods and services. Trade credit facilitates the
purchase of supplies without immediate payment. Such credit
appears in the records of the buyer of goods as ‘sundry
creditors’ or ‘accounts payable’.
• Trade credit is commonly used by business organizations as a
source of short-term financing. It is granted to those customers
who have reasonable amount of financial standing and
goodwill. The volume and period of credit extended depends
on factors such as reputation of the purchasing firm, financial
position of the seller, volume of purchases, past record of
payment and degree of competition in the market.
• Terms of trade credit may vary from one industry to another
and from one person to another. A firm may also offer different
15
credit terms to different customers.
 FACTORING

• Factoring is a financial service under which the

‘factor’ renders various services which includes:
• (a) Discounting of bills (with or without recourse)
and collection of the client’s debts. Under this, the
receivables on account of sale of goods or services
are sold to the factor at a certain discount.
• (b) Providing information about credit worthiness
of prospective client’s etc.

16
 LEASE FINANCING

• A lease is a contractual agreement whereby one

party i.e., the owner of an asset grants the other
party the right to use the asset in return for a
periodic payment. In other words it is a renting of
an asset for some specified period. The owner of
the assets is called the
• ‘lessor’ while the party that uses the assets is
known as the ‘lessee’. The lessee pays a fixed
periodic amount called lease rental to the lessor
for the use of the asset.

17
 COMMERCIAL PAPER (CP)
• Commercial Paper emerged as a source of short term
finance in our country in the early nineties.
Commercial paper is an unsecured promissory note
issued by a firm to raise funds for a short period,
varying from 90 days to 364 days.
• It is issued by one firm to other business firms,
insurance companies, pension funds and banks. The
amount raised by CP is generally very large. As the
debt is totally unsecured, the firms having good credit
rating can issue the CP.
• Its regulation comes under the purview of the Reserve
Bank of India.
18
 COMMERCIAL BANKS
• Commercial banks occupy a vital position as they
provide funds for different purposes as well as for
different time periods.
• Banks extend loans to firms of all sizes and in
many ways, like, cash credits, overdrafts, term
loans, purchase/discounting of bills, and issue
of letter of credit.
• The rate of interest charged by banks depends on
various factors such as the characteristics of the
firm and the level of interest rates in the economy.
The loan is repaid either in lump sum or in
installments.
19
• Bank credit is not a permanent source of
funds. Though banks have started extending
loans for longer periods, generally such
loans are used for medium to short periods.
• The borrower is required to provide some
security or create a charge on the assets of
the firm before a loan is sanctioned by a
commercial bank.
20
 END OF SESSION

for any query,

please contact @
[email protected] , # 9438485460

21