Public deposit invited by company suggestions
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Public Deposits: Definition, Merits and Demerits of Public Deposits!
Public deposits refer to the unsecured deposits invited by companies from the public mainly to finance working capital needs. A company wishing to invite public deposits makes an advertisement in the newspapers.
Any member of the public can fill up the prescribed form and deposit the money with the company. The company in return issues a deposit receipt. This receipt is an acknowledgement of debt by the company. The terms and conditions of the deposit are printed on the back of the receipt. The rate of interest on public deposits depends on the period of deposit and reputation of the company.
A company can invite public deposits for a period of six months to three years. Therefore, public deposits are primarily a source of short-term finance. However, the deposits can be renewed from time-to-time. Renewal facility enables companies to use public deposits as medium-term finance.
Public deposits of a company cannot exceed 25 per cent of its share capital and free reserves. As these deposits are unsecured, the company having public deposits is required to set aside 10 per cent of deposits maturing by the end of the year. The amount so set aside can be used only for paying such deposits.
Thus, public deposits refer to the deposits received by a company from the public as unsecured debt. Companies prefer public deposits because these deposits are cheaper than bank loans. The public prefers to deposit money with well-established companies because the rate of interest on public deposits is higher than on bank deposits. Now public sector companies also invite public deposits. Public deposits have become a popular source of industrial finance in India.
Merits of Public Deposits:
1. Simplicity:
Public deposits are a very convenient source of business finance. No cumbersome legal formalities are involved. The company raising deposits has to simply give an advertisement and issue a receipt to each depositor.
2. Economy:
Interest paid on public deposits is lower than that paid on debentures and bank loans. Moreover, no underwriting commission, brokerage, etc. has to be paid. Interest paid on public deposits is tax deductible which reduces tax liability. Therefore, public deposits are a cheaper source of finance.
3. No Charge on Assets:
Public deposits are unsecured and, therefore, do not create any charge or mortgage on the company’s assets. The company can raise loans in future against the security of its assets.
4. Flexibility:
Public deposits can be raised during the season to buy raw materials in bulk and for other short-term needs. They can be returned when the need is over. Therefore, public deposits introduce flexibility in the company’s financial structure.
5. Trading on Equity:
Interest on public deposits is paid at a fixed rate. This enables a company to declare higher rates of dividend to equity shareholders during periods of good earnings.
6. No Dilution of Control:
There is no dilution of shareholders’ control because the depositors have no voting rights.
7. Wide Contacts:
Public deposits enable a company to build up contacts with a wider public. These contacts prove helpful in the sale of shares and debentures in future.
Demerits of Public Deposits:
1. Uncertainty:
Public deposits are an uncertain and unreliable source of finance. The depositors may not respond when economic conditions are uncertain. Moreover, they may withdraw their deposits whenever they feel shaky about the financial health of the company.
Moreover, if a large number of depositors simultaneously withdraw their deposits during slump, the company may find it difficult to repay a huge sum at once. Therefore, public deposits are described as ‘fair weather friends’.
2. Limited Funds:
A limited amount of funds can be raised through public deposits due to legal restrictions.
3. Temporary Finance:
The maturity period of public deposits is short. The company cannot depend upon public deposits for meeting long-term financial needs.
4. Speculation:
As public deposits can be raised easily and quickly, a company may be tempted to raise more funds than it can profitably use. It may keep idle money to meet future contingencies. The management of the company may indulge in over-trading and speculation which exercise harmful effects on the business.
5. Hindrance to Growth of Capital Market:
Public deposits hamper the growth of a healthy capital market in the country. Widespread use of public deposits creates a shortage of industrial securities.
6. Limited Appeal:
Public deposits do not appeal as a mode of investment to bold investors who want capital gains. Conservative investors may also not like these deposits in the absence of proper security.
7. Unsuitable for New Concerns:
New companies lacking in sound credit standing cannot depend upon public deposits. Investors do not like to deposit money with such companies.
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