State various sources of long term funds.
Answers
1. Equity Shares:
It represents the ownership capital of a firm. A public limited company may raise funds from public or promoters as equity share capital by issuing ordinary equity shares.
Ordinary shareholders are those the owners of which receive their dividend and return of capital after the payment to preference shareholders.
They undertake the risk of the company. They elect directors and have total control over the management of the company. These shareholders are paid dividends only when there are distributable profits. As equity shares are paid only on liquidation, this source has the minimum risk.
The liability of equity shareholders is limited up to the face value of the shares. Further, equity share capital provides a security to other investors of funds. Hence, it will be easier to raise further funds for companies having adequate equity share capital.
2. Preference Shares:
These are shares which carry the following two rights:
(i) The right to receive dividend at a fixed rate before any dividend is paid on other shares.
(ii) The right to return of capital in the case of winding-up of company, before the capital of the equity shareholders is returned.
Long-term funds from preference shares are raised by a public issue of shares. It does not require any security nor ownership of a firm is affected. It has some characteristics of equity capital and some of debt capital. It resembles equity as preference dividend, like equity dividend is not tax deductible payment.
3. Debentures:
A debenture is a document of acknowledgement of a debt with a common seal of the company. It contains the terms and conditions of loan, payment of interest, redemption of the loan and the security offered (if any) by the company.
According to Section 2(12) of the Companies Act, 1956, debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.
Thus, a debenture has been defined as acknowledgement of debt, given under the common seal of the company and containing a contract for the repayment of the principal sum at a specified date and for the payment of interest at fixed rate/per cent until the principal sum is repaid and it may or may not give the charge on the assets to the company as security of loan. It is an instrument for raising long-term debt.
Debenture holders are the creditors of the company. They have no voting rights in the company. Debenture may be issued by mortgaging any asset or without mortgaging the asset, i.e., debentures may be secured or unsecured.
Interest on debenture is payable to debenture holders even when the company does not make profit. The cost of debenture is very low as the interest payable on debentures is charged as an expense before tax.
4. Loans from Financial Institutions:
In India specialised financial institutions provide long-term financial assistance to private and public firms. Generally firms obtain long-term debt by raising term loans. Term loans, also referred to as term finance, represent a source of debt finance which is repayable in less than 10 years.
Before giving a term loan to a company the financial institutions must be satisfied regarding the technical, economical, commercial, financial and managerial viability of project for which the loan is needed. Term loans are secured borrowings and a significant source of finance for investment in the form of fixed assets and also in the form of working capital needed for new project.
5. Retained Earnings:
When a company retains a part of undistributed profits in the form of free reserves and the same is utilised for further expansion and diversification programmes, is known as ploughing back of profit or retained earnings. These funds belong to the equity shareholders. It increases the net worth of the business.
Although it is essentially a means of long-term financing for expansion and development of a firm, and its availability depends upon a number of factors such as the rate of taxation, the dividend policy of the firm, Government policy on payment of dividends by the corporate sector, extent of profit earned and upon the firm’s appropriation policy etc.