long term finance sources
These funds may be used to finance the cost of acquisition of fixed assets that are needed for expansion, modernization and diversification programmes of the company. iv. Create pressure on an organization to make profit at any cost as the interests on these loans are very high and may be paid on quarterly and half yearly basis, iv. The saved taxes are allowed to accumulate as reserves. Such long-term financing is generally of high amount. However, the use of internal accruals as opposed to new shares or debentures avoids costs that are associated with fresh issues. On the balance sheet of the company, equity share capital is listed as stockholders equity or owners equity. The sources from which a finance manager can raise long-term funds are discussed below: 1. The characteristics of debentures are as follows: i. It is a standard clause of the bond contracts and loan agreements. Equity and Loans from Government 2. iii. 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. The rate of interest is high for overdrafts compared to bank loans. Debentures normally carry a fixed interest rate and a certain date of maturity. SBA Loans. 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. Debt Capital 9. Issue of Shares. In case the SPN holder holds it further, the holder will be repaid the principal amount along with the additional amount of interest/premium on redemption in installments as decided by the company. 3.5 Profitability and liquidity ratio analysis. The total value of retained profits in a company can be seen in the equity section of the balance sheet. A holder of a zero-coupon bond does not receive any coupon or interest payments. Internal Sources 5. These shares carry a fixed percent of dividend, which is lower than equity shareholders. Provide right to equity shareholders to share profit, assets, and control of the management. (f) The less debt the company has, the more attractive it is to potential investors and buyers. Help in maintaining good relation with financial institutions, iii. Equity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. Debt Capital 9. As stated earlier, in case of sole proprietary concerns and partnership firms, long-term funds are generally provided by the owners themselves and by the retained profits. Debentures are offered to the public for subscription in the same way as for issue of equity shares. (b) Interest payable on term loan is tax deductible expenditure and thus tax benefit becomes available on interest that renders the cost of debt cheap. Funds required for a business may be classified as long term and short term. From investors point of view, equity shares are riskier as there is uncertainty regarding dividend and capital gains. The advantages of preference shares are as follows: i. (iv) Helpful in Making the Company Self-Dependent Ploughing back of profits makes the company self-dependent because it has not to depend upon outsiders such as banks, financial institutions, debentures etc. The common sources of financing are capital that is generated by the firm itself and . In addition, they can be issued at discount, par, and premium. Equity capital represents the ownership capital. (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. (vi) Hindrance in the Free Flow of Capital According to Prof. Pigou, Excessive ploughing back entails social waste, because money is not made available to those who can use it to the best advantage of the community, but is retained by those who have earned it.. Banks or financial institutions generally give them for more than one year. They have control over the working of the company. Dilution of control is an inherent characteristic of financing through issue of equity shares. These shares carry a fixed rate of dividend and such dividend must be paid in full before the payment of any dividend on equity shares. (iv) Excessive Penalties Sometimes, lessee has to pay excessive penalties if he terminates the lease before the expiry of lease period. Registered debenture holders cannot transfer their debentures without giving prior information to the organization. Ploughing Back of Profits 4. The foreign capital may be provided by foreign government, institutions, banks, business corporations or individual investors. Refer to the shares that are issued to the employees of an organization. A debenture is a marketable legal contract whereby the company promises to pay, whosoever owns it, a specified rate of interest for a defined period of time and to repay the principal on the specific date of maturity. Cumulative Preference Shares Refer to the shares for which dividends get accumulated over a period of time. 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. Term loans carry a fixed interest rate and the payment is made in installments which consist of both principal and interest. 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. Huge Collection of Essays, Research Papers and Articles on Business Management shared by visitors and users like you. (iii) Free from Restrictive Covenants Lease financing is free from restrictive covenants whereas the financial institutions often put a number of restrictions on borrowers, such as, conversion of loan into equity, appoint nominee directors, restrictions on payment of dividend, and so on. Being the owners of the company, they bear the risk of ownership also. Capital expenditures in fixed assets like plant and machinery, land and building, etc of business are funded using long-term sources of finance. (iii) Security Such loans are always secured. Bonds (debentures) belong to external sources of finance. If a company wants to raise money privately, it may approach the major debt investors in the market and borrow from them at higher interest rates. It is required by an organization during the establishment, expansion, technological innovation, and research and development. It is allowed to be deducted while arriving at the net profits of the firm subject to adherence of the percentages of allowable depreciation fixed under the tax laws. Term Loans 8. As the legal owner, it is the lessor (and not the lessee), who will be entitled to claim depreciation on the leased asset. Foreign Capital. There are various forms of foreign capital flowing into India that have given a major boost to the Indian economy. The advantages of debentures are as follows: i. A debenture is a form of financial instrument that provides long-term debt to an organization. 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. Equity warrant is generally attached to non-convertible debentures as a sweetener to improve their marketability. Financial Institutions 6. The holders of these shares are the legal owners of the company. The advantages of term loans are as follows: ii. When these are redeemed on its maturity date after seven years, the holder will get Rs.20,000 for every bond. (e) Debt financing by term loan has fixed installments till the maturity of the loan. 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. Debt capital includes debentures and term loans. The characteristics of preference shares are as follows: i. Generally, the financial institutions charge an interest rate that is related to the credit risk of the proposal, subject usually to a certain minimum prime lending rate (PLR) or floor rate. There is a lock-in period up to which no interest will be paid. When the organization has sufficient profit, the accumulated dividend of these preference shares is paid. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. (ii) Direct Negotiation Terms and conditions of such loans are directly negotiated between the borrower and the financial institution providing the loan. They have the right to elect the directors as well as vote in the meetings of the company. In fact, the foremost objective of a company is to maximise the value of its equity shares. ii. The main sources of term loans are commercial banks, Industrial development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), and Industrial Finance Corporation of India (IFCI). 1) Funds raised by an NBFC named NeoGrowthCredit Pvt. Thus flexibility is not available in case of loans from financial institutions where the loans are repaid in instalments resulting in heavy burden in the earlier years of a project, whereas the project may actually generate substantial cash flows in later years. Overall, long-term finance may have its advantages and disadvantages. The amount of long term capital depends upon the scale of business and nature of business. They are a flexible source of finance provided by the banks to meet the long-term capital needs of the organization. (iii) Creation of Monopolies Continuous ploughing back of profits over a long time may lead a company to grow into a monopoly. Login details for this Free course will be emailed to you, Leasing is an arrangement in which the asset's right is transferred to another person without transferring the ownership. (d) Since term loans do not represent debt financing, neither the control nor the profit sharing of the equity shareholders is diluted. 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. This is known as retained earnings. (ii) Restrictions on the Use of Asset Leasing contracts usually impose certain restrictions on the use of the asset or require compulsory insurance, and so on. Involve less cost in raising funds than equity shares, ii. A portion of the net profits may be retained in the business for use in the future. These shares are a kind of award for employees for the work rendered by them to organization. (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. (ii) Over-Capitalisation Retained earnings are used for the issue of bonus shares which may result to over-capitalisation without any corresponding increase in its earnings. Raising funds through equity shares for long-term investment as these shares are repaid during the lifetime of the organization, iii. Long term 2; Basics Long term finance - Funding obtained exceeding three years in duration. Public Deposits 4. They may invest the funds in unprofitable areas or may invest in other concerns under the same management, bringing little gain to the shareholders. 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. (iv) Flexibility in Fixing the Rentals Lease rentals are fixed in such a way that the lessee is able to pay them from the cash flows generated from his business operations. Covenants may also include the appointment of nominee director by financial institutions to safeguard their interests. 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. Internal Sources 10. SBA loans offer competitive rates and repayment periods of up to 25 years. On Tuesday . 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. 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. It is a source of internal financing which does not affect the working capital of the concern as it does not involve outflow of any cash like other expenses. After discussing the characteristics and types of equity shares, let us look at their following advantages: i. Image Guidelines 4. This article is a guide to the Long-Term Financing definition. Limiting the liability of equity shareholders to the amount of shares they hold, iv. Hence, raising finance via debt is a desirable and prominent source of finance. (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. The payment of a portion of the unpaid balance of the loan is called a payment of principal. (vi) Helpful in the Repayment of Long-Term Liabilities It enables the company to repay its long-term loans and debentures and thus relieves the company from the burden of fixed interest payments. It is obtained from Capital market. Instalment credit 5. Even during the winding up of the organization, the investment of preference shareholders is paid before 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. The companys credit rating also plays a major role in raising funds via long-term or short-term means. SBA 7 (a) loans, for example, range from $25,000 . A debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holders. (e) They strengthen the financial position of a company and appreciate the capital, which ultimately increases the market value of shares and the wealth of shareholders in case of a growing firm. You are free to use this image on your website, templates, etc., Please provide us with an attribution link. The common practice in India is the repayment of principal in equal instalments and payment of interest on the outstanding loan. For new company recourse to equity share financing is most desirable because the management is under no legal obligation to pay dividends to shareholders and the management can retain its earnings entirely for their investment in the enterprise. They can be redeemable, irredeemable, convertible, and non-convertible. (i) Right to Control Equity shareholders are the real owners of the company. Tax liability on dividends differs in different zones, states, and countries. These are the companys free reserves, which carry nil cost and are available free of charge without any interest repayment burden. However, prime basis on which a share is valued is the price at which it is expected to be sold. Following points discuss the different types of preference shares briefly: i. The holder of a zero-coupon bond only receives the face value of the bond at maturity. Equity Shares, also known as ordinary shares, represent the ownership capital in a company. Do not consider the term loan providers as the owners of the organization. (i) Irregular Dividend Dividend paid on equity shares is neither regular nor at a fixed rate. Some of the new financial instruments are discussed below: Zero-coupon bonds are purchased at a high discount, known as deep discount, on the face value of the bond. (iii) High Profitability Leasing business is highly profitable to the lessor because the rate of return is more than what the lessor pays on his borrowings. Generally used for financing big projects, expansion plans, increasing production, funding operations. In other words, a debenture is an agreement between a debenture holder and an organization, which acknowledges that the organization would repay the debt at a specified date to debenture holders. Sources of Long Term Financing #1 - Equity Capital #2 - Preference Capital #3 - Debentures #4 - Term Loans #5 - Retained Earnings Examples of Long Term Financing Sources Advantages of Long Term Financing Limitations of Long Term Financing Important Points to Note Recommended Articles Long-term finance Personal savings. These are issued for a fixed period of time. Term Loans 8. Depending on various factors, the period can stretch for more than 5 to 20 years. Debentures 5. However, they rank behind the companys creditors. ii. Short-Term Sources of Finance Short-term sources of funds: Money acquired must be paid back within one year. (c) Zero Interest Fully Convertible Debentures (FCD): The investors in zero-interest fully convertible debentures are not paid any interest. 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. Investors have also become more aware, selective and demanding. Further, this provision has been incorporated in the corporate laws by section 43(a) (ii) of Companies Act, 2013. Some of the long-term sources of finance are:- 1. These covenants may be in respect of maintaining a minimum current ratio, not to create further charge on assets, not to sell fixed assets without the lenders approval, restrain on taking additional loan, reduction in debt-equity ratio by issuing additional shares etc. They have voting rights to elect directors of the company and the directors control the business. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. 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. iii. Make it difficult for an organization to provide security against debentures if an organization has insufficient fixed assets. Out of the realised value of assets, first the claims of creditors and then preference shareholders are satisfied, and the remaining balance, if any, is paid to equity shareholders. Do not require any security from the organization. Issue of debentures. (ii) No Advantage of Trading on Equity If a Company issues only equity shares, it will be deprived of the benefits of trading on equity. Make it difficult to repay funds raised by issuing equity shares during the lifetime of an organization, even if these funds are not in use. The interests of the debenture holders are protected by a trustee (generally bank or an insurance company or a firm of attorneys). However, sometimes term loans can be unsecured in nature. It may come from different sources such as equity, debt, hybrid instruments, or internally generated retained earnings. Help in raising funds from investors who are less likely to take risks, iii. ii. 3) Long-term Sources of finance. Features of Long-term Sources of Finance -. You are free to use this image on your website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Long-Term Financing (wallstreetmojo.com). It is of vital significance for modern business which requires huge capital. Long-term funds are paid back during the lifetime of an organization. Loans from co-operatives 1. (a) The directors of quoted companies occasionally get criticised for restricting the value of dividends and for hoarding too much cash in the business. Internal finance includes the funds generated within the corporate unit irrespective of the nature of source. Financial Institutions 6. Depending on various factors, the period can stretch for more than 5 to 20 years. Whatever may be the outcome of such controversy, the fact remains that the depreciation is a sum that is set apart out of profits and retained within the business. Long-term finance can be defined as any financial instrument with maturity exceeding one year (such as bank loans, bonds, leasing and other forms of debt finance), and public and private equity instruments. An organization pays interest on the irredeemable debentures till its existence. Similarly, when the company is wound up, they can exercise their claim on those assets which are left after the payment of all other claims including that of preference shareholders. 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.. Sweat equity shares are always issued at a discount. (ii) Simplicity Borrowing from banks and financial institutions involve time consuming and complicated procedures whereas a leasing contract is simple to negotiate and free from cumbersome procedures. Hence, improving the companys credit rating might help the organizations raise long-term funds at a much cheaper rate. Long-term funds are paid back during the lifetime of an organization. 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. A repayment schedule is a complete table of periodic loan payments that includes an interest amount computed on the unpaid balance of the loan plus a portion of the unpaid balance of the loan. They do not carry voting rights and are secured against the companys assets. Long-term financing means financing by loan or borrowing for more than one year by issuing equity shares, a form of debt financing, long-term loans, leases, or bonds. It is recorded as expenditure in the accounting system of a firm. Borrowing for long-term means that the business does not expect to repay this debt in less than five years. The payment of dividend depends on the availability of divisible profits and the discretion of directors. 3.4 Final accounts. In most developing countries like India, domestic capital is inadequate for the purpose of economic growth. Long term sources of finance are those, which remains with the business for a longer duration of time. (c) They do not dilute the ownership of the company. It is usually done for big projects, financing, and company expansion. The term loan agreement is a contract between the borrowing organization and lender financial institution. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. (c) Financial institutions may insist the borrower to convert the term loans into equity. These are foreign direct investment, foreign portfolio investment and foreign commercial borrowings. Stringent provisions under the IBC Code for non-repayment of the debt obligations may lead to. Financial institutions impose a penalty for defaults on the payment of installment of principal and/or interest. 3.6 Efficiency ratio analysis. The control of the company may change to new shareholders who may reap the benefits of the companys prosperity and progress. (iii) Consequences of Default Since the lessee is not the owner of the leased asset, the lessor may take over the possession of the same, in case of default in payment of lease rentals. Equity shareholders control the business. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders. Sources of Long-Term Finance for a Company, Firm or Business, The main characteristics of retained profits are that there is no compulsory maturity like term loans and debentures and they are not characterized by fixed burden of interest or installment p, Essays, Research Papers and Articles on Business Management, Raising of Finance for a Company: 12 Methods, Sources of Industrial Finance in India | Financial Management, Essay on the Sources of Business Finance | Finance | Financial Management, Human Resource Planning: Meaning, Objectives, Purpose, Importance and Process, Long-Term Sources of Finance Equity Shares, Preference Shares, Ploughing Back of Profits, Debentures, Financial Institutions and Lease Financing, Long-Term Sources of Finance Shares, Debentures and Term Loans, Long-Term Sources of Finance Equity Capital, Preference Capital, Debt Capital, Internal Sources and Foreign Capital. Discounts and premiums on shares are calculated from their par value or face value. There are generally two types of loan repayment schedules: In equal principal payment schedule, the size of the principal payment is the same for every payment. It may also be attached to convertible debentures and equity shares also to make these instruments more attractive to investors. (ii) Increase in Rate of Dividends In case of higher profits in the company, these shareholders are handsomely rewarded in the form of higher dividends. The fundamental principle of long-term finances is to finance the strategic capital projects of the company or to expand the companys business operations. The disadvantages of preference shares are as follows: i. Most of the new instruments are simply old conventional instruments with some added features. Issued for a business may be provided by foreign government, institutions, banks business! Giving prior information to the amount of shares in the meetings of the organization, iii capital. 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