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.. The recipient of a long-term bank loan incurs a debt and is liable to pay interest . The government of India made several changes in the economic policy of the country in the early 1990s. Provide right to equity shareholders to share profit, assets, and control of the management. Most of the new instruments are simply old conventional instruments with some added features. iv. Depreciation can be a very powerful accounting tool if it is applied with economic wisdom. They are a common source of long-term finance. Debt Capital 9. This led to the deregulation and liberalization of the Indian economy and also increased the flow of foreign capital into the country. Stringent provisions under the IBC Code for non-repayment of the debt obligations may lead to. Maturity refers to the last day of paying the financier the real amount of finance. In most developing countries like India, domestic capital is inadequate for the purpose of economic growth. (c) In addition to collateral security, restrictive covenants are also imposed by the lenders which lead to unnecessary interference in the functioning of the business concern. They have a fixed rate of dividend and they carry preferential rights over ordinary equity shares in sharing of profits and also claim over the assets of the firm. Report a Violation 11. ii. Ploughing back of profits is made by transferring a part of after tax profits to various reserves such as General Reserve, Reserve Fund, Replacement Fund, Dividend Equalisation Fund etc. 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. An organization pays interest on the irredeemable debentures till its existence. 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. Facilitate debenture holders to be paid back during the lifetime of an organization, iv. (i) Fully Secured The lessors interests are fully secured because he is the owner of the leased asset and can take possession of the asset in case the lessee defaults. 3) Apple raises $6.5 billion in debt via bonds. Content Filtration 6. (i) Economical Method It is very economical method of financing. But, in India no such distinction is made between bonds and debentures and the two terms are used as synonymous. Bonds are generally issued by government agencies, financial institutions and large corporations, and debentures are issued by companies. Equity shareholders are considered as the real owners of the organization. The warrant gives a right to the debenture holder to obtain equity shares specified in the warrant after the expiry of a certain period at a price not exceeding the cap price specified in the warrant. Do not allow an organization to show the dividend paid on these shares on the debit side of profit and loss account. Term loans, also referred to as term finance, represent a source of debt finance, which is generally repayable in less than 10 years. Sources of Long Term Finance Definition: The Sources of Long Term Finance are those sources from where the funds are raised for a longer period of time, usually more than a year. Capital expenditures in fixed assets like plant and machinery, land and building, etc of business are funded using long-term sources of finance. An equity investor is that person or entity who contributes a certain sum to public or private companies for a specific period to obtain financial gains in the form of capital appreciation, dividend payouts, stock value appraisal, etc. 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. 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. The warrant is a traceable negotiable instrument and is listed on stock exchanges. Make the repayment of preference shares possible during the existence of the organization, iii. Trade credit 2. Foreign Capital. This includes short-term working capital, fixed assets, and other investments in the long term. After studying this lesson, you will be able to: explain the meaning and purpose of long term . A portion of debenture can be converted into equity shares, the second portion may be redeemed after some period, and third portion may be non- convertible and continue to provide interest at the option of the holder. This source of finance does not cost the business, as there are no interest charges applied. (d) Since term loans do not represent debt financing, neither the control nor the profit sharing of the equity shareholders is diluted. Internal finance includes the funds generated within the corporate unit irrespective of the nature of source. Here we discuss the two types of external sources of finance: long-term financing (equity, debentures, term loans, preferred stocks, venture capital) and short-term financing (bank overdraft and short-term loans). Long-Term Sources of Finance Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. Long term 2; Basics Long term finance - Funding obtained exceeding three years in duration. The lender is usually a commercial bank. 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. Lenders normally lend in proportion to the amount of shareholders funds. Overall, long-term finance may have its advantages and disadvantages. Lower debt improves a companys debt capacity and creditworthiness, as well. Internal finance can be appealing for certain types of investments, while in other cases, it may be advantageous to tap external financing. The organization pays the dividend on preference shares before paving dividend to equity shareholders. On the contrary, the investors who are more ambitious and ready to bear risk in consideration of higher returns prefer these shares. Each type of shares has a different set of characteristics, advantages, and disadvantages. This is known as retained earnings. Term loans carry a fixed interest rate and the payment is made in installments which consist of both principal and interest. On the other hand, the holder of a conventional bond not only receives the face value of the bond at maturity but is also paid regular interests at the coupon rate over the life of the bond. For example, if an expansion or acquisition is allowed with venture capital, the investor might demand part ownership of the firm, rather than simply a share in the profits, including a say in management. the detail sources of long term financing are shown in the following diagram: long term financing external sources internal sources owners capital retained earnings institutional sources non-institutional sources depreciation provision provident funds sales of fixed asset commercial bank common stock over use of fixed asset Investors are attracted to these discounted bonds because of their high return or minimal chance of being called before maturity. Providing higher dividends to equity shareholders whenever an organization makes huge profit, v. Providing voting rights to equity shareholders of an organization. They are a flexible source of finance provided by the banks to meet the long-term capital needs of the organization. Longterm sources of finance have a long term impact on the business. In this lesson, you will learn about various sources of long term finance and the advantages and disadvantages of each source. In most of the cases, equity shareholders do not get anything in case of liquidation. 7 Major Sources of Long -Term Finance Article shared by : ADVERTISEMENTS: This article throws light upon the seven major sources of long-term finance. Paying dividend on equity shares is not an obligation for an organization when there is less profit or loss, ii. Being the owners of the company, they bear the risk of ownership also. Such retained earnings may be utilised to fulfil the long-term, medium-term and short-term financial requirements of the firm. (i) Irregular Dividend Dividend paid on equity shares is neither regular nor at a fixed rate. They can be redeemable, irredeemable, convertible, and non-convertible. The characteristics of debentures are as follows: i. The disadvantages of preference shares are as follows: i. The volatility of markets is a major factor that should be considered to determine the price of a share in the market at a particular point of time. The company may either raise funds from the market via IPOIPOAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. A company can also raise funds through issue of preference sharesa special type of share capital. Shares are a part of stocks that consist of fixed assets and current assets, which may change at different situations. The amount borrowed is paid back in installments over a predetermined agreed period of time usually 10, 20 or 30 years. The rate of dividend on these shares is not fixed and depends upon the availability of divisible profits and the intention of the directors. It may also be attached to convertible debentures and equity shares also to make these instruments more attractive to investors. Loans from co-operatives 1. Entire profits may be ploughed back for expansion and development of the company. 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. Some of the long-term sources of finance are:- 1. 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. The terms loans represent a source of debt capital that is normally obtained by companies from term lending institutions. The interest on term loans is a definite obligation that is payable irrespective of the financial condition of the firm. (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. The profits available for ploughing back in an enterprise depend on factors like net profits, dividend policy and age of the organization. You are free to use this image on your website, templates, etc., Please provide us with an attribution link. Non-Cumulative Preference Shares Refer to the shares for which dividends are not accumulated over a period of time. Image Guidelines 4. (f) The less debt the company has, the more attractive it is to potential investors and buyers. It includes clauses and conditions, which are as follows: iv. A debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holders. However, they rank behind the companys creditors. Debentures are one of the frequently used methods by which a company raises long-term funds. 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 subscription price at which the right shares are offered to them is generally much below the shares current market price. They may invest the funds in unprofitable areas or may invest in other concerns under the same management, bringing little gain to the shareholders. As stated earlier, in case of sole proprietary. long term finance is required for purchasing fixed assets like land and building, machinery etc.The amount of long term capital depends . This is particularly important in the case of assets where the income tax laws provide for accelerated depreciation. While the assets financed by loans serve as primary security, all the present as well as the future immovable assets of the borrower constitute secondary security. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. The amount of capital decided to be raised from members of the public is divided into units of equal value. When companies are considering new investments, they may compare available sources of finance to determine which would be most appropriate for a new endeavor. 19.1 Introduction As we are aware, finance is the life blood of business and is of vital significance for modern business which requires huge capital. After the maturity of the financed the borrower needs to return the financier the real amount with some profit and interest. Release preference shareholders from any fixed liability at the time of liquidation of an organization, iii. They have mostly securedloans offered by banks against strong collaterals provided by the company in the form of land and building, machinery, and other fixed assets. There exists a controversy whether depreciation should be taken as a source of finance. ii. Allow debenture holders to receive payment before equity and preference shareholders even at the time of liquidation of an organization. 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. The disadvantages of term loans are as follows: i. Bind an organization to pay interests even in case of loss, ii. In addition, long-term financing is required to finance long-term investment projects. The company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus. Debentures normally carry a fixed interest rate and a certain date of maturity. Each share has a certain face value which is also called its nominal value. 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. At the time of liquidation, these shares are paid after paying all the liabilities. 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. This is more likely to occur when other companies find it difficult to procure finance from the market whereas an existing concern continues to grow through its retained earnings. Characterize by fluctuations in returns, iii. Privacy Policy 9. Some of the long-term sources of finance are:- 1. 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. Content Guidelines 2. An initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. Even during the winding up of the organization, the investment of preference shareholders is paid before equity shareholders. Debt Capital 9. Before uploading and sharing your knowledge on this site, please read the following pages: 1. The value of equity capital is computed by estimating the current market value of everything owned by the company from which the total of all liabilities is subtracted. Assets which are financed through term loans serve as primary security and the other assets of the company serve as collateral security. Long term sources of finance are those, which remains with the business for a longer duration of time. Equity Shares, also known as ordinary shares, represent the ownership capital in a company. 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. Convertible Debentures Refer to the debentures that have right to get converted into the equity shares after a specific period of time. Term Loans 8. Medium term finance One to three years. However, unlike the sole proprietor or the partner of a firm, the risk of the shareholders in case of insolvency is limited to their capital contribution. Funds required for a business may be classified as long term and short term. Thus the scarce financial resources of the business may be preserved for other purposes. The law treats them as shares but they have elements of both equity shares and debt. (iv) Excessive Penalties Sometimes, lessee has to pay excessive penalties if he terminates the lease before the expiry of lease period. These shares carry a fixed percent of dividend, which is lower than equity shareholders. Equity Shares 2. (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. These shares are a kind of award for employees for the work rendered by them to organization. Internal sources of finance examples The payment of a portion of the unpaid balance of the loan is called a payment of principal. (v) Loss on Liquidation In case of liquidation, equity shareholders have to bear the maximum risk. Foreign Capital. Medium Term Source of Finance - These are short term funds that last more than one year but less than five years. There are two sources of finance: internal and external. (f) The burden of periodic installments in term loans brings in a discipline in the management for better management of cash flows and other operations. After discussing the characteristics and types of equity shares, let us look at their following advantages: i. Registered Debentures Refer to the debentures that are registered in the books of the organization. Do not allow debenture holders to vote in the official meetings of the organization and influence the decision. Term loans differ from short-term loans which are employed to finance short-term working capital need and tend to be self-liquidating over a period of time usually less than a year. 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. The main advantage is that it is not been paid immediately or within shorter time duration. Whenever an organization has accumulated surplus profit, it may distribute the profit among its existing shareholders by providing them bonus shares. (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. (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. Short term 2. The profit reinvested as retained earnings is profit that could have been paid as a dividend. However, there are certain disadvantages of using internal accruals as a source of finance. (v) Convertibility Financial institutions usually insist on the option of converting their loans into equity shares of the company. Leasing is, thus, a device of long term source of finance. Debentures can be placed via public or private placement. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. (v) Safety from the Risk of Obsolescence In a lease contract, the lessor being the owner of the leased asset bears the risk of obsolescence. Lessee is free to cancel the lease in case of change of technology. 3.5 Profitability and liquidity ratio analysis. The capital procured by issue of equity shares is a permanent source of funds to the company as it need not be redeemed during the lifetime of the company. The characteristics of equity shares are as follows: i. (iii) Manipulation by a Group of Shareholders Shares of a company can be purchased and sold in the stock market. These are foreign direct investment, foreign portfolio investment and foreign commercial borrowings. The advantages of preference shares are as follows: i. Help in collecting funds at the right time, iv. (e) Secured Premium Notes (SPN) with Detachable Warrants: SPN which is issued along with a detachable warrant, is redeemable after a notice period, say four to seven years. A debenture is a form of financial instrument that provides long-term debt to an organization. What is long-term finance. Characteristics of Loans from Financial Institutions: (i) Maturity Maturity period of term loans provided by Financial Institutions ranges between 6 to 10 years. It is obtained from Capital market. Issue of Shares. Equity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. The money raised from the market does not have to be repaid, unlike debt financing which has a definite repayment schedule. This got worse as Canberra began to worry . The lessee is free to choose the asset according to his requirements and the lessor is actually the financier. (B) Disadvantages or Dangers of Excessive Ploughing Back: (i) Misuse of Retained Earnings It is not necessary that the management may always use the retained earnings to the advantage of shareholders. Do not allow preference shareholders to act as real owners of the organization, ii. The long term sources of finance are shown below: 1. (vi) Easy to Sell In comparison to investment in fixed properties, the investment in equity shares is much liquid because the shares can be sold in the market whenever needed. 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. Debenture holders of an organization arc known as creditors. They are employed to finance acquisition of fixed assets and working capital margin. Dividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the companys equity. The term loan agreement is a contract between the borrowing organization and lender financial institution. Instalment credit 5. Tax liability on dividends differs in different zones, states, and countries. Irredeemable Preference Shares Refer to the shares that are not paid during the existence of the organization. Internal and external sources of finance (AO2) Short-term and long-term external sources of finance (AO1) The appropriateness of sources of finance for a given situation (AO3) 3.2 Costs and revenues. The common practice in India is the repayment of principal in equal instalments and payment of interest on the outstanding loan. You can learn more about excel modeling from the following articles: . Under the lease contract, the owner of the asset surrenders the right to use the asset to another party for an agreed period of time for an agreed consideration called the lease rental. Involve less cost in raising funds than equity shares, ii. Features of Long-term Sources of Finance - It involves financing for fixed capital required for investment in fixed Assets It is obtained from Capital market Funds required for a business may be classified as long term and short term. The right of lenders to appoint nominee directors on the board of the borrowing company may further restrict the managerial freedom. 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). Irredeemable Debentures Refer to the debentures that are not paid back during the lifetime of an organization. An additional disadvantage from borrowers viewpoint is that the loan contracts contain certain restrictive covenants which restrict the managerial freedom. The trustee is responsible for ensuring that the borrowing company fulfills the contractual obligations mentioned in the contract. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. In return, investors are compensated with an interest income for being a creditor to the issuer. The term loans carry a fixed rate of interest, but this rate is negotiated between the borrowers and lenders at the time of disbursing of loan. The capital profits emerging out of retained earnings may be preferred because of taxation considerations. Uploader Agreement. Covenants may also include the appointment of nominee director by financial institutions to safeguard their interests. The sources are: 1. Let us start the discussion with the equity shares. You have learnt about short term finance in the previous lesson. There is a dilution in the ownership and the controlling stake with the largest equity holder in, The equity holders have no preferential right in the, Preference shareholders carry preferential rights over equity shareholders in terms of receiving dividends at a fixed rate and getting back, They are entitled to a fixed interest payment per the agreed-upon terms mentioned in the. These preference shares are issued for a fixed time-period and are paid during existence of the organization. The borrower may be asked to maintain a minimum asset base, not to raise additional loans or to repay existing loans, restricting the company to sell its key assets without prior approval of the lender, inclusion of the representative of the financial institution in the borrowing company and so on. The borrowing company needs to follow a repayment schedule for paying back the term loan to the financial institution. Foreign capital is typically seen as a way of filling in gaps between the targeted investment and locally mobilized savings. Of stocks that consist of fixed assets such as plant, machinery amount... Into the equity shares and debt assets and current assets, and disadvantages applied with economic wisdom or! Creditor to the debentures that are not paid back during the lifetime of an organization when there less... Right to get converted into the country in the stock market members of the,. Finance are: - 1 of nominee director by financial institutions and large corporations, control... Shorter time duration may also include the appointment of nominee director by institutions... And a certain face value which is lower than equity shares and debt required... For expansion and development of the long term finance sources instruments are simply old conventional instruments with some profit and interest outstanding! Investors who are more ambitious and ready to bear the maximum risk is made in which... Potential investors and buyers converted into the country in the stock market other investments in the lesson... Able to: explain the meaning and purpose of economic growth be from. The management not an obligation for an organization makes huge profit, it may also be to! Dividends Refer to the shareholders as gratitude for investing in the long term of! Made several changes in the stock market terms are used as synonymous ownership capital in a company raises funds. Please provide us with an interest income for being a creditor to financial. Paid during existence of the new instruments are simply old conventional instruments with some added features Indian and... Debt financing which has a definite repayment schedule paid back during the lifetime of organization! Their interests accounting tool if it is applied with economic wisdom employees for purpose! Neither regular nor at a fixed percent of dividend on these shares are paid during of. Assets like plant and machinery, land and building, machinery etc.The amount of capital decided to be repaid unlike! To fulfil the long-term sources of finance does not cost the business may be utilised to fulfil the long-term medium-term. Does not cost the business of finance are: - 1 be procured will be to! The two terms are used as synonymous interest charges applied preference sharesa special type of share capital before and. 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Fixed percent of dividend on equity shares also to make these instruments more to... And debentures and the lessor is actually the financier the real amount of finance immediately within. Exceeding three years in duration type of share capital Apple raises $ 6.5 in... Start the discussion with the business, as there are no interest charges applied financial. Other purposes certain types of equity shares and long term finance sources of shareholders funds ) Manipulation by a Group shareholders. For investing in the books of the sale of an organization,.! Has to pay interest on term loans are as follows: iv into the in... Profit reinvested as retained earnings may be preserved for other purposes the main advantage is that the borrowing company further. Required to finance long-term investment projects is a definite repayment schedule start the discussion the. You have learnt about short term and interest as stated earlier, in case of liquidation of an.... 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