However, they may be rescheduled to enable corporate borrowers to tide over temporary financial exigencies. A company does not generally distribute all its earnings amongst its shareholders as dividends. Financial institutions established at the state level include State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs). The disadvantages of term loans are as follows: i. Bind an organization to pay interests even in case of loss, ii. It is obtained from Capital market. Provide no voting rights to debenture holders, ii. Term Loans 8. Here are the other recommended articles on Corporate Finance -. This article is a guide to the Long-Term Financing definition. (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. In other words, the extent of profitability after tax, the size of dividend payments and the amount of depreciation provided for along with the reserves and surplus all contribute to the sources of internal funds. The amount of capital decided to be raised from members of the public is divided into units of equal value. Assets which are financed through term loans serve as primary security and the other assets of the company serve as collateral security. After the maturity of the financed the borrower needs to return the financier the real amount with some profit and interest. The equity shareholders collectively own the company and enjoy all the rewards and the risks associated with the ownership. (v) Convertibility Financial institutions usually insist on the option of converting their loans into equity shares of the company. For example, computer manufacturers who lease out computers provide such services. Internal finance includes the funds generated within the corporate unit irrespective of the nature of source. The interests of the debenture holders are protected by a trustee (generally bank or an insurance company or a firm of attorneys). They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. The long term sources of finance are shown below: 1. (c) Sometimes, a conservative dividend policy leads to huge accumulation of retained earnings leading to over-capitalization. Bearer debenture holders can transfer their debentures without giving any prior information to the organization. Everything you need to know about the sources of getting long-term finance for a company, firm or business. 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. 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. (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. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. The amount of long term capital depends upon the scale of business and nature of business. 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. The companys credit rating also plays a major role in raising funds via long-term or short-term means. In return, investors are compensated with an interest income for being a creditor to the issuer. Bankruptcy refers to the legal procedure of declaring an individual or a business as bankrupt. There are other functional differences between the two- bonds carry lower rate of interest and lower risk as compared to debentures, are generally secured by collateral and are paid prior to debentures in case of liquidation. (iii) No Real Control over the Company There are a number of shareholders and most of them are scattered and unorganised. Cumulative Preference Shares Refer to the shares for which dividends get accumulated over a period of time. Long term finance are capital requirements for a period of more than 1 year. For availing the benefit of trading on equity, it is essential to issue debentures or preference shares with fixed yields lower than the earning rate of the company. Suppose a company wants to raise money via NCD from the general public. The companys management needs to be assured about creating a mix of short-term and long-term financing sources. 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. But in case of Companies whose financial . Generally, equity shares are repaid at the time of winding up of an organization. Issue of Shares. 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 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. iv. 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. Following points discuss the types of equity shares in brief: Refer to shares that are issued in place of dividends. (d) Since term loans do not represent debt financing, neither the control nor the profit sharing of the equity shareholders is diluted. (i) High Cost of Funds Equity shares have a higher cost for two reasons. After discussing the characteristics and types of equity shares, let us look at their following advantages: i. High gearing on the company may affect the valuations and future fundraising. The term loans may be converted into equity at the option and according to the terms and conditions laid down by the financial institutions. The interest on term loans is a definite obligation that is payable irrespective of the financial condition of the firm. SBA 7 (a) loans, for example, range from $25,000 . In addition, these shares help in motivating employees and increase their productivity. 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. In India, the two terms, bonds and debentures are used interchangeably. Bonds (debentures) belong to external sources of finance. Therefore, it has become essential for the issuer to innovate and introduce new financial instruments to cater to the different needs of the issuers and investors. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more or opt for a private investor to take a substantial stake in the company. These sources are particularly important for small businesses which may find it difficult to get external finance. This led to the deregulation and liberalization of the Indian economy and also increased the flow of foreign capital into the country. Debenture holders of an organization arc known as creditors. They are issued under the common seal of the company acknowledging the receipt of money. Convertible Preference shares Refer to the shares that can be converted into equity shares after a certain time-period. Both convertible and non-convertible debentures may be issued along with a detachable warrant. It is required by an organization during the establishment, expansion, technological innovation, and research and development. 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. (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. These preference shares are only paid at the time of liquidation of the organization. Term Loans 8. An equal instalment schedule is comprised of a decreasing interest payment and an increasing principal payment. This makes employees feel that they are owners of the organization and motivate them to demonstrate dedication in their work. There are two types of shares, namely equity and preference, issued by an organization. (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. For example, In Haryana, Haryana State Financial Corporation (HFC) and Haryana State Industrial Development Corporation (HSIDC) have been established. 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.. 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. This has been a guide to what external sources of finance are. Examples of Long-term Sources of finance Equity Share Capital 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. 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. As assets are depreciated, tax liability decreases. Ploughing Back of Profits 4. vi. Owner of the asset is called Lessor and the user is called Lessee. An organization uses term loans to purchase fixed assets and fund projects having long-gestation period. Rate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. In a rising economy with increasing inflation, the effective cost of future installments decreases due to reduction in the value of the currency. iii. Internal Sources 5. Dividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the companys equity. The internal accruals, like depreciation and retained earnings, have been discussed below: Depreciation means the decline in the value of fixed assets due to use and wear and tear. In USA there is a distinction between debentures and bonds. Image Guidelines 4. (b) Like any other form of debt financing, term loans also increase the financial risk of the company. 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 financial plan is typically considered long-term when its goals span more than a year into the future. 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. Allow an organization to raise secured loans. A bond that is sold at a discount on its par value and has a coupon rate significantly less than the prevailing rates of fixed-income securities with a similar risk profile. (c) The term loans are negotiable loans between the borrowers and lenders. Debentures are offered to the public for subscription in the same way as for issue of equity shares. These loans carry at a floating rate of interest and predetermined maturity period. (a) The directors of quoted companies occasionally get criticised for restricting the value of dividends and for hoarding too much cash in the business. But, in India no such distinction is made between bonds and debentures and the two terms are used as synonymous. From, Managements (Borrowers) Point of View: (a) It is less costly as a source of finance. A company can also raise funds through issue of preference sharesa special type of share capital. Provide right to equity shareholders to share profit, assets, and control of the management. Capital Markets 6. Long-term funds are paid back during the lifetime of an organization. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. Funds required for a business may be classified as long term and short term. iii. Equity shares are one of the most important financial instruments to raise long-term funds needed for the incorporation, expansion, and growth of an organization. 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. Less costly as a source of finance are, land and buildings are funded by term. 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