Long Term Finance
3 Term loans
finance is mobilized through issue of securities such as shares and debenture,
it is called as security finance. It is also called as corporate securities.
of finance plays a major role in the field of deciding the capital structure of
Characters of Finance
finance consists of the following important characters:
sources of finance.
It is also called as corporate
Security finance includes both
shares and debentures.
It plays a major role in deciding
the capital structure of the company.
Repayment of finance is very
It is a major part of the
company‘s total capitalization.
Shares also known as ordinary shares, which means, other than preference
shares. Equity shareholders are the real owners of the company. They have a
over the management of the company. Equity shareholders are eligible to get
dividend if the company earns profit. Equity share capital cannot be redeemed
during the lifetime of the company. The liability of the equity shareholders is
the value of unpaid value of shares.
Features of Equity Shares
Maturity of the s hares: Equity shares have permanent nature of capital, which
has no maturity period. It cannot be redeemed during the lifetime of the
Residual claim on income: Equity shareholders have the right to get inco me
left after paying fixed rate of dividend to preference shareholder. The
earnings or the income available to the shareholders is equal to the profit
after tax minus preference dividend.
claims on assets: If the company wound up, the ordinary or equity shareholders
have the right to get the claims on assets. These rights are only available to
the equity shareholders.
to control: Equity shareholders are the real owners of the company.
rights: Equity shareholders have voting rights in the meeting of the company
with the help of voting right power; they can change or remove any decision of
the business concern. Equity shareholders only have voting rights in the company
meeting and also they can nominate proxy to participate and vote in the meeting
instead of the shareholder.
-emptive right: Equity shareholder pre-emptive rights. The pre- emptive right
is the legal right of the existing shareholders. It is attested by the company
in the first opportunity to purchase additional equity shares in proportion to
the ircurrent holding capacity.
Limited liability: Equity shareholders are having only limited liability to the
value of shares they have purchased. If the shareholders are having fully paid
up shares, they have no liability.
Advantages of Equity Shares
ources of finance : Equity share capital is belonging to long- term permanent
nature of sources of finance, hence, it can be used for long-term or fixed
capital requirement of the business concern.
rights: Equity shareholders are the real owners of the company who have voting
rights. This type of advantage is available only to the equity shareholders.
fixed divide nd: Equity shares do not create any obligation to pay a fixed rate
cost of capital: Cost of capital is the major factor, which affects the value
of the company. If the company wants to increase the value of the company, they
have to use more share capital because, it consists of less cost of capital (K e) while compared to
other sources of finance.
earnings : When the company have more share capital, it will be suitable for
retained earnings which is the less cost sources of finance while compared to
other sources of finance.
Disadvantages of Equity Shares
1. Irre dee
mable : Equity shares cannot be redeemed during the lifetime of the business
concern. It is the most dangerous thing of over capitalization.
in manage me nt: Equity shareholder can put obstacles in ma nage ment by
manipulation and organizing themselves. Because, they have power to contrast
any decision which are against the wealth of the shareholders.
to speculation: Equity shares dealings in share market lead to secularis m
during prosperous periods.
Limited income to investor: The Investors who desire to invest in safe
securities with a fixed income have no attraction for equity shares.
trading on equity: When the company raises capital only with the help of
equity, the company cannot take the advantage of trading on equity.
of corporate securities are called as preference shares. It is the shares,
which have preferential right to get dividend and get back the initial
investment at the time of winding up of the company. Preference shareholders
are eligible to get fixed rate of dividend and they do not have voting rights.
Preference shares may be classified into the
following major types:
Cumulative preference shares: Cumulative preference shares have right to claim
dividends for those years which have no profits. If the company is unable to
earn profit in any one or more years, C.P. Shares are unable to get any
dividend but they have right to get the comparative dividend for the previous
years if the company earned profit.
Non-cumulative preference s hares : Non- cumulative preference shares have no
right to enjoy the above benefits. They are eligible to get only dividend if
the company earns profit during the years. Otherwise, they cannot claim any
deemable preference s hares : When, the preference shares have a fixed maturity
period it becomes redeemable preference shares. It can be redeemable during the
lifetime of the company. The Company Act has provided certain restrictions on
the return of the redeemable preference shares.
Irredeemable Preference Shares
mable preference shares can be redeemed only when the company goes for
liquidator. There is no fixed maturity period for such kind of preference
preference sharesholders have right to participate extra profits after
distributing the equity shareholders.
preference sharesholders are not having any right to
extra profits after distributing to the equity shareholders. Fixed rate
dividend is payable to the type of shareholders.
preference sharesholders have right to convert their holding into equity shares
after a specific period. The articles of association must author ize the right
shares, cannot be converted into equity shares from preference shares.
of Preference Shares
following are the important features of the preference shares:
period: Normally preference shares have no fixed maturity period except in the
case of redeemable preference shares. Preference shares can be redeemable only
at the time of the company liquidation.
Residual claims on income: Preferential sharesholders have a residual claim on
income. Fixed rate of dividend is payable to the preference shareholders.
idual claims on assets : The first preference is given to the preference
shareholders at the time of liquidation. If any extra Assets are available that
should be distributed to equity shareholder.
Control of Management: Preference shareholder does not have any voting rights.
Hence, they cannot have control over the management of the company.
Advantages of Preference Shares
shares have the following important advantages.
1. Fixe d
divide nd: The dividend rate is fixed in the case of preference shares.
Cumulative divide nds : Preference shares have another advantage which is
called cumulative dividends. If the company does not earn any profit in any
previous years, it can be cumulative with future period dividend.
demption: Preference Shares can be redeemable after a specific period except in
the case of irredeemable preference shares. There is a fixed maturity period
for repayment of the initial investment.
Participation: Participative preference sharesholders can participate in the
surplus profit after distribution to the equity shareholders.
Convertibility preference shares can be converted into equity shares when the
articles of association provide such conversion.
Disadvantages of Preference Shares
sources of finance : Preference shares have high expensive source of finance
while compared to equity shares.
voting right: Generally preference sharesholders do not have any voting rights.
Hence they cannot have the control over the management of the company.
3. Fixe d
divide nd only: Preference shares can get only fixed rate of dividend. They may
not enjoy more profits of the company.
Permanent burden: Cumulative preference shares become a permanent burden so far
as the payment of dividend is concerned. Because the company must pay the
dividend for the unprofitable periods also.
Taxation: In the taxation point of view, preference shares dividend is not a
deductible expense while calculating tax. But, interest is a deductible
expense. Hence, it has disadvantage on the tax deduction point of view.
shares also called as founder shares because these shares were normally issued
to founders. The shareholders have a preferential right to get dividend before
the preference shares and equity shares. According to Companies Act 1956 no
public limited company or which is a subsidiary of a public company can issue
shares were issued to the founder at small denomination to control over the
management by the virtue of their voting rights.
Securities also known as debt finance which means the finance is mobilized from
the creditors. Debenture and Bonds are the two major parts of the Creditorship
Debenture is a document issued by the company. It is a certificate issued by
the company under its seal acknowledging a debt.
to the Companies Act 1956, ―debenture includes debenture stock, bonds and any
other securities of a company whether constituting a charge of the assets of
the company or not.‖
Types of Debentures
may be divided into the following major types:
Unsecured debentures : Unsecured debentures are not given any security on
assets of the company. It is also called simple or naked debentures. This type
of debentures are treaded as unsecured creditors at the time of winding up of
Secured debentures : Secured debentures are given security on assets of the
company. It is also called as mortgaged debentures because these debentures are
given against any mortgage of the assets of the company.
Redeemable de bentures: These debentures are to be redeemed on the expiry of a
certain period. The interest is paid periodically and the initial investment is
retur ne d after the fixed maturity period.
Irredeemable debentures: These kind of debentures cannot be redeemable during
the life time of the business concern.
Convertible de be ntures : Convertible debentures are the debentures whose
holders have the option to get them converted wholly or partly into shares.
These debentures are usually converted into equity shares.
Conversion of the debentures may be:
types: Debentures can also be classified into the following types.
Some of the common types of the debentures are
Features of Debentures
Maturity period: Debentures consist of long-term fixed maturity period.
Normally, debentures consist of 10–20 years maturity period and are repayable
with the principle investment at the end of the maturity period.
claims in income: Debenture holders are eligible to get fixed rate of interest
at every end of the accounting period. Debenture holders have priority of claim
in income of the company over equity and preference shareholders.
claims on asset: Debenture holders have priority of claims on Assets of the
company over equity and preference shareholders. The Debenture holders may have
either specific change on the Assets or floating change of the assets of the
company. Specific change of Debenture holders are treated as secured creditors
and floating change of Debenture holders are treated as unsecured creditors.
voting rights: Debenture holders are considered as creditors of the company.
Hence they have no voting rights. Debenture holders cannot have the control
over the performance of the business concern.
5. Fixe d
rate of interest: Debentures yield fixed rate of interest till the maturity
period. Hence the business will not affect the yield of the debenture.
is one of the major parts of the long-term sources of finance which of consists
the following important advantages:
Long-term sources : Debenture is one of the long-term sources of finance to the
company. Normally the maturity period is longer than the other sources of
2. Fixe d
rate of interest: Fixed rate of interest is payable to debenture holders, hence
it is most suitable of the companies earn higher profit. Generally, the rate of
interest is lower than the other sources of long- term finance.
on equity: A company can trade on equity by mixing debentures in its capital
structure and thereby increase its earning per share. When the company apply
the trade on equity concept, cost of capital will reduce and value of the
company will increase.
tax deduction: Interest payable to debentures can be deducted from the total
profit of the company. So it helps to reduce the tax burden of the company.
Protection: Various provisions of the debenture trust deed and the guidelines
issued by the SEB1 protect the interest of debenture holders.
Disadvantages of Debenture
finance consists of the following major disadvantages:
1. Fixe d
rate of inte res t: Debenture consists of fixed rate of interest payable to
securities. Even though the company is unable to earn profit, they have to pay
the fixed rate of interest to debenture holders, hence, it is not suitable to
those company earnings which fluctuate considerably.
voting rights: Debenture holders do not have any voting rights. Hence, they
cannot have the control over the ma nagement of the company.
Creditors of the company: Debenture holders are merely creditors and not the
owners of the company. They do not have any claim in the surplus profits of the
risk: Every additional issue of debentures becomes more risky and costly on
account of higher expectation of debenture holders. This enhanced financial
risk increases the cost of equity capital and the cost of raising finance thro
ugh debentures which is also high because of high stamp duty.
Restrictions of further issues : The company cannot raise further finance
through debentures as the debentures are under the part of security of the
assets already mortgaged to debenture holders.
3 Term loans
financing is the important mode of finance raised by the company. Loan finance
may be divided into two types:
Short- Term Sources
banks also provide loans to the business concern to meet the short- term
financial requirements. When a bank makes an advance in lump sum against some
security it is termed as loan. Loan may be in the following form:
credit: A cash credit is an arrange me nt by which a bank allows his customer
to borrow money up to certain limit against the security of the commodity.
Overdraft: Overdraft is an arrangement with a bank by which a current account
holder is allowed to withdraw more than the balance to his credit up to a
certain limit without any securities.
banks were established mainly for the purpose of pro motion and development the
industrial sector in the country. Presently, large number of development banks
are functioning with multidimensional activities. Development banks are also called
as financial institutions or statutory financial institutions or statutor y no
n- banking institutions. Development banks provide two important types of
Indirect Finance/ Refinance