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CHAPTER – 14 : SOURCES OF BUSINESS FINANCE – 2
Introduction : During the industrial revolution, many innovations in the fields of science and technology were made. Mechanism in production field was implemented. Large scale production was made possible. Each work. in the unit has become a specialised job. The size of unit increased and capital investment on a big scale became inevitable. It turned to be impossible for a person or a group of persons to take risk so company form was developed along with this, and various sources of finance have come into existence.
We shall get information of certain important sources of business finance in this chapter.
(1) Share Capital : Share means a part or a division. Generally, owner’s capital of a company is of big amount. This capital is divided into small parts. This each part is known as a share. So, this capital is known as a share capital. This source is able to fulfill the long-term or permanent needs of business unit.
As for example, Total share capital of a company is Rs. 1,00,00,000 (Rs. One Crore), which has been divided into one million shares of Rs. 10 each. This means that the price of one share (Part) of this company is Rs. .10 and share capital is divided into one million shares. It is convenient for the small investors to subscribe for one or more shares of Rs. 10 each and only for this reason a number of investors can subscribe for these shares and by this way big industrial units can procure capital on a big scale.
Types of shares
Equity Shares Preference Shares
With reference to the right With reference to the With reference to the With reference to
of Dividend share in surplus profit refund of the amount the conversion
into equity Shares
- Cumulative Pref. Share - Participating Pref. Share - Redeemable Pref. share - Convertible Pref. share
- Non Cumulative Pref. Shares - Non Participating - Irredeemable Pre. Share - Non-Convertible Pre.
Shares
Equity Share
Equity shareholders are the real owners of the company. Business unit is not possible without the owners. So, it is inevitable for a company to issue these shares. Excess of liability over the assets leads to the reduction of this share capital. When the company goes into liquidation or dissolve, the company makes payment to the preference shareholders after paying for debt from the sales of assets, profit and receipts. After that, if any disbursable balance remains, that balance is distributed amongst the equity shareholders on the basis of ratio of equity shares.
Characteristics of Equity Share
(1) Profit can be disbursed to the equity shareholders only after dividend is paid to the preference shareholders.
(2) At the time of liquidation of the company also surplus balance is disbursed to the equity shareholders only after the payment of preference share capital.
(3) Equity shareholders have the franchise of voting in the general meeting. This franchise is not per person but per share.
(4) It is not compulsory to pay dividend to the equity shareholders and the rate of dividend is-also not fixed.
(5) As equity shares are of ownership, their holders have to be called for the general meeting at least once in a year and accounts are to be approved in this meeting and certain policy decisions are taken.
(6) As these shareholders are the real owners they carry more risk than preference shareholders.
(7) Generally, these shares are listed on the approved stock exchanges and they can be bought and sold at market price.
(8) Equity shareholders are entitled for bonus shares.
(9) The working of the company affects the value of equity share.
Preference Shares : Dividend is disbursed on equity shares only after the dividend at predetermined rate is paid on preference shares. In the same way, at the time of liquidation of the company the preference shareholders are paid their amount after the payment of all debts but before the payment to equity shareholders. They are given preference over equity shareholders in the refund of share capital also. That is why this type of shares is known as preference share.
Characteristics of Preference Shares
(1) Dividend is paid to the preference shareholders before disbursing it to the equity shareholders. The rate of dividend is fixed.
(2) Share capital of this type of shares is fully paid at the time of dissolution of the company (but before paid to the equity shareholder).
(3) Voting franchise to the preference shareholders is limited for certain matters only.
Types of Preference Shares
We shall understand the meaning of various types of preference shares as mentioned previously.
(1) Cumulative Preference Share : When a company during any year has not earned profit or suffered a loss or earned profit and if dividend is not paid, then that dividend is carried forward to the next year. It means that when a company earns profit it will pay dividend of past years for which dividend was not paid. This type of preference shares is known as cumulative preference shares.
(2) Non-cumulative Preference Share : In this type of preference shares dividend is paid in those years only when the company earns profit sufficiently. However, non-cumulative preference shareholders & not got right to get dividend for non-profit years.
(3) Participating Preference Share : This type of preference shares firstly get the fixed raw of dividend. Then, out of the remaining profit me equity shareholders gets the dividend. If after disbursement to the equity shareholders the remaining profit will be Distributed amongst the participating preference shareholder.
(4) Non-participating Preference Share : The type of preference shares which doe not participate in profit as stated in (3) above is known as non-participating preference share.
(5) Redeemable Preference Shares : The preference share which has been issued for a fixed duration and with the completion of that duration, share capital is refunded is know as redeemable preference share. This source is useful for the requirement of finance for certain time period.
(6) Irredeemable Preference Share : The preference share in which time for repayment is not determined is known as irredeemable preference share. This owner’s capital is useful for permanent or long-term procurement of finance.
(7) Convertible Preference Share : The preference share which is converted fully or partly into equity share is known as convertible preference share.
(8) Non-convertible Preference share : The preference share which is not converted into equity share is known as non-convertible preference share.
(2) Debenture
Meaning : The company invites the public to purchase debenture as it invites the public to subscribe for shares. Debenture (And) is a debt to it company. Debenture is one type of loan. It is divided into small parts of equal price Q getting funds of certain amount as being done through shares. This each part is known as debenture. The small investors can also purchase debentures as this loan is divided in small parts. Debenture-holders are the creditors of a company but not the owners. They are paid interest at a fixed rate on the money invested in debentures. This alternative is useful for long-term and medium-term procurement of finance. Amount of debentures is refunded at the completion of duration.
Characteristics of debentures
(1) Debenture-holders are the creditors of the company
(2) Interest at fixed rate is to be paid on debentures.
(3) Mostly, title on assets against debentures is bestowed.
(4) Money is to be refunded at the completion of duration of debentures.
(5) Debentures are the sources of long or medium-term finance.
(6) Sometimes, debentures are listed on stock exchanges. So they can be bought and sold like shares.
(7) The amount of debentures can be refunded in installments also, e.g. 25 % of the face value installment of 10-year debentures can be refunded yearly at the end of 7th, 8th, 9th and 10th year of their issue year or total face value can be refunded also.
(8) As debentures are the debt of the company their amount is refunded before the payment of share capital at the time of dissolution of the company.
Types of debentures : We shall study following types of debentures out of its various types :
(A) Classification on the basis of security
(1) Secured debentures
(2) Unsecured debentures
(B) Classification on the basis of conversion into shares
(1) Convertible debentures
(2) Non-convertible debentures
(A) (1) Secured Debentures
Those debentures are secured of which total amount was secured by pledging the company’s assets of me same amount. At the time of dissolution of the company or at the time of repayment of debentures, if the company does not have enough funds to repay the debentures, amount of debentures will be repaid even by selling the mortgaged assets. Thus, the debenture-holders can protect their interest against risk and can feel secured.
(2) Unsecured Debentures : Those debentures are unsecured of which amount was unsecured as no pledging of company’s assets is made.
(B) (1) Convertible Debentures :
If company has announced that after the specific time certain debentures will be converted fully or partly into equity shares, those debentures are known as convertible debentures. Holders of this type of debentures are paid predetermined share/s in exchange of certain part of debentures of specific price at the end of specific time. Due to this, debenture-holders become both-Creditors and owners, if debentures are partly convertible but in the case of fully convertible they cease to be the creditors from the declared date and become shareholders-owners.
(2) Non-convertible Debentures : This type of debentures is not converted into equity shares. The amount of debentures is paid at the specific time.
(3) Bonds : Bonds are the debt of the company. Generally, the face value of a bond is more than a debenture. Bond-holders also get interest at the specific rate and at the specific time like debenture-holders.
This source is useful for long-term needs. Bonds are issued by government, municipalities and even by the companies. This type of bonds is known as government bond.
Bonds can be of 10 years or more. At the end of its duration money is to be refunded.
Bond as a source of finance is more favourable in the circumstances of tide needs for undertaking big plans requiring big amount for long time.
4. Retained Profit or Ploughing Back of Profit
This is an internal source of finance for providing long-term capital and working capital. Profit, which has been retained in business for fulfilling the liabilities which have been estimated for the future and for the development, expansion and modernisation of business and for the protection against risk is ploughed back in business.
Sometimes, profit might not be disbursed in the initial years of establishment of company and shareholders are also not expecting for it. Profit can be utilised for future needs, by retaining it.
Advantages
(1) This source of finance is very much useful at the time of fluctuations in market and during depression.
(2) Retained profit is favourable for the implementation of development, expansion and modernisation of business plans.
(3) If the provision for depreciation on assets is inadequate, this source is useful for purchasing new assets.
(4) Ploughing back of profit is useful also for maintaining rate of dividend disbursed to shareholders.
(5) Due to ploughing. back of profit, efforts and expenses spent for other sources are not made. So the working of business can fun smoothly.
(6) If finance is borrowed from other sources, interest is to be paid and assets are to be pledged. These are not necessary for the alternative of ploughing back in business.
(7) Retained profit proves to be useful against the time of changes in the business and risks.
(8) National capital creation is enhanced due to ploughing back of profit in business.
Limitations
(1) Business. unit’s economic power increases through this source.
(2) Monopoly increases due to increase in economic power.
(3) Many a time directors / managers disburse low rate of dividend and retain the remaining profit and then resort to malpractices.
(4) Cheating may take place by not paying part of profit to the investors and by re-investing profit in various ways.
(5) Many a time small investors do not get any gain by retained profit.
Public Deposits
For satisfying the short-term needs of finance, the company accepts deposits from the public which is known as public deposits. The company accepts finance from the investors for specified time-period through public deposits. This duration may be from 6 months to 36 months (3 years). Monthly, quarterly, half-yearly or yearly interest of fixed rate is paid on invested money for this duration or interest may be paid along with original amount at the due date.
Advantages
(1) If the company has a good image amongst investors, it is very easy for it to get finance.
(2) The cost of procurement of finance through this source is comparatively low, whereas, the procedure for getting money through other sources of finance is longer, complicated and costly.
(3) No security is necessary against public deposits.
(4) The interest paid on public deposits is considered as an expense so tax-burden on the company is lessened.
Limitations
(1) This source is very much uncertain because the response of the investors cannot be judged beforehand. (Over and above, it has no provision of underwriters like Shares)
(2) As there is no security given for public deposits the investors face much risk.
(3) Public deposits are ‘fair weather friends’. During the financial crisis of company or its rumor investors rush for its premature payment of deposits. This rush increases the economic crisis of company. So, it is known as fair weather friends also.
The importance of international sources of finance
Introduction
Foreign investment has increased after the implementation of liberalisation policies in India
Importance
(1) Investment in India has increased by Non-Residential Indians, personal and institutional foreign investors and by foreign companies through their subsidiary companies which are in India
(2) Indian subsidiary company of foreign origin will get information of technology and patents along with direct foreign investments.
(3) Indian subsidiary company gets financial help by the guarantee of payment by the foreign company.
(4) Speedy development has become possible in the fields of production, technology and infrastructure of the country due to foreign investments.
(5) Employment opportunities have also increased due to increase in foreign investments.
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