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). Investors who desire to invest in safe securities with a regular and fixed income have no attraction for such shares. Equity Shares 2. It is of vital significance for modern business which requires huge capital. The maturity period of term loans is typically longer, in case of sanctions by financial institutions, in the range of 6-10 years in comparison to 3-5 years of bank advances. and is accumulated from the capital market. However, for obtaining further finance in case of any existing company, the management should, as far as possible, avoid issuing equity shares. 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. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. Preference shares are a long-term source of finance for a company. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash. The value of shares is calculated according to various principles in different capital markets. This can include real estate, patents, works of art, and other assets controlled by the company. 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 The ever growing financial requirements of the corporate sector have resulted in an intense competition between them to corner investors funds. Generally, equity shares are repaid at the time of winding up of an organization. Financial institutions established at the state level include State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs). The lender is usually a commercial bank. Financial Institutions 6. (b) If the purpose for utilization of retained earnings is not clearly stated, it may lead to careless spending of funds. These units are known as share and the aggregate values of shares are known as share capital of the company. Allows the equity shareholders to interfere in the internal affairs of an organization. Debenture holders of an organization arc known as creditors. For example, In Haryana, Haryana State Financial Corporation (HFC) and Haryana State Industrial Development Corporation (HSIDC) have been established. Secondly, equity shares have high floatation cost in terms of underwriting, brokerage and other issue expenses in comparison to other securities. 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. The equity shareholders collectively own the company and enjoy all the rewards and the risks associated with the ownership. Australia concerned over long-term Chinese security presence in Solomon islands. Some of the long-term sources of finance are:- 1. In case of lower profits, the company can reduce or suspend payment of dividend. The interest on term loans is a definite obligation that is payable irrespective of the financial condition of the firm. 4 Sources of Long Term Financing 4.1 External sources of finance 4.2 Equity Shares 4.3 Preference Shares 4.4 Debentures and Bonds 4.5 Venture capital 4.6 Term Loans 4.7 Lease financing 5 Internal Sources of finance 5.1 Retained earnings 5.1.1 Advantages of Retained Earnings 5.2 Sale of assets Long Term Financing Needs of a Business 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.. Each type of shares has a different set of characteristics, advantages, and disadvantages. 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. The advantages of debentures are as follows: i. Term Loans 8. ii. Most of the new instruments are simply old conventional instruments with some added features. As the foreign capital plays a constructive role in a countrys economic development, it has led to a progressive reduction in regulations and restraints that had earlier inhibited the inflow of foreign capital. Such long-term financing is generally of high amount. (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. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. These low-coupon bonds are issued with call or put provisions. The law treats them as shares but they have elements of both equity shares and debt. Covenants may also include the appointment of nominee director by financial institutions to safeguard their interests. (v) Not Entitled to Tax-Benefits Lessee is not entitled to certain tax benefits like depreciation and investment allowance because he is not the owner of the asset. (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. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. The amount borrowed is paid back in installments over a predetermined agreed period of time usually 10, 20 or 30 years. (i) Economical Method It is very economical method of financing. They have voting rights to elect directors of the company and the directors control the business. The lessee is free to choose the asset according to his requirements and the lessor is actually the financier. (e) Debt financing by term loan has fixed installments till the maturity of the loan. 1) Funds raised by an NBFC named NeoGrowthCredit Pvt. It is required by an organization during the establishment, expansion, technological innovation, and research and development. 3.6 Efficiency ratio analysis. An organization pays interest on the irredeemable debentures till its existence. 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. (f) The less debt the company has, the more attractive it is to potential investors and buyers. Loans from banks are however less flexible. At the time of liquidation, these shares are paid after paying all the liabilities. In the event of the company going for rights issue prior to the allotment of equity to the holders of FCDs, FCD holders shall be offered securities as may be determined by the company. Dilution of control is an inherent characteristic of financing through issue of equity shares. Bank loan/financing from financial institutions. In addition, long-term financing is required to finance long-term investment projects. (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. Features of Long-term Sources of Finance -. Equity Share Capital: Equity shares, also known as ordinary shares or common shares represent the owners' capital in a company. (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. The profit reinvested as retained earnings is profit that could have been paid as a dividend. It is also referred to as ploughing back of profit. But, in India no such distinction is made between bonds and debentures and the two terms are used as synonymous. Hence, improving the companys credit rating might help the organizations raise long-term funds at a much cheaper rate. In India, the two terms, bonds and debentures are used interchangeably. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. 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 In case of higher profits too, the company is not legally bound to distribute dividends. The advantage of having internal accruals like depreciation and retained earnings is clearly seen in their characteristics. The recipient of a long-term bank loan incurs a debt and is liable to pay interest . Each share has a certain face value which is also called its nominal value. Such short-term sources of working capital help in assisting the seasonal fluctuations and short-term liquidity crisis. In a rising economy with increasing inflation, the effective cost of future installments decreases due to reduction in the value of the currency. 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. Everything you need to know about the sources of getting long-term finance for a company, firm or business. (a) They are cheap although they have an opportunity cost, that is, the return they could have obtained elsewhere. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. The dividend policy of the company is determined by the directors. The person who gives the asset is Lessor, the person who takes the asset on rent is Lessee.. Disclaimer 8. As the legal owner, it is the lessor (and not the lessee), who will be entitled to claim depreciation on the leased asset. 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. 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. 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. But, in case of companies Long-term financial management, often referred to as strategic financial planning or simply financial planning is an investment plan or strategy that is geared toward aiming investments in a direction to promote long-term growth. The saved taxes are allowed to accumulate as reserves. Serve as a source of long-term capital and are repaid during the lifetime of the organization. The borrowing company needs to follow a repayment schedule for paying back the term loan to the financial institution. Bonds 7. International Sources. The main advantage is that it is not been paid immediately or within shorter time duration. 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 payments like borrowed capital. Companies can also raise internal finance by selling off assets for cash. Debentures are one of the frequently used methods by which a company raises long-term funds. These can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures. The common practice in India is the repayment of principal in equal instalments and payment of interest on the outstanding loan. Do not allow an organization to show the dividend paid on these shares on the debit side of profit and loss account. Loans from co-operatives 1. (c) Zero Interest Fully Convertible Debentures (FCD): The investors in zero-interest fully convertible debentures are not paid any interest. Non-Convertible Debentures Refer to the debentures that have no right to get converted into the equity shares during their maturity period. However, they may be rescheduled to enable corporate borrowers to tide over temporary financial exigencies. Discounts and premiums on shares are calculated from their par value or face value. Australia and China have adopted more assertive strategies for security cooperation with Pacific countries during the previous year, with significant efforts concentrated on the Solomon Islands, reported Financial Post. The disadvantages of preference shares are as follows: i. Do not consider the term loan providers as the owners of the organization. Non-Convertible Preference Shares Refer to the shares that cannot be converted into equity shares. In addition, these shares help in motivating employees and increase their productivity. 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. It is a standard clause of the bond contracts and loan agreements. (c) The term loans are negotiable loans between the borrowers and lenders. (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. This got worse as Canberra began to worry . Issue of Shares. Long term finance can be said as an investment or financing that is bound to be kept continue for a period exceeding one year. Result in overcapitalization if more than required equity shares are issued. The warrants attached to it ensure the holder the right to apply and get allotted equity shares; provided the SPN is fully paid. Following points explain the type of debentures in brief: i. These various sources are described below. For this reason, they are also called hybrid financing instruments. 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. 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