Sources of finance

Finance is the life blood of business. No business can be carried on without a suitable source of Finance. The financial manager is mainly responsible for raising the required finance for the business. There are several sources of finance and as such the finance has to be raised from the right kind of source. Classification of sources of finance The sources of finance can be classified as follows: According to period: a) Short term finance This is a finance that is required for a period of one year. b) !edium"term finance The period of medium term finance may be # to $ years. c) %ong term finance The long term finance generally e&ceeds $ years period. According to Ownership 'n this basis the finance is classified as ownership(equity) capital and borrowed(debt) capital. According to source of generation )apital can be raised through internal sources such as retained earnings and depreciation. *t can also be generated through e&ternal sources such as shares and debentures etc. Different sources of finance Equity Shares: +quity share capital is the capital that is raised by issue of equity shares. *t is called owner,s equity. The person who invests in equity shares of the company are called as shareholders. They get the ownership in the co by fraction of amount they have invested in total capital. +quity share holders are residual owners of the company. Their claims on income arise only when the claims of creditors and preference shareholders have been met. +quity shareholders get dividend- the rate of dividend is not fi&ed. They cannot legally compel the company to pay dividends to them even if the company has sufficient income left after meeting all obligations. They possess all the voting power in the company. +quity share capital is the permanent capital as a company is not under contractual obligation to refund the capital during its life time. +quity share holders can demand their capital only in the event of liquidation and that to when funds are left after paying all prior claims. Preference shares: .reference shares represent that part of share capital of a company which carries preferential rights with respect to income and assets over equity shares. Their claims on income arise only after claims of creditors have been met but before equity shareholders. /ence they have a preference over equity shareholders. They get fi&ed rate of dividend every year. .reference shares are redeemable which are redeemed after a certain period or at a fi&ed date. *n the event of dissolution of the companythe preference shareholders will receive their portion of the proceeds before holders of equity shares. The preference shareholders do not en0oy direct right to participate in the management through voting for directors and on the other matters. .reference shareholders are given the right to vote on resolutions which directly affect the rights attached to their preference shares.

Debentures: 1 debenture is a written instrument signed by the company under its common seal acknowledging the debt due by it to its holders. Through this document the company promises to pay a specific amount of money as stated therein at a fi&ed date in future together with periodic payment of interest to compensate the holders for the use of funds. Different types of debentures These are of different types depending on the terms and conditions under which they are issued. They may be secured or unsecured a) Unsecured debentures are those debentures which are not secured by the assets of the company. b) Secured debentures are those debentures which are secured by the assets of the company. c) Redee able debentures are redeemable at the end of a stipulated period. d) !rredee able debentures are those debentures which are redeemable only in the event of winding up of the company. d) Con"ertible debentures are those debentures which are convertible into equity shares. e) #on$con"ertible debentures are those debenture which are not convertible into equity shares. #ew Debt instru ents Following newly devised debt instruments are used by companies for raising capital. a) 2ero *nterest 3ond(2*3) These bonds are issued at a discount. The difference between face value and issue price is the gain to investors. *nvestors are not entitled to any interest. b) +quity warrants with N)4s *t is a piece of paper attached to a non"convertible debenture which gives the holder right to acquire equity shares in future. c) 4eep discount 3onds (443) *43* for the first time issued 443. For a deep discount price of 5s 6-788 an investor gets a bond with a face value of 5s 9-88-888. !nternal financing a) 4epreciation as a source of finance 4epreciation means decrease in the value of asset. Such a decrease may be due to wear and tear- lapse of time- obsolescence- e&haustion and accident. 4epreciation can be regarded as a source of finance because of the following reasons: 9) 4epreciation being non"cash e&pense. 6) 1lthough depreciation does not raise funds- it certainly saves funds. #) 4epreciation results into reduction of ta&able income and hence income ta& liability for the period is reduced. b) Financing through retained earnings 5etained earnings is not a method of financing but it refers to accumulation of profits by a company to finance its developmental activities or repay loans. *t is also called as :*nternal financing; or : .lough back of profits;. 5aising finance through retained earnings is the best source since it is easily available. Therefore management finds it an easy and cheap source of funds.

%oan financing %oans 1 loan is a advance to the business enterprise made with or without security. %oan is advanced for a fi&ed period at an agreed rate of interest. 5epayment of loan may be made either in instalments or at the end of the e&piry period. The borrower has to pay interest on the total amount of advance. )ash credits 1 cash credit is a financial arrangement through which the commercial banks allow the borrower to borrow money upto a certain limit. 'verdrafts *f the borrower requires temporary finance- the banker may allow him to overdraw on his account with or without security. .ublic deposits *n the recent years- business firms are raising short"term finance from their membersdirectors and general public. This is a suitable method of raising short"term finance. 1 company cannot accept deposits foe a period less than < months and more than #< months. 5aising of finance through public deposits does not require any security.

Sources of &inance

Short Term a) 3ank 'verdraft b) )ash credit c) .ublic 4eposits d) Short term loans

%ong Term

*nternal a)5etained earnings b).rovision for depreciation

+&ternal a)Share capital b)%ong term %oans c) 4ebentures