Sources of Corporate Finance

Justify the following statements.

1. Equity shareholders are real owners and controllers of the company.
Reasons: A person invests money in the Equity shares is known as Equity shareholder. Due to following
point’s equity shareholder are considered real owners and controllers of the company.
1) Equity shares: Those shares do not have any priority regarding payment of dividend and repayment of
capital at the time of winding up company is known as Equity shares. It provides long term capital to
the organization for satisfying fixed capital requirement. This capital used by company up to dissolution
of business. Equity shareholder gets dividend and repayment after the preference shares. They bear
risk of organization. They do not create charge on assets. They enjoy various rights in the organization.
So they are real owners and controllers.
2) Permanent Capital: Equity shares are part of owned capital which does not create any obligation
regarding repayment of capital. These shares does not have maturity period, it means these share
capital cannot be redeemed during the lifetime of company. These shares repay on winding up
company after the payment of all liabilities and preference share capital. Therefore equity share
provide permanent capital to the company. According to section 68 companies to purchase its own or
other securities on certain conditions and repay before maturity period.
3) Rights: Equity shareholders are real owners of the company and they enjoy all membership rights.
They get various rights such as get notice of meeting, attend the meeting, take active participation in
meeting discussion, to vote on resolution, to appoint proxy for voting, to elect as director and manage
the company affairs, to get dividend, to inspect the books of accounts and other statutory books, to
transfer shares, to get bonus shares and right shares, to get evidence of membership, to protect the
corporation, etc.
4) Control: The control of company is vested with the equity shareholders. They are often described as
‘real masters’ of the company. It is because they enjoy exclusive voting rights. The Act provides the
right to cast vote in proportion to shareholding. They can exercise their voting right by proxies, without
even attending meeting in person. By exercising voting right they can participate in the management
and affairs of the company. They elect their representatives called Directors for management of the
company. They are allowed to vote on all matters discussed at the general meeting. Thus equity
shareholders enjoy control over the company.
Conclusion: Equity shares are part of owned capital and long term funds with bearing risks of business. The
equity shareholder enjoy the voting rights and management rights, by rights they control the organization.
So they are real owners and controllers of organizations.
2. Preference shares do not carry any voting right.
Answer: Those shares enjoy preference in payment of dividend and repayment of capital at the time of
winding up of company is known as Preference Shares. Due to following features these shares do not carry
any voting rights
1. Fixed Rate of Dividend: These shares get dividend at fixed rate. The rate of dividend is pre-determined
at the time of issue. It is disclosed in the prospectus of issue and share certificate. This ensures the
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 investors the security of fixed returns. Preference shares get dividend when company is in profit. In the
loss period or financial crisis, if the directors decide not pay dividend, then preference shareholders
have no claim on dividend.
2. Nature of Capital: Preference shares capital does not use for permanent basis, because it is repay after
specific period. As per Companies Act, 2013 a company cannot issue irredeemable preference shares.
The maximum period of preference shares is 20 years. They get fixed rate of dividend and also
preference in dividend and repayment at winding up of company. The market value of these shares
does not fluctuate. Therefore preference share capital is considered as ‘safe capital’ with stable return.
3. Risk: The investment in preference shares is less risky as compared to equity shares. They enjoy
preference in payment of dividend and repayment of capital. They get dividend at fixed rate. It is
repaid after specific time period. The investor who are conservative, cautious, interested in safety of
capital who wants steady returns on investments generally purchase preference shares. These shares
are boon for shareholder during depression period when interest rate is continuously falling.
4. No Voting Rights: Preference shareholders do not enjoy any normal voting rights like equity shares.
They do not have right to attend the meetings, elect as directors and to participate in the management
of the company. They can attend the class meeting and vote on matters. They have to sacrifice their
voting rights in exchange of the privileges enjoyed by them. Cumulative preference shares have a right
to vote on all resolutions of the company if their dividends are not paid for two consecutive years.
Conclusion: Preference share capital is safe capital with stable return, as they get preference in payment
of dividend & repayment of capital. They do not bear risk of organization. They have to sacrifice voting
rights I exchange of privileges enjoyed by them.
3. Equity share capital is risk capital.
Reasons: Those shares do not enjoy preference in payment of dividend and repayment of capital at the
time of winding up of company is known as Equity Shares. Due to following features it is considered ‘Risk
Capital’.
1. Fluctuating Rate of Dividend: Dividend is a part profit which is distributed to the shareholders.
Dividend is return on share investment. Equity shares do not create any obligation regarding payment
dividend and also not get guarantee regarding minimum rate of dividend. On the issue of equity shares
company cannot make any commitment or agreement regarding rate of dividend. The dividend
depends upon earnings of the company. If earning is more, get more dividends. If earning is low, the
rate of dividend also low. When company bears losses that time equity shares does not get dividend.
Therefore equity shareholder get dividend at fluctuating rate of dividend. It changes every year.
Normally rate of dividend is average of last 3 years.
2. No Preferential Rights: Equity shareholders do not enjoy any preferential rights in respect of payment
of dividend as well as repayment of capital at the time of winding up of the company. It explain as
follows:
At the time of Dividend Payment
Particulars Amount ( )
Sales XXXXX
Less: All Expenses
XXXX
(Purchase, Production, Marketing and Administration)
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Earnings Before Interest and Tax XXXX
The earnings available for equity
Less: Interest on Borrowed Capital XXX
shareholders can be divided into
Earnings Before Tax XXXX Retained Earnings (Reserve Fund)
Less: Corporate Tax XXX and Dividend to shareholders.

Earnings After Tax XXXX

Less: Dividend on Preference Shares Capital XXX
Earnings Available for Equity Shareholders XXXX
At the time of winding up of the company
Particulars Amount ( )
Sales of All Assets XXXXX
Less: Outside Liabilities XXXX
Amount Available for Share Capital XXXX
Less: Preference Share Capital XXX
Remaining for Equity Shareholders XXXX
If not remain profit, they does not get dividend and also on the winding up if not remain any amount
after repayment of all these, equity shareholders does not get anything as repayment.
3. Residual Claimants: Every equity shareholders are owners of the company. They do not get preference
in payment of dividend and repayment of capital. They get remaining profit after payment of expenses,
interest on borrowed capital, corporate tax, and dividend for preference shares and also provision for
future (retained earnings). Due to this rate of dividend always change. At time of dissolution the
Official Liquidator sell the all assets of the company and pay all the outstanding liabilities, then pay the
preference share capital and remaining amount distribute into equity shareholders. Therefore in
payment dividend they are last and also repayment of capital they are last. So equity shareholders are
residual claimants of the company.
4. No Charge on Assets: Charge on assets means an interest or lien created on assets of company in
favour of creditors. In case company fails to pay the debt, creditors can claim it from the company’s
assets. Equity shares do not carry any charge on the assets of the company, because company never
provides any security or mortgage assets for them only solvency is the security.
5. Risk: Equity shareholder does not get guarantee from the company regarding rate of dividend and
repayment of capital. They get dividend as per profit. They do not get preference in payment of
dividend and repayment of capital. There is no any commitment and agreement regarding payment of
dividend and repayment of capital. There is a risk of not getting regular income and also the repayment
of principal investment in the company. They do not make demand regarding repayment of capital to
the company. If not remain profit, they does not get dividend and also on the winding up if not remain
any amount after repayment of all these, equity shareholders does not get anything as repayment.
They bear risk of the organization. Therefore equity share capital considers risky capital. Equity
shareholders describe as ‘shock absorbers’ when company has financial crisis.

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 Conclusion: Equity shares are ordinary/common shares. Company does not any guarantee regarding
payment of dividend and repayment of capital. The rate of dividend is not fixed; it changes as per the
financial condition of the company. They are residual claimants. they bear risk of organization. So it is
considered Risk Capital of the company.
4. Retained earnings are simple and cheapest method of raising finance.
Answer: Retained earning means it is the portion of the profit which is not distributed into equity
shareholders, but retained & reinvested in the business. It is the simplest & cheapest method for raising
finance due to following reasons.
1. Internal source: Retained earnings are the internal source of finance. It is created from savings of
organization. For saving purpose, company minimizes the expenditure for increase the income sources.
Internal sources of finance always easy & cheapest compared to the external sources.
2. No Fixed Obligation: When capitalize the profit, company issue bonus shares to equity shareholders as
a free of cost. The bonus shares are similar in nature as equity shares. They carry same features, so
these do not create any obligation regarding payment of dividend and repayment of capital.
3. Easy Method: It is very easy for the company to retained earnings as a source funds. For this purpose
require sufficient reserve fund and obtain approval from shareholders by passing special resolution in
general meeting. For raising finance does not require any major approval from other authorities.
4. Cheapest Source of Finance: When company use retained earnings as a source of finance that
company does not incur any expenditure. It is a less costly method as compared to others. For the use
of retained earnings, a company requires only to issue bonus shares to equity shareholders and
approval from them in the general meeting
Conclusion: From the above points it is clear that an existing company can generate the finance through its
internal sources i.e. retained earnings. It is cheapest & simplest source of finance.
5. The debentures are secured by charge on assets of the company.
Answer: Debenture means debenture stock, bonds or any other instruments of the company, evidencing a
debt, whether constituting charge on the assets of company or not. Every Debenture creates charge on the
assets of company, it explained by following points.
1) Promise: Debenture is a written promise by the company that it is obtain loan of specific amount for
specified period. It is a promise made by the company to holder to pay interest (return) and repayment
of capital on specific date. Debenture certificate is given to debenture holder as an acknowledgement
of debt. The certificate issue within six months from the allotment of debentures.
2) Interest: Debenture is a borrowed/Loan/debt capital. The company provides interest as return on loan.
The rate of interest is fixed on the issue. The rate of interest does not change by company throughout
the debenture period. It never depends upon company’s financial position. It is a compulsory payment
either company in profit or bearing the losses. It is an expenditure of the company; it is calculated and
paid before the tax. The interest is paid periodically-six monthly or yearly.
3) Assurance of repayment: Debenture is a borrowed capital of the company. It creates fixed obligations
regarding payment of interest and repayment of capital. Company gives the assurance for payment of
interest and repayment of capital on particular date. If company fails to make payments to debentures,
it is considered default of company and for this default penalized by the Companies Act. For the
assurance company provide security for the debentures. These create charge on the assets of the
company.
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 4) Security: As per Companies Act, 2013 company only issue secured debentures. It means debentures
must create charge on the assets of the company. This charge may be fixed or floating on assets. If
company fails to repayment of capital on maturity date that time debenture holder consult the trustee
regarding this. Debenture trustees take charge of the assets; sell in the market and repayment of
debentures. Company also create special fund for redemption of debentures from the profit. It means
investment in debentures is totally risk-free.
Conclusion: From the above points, it is clear that Debenture is borrowed source of capital having prior
rights of payment of interest & repayment of principal amount after a specific period, thus it create fixed
obligation. So debentures are secured by the charge on assets of the company.
6. Debenture is a loan capital of the company.
Answer: Debenture means debenture stock, bonds or any other instruments of the company, evidencing a
debt, whether constituting charge on the assets of company or not. Debenture is a loan capital of the
company, it explained by following points.
1) Promise: Debenture is a written promise by the company that it is obtain loan of specific amount for
specified period. It is a promise made by the company to holder to pay interest (return) and repayment
of capital on specific date. Debenture certificate is given to debenture holder as an acknowledgement
of debt. The certificate issue within six months from the allotment of debentures.
2) Interest: Debenture is a borrowed/Loan/debt capital. The company provides interest as return on loan.
The rate of interest is fixed on the issue. The rate of interest does not change by company throughout
the debenture period. It never depends upon company’s financial position. It is a compulsory payment
either company in profit or bearing the losses. It is an expenditure of the company; it is calculated and
paid before the tax. The interest is paid periodically-six monthly or yearly.
3) Assurance of repayment: Debenture is a borrowed capital of the company. It creates fixed obligations
regarding payment of interest and repayment of capital. Company gives the assurance for payment of
interest and repayment of capital on particular date. If company fails to make payments to debentures,
it is considered default of company and for this default penalized by the Companies Act. For the
assurance company provide security for the debentures. These create charge on the assets of the
company.
4) No Voting Rights: Debenture holders provides borrowed capital to the organizations, they are
considered creditors of the company. They do not enjoy any membership rights (voting and
management). According to section 71 (2) of the Companies Act, 2013, Company cannot issue any
debentures with voting rights.
Conclusion: From the above points, it is clear that Debenture is a loan capital of the company.
7. Bond holder is creditor of the company.
Answer: Bond is an interest bearing certificate issued by the government or business firms promising to
pay the holder a specific sum at a specified date. A person who invests money in the bonds is known as
bondholder. Due to following features bondholder considered as creditors of the company.
1) Contract: - Bond is a formal contract between the company and bond holders. In this contract a
company promises to repay the borrowed amount with interest or without interest. This contract
includes all terms and conditions regarding interest payment as well as repayment of principal amount.
If bonds are secured by assets that time in the contract involve third party ‘Bond Trustee’

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 2) Nature of Finance: - Bond is a long term source of finance. Bonds are issued for 5 years, 10 years, 25
years, 50 years, and 100 years. Normally bonds are issued for more than 10 years. A company uses
bond capital to purchase fixed assets. A bond a loan capital, therefore it is less risky than share capital.
3) Return on Bonds: - It is a borrowed capital, therefore company provide interest as a return on the
bonds. The rate interest may be fixed or floating. The interest may be paid annually or on maturity
period.
4) Status of Investor: - The bonds are one of the securities of borrowed capital. Therefore bondholders
are creditors of the company. They do not enjoy any membership rights such as voting and
management rights.
Conclusion: From the above points, it is clear that Bond is a source of borrowed capital so bondholder is a
creditor of the company.
8. Public Deposit is good source of short term financing.
Answer: Public Deposit means any receipt of money by the way of deposits or loan or any other form by
Company, but does not include such categories of amount as may be prescribed in consultation with RBI.
Due to following features, it is considered as a good source of the short-term financing.
1. Part of Borrowed Capital: Public deposit considered as source of borrowed capital. Company uses this
source for satisfying working capital requirements. This requirement is up to 1 year, so public deposit is
short finance.
2. Interest on Deposit: Public deposit is a part borrowed capital, so company pay interest as return on
investment. The interest on deposit must not be more than the maximum rate of interest as prescribed
by the RBI. This interest rate is similar to bank deposits interest rate. The interest may be paid half-
yearly, yearly or on maturity period. This rate of interest is low compare to loan interest rate. So it is
good source.
3. Maturity of Deposits: Company can raise finance from the public deposit for minimum 6 months and
maximum 36 months. The company cannot receive any deposit which is repayable on demand.
However the Public deposits can be renewed from time-to-time. Renewal facility enables companies to
use the public deposit medium term finance.
4. Status of Depositors: Public is a source of short-term borrowed capital, therefore deposit holders are
creditors of the company. He does not enjoy any voting and management rights in the company. They
do not chance to convert his investment into equity shares. So it is beneficial for company.
Conclusion: from the above points it is clear that Public deposit is a source of borrowed capital, it provide
finance from 6 months to 36 months. The rate of interest is low compare to other securities. Depositors
are creditors of the company. So it is a good source of short-term financing.
9. Financial institutions perform various functions regarding financing to business sector.
Answer: Financial Institutions means Banking and non-banking organization provide financial assistance
for the industrial development. These organizations include IFCI, ICICI, IRBI, SIDBI, LIC, GIC, UTI, TDCI, RCTC,
commercial banks and others. These organizations perform following functions towards financing to
business sector.
1. Granting Loans: The Financial Institution provides long-term and medium term loans to industrial
organization for the purpose of starting, developing, modernization and restructure of business. The
loan amount used by company to satisfy fixed capital requirement of business.

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 2. Guarantee of Loans: They also provide guarantees for loans raised by business concerns from other
sources. Companies raise finance from commercial banks and cooperative banks by way of loans, when
obtain loans require guarantee. This guarantee is provided by financial institutions. They also provide
guarantees for deferred payments for purchase of capital goods from foreign nations.
3. Subscription of Securities: The financial institution purchase the securities issued by the companies.
They purchase equity shares, preference shares, debentures and bonds.
4. Act as an Underwriter: Development banks also act as an underwriter in the capital market. They
underwrite the issue of shares, bonds or debentures of industrial organizations.
5. Other Activities: The financial institutions also perform other functions such as:
a) Acting as agent of government
b) Guarantee for Foreign Currency Loans
c) Guarantee for credit purchase of capital goods
d) Issue of letter of credit
e) Arrange Industrial Exhibitions
f) Discounting the bills
g) Guidance for management and marketing of business
h) Act as broker in the financial market.
i) Provide merchant banking services
Conclusion: from the above points it is clear that financial institution provide a long-term, medium-term
and short term loans to the business sector for purpose of establishment, expansion, modernization,
restructure & other purposes and perform regarding functions.
10. Providing loan to business is a primary function of banks. / Bank credit is a primary institutional source
of finance.
Answer: Bank is a financial organization that receives the deposits from public which is repayable on
demand by cheque, draft or any other instrument provided by bank. This deposit money is used for
lending to others and invests money in financial market. Therefore providing loan to business is a
primary/basic function of the Bank. It’s more explained by following points.
1) Bank Overdraft: When a bank allows its depositors or account holders to withdraw money in excess of
the balance in his account up to a specified limit, it is known as overdraft facility. This limit is granted
purely on the basis of credit-worthiness of the borrower. Banks generally give the limit up to Rs.20,
000. In this system, the borrower has to show a positive balance in his account on the last Friday of
every month. Interest is charged only on the overdrawn money. Rate of interest in case of overdraft is
less than the rate charged under cash credit.
2) Cash Credit: It is an arrangement whereby banks allow the borrower to withdraw money up to a
specified limit. This limit is known as cash credit limit. Initially this limit is granted for one year. This
limit can be extended after review for another year. However, if the borrower still desires to continue
the limit, it must be renewed after three years. Rate of interest varies depending upon the amount of
limit. Banks ask for collateral security for the grant of cash credit. In this arrangement, the borrower
can draw, repay and again draw the amount within the sanctioned limit. Interest is charged only on the
amount actually withdrawn and not on the amount of entire limit.

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 3) Cash Loan: It is short term advance sanctioned by bank for specific period. It is one year loan provided
by banks for satisfying working capital requirement such as money at call, short notice etc. Interest is
payable on actual balance outstanding.
4) Discounting of Bills of Exchange: Bills of exchange are a definite promise in writing from buyer, for
paying the amount on a specific date. It is a negotiable instrument used in business for satisfying
working capital requirements. Discounting of bills of exchange is another method of granting advances
to the traders. The banks can advance funds by purchasing or discounting the bills from traders which
arise from trade. Trade bills are those bills which emerge due to credit sale to customers. If the traders
require money before the expiry of the bills, they can discount the bills with the banks. The banker will
pay an amount to the drawer or beneficiary of the bill (usually trader who sold goods on credit basis to
customers) after deducting the discount amount. On maturity of the bill, the banker will receive the
amount from the drawee or acceptor of the bill (the customer who bought goods on credit terms).
5) Term Loans: A term loan is a loan issued by a bank for a fixed amount and fixed repayment schedule
with either a fixed or floating interest rate. Bank also provide term loans to business sector on the
mortgage. Loan term is more than one year and as per requirement of the business. This loan repay by
business sector in monthly installments (interest + principal amount).
Conclusion: From the above points it is clear that bank provide various types of loans to business sector. It
is basic/primary function of bank.
11. Trade credit is not cash loan.
Answer: A trade credit is an agreement where a customer can purchase goods on account (without paying
cash), paying the supplier at a later date. Due to following features, it is considered not cash loan of the
organization.
1) Source of Short-term Finance: Trade credit is a commonly used by business organization as a source of
short term finance. It is granted to customers who have ability to repay and good credit standing in the
market. It is available for 30, 60, 90 days, especially in jewelry business up to 180 days. By the trade
credit, the customer get time period for the payment of the money, it is less than one year.
2) No Formal Agreement: Not involve any formal and written agreement between buyers and sellers for
trade credit. It is only depend upon oral agreement and mutual trust between them. So cost of
documentation is not involved in the transaction. Therefore it is the cheapest and easiest method of
financing.
3) No Cash Flow: In the trade credit not actually transfer cash from the seller to buyer, just only get time
period for payment of credit purchase. Buyers get chance use this money for other purpose. This
practice done by business organization with a motive to increase its sales turnover, generate additional
business and maintain a good relationship with buyers. So it is not a cash loan and considered as
routine business function.
4) No Interest: In the trade credit, does not charge any interest, because no cash flow between the sellers
and buyers. Just provide only time period for payment of the credit purchases.
Conclusion: From the all above the points, it is clear that trade credit is credit extended by one seller,
without cash sales, so not cash flow or cash loan.
12. Different investors have different preferences.
Answer: An investor is any person or other entity (such as a firm or mutual fund) who invests capital with
the expectation of receiving financial returns. They invest money into various types of securities such as
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Equity shares, preference shares, debentures, bonds, deposits and others. While investing money he
considers the risk and return factor. Different investors have different preference of investment as follows.
1) Conservative Investor: A conservative investor is someone who wants his money to grow but does not
want to risk his principle investment. He is unable to bear any risk of the principal amount he has
invested. He focuses on the protection of his capital. Conservative investors choose financial products
that do not fluctuate much in value. Since he is not aggressive in his expectations, he does not mind
the likelihood of moderate capital growth with steady returns. They are very conservative and
cautious regarding his investment. They want assurance for returns and investment. A low-risk investor
is therefore likely to be happy investing in debt instruments, such as debentures, bonds, deposits and
other debt instruments.
2) Balanced Investor: A balanced investor is someone who is willing to take a little more risk to enhance
the value of his investment. He wants to safety of investment with some risk. He will take more risk
than a conservative investor, but will not be willing to invest in high-risk instruments for greater
returns. A medium-risk investor seeks a balance between stability and growth. He wants safe
investment, regular fixed rate of return and repayment or conversion after specific time period. He
invests money in the convertible debentures, convertible preference shares and other preference
shares.
3) Aggressive Investor: An aggressive investor is someone who is willing to take a higher risk to increase
the value of his investment. He always ready to bear risk of the business. He is an adventurous for his
investment. He focuses on capital appreciation and long term investment. They get return by
fluctuating rate. They get He invests money in the equity shares.
Investor Preference Securities
Conservative Protection of Capital, Fixed returns Debentures, bonds, deposits
Balanced Growth & stability, conversion Convertible Securities, Preference
shares
Aggressive Capital Appreciation, rights, growth, liquidity Equity Shares
Conclusion: From the above points it is clear that while investing money in the securities investor
considered various factors such as risk, return, liquidity, growth, stability, security of investment, rights,
etc. so different investors have different preferences.