SOURCES OF FUNDS

CHAPTER 2
 I. SHORT TERM FUNDS
• The Finance acquired for a period of one year or slightly more, falls under this
category. This is also called as working capital finance. It is needed for:
• Fulfilling daily expenses, like payment of wages and salaries to workers or
employees
• Purchase of Raw Materials
• Meeting tax liabilities arising out of the process of conversion of raw material into
finished goods, etc.
 II. MEDIUM TERM FINANCE
Working capital finance acquired for a period beyond one year is known as medium-
term finance. Generally, this finance is used to purchase assets with a medium-term
life. Eg., Plant and machinery. The medium term finance is raised through:
 Debenture issue
 Borrowing from Commercial Banks or Financial Institutions,
 Acceptance of public deposit, etc..,
 Medium term finance is raised for a period between 1 year and 5 years
 LONG TERM FINANCE
Long-Term Finance is the backbone for the financial strength of a business
entity (firm or company). In general, the financial requirements of more than
5 years are considered long-term finance. The long-term funds are required to
purchase fixed assets such as land and per annum for the following building,
plants, machinery, furniture, fixture, etc. As the funds required for investment
in these assets, which are permanent in nature, are for a long period, their
‘repayment schedule' is also set accordingly for a long period.
 SHORT TERM SOURCES
• Short Term Finance may be obtained through various means, some of which are as
follows:
• 1) Trade Credit: Under this type of short-term finance, an understanding between the
companies to purchase goods or services without paying instantly is referred to as trade
credit. In simple words, the payment is deferred for a period, as agreed upon by both
parties. The merit of trade credit is that it is an informal and spontaneous source of
finance, which is quite convenient as it does not involve any negotiation or formal
agreement. There are no restrictions or terms and conditions, which are generally
imposed upon under negotiated source of finance. Another merit of trade credit is the
flexibility of not paying instantly. The volume of trade credit is directly proportional to
the level of sales of the organization.
 ACCRUED EXPENSES AND
DEFERRED INCOME
• Accrued Expenses and Deferred Income: Accrued expenses are the expenses, which have already been incurred by the
organization but the payment thereof has not become due and not yet made. Such accruals are liabilities of an
organization, as they represent the goods and services already received and payment of which would be made in due
course. Some examples of accrued expenses or liabilities are salaries, wages, interest, taxes, etc., which become
payable only on their becoming due (at week-end, month-end, quarter-end or year-end, as the case may be At the time
of finalisation of balance sheet, such items are shown as liabilities (accrued but not due) of the organisation. The
biggest advantage of this type of short-term finance is that it is spontaneous and interest-free .
• Those incomes which are received in advance by the company for the supply of goods or services
in the future period are known as deferred incomes. These incomes increase the flow of liquidity of
the company. This income is also, like accrued expenses, a liability for the organization and a
source of indirect short-term finance. Until the goods are supplied to the customers, these
payments are not shown as income but showed in the balance sheet as income received in advance.
Such type of short-term finance can be availed only by the organisations having: i) Monopoly in
the market ii) Great demand for its products/services, and iii) Unique products on special order.
 COMMERCIAL PAPERS
• Commercial Papers (CPs): A commercial paper is an unsecured promissory note and
money-market instrument, issued by large corporate houses for raising funds with a
view to meeting their short term debt obligations such as payroll. CP is not secured
by any collateral security. It is supported by an issuing bank or company who
promise to pay the face value at the maturity date indicated on the note. As it is an
unsecured instrument, only the organizations with exceptional credit ratings are
capable of issuing their commercial paper at an economical price. The maturity
period of a commercial paper ranges between 15 days and one year. On maturity
date, the issuer has to repay the due amount without any delay. There is no provision
of grace period in this case.
 CERTIFICATES OF DEPOSIT (CD)
• Certificates of Deposit (CD): A Certificate of Deposit (CD) is also a money market
instrument issued banks to the depositors. in the form of certificate showing the
existence of such deposit with them. These certificates are in turn traded by the
depositors (when such a need arises) between their business associates. In short,
under this arrangement, the bank deposit may be transferred from one owner to
another, any number of times, before its maturity. Interest on such deposits continues
to be paid in the normal course. The price of CD depends I on the rate of interest
available on the bank deposit (which is fixed) and rate of interest prevailing in the
market at that particular time. The unique feature of CD is that it is the only money
market instrument, wherein the element of 'discounts' is missing. Certificates of
deposit are issued by banks as a means to promote awareness of short-term deposits.
 LETTER OF CREDIT
• Letter of Credit (LC): Letter of Credit (LC) is a form of Bank Guarantee
(BG). It is an arrangement, under which a bank helps its customers to
obtain credit from their suppliers, by undertaking the responsibility to
honour the commitment of its customer, in case of the customer's
inability to do so. LC is opened by banks in respect of specific
transactions entered into by their customers.
 INSTALMENT CREDIT
• Instalment Credit: Under this type of finance, the payment for the purchase of
goods/services is made in one go by the lender (either the seller himself or a
financier) and the buyer is required to make payment in equal instalments (generally
monthly) Each instalment includes part payment of principal and interest accrued
thereon. Auto loans and consumer loans for the purchase of luxury goods like
televisions, refrigerators, furniture, etc., are good examples of this type of finance.
 BANK FINANCE
• Bank Finance: For business organisations borrowing from banks is a common and
important source of funds, not only for short-term working capital finance but also
for medium-term. In our country, working capital needs of business entities are
generally met through Trade Credit arrangement followed by 'Institutional Finance
provided by banks. Banks have a methodology to assess the working capital
requirement of borrowers; the amount so approved is called 'credit limit'. The 'credit
limit' represents the maximum funds, which can be availed by the borrower from the
entire banking system.For the borrowers engaged in seasonal activities, banks assess
separate credit limits for 'peak season' and 'non-peak season' and borrowers are
expected to avail the limits mentioned under 'peak level' and 'non-peak level'
respectively.
 FACTORING
• Factoring: Factoring is a process under which invoices representing commercial
"accounts receivables are sold to another buyer called 'Factor' at a discount to get
instant cash. The factor has the whole responsibility regarding the credit analysis,
collection of payments, and credit losses on new accounts. There are three parties
involved in factored invoice:
• i) Seller: Sells the product or service and acts as maker of the invoice/bill.
• ii) Debtor: He is the receiver of the invoice and agrees to pay remaining amount for
the services.
• iii) Factor: He is the intermediary or an agent whobuys the invoices and assumes all
theresponsibilities of the original buyer.
 BILL DISCOUNTING:
• Raising short-term finance, through discounting of trade bills drawn by
bank borrowers on their customers, is a common practice amongst
traders. Discounting is done by the banker of the drawer on the
consideration of discount or commission amount, which adds to the
bank's revenue. On due date, the bills so discounted are presented by the
bank to the borrower's customer for payment and the entire amount is
collected by the bank. If there is a delay in the payment of bills, the
borrower or his customer is liable to pay the bank a pre-determined
interest as per the terms of transaction.
 EQUITY SHARES
Equity Shares Equity shares are also termed as ordinary shares o common shares. Holders of
the equity shares are the of a company as they have invested in the company. They have the
voting rights and part of decision making process on major issues relating to the affairs of the
company.The shareholders' return on the funds invested by them in a company is in the form
of 'Dividend Depending upon the performance of the company, Le net profit earned by it
during a particular year, Board of Directors of the company decide the quantum of dividend to
be distributed amongst the shareholders. In case of loss incurred during a particular year, the
Board may decide against the distribution of dividend. This is precisely the reason why equity
shares are described as "Variable Income Security'. In case of liquidation of a company, equity
shareholders are the Jast one to get their money back.
 FEATURES OF EQUITY SHARES
• 1) Owned Capital: Equity Share Capital is the money of a company's investors, i.e., shareholders. As
such, equity share capital is owned capital so the shareholders are the real owners of the company.
• 2) Fixed or Nominal Value: Every share price of a company is fixed or a nominal value.
• 3) Distinctive Number: For the purpose of identification, each share is allotted a serially running
unique number.
• 4) Attached Rights: By virtue of holding share(s) of a company, the shareholders have certain rights,
like: Right to attend meetings, Right to vote, the Right to receive dividends, Right to inspect the
company's books of accounts, etc.
• 5) Return on Shares: Out of the net profit eamed by company in a particular year, each shareholder is
entitled to a return on his investment. Such return is in the form of a 'Dividend', the amount of which
is decided by the Board of the company. Thus, the dividend is directly proportional to the profit
earned by a company.
 FEATURES

• 6)Transfer of Shares: This is one of the most important features of equity shares. A shareholder. whenever he/she wishes not to
continue holding those shares, can transfer his/her shares in the name of another person easily without any hindrance.
• 7)Benefit of Right Issue: The equity shareholders have certain rights at the time of issuing new shares by a company. The new
(fresh) shares are offered first to the existing equity shareholders in proportion to their shareholding. In case they are not interested
in the offer made by the company. the same may be issued to others.
• 8) Benefit of Bonus Shares: Companies which make huge profits year after year have a treasure of accumulated profits. In such a
situation, they may decide to issue additional shares, termed as 'Bonus Shares', to their shareholders. Bonus Shares are issued free
of cost in proportion to number of shares held by existing shareholders.
• 9) Irredeemable: Equity shares, although transferable, cannot be redeemed by the holder thereof, during the lifetime of the
company. Thus, we can say that the equity shares are forever irredeemable.
• 10) Capital Appreciation: Nominal value of an equity share is fixed, but its market value is variable depending upon the
performance and financial position of the company. In case of good performance and strong financial health of a company, it is in
a position to pay higher dividend to its shareholders. This results in a high demand for the company's shares, which in turn
increases its value in the market. Thus, the shareholders get additional benefits also in the form of capital appreciation.
 TYPES OF EQUITY SHARES
• 1) Blue Chip Shares: Shares belonging to financially and operationally sound companies with a
perfect track record of dividends and earnings.
• 2) Growth Shares: Shares of companies engaged in growing industries. These companies generally
have high profitability and growth.
• 3) Income Shares: Shares issued by the companies enjoying steady operations, high dividend payout
ratios, and moderate growth avenues.
• 4) Cyclical Shares: Shares of companies working in sectors with a prominent level of seasonality and
cyclicality.
• 5) Defensive Shares: Shares issued by the companies linked with relatively stable industrial sectors,
experiencing mild ups and downs during worst market situation.
• 6) Speculative Shares: These shares exhibit wide fluctuations due to high level of speculative trading.
 ADVANTAGES OF EQUITY SHARES
• Equity shares are beneficial for both, the investors and the company, which is evident from the following facts
• 1) Advantages to Investors: An investor is likely to have the following benefits as a result of his/her investment in
a company 0 Capital Profit: If a company is performing well and making a profit year after year, the demand of its
shares would be high and there will be an increase in the market value of its share. The shareholder has an option to
sell the share at a higher price and earn capital gains.
• ii) Interest in the Company's Activities: The owners (equity shareholders) of a company have their interest in the
growth of the company. Therefore, they take keen interest and keep a watch over the performance and other
activities of the company.
• iii) Best for Investment: A company may or may not perform well. Hence, there is always an element of risk in
investing in equity shares of a company. An investor may gain or lose. Therefore, Equity share is the best
investment alternative for the risk-taker investors.
• iv) Right to Interfere in Management: Equity shareholders have stake in a company. As the owners of the company,
they have a right to participate in decision-making process of the management. They can actively participate in
various meetings, election of Board of Directors and have voting rights to the extent of their holdings.
 ADVANTAGES TO COMPANY:
• i) No Fixed Burden of Dividend: Quantum of dividend on equity shares to be distributed by a
company is variable and depends on the profit earned during a particular year. Unlike preference
shares, dividends on equity shares are not a burden for a company; if a company incurs losses,
dividend distribution may be avoided in that particular year.
• ii) No Outflow of Cash: As the equity shares are not redeemable during the life of a company, it
should not be afraid of the outflow of cash due to redemption. The funds lying in equity share capital
accounts are a permanent source of capital for a company.
• iii) Bear the Risk: Funds lying in 'Equity Shares Capital' act as a cushion against the possible risks
for a company. Due to the availability of this "Protective Wall, the company can afford to take more
risk to enhance its profitability.
• iv) Availability of Fixed Capital: The share capital is a long-term permation of finance. The funds
raised through source are generally utilised for acquisition of fixed assets for the com long-term uses.
 DISADVANTAGES OF EQUITY SHAR
• 1) Disadvantages to Investors: Followings are possible disadvantages, an investor is likely to have
• i) Uncertainty of Income: Dividend in from the investments made in equity shares not certain. In case of
losses in any year aga company may decide to avoid payment dividends to its shareholders. Even in the of
huge profit, company may decide payment of dividends. It may like to retain earnings or profits for:
• a) The expansion of existing business, or
• b) Diversification into new ventures, or
• c) Any other purpose, as decided by management.
• ii) Irregular Income: The dividend paymenthe shareholders is directly proportional to company profits. At
times, when the prof low or minimum, the dividend is also low
• iii) Capital Loss: Prices of the equity shares are decided by the market forces and performance of the
company. Equity ma fluctuates according to various domestic and global factors. In case a shareholder’s
necessity of funds and the market conditions are not favorable, he has to suffer a loss selling his shares.
• iv) Not the Best Alternative: The investment equity shares is not the best alternative for investors who
require regular and con income on their investment.
 DISADVANTAGES TO COMPANY:
• i) Difficult to Remove Over-Capitalisation: a situation, where a company faces on
capitalisation, reduction in the number equity shares to bring the capitalization normal level is
not an easy task.
• Ii) Centralisation of Control: As equity sh are easily transferable in the name of ano person, it
is possible for a group of persons they decide to do so, to acquire or come a substantial
number of shares of a comp Such a group, having majority sharehold will have control over
the management affairs of the company.
• Iii) Change in Management Polley: Due to the transferable nature of equity shares.the
shareholding pattern keeps on changing. This, at times, results in changes in management and
long-term policies of the company.
• iii) Change in Management Polley: Due to the transferable nature of equity shares.the
shareholding pattern keeps on changing. This, at times, results in changes in management and
long-term policies of the company.
 PREFERENCE SHARES
• Preference shares have the unique characteristics of being hybrid in nature, i.e., they have certain
features of equity and at the same time certain features of debentures. It is similar to equity shares in
the following ways:
• 1) From disposable profits, the dividend of preference shares is paid.
• 2) The payment of the fixed amount of dividend is not compulsory in the case of preference shares.
It totally depends upon the Board's decision.
• 3) There is no tax deduction in Preference Dividend.
• Preference shares exhibit the following characteristics:
• 1) The rate of dividend on preference shares is generally fixed.
• 2) Preference shareholders get priority over the claim of equity shareholders.
• 3) Preference shareholders generally do not have the right to vote.
 FEATURES OF PREFERENCE
SHARES
• Preference shares are characterised by the followingfeatures:
• 1) Accumulation of Dividends: According to the nature of dividend payment, preference shares are of two
types, viz., cumulative and non-cumulative. In India, preference shares are generally cumulative in nature. The
dividends amount keeps on accumulating over a period of time as decided by the company, and the entire
amount so accumulated is paid at a later date. Here it is noteworthy that a company cannot declare dividends
on equity shares, before the payment of dividends, along with the arrears (if any) due on preference shares. For
example, in case a company avoid dividend payment for 5 year in respect of 15% cumulative preference
shares, a dividend arrear of 75% becomes payable to the preference shareholders after 5 years.
• 2) Call Option for the Company: For the issuing company, it is possible to call the preference shares (wholly
or partly) at a certain price. However, this is possible only when the terms and conditions of issued preference
shares include clause a empowering the issuing company the right to 'call' the preference share.
• 3) Convertibility: Sometimes, the preference shareholders are given the choice of converting their preference
shareholdings into equity shareholdings. Such conversions are allowed by a company for a stipulated period
and ratio. For example, a company may give its preference shareholders the benefit to convert their holding of
preference shares into equity shares, say, in the ratio of 1:6 after 3 years for a period of 5 months.
 FEATURES OF PREFERENCE
SHARES
• 4) Redeemability: Unlike equity shares, which are perpetual in nature and not redeemable, preference shares are generally
redeemable. However, there is no restriction as such, and a company may also issue perpetual preference shares. As the
term itself suggests, a perpetual preference share has no maturity period, whereas a redeemable preference share has a
maturity period, after which the investors are paid their money back.
• 5) Participating Preference Shares: Companies have the powers to issue participating preference shares. Under the
provisions of this category of preference shares, the shareholders have the right to participate in the decision-making
process with regard to the utilization of:
• i) Surplus net profit (profit remaining after dividend distribution in respect of equity and preference shares) every year, and
• ii) In case the company goes into liquidation. residual assets (assets left after meeting the claims of preference
shareholders), as per theparticular formula.
• 6) Voting Power: Subsequent to the commencement of the Companies Act, 1956, preferences shareholders ceased to have
voting rights. However, they are eligible to vote only in respect of certain type of resolutions placed before the board of the
company as mentioned below:
• i) In the case of cumulative preference shares, the resolution pertaining to preference dividend remaining in arrears for two
or more years, and.
• ii) The resolution pertaining to preference dividend remaining unpaid for a period of two or more successive preceding
years or for an aggregate period of three or more years in the preceding six years ending with the expiry of the immediately
preceding financial year.
 TYPES OF PREFERENCES SHARES
• On the basis of certain features, preference share may be categorised as below:
• 1) Cumulative Preference Shares: Under this category of preference shares, if a company does not make enough
profit during a year to pay dividends, dividend payment is deferred for the next year or the year thereafter. Such
dividends continue to accumulate till the company's turnaround. Once the company starts making profits and
becomes able to pay dividends, dividend for the year, along with the accumulated dividends for the previous
years, is paid to the cumulative preference shareholders.
• 2) Non-Cumulative Preference Shares: Under this category of preference shares, if a company incurs losses in a
particular year and is incapable to pay dividends to the preference shareholders, it does not lead to accumulation
of dividends. Generally. preference shares are cumulative in nature, unless specified otherwise.
• 3) Participating Preference Shares: Participating Preference Shareholders have the right to participate in the
decision-making process relating to the utilisation of net profit of a company. They have more say in the affairs
of the company as compared to the ordinary preference shareholders.
• 4) Non-Participating Preference Shares: Non Participating Preference Shareholders are not entitled to participate
in decision-making process of the company.
 TYPES OF PREFERENCE SHARES
• 5) Convertible Preference Shares: Convertible Preference Shareholders may get their holdings
converted into ordinary shares, subject to specific terms and conditions.
• 6) Redeemable Preference Shares: Companies have an option to redeem such shares at a
prescribed rate and at a given date (or over a certain period of time). Till the time of
redemption, the shareholders continue to receive dividends.
• 7) Irredeemable Preference Shares: These shares cannot be redeemed during the life-time of a
company. Irredeemable preference shareholders, however, continue to get dividend income as
long as the company continues to be in profits. In the balance sheet of a company,
irredeemable preference shares are shown under the head 'Equity'.
 ADVANTAGES OF PREFERENCE SHARES
(INVESTOR)
Investing in preference shares and issuing of preference shares are advantageous for the investor
and the company respectively, as is evident from the following points:
1) Advantages to Investors
i) Priority in Repayment of Capital: In comparison of equity shareholders, preference
shareholders get priority in repayment of capital.
ii) Best Security: Preference shares are the preferred choice of investment, especially during the
onset of recession or declining profits.
iii) Regular and Fixed Income: Preference shares provide a stream of assured and regular source
of fixed income to their investors by way of dividends.
iv) Safety of Interest: Preference shareholders, just like like the equity shareholders, are
empowered to safeguard their rights.
 ADVANTAGES OF PREFERENCE
SHARES TO COMPANY
• I) Independent Management: Management of company is shielded from the interference
ofpreference shareholders in its affairs, preference shareholders have no such power.
• ii) Economical Financing: Raising the finance by issuing preference shares is not expensive
ascompared to issuing equity shares. Therefore, it is a preferred mode of raising funds..
• iii) Availability of Huge Market: Investors having a low level of risk appetite (risk taking
capability) are attracted towards investment in preference shares. As a result, a company gets
an opportunity to have a huge market to raise finances.
• iv) Assets Remaining Unencumbered: While issuing preference share capital, a company is
not required to mortgage its assets. The assets of the company continue to remain
unencumbered (available), which proves to be handy at the time of raising further finance at
a future date.
 DISADVANTAGES OF PREFERENCE SHARES
1) DISADVANTAGES TO INVESTORS
• i) Fixed Rate of Dividends: The rate of payment of dividends, in the case of non-
participative preference share, is fixed. Such shareholders are thus deprived of the benefits
of the growth made by a company by the ways of diversification, expansion, etc.
• ii) Uncertainty in Respect of Redeemable Preference Shares: The management of a company
takes decisions regarding redemption of Redeemable Preference Shares. Whenever, the
management of a company decides, it can call back the above category of shares from the
holders. Investors are not left with any other choice but to get back the money after the
redemption.
• iii) Limited Voting Rights: Unlike the absolute voting rights of equity shareholders, the
Preference Shareholders have limited voting rights. They cannot include in the management
of company's affairs.
 DISADVANTAGES TO COMPANY
• i) Disadvantage to Equity Shareholders:
• Preference Shareholders are entitled to dividends at a fixed rate in preference to the other
Shareholders irrespective of the fact whether the company makes profit or suffers loss in a
particular year. This disadvantageous to Equity Shareholders.
• ii) Fixed Financial Burden: A company has to necessarily pay dividend to Preference
Shareholders at a fixed rate even in the case of incurring loss during a year in the form of
cumulative dividend, which is a fixed financial burden for a company.
• iii) High Cost of Capital: Dividend payment to Shareholders is subjected to Preference
Shareholders is taxation at the prevailing rates. Thus, raising funds through the issue of
Preference Shares is costly as compared to the funds raised through the issue of debentures.