Financial needs & sources of finance of a part 1


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Financial needs & sources of finance of a part 1

  1. 1. Financial Needs & Sources of Finance of a Business1. Long-term financial needs: For starting business, business needs fund for buyingfixed assets like machinery, land, plant and building. This requirement may be of 10to 15 years.The important sources of long-term finance are :- Issue of shares Issue of debentures Loans from financial institutions Reinvestment of profits2. Medium-term financial needs: Such requirements refer to funds for a periodexceeding one year but not exceeding 5 years. . It involves financing certain activitieslike renovation of buildings, modernization of machinery, heavy expenditure onadvertising, etc.The important sources of mid-term finance are :- Preference shares Debentures/Bonds Public deposits/fixed deposits for a duration of three years Financial institutions
  2. 2. 3. Short term financial needs: Short term financial needs are for fulfilling theworking capital requirements. In this, we manage to get short term loanwhich will be repayable within one year.The important sources of short-term finance are :- Banks Trade credit Installment credit Advances received from customers
  3. 3. Long Term Sources of Financea)Owner’s Capital or Equity: A public limited company may raise funds frompromoters or from the investing public by way of owners capital or equitycapital by issuing ordinary equity shares. Ordinary shareholders are owners ofthe company and they undertake the risks inherent in business. In other word,Owner’s equity, often just called equity, represents the value of the assets thatthe owner can lay claim to.b)Preference Share Capital: The money or capital that a company raise fromselling preference shares. Shareholders with these shares must be paid beforethose with ordinary shares when a company is paying dividends or if it goesbankrupt. The rate of dividend on preference shares is normally higher thanthe rate of interest on debentures, loans, etc.c)Debentures or Bonds: Debenture is a document of loan taken by thecompany. A debenture is a written acknowledging a debt containing provisionsas regarding the repayment of principal and payment of interest at fixed rate.Debenture includes debenture stock, bonds and other securities of a company.
  4. 4. d) Types of Debentures1. Bearer Debenture: The names of the holders of such debenture are notregistered in the company’s book. Such debentures are transferablemerely by physical delivery of the document.2. Registered Debenture: The names and addresses of such debentureholders are registered in the company’s book. Such a debenture is nottransferable by mere delivery. The transfer of debentures in this caserequires the execution of proper transfer deed.3. Naked Debenture: The debenture which does not have security isknown as naked debenture. It is also called as unsecured or simpledebentures.4. Secured Debenture: The debenture which is secured either on aparticular assets or on the whole assets of the company is known assecured debenture.5. Redeemable Debenture: The debenture which is issued for a particularfixed period is known as redeemable debenture. On the expiry of thefixed period, the principal amount of debenture is paid off to thedebenture holder.
  5. 5. 6. Irredeemable Debenture: It is also known as perpetual debenture,which is not redeemable during the life time of the company. It isredeemable only at the time of liquidation of company.7. Convertible Debenture: The debenture which is convertible intoshares of the company, after some time at the option of debentureholder is termed as convertible debenture.8. Non-Convertible Debenture: The debenture which is not convertibleinto shares of the company is termed as non-convertible debenture.
  6. 6. e)New Financial Instrument: Participating preference shares Non-voting shares Detachable equity warrants Participating debentures Convertible debentures redeemable at premium Zero coupon convertible note Mortgage backed securitiesf) Loans From Financial Institution: The specialized institutions provide long-term financial assistance to industry i.e. term loan. Term loan is a loan madeby bank/financial institution to a business having an initial maturity of morethan one year. Term loans represent secured borrowings and at present it is themost important source of finance for new projects. They generally carry a rate ofinterest inclusive of interest tax, depending on the credit rating of the borrower,the perceived risk of lending and the cost of funds. These loans are generallyrepayable over a period of 6 to 10 years in annual, semi-annual or quarterlyinstallments.
  7. 7. g)Internal Accrual: This basically means what is being ploughed back inbusiness i.e., retained earnings and the depreciation charge. While depreciationis used for replacing an old machinery etc., retained earnings can be used, forfinding other long-term requirements of the business.Advantages Retained earnings are easily available internally. It eliminates issue and transaction cost. No dilution of control.Disadvantages Only limited amount can be raised. High opportunity cost.
  8. 8. Issues of Securities Public Issue: Companies issue securities in the public in the primary marketand get them listed in the stock exchange. Initial public offerings are used bycompanies to raise expansion capital, to possibly monetize the investments ofearly private investors, and to become publicly traded enterprises. The issuerobtains the assistance of an underwriting firm, which provide a valuableservice, which includes help with correctly assessing the value of shares (shareprice), and establishing a public market for shares (initial sale). Private Placement: The sale of securities to a relatively small number of selectinvestors as a way of raising capital. Investors involved in private placementsare usually large banks, mutual funds, insurance companies and pension funds.Private placement is the opposite of a public issue, in which securities are madeavailable for sale on the open market.
  9. 9.  Right Issue: A rights issue is an issue of rights to buy additionalsecurities in a company made to the companys existing securityholders. A rights issue is directly offered to all shareholders of record orthrough broker dealers of record and may be exercised in full orpartially. Subscription rights may either be transferable, allowing thesubscription-rights holder to sell them privately, on the open market ornot at all. A rights issue to shareholders is generally made as a tax-freedividend on a ratio basis (e.g. a dividend of one subscription right forone share of Common stock issued and outstanding).
  10. 10.  Bought Out Deals: A bought deal is one form of financial arrangement oftenassociated with an Initial Public Offering. It occurs when an underwriter, suchas an investment bank or a syndicate, purchases securities from an issuer beforea preliminary prospectus is filed. The investment bank (or underwriter) acts asprincipal rather than agent and thus actually "goes long" in the security. Thebank negotiates a price with the issuer (usually at a discount to the currentmarket price, if applicable).Advantages of Bought Out deals are:- Bought deals are usually priced at a larger discount to market than fullymarketed deals, and thus may be easier to sell. The issuer/client may only be willing to do a deal if it is bought (as it eliminatesexecution or market risk.
  11. 11.  Euro Issues: Simply when company taps the European Market for theirfinancial requirements especially for financing projects in the infrastructuresector like power generation, telecommunication, petroleum exploration andrefining, ports, airports and roads. Where the resources are raised through themechanism of Euro Issues i.e., Global Depository Receipts (GDRs), ForeignCurrency Convertible Bonds (FCCB) and pure debt bonds. These investmentsare issued abroad and listed and traded as a foreign stock exchange. Once theyare converted into equity, the underlying shares are listed and traded on thedomestic exchange.