PREPARED BY

RESHMI. K. L

PGT COMMERCE

JNV PATHANAMTHITTA

KERALA

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SOURCES OF BUSINESS FINANCE

Meaning of finance:

The requirements of funds by business to carry out its various activities is called business finance.

*funds are required for purchase of plant and machinery, furniture, and other fixed assets.day-to-day operations, * purchase raw materials, pay salaries to employees, etc. Also when the business expands, it needs funds.

SOURCES OF BUSINESS FINANCE

• The financial needs of a business can be categorised as follows:
• (a) Fixed capital requirements :funds are required to purchase fixed assets like land and building, plant and machinery, and furniture and fixtures. This is known as fixed capital requirements of the enterprise.

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• Different business units need varying amount of fixed capital depending on various factors such as the nature of business, etc.
• A trading concern for example, may require small amount of fixed capital as compared to a manufacturing concern.

SOURCES OF BUSINESS FINANCE

• The financial needs:

(b)Working capital requirements: funds required for its day-to-day Operations is known as working capital of an enterprise, which is used for holding current assets such as stock of material, bills receivables and for meeting current expenses like salaries, wages, taxes, and rent.

SOURCES OF BUSINESS FINANCE

SOURCES OF BUSINESS FINANCE

Sources of funds:

long-term sources

medium-term sources

short-term sources.

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Period Basis

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SOURCES OF BUSINESS FINANCE

• Sources of funds:

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Ownership Basis

owner’s funds

borrowed funds

SOURCES OF BUSINESS FINANCE

• Source of funds

Generation Basis

externalsources

Internal sources

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SOURCES OF BUSINESS FINANCE

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• Retained Earnings: A portion of the net earnings may be retained in the business for use in the future. This is known as retained earnings.
• It is a source of internal financing or self -financing or ‘ploughing back of profits’.

SOURCES OF BUSINESS FINANCE

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Merits of retained earning :

(i) Retained earnings is a permanent source of funds available to an organisation;

(ii) It does not involve any explicit cost in the form of interest, dividend or floatation cost;

(iii) As the funds are generated internally, there is a greater degree

of operational freedom and flexibility;

(iv) It enhances the capacity of the business to absorb unexpected

losses;

(v) It may lead to increase in the market price of the equity shares

of a company.

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SOURCES OF BUSINESS FINANCE

• Limitations of Retained earning

(i) Excessive ploughing back may cause dissatisfaction amongst the shareholders as they would get lower dividends;

(ii) It is an uncertain source of funds as the profits of business are fluctuating;

(iii) The opportunity cost associated with these funds is not recognised by many firms. This may lead to sub-optimal use of the funds.

SOURCES OF BUSINESS FINANCE

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• Trade Credit is the credit extended by one trader to another for the purchase of goods and services.

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• Merits

(i) Trade credit is a convenient and continuous source of funds;

(ii) Trade credit may be readily available in case the credit worthiness of the customers is known to the seller;

iii) Trade credit needs to promote the sales of an organisation;

(iv) If an organisation wants to increase its inventory level in order to meet expected rise in the sales volume in the near future, it may use trade credit to, finance the same;

(v) It does not create any charge on the assets of the firm while providing funds.

SOURCES OF BUSINESS FINANCE

• Trade credit Limitations

(i) Availability of easy and flexible trade credit facilities may induce a firm to indulge in overtrading, which may add to the risks of the

firm;

(ii) Only limited amount of funds can be generated through trade credit;

(iii) It is generally a costly source of funds as compared to most other sources of raising money.

SOURCES OF BUSINESS FINANCE

Public Deposits: The deposits that are raised by organisations directly from the public are known as public deposits. Rates of interest offered on public deposits are usually higher than that offered on bank

• Merits

(i) The procedure of obtaining deposits is simple

(ii) Cost of public deposits is generally lower than the cost of borrowings

(iii) Public deposits do not create any charge on the assets of

the company.

(iv) As the depositors do not have voting rights, the control of the

company is not dilute

• Limitations:

(i) New companies generally find it difficult to raise funds through public deposits;

(ii) It is an unreliable source of finance

(iii) Collection of public deposits may prove difficult, particularly when

the size of deposits required is large.

SOURCES OF BUSINESS FINANCE

The capital obtained by issue of shares is known as share capital.

The capital of a company is divided into small units called shares.

The person holding the share is known as shareholder.

There are two types of share (I) Equity share (II) preference share.

SOURCES OF BUSINESS FINANCE

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• a) Equity Share : Equity shares represent the ownership of a company. They have right to vote and right to participate in the management because they are the owner of the company.

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• ADVANTAGES / MERITS of Equity Share :

1. Permanent Capital : Equity share capital is important source of finance for a long term.

2. No charge on assets : For raising funds by issue of equity shares a company does not need to mortgage its assets.

3. Higher returns : Equity share holder get higher returns in the years of high profits.

4. Control : They have right to vote and right to participate in the management.

5. No burden on company : Payment of equity dividend is not compulsory.

SOURCES OF BUSINESS FINANCE

LIMITATIONS / DEMERITS of Equity Share

(i) Investors who want steady income may not prefer equity shares as equity shares get fluctuating returns;

(ii) The cost of equity shares is generally more as compared to the cost of raising funds through other sources;

(iii) Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders;

(iv) More formalities and procedural delays are involved while raising funds through issue of equity share.

SOURCES OF BUSINESS FINANCE

• Preference Shares
• The capital raised by issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential position over equity shareholders in two ways:
• Preference shareholders have a preferential claim (i)over dividend and

(ii) repayment of capital.

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SOURCES OF BUSINESS FINANCE

Types of preference shares :

1. Cumulative preference shares.

2. Non cumulative preference shares.

3. Participating preference shares.

4. Non participating preference shares.

5. Convertible preference shares.

6. Non Convertible preference shares.

SOURCES OF BUSINESS FINANCE

• Merits

(i) Preference shares provide reasonably steady income and safety of investment;

(ii) Preference shares are useful for those investors who want fixed rate of return with comparatively low risk;

(iii) It does not affect the control of equity shareholders over the management as preference shareholders don’t have voting rights;

(iv) Payment of fixed rate of dividend to preference shares may enable a company to declare higher rate of dividend for the equity shareholders in good times;

(v) Preference shareholders have a preferential right of repayment over equity shareholders in the event of liquidation of a company;

(vi) Preference capital does not create any sort of charge against the assets of a company.

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• Limitations

(i) Preference shares are not suitable for those investors who are willing to take risk and are interested in higher returns;

(ii) Preference capital dilutes the claims of equity shareholders over assets of the company;

(iii) The rate of dividend on preference shares is generally higher than the rate of interest on debentures;

(iv) As the dividend on these shares is to be paid only when the company earns profit, , these shares may not be very attractive to the investors;

(v) The dividend paid is not deductible from profits as expense. Thus, there is no tax saving as in the case of interest on loans.

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SOURCES OF BUSINESS FINANCE

Debentures

Debentures are an important instrument for raising long term debt capital. It bear a fixed rate of interest and repayable after a fixed period of time

Debenture holders are creditors of the company.

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Type of Debentures :

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1. Secured Debentures

2. Unsecured Debentures

3. Convertible Debentures.

4. Non Convertible Debentures.

5. Redeemable Debentures.

6. Registered Debentures.

SOURCES OF BUSINESS FINANCE

• Merits of debentures

(i) It is preferred by investors who want fixed income at lesser risk;

(ii) Debentures do not participate in profits of the company;

(iii) The issue of debentures is suitable in the situation when earnings are relatively stable;

(iv) As debentures do not carry voting rights

(v) Financing through debentures is less costly

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• Limitations

(I )There is a greater risk when earnings of the company fluctuate;

(ii) In case of redeemable debentures, the company has to make provisions for repayment even during periods of financial difficulty;

(iii)borrowing capacity of the company reduces.

SOURCES OF BUSINESS FINANCE

COMMERCIAL BANKS :

• Commercial Banks give loan and advances to business in the form of cash credit, overdraft loans and discounting of Bill. Rate of interest on loan is fixed.
• Merits

The merits of raising funds from a commercial bank are as follows:

(i) Banks provide timely financial assistance

(ii) Secrecy of business can be maintained

(iii) less formalities for raising funds

(iv) a flexible source of finance

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• Limitations

(i) Funds are generally available for short periods and its extension or renewal is uncertain and difficult;

(ii) Banks may ask for security of assets and personal sureties. This makes the procedure of obtaining funds slightly difficult

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SOURCES OF BUSINESS FINANCE

FINANCIAL INSTITUTION :

The state and central government have established many financial institutions to provide finance to companies. They are called development Bank.These are IFCI, ICICI, IDBI and LIC, UTI.

• MERITS of FINANCIAL INSTITUTION :

1. Long term Finance : Financial Institution provide long term finance which is not provided by Commercial Bank.

2. Managerial Advice : They provide financial, managerial and technical advice to business firm.

3. Easy installments : Loan can be made in easy installments. It does not prove to be much of a burden on business.

• LIMITATIONS of FINANCIAL INSTITUTION :

1. More time Consuming : The procedure for granting loan is time consuming due to rigid criteria and many formalities.

2. Restrictions : Financial Institution place restrictions on the company’s autonomy of management.

SOURCES OF BUSINESS FINANCE

• GDR : When the local currency shares of a company are delivered to the depository bank, which issues depository receipt against shares, these receipt

denominated in US dollar are called GDRs.

I. Feature of GDR :-

1. GDR can be listed and traded on a stock exchange of any foreign country other than America.

2. It is negotiable instrument.

3. A holder of GDR can convert it into the shares.

4. Holder get dividends.

5. Holder does not have voting rights.

6. Many Indian companies such as Reliance, Wipro

and ICICI have issue GDR.

SOURCES OF BUSINESS FINANCE

ADR : The depository receipt issued by a company in USA are known as ADR s

• Feature of ADR :-
• 1. It can be issued only to American Citizens.
• 2. It can be listed and traded is American stock exchange.
• 3. Indian companies such as Infosys, Reliance issued ADR

SOURCES OF BUSINESS FINANCE

IDRs are like GDR or ADR except that the issuer is a foreign company raising funds from Indian Market.

IDRs are rupee dominated. They can be listed on any

Indian stock Exchange.

• Features of IDRs

1. IDRs are issued by any foreign company

2. The IDRs can be listed on any Indian stock exchange.

3. A single IDR can represent more than one share,

such as one IDR = 10 shares.

4. The holders of IDR have no right to vote in the company.

5. The IDRs are in rupee denomination.