Sources of Long Term Finance

Unit 17

Overview
Equity Capital Internal Accruals Preference Capital Term Loans Debenture Comparative Picture Pattern of Corporate Financing in India

Equity Capital
Some Terms Authorized, Issued, Subscribed, and Paid-up Capital Par Value, Issue Price, Book Value, and Market Value

Internal Accruals
The internal accruals of a firm consist of depreciation charges and retained earnings. Depreciation represents the allocation of capital expenditure to various periods over which the capital expenditure is expected to benefit the firm. Retained earnings are that portion of equity earnings(profit after tax less preference dividend) which are ploughed back in the firm. Because retained earnings are the sacrifice made by equity shareholders, they are referred to as internal equity.

Preference Capital
It represents a hybrid form of financing it partake some characteristics of equity and some attributes of debentures. It resembles equity in the following ways: i. Preference dividend is payable only out of distributable profits ii. Preference dividend is not an obligatory payment and iii. Preference dividend is not a tax-deductible payment.

Cont
Preference capital is similar to debenture in several ways: i. The dividend rate of preference capital is fixed - since preference shares in India usually carry a cumulative feature with respect to dividends, unpaid dividends are carried forward and payable when the dividend is restored ii. The claim of preference shareholders is prior to the claim of equity shareholders and iii. Preference shareholders do not normally enjoy the right to vote iv. Preference capital is typically repayable.

Term Loans
Firms obtain long term debt mainly by raising term loans or issuing debentures. It also referred to as term finance, represent a source of debt finance which is generally repayable in less than 10 years. They are mainly employed to finance acquisition of fixed assets and working capital margin. Term loans differ from short-term bank loans which are employed to finance short-term working capital need and tend to be self-liquidating over a period of time, usually less than one year*.

Debentures
These are a variable alternative to term loans. Akin to promissory notes, debentures are instruments for raising long term debt. Debenture holders are the creditors of company. The obligation of a company towards its debenture holder is similar to that of a borrower who promises to pay interest and principal at specified times. Debenture often provide more flexibility than term loans as they often greater variety of choices with respect to maturity, interest rate, security, repayment, and special features.

Comparative Picture
Dilution of Cost Control Equity capital High Retained earnings High Preference capital High Term loans Debentures Low Low Yes No No No No

Risk Nil Nil

Restraint on Managerial Freedom

No No

Negligible No High High Moderate Some

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