Sources of Finance for Company
A Company (Joint Stock Company ) can raise funds from two main sources:
(a) Owned funds, and
(b) Borrowed funds.
Owned funds refer to the funds provided by the owners. In a sole proprietorship, the
proprietor himself provides the owned fund from his personal property. In a partnership
firm, the funds contributed by partners as capital are called owned funds. In a joint
stock company, funds raised through the issue of shares and reinvestment or earnings
are the owned funds.
Borrowed funds refer to the borrowings of a business firm. In a company, borrowed
funds consist of the finance raised from debenture holders, public deposits, financial
institutions and commercial banks. Thus, the various sources of finance may be divided
as shown in Fig. 8.1.
a) Owned funds
Equity shares, preference shares, ploughing back of profits and debentures are generally
used for long-term finance. Public deposits, commercial banks and financial institutions
are the main sources of medium-term and short-term finance.
Equity or Ordinary Shares:
Equity shares carry no preferential rights.
Advantages:
As a source of finance, equity shares offer the following advantages:
1. Permanent Capital:
Equity shareholders provide the permanent funds of a company. There is no obligation
to return the money except at the time of winding up the company.
2. No Obligation as to Dividend:
Equity shares do not impose an obligation to pay a fixed dividend. Dividends are
payable only if the company has adequate profits. Equity shareholders stand by the
company through thick and thin.
3. No Charge on Assets:
For issuing equity shares, the company is not required to mortgage or pledge its assets.
The assets remain free of charge for borrowing money in future.
4. Source of Prestige:
A company with substantial equity capital has a high credit- standing. Creditors readily
lend money to it because they regard equity capital as a safety shield.
5. Small Denomination:
The nominal or face value of an equity share is generally quite low, such as Rs. 10.
Therefore, equity shares have a wide appeal. The company can mobilise huge funds
investors belonging to different income groups.
6. Suitable for Adventurous Investors:
Equity shares are the ideal investment for bold and enterprising investors. They get
handsome dividends and the value of their holdings appreciates during boom periods.
In addition, they enjoy full voting power in the management of the company. They also
have the pre-emptive right to buy new shares. The company has to first offer its new
shares to the existing shareholders in proportion to their existing holdings.
PREFERENCE SHARE
Preference shares, more commonly referred to as preferred stock, are shares of
a company’s stock with dividends that are paid out to shareholders before
common stock dividends are issued. If the company enters bankruptcy, preferred
stockholders are entitled to be paid from company assets before common
stockholders. Most preference shares have a fixed dividend, while common
stocks generally do not. Preferred stock shareholders also typically do not hold
any voting rights, but common shareholders usually do.
RETAINED PROFITS
Retained profit is the amount of a business’s net income that is kept
within its accounts, rather than paid out to shareholders. Retained
profit is a strong indicator of the long-term financial stability of a
business.
b) Borrowed funds
DEBENTURE
A debenture is a type of debt instrument unsecured by collateral. Since debentures have no
collateral backing, debentures must rely on the creditworthiness and reputation of the issuer for
support. Both corporations and governments frequently issue debentures to raise capital or
funds.
PUBLIC DEPOSITS
Public deposits refer to the unsecured deposits invited by companies from the public mainly to
finance working capital needs. A company wishing to invite public deposits makes an
advertisement in the newspapers.
Any member of the public can fill up the prescribed form and deposit the money with the
company. The company in return issues a deposit receipt. This receipt is an acknowledgement of
debt by the company. The terms and conditions of the deposit are printed on the back of the
receipt. The rate of interest on public deposits depends on the period of deposit and reputation
of the company.
A company can invite public deposits for a period of six months to three years. Therefore, public
deposits are primarily a source of short-term finance. However, the deposits can be renewed
from time-to-time. Renewal facility enables companies to use public deposits as medium-term
finance.
Public deposits of a company cannot exceed 25 per cent of its share capital and free reserves.
FINANCIAL INSTITUTIONS AND DEVELOPMENT BANKS
Financial institutions, otherwise known as banking institutions,
are corporations that provide services as intermediaries of financial markets. Broadly speaking,
there are three major types of financial institutions:
Depository institutions – deposit-taking institutions that accept and manage deposits and
make loans, including banks, building societies, credit unions, trust companies, and mortgage
loan companies Contractual institutions – insurance companies and pension funds Investment
institutions – investment banks, underwriters, brokerage firms.
Financial institutions can be distinguished broadly into two categories according to ownership
structure:
Commercial Banks
Cooperative Banks
Development Bank
Development banks are specialized financial institutions. They provide
medium and long-term finance to the industrial and agricultural sector.
They provide finance to both private and public sector. Development
banks are multipurpose financial institutions. They do term lending,
investment in securities and other activities. They even promote saving
and investment habit in the public.
development bank may, thus, be defined as a financial institution
concerned with providing all types of financial assistance (medium as well
as long-term) to business units, in the form of loans, underwriting,
investment and guarantee operations, and promotional activities —
economic development in general, and industrial development, in
particular. “In short, a development bank is a development-oriented bank.”
Working capital requirements are provided by commercial banks, indigenous
bankers, co-operative banks, money lenders, etc. The money market provides
short-term funds which mean working capital requirements.
The long-term requirements of business concerns are provided by industrial
banks and the various long-term lending institutions which are created by the
government. In India, these long-term lending institutions are collectively
referred to as development banks.
They are:
1. Industrial Finance Corporation of India (IFCI), 1948
2. Industrial Credit and Investment Corporation of India (ICICI), 1955
3. Industrial Development of Bank of India (IDBI), 1964
4. State Finance Corporation (SFC), 1951
5. Small Industries Development Bank of India (SIDBI), 1990
6. Export-Import Bank (EXIM)
7. Small Industries Development Corporation (SIDCO)
8. National Bank for Agriculture and Rural Development (NABARD).
In addition to these institutions, there are also institutions such as Life Insurance
Corporation of India, General Insurance Corporation of India, National Housing
Bank, Unit Trust of India, etc., which are providing investment funds.
Development banks in India are classified into the following four groups:
▪ Industrial Development Banks: It includes, for example, Industrial Finance
Corporation of India (IFCI), Industrial Development Bank of India (IDBI), and
Small Industries Development Bank of India (SIDBI).
▪ Agricultural Development Banks: It includes, for example, National Bank for
Agriculture & Rural Development (NABARD).
▪ Export-Import Development Banks: It includes, for example, Export-Import Bank
of India (EXIM Bank).
▪ Housing Development Banks: It includes, for example, the National Housing Bank
(NHB).
Industrial Finance Corporation of India (IFCI) is the first development bank in
India. It started in 1948 to provide finance to medium and large-scale industries
in India.
Bank
A bank is a financial institution that accepts deposits from the public and
creates Demand Deposit.[1] Lending activities can be performed either directly or
indirectly through capital markets.
