The amount of long term capital depends upon the scale of business and nature of business. An equity investor is that person or entity who contributes a certain sum to public or private companies for a specific period to obtain financial gains in the form of capital appreciation, dividend payouts, stock value appraisal, etc. Image Guidelines 4. Whenever an organization has accumulated surplus profit, it may distribute the profit among its existing shareholders by providing them bonus shares. Long-term funds are paid back during the lifetime of an organization. Long term finance are capital requirements for a period of more than 1 year. Lessee gets the right to use the asset without buying them. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. However, unlike the sole proprietor or the partner of a firm, the risk of the shareholders in case of insolvency is limited to their capital contribution. The term preference indicates that they rank ahead of the companys ordinary shareholders for the payment of dividends, and have a prior claim on the companys assets if the company is wound up. For example, computer manufacturers who lease out computers provide such services. They can be redeemable, irredeemable, convertible, and non-convertible. (iv) Ownership Dilution If the new shares are issued to the public, it may dilute the ownership and control of the existing shareholders. This got worse as Canberra began to worry . Non-Cumulative Preference Shares Refer to the shares for which dividends are not accumulated over a period of time. Debt financing is beneficial only if the internal rate of return of the concern is greater than its cost of capital; otherwise it adversely affects the shareholders. These are foreign direct investment, foreign portfolio investment and foreign commercial borrowings. The characteristics of debentures are as follows: i. 19 Sources of Long-term Finance 19.1 Introduction As you are aware finance is the life blood of business. (iii) Free from Restrictive Covenants Lease financing is free from restrictive covenants whereas the financial institutions often put a number of restrictions on borrowers, such as, conversion of loan into equity, appoint nominee directors, restrictions on payment of dividend, and so on. (ii) Over-Capitalisation Retained earnings are used for the issue of bonus shares which may result to over-capitalisation without any corresponding increase in its earnings. (iii) Creation of Monopolies Continuous ploughing back of profits over a long time may lead a company to grow into a monopoly. From Managements (Borrowers) Point of View: (a) Yearly interest payment and repayment of principal is obligatory on the part of borrower. These shares do not carry any preferential or special rights in respect of annual dividends and in the repayment of capital at the time of liquidation of the company. Some of the new financial instruments are discussed below: Zero-coupon bonds are purchased at a high discount, known as deep discount, on the face value of the bond. Entire profits may be ploughed back for expansion and development of the company. This includes short-term working capital, fixed assets, and other investments in the long term. An additional disadvantage from borrowers viewpoint is that the loan contracts contain certain restrictive covenants which restrict the managerial freedom. These sources are particularly important for small businesses which may find it difficult to get external finance. 1 min read. The warrant gives a right to the debenture holder to obtain equity shares specified in the warrant after the expiry of a certain period at a price not exceeding the cap price specified in the warrant. Foreign capital is typically seen as a way of filling in gaps between the targeted investment and locally mobilized savings. Carry high risks as these are secured loans, iii. Make the repayment of preference shares possible during the existence of the organization, iii. As the legal owner, it is the lessor (and not the lessee), who will be entitled to claim depreciation on the leased asset. Hence, if the company desires to raise further finance from other sources, it can easily do so by mortgaging its assets. Foreign Capital. Cookies help us provide, protect and improve our products and services. A debenture is a marketable legal contract whereby the company promises to pay, whosoever owns it, a specified rate of interest for a defined period of time and to repay the principal on the specific date of maturity. By using our website, you agree to our use of cookies (. They are employed to finance acquisition of fixed assets and working capital margin. In addition, they can be issued at discount, par, and premium. (vii) No Effect on Debt-Equity Ratio Lease is considered a hidden form of debt because neither the leased asset nor the lease liability is depicted on the balance sheet. Some of the long-term sources of finance are:- 1. (B) Disadvantages or Dangers of Excessive Ploughing Back: (i) Misuse of Retained Earnings It is not necessary that the management may always use the retained earnings to the advantage of shareholders. Some of the long-term sources of finance are:- 1. Most of the new instruments are simply old conventional instruments with some added features. For example, In Haryana, Haryana State Financial Corporation (HFC) and Haryana State Industrial Development Corporation (HSIDC) have been established. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. Make it difficult for an organization to provide security against debentures if an organization has insufficient fixed assets. The value of equity capital is computed by estimating the current market value of everything owned by the company from which the total of all liabilities is subtracted. (d) Sometimes internal accruals as a source of finance are preferred over the other sources due to the financial and taxation position of the companys shareholders. The conversion of detachable warrants into equity shares will have to be made within the time limit notified by the issuing company. Similarly, at the time of liquidation, the whole of preference capital must be paid before any payment is made to equity shareholders. The total value of retained profits in a company can be seen in the equity section of the balance sheet. The rate of interest is high for overdrafts compared to bank loans. Long-term sources are those sources that are required to be Re-paid after 5 years. Rate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. They have mostly securedloans offered by banks against strong collaterals provided by the company in the form of land and building, machinery, and other fixed assets. Interest is paid every year and principal is paid on the date of maturity. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. A debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holders. Trade credit 2. Result in overcapitalization if more than required equity shares are issued. There are two types of shares, namely equity and preference, issued by an organization. 3.3 Break-even analysis. Bonds 7. International Sources. Long term sources of finance are the institutions or agencies or institutions from which finance/ funds can be raised for a long period of time. (iv) Bonus Shares Equity shareholders have a claim on the residual income of the company. (c) They do not dilute the ownership of the company. The fundamental principle of long-term finances is to finance the strategic capital projects of the company or to expand the companys business operations. (iii) Not Bound to Pay Dividend A company is not legally bound to pay dividend to its equity shareholders. The terms loans represent a source of debt capital that is normally obtained by companies from term lending institutions. Sources of Long-term Finance. The advantages of term loans are as follows: ii. (ii) Tax Benefits The lessor is entitled to claim the depreciation of leased asset and thus reduces his tax liability. Under the lease contract, the owner of the asset surrenders the right to use the asset to another party for an agreed period of time for an agreed consideration called the lease rental. In case of sole-proprietary concerns and partnership firms long term funds are generally provided by the owners themselves or by their retained profits. The disadvantages of term loans are as follows: i. Bind an organization to pay interests even in case of loss, ii. Besides asset security, the lender of the term loans imposes other restrictive covenants to the borrower depending upon the nature of the project and the financial condition of the borrowing company. (iv) Excessive Penalties Sometimes, lessee has to pay excessive penalties if he terminates the lease before the expiry of lease period. The companys credit rating also plays a major role in raising funds via long-term or short-term means. Such short-term sources of working capital help in assisting the seasonal fluctuations and short-term liquidity crisis. The value of shares is calculated according to various principles in different capital markets. These various sources are described below. Paying dividend on equity shares is not an obligation for an organization when there is less profit or loss, ii. Financial institutions impose a penalty for defaults on the payment of installment of principal and/or interest. Long-Term Sources of Finance Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. It is a standard clause of the bond contracts and loan agreements. (iv) Flexibility in Fixing the Rentals Lease rentals are fixed in such a way that the lessee is able to pay them from the cash flows generated from his business operations. Therefore, it can be used to finance the capital needs in the normal business routine, and as such depreciation in true academic sense can be deemed as a source of internal finance. The company may either raise funds from the market via IPOIPOAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more or opt for a private investor to take a substantial stake in the company. (vi) Benefit of Maintenance Lessee gets the benefit of maintenance and specialized services provided by the lessor. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. Capital Markets 6. The right of lenders to appoint nominee directors on the board of the borrowing company may further restrict the managerial freedom. It is recorded as expenditure in the accounting system of a firm. Lessee is free to cancel the lease in case of change of technology. Depending on various factors, the period can stretch for more than 5 to 20 years. Debenture holders of an organization arc known as creditors. Release preference shareholders from any fixed liability at the time of liquidation of an organization, iii. Help in maintaining good relation with financial institutions, iii. (v) Convertibility Financial institutions usually insist on the option of converting their loans into equity shares of the company. Internal sources of finance come from inside the business, meanwhile, external sources of finance come from outside the business. The borrowing organization has to submit audited annual accounts report to the lender or financial institution, v. Details of fixed assets purchased from the loan. Generally, equity shares are repaid at the time of winding up of an organization. The main advantage is that it is not been paid immediately or within shorter time duration. The holders of these shares are the legal owners of the company. This may hamper the smooth functioning of an organization at times. The management is free to utilise such capital and is not bound to refund it. As the foreign capital plays a constructive role in a countrys economic development, it has led to a progressive reduction in regulations and restraints that had earlier inhibited the inflow of foreign capital. Characteristics of Loans from Financial Institutions: (i) Maturity Maturity period of term loans provided by Financial Institutions ranges between 6 to 10 years. Long term financing is required for modernization, expansion, diversification and development of business operations. Owner of the asset is called Lessor and the user is called Lessee. Equity Shares 2. They have control over the working of the company. (b) If the purpose for utilization of retained earnings is not clearly stated, it may lead to careless spending of funds. Preference shares are a long-term source of finance for a company. The interest on term loans is a definite obligation that is payable irrespective of the financial condition of the firm. Lease Financing 7. (iii) High Profitability Leasing business is highly profitable to the lessor because the rate of return is more than what the lessor pays on his borrowings. If a company wants to raise money privately, it may approach the major debt investors in the market and borrow from them at higher interest rates. Accounting system of a firm which may find it difficult to get external finance -! Not legally bound to refund it according to various principles in different capital markets companys business operations par., if the company or to expand the companys business operations the option of converting their loans into shares. Expenditure in the equity section of the long-term sources of finance come from outside business. Be paid before any payment is made to equity shareholders have a on. 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