Financing
Content
Wednesday, October 06, 2010
1
SIGNIFICANCE OF FINANCE
It is the life blood of the business It helps the business to carry on its business operations smoothly It is required to acquire fixed assets It determines the scale of production It helps the firm to maintain the flow of production It bridges the gap between production and sales It helps to face recession, trade cycles and other crisis It helps the firm to replace its fixed assets in time It helps to helps the firm to meet its liabilities in time
Wednesday, October 06, 2010 2
Capital requirement for different forms of business
For Sole Trader : Proprietor¶s brings own capital; As the scope of the business is less he is the only source to raise finance. The liability of the proprietor is unlimited For Partnership firm: The capital base of the firm is bigger than that of a sole trader business. Here the risk is shared. For Joint Stock Company: Source for the capital is very much large. Here with the scope of public issue in the form of shares and debentures apart from these joint stock company can go for loans from from banks for short term
plans.
Wednesday, October 06, 2010 3
Sources of Finances of a company
On the basis of Time (period of use)
Long Term Capital Medium Term Capital Short Term Capital
On the basis of purpose of use
Fixed or Permanent Capital Working or Revolving or Circulating Capital
On the basis of sources of finance
External Sources of finance Internal Sources of finance
On the basis of risk
Owned or Risk Capital Borrowed Capital
Wednesday, October 06, 2010 4
On the basis of Time (Period of Use)
As discussed earlier capital is classified into three categories. Long-Term Capital : It is required by the business house for a long period of time. (5 to 20 years). It is essential for permanent investments in capital assets. The sources of long-term finance are as follows:
Issue of Shares Issues of Debentures Long-Term loans from Banks and financial institutions Accepting Public Deposits Ploughing back of profits (or retained earnings)
Wednesday, October 06, 2010 5
Medium Term Capital : It is required by a business house for long period of time I.e from one to five years. This is usually required for Permanent Working Capital Normal Extensions and Replacement of Assets The main sources of medium term capital are
Issues of Preference Shares Issues of Debentures Receiving Public Deposits Loans from Financial Institutions
Wednesday, October 06, 2010
6
Short Term Capital : This is maintained by the business house for a period of less than one year. It is necessary to run the business very smoothly, efficiently and economically. The sources of short term finances are
Trade Credit Bank Overdraft Short Term borrowings from Banks and Financial Institutions Bills of Exchange Customers¶ Advances Borrowings from Subsidiaries Installment Credit Trade Credit Commercial Banks
Loans and Advances Cash Credits Bank Overdrafts Discounting Bills of Exchange Factoring (Accounts Receivable Financing)
Wednesday, October 06, 2010 7
Capital Planning
Cost of promotion Cost of financing Cost of fixed assets Cost of intangible assets Cost of current assets Cost of developing business
Wednesday, October 06, 2010
8
Factors to be considered for devising the capital structure
Nature of business Size of business Cash inflows Cost of raising capital Period of finance Flexibility of capital structure Trading on equity Control of the company Needs of Investors Capital market conditions Legal requirements
9
Wednesday, October 06, 2010
Fixed Capital : It is permanently locked in the Fixed assets of the business for a long period. The amount of fixed capital varies from industry to industry. Thus fixed capital is required for: (I) Establishing a new enterprise (II) Expanding the existing enterprise (III) Diversifying the existing enterprise (IV) Remodeling the present Equipment. Now let us see the factors that determine the amount of fixed capital :
Wednesday, October 06, 2010 10
Factors Determining Fixed Capital
Nature of the Business Size of the business Nature of the products Method of Production Diversity of production Lines Technique of Production Volume of Production Sources of Raising Capital Mode of acquiring fixed assets Intangible Assets
Wednesday, October 06, 2010 11
Working Capital
This is also known as Circulating or Revolving Capital. The equation of working capital is Working Capital = Current Assets ± Current Liabilities Classification of Working Capital
Permanent Working Capital
Temporary Working Capital
Initial
Regular
Seasonal
Special
12
Wednesday, October 06, 2010
Working Capital Cycle
Wednesday, October 06, 2010
13
Importance of Working Capital
Timely Payment of Dues Ensures solvency of business High credit-worthiness Timely payment of dividends Advantage of cash-discounts Meeting daily operational expenses Possibility of acquiring loans Enhancing the morale of the employees Executing special orders Availing better marketing opportunities
Wednesday, October 06, 2010 14
Factors determining the amount of Working Capital
Nature of Business Size of the business Manufacturing cycle Business Cycles Length of processing period Rapidity of Turnover Terms of Purchase and Sale Volume of Production Price level changes Credit policy Growth and expansion policies Operating efficiency Profit margin and profit appropriation Convertibility of current assets into cash Goodwill of the business
Wednesday, October 06, 2010
15
On the basis of Sources of Finance
On the basis of sources of finances capital is classified into two categories. They are :External Sources Internal Sources
Wednesday, October 06, 2010 16
On the basis of Sources of Finance
External Sources : Sources from outside the business. This is of two kinds. They are
Owned Capital Borrowed Capital
Wednesday, October 06, 2010
17
External Sources ± Owned Capital
The capital which is owned by the company is known as owned capital. They are :
New Issue of Equity Shares Right Shares Bonus Shares
Wednesday, October 06, 2010 18
External Sources ± Borrowed Capital
The capital which is borrowed from outsiders by the company is known as owned capital. They are :
Preference Shares Debentures Financial Institutions Others
Wednesday, October 06, 2010
19
Capital ± Several Senses
Authorised or Nominal Capital Issued Capital ± Part of Authorised issued to public Subscribed Capital ± part of the issued which the public apply for purchase Called up Capital ± Part of subscribed which is called up by the company Paid up capital ± part of called up which is paid up by the public Reserve Capital ± uncalled portion of the subscribed capital, which is collected at the time of liquidation Calls in arrear ± part of called up capital which is not paid by the public Calls in advance ± part of the subscribed capital which is not called but paid by the public.
Wednesday, October 06, 2010 20
Capital ± Equity Shares
The investors are treated as owners The degree of risk in investing is very high The investors enjoy voting rights The investors can participate in management The rate of dividend fluctuates with profits The nominal value of shares is generally low The arrears of dividend can not accumulate The shares can not be converted into any form The shares are not redeemable The refund of capital is done after giving preference to preference share holders are paid The dividend is paid after the interest of the preference share holders is attended The investors that invest in these shares are treated as adventurous investors The market value of these shares do fluctuate many times This is also known as Risk Capital.
Wednesday, October 06, 2010
21
Equity Shares ± Merits
Point of View of Share holders Point view of the Company
High Dividends Voting Rights Appreciation in the value of shares High Returns in boom periods Possibility of getting bonus shares High liquidity of invested funds Profitable during inflation
Wednesday, October 06, 2010
Permanent Capital No mortgage of assets No fixed obligation to pay dividend Makes a company financially sound Diffusion of risk Capacity to raise further capital
22
Equity Shares ± Demerits
Point of View of Share holders Point view of the Company
Uncertainty of Earnings High Risk Less preferred by cautious investors Inability to participate in the management Less refund of capital during liquidation No control over dividend
Wednesday, October 06, 2010
High Cost of Finance Danger of Over-Capitalization Danger of manipulation of dividends Manipulation by a powerful group Concentration of power in a few hands
23
Owned Capital ± Bonus Shares
Shares which are issued free of cost to the existing shareholders are called as Bonus shares. Sometimes, when a company is not in a position to pay dividend due to inadequate liquid resources, it can issue bonus shares. Fully paid bonus shares can be issued at par or at a premium. A company can also issue partly paid bonus shares to make uncalled capital being called-up. Issue of bonus shares boosts the image of the company. Bonus shares are also popularly known as Capitalisation of Reserves. The company has got the same obligations to bonus shares, as it has to equity shares. Bonus shares can be issued from the following funds :
Profit and Loss Account (Credit Balance) General Reserve of Reserve Fund Capital Reserves and Profit Share Premium Account Capital Redemption Reserve Account Balance in Sinking Fund for redemption of debentures or other liabilities.
Wednesday, October 06, 2010 24
Owned Capital ± Right Shares
Shares which are issued after the original issue of equity shares are known as Right Shares. These are issued when a public limited company wants to increase its share capital. These are to be issued first to the existing equity share holders on a pro rata basis. When they reject to accept the same these could be offered to non-members. The company has got the same obligation to right shares , as it has to equity shares.
Wednesday, October 06, 2010 25
Owned Capital ± Deferred Shares
These shares participate in the profits of the company only after all the claims of all other shareholders have been met (both equity and preference). These are generally issued to the promoters of the company. That is the reason these are also called as ³Founders Shares´. The denomination of these shares is very low and are purchase by those who want to keep control over the managerial affairs of the company. Deferred shares have voting right which are very significant in controlling the affairs of the company. A public limited company is not supposed to issue these shares. Any how no private companies also are not issuing these shares these days.
Wednesday, October 06, 2010
26
Capital ± External Sources ± Borrowed Capital - Preference Shares
The rate of dividend is fixed The investors do not enjoy voting rights The degree of risk in investing these shares is low The investors are treated as creditors The investors can not participate in the management of the company The nominal value of these shares is generally high The arrears of the may accumulate These shares can be converted into Equity shares At the time of redemption preference share holders are given first importance At the time of payment of dividend preference share holders are given first importance Generally safe players do invest in these shares The market value of these shares do not alter
Wednesday, October 06, 2010 27
Types of Preference Shares Cumulative Non-Cumulative Redeemable Irredeemable Participating Non-participating Convertible Non-convertible
Wednesday, October 06, 2010 28
Preference Shares ± Merits
Point of View of Share holders Point view of the Company
Right to receive dividend Repayment of Capital Fixed Rate of dividend Less Risks Cumulative Dividend Right to be redeemed
Wednesday, October 06, 2010
Capital without charge No loss of control Cheaper modes of finance Cushion to the Debenture Holders Strengthening the financial position Long maturity
29
Preference Shares ± Demerits
Point of View of Share holders Restricted Voting Rights Point view of the Company Permanent Burden
Deprived of Capital Appreciation Deprived of increased rate of dividend Unattractive during boom period
Wednesday, October 06, 2010
Costly method of raising finance Compliance with certain conditions Paves the way for insolvency of the company
30
Transactions - Shares
Forfeiture of Shares Surrender of Shares Transmission of Shares Underwriting of Shares Converting Shares into Stock
Wednesday, October 06, 2010 31
Shares Vs Stock
Basis of Distinction Nominal Value Shares Has a nominal or face value Stock No face value. It can be of any denomination Always fully paid up
Paid-Up
It could be partly paid up or fully paid up Always assigned a distinct number
Distinctive Number
Does not bear a number
Transfer in fraction
Can not be transferred
Can be transferred
Time of issue
Should be issued at the inception of the company Can be offered directly to the public for subscription Can be issued by an unlimited company Has always a fixed denomination
Should not be issued at the time of inception Can not be directly issued to the public Only a limited company can convert its fully paid-up shares into stock Can be of any denomination
32
Direct issue to public
Nature of issuing company
Denomination
Wednesday, October 06, 2010
Equity Shares Vs Preference Shares
Basis of Distinction Rate of Dividend Voting Rights Status of investors Participation in management Nominal value of shares Arrears of dividend Convertibility of shares Redeemability of shares Refund of capital Right to receive dividend Appeal to the investors Market value of shares
Wednesday, October 06, 2010
Equity Shares Fluctuates with profits Enjoy Voting Rights Owners Can participate Generally Low Can not accumulate Not convertible Not redeemable After preference shares are paid After preference shares are paid Adventurous investors Do fluctuate
Preference Shares Fixed rate of dividend Do not enjoy voting rights Creditors Cannot participate Generally High May accumulate May be convertible Redeemable Priority over equity shares Priority over equity shares Conservative investors Do not alter
33
Capital ± External Sources ± Borrowed Capital - Debentures
The nature of investment is it is a borrowed fund The investors are treated as creditors The reward for the investment is the interest The assets are the security for the investment made Debenture holders do not enjoy voting rights The return on investment is fixed Debentures are redeemable after a certain period The risk in investment is low Debenture holders have no control over the affairs of the company Priority is given to debenture holders at the time of payment of interest and liquidation There are no restrictions on issue of debentures Debentures could be converted into equity shares after certain time Payment of interest on debentures is a charge against profit.
Wednesday, October 06, 2010 34
Types of Debentures Registered Unregistered or Bearer Secured or Mortgaged Unsecured or Simple Redeemable Irredeemable Convertible Non-Convertible
Wednesday, October 06, 2010 35
Debentures ± Merits
Point of View of Debenture Holders Point view of the Company
Fixed Returns and better security Stable Prices Safety of Investment Preferred by Cautious Investors
Wednesday, October 06, 2010
Income Tax relief Economy on financing Trading on Equity Flexibility
36
Debentures ± Demerits
Point of View of Share holders No Voting Rights Point view of the Company Permanent Burden of interest
High Unit Price Unattractive terms of issue Unattractive for newinvestors
Wednesday, October 06, 2010
Charge on Assets Reduction in Dividend Heavy Stamp Duty
37
Shares Vs Debentures
Basis of Distinction Nature of investment Shares Owned Capital Debentures Borrowed Fund
Status of Holders
Owners
Creditors
Reward for investment
Dividend
Interest
Security of Investment
No charge on Assets
Charge on Assets
Voting Rights of investors
Wednesday, October 06, 2010
Have voting rights
Do not have voting rights
38
Shares Vs Debentures
Basis of Distinction Return from Investment Shares Fluctuates Not redeemable (except redeemable preference shares) High risk No priority Certain restrictions Not convertible Appropriation of profit Debentures Fixed Redeemable after a certain period Low risk Prior to shareholders No restrictions May be convertible Charge against profit
39
Redemption Risk associated with Investment Priority on refund of capital Restriction on issue Convertibility Charge/Appropriation of Profit
Wednesday, October 06, 2010
Capital ± Internal Sources ± Retained Earnings
The balance of profits after income tax, interest on debentures, payment of dividends and transfer of funds to different Reserves is known as Retained Earnings. When this amount is accumulated for a number of years this is known as Retained Earnings This method of financing a company is also known as ³Self-Financing´.
Wednesday, October 06, 2010
40
Retained Earnings Merits and Demerits
MERITS Interest and Obligation Free Financial Assistance DEMERITS Danger of Over Capitalization
Funds without charge on assets Safe Investment Safety from business cycles
Misuse of funds Indulge in speculation Dissatisfaction among shareholders
Appreciation of value of shares
Convenient source of finance
Wednesday, October 06, 2010 41
Capital ± External Sources ± Public Deposits
These are invited only by Public Limited Companies The minimum period is for 6 months and the maximum period is for 3 years These are an effective way of raising Medium and Short term finance There is no need to go mortgaging of assets to acquire these deposits This is a direct method of channelising the public money into industrial activities This is less expensive compared to other modes of raising finance This is a quick method of current financing These are also known as ³fair weather friends´
Wednesday, October 06, 2010 42
Public Deposits Merits and Demerits
MERITS DEMERITS
Economical source of raising finance No legal formality Higher return to investors Higher distribution of dividend Loans without mortgage of assets No-interference in the management Elasticity in the capital structure
Wednesday, October 06, 2010
Unsuitable for new concerns Possibility of cheating Uncertainty of getting deposits Unsuitable of long-term financing Encouraging speculation Unsecured deposit Loss of credit worthiness
43 Hampering the growth of capital markets
Short Term Capital
This is maintained by the business house for a period of less than one year. It is necessary to run the business very smoothly, efficiently and economically. The sources of short term finances are
Trade Credit Bank Overdraft Short Term borrowings from Financial Institutions Bills of Exchange Customers¶ Advances Borrowings from Subsidiaries Installment Credit Trade Credit
Wednesday, October 06, 2010
Banks
and
44
Short Term Capital
Commercial Banks
Loans and Advances Cash Credits Bank Overdrafts Discounting Bills of Exchange Factoring (Accounts Receivable Financing)
Indigenous Bankers Accrual Accounts Commercial Papers
Wednesday, October 06, 2010 45
Factors to be considered in determining the Capital Structure
Nature of the business Size of the business Cost or raising capital Elasticity of capital structure Control of the company Financial solvency Cash inflows Trading on equity Needs of potential investors Conditions of capital market Legal requirements Period of finance
Wednesday, October 06, 2010 46
1
SIGNIFICANCE OF FINANCE
It is the life blood of the business It helps the business to carry on its business operations smoothly It is required to acquire fixed assets It determines the scale of production It helps the firm to maintain the flow of production It bridges the gap between production and sales It helps to face recession, trade cycles and other crisis It helps the firm to replace its fixed assets in time It helps to helps the firm to meet its liabilities in time
Wednesday, October 06, 2010 2
Capital requirement for different forms of business
For Sole Trader : Proprietor¶s brings own capital; As the scope of the business is less he is the only source to raise finance. The liability of the proprietor is unlimited For Partnership firm: The capital base of the firm is bigger than that of a sole trader business. Here the risk is shared. For Joint Stock Company: Source for the capital is very much large. Here with the scope of public issue in the form of shares and debentures apart from these joint stock company can go for loans from from banks for short term
plans.
Wednesday, October 06, 2010 3
Sources of Finances of a company
On the basis of Time (period of use)
Long Term Capital Medium Term Capital Short Term Capital
On the basis of purpose of use
Fixed or Permanent Capital Working or Revolving or Circulating Capital
On the basis of sources of finance
External Sources of finance Internal Sources of finance
On the basis of risk
Owned or Risk Capital Borrowed Capital
Wednesday, October 06, 2010 4
On the basis of Time (Period of Use)
As discussed earlier capital is classified into three categories. Long-Term Capital : It is required by the business house for a long period of time. (5 to 20 years). It is essential for permanent investments in capital assets. The sources of long-term finance are as follows:
Issue of Shares Issues of Debentures Long-Term loans from Banks and financial institutions Accepting Public Deposits Ploughing back of profits (or retained earnings)
Wednesday, October 06, 2010 5
Medium Term Capital : It is required by a business house for long period of time I.e from one to five years. This is usually required for Permanent Working Capital Normal Extensions and Replacement of Assets The main sources of medium term capital are
Issues of Preference Shares Issues of Debentures Receiving Public Deposits Loans from Financial Institutions
Wednesday, October 06, 2010
6
Short Term Capital : This is maintained by the business house for a period of less than one year. It is necessary to run the business very smoothly, efficiently and economically. The sources of short term finances are
Trade Credit Bank Overdraft Short Term borrowings from Banks and Financial Institutions Bills of Exchange Customers¶ Advances Borrowings from Subsidiaries Installment Credit Trade Credit Commercial Banks
Loans and Advances Cash Credits Bank Overdrafts Discounting Bills of Exchange Factoring (Accounts Receivable Financing)
Wednesday, October 06, 2010 7
Capital Planning
Cost of promotion Cost of financing Cost of fixed assets Cost of intangible assets Cost of current assets Cost of developing business
Wednesday, October 06, 2010
8
Factors to be considered for devising the capital structure
Nature of business Size of business Cash inflows Cost of raising capital Period of finance Flexibility of capital structure Trading on equity Control of the company Needs of Investors Capital market conditions Legal requirements
9
Wednesday, October 06, 2010
Fixed Capital : It is permanently locked in the Fixed assets of the business for a long period. The amount of fixed capital varies from industry to industry. Thus fixed capital is required for: (I) Establishing a new enterprise (II) Expanding the existing enterprise (III) Diversifying the existing enterprise (IV) Remodeling the present Equipment. Now let us see the factors that determine the amount of fixed capital :
Wednesday, October 06, 2010 10
Factors Determining Fixed Capital
Nature of the Business Size of the business Nature of the products Method of Production Diversity of production Lines Technique of Production Volume of Production Sources of Raising Capital Mode of acquiring fixed assets Intangible Assets
Wednesday, October 06, 2010 11
Working Capital
This is also known as Circulating or Revolving Capital. The equation of working capital is Working Capital = Current Assets ± Current Liabilities Classification of Working Capital
Permanent Working Capital
Temporary Working Capital
Initial
Regular
Seasonal
Special
12
Wednesday, October 06, 2010
Working Capital Cycle
Wednesday, October 06, 2010
13
Importance of Working Capital
Timely Payment of Dues Ensures solvency of business High credit-worthiness Timely payment of dividends Advantage of cash-discounts Meeting daily operational expenses Possibility of acquiring loans Enhancing the morale of the employees Executing special orders Availing better marketing opportunities
Wednesday, October 06, 2010 14
Factors determining the amount of Working Capital
Nature of Business Size of the business Manufacturing cycle Business Cycles Length of processing period Rapidity of Turnover Terms of Purchase and Sale Volume of Production Price level changes Credit policy Growth and expansion policies Operating efficiency Profit margin and profit appropriation Convertibility of current assets into cash Goodwill of the business
Wednesday, October 06, 2010
15
On the basis of Sources of Finance
On the basis of sources of finances capital is classified into two categories. They are :External Sources Internal Sources
Wednesday, October 06, 2010 16
On the basis of Sources of Finance
External Sources : Sources from outside the business. This is of two kinds. They are
Owned Capital Borrowed Capital
Wednesday, October 06, 2010
17
External Sources ± Owned Capital
The capital which is owned by the company is known as owned capital. They are :
New Issue of Equity Shares Right Shares Bonus Shares
Wednesday, October 06, 2010 18
External Sources ± Borrowed Capital
The capital which is borrowed from outsiders by the company is known as owned capital. They are :
Preference Shares Debentures Financial Institutions Others
Wednesday, October 06, 2010
19
Capital ± Several Senses
Authorised or Nominal Capital Issued Capital ± Part of Authorised issued to public Subscribed Capital ± part of the issued which the public apply for purchase Called up Capital ± Part of subscribed which is called up by the company Paid up capital ± part of called up which is paid up by the public Reserve Capital ± uncalled portion of the subscribed capital, which is collected at the time of liquidation Calls in arrear ± part of called up capital which is not paid by the public Calls in advance ± part of the subscribed capital which is not called but paid by the public.
Wednesday, October 06, 2010 20
Capital ± Equity Shares
The investors are treated as owners The degree of risk in investing is very high The investors enjoy voting rights The investors can participate in management The rate of dividend fluctuates with profits The nominal value of shares is generally low The arrears of dividend can not accumulate The shares can not be converted into any form The shares are not redeemable The refund of capital is done after giving preference to preference share holders are paid The dividend is paid after the interest of the preference share holders is attended The investors that invest in these shares are treated as adventurous investors The market value of these shares do fluctuate many times This is also known as Risk Capital.
Wednesday, October 06, 2010
21
Equity Shares ± Merits
Point of View of Share holders Point view of the Company
High Dividends Voting Rights Appreciation in the value of shares High Returns in boom periods Possibility of getting bonus shares High liquidity of invested funds Profitable during inflation
Wednesday, October 06, 2010
Permanent Capital No mortgage of assets No fixed obligation to pay dividend Makes a company financially sound Diffusion of risk Capacity to raise further capital
22
Equity Shares ± Demerits
Point of View of Share holders Point view of the Company
Uncertainty of Earnings High Risk Less preferred by cautious investors Inability to participate in the management Less refund of capital during liquidation No control over dividend
Wednesday, October 06, 2010
High Cost of Finance Danger of Over-Capitalization Danger of manipulation of dividends Manipulation by a powerful group Concentration of power in a few hands
23
Owned Capital ± Bonus Shares
Shares which are issued free of cost to the existing shareholders are called as Bonus shares. Sometimes, when a company is not in a position to pay dividend due to inadequate liquid resources, it can issue bonus shares. Fully paid bonus shares can be issued at par or at a premium. A company can also issue partly paid bonus shares to make uncalled capital being called-up. Issue of bonus shares boosts the image of the company. Bonus shares are also popularly known as Capitalisation of Reserves. The company has got the same obligations to bonus shares, as it has to equity shares. Bonus shares can be issued from the following funds :
Profit and Loss Account (Credit Balance) General Reserve of Reserve Fund Capital Reserves and Profit Share Premium Account Capital Redemption Reserve Account Balance in Sinking Fund for redemption of debentures or other liabilities.
Wednesday, October 06, 2010 24
Owned Capital ± Right Shares
Shares which are issued after the original issue of equity shares are known as Right Shares. These are issued when a public limited company wants to increase its share capital. These are to be issued first to the existing equity share holders on a pro rata basis. When they reject to accept the same these could be offered to non-members. The company has got the same obligation to right shares , as it has to equity shares.
Wednesday, October 06, 2010 25
Owned Capital ± Deferred Shares
These shares participate in the profits of the company only after all the claims of all other shareholders have been met (both equity and preference). These are generally issued to the promoters of the company. That is the reason these are also called as ³Founders Shares´. The denomination of these shares is very low and are purchase by those who want to keep control over the managerial affairs of the company. Deferred shares have voting right which are very significant in controlling the affairs of the company. A public limited company is not supposed to issue these shares. Any how no private companies also are not issuing these shares these days.
Wednesday, October 06, 2010
26
Capital ± External Sources ± Borrowed Capital - Preference Shares
The rate of dividend is fixed The investors do not enjoy voting rights The degree of risk in investing these shares is low The investors are treated as creditors The investors can not participate in the management of the company The nominal value of these shares is generally high The arrears of the may accumulate These shares can be converted into Equity shares At the time of redemption preference share holders are given first importance At the time of payment of dividend preference share holders are given first importance Generally safe players do invest in these shares The market value of these shares do not alter
Wednesday, October 06, 2010 27
Types of Preference Shares Cumulative Non-Cumulative Redeemable Irredeemable Participating Non-participating Convertible Non-convertible
Wednesday, October 06, 2010 28
Preference Shares ± Merits
Point of View of Share holders Point view of the Company
Right to receive dividend Repayment of Capital Fixed Rate of dividend Less Risks Cumulative Dividend Right to be redeemed
Wednesday, October 06, 2010
Capital without charge No loss of control Cheaper modes of finance Cushion to the Debenture Holders Strengthening the financial position Long maturity
29
Preference Shares ± Demerits
Point of View of Share holders Restricted Voting Rights Point view of the Company Permanent Burden
Deprived of Capital Appreciation Deprived of increased rate of dividend Unattractive during boom period
Wednesday, October 06, 2010
Costly method of raising finance Compliance with certain conditions Paves the way for insolvency of the company
30
Transactions - Shares
Forfeiture of Shares Surrender of Shares Transmission of Shares Underwriting of Shares Converting Shares into Stock
Wednesday, October 06, 2010 31
Shares Vs Stock
Basis of Distinction Nominal Value Shares Has a nominal or face value Stock No face value. It can be of any denomination Always fully paid up
Paid-Up
It could be partly paid up or fully paid up Always assigned a distinct number
Distinctive Number
Does not bear a number
Transfer in fraction
Can not be transferred
Can be transferred
Time of issue
Should be issued at the inception of the company Can be offered directly to the public for subscription Can be issued by an unlimited company Has always a fixed denomination
Should not be issued at the time of inception Can not be directly issued to the public Only a limited company can convert its fully paid-up shares into stock Can be of any denomination
32
Direct issue to public
Nature of issuing company
Denomination
Wednesday, October 06, 2010
Equity Shares Vs Preference Shares
Basis of Distinction Rate of Dividend Voting Rights Status of investors Participation in management Nominal value of shares Arrears of dividend Convertibility of shares Redeemability of shares Refund of capital Right to receive dividend Appeal to the investors Market value of shares
Wednesday, October 06, 2010
Equity Shares Fluctuates with profits Enjoy Voting Rights Owners Can participate Generally Low Can not accumulate Not convertible Not redeemable After preference shares are paid After preference shares are paid Adventurous investors Do fluctuate
Preference Shares Fixed rate of dividend Do not enjoy voting rights Creditors Cannot participate Generally High May accumulate May be convertible Redeemable Priority over equity shares Priority over equity shares Conservative investors Do not alter
33
Capital ± External Sources ± Borrowed Capital - Debentures
The nature of investment is it is a borrowed fund The investors are treated as creditors The reward for the investment is the interest The assets are the security for the investment made Debenture holders do not enjoy voting rights The return on investment is fixed Debentures are redeemable after a certain period The risk in investment is low Debenture holders have no control over the affairs of the company Priority is given to debenture holders at the time of payment of interest and liquidation There are no restrictions on issue of debentures Debentures could be converted into equity shares after certain time Payment of interest on debentures is a charge against profit.
Wednesday, October 06, 2010 34
Types of Debentures Registered Unregistered or Bearer Secured or Mortgaged Unsecured or Simple Redeemable Irredeemable Convertible Non-Convertible
Wednesday, October 06, 2010 35
Debentures ± Merits
Point of View of Debenture Holders Point view of the Company
Fixed Returns and better security Stable Prices Safety of Investment Preferred by Cautious Investors
Wednesday, October 06, 2010
Income Tax relief Economy on financing Trading on Equity Flexibility
36
Debentures ± Demerits
Point of View of Share holders No Voting Rights Point view of the Company Permanent Burden of interest
High Unit Price Unattractive terms of issue Unattractive for newinvestors
Wednesday, October 06, 2010
Charge on Assets Reduction in Dividend Heavy Stamp Duty
37
Shares Vs Debentures
Basis of Distinction Nature of investment Shares Owned Capital Debentures Borrowed Fund
Status of Holders
Owners
Creditors
Reward for investment
Dividend
Interest
Security of Investment
No charge on Assets
Charge on Assets
Voting Rights of investors
Wednesday, October 06, 2010
Have voting rights
Do not have voting rights
38
Shares Vs Debentures
Basis of Distinction Return from Investment Shares Fluctuates Not redeemable (except redeemable preference shares) High risk No priority Certain restrictions Not convertible Appropriation of profit Debentures Fixed Redeemable after a certain period Low risk Prior to shareholders No restrictions May be convertible Charge against profit
39
Redemption Risk associated with Investment Priority on refund of capital Restriction on issue Convertibility Charge/Appropriation of Profit
Wednesday, October 06, 2010
Capital ± Internal Sources ± Retained Earnings
The balance of profits after income tax, interest on debentures, payment of dividends and transfer of funds to different Reserves is known as Retained Earnings. When this amount is accumulated for a number of years this is known as Retained Earnings This method of financing a company is also known as ³Self-Financing´.
Wednesday, October 06, 2010
40
Retained Earnings Merits and Demerits
MERITS Interest and Obligation Free Financial Assistance DEMERITS Danger of Over Capitalization
Funds without charge on assets Safe Investment Safety from business cycles
Misuse of funds Indulge in speculation Dissatisfaction among shareholders
Appreciation of value of shares
Convenient source of finance
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Capital ± External Sources ± Public Deposits
These are invited only by Public Limited Companies The minimum period is for 6 months and the maximum period is for 3 years These are an effective way of raising Medium and Short term finance There is no need to go mortgaging of assets to acquire these deposits This is a direct method of channelising the public money into industrial activities This is less expensive compared to other modes of raising finance This is a quick method of current financing These are also known as ³fair weather friends´
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Public Deposits Merits and Demerits
MERITS DEMERITS
Economical source of raising finance No legal formality Higher return to investors Higher distribution of dividend Loans without mortgage of assets No-interference in the management Elasticity in the capital structure
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Unsuitable for new concerns Possibility of cheating Uncertainty of getting deposits Unsuitable of long-term financing Encouraging speculation Unsecured deposit Loss of credit worthiness
43 Hampering the growth of capital markets
Short Term Capital
This is maintained by the business house for a period of less than one year. It is necessary to run the business very smoothly, efficiently and economically. The sources of short term finances are
Trade Credit Bank Overdraft Short Term borrowings from Financial Institutions Bills of Exchange Customers¶ Advances Borrowings from Subsidiaries Installment Credit Trade Credit
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Banks
and
44
Short Term Capital
Commercial Banks
Loans and Advances Cash Credits Bank Overdrafts Discounting Bills of Exchange Factoring (Accounts Receivable Financing)
Indigenous Bankers Accrual Accounts Commercial Papers
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Factors to be considered in determining the Capital Structure
Nature of the business Size of the business Cost or raising capital Elasticity of capital structure Control of the company Financial solvency Cash inflows Trading on equity Needs of potential investors Conditions of capital market Legal requirements Period of finance
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