Long-term Sources of Finance in Financial Management

Long term Sources of Finance

Long-term Financing involves long-term debts and financial obligations on a business which last for a period of more than a year, usually 5 to 10 years. 

Features of Long-term Sources of Finance –

• It involves financing for fixed capital required for investment in fixed Assets
• It is obtained from Capital market
• Longterm sources of finance have a long term impact on the business
• Generally used for financing big projects, expansion plans, increasing production, funding operations

Sources of Finance –

(A) Ownership Capital

• Equity Share Capital
• Preference Share Capital
• Retained Earnings

(B) Borrowed Capital

• Debentures – An acknowledgement in writing of the debt taken by the company carrying a periodic payment of interest at a fixed rate.
• Term Loans – Long-term Loans provided by Government, Financial Institutions(IFCI, SFC, ICICI (Indian), LIC, UTT), International agencies (IDA, IFC, ADB)
• Others – Bonds, Pubic Deposits, Deferred Credit, Leasing and Hire Purchase Finance, Incentive sources, Unsecured borrowings

(a) Share capital – It is the capital raised by a company by issue of shares. It may take two forms –

Equity share capital – It represents the investment made by the owners of the business. They enjoy the rewards and bear the risks of ownership. They are paid dividend only after paying dividend to preference shareholders and after meeting the future investment needs of the organization.

Preference share capital – It represents the investment made by preference shareholders. Preference shareholders as the name suggests enjoy preference over payment of dividend. The dividend paid on these shares is generally at a fixed rate.

(b) Retained Earnings: It represents the earnings not distributed to shareholders. A firm may retain a portion or whole of its profits and utilize it for financing its projects.

(c) Term Loan –Term loans are provided by Financial Institutions and Commercial banks. It represents secured borrowings for financing new projects as well as expansion, modification, renovation schemes.

It may be of two types –

• Rupee term loans – They are given for financing land, building, plant & machinery etc.
• Foreign currency term loan –They are given to meet foreign currency expenses towards import of machinery, equipment and technology.

(d) Debenture Capital

Debenture capital is a financial instrument for raising long term debt capital. A debenture holder is a creditor of the company. A fixed rate of interest is paid on debentures. It may be convertible or Non-convertible.

Non-convertible debentures are straight debt instrument carrying a fixed rate and have a maturity period of 5-9 years. If interest is accumulated it has to be paid by the company by liquidation of its assets. It is an economical method of raising funds. Debenture holders do not have any voting rights and there is no dilution of ownership. They cannot be converted into equity shares.

Convertible debentures are debentures which are convertible wholly or partly into equity shares after a fixed period of time.

(e) Other sources of Finance –

1) Deferred credit

At times suppliers of plant and machinery offer a deferred payment facility under which payment of plant and machinery can be made after a period of time.

2) Incentive Sources

The Government and its agencies may provide financial support or incentives to certain types of promoters for setting up industrial units in certain location.  It may take form of –

• Seed capital assistance
• Capital subsidies
• Tax deferment
• Exemptions

3) Bonds

A Bond is a financial instrument issued by public authorities, credit institutions, companies or government when it borrows money from public or banks at large. The bondholders are paid the principal amount and the interest (coupon rate) at a fixed rate after a stipulated period of time.

4) Miscellaneous sources

– Public borrowings – These are unsecured borrowings from public at large

– Leasing and Hire purchase finance