A debenture is a form of financial instrument that provides long-term debt to an organization. Huge Collection of Essays, Research Papers and Articles on Business Management shared by visitors and users like you. Do not require any security from the organization. Lower debt improves a companys debt capacity and creditworthiness, as well. 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. Long term finance are capital requirements for a period of more than 1 year. The amount of capital decided to be raised from members of the public is divided into units of equal value. What is long-term finance. If an organization raises funds through issuing debentures, it needs to pay a fixed rate of interest at regular intervals. Higher amount of shareholders funds provides higher safety to the lenders. Some of the long-term sources of finance are:- 1. Depending on various factors, the period can stretch for more than 5 to 20 years. Equity Shares 2. Allow debenture holders to receive fixed rate of interest, iii. Entire profits may be ploughed back for expansion and development of the company. Do not allow debenture holders to vote in the official meetings of the organization and influence the decision. These preference shares are issued for a fixed time-period and are paid during existence of the organization. Dividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the companys equity. This can include real estate, patents, works of art, and other assets controlled by the company. Term loans, also referred to as term finance, represent a source of debt finance, which is generally repayable in less than 10 years. These sources are particularly important for small businesses which may find it difficult to get external finance. 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. The rate of dividend on these shares is not fixed and depends upon the availability of divisible profits and the intention of the directors. Firstly, as compared to interest, dividends cannot be deducted from the income of the company while calculating taxes. 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. Here we discuss the two types of external sources of finance: long-term financing (equity, debentures, term loans, preferred stocks, venture capital) and short-term financing (bank overdraft and short-term loans). Investors who desire to invest in safe securities with a regular and fixed income have no attraction for such shares. Debentures are usually secured by a charge on the immovable properties of the company. ii. After studying this lesson, you will be able to: explain the meaning and purpose of long term . 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. A capital profit is taxed when shares are sold, rather than receiving the profits as dividends, which becomes a part of current taxable income. Make it difficult for an organization to provide security against debentures if an organization has insufficient fixed assets. The common practice in India is the repayment of principal in equal instalments and payment of interest on the outstanding loan. 19.2 Objectives. They have voting rights to elect directors of the company and the directors control the business. (vi) Repayment Schedule Such loans have to be repaid according to predetermined schedule. Long-term financial management, often referred to as strategic financial planning or simply financial planning is an investment plan or strategy that is geared toward aiming investments in a direction to promote long-term growth. A list of sources of long term financing looks something like this: Equity shares Term loans differ from short-term 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 a year. However, term loan providers are considered as the creditors of the organization. This includes short-term working capital, fixed assets, and other investments in the long term. The basic characteristics of term loan have been discussed below: The term loans are secured loans. (a) The terms and conditions of term loans are negotiable between borrowers and lenders and as a result, it may sometimes affect the interest of lenders. Prohibited Content 3. Trade Credit This source of finance does not cost the business, as there are no interest charges applied. When companies are considering new investments, they may compare available sources of finance to determine which would be most appropriate for a new endeavor. The decrease in the size of the interest payment is matched by an increase in the size of the principal payment so that the size of the total loan payment remains constant over the maturity period of the loan. The fund is arranged through preference and equity shares and debentures etc. They are issued under the common seal of the company acknowledging the receipt of money. Debentures 5. A company does not generally distribute all its earnings amongst its shareholders as dividends. The rate of interest is high for overdrafts compared to bank loans. The profit reinvested as retained earnings is profit that could have been paid as a dividend. There exists a controversy whether depreciation should be taken as a source of finance. On Tuesday . 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 fundamental principle of long-term finances is to finance the strategic capital projects of the company or to expand the companys business operations. Foreign Capital. Equity capital represents the ownership capital. Long term finance are capital requirements for a period of more than 1 year. 19 Sources of Long-term Finance 19.1 Introduction As you are aware finance is the life blood of business. The volatility of markets is a major factor that should be considered to determine the price of a share in the market at a particular point of time. Allow debenture holders to receive payment before equity and preference shareholders even at the time of liquidation of an organization. Do not allow the interference of creditors, who have provided term loans to the organization, in the internal affairs of the organization. An initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. In return, investors are compensated with an interest income for being a creditor to the issuer.read more certificates under the companys common seal? These units are known as share and the aggregate values of shares are known as share capital of the company. Allow the debenture holders of an organization to transfer bearer debentures to other individuals, v. Increase the liability of an organization. The lessee is free to choose the asset according to his requirements and the lessor is actually the financier. Hence they are unable to exercise effective and real control over the company. The management is free to utilise such capital and is not bound to refund it. For example, a ZCB offered by a financial institution has a face value of Rs.20,000 but will be issued to the subscribers as part of this offer at Rs.11,980. These are also known as preferred stock or preferred shares. Disclaimer 8. Equity and Loans from Government 2. This may hamper the smooth functioning of an organization at times. Lease Financing 7. Borrowing for long-term means that the business does not expect to repay this debt in less than five years. These loans carry at a floating rate of interest and predetermined maturity period. If the holder exercises this option, no interest/premium will be paid on redemption. They do not carry voting rights and are secured against the companys assets. (v) Increase in the Credit Worthiness of the Company Since the company need not depend upon outside sources for its financial needs; it increases the credit worthiness of the company. These low-coupon bonds are issued with call or put provisions. This is one of the important sources of internal financing used for fixed as well as working capital. However, they rank behind the companys creditors. 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. Debentures are one of the frequently used methods by which a company raises long-term funds. However, for obtaining further finance in case of any existing company, the management should, as far as possible, avoid issuing equity shares. After the maturity of the financed the borrower needs to return the financier the real amount with some profit and interest. vi. A term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment. They have control over the working of the company. It is obtained from Capital market. They are a common source of long-term finance. iv. 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) Helpful in Making the Company Self-Dependent Ploughing back of profits makes the company self-dependent because it has not to depend upon outsiders such as banks, financial institutions, debentures etc. Bound an organization to pay interest for term loans, even if the organization is incurring losses, v. Carry high risk because term loans are secured loans and the organization has to repay them even if it is running into losses. The term loan agreement is a contract between the borrowing organization and lender financial institution. Do not allow an organization to show the dividend paid on these shares on the debit side of profit and loss account. Registered debenture holders cannot transfer their debentures without giving prior information to the organization. In case of sole-proprietary concerns and partnership firms long term funds are generally provided by the owners themselves or by their retained profits. iii. 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. Characterize by fluctuations in returns, iii. You are free to use this image on your website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Long-Term Financing (wallstreetmojo.com). There are different vehicles through which long-term and short-term financing is made available. ii. The warrant is a traceable negotiable instrument and is listed on stock exchanges. Debentures normally carry a fixed interest rate and a certain date of maturity. ii. The conversion of detachable warrants into equity shares will have to be made within the time limit notified by the issuing company. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance. (iii) No Real Control over the Company There are a number of shareholders and most of them are scattered and unorganised. A holder of a zero-coupon bond does not receive any coupon or interest payments. Characteristics of Loans from Financial Institutions: (i) Maturity Maturity period of term loans provided by Financial Institutions ranges between 6 to 10 years. Term loans are the types of long-term loans that are raised for the duration of 3 to 10 years from financial institutions. Ploughing Back of Profits 4. 2) Amazon raised $54 million via the IPO route to meet the long-term funding needs of the company in 1997. Registered Debentures Refer to the debentures that are registered in the books of the organization. The sources from which a finance manager can raise long-term funds are discussed below: 1. For this reason, they are also called hybrid financing instruments. 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. Short term 2. They form part of the net worth and directly impact the equity share valuation. In the name of ploughing back of profits, they may declare lower dividends and when the share values fall in the market, they may purchase them at reduced prices. Dividends are paid out of post-tax profits. A portion of the net profits may be retained in the business for use in the future. Later, they may increase the rate of dividend out of past profits and may sell their shares at a profit. These shares are treated as the base for capital formation of the organization. These are the profits the company has kept aside over time to meet the companys future capital needs. They can be redeemable, irredeemable, convertible, and non-convertible. 7 Major Sources of Long -Term Finance Article shared by : ADVERTISEMENTS: This article throws light upon the seven major sources of long-term finance. Provide fixed returns to debenture holders even if there is no profit, iv. You are free to use this image on your website, templates, etc., Please provide us with an attribution link. The value of shares is calculated according to various principles in different capital markets. Bank credit - Loans and advances - Cash credit - Overdraft - Discounting of bills 3. Owner of the asset is called Lessor and the user is called Lessee. Such short-term sources of working capital help in assisting the seasonal fluctuations and short-term liquidity crisis. Non-Cumulative Preference Shares Refer to the shares for which dividends are not accumulated over a period of time. (c) They do not dilute the ownership of the company. Australia concerned over long-term Chinese security presence in Solomon islands. Long term finance can be said as an investment or financing that is bound to be kept continue for a period exceeding one year. Similarly, when the company is wound up, they can exercise their claim on those assets which are left after the payment of all other claims including that of preference shareholders. 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. (ii) Simplicity Borrowing from banks and financial institutions involve time consuming and complicated procedures whereas a leasing contract is simple to negotiate and free from cumbersome procedures. 4 Sources of Long Term Financing 4.1 External sources of finance 4.2 Equity Shares 4.3 Preference Shares 4.4 Debentures and Bonds 4.5 Venture capital 4.6 Term Loans 4.7 Lease financing 5 Internal Sources of finance 5.1 Retained earnings 5.1.1 Advantages of Retained Earnings 5.2 Sale of assets Long Term Financing Needs of a Business Carry high risks as these are secured loans, iii. Investors are attracted to these discounted bonds because of their high return or minimal chance of being called before maturity. vi. There are different types of SBA loans with varying amounts. Irredeemable Debentures Refer to the debentures that are not paid back during the lifetime of an organization. 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. It is recorded as expenditure in the accounting system of a firm. Help in collecting funds at the right time, iv. Depreciation can be a very powerful accounting tool if it is applied with economic wisdom. In an organized sector, there are five specific sources of financing to meet the long-term requirements of a firm: These are discussed in the following paragraphs: Equity shares were earlier known as ordinary shares (or common stock). (f) The less debt the company has, the more attractive it is to potential investors and buyers. (a) They are cheap although they have an opportunity cost, that is, the return they could have obtained elsewhere. The interests of the debenture holders are protected by a trustee (generally bank or an insurance company or a firm of attorneys). These covenants may be in respect of maintaining a minimum current ratio, not to create further charge on assets, not to sell fixed assets without the lenders approval, restrain on taking additional loan, reduction in debt-equity ratio by issuing additional shares etc. They are employed to finance acquisition of fixed assets and working capital margin. A portion of debenture can be converted into equity shares, the second portion may be redeemed after some period, and third portion may be non- convertible and continue to provide interest at the option of the holder. Equity shares offer the following advantages to the company: (i) Permanent Source of Funds Equity capital is a permanent capital, and is available for use as long as the company continues. Debt Capital 9. Whenever an organization has accumulated surplus profit, it may distribute the profit among its existing shareholders by providing them bonus shares. More long-term funds may not benefit the company as it affects the ALM position significantly. Term Loans 8. When the organization has sufficient profit, the accumulated dividend of these preference shares is paid. Such retained earnings may be utilised to fulfil the long-term, medium-term and short-term financial requirements of the firm. Financial Institutions 6. 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. They have unrestricted claim on income and assets of the company and possess all the voting power in the company. Finance is required for a long period also. Foreign Capital. These are called covenants. (ii) Direct Negotiation Terms and conditions of such loans are directly negotiated between the borrower and the financial institution providing the loan. Privacy Policy 9. SBA 7 (a) loans, for example, range from $25,000 . In return, investors are compensated with an interest income for being a creditor to the issuer. Internal finance includes the funds generated within the corporate unit irrespective of the nature of source. Debt capital includes debentures and term loans. Preference shares give preferential rights to their holders in comparison to equity shares. (v) Not Entitled to Tax-Benefits Lessee is not entitled to certain tax benefits like depreciation and investment allowance because he is not the owner of the asset. (iv) Excessive Penalties Sometimes, lessee has to pay excessive penalties if he terminates the lease before the expiry of lease period. (i) Economical Method It is very economical method of financing. (viii) Tax Benefits Lease rentals can be adjusted in such a way that the lessee can reduce his tax liability. 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. (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. This got worse as Canberra began to worry . Make organizations more focused on profitable projects, as they have to pay interests on quarterly, half yearly, and annual basis, vi. In addition, the lessee is not free to make alterations to the leased asset. Funds required for a business may be classified as long term and short term. There are term lending institutions sponsored by governments or reputed banks. Do not provide any voting rights to preference shareholders, iv. Funds raised through these can be paid back over many years. 3.5 Profitability and liquidity ratio analysis. Bonds (debentures) belong to external sources of finance. These funds are normally used for investing in projects that will generate synergies for the company in the future years. The amount of earnings retained within the business has a direct impact on the amount of dividends. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. Long term 2; Basics Long term finance - Funding obtained exceeding three years in duration. The warrants attached to it ensure the holder the right to apply and get allotted equity shares; provided the SPN is fully paid. At the time of liquidation, these shares are paid after paying all the liabilities. In India, financial institutions such as the Industrial Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI), Industrial Credit and Investment Corporation of India (ICICI) or any state level finance corporations like State Finance Corporation (SFC) and commercial banks provide term loans. Internal sources of finance examples There is a lock-in period for SPN during which no interest will be paid for an invested amount. (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. In addition, these shares help in motivating employees and increase their productivity. Cookies help us provide, protect and improve our products and services. The terms loans represent a source of debt capital that is normally obtained by companies from term lending institutions. Earlier all equity shares had equal voting rights. ii. In simple terms, it means giving the asset on hire or rent. Allow the organization to pay interest on a monthly, quarterly, and half yearly basis at a mutually agreed rate, iv. Save an organization from unnecessary interference of preference shareholders as they do not enjoy any voting right, v. Prevent preference shareholders from claiming f or the assets of the organization. Convertible Debentures Refer to the debentures that have right to get converted into the equity shares after a specific period of time. iii. Share capital or Equity shares Sources of Long-Term Finance for a Company, Firm or Business Here, we discuss the top 5 sources of long-term financing, examples, advantages, and disadvantages. Facilitate debenture holders to be paid back during the lifetime of an organization, iv. Help in maintaining good relation with financial institutions, iii. v. Redeemable Preference Shares Refer to the shares that are repaid by the organization. Do not allow preference shareholders to act as real owners of the organization, ii. Long Term Source of Finance - This long term fund is utilized for more than five years. These are foreign direct investment, foreign portfolio investment and foreign commercial borrowings. The government of India made several changes in the economic policy of the country in the early 1990s. Do not consider the term loan providers as the owners of the organization. (iii) Consequences of Default Since the lessee is not the owner of the leased asset, the lessor may take over the possession of the same, in case of default in payment of lease rentals. In this lesson, you will learn about various sources of long term finance and the advantages and disadvantages of each source. Bearer debenture holders can transfer their debentures without giving any prior information to the organization. These are issued for a fixed period of time. (a) The directors of quoted companies occasionally get criticised for restricting the value of dividends and for hoarding too much cash in the business. The organization has to pay dividends on these preference shares at the end of financial year. Internal sources of finance come from inside the business, meanwhile, external sources of finance come from outside the business. (i) Fully Secured The lessors interests are fully secured because he is the owner of the leased asset and can take possession of the asset in case the lessee defaults. Lenders normally lend in proportion to the amount of shareholders funds. iii. Help in raising more funds as they are less risky, ii. 3.4 Final accounts. The advantages and disadvantages of term loans from the lenders and borrowers point of view are discussed below: (a) Term loans are provided by banks and other financial institutions against security because of which the term loans are secured. For availing the benefit of trading on equity, it is essential to issue debentures or preference shares with fixed yields lower than the earning rate of the company. The capital procured by issue of equity shares is a permanent source of funds to the company as it need not be redeemed during the lifetime of the company. iv. It is usually done for big projects, financing, and company expansion. Further, this provision has been incorporated in the corporate laws by section 43(a) (ii) of Companies Act, 2013. The regulators lay down strict regulations for the repayment of interest and principal amounts. On the contrary, the investors who are more ambitious and ready to bear risk in consideration of higher returns prefer these shares. In most of the cases, equity shareholders do not get anything in case of liquidation. Therefore, they can get the right to control the affairs of the company. The borrowing company needs to follow a repayment schedule for paying back the term loan to the financial institution. The profits available for ploughing back in an enterprise depend on factors like net profits, dividend policy and age of the organization. (ii) No Advantage of Trading on Equity If a Company issues only equity shares, it will be deprived of the benefits of trading on equity. Financial institutions established at the state level include State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs). (ii) A Cushion to Absorb the Shocks of the Business A concern with large reserves can easily absorb the shocks of trade cycles and the uncertainty of market. The common sources of financing are capital that is generated by the firm itself and . (i) Right to Control Equity shareholders are the real owners of the company. Expenditure on fixed assets such as plant, machinery, land and buildings are funded by long term finance. For new company recourse to equity share financing is most desirable because the management is under no legal obligation to pay dividends to shareholders and the management can retain its earnings entirely for their investment in the enterprise. Interest is paid every year and principal is paid on the date of maturity. However, the use of internal accruals as opposed to new shares or debentures avoids costs that are associated with fresh issues. 3.3 Break-even analysis. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. This residual income is either directly distributed to them in the form of dividend or indirectly in the form of bonus shares. 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. For example, if an expansion or acquisition is allowed with venture capital, the investor might demand part ownership of the firm, rather than simply a share in the profits, including a say in management. This article is a guide to the Long-Term Financing definition. The holders of these shares are the legal owners of the company. Generally, equity shares are repaid at the time of winding up of an organization.