Sources of Long-term Finance and their advantages

Sources of Long-Term Finance

The sources of long term finance are as follows:

Long-term finance

Long-term finance – Sources, Merits

1. Shares

An organization can raise long term funds through issue of shares. It is one’s share in the share capital of the company. The share capital contributed by shareholder is not returned to them during the life time of the company. The person holding the share is called a shareholder.

The share holder receives dividend from the company for investing his money in the company. The shares can be classified into equity shares and preference shares.

2. Preference shares

Preference shares are those shares which has got preferential right or privileges to receive fixed rate of dividend. It has also got the privilege to receive repayment of capital.

The preference shareholders have the right to vote only in matters that affect their interest.

Merits of Preference Shares

Following are the merits of raising funds through issue of preference shares.

1. Dividend need not be paid by the company if profits are not earned by the company.

2. Since they have right to vote only on matters affecting their interest, the promoters of the company can only exercise control in the affairs of the company.

3. Preference shareholders receive only fixed rate of dividend. Hence the promoters do not have to share the surplus profit with them if surplus earning are generated by the company.

4. If redeemable shares are issued by the company, then the amount can be repaid as soon as the company gets sufficient funds.

3. Equity Shares

They are also known as ordinary shares. They are the shares which do enjoy any preferential right to receive dividend and repayment of capital. These shares do not have any fixed rate of dividend. The rate of dividend depends on the profit earned by the company.

The holders of equity shares are called equity shareholders. Equity holders can vote at the general meeting of the company. Hence they can exercise control in the affairs of the company. When the company earns good profit, the equity shareholders can get good rate of dividend for the amount invested by them. On the other hand, if the company does not earn profit, then they may not receive dividend.

Merits of Equity Shares

Following are the merits of raising funds through issue of Equity shares.

1. The company need not declare dividend if profits are not earned by the company.

2. The equity share holders do not receive any fixed rate of dividend. Hence, the management can decide about the rate of dividend  based on the profits and expansion of the business.

3. It is a good source of long-term finance as the capital need not be repaid, during the lifetime of the company.

4. Equity share do not create any charge on the assets of the company.

4. Debentures

Debentures create a debt. They are called creditor-ship securities. Debenture is a document issued by the company. It is issued under the seal of the company. It shows that the company has to pay the debt to the holders of the debentures. It carries a fixed rate of interest. It is document of loan.

The company has to pay interest on the debenture at a fixed rate. Similarly, the principal amount has to be repaid by the company on a  fixed date. Debenture may create a charge on the assets.

Merits of Debentures

The following are the merits of raising funds through issue of debentures.

1. It is a good source of long-term finance

2. The company has to pay only fixed rate of interest on dentures, irrespective of profit earned by it.

3. Debentures do not carry any voting rights. Hence the management does not lose control in conducing the affairs of the cmpany.

4. Debentures help in paying less amount of tax as the interest paid on debenture is deducted from the profit.

5. As the repayment of debenture is determined, company can effectively plan its activities.

6. It is the cheapest source of raising long term funds.

5. Public Deposits

Public deposits are the deposits made by individuals in a company. They carry fixed rate of interest. They are deposited by the individuals for a fixed period.

Merits of public deposits

The following are the merits of raising funds through public deposits.

1. It is a cheaper method of raising long term funds as only fixed rate of interest has to be paid by the company to the individuals who have deposited the money.

2. It is least costly when compared to other sources of finance.

3. The individuals who have deposited the money do not interfere in the affairs of the company.

4. It is a good source of finance as the issue of public deposit does not pose very strict legal formalities.

5. It helps the company to trade on equity. It carries fixed rate of interest.

6. Long Term Loans

A loan is a kind of advance provided by a bank on a financial institution. It carries fixed rate of interest, repayment can be made by the organization in installments or at the expiry of certain period. It may be granted for a longer period like 5 years or 10 years etc. It may be secured loan. It created charge on assets.

Merits of Long Term Loans

The following are the merits of raising funds through long term loans.

1. The funds can be utilized for a longer period. Today, many financial institutions are providing long term loans.

2. To boost small scale entrepreneur, a concessional rate of interest is given by banks on financial institution.

3. It is a good source of long-term finance.

4. The company has to pay only fixed rate of interest on long term loans, irrespective of profit earned by it.

7. Ploughing Back of Profits/Retained Earnings

Companies usually do not distribute all the profits to the shareholders. A part of profit in set aside by the company for meeting future expenses. A company by following a conservative dividend policies creates reserves. The utilization of such undistributed profits, is called financing from internal sources.

Merits of Retained earnings

1. It is the internal source of finance.

2. It does not carry any obligation.

3. It helps the business organization to escape from crushing effects-of depression.

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