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Sources of Finance
By: Dr. Sandeepa Kaur
Long Term Source of Finance
 Equity Shares
 Features of Equity shares
 Preference shares
 Debentures
Share: Capital of a company is divided into small parts and each
part is known as share.

 In business and finance, a share (also referred to as equity share) of stock

means a share of ownership in a corporation (company).

Features of equity:

 Maturity
 Right to income
 Claim on asset
 Right to control
 Pre-emptive rights
 Limited liability
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Preference Shares
Features

Preferential treatment
Dividend distribution (@ fixed rate)
Distribution of assets on liquidation
Redemption
Usually no voting rights
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Types of preference shares

•Redeemable & Irredeemable preference shares

•Convertible & Nonconvertible preference shares
•Cumulative & Non cumulative preference shares
•Participative & Non participative preference shares
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Debentures
Debentures are bonds given in exchange for a loan to
the company.
Company agrees to repay the borrowed amount at
some date in the future (maturity date), and to make
annual payments of interest until maturity (coupon
payments).
Debenture holders will be paid interest before dividends
are paid to shareholders.
Debenture holders are NOT owners, but they are
Secured Creditors of the company.
This is a form of debt financing.
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Type of Debentures

•Registered Debentures
•Bearer Debentures
•Secured Debentures
•Unsecured Debentures
•Convertible Debentures
•Non-Convertible Debentures
•Redeemable Debentures
•Irredeemable Debentures
+ Basis Shares Debentures

Meaning Share is a part of share Debentures are

in the share capital of a acknowledgment of
company debt issued by a
company

Nature of Owned capital Borrowed capital

Capital

Return Dividend as return on Interest as a return

investment on investment

Position Owner of the company Creditor of the

company
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Risk High Low

Voting Enjoy voting rights Do not enjoy

Right voting rights

Rate of Rate of dividend on equity Rate of interest is

Return share is fluctuating, that is fixed
dividend depends on the
profits made by a
company
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Lease Financing
A lease is a contractual agreement whereby one party i.e., the owner of an
asset grants the other party the right to use the asset in return for a periodic
payment. In other words it is a renting of an asset for some specified
period.
Lessor: The owner of the assets is called the ‘lessor’.
Lessee: Party that uses the assets is known as the ‘lessee’.
Lease rental: The lessee pays a fixed periodic amount called lease rental to
the lessor for the use of the asset. The terms and conditions regulating the
lease arrangements are given in the lease contract. At the end of the lease
period, the asset goes back to the lessor.
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Lease finance provides an important means of modernization and

diversification to the firm. Such type of financing is more prevalent in
the acquisition of such assets as computers and electronic equipment
which become obsolete quicker because of the fast changing
technological developments. While making the leasing decision, the
cost of leasing an asset must be compared with the cost of owning the
same.
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Term loan- Many industrial development banks, cooperative banks
and commercial banks grant medium term loans for a period of three to
five years.
The merits of long-term borrowing from banks are as follows:
 It is a flexible source of finance as loans can be repaid when the
need is met.
 Finance is available for a definite period, hence it is not a
permanent burden.
 Banks keep the financial operations of their clients secret.
 Less time and cost is involved as compared to issue of shares,
debentures etc.
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Syndicated loan
A syndicated loan is offered by a group of lenders who work together
to provide credit to a large borrower. The borrower can be
a corporation, an individual project, or a government. Each lender in
the syndicate contributes part of the loan amount, and they all share in
the lending risk, while one of the lenders will act as the manager
(arranging bank), which administers the loan on behalf of the other
lenders in the syndicate. The syndicate may be a combination of
various types of loans, each with different repayment terms that are
agreed during negotiations between the lenders and the borrower
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Venture Capital
Venture capital is the money provided by investors to startup firms and
small businesses with perceived long-term growth potential. This is a
very important source of funding for startups that do not have access to
capital markets. It typically entails high risk for the investor, but it has
the potential for above-average returns.
Venture capital can also include managerial and technical expertise.
Most venture capital comes from a group of wealthy investors,
investment banks and other financial institutions that pool such
investments or partnerships. This form of raising capital is popular
among new companies or ventures with limited operating history, which
cannot raise funds by issuing debt.
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The venture capital recognizes different stages of financing, namely:-
•Early stage financing - This is the first stage financing when the firm is
undertaking production and need additional funds for selling its products. It
involves seed/ initial finance for supporting a concept or idea of an
entrepreneur. The capital is provided for product development, R and D and
initial marketing.
•Expansion financing - This is the second stage financing for working
capital and expansion of a business. It involves development financing so as
to facilitate the public issue.
•Acquisition/ buyout financing - This later stage involves acquisition
financing in order to acquire another firm for further growth
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Working Capital
Capital needed for day to day operations is known as working
capital. It may be gross working capital or net Working capital.
Gross Working capital is the sum of all current assets while net
working capital is the difference between CA and CL.
+ Determinants of WC
 Nature of business
 Terms of sales and purchases
 Manufacturing cycle
 Rapidity of turnover
 Business cycle
Changes in technology
 Seasonal variation
 Market condition
 Dividend policy
+Sources of Working Capital Finance
Trade credit:
Trade credit is an important external source of working capital financing. It is
a short-term credit extended by suppliers of goods and services in the normal
course of business, to a buyer in order to enhance sales. Trade credit arises
when a supplier of goods or services allows customers to pay for goods and
services at a later date. Cash is not immediately paid and deferral of payment
represents a source of finance.
Features of Trade Credit:
The features of trade credit are given below:
1. There are no formal legal instruments/acknowledgements of debt.
2. It is an internal arrangement between the buyer and seller.
3. It is a spontaneous source of financing.
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4. It is an expensive source of finance, if payment is not made within the
discount period.
Advantages of Trade Credit:
The advantages of trade credits are:
1. It is easy and automatic source of short-term finance.
2. It reduces the capital requirement.
3. It helps the business focus on core activities.
4. It does not require any negotiation or formal agreement.
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Bank Overdraft:
Overdraft is a facility extended by the banks to their current account
holders for a short-period generally a week. A current account holder is
allowed to withdraw from its current deposit account upto a certain
limit over the balance with the bank. The interest is charged only on
the amount actually overdrawn. The overdraft facility is also granted
against securities.
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Cash Credit:
Cash credit is an arrangement whereby the commercial banks allow
borrowing money up to a specified-limit known as 'cash credit limit.' The
cash credit facility is allowed against the security. The cash credit limit
can be revised from time to time according to the value of securities. The
money so drawn can be repaid as and when possible.
The interest is charged on the actual amount drawn during the period
rather on limit sanctioned. The rate of interest charged on both overdraft
and cash credit is relatively higher than the rate of interest given on bank
deposits.
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Discounting Bills of Exchange:
When goods are sold on credit, bills of exchange are generally drawn
for acceptance by the buyers of goods. The bills are generally drawn
for a period of 3 to 6 months. In practice, the writer of the bill,
instead of holding the bill till the date of maturity, prefers to discount
them with commercial banks on payment of a charge known as
discount.
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Letter of credit: A letter from a bank guaranteeing that a buyer's

payment to a seller will be received on time and for the correct
amount. In the event that the buyer is unable to make payment on the
purchase, the bank will be required to cover the full or remaining
amount of the purchase.
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Factoring
Factoring may also be defined as a continuous relationship between
financial institution (the factor) and a business concern selling goods
and/or providing service (the client) to a trade customer on an open
account basis, whereby the factor purchases the client’s book debts
(account receivables) with or without recourse to the client - thereby
controlling the credit extended to the customer and also undertaking to
administer the sales ledgers relevant to the transaction
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+ Commercial Paper

A Commercial Paper is a short term unsecured promissory note issued

by the raiser of debt to the investor
Issued by large corporation:
• must have a tangible net worth of Rs 4 crore or more
• have a sanctioned working capital limit sanctioned
by a bank/FI
• Minimum 2 credit rating from any credit rating agency
Standard maturities:
• 15 days to max. 1 year
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Denominations:
Minimum Rs. 5,00,000 and in multiples thereof
Interest rate:
No coupon payment
Sold at a discount to face value (implied rate of return)

Issued to
•Individuals

•Banking companies

•Corporate bodies

•NRIs

•FIIs
+ Certificate of Deposits

Certificates of deposits (CDs) represent short-term deposits,

which are transferable from one party to another

Issued by
Banks and financial institutions
Standard maturities:
• 3 months to 1 year
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Interest rate:
No coupon payment
CDs are issued at a discount and redeemed at par

Issued to

•banks,

• financial institutions,

• Corporates, and mutual funds Individuals

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International Financing
Commercial Banks: Commercial banks all over the world extend foreign
currency loans for business purposes.

International Agencies and Development Banks: A number of international

agencies and development banks have emerged over the years to finance
international trade and business. These bodies provide long and medium term
loans and grants to promote the development of economically backward areas
in the world. These bodies were set up by the Governments of developed
countries of the world at national, regional and international levels for funding
various projects. The more notable among them include International Finance
Corporation (IFC), EXIM Bank and Asian Development Bank
+ International Capital Markets:
(a) Global Depository Receipts (GDR’s): The local currency shares of a
company are delivered to the depository bank. The depository bank issues
depository receipts against these shares. Such depository receipts
denominated in US dollars are known as Global Depository Receipts
(GDR). GDR is a negotiable instrument and can be traded freely like any
other security. In the Indian context, a GDR is an instrument issued abroad
by an Indian company to raise funds in some foreign currency and is listed
and traded on a foreign stock exchange. A holder of GDR can at any time
convert it into the number of shares it represents. The holders of GDRs do
not carry any voting rights but only dividends and capital appreciation
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American Depository Receipts (ADRs):

The depository receipts issued by a company in the USA are

known as American Depository Receipts. ADRs are bought and
sold in American markets, like regular stocks. It is similar to a
GDR except that it can be issued only to American citizens and
can be listed and traded on a stock exchange of USA.
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Security Financing

 Certain firms need to borrow securities in order to convert their

settlement obligations in the event of failed trades or taking short
positions, or to make advantage of arbitrage and other opportunities.

 Institutions with large portfolios of securities are attractive to

securities securities borrowers. Accordingly global custodians
provides securities lending services, typically with the custodian as
agent matching its clients with approved borrowers.

 The custodian overseas the posting of collateral by the borrower,

collects dividends and other economic benefits for the lender during
the life each loan and shares in the lending fee payable by the
borrower.

 The lender can terminate the loan any time, generally with recall
notice of three business days.
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Loan Financing

 The extension of money from one party to another with the

agreement that the money will be repaid. Nearly all loans (except for
some informal ones) are made at interest, meaning borrowers pay a
certain percentage of the principal amount to the lender as
compensation for borrowing. Most loans also have a maturity date,
by which time the borrower must have repaid the loan.

 A loan may be guaranteed by collateral, meaning that the lender

either keeps an asset belonging to the borrower until the loan is
repaid or has the right to seize such an asset in the event of default.
Often, loans are obtained to purchase a major asset, such as a house.
These loans are generally guaranteed by the asset they are used to
buy. Lending is a foundational component of capitalism.
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Types of Loan Financing

 Uncommitted facilities

 Committed facilities

 Bilateral/syndicated/club

 Term/revolver