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Description of Various Sources of Finance - Part 2

Key Point 5: Equity Shares

  • Explanation:

  • Equity shares represent the ownership of a company.

  • The money raised by selling these shares is called share capital.

  • This share capital is also called ownership capital or owner’s funds.

  • People who buy equity shares are the actual owners and have the right to vote in crucial company decisions.

  • Importance:

  • Equity shareholders receive dividends, which depend on the company’s profits.

  • Equity capital is permanent and is not refunded unless the company is closed.

  • Examples:

  1. If a startup company needs funds, it sells equity shares to the public.
  2. A person buying shares of Tata Motors becomes a part-owner of the company.
  3. Shareholders of Reliance Industries get voting rights in shareholder meetings.
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Key Point 6: Preference Shares

  • Explanation:

    • Preference shares are a special type of share with preferential rights.
    • The money raised from these is called preference share capital.
    • Preference shareholders get a fixed rate of dividend before equity shareholders.
    • At the time of winding up the company, preference shareholders get their money back before equity shareholders.

  • Importance:

    • Preference shares provide a stable source of income.
    • They do not generally carry voting rights on company matters.

  • Examples:

    1. ABC Ltd. issues preference shares with a guaranteed 8% dividend.
    2. If a company earns profit, preference shareholders are paid dividends before equity shareholders.
    3. During company liquidation, preference shareholders are paid back their capital before ordinary shareholders.

Key Point 7: Debentures

  • Explanation:

    • Debentures are instruments used by a company to borrow money.
    • Investors who buy debentures lend money to the company.
    • Debenture holders receive a fixed rate of interest regardless of company profits.

  • Importance:

    • Debentures are attractive to investors seeking regular income.
    • The company must pay interest to debenture holders even if there is no profit.

  • Examples:

    1. A company issues ₹1 crore worth of debentures at 10% interest rate.
    2. A person investing in debentures of NTPC Ltd. receives regular interest payments.
    3. During financial crunches, companies can issue debentures to arrange quick funds.

Key Point 8: Commercial Banks

  • Explanation:

    • Banks provide loans and advances to businesses of all sizes.
    • Methods include cash credits, overdrafts, term loans, purchase or discounting of bills, and letters of credit.

  • Importance:

    • Banks help companies to meet immediate fund requirements.
    • The process of getting a bank loan is often faster than issuing shares or debentures.

  • Examples:

    1. A small manufacturing firm gets a cash credit facility from SBI for raw materials.
    2. A business uses an overdraft facility to pay suppliers when its own account balance is low.
    3. An export company receives a letter of credit from a bank to guarantee payment.

Key Point 9: Financial Institutions

  • Explanation:

    • The government has set up financial institutions to support businesses.
    • These institutions provide both owned capital and loan capital.
    • They mainly focus on long-term and medium-term finance needs.

  • Importance:

    • Financial institutions help in the growth of industries and infrastructure.
    • They offer lower interest rates and special schemes for certain sectors.

  • Examples:

    1. Industrial Development Bank of India (IDBI) provides loans to new industries.
    2. A tech startup receives long-term finance from the Small Industries Development Bank of India (SIDBI).
    3. National Housing Bank gives financial assistance to real estate companies.

Scenario-Based Questions

  1. Scenario: You are managing a tech startup and want to retain complete control over major decisions.
    • Question: Which source of finance would allow you direct ownership and voting rights?
    • Answer: Raising funds through equity shares ensures ownership, allowing you to retain voting rights.
  1. Scenario: Your company needs to pay regular interest to investors even in loss-making years.
    • Question: What source of finance should be chosen?
    • Answer: Issuing debentures, as they require payment of fixed interest regardless of profits.
  1. Scenario: A business needs short-term funds quickly to take advantage of a sudden bulk raw material discount.
    • Question: Which source of finance is most suitable?
    • Answer: Commercial banks, offering facilities like cash credit or overdraft for quick, short-term funding.
  1. Scenario: A manufacturing unit wants funds with a guarantee of fixed dividends before any other pay-outs.
    • Question: Which type of share should it issue?
    • Answer: Preference shares, as they offer fixed dividends to shareholders before equity shareholders.
  1. Scenario: A new industry in the infrastructure sector needs long-term, affordable finance and special assistance.
    • Question: Which source can provide such support?
    • Answer: Financial institutions, since they are set up by the government for industry growth and offer special financial assistance.

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