It is usually done for big projects, financing, and company expansion. Internal finance can be appealing for certain types of investments, while in other cases, it may be advantageous to tap external financing. Long-term financing means financing by loan or borrowing for more than one year by issuing equity shares, a form of debt financing, long-term loans, leases, or bonds. As the legal owner, it is the lessor (and not the lessee), who will be entitled to claim depreciation on the leased asset. The amount borrowed is paid back in installments over a predetermined agreed period of time usually 10, 20 or 30 years. The warrant is a traceable negotiable instrument and is listed on stock exchanges. Debentures are offered to the public for subscription in the same way as for issue of equity shares. Long-term financing is a mode of financing that is offered for more than one year. There are other functional differences between the two- bonds carry lower rate of interest and lower risk as compared to debentures, are generally secured by collateral and are paid prior to debentures in case of liquidation. (ii) Over-Capitalisation Retained earnings are used for the issue of bonus shares which may result to over-capitalisation without any corresponding increase in its earnings. For example, computer manufacturers who lease out computers provide such services. 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. Loans from co-operatives 1. The organization pays the dividend on preference shares before paving dividend to equity shareholders. and is accumulated from the capital market. The total value of retained profits in a company can be seen in the equity section of the balance sheet. Sources of Long Term Finance Definition: The Sources of Long Term Finance are those sources from where the funds are raised for a longer period of time, usually more than a year. 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. These various sources are described below. The maturity period of term loans is typically longer, in case of sanctions by financial institutions, in the range of 6-10 years in comparison to 3-5 years of bank advances. Therefore, they can get the right to control the affairs of the company. An organization pays interest on the irredeemable debentures till its existence. This may hamper the smooth functioning of an organization at times. (c) Sometimes, a conservative dividend policy leads to huge accumulation of retained earnings leading to over-capitalization. The characteristics of equity shares are as follows: i. Financial Institutions are another important source of long-term finance. The terms and conditions of such type of loans are not rigid and this provides some sort of flexibility. (Nickels, McHugh, McHugh, N.D.) Long-Term Finance In addition, the lessee is not free to make alterations to the leased asset. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. The board members vote on whether or not new investments should be pursued and the type of financing the company should use. ii. Do not allow an organization to show the dividend paid on these shares on the debit side of profit and loss account. (f) The less debt the company has, the more attractive it is to potential investors and buyers. Loan from Public Financial Institutions 3. Generally, equity shares are repaid at the time of winding up of an organization. In those sources, they are mainly divided in two groups, which are short-term sources of finance and long-term sources of finance. Allow preference shareholders to receive dividends out of profit earned by the organization, iv. Public Deposits 4. It is also referred to as ploughing back of profit. (iv) Excessive Penalties Sometimes, lessee has to pay excessive penalties if he terminates the lease before the expiry of lease period. Result in overcapitalization if more than required equity shares are issued. Long term finance are capital requirements for a period of more than 1 year. The law treats them as shares but they have elements of both equity shares and debt. Sources of Long-term Finance. iii. Do not bind an organization to offer any asset as security to preference shareholders, v. Carry less risk for investors as compared to equity shares. Lease is a contract between the owner of an asset and the user of such asset. To conclude, equity shares are the most convenient and popular source of long-term finance for a company. Help in raising funds from investors who are less likely to take risks, iii. There are different types of SBA loans with varying amounts. The firms that choose to finance through the external sources can retain internal funds to cover the company in an emergency. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. This is one of the important sources of internal financing used for fixed as well as working capital. Term Loans 8. Such debentures provide many options to debenture holders. Long term sources of finance are the institutions or agencies or institutions from which finance/ funds can be raised for a long period of time. Trade Credit Short-Term Finance Short-term finance is an amount of money, which is borrowed, will be repaid in one year. (iii) Increase in Market Value Usually a portion of the profits is ploughed back into the business which results in enhanced earning power of the company and increase in the market value of its shares. ii. The advantages of debentures are as follows: i. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. The profits available for ploughing back in an enterprise depend on factors like net profits, dividend policy and age of the organization. long term finance is required for purchasing fixed assets like land and building, machinery etc.The amount of long term capital depends . Covenant refers to the borrower's promise to the lender, quoted on a formal debt agreement stating the former's obligations and limitations. Serve as a source of long-term capital and are repaid during the lifetime of the organization. It is a source of internal financing which does not affect the working capital of the concern as it does not involve outflow of any cash like other expenses. Share capital or Equity shares Funds required for a business may be classified as long term and short term. vi. 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. 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. Irredeemable Preference Shares Refer to the shares that are not paid during the existence of the organization. 3.6 Efficiency ratio analysis. They carry a fixed interest rate and give the borrower the flexibility to structure the repayment schedule over the tenure of the loan based on the companys. The main characteristics of retained profits are that there is no compulsory maturity like term loans and debentures and they are not characterized by fixed burden of interest or installment payments like borrowed capital. As the name suggests, these shares carry preferential rights over equity shares both regarding the payment of dividend and the return of capital. The interests of the debenture holders are protected by a trustee (generally bank or an insurance company or a firm of attorneys). The warrants attached to it ensure the holder the right to apply and get allotted equity shares; provided the SPN is fully paid. However, they rank behind the companys creditors. A portion of the net profits may be retained in the business for use in the future. (iii) Security Such loans are always secured. 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. These shares are a kind of award for employees for the work rendered by them to organization. The amount of dividend may vary from one financial year to another. The advantages of term loans are as follows: ii. These various sources are described below. On the balance sheet of the company, equity share capital is listed as stockholders equity or owners equity. (ii) Direct Negotiation Terms and conditions of such loans are directly negotiated between the borrower and the financial institution providing the loan. Suppose a company wants to raise money via NCD from the general public. Cumulative Preference Shares Refer to the shares for which dividends get accumulated over a period of time. This is more likely to occur when other companies find it difficult to procure finance from the market whereas an existing concern continues to grow through its retained earnings. A company can also raise funds through issue of preference sharesa special type of share capital. However, there is a notified period after which fully paid FCDs will be automatically and compulsorily converted into shares. Provide no voting rights to debenture holders, ii. Do not consider the term loan providers as the owners of the organization. Lease Financing 7. The ever growing financial requirements of the corporate sector have resulted in an intense competition between them to corner investors funds. Is a loan taken from the public by issuing debentureIssuing DebentureDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. The characteristics of debentures are as follows: i. After studying this lesson, you will be able to: explain the meaning and purpose of long term . When the organization has sufficient profit, the accumulated dividend of these preference shares is paid. Financial Institutions 6. Huge Collection of Essays, Research Papers and Articles on Business Management shared by visitors and users like you. The government of India made several changes in the economic policy of the country in the early 1990s. 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). Debenture holders of an organization arc known as creditors. From investors point of view, equity shares are riskier as there is uncertainty regarding dividend and capital gains. This is particularly important in the case of assets where the income tax laws provide for accelerated depreciation. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange. Increase cost of capital when an organization raises fund from equity shares. The holders of these shares are the legal owners of the company. The rate of interest is high for overdrafts compared to bank loans. In addition, these shares help in motivating employees and increase their productivity. This makes employees feel that they are owners of the organization and motivate them to demonstrate dedication in their work. In return, investors are compensated with an interest income for being a creditor to the issuer.read more certificates under the companys common seal? However, term loan providers are considered as the creditors of the organization. If the holder exercises this option, no interest/premium will be paid on redemption. Long-term sources are those sources that are required to be Re-paid after 5 years. Bonds (debentures) belong to external sources of finance. Equity shares are one of the most important financial instruments to raise long-term funds needed for the incorporation, expansion, and growth of an organization. This led to the deregulation and liberalization of the Indian economy and also increased the flow of foreign capital into the country. They are entitled to dividends after paying the preference dividends. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance. Banks or financial institutions generally give them for more than one year. This method of financing is also known as self-financing or internal financing. Shares are a part of stocks that consist of fixed assets and current assets, which may change at different situations. 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. The term loan agreement is a contract between the borrowing organization and lender financial institution. The common practice in India is the repayment of principal in equal instalments and payment of interest on the outstanding loan. Bearer debenture holders can transfer their debentures without giving any prior information to the organization. (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 funds may be used to finance the cost of acquisition of fixed assets that are needed for expansion, modernization and diversification programmes of the company. 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