SOURCES OF FINANCING

INTRODUCTION In our present day economy, finance is defined as the provision of money at the time when it is required. Every enterprise, whether big, medium or small, needs finance to carry on its operation and to achieve its targets. In fact, finance is SO indispensable today that it is rightly said that it is the lifeblood of an enterprise. Without adequate finances, no enterprise can possible accomplish its objectives. Capital required for a business can be classified under two main categories, viz. 1. Fixed Capital, and 2. Working Capital, Every business needs funds for two purposes - for establishment and to carry out its day-today operations. Long-term funds are required to create production facilities through purchases of fixed assets such as plant, machinery, land, building, furniture, etc. The various sources of raising long-term funds include issue of shares, debentures, ploughing back of profits and loans from financial institute etc. The short-term requirement of fund can be met from commercial bank, trade credit. Installment credit, advances, factoring or receivable credit, accruals, deferred income and commercial paper, etc. The various sources of finance have been classified in many ways, such as: 1. According to Period i. Short-term sources, viz., bank credit, customer advances, trade credit, factoring, accruals, commercial paper, etc. ii. A medium-term source, viz., issue of preference shares debentures, bank loans, and public deposits/fixed deposits etc. iii. Long term sources, viz., issue of shares, debenture, ploughing back of profits, loans from specialized financial institutions, etc. 2. According to Ownership i. Owned capital, viz. share capital, retained earnings, profits and surpluses, etc. ii. Borrowed capital such as debentures, bonds, public deposits, loans, etc. 3. According to Source of Finance i. Internet sources such as ploughing back of profits retained earnings, profits, surpluses and depreciation funds, etc. ii. External sources, viz., shares, debentures, public deposits, loans, etc. 4. According to Mode of Financing i. Security was financing or External financing; i.e., financing through raising of corporate securities such as shares, debentures, etc. ii. Internal financing, i.e., financing through retained earnings, capitalization of profits and depreciation of funds, etc. iii. Loan financing through raising of long-term and short term loans. iv. For the sake of convenience, we have discussed the various sources of finance according to the mode of financing in this chapter. 1. SECURITY FINANCING i. Corporate securities can be classified under two categories: ii. Ownership securities or capital stock. iii. Creditorship securities or Debt Capital. LONG TERM KINDS OF LONG TERM OR SHARES Companies issue different types of shares to mop up funds from various investors. Before Companies Act, 1956 public companies used to issue three types of shares i.e., Preference Shares, Ordinary Shares and Deferred Shares. The Companies Act 1956 has limited the type of shares to only two-Preference shares and Equity shares. EQUITY SHARES

Equity shares, also known as ordinary shares or common shares represent the owners capital in a company. The holders of these shares are the real owners of the company. They have a control over the working of the company. Equity shareholders are paid dividend after paying it to the preference shareholders. The rate of dividend on these shares depends upon the profit of the company. They may be paid a higher rate of dividend or they may not get anything. These shareholders take more risk as compare to preference shareholders. Equity capital is paid after meeting all others claim including that of preference shareholders. They take risk both regarding dividend and return of capital. Equity share capital cannot be redeemed during the life-time of the company. CHARACTERISTICS OF EQUITY SHARES Equity shares have a number of features which distinguish them from other shares and securities. These features generally relate to the rights and position of equity shareholders . The following are the most significant features of the equity shares: 1. Maturity. Equity shares provide permanent capital to the company and cannot be redeemed during the life time of the company. Under the Companies Act, 1956, accompany cannot purchase its own shares. Equity share holders can demand refund of their capital only at the time of liquidation of a company. Even at the time of the liquidation, equity capital is paid back after meeting all other prior claims including that of preference shareholders. 2. Claims/right to Income. Equity shareholders have a residual claim on the income of the company. They have a claim on the income left after paying dividend to preference shareholders. The rate of dividend of these shares are not fixed, it depends upon the earning available after paying dividends on preferences share holders. In many cases, they may not get anything if profits are insufficient; or may get even a higher rate of dividend. That is why, equity shares are also known as variable security. Even if the company is left with sufficient profits after meeting all obligations including that all preference shareholder cannot legally force the company to pay dividends to them. The distribution of income as dividend to equity shareholders is left to the discretion of the Board of Directors of the Company under the Companies, 1956. But, even when the residual income is not distributed to equity shareholders by way of cash dividends, they stand to benefit in future by way enhanced earning capacity of the company resulting in higher dividends in future as well as capital appreciation. 3. Claims on Assets. Equity shareholders have residual on ownership of a companys assets, are utilized first to meet the claims of creditors and preference shareholders but everything left, thereafter, belong to the equity shareholders. Thus, equity Shares provide a cushion to absorb losses on liquidation and may, usually, remain unpaid. 4. Right to Control or Voting Rights. Equity shareholders are the real owners of the company. They have voting rights in the meeting of the company and have control over the working of the, company. The control in the case of the company with the Board of directors who are elected by the equity shareholders. Directors are appointed in the Annual General Meeting by majority votes. Each equity share carries one vote and a shareholder has votes equal to the number of equity shares held by him. Hence, equity shareholders exercise an indirect control over the working of the company. But, often, such indirect control is weak and ineffective because of the indifference of most of the shareholders in casting their votes. 5. Pre-emptive Right. To safeguard the interest the equity shareholders are enable them maintain their proportional ownership, section 81 of the Companies Act, 1956 provide that whenever a public limited company proposes to increase its subscribed capital by the allotment of other shares after the expiry of two years from the formation of the company or the expiry of one years from the first allotment of the share of the company, which ever is earlier, such shares must be offered to holders of existing equity shares in proportion, as nearly as circumstances admit, to the capital paid upon these shares to offered to existing shareholders are called Right Shares, and their prior right to such is known as pre-emptive right protects equity shareholders by ensuring that management cannot issue additional

shares to the person of their choice in order to strengthen their control over the company. It protects them from dilution of their financial interest in the company. 6. Limited Liability. Another distinct feature of equity shares is limited liability. Thus, although, equity shareholders are the real owners of the company, their liability is limited to the value of share they have purchased. If a shareholder has already fully paid the share price, he cannot be held liable further for any losses of the company even at the time of liquidation. This enables the equity shareholders to enjoy the ownership of a firm without risking unlimited liability as is the case of sole-proprietorship or partnerships firms. Advantages of Equity Shares i. Equity shares do not create any obligation to pay a fixed rate of dividend, ii. Equity shares can be issued without creating any charge over the assets of the company. iii. It is a permanent source of capital and the company has not to repay it except under liquidation. iv. Equity shareholders are the real owners of the company who have the voting rights. v. In case of profits, equity shareholders are the real gainers by way of increased dividends and appreciation in the value of shares. Disadvantages of Equity Shares i. If only equity shares are issued, the company cannot take the advantage of trading on equity. ii. As equity capital cannot be redeemed, there is a danger of over capitalization. iii. Equity shareholders can put obstacles in management by manipulation and organizing themselves. iv. During Prosper sours period higher dividends have to be paid leading to increase in the value of shares in the market and speculation. v. Investors who desire to invest in safe securities with a fixed income have no attraction for such shares. 2. PREFERENCE SHARES As the name suggests, these shares have certain preferences as compared to other types of shares. These shares are given two preferences. There is a preference for payment of dividend. Whenever the company has distributable profits, the dividend is first paid on preference share capital. Other shareholders are paid dividend only out of the remaining profits, if any. The second preference for these shares is the repayment of capital at the time of liquidation of company. After paying outside creditors, preference share capital is returned. Equity shareholders will be paid only when preference share capital is returned in full. A fixed rate of dividend is paid on preference share capital. Preference shareholders do not have voting rights; so they have no say in the management of the company. However, they can vote if their own interests are affected. Those persons who want their money to fetch a constant rate of return even if the earning is less will prefer to purchase preference shares. Types of Preference Shares Preferences shares are of the following types: a. Cumulative Preference Shares. These shares have a right to claim dividend for those years also for which there are no profits. Whenever there are divisible profits, cumulative preference shares are paid dividend for all the previous years in which dividend could not be declared. b. Non-Cumulative Preference Shares. The holders of these shares have no claim for the arrears of dividend. They are paid a dividend if there are sufficient profits. They cannot claim arrears of dividend in subsequent years. c. Redeemable Preference Shares. Normally, the capital of a company is repaid only at the time of liquidation. Neither the company can return the share capital nor the shareholders can demand its repayment. The company, however, can issue redeemable' preference shares if Articles of Association allow such an issue. d. Irredeemable Preference Shares. Those shares, which cannot be redeemed unless the company is liquidated, are known as irredeemable preference shares.

e. Participating Preference Shares. The holders of these shares participate in the surplus profits of the company. They are firstly paid a fixed rate of dividend and then a reasonable rate of dividend is paid on equity shares. If some profits remain after paying both these dividends, then preference shareholders participate in the surplus profits. The mode for dividing surplus profits between preference and equity shareholders is given in the Articles of Association. f. Non-Participating Preference Shares. The shares on which only a fixed rate of dividend is paid are known as non-participating preference shares. These shares do not carry the additional right of sharing of profits of the company. g. Convertible Preference Shares. The holders of these shares may be given a right to convert their holdings into equity shares after a specific period. These are called convertible preference shares. The right of conversion must be authorized by the Articles of Association. h. Non-Convertible Preference Shares. The shares, which cannot be converted into equity shares, are known as non-convertible preference shares. Features of Preference Shares Preference shares have several features. Some of them are common to all the types of preference shares while other is specific to some of them. The following are the most significant features of preference shares: 1. Maturity. Generally, preference shares resemble equity shares in respect of maturity. These are perpetual (irredeemable) and the company is not required to repay the amount during its life time. It is only the time of liquidation that a company has to repay the preference shareholder after meeting the claim of creditors but before paying back the equity shareholders. However, a company may issue redeemable preferences shares with a limited life after which these are supposed to be retired or paid back. The terms of the issue of preference shares with a limited life after which these are supposed to be retired or paid back. The terms of the issue of preference shares may contain a call feature by which the company may call or buy back the shares at a specific price. 2. Claims on Income. A fixed rate or dividend is payable on preference shares. Preference shareholders have prior claim on income (dividend) over shareholders. Whenever the company has distributable profits, the dividends share capital. Only after payment of stipulated dividend is first paid on preferred stock, the company can pay any dividend to other (equity) shareholders. But like equity shareholders, the holders of preference shares also cannot legally demand payment of dividends or distribution of earnings, as it is the prerogative of the management to decide whether to pay whether to pay dividend or to reinvest its earnings. However, the rate of dividend on preference shares, unlike equity shares, is fixed and they do not have share in the extra earnings of the company. But, a company may issue participating preference shares giving its holders a right to participate in the surplus. 3. Claims on Assets. Preference shares have a preference in the repayment of capital at the time of liquidation of a company. Their claims on assets are superior to those of equity shareholders. In the event of winding up of the company, their claim is to be settled first before making any payment to the equity shareholders. But as they are not the real owners of the company, the preference shareholders, usually, do not have any right in the surplus assets, of the company. 4. Control. Ordinarily, preference shareholders do not have any say in the management or control of the company. However, under section 87 of the Companies Act, 1956, preference shareholders can vote on a resolution which directly affects the rights to be attached to their preference shares. They can also vote on every kind of resolution placed before the meeting of the company if the dividend due on their shares or any part of has remained unpaid. In these situations, their right to vote shall be the same proportion as the paid up preference share capital bears to the total paid up equity capital of the company. 5. Hybrid Form of Security. Preference share capital, in the real sense, represents a hybrid form of securities as it includes some features of equity and other of debt financing. It resembles equity in the sense that (i) payment of dividend is not obligatory; (ii) preference

dividend is payable only out of distributable profits and, (iii) it is not deductible as an expense while tax liability of the company. At the same time, it has certain characteristics for debt financing such as (i) it carries a fixed rate of dividend like interest; (ii)it entitles to the rights to its holder prior to equity shareholders and (iii) it does not provide right to vote. Advantages or Merits of Preference Shares Preference shares provide a number of advantages both to the company as well as investors or shareholders. a. Company's Point of View. The company has the following advantages by issuing the preference shares: i. There is no legal obligation to pay dividend on preference shares. Preference dividend is payable only out of distributable profits at the discretion of the management. Hence, a company does not face a financial burden or legal action if it does not pay dividend. ii. Preference shares provide a long-term capital for the company. iii. There is no liability of the company to redeem preference shares during the life time of the company. Even in case of redeemable preference shares, they have to be redeemed either out of accumulated profits or out of the proceeds of a fresh issue of shares. Further, there are no significant penalties for delaying redemption of preference shares. iv. Redeemable preference shares have the added advantage of repayment of capital whenever there are surplus funds with the company. v. As a fixed rate of dividend is payable on preference shares, these enable a company to adopt trading on equity i.e. to increase rate of earnings on equity shares after paying a lower rate of fixed dividend on preference shares. vi. As preference share capital is generally regarded as part of company's net worth, it enhances the credit worthiness of a firm. vii. Preference shares do not carry voting rights under normal circumstances and hence there is no dilution of control. viii. As no specific assets are pledged against preferred stock, the mortgageale assets of the company are conserved. b. Investor's Shareholder's Point of View. Investors in preference shares enjoy the following advantages: i. It earns a fixed rate of dividend. ii. It is a superior security over equity shares. iii. It provides preferential rights in regard to payment of dividends and repayment of capital at the time of liquidation of the company. Hence, such investors who prefer safety of their capital and want to earn income with greater certainty always prefer to invest in preference shares. iv. Preference shares although carry on voting right, but the holders of such shares can vote on matters directly affecting their rights as well as on all resolutions if the dividend due on their shares is remaining unpaid. Disadvantages of Preference shares In spite of many advantages, preference shares suffer from many shortcomings: a. Company's Point of view. The following are the main disadvantages of preference shares from the company's point of view: i. It is an expensive source of finance as compared to debt because generally the investor's expect a higher rate of dividend on preference shares as compared to the rate of interest on debentures. This is so because of high risk factor as compared to debt. ii. Cumulative preference shares become a permanent burden so far as the payment of dividend is concerned. iii. Although there is no legal obligation of a company to pay dividend on preference shares, but frequent delays or non-payment adversely affect the creditworthiness of the firm.

Preference share dividend is not a deductible expense while calculating tax while interest is a deductible expense. Thus, there is a tax disadvantage to the company. v. In some cases, preference shares carry even the voting right and hence the control and management of the company may be diluted. b. Shareholder' Pointy of View. Investors suffer from the following demerits of preference shares: i. As the preference shareholders, ordinarily, do not have any voting rights, they remain at the mercy of the management for the payment of dividend and redemption of their capital. ii. The rate of dividend on preference shares is usually lower as comported and redemption of their capital. iii. Preference shareholders do not have any charge on the assets of the company while debentures, usually, provide a charge on all the assets of the company. iv. The market prices of preference shares fluctuate much more than that of debentures. 3. DEFERRED SHARES These shares were earlier issued to promoters or founders for services rendered to the company. These shares were known as founders Shares because they were normally issued to founders. These shares ran last so far as payment of dividend and return of capital is concerned. Preference shares and equity shares have priority as to payment of dividend. These shares were generally of a small denomination and the management of the company remained in their hands by virtue of their voting rights. 4. NO PAR STOCK/SHARES No par stock means shares having no face value. The capital of a company issuing such shares is divided into a number of specified shares without any specific denomination. The share certificate of the company simply states the number of shares held by its owner without mentioning any face value. The value of a share can be determined by dividing the real net worth of the company with the total, number of shares of the company. Divided on such shares is paid per share and not as a percentage of fixed nominal value of shares. DEBENTURES OR BONDS A Company may raise long-term finance through public borrowings. These loans are raised by the issue of debentures. A debenture is an acknowledgement of a debt. According to Thomas Evelyn. "A debenture is a document under the company's, seal which provides for the payment of a principal sum and interest thereon at regular intervals, which is usually secured by a fixed or floating charge on the company's property or undertaking and which acknowledges a loan to tire company's property or undertaking and which acknowledges a loan to the company. A debenture-holder is a creditor of the company. A fixed rate of interest Ts paid on debentures. The interest on debentures is a charge on the profit and loss account of the company. When the debentures are secured, they are paid on priority in comparison to all other creditors. * Types of Debentures 1. Simple, Naked or Unsecured Debentures. These debentures are not given any security on assets. They have no priority as compared to other creditors. They are treated along with unsacred creditors at the time of winding up of the company. So, they are just unsecured creditors 2. Secured or Mortgaged Debentures. These debentures are given security on assets of the company. In case of default in the payment of interest or principal amount, debenture holders can sell the assets in order to satisfy their claims. The debentures may be given a floating charge over all assets of company. In this-case debentures are paid in priority to unsecured creditors. The sale proceeds of assets are first applied to pay debentures with a floating charge. 3. Bearer Debentures. These debentures are easily transferable. They are just like negotiable instruments. The debentures are handed over to the purchaser without any registration deed. Anybody purchasing them with a consideration and in good faith becomes the lawful owner of the debentures. The coupons for interest are

iv.

attached to the debentures. The bearer can get interest from the company' bank when it becomes due. 4. Registered Debentures. As compared to bearer debentures, which are transferred by mere delivery, registered debentures require a procedure to be followed for their transfer. Both the transfer and the transferee are expected to sign a transfer voucher. The form is sent to the company along with the registration fees. The name of the purchaser is entered in the register. The coupons for interest are sent only to the persons in whose names the debentures are registered. Every transfer of debenture requires the same transfer procedure to be repeated. 5. Redeemable Debentures. These debentures are to be redeemed on expiry of a certain period. The interest on the debentures is paid periodically but the principal amount is returned after a fixed period. The time for redeeming the debentures is fixed at the time of their issue. 6. Irredeemable Debentures. Such debentures are not redeemable during the lifetime of the company. They are payable either on the winding up of the company or at the time of any default on the part of the company. The company can retain the right to redeem these debentures after giving due notice to the debenture holders. 7. Convertible Debentures. Sometimes convertible debentures are issued by a, company and the debenture holders are given an option to exchange the debentures into equity shares after the lapse of specified period. However, debentures issued at discount can be converted either into the equivalent number of shares (representing the nominal amount of debentures), credited as paid-up in proportion to the cash originally paid on the nominal value of debentures or into the proportionately reduced number of fully paid-up shares. Convertible debentures given an investor the privilege of being a secured creditor of the company and to change his status to that of a shareholder if the returns are lucrative and the company is financially strong. 8. First Debentures and Second Debentures. From the view of priority in the payment of interest and repayment of the principal amount, the debentures may be first debenture or second debentures, etc. The debentures, which have to be paid back first, or who have preference over other debentures in payment of interest or called first debentures and the debentures who rank after these are known as second debentures. 9. Guaranteed debentures. These are debentures or bonds on which the payment of interest and principal of is guaranteed by third parties, generally, banks and Government, etc. 10.Collateral debentures. A Company may issue debentures in fervor of a lender of money, generally the banks and financial institutions, as collateral, i.e., and subsidiary of secondary, security for a loan raised by it. These debentures are called collateral debentures and these become effective only when the company makes default in the repayment of the loan against which these have been issued. Distinguished between Shares and Debentures Shares Debentures

1. A share is a part of owned capital. 2. Shareholders are paid dividend on the shares held by them. 3. The rate of dividend depends upon the amount of divisible profits and policy of the Board of Directors. 4. Dividend on shares is a charge against Profit and Loss appropriation account. 5. Shareholders have voting rights. They have control over the management of the company. They are the owners of the company. 6. Shares are not redeemable (with the exception of redeemable preference shares) during the life of the company. 7. At the time of liquidation of the company, share capital is payable after meeting all outside liabilities.

1. A debenture is a acknowledgment of a debt. 2. Debenture-holders are paid interest on debentures. 3. A fixed rate of interest is paid on debentures irrespective of profit or loss. 4. Interest on debentures is a charge against Profit and Loss account. 5. Debenture-holders are only creditors of the company. They have no say in the company. 6. Debentures can be redeemed after a certain period. 7. Debentures are payable in priority over share capital.

Features of Debentures or Bonds 1. Maturity. Although debentures provide long-term funds to the company, they mature after a specific period. Generally, the debentures are to be repaid at a definite time as stipulated as the issue. The company must pay back the principal amount on these debentures on the given date otherwise the debenture holders may force winding up the company as creditors. However, a company may issue irredeemable or perpetual bonds or debentures which have no maturity date. The effect of issuing the irredeemable debentures is that they do not have any fixed time limit within which the company must pay back the principal amount of debentures and hence the holders cannot compel the company to pay them. But, it does not mean that the company cannot redeem these debentures. In that sense, all debentures are redeemable or mature at time or the other. The various methods of redemption of debentures have been discussed separately under the heading of Extinction of Bonded Indebtedness in this very chapter. 2. Claims on Income. A fixed rate of interest is payable on debentures. Unlike shares, a company has a legal obligation to pay the interest on due dates irrespective of level of earnings. Even if a company makes no earnings or incurs loss, it is under an obligation to pay interest to its debenture holders. The default in payment of interest may cause winding up the company because the debentures holders may recourse to law for the same. In any case, bond holders have priority of claim on income of the company over equity and preference shareholders. 3. Claims on Assets. Even a respect of claim on assets, debenture holders have priority of claim on assets on the company. They have to pay first making any payment to the preference of equity shareholders in the event of liquidation of the company. However, they have a claim on principal amount and interest due only and do not have any shares in the surplus assets of the company, if any. 4. Control. Since, debenture holders are creditors of the company and not its owners, they do not have any control of the management of the company. They do not have any voting rights to elect the directors of the company or on any matters. But, at the time of liquidation of the company they have prior claim over shareholders and if remain unpaid, they may take control over the company. 5. Call Features. Issue of debentures sometimes provides a call feature which entitles the company to redeem its debentures at a certain time before the maturity date.

Since, the call feature provides advantages to the company at the expense of its debenture holders; the call price is usually mare than the issue price. Importance of Debentures as a Source of Finance Debentures or bonds have a great significance in the financial plan of a company. The use of such creditor ship securities along with ownership securities in financing of a company generally tends to reduce the cost of capital and consequently helps to improve the earnings of the shareholder. The importance of debentures or bonds as a source of corporate finance can be evaluated from the following advantages and limitations. Advantages of Debentures Debentures offer number of advantages both to the company as well as investors. These are discussed as below: a. Advantages to the Company. The company has the following main advantages of using debentures of using Debentures and bonds as a source of finance. 1. Debentures provide long-term funds to a company. 2. The rate of interest payable on Debentures is, usually, lower than the rate of dividend paid on shares. 3. The interest on Debentures is a tax-deductible expense and hence the effective cost of debentures (debt-capital) is lower as compared to ownership securities where dividend is not a tax-deductible expense. 4. Debt financing does not result into dilution of control because debentureholders do not have any voting rights. 5. A Company can trade on equity by mixing debentures in its capital structure and thereby increase its earnings per share. 6. Many companies prefer issue of debentures because of the fixed rate of interest attached to them irrespective of the changes in price levels. 7. Debentures provide flexibility in the capital structure of a company as the same can be redeemed as and when the company has surplus funds and desires to do so. 8. Even during depression, when stock market sentiment is very low, a company may be able to raise funds through issue of debentures or bonds because of certainty of income and low risk to investors. b. Advantages to Investors. It is not only the company but also the investors who are benefited by investing in Debentures or bonds. The following are the main advantages from the point of view of investors: 1. Debentures provide a fixed, regular and stable source of income to its investors. 2. It is comparatively a safer investment because debentureholders have either a specific or a floating charge on all the assets of the company and enjoy the status of a superior creditor in the event of liquidation of the company. 3. Many investors prefer debentures because of a definite maturity period. 4. A debenture is usually more liquid investment and an investor can sell or mortgage his instrument to obtain loans from financial institutions. 5. The interest of debentureholders is protected by various provisions of the debenture trust deed and the guidelines issued by the Securities and Exchange Board of India in this regard. Disadvantages of Debenture Finance In spite of many advantages, debenture financing suffers from certain limitations. The following are the major disadvantages of debentures: a. From the Point of View of Company. A accompany suffers from the following disadvantages of debt-financing: 1. The fixed interest charges and repayment of principal amount on maturity are legal obligations of the company. These have to be paid even when there are no profits. Hence, it is a permanent burden on the company. Default in these payments, adversely affects the credit-worthiness of the firm and even may lead to winding up of the company.

2. Charge on the assets of the company and other protective measures provided to investors by the issue of debentures usually restrict a company from using this source of finance. A Company cannot raise further loans against the security of assets already mortgaged to debentureholders. 3. The use of debt financing usually increases the risk perception of investors in the firm. This enhanced financial risk increases the cost of equity capital. 4. Cost of raising finance through debentures is also high because of high stamp duty. 5. A company whose expected future earnings are not stable or who deals in products with highly elastic demand or who does not have sufficient fixed assets to offer as security to debentureholders cannot use this source of raising funds to' its benefit. b. From the Point of View of Investors. Many investors do not find debentures or bonds as an attractive investment because of the following: 1. Debentures do not carry any voting rights and hence its holders do not have any controlling power over the management of the company. 2. Debentureholders are merely creditors and not the owners of the company. They do not have any claim on the surplus assets and profit of the company beyond the fixed interest and their principal amount. 3. Interest on debentures is fully taxable while shareholders may avoid tax by way of stock dividend (bonus shares) in place of cash dividend. 4. The prices of debentures in the market fluctuate with the changes in the interest rates. 5. Uncertainly about redemption also restricts certain investors from investing in such securities. TERM LOANS In addition to the raising of funds by means of share capital, debentures public deposits and internal financing, firms may also raise term loans for meeting their medium-term and long*term financial needs. Medium-term loans are for periods ranging from one to five years and long-term loans are granted for periods beyond five years. A term loan is granted on the basis of a formal agreement between the borrower and the lending institution. The major advantage of a term loan is that it is for a fixed period and is to be paid back out of the cash generations from "the operations. Term loans do not cause dilution of control, as lending institutions do not have the right to vote. Another advantage of term loan financing is savings in income tax as interest on term loans is a deductible expense under income tax. However, term loan is deductible expense under income tax. However, term loan agreements, usually, carry restrictive convenience, which may reduce managerial freedom. Term loans also increase the financial risk of the firm. In our country there are two major sources of term lending, (a) specialized financial institutions or development banks; and (b) commercial banks. A. Specialized financial institutions or development banks These specialized financial institutions are also called Development Banks because they provide not only finances but also help in promotion of new enterprises. These institutions have to play a very significant role in the industrial development of our country for the following reasons: A. absence of organized capital markets, B. lack of entrepreneurial talent, C. low capital formation, D. Shyness of capital, i.e., people prefers to invest only in traditional areas and are reluctant to take risk in new ventures. E. inadequacy of financial facilities to meet huge requirements of funds for industrial development, and F. Planned economic development to achieve the socio-economic objectives. At present there are four such institutions at the national level i.e., the Industrial Finance Corporation on India (IFCI), Industrial Development Bank of India (IDBI), Industrial Credit and

Investment Corporation of India (ICICI), and Industrial Reconstruction Corporation of India (IRCI). In addition, there are 19 State Financial Corporations (SFCs) and 24 State Industrial Development Investment Corporations. There are many advantages of raising loans from the specialized financial institutions, such as: A. Availability of finance for development schemes. B. Reasonable security requirements. C. Availability of finance during periods of depression. D. Easy repayment facility. E. Underwriting facility. Example: Small industries development bank of India (SIDBI) The Small Industries Development Bank of India (SIDBI) was set up in 1990 under the SIDBI Act, 1990. The main objective of SIDBI has been to work as a principal financial institution for the promotion, financing and development of industries in the small-scale sector. It is also expected to co-ordinate the functions of various financial institutions, such as, State Financial Corporations, Small-Scale Industries Development Corporations, Scheduled Banks and State Co-operative Banks, etc., engaged in the financing, promotion and development of small-scale industries. Resources The financial resources at SIDBI mainly comprise contribution from the Industrial Development Bank of India (IDBI) in the form of share capital and loans, funds of Reserve Bank of India, loans from the Government of India and market borrowings. The authorized capital of SIDBI is Rs.250 crores which may increase to Rs.1000 crores. Working The Small Industries Banks of India began its operations in 1990 by taking over the activities of IDBI relating to small industrial sector. Since, that it has been providing very useful service to the small-scale industries. The other specialized financial institutions where generally providing institutions were generally providing assistance only to the big industrial units and hence SIDBI has fill this gap very well. However, there is a need to further provide assistance to this sector. B. Term financing by commercial banks Commercial banks normally concentrate on providing short-term financial assistance to industrial sector. The working capital needs of industrial enterprises were met. A massive investment in industries during second plan and after changed the priority of bank lending. The industrial sector required huge funds for long-term financing. The financial institutions could not cope with this demand. The commercial banks came into the picture for filling the gap between demand and supply of long-term requirements. The banks started giving them loans to meet long-term needs of the industry. The commercial banks are assisting industrial units by granting term-loans, subscribing to shares and debentures for corporate units and underwriting securities issued of these companies. 1. Term Lending. The term lending activities of commercial banks can be traced to Second Plan period when Government of India encouraged it. It set up a Refinance Corporation for Industry Ltd., in 1958 with a facility to refinance loans by commercial banks. This facility was available for approved terms only. In 1964, industrial Development Bank of India was set up and Refinance Corporation was merged with it. The IDBI sanctioned Rs.20.5 crores to commercial banks under refinance scheme in 1964-65. This scheme does not attract banks in the next ten years and the amount sanctioned under this scheme came at a low of 2.8 crores in 1972-73. This scheme was liberalized and banks started taking interest in it. Since 1975-76 the sanctions under this scheme have been rising with the exceptions in one or two years. The ceiling on outstanding refinance able loans was raised from Rs.2 crores to Rs.5 crores for new projects and units undertaking expansion or diversification.

2. Underwriting the Capital Issues. The entry of commercial banks in underwriting business has given a fillip to the capital market. Banks were undertaking this work on adhoc basis earlier. They use to enter this business when there was boom in the market and demand for securities was high. After the entry of ICIC1 in underwriting work, banks have also take up on regular basis. The banks try to play very safe in selecting the securities to be underwritten. Instead of evaluating the viability of the project they look at the financial position of the concern and the reputation of the promoters. The amount of securities underwritten by commercial banks has been varying period from period. 3. Subscribing to Shares and Debentures. Commercial banks are also providing financial assistance to industrial units by subscribing directly to there securities. Banks are given freedom to invest in corporate shares and debentures through the primary market to the extent of five percent of the previous year's incremental deposits. The investments in equities/bonds issued by all India Financial Institution and PSU bonds remained outside the ceiling. MUTUAL FUNDS Mutual funds started in England during 19th Century. These funds could not succeed due to highly speculative nature. Mutual funds started in USA during 1990 but they picked up only after 1924 when a number of such funds were started. After world war II mutual funds expanded rapidly. In India first mutual fund started in 1964 when Unit Trust of India was established to mop up savings of small investors and channelize them into productive avenues. UTI brought out a number of schemes are those who prefer safe and steady returns and those who prefer safe and steady returns and those who prefer high growth. UTI has brought schemes for nonresident Indians too for mopping up their resources. The Government of India amended Banking Regulation Act to enable commercial banks to launch funds in India, A number of commercial banks have started mutual funds to mop up savings of every section of society. Canara Bank formed Canbark Mutual Funds with the objective of housing investment expertise under a single roof for the benefit of investors. It started to close-ended schemes Canstock and Canshare in 1987. The object of these schemes was a long-term capital appreciation by adopting flexible and pragmatic investments strategies. Canstock was to raise Rs.50 crores though the scrip's of Rs.100 each. The objective is to secure regular income and growth. An investor in this scheme is assured of a minimum interest rate of 12.5 percent. There is a provision of re-purchase after the expiry of one year at a price periodically. Can share is also a close-end fund raising Rs.50 crores through canshares of Rs 100 each. This is purely growth scheme. The capital gains from the scrip's are re-invested. The Trustees may declare reasonable dividend before re-investment. These shares are listed at stock exchanges for ensuring liquidity. The State Bank of India has also launched a mutual fund called SB1 Mutual Funds in 1987. The first scheme launched was known as 'Magnum Regular Income' Scheme while .another scheme was named 'Magnum Monthly Income Scheme', It has also introduced 'Magnum Tax Savings Scheme' with a tax benefit under section 80 CC and 'Magnum Regular Income with 12 percent minimum assured rate of return per annum. Indian Banks established a mutual fund called Indian Bank Mutual .Fund in 1990. It floated schemes such as Swarana Pusha'p; Ind Ratna; Ind 88A; Ind .Jyoti; Swarana Jyoti is a close ended monthly income and growth scheme assuring a minimum return of 12.68 percent per annum. Ind Ratna also a close-end growth scheme with a loyalty dividend for redemption with a buy back facility after one year. Ind 88A is tax saving growth scheme. In Jyoti is closed end annual income and growth scheme assuring a minimum return of 12.75 percent per annum. Punjab National Bank also set up a mutual fund called PNB Mutual Fund in 1990. It has floated a PNB Regular Income Plus Scheme. It is a closed end income and growth

scheme with a minimum return. of 12.5 percent per annum. It has a buy back facility after one year. Bank of India introduced Rising Monthly Income Scheme with varying rate of return between 12% to 13.5/- over a period of 5 years and also assuring the doubling amount after this period. LIC Mutual Fund was set up in 1989 by LIC. It has introduced open-ended schemes such as Dhanraksha, 1989; Dhanyridhi; Dhansahayog and Dhanvidya. The close-ended schemes include Dhanshree, 1989; Dhan 80CCB; Dhansamridhi, Dhan Tax Saver, 1995 etc. GIC Mutual Fund was set up in 1990. It has launched schemes like GIC SAFE; GIC RISE. The first scheme is insurance-cum-income plan with regular income of 12 percent per annum and a buy back facility after one year. The second scheme allows the rising of income from 13 to 14 percent per annum or cumulative bonus increasing original investment by 4 times on maturity at the end of 10 years. LEASING: MEANING Leasing is an arrangement that provides a firm with the use and control over assets without buying and owning the same. It is a form of renting assets. Lead is a contract between the owner of the asset (lessor) and the user of the asset called the lessee, whereby the lessor gives the right to use the asset to the leassee over an agreed period of time for a consideration called the. lease rental. The lease contract is regulated by the terms and conditions of the agreement. The lessee pays the lease rent periodically to the lessor as regular fixed payments over a period of time. The rentals may be payable at the beginning or end of a month, quarter, half-year or year. The lease rentals can also be agreed both in terms of amount and timing as per the profits and cash flow position of the lessee. At the expiry of the lease period, the asset reverts back to the lessor who is the legal owner of the asset. However, in long-term lease contracts, the lessee is generally given an option to buy or renew the lease. ' In the words Of Miller, M.H. and C.W. Upton, "Leasing separates ownership and use as two economic activities, and facilitates asset use without ownership". TYPES OF LEASING There are two basic kinds of leases: 1. Operating or Service Lease 2. Financial Lease 1. Operating or Service Lease An operating lease is usually characterized by the following features: 1. It is a short-term lease on a period basis. The lease period in such a contract is less than the useful life of the asset. 2. The lease is usually cancelable at short-notice by the lessee. 3. As the period of an operating lease is less than the useful life of the asset, it does not necessarily amortize the original cost of the asset. The lessor has to make further leases or sell the asset to recover his cost of investment and expected rate of return. 4. The lessee usually has the option of renewing the lease after the expiry of lease period. 5. The lessor is generally responsible for maintenance, insurance and taxes of the asset. He may also provide other services to the lessee. 6. As it is a short-term cancelable lease, it implies higher risk to the lessor but higher lease rentals to the lessee. Operating or service leasing is common to the equipments, which require expert technical staff for maintenance and are exposed to technological developments, i.e.; computers, vehicles, data processing equipments, communication systems, etc. 2. Financial Lease A lease is classified as financial lease if it ensures the lessor for amortization of the entire cost of investment plus the expected return on capital outlay during the term of the lease. Such a lease is usually for a longer period and non-cancellable. As a-source of funds, the financial lease is an alternative similar to debt-financing. Most of the leases in India are financial leases that are commonly used for leasing land, building, machinery and fixed

equipments, etc. A financial lease is usually characterized by the following features: 1. The present value of the total lease rentals payable during the period of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset. It implies that within the lease period, the lessor recovers his investment in the asset along with an acceptable rate of return. 2. As compared to operating lease, a financial lease is for a longer period of time. 3. It is usually non-cancellable by the lessee prior to its expiration date. 4. The lessee is generally responsible for the maintenance, insurance and service of the asset. However, the terms of lease arrangement, in some cases, may require the lessor to maintain and service the asset. Such an arrangement is called 'maintenance or gross lease'. But usually in an operating lease, it is the lessee who has to pay for maintenance and service costs and such a lease is known as 'net lease'. 5. A financial lease usually provides the lessee an option -of renewing the lease for further period at a nominal rent. Forms of Financial Lease The following are the important kinds of financial lease arrangements: 1. Sale and Leaseback. A sale and leaseback arrangement involves the sale of an asset already owned by a firm (vendor) and leasing of the same asset back to the vendor from the buyer. This form of lease arrangement enables a firm to receive cash from the sale of asset and also retain the economic use of the asset in consideration of periodic lease payments. A sale and leaseback arrangement is generally preferred by firms facing shortage of working capital funds. The lessors engaged in sale and lease back include insurance companies, leasing companies, pension funds, private finance companies and financial institutions. 2. Direct Leasing. In contrast with sale and leaseback, under direct leasing a firm acquires the use of an asset that it does not already own. A direct lease may be arranged either from the manufacturer supplier directly or through the leasing company. In the first case, the manufacturer/supplier himself acts as the lessor while in the second case the lessee firm arranges the purchase of the asset for the leasing company (lessor) from the manufacturer or the supplier and also enters into an agreement with the lessor for the lease of the asset. 3. Leveraged Lease. A leveraged lease is an arrangement under which the lessor borrows funds, for purchasing the asset, from a third party called lender, which is usually a back or finance, company. The loan is usually secured by the mortgage of the asset and the lease rentals to be received from the lessee. The loan is paid back out of the lease rentals, may be directly by the lessee by paying only the excess amounts to the lessor. The lessor acts as the owner as well as the borrower and the lender is usually a bank, insurance company, financial institution or a private financing company. 4. Straight Lease and Modified Lease. Straight lease requires the lessee firm to pay lease rentals over the expected service life of the asset and does not provide for any modifications to the terms and conditions of the basic lease. Modified lease, on the other hand, provides several options to the lease during the lease period. For example, the option of terminating the lease may be providing by either purchasing the asset or returning the same. 5. Primary and Secondary Lease (Front-ended and Back-ended Lease) Under primary and secondary lease, the lease rentals are charged in such a manner that the lesser recovers the cost of the asset and acceptable profit during the initial period of the lease and then a secondary lease is provided at nominal rentals. In simple words, the rentals charged in the primary period are much more than that of the secondary period. This form of lease arrangement is also known as front-ended and back-ended lease. Public Deposits Acceptance of fixed deposits from the public by all type of manufacturing and non-bank financial companies in the private sector has been a unique feature of Indian financial system The important of such deposits in financing of Indian industries was recognised as early as in 1931 by the Indian Central Bank Enquiry Committee.

Inspite of the fact that public deposits are unsecured, more risky, and less liquid and without any tax advantage, there has been a tremendous growth both in the amount of public deposits as well in the number of companies accepting such deposits. The number of people making investment in public deposits has also increased manifold. Advantages of raising funds through public deposits from the company's point of view as below: a. It is less costly method for raising short and medium term funds for meeting working capital requirements. The post tax cost of public deposits is also fairly reasonable. b. The procedure for raising funds through public deposits is more simple, more / convenient and less bothersome. c. As there is no need of creation of any charge on the assets of the company^ for raising funds through public deposits the companys mortgageale assets are conserved. d. A company can take advantage of trading on equity as 'the maturity period of deposits and the rates of interest are fixed. e. A company can avail this source of finance even when other sources of finance are not available to it because of margin money or other Govt, regulations. Limitations of public deposits from the company's point of view: The quantum of funds that can be raised through public deposits is limited to a maximum of 35 percent of paid up capital and free reserves (25 percent from general public and 10 percent from shareholders, directors, etc.) as per the provisions of the Companies (Acceptance of Deposits) Rules. The maturity period of public deposits is very short. Raising funds through public deposits is not a reliable and definite source of finance. Only companies enjoying good reputation can attract public deposits. The Govt, has restricted the growth of public deposits through imposing ceilings on rates of interest, rates of brokerage and the amounts of deposits. 2. Investor's Point of View. It is not only the company, which is benefited from public deposits, the investors also find certain advantages in public deposits. We can evaluate the advantages of public deposits from the investor's point of view in terms of rates of interest and the maturity period. Rate of Interest. The rates of interest payable on public deposits are usually higher than the alternative sources of safer investments such as banks, post offices, etc. Inspite of the ceiling on maximum rate of interest, it is still fairly reasonable. Although, income from interest on public deposits is taxable. Govt. Regulation on Public Deposits In exercise of the powers conferred by Sec. 58A of the Companies Act, the Govt, of India had framed the Companies (Acceptance of Deposits) Rules, 1975 for governing invitation and acceptance of deposits by companies from public. These rules have undergone certain amendments from time to time. The important features of Govt, regulation on public deposits by non-banking corporate sector are as follows: 1. Ceiling on Deposits. The limits up to which deposits can be accepted by the company are: a. .25% of the aggregate of the paid up capital and free reserves of the company from the general public. b. 10% of the aggregate of the paid up capital and free reserves as against unsecured debentures, or any deposits from its shareholders or any deposits guaranteed by its directors. While arriving at the aggregate of he paid up share capital and free reserves of the company, the amount of accumulated balance of loss, the balance of deferred revenue expenditure and other intangible assets, if any, shall be deducted. 2. Maturity of Deposits. The maximum deposits period allowed for public deposits in 36 months and the minimum period of 3 months is allowed for deposits amounting to 10 percent of share capita! and free reserves for meeting short-term requirements.

3. Form and Particulars of Advertisement. Every company intending to invite deposits shall issue an advertisement for the purpose in leading English newspapers and in one vernacular newspaper circulating in the state at which the registered office .of the company is situated. Such advertisement is issued on the authority and in the name of Board of Directors of the company. It should provide details regarding the name of the company, date of its incorporation, business carried on by the company, management of the company, particulars of directors, profitability of the company, etc. A declaration to the effect that on the day of advertisement, the has no overdue deposits other than unclaimed deposits at that the companies has complied with the provisions of the Companies (Acceptance of Deposits) Rules. It should further declare that the compliance with the rules does not imply that repayments of deposits are guaranteed by the Central Govt. It should clearly mention that the deposits accepted by the company are unsecured and rank pari passu with other unsecured liabilities. 4. Form of Application for Deposits. No company can accept or renew any deposit unless an application is made by intending depositor and such application should contain a declaration by such persons to the effect that the amount is not being deposited out of funds acquired by him by borrowings or accepting deposits from any person. 5. Furnishings of Recipients to Depositors. Every company accepting or renewing deposits is required to furnish to the depositors or agent, a receipt for the amount received by the company. 6. Register of Deposits. A company accepting deposits shall keep at its registered office one or more registers containing details of the deposits as to name, address of the depositor date and amount of such deposits, duration of deposits, maturity date, rate of interest, the dates on which interest shall be paid, etc. 7. Interest on Deposits. The maximum rate of interest which may allowed for accepting deposits by a company cannot at present exceed 15 percent per annum on quarterly rest. However, the company usually allow different rates of interest on deposits depending upon the tenure of deposits. * 8. Ceiling or brokerage. Companies may employ the services brokers, managers and consultants for mobilizing deposits. However, the brokerage or commission on deposits cannot exceed the prescribed limits, which has been, usually, one percent of such deposits. 9. Repayment of Deposits. Once a deposit is accepted for certain period, the company cannot repay the same before the expiry of six months. 10. Maintenance of Liquid Assets. A company which has public deposits or invest by a 30th day of April every year, an amount which shall not be less than 10 percent Of the amount of deposits maturing by 31s1 March of the following year. The amount so shall not be utilized for any purpose other than the repayment of the deposits. 11. Return of Deposits. Every company inviting deposits from the public to which these rules apply, shall file with the Registrar of the Companies a return in the prescribed form duly certified by the auditors of the company. The return has to be filled on or before 30th June everyyear and should contain information as on 31s' March of that year. A. SHORT-TERM LOANS AND CREDITS The short-term loans and credits are raised by a firm for meeting its working capital requirements. These are generally for a short period not exceeding the accounting period, i.e., one year. The main sources of short-term funds are as follows: I. Indigenous Bankers II. Trade Credit III. Installment Credit IV. Advances V. Accounts Receivable Credit or Factoring VI. Accrued Expenses VII. Deferred Incomes VIII. Commercial Paper

IX. X.

Commercial Banks Public Deposits

1. Indigenous Bankers Private money - leaders and other country bankers used to be the only sources of finance prior to the establishment of commercial banks. Now-a-days with the development of commercial banks they have lose their monopoly. But even today, some business houses have to depend upon indigenous bankers for obtaining loans to meet their working capital requirements. 2. Trade Credit Trade credit refers to the extended by the suppliers of goods in the normal course of business. As present day commerce is built upon credit, the trade credit arrangement of a firm with its suppliers is an important source of short-term finance. The main advantages of trade credit as a source of short-term finance include: 1. It is easy and convenient method of finance, 2. It is flexible as the credit increases with the growth of the firm, 3. It is informal and spontaneous source of finance. However the biggest disadvantage of this method of finance is charging of higher prices by the suppliers and loss of cash discount 3. Installment Credit This is another method by which the assets are purchased and the procession of goods is taken immediately but the payment is made in installment over predetermined period of time. Generally, interest is charged on the unpaid price or it may be adjusted in the price. But, in any case, it provides funds for sometimes and is used as a source of short-term working capital by many business houses, which have difficult funds position. 4. Advances Some business houses get advances from their customers and agents against orders and this source is a short-term sources of finance Tor them. It is a cheap source of finance and in order to minimise their investment in working capital, some firms having long production cycle, especially the firms manufacturing industrial products prefer to take advance from their customers. 5. Factoring or Accounts Receivable Credit Another method of raising short-term finance is through account receivable credit offered by commercial banks and factors. A commercial bank may provide finance by discounting the bills or invoices of its customers" Thus, a firm gets immediate payment for sales made on credit. A factor is a financial institution, which offers services relating to management and financing of debts arising out of credit sales. 6. Accrued Expenses Accrued expenses are the expenses which have been not yet due and hence not yet paid also. These simply represent a liability that a firm has t6 pay for the services already received by it. The most important items of accruals are wages and salaries, interest, and taxes. Wages and salaries are usually paid on monthly. 7. Deferred Incomes Deferred incomes are incomes received in advance before supplying goods or services. They represent funds received by a firm for which it has to supply goods or services in future. These funds increase the liquidity, of a firm and constitute an important source of short-term finance. However, firms having great demand for its products and services, and those having good reputation in the market can demand deferred incomes. 8. Commercial Paper Commercial paper represents unsecured promissory notes issued by firms to raise shortterm funds. It is an important money market instrument in advanced countries like U.S.A. In India, the Reserve Bank of India introduced commercial paper in the Indian money market on the recommendations of the Working group on money market (Vaghul Committee). But only large companies enjoying high credit rating and sound financial health can issue commercial paper to raise short-term funds.

9. Commercial Banks Commercial banks are the most important source of short-term capital. The major portion of working capital loans are provided by commercial banks. They provide a wide variety of loans tailored to meet the specific requirements of a concern, the different forms in which the banks normally provide loans and advances are as follows: A. Loans B. Cash Credits C. Overdrafts D. Purchasing and discounting of bills. a. Loans When a bank makes an advance in lump-sum against some security it is called a loan. In case of a loan, a specified amount is sanctioned by the bank to the customer. The entire loan amount is paid to the borrower either in cash or by credit to his account. The borrower is required to pay interest on the entire amount of the loan from the date of sanction. A loan m repayable in lump sum or installments. b. Cash Credits A cash credit is an arrangement by which a bank allows his customer to borrow money upto a certain limit against some tangible securities or guarantees. The customer can withdraw from his cash credit limit according to his need and he can also deposit any surplus amount with him. The interest in case of cash credit is charged on the daily balance and not on the entire amount of the account. For these reasons, it is the most favorite mode of borrowing by industrial and commercial concerns. c. Overdrafts Overdraft means an agreement with a bank by which a current account-holder is allowed to withdraw more than the balance to his credit upto a certain limit. There are no restrictions for operation of overdraft limit. The interest is charged on daily overdrawn balances. The main difference between cash credit and overdraft on daily overdrawn balances is that overdraft is allowed for a short period and is a temporary accommodation whereas the cash credit is allowed for a longer period. Overdraft accounts can either be clean overdrafts, partly secured or fully secured. d. Purchasing and discounting of bills Purchasing and discounting of bills is the most important from in which a bank lends without any collateral security. Present day commence is built upon credit. The seller draws a bill of exchange on the buyer of goods on credit. Such a bill may be either a clean bill or a documentary bill, which is accompanied by documents of title to goods such as a railway receipt. The bank purchases the bill payable on demand and credits the customer's account with the amount of bills less discount. A*t the maturity of the bills, bank presents the bill to be accepting for payment. 10. Public Deposits Acceptance of fixed deposits from the public by all type of manufacturing and non-bank financial companies in the private sector has been a unique feature of Indian financial system. The important of such deposits in financing of Indian industries was recognised as early as in 1931 by the Indian Central Bank Enquiry Committee. Inspire of the fact that public deposits are unsecured, more risky, less liquid and without any tax advantage, there has been a tremendous growth both in the amount of public deposits as well in the number of companies accepting such deposits. The number of people making investment in public deposits has also increased manifold. Advantages of raising funds through public deposits from the company's point of view as below: I. It is less costly method for raising short and medium term funds for meeting working capital requirements. The post tax cost of public deposits is also fairly reasonable. II. The procedure for raising funds through public deposits is simpler, more convenient and less bothersome.

III. IV. V.

As there is no need of creation of any charge on the assets of the company for raising funds through public deposits the company mortgage ale assets are conserved. A company can take advantage of trading on equity as the maturity period of deposits and the rates of interest are fixed. A company can avail these sources of finance even when other sources of finance are not available to it because of margin money or other Government, regulations.

Limitations of public deposits from the 1. Company's point of view: I. The quantum of funds that can be raised through public deposits is limited to a maximum of 35 percent of paid up capital and free reserves (25 percent from general public and 10 percent from shareholders, directors, etc.) as per the provisions of the Companies (Acceptance of Deposits) Rules. II. The maturity period of public deposits is very short. III. Raising funds through public deposits is not a reliable and definite source of finance. Only companies enjoying good reputation can attract public deposits. IV. The Government has restricted the growth of public deposits through imposing ceilings on rates of interest, rates of brokerage and the amounts of deposits. 2. Investor's Point of View. It is not only the company, which is benefited from public deposits; the investors also find certain advantages in public deposits. We can evaluate the advantages of public deposits from the investor's point of view in terms of rates of interest and the, maturity period. Rate of Interest. The rates of interest payable on public deposits are usually higher than the alternative sources of safer investments such as banks, post offices, etc. Inspite of the ceiling on maximum rate of interest, it is still fairly reasonable. Although, income from interest on public deposits is taxable. Govt. Regulation on Public Deposits In exercise of the powers conferred by Sec. 58A of the Companies Act, the Govt, of India had framed the Companies (Acceptance of Deposits) Rules, 1975 for governing invitation and acceptance of deposits by companies from public. These rules have undergone certain amendments from time to time. The important features of Govt, regulation on public deposits by non-banking corporate sector are as follows: 1. Ceiling on Deposits. The limits up to which deposits can be accepted by the company are: A. 25% of the aggregate of the paid up capital and free reserves of the company from the general public. B. 10% of the aggregate of the paid up capital and free reserves as against unsecured debentures, or any deposits from its shareholders or any deposits guaranteed by its directors. C. While arriving at the aggregate of he paid up share capital and free reserves of the company, the amount of accumulated balance of loss, the balance of deferred revenue expenditure and other intangible assets, if any, shall be deducted. 2. Maturity of Deposits. The maximum deposits period allowed for public deposits in 36 months and the minimum; period of 3 months is allowed for deposits amounting to 10 percent of share capital and free reserves for meeting short term requirements. 3. Form and Particulars of Advertisement. Every company intending to invite deposits shall issue an advertisement for the purpose in leading English newspapers and in one vernacular newspaper circulating in the state at which the registered office of the company is situated. Such advertisement is issued on the authority and in the name of Board of Directors of the company. It should provide details regarding the name of the company, date of its incorporation, business carried on by the company, management of the company, particulars of directors, profitability of the company, etc. A declaration to the effect that on the day of advertisement, there has no overdue deposits other than unclaimed deposits at that the companies has complied with the provisions of the Companies (Acceptance of

Deposits) Rules. It should further declare that the compliance with the rules does not imply that repayments of deposits are guaranteed by the Central Govt. It should clearly mention that the deposits accepted by the company are unsecured and rank pari passu with other unsecured liabilities. 4. Form of Application for Deposits. No company can accept or renew any deposit unless an application is made by intending depositors for the acceptance of such deposits and such application should contain a declaration by such person to the effect that the amount is not being deposited out of funds acquired by him by borrowings or accepting deposits from any person. 5. Furnishings of Recipients to Depositors. Every company accepting or renewing deposits is required to furnish to the depositors or agent, a receipt for the amount received by the company. 6. Register of Deposits. A company accepting deposits shall keep at its registered office one or more registers containing details of the deposits as to name, address of the depositor, date- and amount of such deposits, duration of deposits, maturity date, rate of interest, the dates on which interest shall be paid, etc. 7. Interest on Deposits. The maximum rate of interest which may allowed for accepting deposits by a company cannot at present exceed 15 percent per annum on quarterly rest. However, the company usually allows different rates of interest on deposits depending upon the tenure of deposits. 8. Ceiling or brokerage. Companies may employ the services brokers, managers and consultants for mobilizing deposits. However, the brokerage or commission on deposits cannot exceed the prescribed limits, which has been, usually, one percent of such deposits. 9. Repayment of Deposits. Once a deposit is accepted for certain period, the company cannot repay the same before the expiry of six months. 10. Maintenance of Liquid Assets. A company which has public deposits or invest by a 30th day of April every year, an amount which shall not be less than 10 percent Of the amount of deposits maturing by 31s' March of the following year. The amount so shall not be utilized for any purpose other than the repayment of the deposits. 11. Return of Deposits. Every company inviting deposits from the public to which these rules apply, shall file with the Registrar of the Companies a return in the prescribed form duly certified by the auditors of the company. The return has to be filled on or before 30th June every year and should contain information as on 31st March of that year. INTERNAL FINANCING A new company can raise finance only through external sources, such as shares, debentures, loans, public deposits, etc. However, an existing or going concern, which needs finance " through its future growth an expansion, can also generate finance through its internal sources, viz; retained earnings or ploughing back of profits, capitalization of profits depreciation. Retained Earnings or Ploughing Back of Profits The 'Ploughing Back of Profits' is a technique of financial management under which all profits of company are not disturbed amongst the shareholders as dividend, but a part of profit is retained or re-invested in the company. This process of retaining profits year after year and their utilization in the business is also known as ploughing back of profits. The Necessity of Ploughing Back The need for re-investment of retained earnings or ploughing back of profits arises for the following purposes: 1. For the replacement of old assets which become obsolete. 2. For the expansion and growth of business. 3. For contributing towards the fixed as well as working capital needs of the company. 4. For improving the efficiency of the plant and equipment. 5. For making the company self-dependent of finance from outside sources. 6. For redemption of loans and debentures. Factors Influencing the Re-investments of Profits or Ploughing-back of Profits

1. Earning Capacity. Ploughing-back of profits depends largely upon the earnings capacity of the economy. If a concern does not earn sufficiently, there is no possibility of ploughingback of profits. Usually, greater the earning capacity of the company, larger the possibility of ploughing-back of profits. 2. Desire and Type of Shareholders. The policy of ploughing back of profits is also affected the desire and type of shareholders. If shareholders largely belong to the class of retired persons, widows and other economically weaker persons, they may desire maximum distribution of profits as dividend. On the other hand, the wealthy investor may not mind if the company retains a portion of profits for future development. 3. Future Financial Requirement. Future financial requirements of the company also affect the policy of ploughing back the profits. If the company has highly profitable investments opportunities for future development, it may plough back its profits more successfully. 4. Dividend Policy. The re-investment of profits depends to a great extent upon the dividend policy of the company. If a company desires to plough back profits it cannot follow a policy of a very high dividend pay out. 5. Taxation Policy. The taxation policy of the Government also affects the re-investment of profits. A high or low rate of business taxation affects the net earnings of the company and thereby its re-investment policy. Merits of Ploughing Back of profits Ploughing back of profits provide a number of advantages to the company, shareholders and the society at large. These merits are discussed as follows: A. Advantages to the Company 1. A cushion to absorb the shocks of economy. Ploughing back of profits acts as a cushion to absorb the shocks of economy and business, such as depression, for the company. The company with large reserves can withstand the shocks trade cycles and the uncertainty of the market with comfort prepared and economy. 2. Economical method of financing. It acts as a very economical method of financing because the company does not depend upon outsiders for raising funds required for expansion, renationalization or growth. 3. Aids in smooth and undisturbed running of business. It adds to the strength and Stability to the company and aids in smooth and undisturbed running of business. 4. Helps on following stable dividend policy. Ploughing back of profits enables a company to follow dividend policy. Stability of dividend simply refers to the payment of dividend regularly and a company with ploughs back its profits can easily pay stable dividends even in the years when there are no sufficient profits. 5. Flexible finance structure. It allows the financial structure to remain completely flexible. As the company need not raise loans for further requirements if its ploughs back its profits, this further adds to the creditworthiness of the company. 6. A Makes the Company Self-dependent or No-dependence on fair weather friends. Ploughing back of profits makes the company self-dependent and. it has not to depend upon- outsiders such as banks, financial institution public deposits and debentures. Outsiders are just like fair weather friends, which may not allow finance when the company is no doing well. But a company with large reserves will not have to depend upon them. 7. Helps in making good the deficiencies. Companies with retained earnings can make good the deficiencies in the provision of depreciation, bad and doubtful etc. 8. Enables to redeem long-term liabilities. It enables the company to redeem certain long-term liabilities such as debentures and thus relieves the company from the burden of fixed interest commitments. (b) Advantages of Shareholders 1. Increase in the value of share. Ploughing back of profits enables a company to adopt a stable dividend policy. Payment of stable dividends earns a good name for company and

the value of shares goes up in the market of the shares in the hand of the investors increases and they dispose off the their holdings earning higher profits and also can utilize their holdings as better collateral securities for borrowing from banks and other financial institutions. 2. Safety of Investments. Retained earnings provide to the investors an assurance of a minimum rate of dividend.lt renders. Safety to their investments in the company as the company can withstand the shocks of trade cycles and uncertainty of the financial market with ease, preparedness and economy. 3. Enhanced earning capacity. With the re-investment of profits in the business, the earning capacity of a concern is enhanced and the shareholders who are the real owners of the company are benefited. 4. No dilution of control. Due to the ploughing back of profits the company need not issue new shares for the requirements-of capital. This enables the existing shareholders to retain their-control. 5. Evasion of super tax. Ploughing back of profits provides an opportunity for evasion of super-tax in a company where the number of shareholders is small. (C) Advantage to the Society or Nation. Ploughing back of profits also offers certain advantages to the society at large: 1. Increases the rate of capital formation. The policy of retained earnings increases the rate of capital formation and thus, indirectly promotes the economic development, of the nation of the whole. 2. Stimulates industrialization. It stimulates industrialization of the country providing self-finance. The society as the whole is benefited by the rapid industrialization. 3. increases productivity. As ploughing-back of profits acts as a very economical method of financing for modernization and rationalization, it increases the industrial productivity of the nation; hence, the scarce resources can be exploited fully for the optimal benefit of the large. 4. Decreases the rate of industrial failure. Retained earnings add to the strength and stability of the business enterprise which are indispensable for the smooth and undisturbed running of the business. Thus, it helps to decrease the rate of industrial failures in the country 5. Higher Standard of Living. Ploughing back of profits, as the most economic method of financing increase productivity, facilities greater, better and cheaper production of goods and services. The cost of the goods is decreased and the consumer stands to gain in the form of better quality goods at reduced price. Limitations or Dangers of Ploughing-back of Profits 1. Over-Capitalization:- Over-Capitalization means, more capital than actually required. Excessive ploughing back of profits may lead to over-capitulation and the earnings of the company may not be sufficient to suffice a normal rate of return on capital employed by it. 2. Creation of Monopolies: - Continuous re-investment of earnings may lead a company to grow into monopoly with all the evils. The company may expand to such limits that it becomes uncontrollable. 3. Depriving the freedom of the investors: - The policy of ploughing back of profits limits the amount of dividend payable to shareholder and this may frustrate the shareholders as they are deprived of the freedom to invest their earnings in better securities. 4. Misuse of retained earnings: - Management may not utilize the retained earnings to the advantage of shareholders at large as they have the tendency to misuse the retained earnings by investing them in unprofitable areas. 5. Manipulation in the value of shares: - Certain management (directors) having vested interest may speculate in the shares by manipulating dividends. By, paying lower dividends in the name of ploughing back of profits, such management achieve

their goal to purchase shares at reduced prices. Thus, genuine investors may easily deceived by such managements by manipulating by the value of shares. 6. Evasion of taxes: - Certain companies retain earnings with a view to evade supertax. Such evasion of taxes reduces revenue of the Government and is detrimental to the interest of the nation as a whole. 7. Dissatisfaction among the shareholders: - Excessive retention of profits creates dissatisfaction among the shareholders. DEPRECIATION AS A SOURCE OF FUNDS Depreciation may be regarded as the capital cost of assets allocated over the life of the asset. In the simple language, it means the gradual decreases in the value of an asset due to wear and tear, use, and passage of time. In real sense, depreciation is simply a book entry having the effect of reducing the book profit of the, current year for the same amount. It does not affect current asset or current liabilities and does not result in the flow of funds or to say more precisely it is a non-found item. Hence, although depreciation is an opening cost there is no actual outflow of cash and so the amount of depreciation charged during the year is added back of profits while findings fund from operation. But, then, is depreciation a source of funds? There cannot be any definite answer in 'yes' or 'no' to this questions as there is difference of opinion on this important point. But it cannot be said with certainty that depreciation, directly at least not amount to a source of funds. However, under certain circumstances, depreciation helps a business concern to effect- sayings in payments of tax and dividends and amounts to withholding a part of a funds generated through normal operations. It is in the sense that depreciation can be regarded as an indirect source of funds.