Sources of Long Term Finance
As you are aware finance is the life blood of business. It is of vital significance for modern business which requires huge capital. Funds required for a business may be classified as long term and short term. You have learnt about short term finance in the previous lesson. Finance is required for a long period also. It is required for purchasing fixed assets like land and building, machinery etc. Even a portion of working capital, which is required to meet day to day expenses, is of a permanent nature.
To finance it we require long term capital. The amount of long term capital depends upon the scale of business and nature of business. In this lesson, you will learn about various sources of long term finance and the advantages and disadvantages of each source. 19. 2 Objectives After studying this lesson, you will be able to explain the meaning and purpose of long term finance; identify the various sources of long term finance; define equity shares and preference shares; distinguish between equity shares and preference shares.
Debentures; enumerate the types of debentures; explain the merits and demerits of debentures as a source of long term finance; compare the relative advantages of issuing equity shares and debentures; explain the benefits and limitations of retained earnings; explain the merits and demerits of Public Deposits; outline the rules and regulations about inviting and accepting public deposits by companies; discuss the merits and demerits of long term borrowing from commercial banks. 19. Long Term Finance – Its meaning and purpose A business requires funds to purchase fixed assets like land and building, plant and machinery, furniture etc. These assets may be regarded as the foundation of a business.
The capital required for these assets is called fixed capital. A part of the working capital is also of a permanent nature. Funds required for this part of the working capital and for fixed capital is called long term finance. Purpose of long term finance: Long term finance is required for the following purposes: 1. To Finance fixed assets : Business requires fixed assets like machines, Building, furniture etc.
Finance required to buy these assets is for a long period, because such assets can be used for a long period and are not for resale. Sources of Long-term finance :: 31 2. To finance the permanent part of working capital: Business is a continuing activity. It must have a certain amount of working capital which would be needed again and again. This part of working capital is of a fixed or permanent nature. This requirement is also met from long term funds. 3. To finance growth and expansion of business: Expansion of business requires investment of a huge amount of capital permanently or for a long period.
Factors determining long-term financial requirements : The amount required to meet the long term capital needs of a company depend upon many factors. These are : (a) Nature of Business: The nature and character of a business determines the amount of fixed capital. A manufacturing company requires land, building, machines etc. So it has to invest a large amount of capital for a long period. But a trading concern dealing in, say, washing machines will require a smaller amount of long term fund because it does not have to buy building or machines.
Nature of goods produced: If a business is engaged in manufacturing small and simple articles it will require a smaller amount of fixed capital as compared to one manufacturing heavy machines or heavy consumer items like cars, refrigerators etc. which will require more fixed capital. (c) Technology used: In heavy industries like steel the fixed capital investment is larger than in the case of a business producing plastic jars using simple technology or producing goods using labour intensive technique. 32 :: Business Studies 19. 4 Sources of long term finance The main sources of long term finance are as follows.
Shares: These are issued to the general public. These may be of two types: (i) Equity and (ii) Preference. The holders of shares are the owners of the business. 2. Debentures: These are also issued to the general public. The holders of debentures are the creditors of the company. 3. Public Deposits : General public also like to deposit their savings with a popular and well established company which can pay interest periodically and pay-back the deposit when due. 4. Retained earnings: The company may not distribute the whole of its profits among its shareholders. It may retain a part of the profits and utilize it as capital. . Term loans from banks: Many industrial development banks, cooperative banks and commercial banks grant medium term loans for a period of three to five years. 6. Loan from financial institutions:
There are many specialised financial institutions established by the Central and State governments which give long term loans at reasonable rate of interest. Some of these institutions are: Industrial Finance Corporation of India ( IFCI), Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Unit Trust of India ( UTI ), State Finance Corporations etc.