What are the various sources of raising business finance in India? / A note on long-term and short-term capital.
Introduction:
Finance is the life-blood of all business activities. Finance is needed not only for establishing a business enterprise, but it is also needed to keep it alive and also to see it growing. Every business enterprise needs two types of capital, viz., fixed or long-term capital and working or short-term capital.
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Source of Finance:
There are several sources which a business enterprise company can use for raising the required amount of capital. What sources and methods the company will use depends largely on the period for which finance is required. Based on the period for which finance is required, it may be broadly classified under two broad heads as given below:
- Fixed or Long-term Finance
- Working or Short-term Capital
Sources of Fixed or Long-term Capital:
The sources of obtaining fixed or long-term capital are as follows:
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Issue of Shares
Issue of shares is the most important, popular and easy source of obtaining fixed or long-term capital. The share is a company’s owned capital which is split into a large number of small equal parts, each such part being called a share. Those who purchase these shares are called ‘shareholders’. They are the owners of the company. It is a permanent capital and provides a base to the capital structure of a company. It is because that the money raised in the form of shares remains in the Company up to the date of winding up. According to the provisions of companies Act, 1956, a company can issue only the following two types of shares, (i) Preference Shares, (ii) Equity Shares.
Issue of Debentures
Issue of debentures is another is important source of obtaining fixed or long-term capital by a joint stock company. A debenture is an acknowledgement of a debt by a company usually issued under a common seal. Debentures are the uniform parts of a loan raised by the company. 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 b a fixed or floating charge on the company’s property or undertaking and which acknowledges loan to the company.” A debenture-holders is a creditor of the company. A fixed rate of interest is paid on debentures. The interest on debentures is a charge on the profit and loss account of the company. Debenture holders are not the owners of the company.
Another important source of obtaining long-term capital is the loan from the financial institutions. They provide loan for a period varying from 7 to 25 years and charge interest @ 13% to 17% per annum. A number of special financial institutions have been established by both the Central and State Governments to provide long-term industrial finance to companies engaged in business. Noteworthy among these financial institutions are- (i) Industrial Development Bank of India, (ii) Industrial Finance Corporation of India, (iii) Industrial Credit and Investment Corporation of India. (iv) Unit Trust of India, (v) The Industrial Reconstruction Corporation of India, (vi) The National Small Industries Corporation, (vii) State Financial Corporations, (viii) State Industrial Development Corporations etc.
Retained Profits
Accumulated large profits are also considered to be good source of financing long-term capital requirements. It is the best and cheapest source of finance. It creates no charge on future profits. Retained profits may be represented by various uncommitted reserves and surpluses or specific reserves created out of profits.
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Sources of Short-term Capital:
The main sources of obtaining short-term capital are as follows:
Loans from Commercial Banks
Commercial banks are the most important and easy source of providing short-term capital to business enterprises. They constitute the major portion of working capital loans. They are given on the security of tangible and readily marketable securities. They provide a wide variety of loans tailored to meet the specific requirements of the business enterprise. The chief forms in which commercial banks provide short-term finance to business enterprises are; (i) Loans, (ii) Cash Credit, (iii) Overdraft, (iv) Discounting of Bills.
Public Deposits
Another source of short-term finance is to invite public deposits for a specified period at a fixed rate of interest. Usually the companies inviting public deposits pay a higher rate of interest than the commercial banks for the similar period. companies accept public deposits for a maximum period of three years which may be renewed on the consent of both the parties. This method is usually employed by the companies established mostly in southern part of India, such as, Mumbai, Chennai, Calcutta etc.
Other Sources:
I. Indigenous Bankers:Indigenous bankers are private money lenders and other country bankers who provide short-term finance and charge high rates of interest. Nowadays with the development of commercial banks and other financial institutions they have lost their earlier monopoly. These days, the business houses take the shelter of indigenous banks only in case of urgency.
II. Depreciation Funds: Depreciation funds created out of profits of the company provide a good service of short-term capital, provided they are not invested in or represented by an asset.
Trade Credit: Present-day business is built on credit. Trade credit refers to the credit extended by the supplier (seller) to the buyer. Under this arrangement, credit is not granted in cash. The goods are sold on credit. The usual duration of trade credit varies from 15 days to 90 days. It is granted to those customers who have sound financial standing, goodwill and reputation.
III. Government Loan and Assistance: Now-a-days governments, both Central and the State also provide business finance to industries in the form of loan for the development of industries, preferably key industries, small-scale industries and cottage industries at concessional rates of interest. Further, financial assistance is also provided to industries of national importance in whose development the government is interested.
IV. Customer’s Advances: Now-a-days leading and reputed industries whose products are in good demand, such as, Tata Steel, Maruti Car, Philips (India) Ltd., Bajaj Auto, A.C.C., Hero Cycle etc. get advances from their customers and agents against orders received from them. It is also a cheap source of short-term finance.