Question

What are the sources of long-term finance for a business enterprise? Explain.

Answer 1

1. Issue of shares: Shares are the smallest units into which the company's entire capital is divided. For example, if a corporation raises ₹ 50 crores from the public by issuing shares, it can divide the capital into units of a specific value, such as ₹10/- or ₹100/-. The individual units are referred to as its share. After determining the value of each share and the quantity of shares to be issued, the corporation invites the public to purchase them. The investing public then purchases the shares based on their capacities. Shareholders are investors who have purchased or invested in shares. They receive dividends as a return on their investment.
2. Issue of Debentures: Companies can raise long-term financing by issuing debentures that provide an assured rate of return to investors in the form of a fixed rate of interest. The company refers to this as debt capital or borrowed capital. The debenture is a written recognition of the amount borrowed. It specifies the terms and circumstances, including the interest rate, repayment period, security supplied, and so on. These are made available for public subscription in the same way as shares.
3. Loans from financial institutions: After independence, India developed numerous financial institutions to support industrial firms with medium- and long-term financing. Institutions like the Industrial Finance Corporation of India (IFCls), Industrial· Reconstruction Bank of India, State Financial Corporations (SFCs), and State Industrial Development Corporations (SIDCs) have been established to provide financial support to set up new enterprises as well as expansion and modernisation of existing enterprises. These financial firms provide loans for a maximum of 25 years. A mortgage on the company's property or the hypothecation of stock shares serves as security for these loans. The main benefits of such loans are:
   1. The rate of interest payable is lower than the market rate and
   2. The amount of the loan is large.
4. Public Deposits: Public deposits refer to unsecured deposits invited by companies from the public, mainly to finance working capital needs. A company wishing to invite public deposits advertises in the newspapers. A company can invite public deposits for a period of six months to three years. Therefore, public deposits are primarily a source of short-term finance.
   Companies can raise capital through this strategy by allowing shareholders, workers, and the general public to deposit their savings with the company. To attract customers, the company typically offers a higher interest rate than the interest on bank deposits. The time for which firms receive public deposits varies from six to 36 months.
5. Retention of Profit: Companies, like individuals, lay away a portion of their revenues for future capital requirements. Retained earnings, also known as ploughing back of profits, refers to a percentage of a company's profits that are not paid to shareholders and instead reinvested in the business. As per the Indian Companies Act 1956, companies are required to transfer a part of their profits into reserves like the general reserve, debt Redemption Reserve, Dividend equalization reserve, etc. These reserves can be utilised for long-term financial needs, such as purchasing fixed assets, renovations, and modernisations. This approach of funding long-term financial needs is also known as retention of profit. 
6. Lease financing: A lease is a contract that allows one party to utilise another's assets with the owner's consent and payment of rent rather than acquiring them outright. The asset's owner is referred to as the 'lessor', while the user is the 'lessee'. After the lease period, the lessee gets the option to acquire the asset. Leasing allows businesses to use and control assets without owning them. The owner receives rent and has the right to cancel the agreement at any moment under the contract provisions. This technique allows businesses to employ fixed assets for extended periods of time without incurring significant costs. When the lease period ends, the asset is returned to the owner.