business finance
TRANSCRIPT
Meaning of Business Finance
Business finance refers to capital and credit funds invested in the business .financing means making available when its needed. Business finance may be defined as planning,raising,managing and controlling all the money used or capital funds of any kind used in connection with business
Definitions by different authors
“Finance is that business activity which is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of business enterprise”.
-B.O Wheeler.
“Business finance involves a set of administrative functions in an organization which relate with the arrangement of cash and credit so that the organization may have the means to carry out its objectives as satisfactory as possible”.
- Howard and Upton
Nature and significance
No one can start the business or run an enterprise without adequate
funds. Every business requires some money which is called initial
capital . The amount of capital required depends upon the nature
and size of business.
Business enterprise requires capital and finance for the
following purposes
While starting a business ,finance is required to procure fixed assets and also for meeting day – to – day expenses .
To meet the working capital requirement when production process is lengthy.
To finance the growth and expansion projects of the company .
Adequate finance provide the following benefits to a business
concern
The firm can meet its liability on time .
The firm can carry on its business smoothly.
The firm can adopt latest technology and new innovative methods of production.
The firm can make use business opportunities.
The firm can replace its assets and machinery whenever necessary.
The firm can face recession and depression period of trade cycle.
The firm can face completion more
strongly.
A business enterprise needs finance at every stage . It must be available in an adequate
amount at the right time for smooth functioning of an enterprise .Is short we can say that finance is the blood of the business
The financial needs of a business can be classified into two categories
Fixed capital requirement.
Working capital
requirement
Fixed capital requirement
In order to start a business finance is required to buy fixed assets such as land ,buliding,plant etc.this is known as fixed capital .the fixed capital remains invested in the company for the long term ,that is , the company should prefer long term sources of finance to meet the requirement.
Working capital requirement
The finance required to carry on operating and day to day activities is known as working capital . Generally working capital is used to buy current assets which get converted into cash in one year. Generally firm prefers short sources of finance to meet working capital requirement .
CLASSIFICATION OF SOURCES OF FUNDS
The various sources of funds can be broadly classified on the basis of following 3
categories
Period basis
Ownership basis
Sources of generation
basis
PERIOD BASISOn the basis of time period, a business
finance can be classified in three categories:-
Long Term Finance
Medium Term Finance
Short Term Finance
Long Term Finance
Funds which are required to be invested in a business for a long period of time, that is, more than 5 years are known
as long term finance.
FEATURES
This type of fund is used for acquiring fixed assets. For example, land, plant etc .
Small factory, retailers, traders etc.
require smaller long term finance.
MEDIUM TERM FINANCE
The finance required by business enterprises for more than one year but less than five years is known as
medium term finance.
FEATURES
Generally manufacturing industries require medium term finance.
Common sources of raising medium term
finance are: accepting public deposits, medium term loans etc.
SHORT TERM FINANCE
The finance required for a short period up to 1 year is known as
short term finance.
FEATURES It is more often called working capital.
Generally trading companies require more
of short term finance as compared to manufacturing companies.
For every business enterprise , there are two sources of business
finance. These are
Owner’s Fund
Borrowed Fund
OWNER’S FUND
Owners Fund refers to the funds contributed by owners as well as the accumulated profit of the company. This fund remains with the company and it has no liability to return this fund. For Example:-Equity shares,
retained earnings.
FEATURES
No security required- No security has to be offered against
ownership capital.
Sources of owner’s fund- The owner’s fund comprises of
share capital, retained earnings.
Merits
Permanent capital – The owner’s fund remains with the
business permanently. It is the most suitable fund to meet problems.
Right to control – The final decision in the business is taken by the owners. By contributing to owner’s fund, share holders acquire the right to control and supervise over the management of the company
DEMERITS
Under Utilization of capital- Ownership funds cannot be reduced
easily as these are a permanent source of capital. If company has no expansion of growth projects then a part of this fund may remain idle.
Diffusion of control- By purchasing the equity shares of the
company a large number of persons can get ownership rights of control over management. This may reduce the control and powers of the real owners who have promoted the company.
BORROWED FUND
Borrowed fund refers to the borrowing of the firm. It includes
all funds available by way of loans or
credit.
FEATURES
Fixed time – The borrowed fund is raised by business firms for
specified periods. These funds may be raised for short term, medium term or long term.
Security- Generally firms can get borrowed funds against the securities of assets. Banks are financial institutions offer loans on different
terms against the security of assets.
MERITS
Flexibility- The amount of borrowed fund can
be increased by raising more and can be decreased by paying them back. So finance can be raised or repaid according to convenience and needs of the company.
No interference – Borrowed funds security holder
do not get any right to control. It does not affect owner’s control over management.
DEMERITS
Adequate security- The borrowed funds are usually available up to
80% of the value of assets. Companies are required to offer adequate securities against loans.
Fixed liability- Payment of interest and repayment of principal
amount of borrowed fund is a fixed liability of a company. Default in payment may lead to serious effects such as decrease in the credit-worthiness of the company and insolvency.
Sources of generation basis
On the basis of generation. It can be classified into two categories
Internal sources External
sources
Internal sources
It include all those sources which are
generated within the business
External sources
It include all those sources that lie
outside
an organization
Methods of raising finance
Retained earningTrade credit
FactoringLease financingPublic deposits
Commercial papersEquity shares
Preference sharesDebentures
Commercial banks Financial institutions
International financing
Retained earning
These are also known as ploughing back of profit ,retained earnings, self financing or
internal financing ,reserves or surplus. It refers to undistributed profits after
payment of dividend and taxes provides the basis of expansion and growth of
companies. It is considered the most important source of
finance since its internally generated this method of financing is known as self–
financing.
Features
Funds for new innovative projects – The retained earnings are common source of funds for financing risky
and innovative projects . This fund is generally used for research work expansion projects etc.
Medium and long term finance – Retained earning is considered as an ownership fund . It serves the
purpose of medium and long term finance.
Conversion into ownership fund- The supplies retained earnings can be converted into share
capital by issue of bonus shares . In issue on bonus shares there is no outflow of cash . Investors to are benefited by the issue of shares fr of cost.
Merits
Most dependable source- As an internal source this is more dependable than the external
source of finance . The external source depends upon the preference
of investors market condition etc.
No fixed liability – There is no fixed commitment to pay dividend or interest on
this source of fund as retained profits are a company's own money.
No security – Unlike debentures no change is created against the assets .
The company is free to use its assets for raising loans in future.
Demerits
Careless use- The retained earnings are available easily at no cost. The management of the company not always use the retained earnings in the best interest of the shareholders. it may misuse them by investing in unprofitable or undesirable investment proposals.
Over- capitalization – large amount of retained earning results in the issue of bonus shares to equity shareholders .frequent capitalization of reserves may result in over-capitalization.
Dissatisfaction among shareholders – Large retained earnings may cause dissatisfaction among the equity shareholders as they do not receive high rate of dividend if a large amount of surplus profit is kept aside in the form of reserves.
Trade credit
Trade credit is a credit extended by one trader to another
for purchase of goods and services trade credit facilitate the purchase of supplies
without immediate payment it is also known as mercantile credit
terms of trade credit may vary from one industry to another and from one person to
another . firm may offer different credit terms to different
credit customers.
The availability of trade credit depends on:
Nature of the firm. Size of the firm. Status of credit worthiness of the firm
MERITS
READILY AVAILABLE Trade credit is available without any special efforts
on the part of a manufacturer or trader
FLEXIBLITY There are no rigid rules and regulations
involved in trade credit .it can be easily adjusted with the changing needs of purchases as time of payment is generally adjusted in view of past dealings.
Demerits
Increases in prices- Sometimes the supplier may increase the price of
commodity or raw material supplied if he is selling
Legal action- In trade credit the buyer generally issues a promissory note and incase he fails to meet his commitment, the supplier can take legal action. goods on credit
FACTORING
It is a financial service under which the factor renders the following services.
Following services are
Discounting of bills and collection of client debts
Discounts bills of exchange and also collects the debts of clients the client sell their receivable on accounts of credit sale or the factor of certain discount the factor become responsible for all credit control and debt collection from a buyer and provide protection against any bed debt losses to the firm
Providing information about credit worthiness of prospective client
Factors hold detailed information about the trading
history of the firm. with the help of the such information
firms using factoring services are saved from doing
business with customers with poor payment record
besides this factors also provide consultancy services in
area of finance marketing etc. the factor charges fees for
the services rendered and these services are provided by
the organization SBI factors, commercial services limited etc.
MERITS
Obtaining funds from factoring is cheaper
than any other sources of finance.
No claims over the asset of the company.
It provides a kind of security for a debt which
the company otherwise might not be able to pay.
DEMERITS
Factors generally charge a high rate of interest.
By involving a factor the company is inviting a
third party between customer and company the
customer may not like it.
LEASE FINANCING
A lease is a contractual agreement in which the owner of the asset grants the other party the right to use the asset in written of a periodic payment retains
title over the property
MERITS
With low financial investment the lessee can use
assets which require huge investment.
Not much of legal formalities is required.
Lease rent is deducted from the income of lessee before calculating the income tax.
Lessee has no risk of obsolescence.
Lessee has no claim over the assets of the company.
Demerits
Lesser may put certain restrictions on use of the assists.
Lessee never become owner of the asset.
The business operations may get affected if lessor terminates the agreement before maturity date or does not renew the lease contract.
PUBLIC DEPOSITS
These are the deposits raised by an organization directly from the public .under this method
company is inviting public deposit. public deposit are required to advertise publically along with it
financial position .public deposit can take care of medium and short term financial requirements of the business such deposits are beneficial to both
depositor as well as organization.
Features
Unsecured – Companies mortgage no asses against the
public deposits raised from general public.
Finance of working capital – The amount raised from public
deposits is generally used by the company for meeting the requirements of working capital. though they are a primary source of short term finance but by renewing these can be used for medium term also.
Time period –
Public deposit can be invited by companies for a period of 6 months to 3 years.
Repayment –
A company which has public deposits is required to set aside 10 percent of the deposits maturing by the end of the year . The amount so set aside can be used for repaying the public deposits.
MERITS
NO SECURITY
Public deposits are unsecured so the assets of the company are free to be used as mortgage in future.
REDUCTION IN TAX LIABILITY.
Interest paid on public deposits is deducted from the total income of the company. hence it helps in bringing down the tax liability.
.
Flexibility
Public deposits can be repaid when they are not required . their for public deposits introduce flexibility in the financial structure of the company
NO DILUTION OF CONTROL
Public depositors have no voting rights they cannot influence the decisions of the company their is no dilution of share holders control.
DEMERITS LIMITED AMOUNT
The amounts of funds that can be raised by way of public deposits is limited because of legal restrictions. public deposits cannot exceed 25% of share capital and free reserves.
UNCERTAINITY
Public deposits are an uncertain and unreliable source of finance. during depression period the depositors may not respond .also deposits may be withdrawn when ever the financial position of the company is not stable.
Not suitable for new concerns
New companies don't have enough goodwill in the market. The advertisements given by new companies do not attracts many people to invest money in their public deposits.
Suitable for conservative investors
Public deposits do not attract bold and adventurous
investors who want capital gains .only cautious and conservatives investors prefers to invest in 6the public deposits.
Commercial papersCommercial papers is source of short term finance. The
commercial paper was introduced in India for the first time
in 1990 . It is an unsecured promissory note issued by public and private sectors companies with a fixed maturity
period ,which varies from 3-12 months . Since these are unsecured that’s why these are generally issued by companies
having a good reputation .
Merits
Commercial papers are unsecured so no asset of the company is mortgaged.
Commercial papers are freely negotiable instrument.
Cost of issuing commercial paper is low.
Its continuous source of funds as its maturity can be changed according to the requirement of the company .
Companies can also invest their excess money in discounting the commercial and earn a good amount of return.
Demerits
Only financially sound companies with a good reputation can issue this security .
The size of money that can be raised through commercial papers is limited.
Commercial papers is an impersonal method of financing.
SHARES
Share is the smallest unit in which owners capital of the company is divided .A share
is the interest of the shareholder in the company measured by a sum of money for the purpose of liability and interest. A share may also be defined as a unit of measure of
share holder's in the company.
TYPES OF THE SHARES
Equity shares
Preference shares
Equity shares
They are the most important source of raising long term capital by company .Equity share are those shares which don't carry any special or preferential rights in respect of payment of annual dividend and repayment of capital the money issued by the issue of equity shares is limited as equity share capital .it represents as the owners capital as equity share holders as are real owners of the company thus the capital raised by issue of such share is common as ownership capital or owners fund.
Features
Risk bearing capital - They are the primary risk bearers they enjoys the reward as
well as bear the risk of ownership ..
Maturity -
Equity shares provide permanent capital to the company and cannot be redeemed during the life time of the company.
Returned The returned earned by equity share
holder is known as dividends which varies with the earning of the company.
Claim on residual income Equity share holders are
referred to a individual owners, as they get dividend only
after all other claims on the companies income
and asset have been settled voting rights.
Voting rights Equity share holders have voting rights
in proportion to the share held by the share
holders .they have a right to participate in the companies management.
Limited liability-
The liability of equity share holders is limited
to the extent capital contributed by the company.
Merits
IT IS IDEAL FOR ADVENTOROUS INVESTORS Equity share are suitable who are willing to assume
risk for higher returns.
NO OBLIGATION AS TO DIVIDENDS There is no burden or obligation on the company to
pay dividend as it depends on the profit available and the decision of
members
PROVIDES CREDIT STANDING Equity capital provide credit worthiness
to the company and confidence to prospective loan providers
No charge on asset Equity shares do not carry any
charge on asset of the company as a result asset can be freely mortgaged purpose of borrowing.
Democratic management Equity shares holders enjoys voting
rights which ensure democratic management of the company.
Small nominal value An equity share is generally low price
as a result ,even person with limited means can buy equity shares.
DEMERITS
Risk of fluctuating return- Equity shares are not suitable
for investors who desire to earn stable return on the investments as equity
share get fluctuating results.
High cost of capital The cost of equity shares is generally more as
compared to the cost of raising funds through other sources.
Legal formalities A company has to comply with no legal formalities
before issue of equity shares to the general public.
Danger of over capitalization Equity share capital is a permanent source of capital
if the company has raised excess equity capital due to faulty financial planning then company may get into a
state of overcapitalization. in such a situation equity capital may become idle and under utilized.
PREFRANCE SHARE
Preference share are those shares which enjoy certain priorities
regarding the payment of dividend under fixed rate and return of
investment the capital raised by issue of preference share is called preference share capital the preference share holders enjoy
preferential rights over equity share holders
Right to receive fixed rate of dividend before any dividend is paid to equity share holders
Right to receive repayment of capital on binding up of company before the capital of equity share holders is a returned.
FEATURES
FIXED RATE OF DIVIDENT :
Preference share holders receive dividend
at a fixed rate before any dividend is paid to equity share holder.
REPAYMENT OF CAPITAL Preference share holders have the
preferential rights as to the redemption of capital at the of time binding up of a company
NO VOTING RIGHTS:
Preference shareholders generally do not enjoy any
voting rights.
NO CHARGE ON ASSET
Preference shares are also used without creating any charge on the fixed assets of the company
TYPES OF PREFRANCE
CUMULATIVE PREFRANCE SHARES
The preference shares which carry the right to accumulate unpaid dividend in future years in case the same is not paid the current year are termed as cumulative preference shares example: if a company is having a loss for 2 years and if the 3 year the company earns the profit than the cumulative preference shares holder with get dividend for 3 years
NON CUMALATIVE PREFRANCE SHARES The preference shares on which the dividend does not get
accumulated are termed as non cumulative preference shares. if the company does not declare dividend for any year right of dividend of such shares holders in respect of that year will be lost.
PARTICIPATING PREFRANCE SHARES
The preference share in which share holder are granted the right to share or participate in the surplus profit of the company after paying dividend in equity shares are termed as participating preference shares
NON PARTICIPATING PREFRANCE SHARES
The preference share in which share holder don't carry the
privilege participation of surplus profit along with equity shares
are termed as non participating preference shares
CONVERTABLE PREFRANCE SHARES The preference shares that can be converted into equity
shares within specified period of time are known as convertible preference shares
NON CONVERTABLE PREFRANCE SHARES
Preference shares that cannot be converted into equity shares are known as non convertible preference shares
MERITS
REASONABLE SAFETY OF RETURN Preference share are useful for those investors
who want steady income in the form of fixed rate of
return and safety of investment.
NO INTERFERENCE IN THE MANAGMENT Preference shares don't affect the control of equity share holders over the management as preference share holders don't carry voting rights.
TRADING ON EQUITY
The preference shares are entitled to a fixed rate of dividend .It enables the company to declare higher dividend to equity share holders during prosperity to take advantages of trading on equity
NO CHARGE ON ASSET
Preference capital does not create any short of charge against a asset of a company . so ,assets may be used as
security for raising loans in future.
Demerits LIMITED CAPITAL Preference shares are not suitable for adventures or bold investors who are willing to take risk &are interested in higher returns .
DILUTE CLAIM OF EQUITY SHARES HOLDERS: Preference capital dilutes the claim of equity share holders over the asset of the company.
UNRELIABLE AND LOW RETURN
Preference shares carry a fixed but low return of dividends even during bumper profits preference share holders have to be satisfied with a fixed dividend while equity shares holders get more share in profit. More over their is no assured return for the
preference share holders as dividend is paid only when the company earns profit.
NO TAX BENEFITS:
Their is no tax saving in case of dividend on preference shares as they are not deductible from profits as expenses.
Debentures Debentures are the common security issued
under borrowed fund capital. Debentures are instrument for raising long term debt
capital . Debentures are called creditorship securities because debentures holders are
called creditors of the company.A debenture can be defined as “a documenter
a certificate “ issued by a company under its seal as an acknowledgement of its debt . Holder of debenture certificate is debenture
holder.
FeaturesBorrowed fund-
Debentures are part of borrowed fund capital as debenture holders are considered as the creditor of the company .
Fixed rate of interest-
The interest on debentures is paid at a fixes rate. The rate of interest is decided in the annual general meeting of the company .
Compulsory payment of interest-
Payment of regular and fixed rate of interest is a legal obligation of the company. company has to pay interest to its debentures –holders irrespective of its profit earning capacity.
Security –
Most of the time debentures are issued against the charge of some fixed assets of the company.
No voting rights-
Debenture holder have no say in the management as
they are never granted voting rights in the company.
Types
Secured debentures
Unsecured debentures
Convertible debentures
Non -convertible debentures
Secured debentures
Debentures which are secured by a charge on the immovable property of the company are known as secured
debentures. In case of default by the company ,debenture-holders can
recover money from the mortgaged property.
Unsecured debentures
Debentures which are unsecured and do not carry a charge on the fixed assets of the company . No property is mortgaged with the debentures holder. In case of default
they can file a case in the court but can not recover money by selling a asset of the
company.
Convertible Debentures
The debentures which get converted into equity shares on expiry of fixed of time are
known as convertible debentures.The ratio and period of conversion is specified
at the time of issue of debentures.
Non –Convertible Debentures
The debentures which do not get converted into equity shares are known as Non- Convertible Debentures. They always remain the creditor of the company.
Merits of Debentures
Low cost -
The cost of raising debentures is less than the cost of raising preference shares. It’s a cheaper source of finance.
Interest is treated as expense-
The interest paid to debenture holder is considered as an expense of the company. Interest is deducted from the total income of the company before calculating income tax . So the liability of the tax reduces.
Attract large number of investors-
The company offers a fixed rate of interest on
debentures. The fixed returns appeals and attracts many investors in invest in debentures. Hence the company can collect a large amount of funds by issue of debentures.
No dilution of control-
Debenture holder do not get any voting rights. They are not allowed to participate in decision – making so debentures financing does not result in the dilution of control of equity share holder.
Demerits
Fixed obligation –
Payment of interest is a fixed commitment of the organization whether its earning profit or not. sometimes companies have to borrow funds for payment of interest to debenture holder.
Reduction in credibility-
Financial institution and lenders hesitate to lent funds in the company more of debentures. The credit worthiness of the company which has issued a large number is low.
Charge on assets- Usually debentures are issued against securities of fixed asset . During the time of depression , if the company is unable to pay the regular amount of interest and finds its difficult to repay the amount , in this situation the debentures holder can have claim over the assets of the company.
No voting rights- Debentures holder are not allowed to vote in the management of the company . All the decision regarding interest rate for debentures are taken by the share holder only . Therefore they remain at the mercy of equity shareholder.
Commercial bank
Commercial banks occupies a very important position as they provide funds
for different purpose and different periods .firms of all size can approach
commercial banks generally commercial banks can provide short and medium term loans but nowadays they have
started giving long term loans against security.
Merits
Banks provide funds to firm as and when required .
The banks keep the information of borrower confidential and the business can maintain
its security.
No formalities of issue of prospects etc. are required so its very easy and economical source of funds.
It’s a flexible source as loan amount can be increased as well as decreased .
Demerits
Funds are generally available for a short period .
Banks make detailed investigation of the company's affairs and financial structure before issue of loans.
In some cases bank may put restrictions and difficult terms and condition.
Financial institutions
Public financial institution are referred to as lending institutions ,development banks or financial institutions . After
independence the government of India realised that economical development
of a country only commercial banks are not sufficient . There must be financial
institution to provide financial assistance and guidance to industries
and business enterprises . The need for public financial institution was felt due
to the following reasons:
Merits
Long term finance – Financial institution provide long term finance.
Managerial advice- Financial institution provide managerial as well as financial advice
on various matters.
Medium and long term finance-
Public financial institutions provide medium and long term finance to industrial enterprise at a reasonable rate of interest
Demerits
Too many formalities have to be fulfilled for taking loans from financial institution .
They may put certain restriction such as restriction on dividend payment etc.
Sometimes financial institution may appoint there nominees as board of directors to restrict the power of a company.
International source of finance
Prior 1991,indian companies were not allowed to raise finance from abroad or from companies .the source
of finance were restricted within India .after the new policy of liberalisation ,the doors of foreign companies and investors were opened to invest in
Indian companies .after 1991 the Indian companies can tape international source of finance for both
debt and equity .the main securities used by Indian companies to tap international source of finance are
given below:
Loans from commercial banks.
International agencies and
development banks.
International capital market
Loans from commercial banksCommercial banks are very popular and common source of medium term finance for companies . Medium term
loans can be raised by companies against the security of assets . The rate of interest of loans is generally
fixed by R.B.I.nowadays with the entry of foreign banks and private
banks .taking loans from commercial banks has become very simple
task .banks don't interfere in the management of companies and such
loans can be repaid in parts and interest can be saved to that extent.
International agencies and development banks
A number of international agencies and development banks have emerged over
the years to finance international trade . These bodies provide long term and medium term loans to promote the
development of economically backward areas in the world . These bodies are set
up by the government of developed countries . For example .international finance corporation ,EXIM.banks.asian
development banks.
International capital market
Modern big and multinational organizations get themselves
listed in the foreign stock exchange and the commercial financial instruments used for
this purpose are:
Global depository receipt [GDR].
American depository receipt [ADR]
Foreign currency convertible bonds [FCBs]
GDR
GDR receipts are issued against issue of equity shares in the global market . These are indirect
equity offerings. The equity shares issued against GDR are held by an international banks called depository. Companies issue dividend
notices ,reports etc. regarding these shares do not get voting rights . The capital contributed by these shares is in dollars . That’s is why these
are called dollar –denominated instruments. The global depository receipts were introduced by
the Citi bank in the year 1990.
ADR
An ADR is just like a GDR except that it can be issued to a citizen of USA only and it can be listed in the US stock exchange . Shares issued by the company are held by an international bank called depository ,which receives dividend notices and reports . ADRs are subject to much strict disclosure requirements than GDRs . Because regulation of us stock exchange are very strict . Annual legal and accounting cost of maintaining an ADR are much higher than GDR.
Fcbs
These are the foreign currency bonds which get converted into equity shares on equity shares on expiry of a fixed period of time .
The holders of FCB have the option of either convert the FCB in equity shares at a
predetermined price or at the exchange rate at that time . FCB get rate of interest and
these are traded by listing in foreign stock exchange.
Factors kept in mind before selecting a suitable source of
business finance
No source of business is free from limitation so we cant say which is the best source of finance . Before
deciding the source of finance to meet financial requirements.
Cost involved
Before finalizing any source of finance the company must find out the cost involved in procurement and using the funds . Both
the cost must be less than the benefit which they get by using that source of
funds
Financial capacity of the firms
If the firm is financially sound then it may prefer borrowed funds and can easily pay the interest amount . But is the firm is not
financially stable then it must depend upon the owners fund securities
Form of business organization
Sole proprietorship and partnership firm can not raise funds by issue of shares
/debentures .they have to depend upon factoring ,leasing,loan,trade credit
etc.whereas joint stock company prefer issue of shares and debentures to raise
funds.
Time period
Another factor which help in deciding the source of funds in the duration for which the firm require funds as for a short period trade
credit , factoring,short term loans etc.are suitable whereas for a long term
shares ,debentures are suitable debentures are suitable for medium term public deposits,
loans are suitable.
Risk involved
Owners fund securities involve no risk whereas borrowed fund securities are risky securities . If a business firm can bear the risk then only it should to go for borrowed funds otherwise it should prefer owner's
fund securities
Control
Equity shareholder are consider as the real owner of the business as they have
complete control over the business . If existing equity shareholder do not want to lose the control , then they must not issue
more equity shares to reuse additional capital as it may result in dilution of control.
Flexibility
Sometimes the financial institution which provide long term debt to companies put
certain restrictions on the companies which restricts the flexibility of company .so if other option are easily availed then firm
don’t prefer loan from financial insitution and bank put restriction .
Claim over assets
Some source of finance mortgage the assets of the firm and reduce its
creditworthiness ,for example debentures , secured loans.wheras some source such as shares ,unsecured loans etc. don’t put claim over the assets, hence result in no reduction
in creditworthiness.
Tax benefits
Interest on debentures ,loans is deducted from the total income of the company before
calculating income tax whereas dividend paid to equity shareholder is not deducted from
the total income . So if a firm wants to get tax benefit it should issue debentures,
preference shares,loans,
public deposits etc.