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Long term financing services are provided to those business entities that face a shortage of
capital.There are various long term sources of finance.
Purpose of Long Term Finance:
To finance fixed assets.
To finance the permanent part of working capital.
Expansion of companies.
Increasing facilities.
Construction projects on a big scale.
Provide capital for funding the operations. This helps in adjusting the cash flow.
The corporations can use long term financing for both debt and equity purposes.
Sources of Long Term Financing:
Following are the various sources of long term finance are as follows
Shares: These are issued to the general public. The holders of shares are the owners of the
business. These may be of two types:
Equity shares and
Preference shares.
Debentures: These are also issued to the general public. The holders of debentures are the
creditors of the company.
Public Deposits: General public also likes to deposit their savings with a popular and well
established company which can pay interest periodically and pay-back the deposit when due.
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 3-5 years.
A. Debt financing
The act of a business raising operatingcapital or other capital by borrowing. Most often, thi
s refers to the issuance of a bond,debenture, or other debtsecurity. In exchange for lendin
g the money, bondholders and others become creditors of the businessand are entitled to
the paymet of interest and to have their loan redeemed at the end of a given period.
-Financial leverage is the degree to which a company uses fixed-income securities such
as debt and preferred equity. The more debt financing a company uses, the higher
its financial leverage.
a) Bonds
The interest rate companies pay bond investors is often less than the interest rate they
would be required to pay to obtain a bank loan.
Issuing bonds also gives companies significantly greater freedom to operate as they see
fit - free from the restrictions that are often attached to bank loans.
b) Bank loans
Debt Advantages
Debt financing allows you to pay for new buildings, equipment and other assets used to grow
your business before you earn the necessary funds. This can be a great way to pursue an
aggressive growth strategy, especially if you have access to low interest rates.
Closely related is the advantage of paying off your debt in installments over a period of time.
Relative to equity financing, you also benefit by not relinquishing any ownership or control of the
business.
Debt Disadvantages
The most obvious disadvantage of debt financing is that you have to repay the loan, plus
interest. Failure to do so exposes your property and assets to repossession by the bank.
Debt financing is also borrowing against future earnings. This means that instead of using all
future profits to grow the business or to pay owners, you have to allocate a portion to debt
payments
B. Equity Financing
Is the method of raising capital by selling company stock to investors. In return for
the investment, the shareholders receive ownership interests in the company.
Equity financing involves not just the sale of common equity, but also the sale of other equity or
quasi-equity instruments such as preferred stock, convertible preferred stock and equity units
that include common shares and warrants.
Equity Advantages
Equity financing doesn't have to be repaid. Plus, you share the risks and liabilities of company
ownership with the new investors. Since you don't have to make debt payments, you can use
the cash flow generated to further grow the company or to diversify into other areas.
Maintaining a low debt-to-equity ratio also puts you in a better position to get a loan in the
future when needed.
It's less risky than a loan because you don't have to pay it back, and it's a good option if you
can't afford to take on debt.
You tap into the investor's network, which may add more credibility to your business.
Investors take a long-term view, and most don't expect a return on their investment
immediately.
You won't have to channel profits into loan repayment.
You'll have more cash on hand for expanding the business.
Equity Disadvantages
By taking on equity investment, you give up partial ownership and, in turn, some level of
decision-making authority over your business
Debt Versus Equity
Bonds are debt, whereas stocks are equity. This is the important distinction between the