SOURCES OF FINANCE BY JASVEEN KAUR (MBA PHARMA) Sources of finance

Internal accruals Securities Term loans Working capital advances

Internal accruals Internal accruals of a firm consist of depreciation, amortisation, and retained earnings. Depreciation Depreciation represents the allocation of capital expenditure to various periods over which the capital expenditure is expected to benefit the firm. It is a non-cash charge. Suppose the estimated economic life of a machine costing Rs 100,000 is 5 years. The machine would be depreciated every year in the P&L a/c with Rs 20,000( straight line method) which represents a non cash expense which can be considered as an internal source of financing Retained Earnings That portion of Equity earnings ( PAT less preference dividend) which are ploughed back in the firm Also called internal equity or ploughed back earnings.

EQUITY CAPITAL Equity capital represents ownership capital as equity shareholders collectively own the company. They enjoy the rewards and bear the risks of ownership Authorised capital Issued capital Subscribed capital Paid-up capital Par value Issue price

Book value( Net worth/ no of outstanding equity shares) Market value SHARE CAPITAL Funds raised by issuing shares in cash .The amount of share capital a company has can change over time because each time a business sells new shares to the public in exchange for cash ,the amount of share capital will increase The amount of share capital a company reports on its balance sheet only accounts for the initial amount for which the original shareholders purchased the shares from the issuing company Any price differences arising from appreciation /depreciation as a result of transactions in secondary market are not included Authorized share capital also referred as registered capital . This is the total of share capital which a limited company is allowed to issue to its shareholders. The number is specified in MOA and AOA when a firm is incorporated ,but can be changed later with shareholders approval Issued share capital is the total of share capital issued to shareholders Paid up share capital is the issued capital paid in full by the shareholders

RIGHTS OF EQUITY SHAREHOLDERS Right to residual claim on Income of the firm Right to Control and Voting rights

Equity shareholders elect the Board of Directors which in turn select the management which controls the operations of the firm. Hence, equity shareholders exercise an indirect control over the operations of the firm Right in Liquidation

Equity shareholders have residual claim over the assets of the firm in the event of liquidation . Claims of all others employees ,tax authorities, debenture holders, secured lenders, unsecured lenders , other creditors and preferred shareholders are settled prior to equity holders

ADVANTAGES

no compulsion to pay dividends equity capital provides a cushion to the lenders,

it enhances the creditwor thiness of the company Dividends are tax exempt in the hands of investors. The company however is required to pay a DDT of 15% PREFERENCE CAPITAL Preference capital represents a hybrid form of financing(senior to equity and subordinate to debt). It partakes some characteristics of equity and some attributes of debt. TYPES Cumulative and Non- cumulative Participating preference shares and Non- participating Redeemable and Non-redeemable Convertible and Non- convertible

DEBENTURES Debentures are instruments for raising debt finance. Debenture holders are the creditors of the company. The obligation of a company toward its debenture holders is similar to that of a borrower who promises to pay interest and principal at specified times. Debentures often provide more flexibility than term loans as they offer greater choice with respect to maturity, interest rate, security, repayment, and special features. TYPES Zero coupon bonds Does not carry coupon or interest rate Issued at a discount over the face value and the bondholder receives the full principal amount at the redemption date( diff bwt the issue price and redeemable price acts as interest for the holder) Helps the issuers in conserving cash flows during the life of the bond Attractive to investors as it protects them from reinvestment rate risk The issue price of this bond is inversely related to their maturity period i.e longer the maturity period lesser the issue price

CONVERTIBLE DEBENTURES Convertible partially(PCD)s or fully in to equity shares(FCDs)

The conversion premium and the conversion timing and guidelines should be stated in the prospectus SEBI restricts the conversion period to 36 months

Compulsory credit rating in conversion period exceeds 18 months Carry a lower rate of interest than non convertible ones, so a cheaper source of finance They entail lower financial burden but can lead to expensive dilution later

JUNK BONDS High risk and high yield bonds Coupon rates range from 16 to 25% Graded below the investment grades.