Source of Finance for a Joint Stock Company
There are two types of finance in a joint stock company – long term finance and short-term finance. Long term finance can be raised by issue of debentures, loans from commercial banks, issue of shares, retained earnings, loans from financial institutions whereas short term finance can be raised through public deposits, trade credits, incorporate deposits, commercial banks, customer advances factoring and instalment credit. Therefore, let us understand the differences and the basics of these two types of sources of finance, which may easily provide assignment help to the students.
The long-term sources of finance are as follows:
● Equity shares:
Equity shares or ordinary shares are those shares which do not carry any preference rights or priority while paying the dividend or repaying the capital.
They are issued before any other securities, but their repayment is done in the last. When the company declares dividend or when there are profits, then only dividend on such shares is payable.
After the dividend is paid on the preference shares, then only the dividend on equity shares is paid. Equity shareholders are paid the dividend after all the other claims are paid, at the time of winding up of a company. Hence, the maximum risk is bared by the equity shareholders.
But they have full control over the management and enjoy full voting rights. All the residual profits of the company are entitled to him. The benefit of trading on equity is not available when the entire share capital is raised through equity shares.
● Preference shares:
Preference shares are those shares which have certain preferential rights or privileges while paying the dividend or returning the capital. Before any dividend is paid on equity shares, the dividend should be paid on preference shares at a fixed rate.
At the time of winding up of the company, before paying the capital to equity shareholders, the capital must be paid to the preference shareholders. Except when dividend is outstanding for more than two years, preference shares do not carry any voting rights.
Therefore, preference shares are known as hybrid security as it comprises the features of both the equity shares and debentures. Just like equity shares, the dividend on preference shares is paid only when there are profits.
Like debentures, preference shares prioritize equity shares and have a fixed rate of dividend but no voting rights. Since, dividends are paid only out of profits, preference shares do not put a fixed burden on finances.
● Retained earnings:
Retained earnings also known as ploughing back of profits means that a part of the net profit is retained year after year and then is reinvested in the business.
It is an internal method of finance. Hence, is called ‘self-financing’. For expansion and modernization of business, retained earnings are popular source of capital.
● Debentures:
A debenture refers to a certificate which is issued by a company under its common seal for acknowledgment of debt with or without charging a company’s asset.
The payment of interest on debentures is at a fixed rate and is periodically paid until the maturity and debentures’ repayment.
They have no voting rights but generally, they involve a charge on the assets of the company. With the help of debentures, a large amount of finance can be raised.
The interest rate at a fixed rate is given to the debenture holders at periodic intervals, ignoring the profits. Without diluting or weakening the existing members, a company can raise funds as the debentures do not carry voting rights.
● Loans from Commercial banks:
Under a term loan, for a specified period, bank advances a fixed amount in lump-sum to the borrower. The interest on the sanctioned amount can be changed at a fixed rate.
The loan is only advanced when there is a security of any asset or on the personal guarantee of the borrower.
There are some short-term sources of finance as well, important to be remembered in order to get help in homework on the topic, which are as follows:
● Public deposits:
The deposits of money which are made by the public with non-banking companies are known as public deposits. In this, the depositors earn a higher rate of interest than the interest available on bank deposits.
● Trade Credit:
Trade credit refers to the credit which is extended by one business firm to another due to sale or purchase of goods and services. It is usually granted for either 15 days or three months. The firm which is buying can receive the supplies without paying immediately. Trade credit shows the power of the buyer to buy now and pay later.
● Instalment credit:
Instalment credit means the facility to buy equipment, machinery and other durable goods on credit. At the time of delivery, it is mandatory for the buyer to pay a part of the price of the asset and the left amount has to be paid in the form of instalments. The interest is charged on the balance due by the supplier and the same is included in the amount of instalment itself.
● Factoring or Accounts Receivable Financing:
Accounts receivable financing refers to the finance which is raised by selling or mortgaging book debts.
● Customer advances:
The part of the price of the goods which is booked or ordered by the customers to be supplied at a later date, it is known as customer advances.
Working capital is provided by the customer advances to the firm. But these are available to the firms which manufacture durable goods which are in short supply.
● Inter-Corporate deposit:
These deposits are very popular and also very convenient because there are no legal formalities involved in this. The identity of the borrower is kept secret.
Depending upon the amount involved and the time period, the rate of interest payable on the inter-corporate deposits varies. Only reputed companies have the inter-corporate deposits.
The points stated above, for the sources of finance for a joint stock company, facilitate the proper functioning of a company, seeing to its profits. These points are a must in case one needs assignment help or help in homework in the field.