Besides asset security, the lender of the term loans imposes other restrictive covenants to the borrower depending upon the nature of the project and the financial condition of the borrowing company. Maturity refers to the last day of paying the financier the real amount of finance. (b) Like any other form of debt financing, term loans also increase the financial risk of the company. When companies are considering new investments, they may compare available sources of finance to determine which would be most appropriate for a new endeavor. It is of vital significance for modern business which requires huge capital. The holder of a zero-coupon bond only receives the face value of the bond at maturity. In other words, bonus shares are issued when an organization has sufficient profit but is in need of more working capital at that particular time. There are generally two types of loan repayment schedules: In equal principal payment schedule, the size of the principal payment is the same for every payment. Lessee gets the right to use the asset without buying them. Preference Shares 3. They may be paid a higher rate of dividend in times of prosperity and also run the risk of no dividends in the period of adversity. Lessee is free to cancel the lease in case of change of technology. The characteristics of term loans are as follows: i. Some of the long-term sources of finance are:- 1. In case of higher profits too, the company is not legally bound to distribute dividends. Foreign Capital. Long-term sources of finance are those which help in getting funds for longer period that is more than one year. In addition, long-term financing is required to finance long-term investment projects. (ii) Over-Capitalisation Retained earnings are used for the issue of bonus shares which may result to over-capitalisation without any corresponding increase in its earnings. Internal and external sources of finance (AO2) Short-term and long-term external sources of finance (AO1) The appropriateness of sources of finance for a given situation (AO3) 3.2 Costs and revenues. A term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment. The characteristics of preference shares are as follows: i. It is required by an organization during the establishment, expansion, technological innovation, and research and development. In return, investors are compensated with an interest income for being a creditor to the issuer. The profit reinvested as retained earnings is profit that could have been paid as a dividend. Sweat equity shares are always issued at a discount. Covenant refers to the borrower's promise to the lender, quoted on a formal debt agreement stating the former's obligations and limitations. These shares carry a fixed percent of dividend, which is lower than equity shareholders. However, they may be rescheduled to enable corporate borrowers to tide over temporary financial exigencies. These low-coupon bonds are issued with call or put provisions. Some of the new financial instruments are discussed below: Zero-coupon bonds are purchased at a high discount, known as deep discount, on the face value of the bond. It is obtained from Capital market. (ii) Direct Negotiation Terms and conditions of such loans are directly negotiated between the borrower and the financial institution providing the loan. (ii) Restrictions on the Use of Asset Leasing contracts usually impose certain restrictions on the use of the asset or require compulsory insurance, and so on. Ploughing back of profits is made by transferring a part of after tax profits to various reserves such as General Reserve, Reserve Fund, Replacement Fund, Dividend Equalisation Fund etc. Cookies help us provide, protect and improve our products and services. Long term finance are capital requirements for a period of more than 1 year. (i) Right to Control Equity shareholders are the real owners of the company. His position is akin to that of a person who uses the asset with borrowed money. (B) Disadvantages or Dangers of Excessive Ploughing Back: (i) Misuse of Retained Earnings It is not necessary that the management may always use the retained earnings to the advantage of shareholders. The SPN holder has an option to sell back the SPN to the company at par value after the lock-in period. Since, both debenture and term loan are a type of debt financing, they share basic characteristics of a debt and hence their pros and cons are also similar. CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. Equity shareholders are considered as the real owners of the organization. (c) Sometimes, a conservative dividend policy leads to huge accumulation of retained earnings leading to over-capitalization. This source of finance does not cost the business, as there are no interest charges. The basic characteristics of term loan have been discussed below: The term loans are secured loans. For example, if an expansion or acquisition is allowed with venture capital, the investor might demand part ownership of the firm, rather than simply a share in the profits, including a say in management. It may also be attached to convertible debentures and equity shares also to make these instruments more attractive to investors. In India, a number of special financial institutions have been established by the Government at the national level and state level to provide medium-term and long-term loans to the industrial undertakings. Hence, if the company desires to raise further finance from other sources, it can easily do so by mortgaging its assets. For this reason, they are also called hybrid financing instruments. Later, they may increase the rate of dividend out of past profits and may sell their shares at a profit. (i) Additional Source of Finance Leasing facilitates the use of assets without making any immediate payment. Copyright 10. The advantages and disadvantages of term loans from the lenders and borrowers point of view are discussed below: (a) Term loans are provided by banks and other financial institutions against security because of which the term loans are secured. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. iii. Funds raised through these can be paid back over many years. The companys credit rating also plays a major role in raising funds via long-term or short-term means. (v) Convertibility Financial institutions usually insist on the option of converting their loans into equity shares of the company. The dividend policy of the company is determined by the directors. Financial institutions impose a penalty for defaults on the payment of installment of principal and/or interest. Being the owners of the company, they bear the risk of ownership also. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. They are issued under the common seal of the company acknowledging the receipt of money. This led to the deregulation and liberalization of the Indian economy and also increased the flow of foreign capital into the country. The regulators lay down strict regulations for the repayment of interest and principal amounts. As the foreign capital plays a constructive role in a countrys economic development, it has led to a progressive reduction in regulations and restraints that had earlier inhibited the inflow of foreign capital. In the event of the company going for rights issue prior to the allotment of equity to the holders of FCDs, FCD holders shall be offered securities as may be determined by the company. Instalment credit 5. (v) Increase in the Credit Worthiness of the Company Since the company need not depend upon outside sources for its financial needs; it increases the credit worthiness of the company. However, there are certain disadvantages of using internal accruals as a source of finance. 3.5 Profitability and liquidity ratio analysis. They have voting rights to elect directors of the company and the directors control the business. For example, the Rs.12,000 loan may be divided by the 12 payment periods each resulting in a principal payment of Rs.1,000 per loan payment. These funds may be used to finance the cost of acquisition of fixed assets that are needed for expansion, modernization and diversification programmes of the company. They have a fixed rate of dividend and they carry preferential rights over ordinary equity shares in sharing of profits and also claim over the assets of the firm. An organization uses term loans to purchase fixed assets and fund projects having long-gestation period. This is more likely to occur when other companies find it difficult to procure finance from the market whereas an existing concern continues to grow through its retained earnings. In return, investors are compensated with an interest income for being a creditor to the issuer.read more certificates under the companys common seal? Firstly, as compared to interest, dividends cannot be deducted from the income of the company while calculating taxes. An initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. Issue of Shares. Lease financing, therefore, does not affect the debt raising capacity of the enterprise. (ii) Tax Benefits The lessor is entitled to claim the depreciation of leased asset and thus reduces his tax liability. Although depreciation is meant for replacement of particular assets but generally it creates a pool of funds which are available with a company to finance its working capital requirements and sometimes for acquisition of new assets including replacement of worn out plant and machinery. (iii) High Profitability Leasing business is highly profitable to the lessor because the rate of return is more than what the lessor pays on his borrowings. These various sources are described below. The sources from which a finance manager can raise long-term funds are discussed below: 1. One can safely use it for business expansion and growth without taking additional debt burden and diluting further. (i) Fully Secured The lessors interests are fully secured because he is the owner of the leased asset and can take possession of the asset in case the lessee defaults. Cumulative Preference Shares Refer to the shares for which dividends get accumulated over a period of time. Share capital or Equity shares Therefore, they can get the right to control the affairs of the company. Long term sources of finance are those, which remains with the business for a longer duration of time. Rate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. They are a common source of long-term finance. Generally, equity shares are repaid at the time of winding up of an organization. Internal finance can be appealing for certain types of investments, while in other cases, it may be advantageous to tap external financing. Foreign capital is typically seen as a way of filling in gaps between the targeted investment and locally mobilized savings.
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