2 SOURCES OF CORPORATE FINANCE

2.1 Sources of Owned Capital

2.1.1 Shares
2.1.2 Retained earnings
2.2 Sources of Borrowed Capital
2.2.1 Debentures
2.2.2 Acceptance of deposits
2.2.3 Bonds
2.2.4 ADR / GDR
2.2.5 Commercial Banks
2.2.6 Financial Institutions
2.2.7 Trade Credit
2.3 Distinction

INTRODUCTION :
Finance holds the key to all business activities. No business activity can ever be pursued
without financial support. Finance is necessary through out the activities of promotion, organisation
and regular operations of business. All functions of business are ultimately dependent on finance.
The Finance needed by business organisation is termed as ‘Capital’. Every business organisation
needs certain capital for its activities. A joint stock company, which is a modern form of business
organisation and being a large undertaking, requires huge capital for business. This huge capital
collection or capital formation has special significance in the management of joint stock company.
Capital formation is a process of collection of capital from various sources according to
financial plan of company.
A joint stock company collects huge funds through different sources. These various sources
of finance available to business may be explained with the following chart :
Sources of Finance based on Types of Capital

Owned Capital Borrowed Capital

Debentures, Public Deposits,

Shares Retained Earning
Bonds, ADR / GDR, Banks,
Financial Institutions,
Equity Shares Preference Shares Trade Credit

The above sources of finance may be external or internal.

External Source : When capital is raised from outsiders.
Internal Source : When capital is made available from within the organisation.

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2.1 SOURCES OF OWNED CAPITAL
The capital raised by company with the help of owners (shareholders) is called owned capital
or ownership capital. The shareholders purchase shares of the company and supply necessary
capital. It is one form of owned capital.
Another form of owned capital is retained earnings. It is also known as ploughing back of
profit. It is reinvestment of profit in the business by the company itself. Retained earning is an
internal source of finance.
Owned capital is regarded as a permanent capital, as it is returned only at the time of winding
up of the company.
Owned capital in the form of share capital, provides initial source of capital for a new
company. It can be raised any time later to satisfy additional capital needs of a company. However,
retained earnings cannot be an initial source of capital but it can be important source of capital
when company runs it’s business profitably during it’s existence.
Promoters decide the share capital required by a company. This amount of share capital is
known as authorised capital. It is stated in the Capital clause of Memorandum of Association of
the company. Let us learn in detail the various sources of owned capital.
2.1.1 Shares
The term share is defined by Section 2 (84) of the Companies Act 2013, ‘Share means a
share in the share capital of a company and includes stock’.
Share is a unit by which the share capital is divided. The total capital of company is divided
into small parts and each part is called share and the value of each part / unit is known as face
value. Share is a small unit of capital of a company. It facilitates the public to subscribe to the
capital in smaller amount.
A person can purchase any number of shares as he wishes. A person who purchases shares
of a company is known as a shareholder or a member of that company.
 Features of Shares :
1. Meaning : Share is a smallest unit in the total share capital of a company.
2. Ownership : The owner of share is called as shareholder. It shows the ownership of a
shareholder in the company.
3. Distinctive Number : Unless dematerialised, each share has distinct number for
identification. It is mentioned in the Share Certificate.
4. Evidence of title : A share certificate is issued by a company under it’s common seal.
It is a document of title of ownership of shares. A share is not any visible thing. It is
shown by share certificate or in the form of Demat share.
5. Value of a Share : Each share has a value expressed in terms of money. There may be :
(a) Face value : This value is written on the share certificate and mentioned in the
Memorandum of Association.
(b) Issue price : It is the price at which company sells it’s shares.

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 (c) Market Value : This value of share is determined by demand and supply forces in

the share market.
6. Rights : A share confers certain rights on its holder such as right to receive dividend,
right to inspect statutory books, right to attend shareholders’ meetings and right to vote
at such meetings, etc.
7. Income : A shareholder is entitled to get a share in the net profit of the company. It is
called dividend.
8. Transferability : The shares of public limited company are freely transferable in the
manner provided in the Articles of Association.
9. Property of Shareholder : Share is a movable property of a shareholder.
10. Kinds of Shares : A company can issue two kinds of shares :
(a) Equity shares. (b) Preference shares.
 Kinds of Shares (As per Section 43 of the Companies Act 2013
A company can issue different types of shares depending upon right to control, income
and risk. The following chart shows different kinds of shares.

Shares

(A) Equity Shares (B) Preference Shares

1) Equity Shares with voting right. 1) Cumulative Preference Shares.

2) Equity Shares with differential 2) Non Cumulative Preference Shares.
voting right. 3) Participating Preference Shares.
4) Non-participating Preference Shares.
5) Convertible Preference Shares.
6) Non Convertible Preference Shares.
7) Redeemable Preference Shares.
8) Irredeemable Preference Shares.

A. Equity Shares : Equity shares are also known as ordinary shares.

Companies Act defines equity shares as ‘those shares which are not preference
shares’.
The above definition reveals that :
a) The equity shares do not enjoy preference for dividend.
b) The equity shares do not have priority for repayment of capital at the time of
winding up of the company.
Equity shares are fundamental source of financing business activities. Equity share
holders own the company and bear ultimate risk associated with the ownership.

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 After paying claims of all other investors the remaining funds belong to equity
shareholders. Thus equity shareholders are ‘residual claimants’ of the income and
assets.
Equity shareholders do not carry any fixed commitment of dividend. They are
paid dividend at the rate recommended by Board of Directors. If there is no profit,
no dividend will be payable. Similarly if there is less profit, lesser dividend will be
paid. Thus the fortune of equity shareholders is tied up with the ups and downs of
the company. If the company is successful, they enjoy great financial rewards and if
the company fails, the risk falls mainly on them. It is exactly because of this position
equity share capital is known as ‘venture capital’ or ‘risk capital’. The owners of
equity shares are real risk bearers.
However, equity shareholders participate in the management of their company.
They are invited to attend general meetings. They are allowed to vote on all matters
discussed at the general meeting. They elect their representatives to manage the
company. Equity shareholders are thus real owners of the company.

 Features of Equity Shares :
1. Permanent Capital : Equity shares are irredeemable shares. The amount received
from equity shares is not refundable by the company during its life time. Equity
shares become refundable only in the event of winding up of the company or company
decides to buyback shares. Thus equity share capital is long term and permanent
capital of the company.
2. Fluctuating Dividend : Equity shares do not have a fixed rate of dividend. The rate
of dividend depends upon amount of profit earned by company. If company earns
more profit, dividend is paid at higher rate. On the other hand if there is insufficient
profit or loss, Board of Directors may postpone the payment of dividend. Equity
shareholders cannot compel them to declare and pay dividend. The income of equity
shares is uncertain and irregular. The equity shares get dividend at fluctuating rate.
3. Rights : Equity Shareholders enjoy certain rights :
a) Right to vote : It is the basic right of equity shareholders through which they
elect directors, alter Memorandum and Articles of Association, etc.
b) Right to share in profit : It is an important right of equity shareholders. They
have right to share in profit, when distributed as dividend. If the company is
successful and makes handsome profit, they have advantage of getting large
dividend.
c) Right to inspect books : Equity shareholders have right to inspect statutory
books of their company.
d) Right to transfer shares : The equity shareholders enjoy the right to transfer
shares as per the procedure laid down in the Articles of Association.
4. No preferential right : Equity shareholders do not enjoy preferential right in respect
of payment of dividend. They are paid dividend only after dividend on preference
shares has been paid.

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 Similarly, at the time of winding up of the company, the equity shareholders
are paid last. Further, if no surplus amount is available, equity shareholders will not
get anything.
5. Controlling power : The control of company is vested with the equity shareholders.
They are often described as ‘real masters’ of the company. It is because they enjoy
exclusive voting rights. The Act provides the right to cast vote in proportion to share
holding. They can exercise their voting right by proxies, without even attending
meeting in person.
By exercising voting right they can participate in the management and affairs
of the company. They elect their representatives called Directors for management
of the company. They are allowed to vote on all matters discussed at the general
meeting. Thus equity shareholders enjoy control over the company.
6. Risk : Equity shareholders bear maximum risk in the company. They are described
as ‘shock absorbers’ when company has financial crisis.
If the income of company falls, the rate of dividend also comes down. Due
to this, market value of equity shares comes down resulting into capital loss. Thus
equity shareholders are main risk takers.
7. Residual claimant : Equity shareholders as owners are residual claimants to all
earnings after expenses, taxes, etc. are paid. A residual claim means the last claim
on the earnings of company.
Although equity shareholders come last, they have advantage of receiving entire
earnings that is left over.
8. No charge on assets : The equity shares do not create any charge over assets of
the company.
Charge on assets : Means an interest or lien created on assets of the company in
favour of creditors. In case company fails to pay the debt, creditors can claim it
from the company's assets.
9. Bonus Issue : Bonus shares are issued as gift to equity shareholders. These shares
are issued free of cost to existing equity shareholders. These are issued out of
accumulated profits. Bonus shares are issued in proportion to the shares held. Thus
capital investment of (ordinary) equity shareholder tends to grow on its own. This
benefit is available only to the equity shareholder.
10. Right Issue : When a company needs more funds for expansion purpose and raises
further capital by issue of shares, the existing equity shareholders may be given
priority to get newly offered shares. This is called ‘Right Issue’. The shares are
offered to equity shareholder first, in proportion to their existing shareholding.
11. Face Value : The face value of equity shares is low. It can be generally ` 10 per
share or even ` 1 per share.
12. Market Value : Market value of equity shares fluctuates according to the demand
and supply of these shares. The demand and supply of equity shares depend on profits
earned and dividend declared. When a company earns huge profit, market value of
its shares increases. On the other hand when it incurs loss, the market value of it’s
shares decreases. There are frequent fluctuations in the market value of equity shares

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 in comparison to other securities. Therefore equity shares are more appealing to the
speculator.

Speculator tries to make profit from a security’s price change.

13. Capital Appreciation : Share Capital appreciation takes place when market value
of shares increases in the share market. Profitability and prosperity of the company
enhances reputation of company in the share market and it facilitates appreciation
of market value of equity shares.

 Types of Equity Shares :

The equity share can be of two types :
a) with voting rights.
b) with differential voting right.
a) Equity shares with normal voting right : Voting right of such equity holders
is in proportion to his share holdings.
b) Equity shares with differential voting right : Such equity holders shall have
varying rights regarding dividend, voting or otherwise in accordance with Rule
4 of Companies (Share Capital and Debentures) Rules 2014.
Thus company can issue shares with limited voting rights or no voting rights. They
may be entitled to extra rate of dividend, if any.

B. Preference Shares :
As the name indicates, these shares have certain preferential rights distinct from
those attached to equity shares.
The shares which carry following preferential rights are termed as preference shares :
a) A preferential right as to payment of dividend during the life time of company.
b) A preferential right as to the return of capital in the event of winding up of company.
The holder of preference share have a prior right to receive fixed rate of dividend
before any dividend is paid to equity shares. The rate of dividend is prescribed at the
time of issue.
Normally preference shares do not carry any voting power. They have voting right
only on matters which affect their interest, such as selling of undertaking or changing
rights of preference shares, etc. or they get voting rights if dividend remains unpaid.
The preference shareholders are co-owners of the company but not controllers. These
shares are purchased by cautious investors who are interested in safety of investment
and who want steady returns on investments.
 Features of Preference Shares :

1. Preference for dividend : Preference shares have the first charge on the distributable
amount of annual net profit. The dividend is payable to preference shareholders
before it is paid to equity shareholders.

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 2. Preference for repayment of capital : Preference shareholders have a preference
over equity shareholders in respect of return of capital when the company is
liquidated. It saves preference shareholders from capital losses.
3. Fixed Return : These shares carry dividend at fixed rate. The rate of dividend is
pre-determined at the time of issue. It may be in the form of fixed sum or may be
calculated at fixed rate.
The preference shareholders are entitled to dividend which can be paid only
out of profits. If the directors, in financial crisis, decide not to pay dividend, the
preference shareholders have no claim for dividend.
4. Nature of Capital : Preference shares do not provide permanent share capital. They
are redeemed after certain period of time. A company can not issue irredeemable
preference shares.
Preference capital is generally raised at a later stage, when the company gets
established. These shares are issued to satisfy the need for additional capital of the
company.
Preference share capital is safe capital as the rate of dividend and market value
does not fluctuate.
5. Market Value : The market value of preference share does not change as the rate
of dividend payable to them is fixed. The capital appreciation is considered to be
low as compared with equity shares.
6. Voting rights : The preference shares do not have normal voting rights. They do
not enjoy right of control on the affairs of the company. They have voting rights
on any resolution of the company directly affecting their rights e.g. : Change in
terms of repayment of capital, dividend payable to them are in arrears for last two
consecutive years, etc.
7. Risk : The investors who are cautious, generally purchase preference shares. Safety
of capital and steady return on investment are advantages attached with preference
shares. These shares are boon for shareholders during depression period when
interest rate is continuously falling.
8. Face Value : Face value of preference shares is relatively higher than equity shares.
They are normally issued at a face value of Rs. 100/-.
9. Rights or Bonus Issue : Preference shareholders are not entitled for Rights or
Bonus issues.
10. Nature of Investor : Preference shares attract moderate type of investors. Investors
who are conservative, cautious, interested in safety of capital and who want steady
return on investment generally purchase preference shares.

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  Types of Preference Shares.
Types of Preference Shares

Cumulative and Participating and Convertible and Redeemable and

Non-cumulative Nonparticipating Non convertible Irredeemable
Preference Shares Preference Shares Preference Shares Preference Shares

1. Cumulative Preference Shares : Cumulative Preference Shares are those shares on

which dividend goes on accumulating until it is fully paid. This means, if the dividend
is not paid in one or more years due to inadequate profits, then this unpaid dividend
gets accumulated. This accumulated dividend is paid when company performs well.
The arrears of dividend are paid before making payment to equity shareholders.
The preference shares are always cumulative unless otherwise stated in the Articles
of Association. It means that if dividend is not paid any year, the unpaid amount is
carried forward to the next year and so on, until all arrears have been paid.
2. Non-cumulative Preference Shares : Dividend on these shares does not get
accumulated. This means, the dividend on shares can be paid only out of profits of
that year. The right to claim dividend will lapse, if company does not make profit
in that particular year. If dividend is not paid in any year, it is lost forever.
3. Participating Preference Shares : The holders of these shares are entitled to
participate in surplus profit besides preferential dividend. The surplus profit which
remains after the dividend has been paid to equity shareholders, up to certain limit,
is distributed to preference shareholders.
4. Non-participating Preference Shares : The preference shares are deemed to be
non-participating, if there is no clear provision in the Articles of Association. These
shareholders are entitled to fixed rate of divided, prescribed at the time of issue.
5. Convertible Preference Shares : The holders of these shares have a right to convert
their preference shares into equity shares. The conversion takes place within a certain
fixed period.
6. Non-convertible Preference Shares : These shares cannot be converted into equity
shares.
7. Redeemable Preference Shares : Shares which can be redeemed after certain fixed
period of time are called redeemable preference shares. A company limited by shares,
if authorised by Articles of Association, issues redeemable preference shares. Such
shares must be fully paid. These shares are redeemed out of divisible profit only
or out of fresh issue of shares made for this purpose.
8. Irredeemable Preference Shares : Shares which are not redeemable i.e. payable
only on winding up of the company are called irredeemable preference shares. As
per Section 55(1) of the Companies Act 2013, a company cannot issue irredeemable
preference shares.

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2.1.2 Retained Earnings :
Business organisations are subject to variation in earnings. It would be a wise decision to
keep aside a part of earning during a period of high profit. A prudent company does not
distribute the entire profit earned among shareholders. A part of profit is retained by company
in the form of reserve fund. These reserves are the retained earnings of the company. The
sum total of retained earnings gets accumulated over the years. This accumulated profits
are reinvested in the business rather than distributed as dividend.
''The process of accumulating corporate profits and their utilisation in business is called
retained earnings.''
In simple words, a part of net profit, which is not distributed to shareholders as dividend
is retained by company in the form of ‘Reserve Fund’. Company converts it’s reserves into
‘bonus share capital’ and capitalise it’s profit. This capitalisation of profit by issue of bonus
shares is known as ploughing back of profit or self financing. Bonus shares are issued free
of cost to the existing equity shareholders out of the retained earnings.
The Management can convert retained earnings into permanent share capital by issuing
bonus shares. It is an important source of raising long term capital. It is simple and cheapest
method of raising finance. It is used by established companies. It is an internal source of
finance.
Determinants of retained earnings. :
1. Total earnings of company : If there is ample profit, company can save and retain
some parts of profit. More the earnings, a company can save more. Attitude of top
management also determines the amount of retained earnings.
2. Taxation Policy : The taxation policy of government is also an important determinant
of corporate savings. If the taxes levied are at high rates, company cannot save much
of the profits in the form of reserves.
3. Dividend Policy : It is a policy of Board of Directors in regards to distribution of profits.
A conservative dividend policy is needed for having good accumulation of profit. But
this policy affects shareholders as they get dividend at a lower rate.
4. Government Control : A government is regulatory body of economic system of the
country. It’s policies, rules and regulations ensures that the companies work as per its
regulations. Company has to formulate it’s dividend policy in accordance with the rules
and regulations framed by the Government.

2.2 SOURCES OF BORROWED CAPITAL

Only owned capital is not sufficient to carry on all business activities of a joint stock
company. A company needs borrowed capital to supplement it’s owned capital.
Every trading company is entitled to borrow money. However, it is a normal practice
to have an express provision in the Memorandum of Association, enabling a company to
borrow money. Memorandum authorises company to exercise borrowing powers where as
Articles of Association provides as to how and by whom these powers shall be exercised.
The power to borrow money is normally exercised by Board of Directors of the company.

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 A private company may exercise it’s borrowing powers immediately after incorporation.
However public company cannot exercise it’s borrowing power until it secures certificate
of commencement of business.
The capital may be borrowed for short, medium or long term requirement. It is better
to raise borrowed capital at a later stage of company’s business, when company want to
expand or diversify it’s business and it requires additional capital. This additional capital
can be raised by : a) issue of debentures b) Accepting deposits c) bonds d) Loans
from commercial banks and Financial institutions, etc. Interest is paid on borrowed capital.
It is paid at fixed rate. Borrowed capital is repayable after a specific period of time.

2.2.1 Debentures
Debentures are one of the principal sources of raising borrowed capital to meet long and
medium term financial needs. Over the years debentures have occupied a significant position
in the financial structure of the companies.
The term debenture has come from the latin word ‘debere’ which means to ‘owe’.
The term debenture has not been defined clearly under Companies Act.
Sec 2(30) of the Companies Act 2013, only states that, ‘the word debenture includes
debenture stock, bonds and any other instrument of a company evidencing a debt, whether
constituting a charge on the assets of the company or not’.
Under the existing definition, debenture includes debenture stock. Debenture means a
document which either creates or acknowledges debt. Ordinarily, debenture constitutes a
charge on some property of company, but there may be a debenture without any such charge.
Palmer defines : “A debenture as an instrument under seal evidencing debt, the essence
of it being admission of indebtedness.”
Topham defines : “A debenture is a document given by a company as evidence of debt
to the holder, usually arising out of loan, and most commonly secured by charge.”
According to the above definitions, debenture is an evidence of indebtedness. It is
an instrument issued in the form of debenture certificate, under the common seal of the
company.
 Features
1. Promise : Debenture is a promise by company that it owes specified sum of money to
holder of the debenture.
2. Face Value : The face value of debenture normally carries high denomination. It is
` 100 or in multiples of ` 100.
3. Time of Repayment : Debentures are issued with the due date stated in the debenture
certificate. The principal amount of debenture is repaid on maturity date.
4. Priority of Repayment : Debentureholders have a priority in repayment of debenture
capital over the other claimants of company.
5. Assurance of Repayment : Debenture constitutes a long term debt. They carry an
assurance of repayment on due date.

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 6. Interest : A fixed rate of interest is agreed upon and is paid periodically in case of
debentures. Payment of interest is a fixed liability of the company. It must be paid by
company irrespective of the fact, whether the company makes profit or not.
7. Parties to Debentures :
a) Company : This is the entity which borrows money.
b) Trustees : A company has to appoint Debenture Trustee if it is offering Debentures
to more than 500 people. This is a party through whom the company deals with
debentureholders. The company makes an agreement with trustees, it is known
as Trust Deed. It contains the obligations of company, rights of debentureholders,
powers of Trustee, etc.
c) Debentureholders : These are the parties who provide loan and receive, ‘Debenture
Certificate’ as an evidence.
8. Authority to issue debentures : According to the Companies Act 2013, Section 179
(3), the Board of Directors has the power to issue debentures.
9. Status of Debentureholder : Debentureholder is a creditor of the company. Since
debenture is a loan taken by company, interest is payable on it at fixed rate, at fixed
interval until the debenture is redeemed.
10. No Voting Right : According to Section 71 (2) of the Companies Act 2013, no company
shall issue any debentures carrying any voting right. Debentureholders have no right to
vote at general meeting of the company.
11. Security : Debentures are generally secured by fixed or floating charge on assets of the
company. If a company is not in a position to make payment of interest or repayment
of capital, the debentureholder can sell off charged property of the company and recover
their money.
12. Issuers : Debentures can be issued by both private company and public limited company.
13. Listing : Debentures must be listed with at least one recognised stock exchange.
14. Transferability : Debentures can be easily transferred, through the instrument of transfer.
 Types of Debentures
Debentures

On the basis of On the basis On the basis of On the basis

security transfer repayment conversion
1. Secured and 3. Registered and 5. Redeemable and 7. Convertible and
2. Unsecured 4. Bearer 6. Irredeemable 8. Non convertible
Debentures. Debentures. Debenture. Debenture.
1. Secured debentures : The debentures can be secured. The property of company may
be charged as security for loan. The security may be for some particular asset (fixed
charge) or it may be the asset in general (floating charge). The debentures are secured
through ‘Trust Deed’.
2. Unsecured debentures : These are the debentures that have no security. The issue of
unsecured debentures is now prohibited by the Companies Act, 2013.

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 3. Registered Debentures : Registered debentures are those debentures on which the
name of holders are recorded. A company maintains ‘Register of Debentureholders’ in
which the name, address and particulars of holdings of debentureholders are entered.
The transfer of registered debentures requires the execution of regular transfer deed.
4. Bearer Debentures : Name of holders are not recorded on the bearer debentures.
Their names do not appear on the ‘Register of Debentureholders’. Such debentures are
transferable by mere delivery. Payment of interest is made by means of coupons attached
to debenture certificate.
5. Redeemable Debentures : Debentures are mostly redeemable i.e. Payable at the end of
some fixed period, as mentioned on the debenture certificate. Repayment can be made
at fixed date at the end of specific period or by instalment during the life time of the
company. The provision of repayment is normally made in ‘Trust Deed’.
6. Irredeemable Debentures : These kind of debentures are not repayable during life time
of the company. They are repayable only after the liquidation of the company, or when
there is breach of any condition or when some contingency arises.
7. Convertible Debentures : Convertible debentures give right to holder to convert them
into equity shares after a specific period of time. Such right is mentioned in the debenture
certificate. The issue of convertible debenture must be approved by special resolution
in general meeting before they are issued to public. These debentures are advantageous
for the holder. Because of this conversion right, convertible debentureholder is entitled
to equity shares at a rate lower than market value.
8. Non-convertible Debentures : Non-convertible debentures are not convertible into
equity shares on maturity. These debentures are redeemed on maturity date. These
debentures suffer from the disadvantage that there is no appreciation in value.

2.2.2 Acceptance of Deposit

Public deposit is an important source of financing short term requirements of company.
Companies receive fixed deposits from the public for the period ranging from 6 months to
36 months. Such deposits are called as Public Deposits.
Under this method, general public is invited to deposit their savings with the company
for varied period. Interest is paid by companies on such deposits. The company issues
‘Deposit Receipt’ to depositor. The terms of deposit are mentioned in the ‘Deposit Receipt’.
Deposit Receipt is an acknowledgement of debt/loan by the company. Deposits are either
secured or unsecured loans offered to the company.
Meaning :
As per section 2 (31) of Companies Act, 2013, ‘deposit’ includes any receipt of money
by way of deposit or loan or in any other form by a company, but does not include such
categories of amount as may be prescribed in consultation with the Reserve Bank of India.
The above expression has been further elaborated by Rule 2 (1)(c) of Companies
(Acceptance of Deposits) Rules 2014. This Rule provides that ‘deposit’ means any receipt

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 of money, in the form of deposit or loan by a company. However, ‘deposit’ does not include
following :
1. Any amount received from Central Government or a State Government.
2. Any amount received as loan from any banking company.
3. Any amount received from foreign government or international banks.
4. Any amount received by a company from any other company.
5. Any amount raised by issuing commercial paper.
6. Any amount raised by issue of bonds.
7. Any amount received in trust.
8. Any amount received by way of subscription to any shares or debentures.
(Terms and conditions of acceptance of Deposits are discussed in detail in Chapter 5.)

2.2.3 Bond
Bond is a debt security. It is a formal contract to repay borrowed money with interest.
Bond is a loan. The holder of bond is a lender to the institution. He is a creditor of the
company. He gets fixed rate of interest.
All bonds have maturity date and is paid in cash at certain date in future.
According to Webster Dictionary, ‘A bond is an interest bearing certificate issued by the
government or business firm, promising to pay the holder a specific sum at a specified date.’
Thus a company borrows money and issues bonds as an evidence of debt. Interest is
payable on bonds at fixed interval or on maturity of bonds.
Features
1. Nature of Finance : It is a debt Finance. It provides long term finance. The bonds can
be issued for longer period i.e. 5 years, 10 years, 25 years, 50 years.
2. Status of bondholder : The bondholders are creditors. Since they are creditors and
non-owners they are not entitled to participate in general meeting. They have no voting
right and hence no participation in the management.
3. Return on bonds : The bondholder gets a fixed rate of interest. It is payable at regular
interval or on the maturity of bond.
4. Repayment : Bonds have specific maturity date on when the principal amount is repaid.
2.2.4 American Depository Receipt (ADR) and Global Depository Receipt (GDR)
In India, the shares of public company are listed and traded on various stock exchanges
like Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).
With adoption of free economic policy and due to globalization some of the Indian
company's shares are also listed and traded on foreign stock exchanges like New York
Stock Exchange (NYSE) or National Association of Securities Dealer Automated Quotation
(NASDAQ). To list shares on these stock exchanges, company has to comply with policies
of those stock exchanges. The policies of these stock exchanges are different than the
policies of Indian Stock Exchanges. Therefore, those Indian companies which can not list
their shares directly on foreign stock exchanges, get listed indirectly using ADR and GDR.

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 ADR and GDR are Dollar/Euro denominated instrument traded in USA and Europe
Stock Exchanges.
Indian Company issues shares to an intermediary called ‘Depository’. Bank of New
York, Citigroup etc. act as foreign Depository Bank. This Depository bank issues ADR and
GDR to investors against these shares. The ADR / GDR represent fixed number of shares.
These ADR / GDR are then sold to people in foreign country. The ADR / GDR are traded
like regular shares. They are listed on stock exchanges. The prices fluctuate depending on
demand and supply.
Both ADR and GDR are depository receipts, but only difference is the location where
they are traded. If the Depository Receipt is traded in USA, it is called American Depository
Receipts (ADR) and if it is traded in a country other than USA is called Global Depository
Receipts (GDR).
Non-Resident Indians (NRI) and Foreign nationals can invest their money in India by
purchasing ADR and GDR. They can buy ADR / GDR using their regular equity trading
Account.
The company pays dividend in home currency to the depository bank and the depository
bank converts it into the currency of investor and pays dividend.
The exchanges on which GDR is traded are as follows :
1) London stock exchange.
2) Luxembourg Stock exchange.
3) NASDAQ Dubai.
4) Singapore Stock exchange.
5) Hongkong Stock exchange.

Activity : Find out Indian Companies who have issued ADR as well as GDR.

2.2.5 Commercial Banks

There are number of sources of financing short and medium term business requirements.
Among these, commercial bank constitute the most predominant source. Commercial banks
play significant role in corporate financing in India. Commercial banks, by introducing
variety of deposit schemes tailored to individual depositor’s need, mop up savings of people
and make use of these savings to meet varied requirements of corporate enterprises.
Commercial banks assist corporate enterprises -
1) By Granting term loans to companies.
2) By subscribing to shares and debentures of companies.
3) By underwriting the issue of securities of the Company.
Commercial banks also play an important role in providing short term finance. They
have become primary source of financing working capital of the business. In India, primary
source of financing working capital are bank credit and trade credit.

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Banks have introduced many innovative schemes for disbursement of credit. They are as follows :
1. Overdraft : A company having current account with bank is allowed overdraft facility.
The borrower can withdraw funds as and when needed. He is allowed to overdraw
on his current account, up to the credit limit which is sanctioned by bank. Within
this stipulated limit any number of drawings are permitted. Repayments can be made
whenever required during the time period. The interest is determined on the basis of
actual amount withdrawn.
2. Cash Credit : It is also an important and popular form of financial aid. This form of
credit is operated in same manner as overdraft facility. The borrower can withdraw
amount from his cash credit account up to a stipulated limit based on security margin.
Cash credit is given against pledge or hypothecation of goods or by providing alternative
securities. Interest is charged on outstanding amount borrowed and not on the credit
limit sanctioned.
3. Cash loans : Under this, the total amount of loan is credited by bank to the borrowers
account. Interest is payable on actual balance outstanding.
4. Discounting bills of exchange : The drawer of the bill i.e. (seller) can receive money
from drawee (i.e. buyer) on due date or after the due date. Drawer can receive money
before due date by discounting the bill with the bank. This is nothing but selling the
bill to the bank. The bank gives money to drawer less than the face value of the bill.
Thus bill of exchange are trade bills. They are accepted by bank and cash is advanced
against them.
2.2.6 Financial Institutions
First industrial policy was declared in 1948 for rapid industrial development in the country.
The Central Government and State Government have established special financial institutions
for providing industrial finance. These institutions provide medium and long term finance.
The assistance of these institutions has become important for new companies as well as
going concerns.
Financial Institutions are classified into four categories as follows.

Financial Institutions in India

Development Financial Investment State Level

Banks Institutions Institutions Institutions

LIC UTI GIC SFC SIDC

RCTC TDICI TFCI

IDBI IFCI ICICI SIDBI IRBI

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 I. Development Banks
1. Industrial Development Bank of India (IDBI).
2. Industrial Finance Corporation of India Ltd. (IFCI)
3. Industrial Credit and Investment Corporation of India (ICICI)
4. Small Industries Development Bank of India (SIDBI)
5. Industrial Reconstruction Bank of India (IRBI)
II. Financial Institutions
1. Risk Capital and Technology Finance Corporation Ltd. (RCTC)
2. Technology Development and Information Companyof India Ltd. (TDICI)
3. Tourism Finance Corporation of India Ltd. (TFCI)
III. Investment Institutions
1. Life Insurance Corporation of India (LIC)
2. Unit Trust of India (UTI)
3. General Insurance Corporation of India (GIC)
IV. State Level Institutions
1. State Finance Corporations (SFC)
2. State Industrial Development Corporation (SIDC)
Above mentioned institutions provide financial assistance in the following forms :
1. To provide term lending facilities.
2. To subscribe to shares and debentures.
3. To underwrite the issue of securities.
4. To lend money.
5. To guarantee term loans raised by company.

Activity :
Study the role of different financial institutions in raising funds for companies.

2.2.7 Trade Credit

No business can be run without ‘credit’. Credit is the soul of business. Trade credit
financing is major source of short term financing.
Manufacturers, wholesalers and suppliers of goods or materials are called ‘trade
creditors’. They sell tangible goods to other business concerns on the basis of deferred
payment i.e. future payment credit is extended by these business concerns with an intention
to increase their sales. The business firm extends credit, also because of custom that has
been built up overtime.
Trade credit is not cash loan. It results from a credit sale of goods / services, which
has to be paid at a future date after the sale takes place. In other words, when goods are
delivered by supplier to a customer and the payment is made after some time, it is called
as trade credit.

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 In distributive trade this kind of credit has great significance. The small retailers, to
large extent rely on obtaining trade credit from supplier. It is an easy kind of credit which
can be obtained without signing any debt instrument. It is readily available and is cheap
method of financing.
Suppliers sell goods and willingly allow 30 days or more, for bill to be paid. They
even offer discount, if bills are cleared within a short period such as 10 days or 15 days,
etc. The terms of trade credit are not rigid.

2.3 DISTINCTION
1. Shares and Debentures

Points Shares Debentures

1. Meaning A share is a part of share capital A debenture is a certificate of loan
of a company. It is known as taken by a company. They are also
ownership securities. known as creditorship securities.
2. Status A holder of shares is the owner of A holder of debenture is creditor
company. Therefore share capital of the company. Debenture capital
is owned capital. is loan capital or borrowed capital.
3. Nature It is permanent capital. It is not It is temporary capital. Generally
repaid during the life time of the it is repaid after a specific period.
company.
4. Voting / Shareholders being owners enjoy Debentureholders being creditors,
Right normal voting rights in general do not have any voting right.
meeting. They participate in the They can not participate in the
management of the company. management of the company.
5. Return on Return on shares is called Return on debenture is called
Investment dividend. Equity shareholders interest. It is fixed at the time of
receive divided at fluctuating rate issue. Interest is paid even when
where as preference shareholders company has no profit.
receive divided at fixed rate.
6. Security Share capital is unsecured capital. Debenture capital being loan
No security is offered to the capital is secured by creating a
shareholder. charge on Company’s property.
7. Time of Shares are issued in the initial Debentures are issued at a later
Issue stages of the company formation. stage, when the company has
properties to offer as security.
8. Suitability Shares are suitable for long term Debentures are suitable for medium
finance. term finance.

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 Points Shares Debentures
9. Types Shares are classified into __
Debentures are classified as :
a) Equity shares a) Registered Debentures
b) Preference b) Bearer Debentures
c) Secured Debentures
d) Unsecured Debentures
e) Redeemable Debentures
f) Irredeemable Debentures
g) Convertible Debentures
h) Non - convertible Debentures
10. Position on On liquidation of a company, Debentureholders being creditors,
liquidation share holders rank last in the list rank prior to shareholders for
of claimants. repayment on liquidation of
company.

2. Equity Shares and Preference Shares

Points Equity Shares Preference Shares

1. Meaning Shares that are not preference Preferences shares are Shares
shares are called equity shares that carry preferential right as to
i.e. these shares do not have payment of :
preferential right for payment of a) Dividend and
dividend and repayment of capital. b) Repayment of capital.
2. Rate of Equity shares are given dividend Preference shareholders get
Dividend at fluctuating rate depending upon dividend at fixed rate.
the profits of the company.
3. Voting Equity shareholders enjoy normal Preference shareholder do not
Right voting right. They participate in enjoy normal voting right. They
the management of their company. can vote only on matters affecting
their interest.
4. Return of Equity capital can not be returned A company can issue redeemable
Capital during the life time of the company. preference shares, which can be
(except in case of buy back) repaid during the life time of the
company.
5. Nature of Equity capital is known as 'Risk Preference capital is ‘Safe Capital’
capital Capital.' with stable return.
6. Nature of The investors who are ready to The investors who are cautious
investor take risk invest in equity shares. about safety of their investment,
invest in preference shares.

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 Points Equity Shares Preference Shares
7. Face value The face value of equity shares The face value of preference shares
is generally ` 1/- or ` 10/- it is is relatively higher i.e. ` 100/- and
relatively low. so on.
8. Right and Equity shareholder is entitled to Preference shareholders are not
bonus issue get bonus and right issue. eligible for bonus and right issue.
9. Capital Market value of equity shares Market value of preference shares
appreciation increases with the prosperity of does not fluctuate, so there is no
company. It leads to increase in possibility of capital appreciation.
the value of shares.
10. Risk Equity shares are subject to higher Preference shares are subject to
risk. That is because of fluctuating less risk. It is because of fixed
rate of dividend and no guarantee rate of dividend and preferential
of refund of capital. right as regards to dividend and
repayment of capital.
11. Types Equity shares are classified into : Preference shares are classified
a) equity shares with normal voting as :
right. a) Cumulative Preference Shares
b) equity shares with differential b) Non-Cumulative Preference
voting right. Shares
c) Convertible Preference Shares
d) Non-Convertible Preference
Shares
e) Redeemable Preference Shares
f) Irredeemable Preference Shares
g) Participating Preference Shares
h) Non-Participating Preference
Shares
3. Owned capital and Borrowed capital
Points Owned Capital Borrowed Capital
1. Meaning It is that capital which is contributed It is that capital which is borrowed
by shareholders. from creditors. It is also known as
debt capital.
2. Sources This capital is collected by issue It is collected by way of issue of
of equity shares and preference debentures, fixed deposits, loan
shares. from bank/financial institutions,
etc.

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 Points Owned Capital Borrowed Capital
3. Return on The shareholders get dividend as The debt capital holders get interest
Investment income on their investment. Rate as income on their investment.
of dividend is fluctuating in case Interest is paid at fixed rate.
of equity shares but fixed in case
of preference shares.
4. Status The shareholders are owners of The debt holders are creditors of
the company. the company.
5. Voting right The equity shareholders enjoy The creditors do not enjoy voting
normal voting right at the general rights at the general meeting.
meeting.
6. Repayment The shareholders do not enjoy The creditors get priority over the
of Capital priority over creditors. They are shareholders in case of return of
eligible for repayment of Capital principal amount at the time of
only after making payment to winding up of the company.
creditors at the time of winding
up of the company.
7. Charge on The shareholders do not have The secured debenture holders have
assets any charge on the assets of the a charge on assets of the company.
company.

SUMMARY

 The various sources of finance can be divided as owned capital and borrowed capital.
 Share is a small unit of share capital of a company.
 Equity Shares do not enjoy preference for dividend and do not have priority for payment of
capital at the time of winding up of company.
 Preference shares have prior right to receive fixed rate of dividend and return of capital in
the event of winding up of the company.
 The debt acknowledged by a company by issuing debenture certificate is called debenture.
 Bond is an instrument issued by government or business firm as an evidence of debt.
 Retained earning is sum total of accumulated profit which are reinvested in the business.
 Public deposit is a loan accepted by company for short period of time ranging from 6 months
to 36 months.
 Company can raise loan from banks in the form of overdraft,cash credit, cash loans, etc.
 Trade credit is a credit extended by manufactures and suppliers to customers.
 ADR and GDR are depository receipts through which Indian companies raise equity capital
in international market.

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