Long term financing is a form of financing that is provided for a period of more than a year which may extends up to 30 years. Long term financing are provided to those business entities that face a shortage of capital.
This type of financing may be needed to fund expansion projects, purchase fixed assets, develop a new product, R&D, Mergers and acquisitions etc. The methods of financing these types of projects will generally be quite complex.
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Finance is needed for all kind of business irrespective of their size and nature of activities. Financing requirement of a business can be classified into two categories namely; long term and short term. Long term finance is needed for the acquisition of fixed assets like plant, machinery and other long term assets.
The main reasons a business needs finance are to:
For example, a lease is a special type of long-term debt-financing instrument that allows lessor to benefit from the use of an asset in exchange for rental payments without having to purchase the asset.
Capital investments, such a real estate, machinery, vehicles, furniture and leases, provide real benefits to a company by either increasing its productivity or expanding its operating capacity.
A business can use a wide range of sources of fund to finance their expansion plan and long term requirements of business. These sources can broadly be categories as (a) Internal sources of finance and (b) External sources of finance. Detailed classification of these sources is presented in the below figure
Every company has a statutory right to issue shares to raise funds. Also known as ordinary shares are issued to the owners of a company. Ordinary share have a nominal or face value.
Dividend on these shares is paid after the fixed rate of dividend has been paid on preference shares, if any amount is left. The rate of dividend on equity shares is not fixed and depends upon the profits available and the intention of the board to distribute dividend among shareholders.
Preference shares as those shares which carry preferential rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of the company.
Thus, both the preferential rights viz.
The rate of dividend on these shares is fixed and the dividend on these shares must be paid before any dividend is paid to ordinary shares
Debentures and Bonds are a fixed-interest, fixed term investment. They are offered by finance and industrial companies which are referred to as issuers.
They usually offer a higher return than is available from other fixed interest investments. Returns are based on a combination of official interest rates and loan rates depending on the issuer’s lending practices. They are not risk-free investments.
The term ‘venture capital’ represents financial investment in a highly risky project with the objective of earning a high rate of return. Venture capital (VC) is financial capital provided to early-stage, high-potential, high risk, growth start-up companies.
The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as biotechnology, IT, and software.
Term loans are provided to the industrial sector by commercial banks, development financial institutions, state level financial institutions and investment institutions.
Terms loans are secured or unsecured loans obtained by the company. The company has to pay interest on these term loans. The shareholders do not lose ownership control of the company by obtaining term loans.
Term loans represent long- term debt with a maturity of more than one year. Term loan is one of the most common methods of financing by companies in India.
A lease is a contract granting use or occupation of property during a specified period in exchange for a specified rent. A lease is a method of obtaining the use of assets for the business without using debt or equity financing.
It is a legal agreement between two parties that specifies the terms and conditions for the rental use of a tangible resource such as a building and equipment. Lease payments are often due annually.
The agreement is usually between the company and leasing or Financing organization and not directly between the company and the organization providing the assets. When the lease ends, the asset is returned to the owner, the lease is renewed, or the asset is purchased.
It is regarded as the most dependable source of longterm finance. Retained earnings are an easy source of internal financing to use because they are readily available (provided company have profits).
Retained earnings are the portion of net income (profit after tax) that have retained in the company and not paid out to the shareholders as dividends. Instead of paying out retained earnings, shareholders can reinvest them into the company. In other words, retained earnings refer to the undistributed profits of companies which are usually kept in the form of general reserve.
The retained profits can be used for expansion and modernization plans by the companies. The amount of retained earnings is determined by the quantum of profits, the dividend payout policy followed by the management, the legal provisions for dividend payment, and the rate of corporate taxes etc.
It is an internal source, which does not involve any cost of floatation and the uncertainties of external financing. It also strengthens the firm’s equity base, which enables to borrow at better terms and conditions.
The main drawbacks of this source are (a) it is fully dependent on the accuracy of profits; and (b) possibility of reckless use of funds by the management.
As firms grow in size they build up various fixed assets. These assets could be in the form of property, machinery, equipment, other companies or even logos. In some cases it may be appropriate for a business to sell off some of these assets to finance other projects.
So, sale of assets is another source of internal finance for financing new projects. Although a convenient method of financing some business requirements but has certain limitations like not available to all companies, no ready market for buying the assets of the companies, etc.
Financial Accounting
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