Sources of business finance

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SOURCES OF BUSINESS FINANCE
Finance is the management of money. It is the provision of money at the time it is wanted. Finance includes the
evaluation, disclosure and management of economic activity. Business Finance is concerned with planning, raising,
controlling and administering the funds used in the business. The business collects the finance from various purposes
and at different stages for different period. Company uses the sources of capital as per requirement of business. These
sources are classified into two groups.
A. Internal Sources: When company collect capital from inside the organization, these sources are known as internal
sources. Such as Reserve Fund, Sales Revenue and other provisions. These sources does not provide huge amount to
the organization.
B. External Sources: When company collect finance from the outside sources, these sources are known as external
sources. The organization collects huge finance from these. It included equity shares, preference shares, debentures,
bonds, deposits, loan from financial institution, short term loans and advances etc.
The internal and external sources are also classified as per the period of finance as follows.
1. Long Term Sources: When organization raise finance for more than five years and requirement of fixed capital,
these sources are known as ‘Long Term Sources’. It included equity shares, preference shares, debentures, bonds,
loan from financial institution etc.
2. Short Term Sources: When company collect finance for satisfy day-to-day expenditure or requirement of working
capital, these sources are known as ‘Short Term Sources’. It included Bank Advances, Trade Credit, Discounting of
Bills of Exchange, and Receive Deposit from Public etc.
SourcesofBusinessFinance
Long Term Sources
Owned Capital
Shares
Equity Shares
Prefernce Shares
Retained Earnings
Borrowed Capital
Debentures
Bonds
Loans From
Financial Institution
Short Term Sources
Public Deposit
Bank Credit
Trade Credit
Other Short Term
Sources

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Owned Capital
Owned Capital consists of the amount contributed by owners as well as the profits reinvested in the business. It
does not create any obligations regarding payment of return as well as repayment of capital. Company provide dividend
as a return on owned capital. The dividend rate always fluctuates. It is repayable at the time of winding up of the
company. Owned Capital is highly risky as there is high degree of uncertainty over the payment of dividend and
repayment of capital. The owned capital providers are known as Shareholder/Owners/Members of the company. The
owner enjoys voting rights as well as management rights. It does not require security of assets to be offered to raise
owned capital. It is mentioned in capital clause of Memorandum of Association. It is a permanent capital. It is issued in
the initial stage of the company. It is collected by issue of shares (Equity and Preference) and Retained Earnings.
Shares
Capital is required by every type of business organization. The capital requirement changes as per the size as well as
nature of business activities. Business organization can neither be formed nor expanded without the availability of
capital. A company has two sources of capital: Owned Capital and Borrowed Capital
Owned Capital consists of the amount contributed by owners as well as the profits reinvested in the business. It
does not create any obligations regarding payment of return as well as repayment of capital. It is a permanent capital. It
is issued in the initial stage of the company. It is collected by issue of shares. The capital collected by a company by
selling its shares is called as share capital.
Definitions
1. “Shares represent a portion of capital which in term refers to money by issue of shares”
2. “Total share capital of a company is divided into many units of small denominations. Each such unit is called as a
share.”
3. “A share is a share in the share capital of a company and includes stock except when a distinction stock and share is
expressed or implied.”_______ Sec. 2(46) of the Companies Act, 1956.
4. “Share means a share in the share capital of a company and includes stock.” ___Sec 2 (84) Companies Act 2013.
From the above definition, it is clear that share is the smallest part of owned capital, which is not repaid up to
longer period of time. Shares include stock. Stock means a bundle of shares. If company mentions separation regarding
share and stock, therefore they are separate from each other. If not mention, there is no difference between share and
stock. Stocks are fully paid but shares may be fully or partly paid. A person invest money in the shares is known as
‘owner/shareholder/member’ of the company. Also, he gets some rights and performs some duties towards the
company.
Features of Shares
1. Unit of Share Capital: A share is a smallest part or unit in the total share capital. The share capital of the company
is divided into small parts and theses parts are known as shares. E.g. Company has total share capital of 1 Crore.
This share capital is divided into 10, 00,000 shares. Therefore one share value is 10/- each.
2. Face Value: This value is written on share certificate and mentioned in the Memorandum of Association (MOA) and
Articles of Association (AOA). The face value of shares has fixed value. It does not change on any circumstances.
When company repay the shares to the shareholders that time consider the face value of share. On the dividend
calculation Company considers only face value of share. The face value of share may be 1/-, 2/-, 5/-, 10/-,
100/- and so on. The shares have market value which may be more or less than the face value.

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3. Issue Value: It is the price of shares when company sells shares to the general public. Company may issue shares at
par (equal to face value), at premium (more than face value) and at discount (less than face value).
4. Paid-up Value: Shares are fully paid up or partly paid up. Fully paid –up means shareholder pay the complete face
value to the company and partly paid up means if shareholder remains not paid full amount of face value. E.g. Mr. A
purchased one share of ABC Limited of face value is 100/- and he paid all face value 100/-. It is known as fully
paid-up shares. Mr. B purchase of XYZ Co. Ltd shares of face value 100/- and he paid only 50/- and remain unpaid
50/-, it is known as partly paid-up shares
5. Distinctive Numbers: The every share have different serial numbers from other shares, these numbers are
mentioned on the share certificate and in the Register of Members. It is a share identification number.
6. Status of holders: The owners of the shares are called ‘Shareholders/Owners/Members’ of the company. The
shareholder may be an individual, joint, company or society. For the holding of shares the person completes the
norms regarding Indian Contract Act 1872. (Major, solvent, sound mind and does not disqualify by any law for
making contract).
7. Transferability: The shares are movable property of the shareholders. They have right to transfer the shares any
time to others by way of sales or gift. It can mortgage to bank for loan. The shares of public limited company are
freely transferable to anybody. But in the private limited company shareholder first have to offer shares to the
existing shareholders, if they are not interested, then offer to general public.
8. Income: The shareholders invest money in the company. For this investment company provide return to the
shareholders. The returns on shares are known as dividend. It is a part of profit which is declared by company to the
shareholders. The preference shareholders get fixed rate of dividend and equity shareholders get fluctuating rate of
dividend.
9. Rights: Shareholders enjoy membership rights, these rights include receive the notice of meeting, attend the
meeting, receive dividend, elect as a director, receive documentary evidence for holding of shares (share certificate
or share warrant), to inspect the books of accounts etc.
10. Types: The Indian Companies Act, 2013 classify the shares into two types: (Sec 43)
A. Equity Shares: Those shares do not get any preference regarding payment of dividend and repayment of capital
at the time of winding up company; these shares are known as Equity Shares.
B. Preference Shares: Those shares have preference regarding payment of dividend and repayment of capital at
the time of winding up company; these shares are known as Preference Shares.
Share Capital
Capital is required by every type of business organization irrespective of its size as well as its nature of activities.
A business organization can neither be formed nor can it be expanded without the availability of capital. Company has
two sources of capital. One is Owned capital and another is borrowed or loaned capital. Owned capital is that capital of
the company which is not returnable and can be used permanently for the purpose of starting and promoting business
activities. It is used for life time of the business. This capital raised either by selling shares to public or by ploughing
backs the profits of the company into business.
“The capital collected by a company by selling its shares to public is called as Share Capital”
Share capital is a part of owned capital of a company. The persons who provide owned capital are known as
shareholders. Shareholder are consider owner of company. The return on their investment in the share capital of the
company is known as dividend which is paid to them only when the company has sufficient distributable profits. It can
be raised by private companies as well as public companies limited by shares. Company issues two types shares- Equity
shares and Preference shares. Equity shares are not repaid during the life time company. Preference shares are repaid
after specific time period.
The term share capital of a company is used in many expressions. It is denoted differently at different levels. All
expressions are known as ‘Types of Share Capital’. They are as follows:

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1. Authorized Capital [Sec 2(8)]: The maximum amount of capital which a company can bring to the market for
sale is called as Authorized Capital. This amount is mentioned in the capital clause of Memorandum of
Association which is registered with the Registrar of Companies. So, this capital is also known as Registered
Capital. If a company wants to raise capital more than the authorized limit then it have to alter Capital Clause of
Memorandum of Association by passing special resolution in shareholder meeting.
2. Issued Capital [Sec 2(50)]: It is that part of authorized capital for which is actually offered by the company for
subscription. It includes both, the shares offered to general public as well as the subscribed by the signatories
(promoters) to Memorandum. Company cannot issue all the shares of authorized capital at a time.
3. Un-issued Capital: It is that part of authorized capital, which is not offered by company for subscription.
Authorized capital is always issued by companies for subscription as per requirement. It is issued in future as per
need of company.
4. Subscribed Capital [Sec 2(86)]: It is that part of issued capital for which the company has actually received the
application. These are shares which are taken up by the public. When the shares issued for subscription are all
purchased by the public then Issued Capital and Subscribed Capital of a company will be exactly same.
Subscribed Capital is such amount of capital for which applications are made by the proposed shareholders.
Sometimes applications are more than issued, that situation is called as Over Subscription. If the applications
received are less than issued, that situation is called as Under Subscription.
5. Unsubscribed Capital: It is that part of issued capital which is not purchased by general public is known as Un-
subscribed Capital. It is happen only in case of under subscription. It is not necessary that all the issued capital
must be subscribed. If company does not have guarantee all issued capital subscribed by people that time
company make underwriting contract with underwriter for satisfying minimum subscription (90% of issue)
criteria.
6. Called up Capital [Sec 2(15)]: Generally, a company does not require the entire subscribed capital at a time. It
goes on demanding the money from the shareholders as and when need arises. A part of subscribed capital
which is demanded or called by the company is known as ‘Called-up Capital’.
7. Uncalled Capital: It is the portion of subscribed capital or nominal value of shares actually issued, which has not
yet been called up, is known as Uncalled Capital. Which is not called-up presently and may be called in future is
called as Uncalled Capital.
8. Reserve Capital: It is that part of subscribed capital which the company has not called up. Because, company has
decided by a resolution that a certain amount of subscribed capital is not be called except at the time of winding
up of the company. The reserve capital is created for created for offering additional security to the creditors.
Where a company has passed a special resolution for reserve capital, theses shares shown as ‘subscribed but not
fully paid up’. Reserve capital is not shown in the company’s balance sheet.
Authorised
Capital
Issued
Capital
Subscribed
Capital
Called up
Capital
Paid up
Capital
Un-paid
Capital
Uncalled
Capital
Reserve
Capital
Unsubscribed
Capital
Un-issued
Capital

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9. Paid up Capital [Sec 2(64)]: It means the amount that the shareholder has paid and the company has received
against the amount ‘called –up’ against the shares towards share capital. The amount of capital which is paid up
by shareholders is called as Paid up Capital. All the capital demanded may not be paid by all the shareholders.
This actual amount paid by shareholder for shares to the company.
10. Un-paid Capital: The amount of capital which is not paid by the shareholders out of called-up capital is called as
Unpaid Capital. It may be subject to forfeiture or cancellation if the called up capital is not paid by the
shareholders within the time limit.
Tata Chemicals Co. Ltd registered their capital with ROC as Authorized Capital is 10, 00,000/- of 1, 00,000 shares of
10 each. Out of Authorized Capital company issued only Rs.6, 00,000/-, 60,000 shares of 10/- each. And Un-issued
Capital is . 4, 00,000/- , 40,000 shares of 10/- each. Out of issued capital 5, 00, 000/-, 50,000 shares of 10/- each
subscribed by general public and remaining . 1, 00, 000/-, 10000 shares of 10 each is unsubscribed by public. Out of
the Subscribe Capital amount 4, 00,000/-is call by company, 50,000 is uncalled capital and 50,000 is reserved
capital. Out of Called capital shareholder paid only 3, 00, 000/- and unpaid 1, 00, 000/-.
Authorised Capital
Rs. 10, 00,000/- of 1,00,000
shares of Rs. 10 each
Issued Capital
Rs.6, 00,000/-, 60,000
shares of Rs. 10/- each
Subscribed Capital
Rs. 5, 00, 000/-, 50,000
Called up Capital
Rs. 4, 00, 000
Paid up Capital
Rs.3,00,000/-
Un-paid Capital
Rs. 1, 00, 000/-
Uncalled Capital
Rs. 50,000/-
Reserve Capital
Rs. 50,000/-
Unsubscribed Capital
Rs. 1, 00, 000/-, 10000
shares of Rs. 10 each
Un-issued Capital
Rs. 4, 00,000/- , 40,000

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Equity Shares [Sec 43 (a)]
A company collects capital by issuing shares to the public. Share is the smallest part of share capital. These
shares have two types: Equity Shares and Preference Shares
“The shares which do not enjoy any preferential right in the matter of payment of dividend and repayment of
capital at the time of winding up of the company are known as Equity Shares.”
“The shares which are not preference shares are called as equity shares or ordinary shares”._____ Indian
Companies Act 2013
From the above definition, it is clear that equity shares do not carry any special rights such as preference in
dividend as well as repayment of capital at the time of winding up company. Every company requires issuing equity
shares for public by the IPO or Private Placement in the initial stage. They are also known as ordinary shares, because
they get normal rights and company does not provide any guarantee regarding payment of dividend and repayment of
capital. These bear risk of the organization, so it is also known as Risk Capital and equity shareholders are real owners of
the company. Equity shares provide long term capital to the organization for satisfying fixed capital requirement;
therefore it is also known as Venture capital.
Features of Equity Shares
1. Permanent Capital: Equity shares are part of owned capital which does not create any obligation regarding
repayment of capital. These shares does not have maturity period, it means these share capital cannot be redeemed
during the lifetime of company. These shares repay on winding up company after the payment of all liabilities and
preference share capital. Therefore equity share provide permanent capital to the company. According to section 68
companies to purchase its own or other securities on certain conditions and repay before maturity period.
2. Fluctuating Rate of Dividend: Dividend is a part profit which is distributed to the shareholders. Dividend is return on
share investment. Equity shares do not create any obligation regarding payment dividend and also not get
guarantee regarding minimum rate of dividend. On the issue of equity shares company cannot make any
commitment or agreement regarding rate of dividend. The dividend depends upon earnings of the company. If
earning is more, get more dividends. If earning is low, the rate of dividend also low. When company bears losses
that time equity shares does not get dividend. Therefore equity shareholder get dividend at fluctuating rate of
dividend. It changes every year. Normally rate of dividend is average of last years.
3. No Preferential Rights: Equity shareholders do not enjoy preferential rights in respect of payment of dividend as
well as repayment of capital at the time of winding up of the company. It explain as follows:
The earnings available for equity
shareholders can be divided into
Retained Earnings (Reserve Fund)
and Dividend to shareholders.
At the time of Dividend Payment
Particulars Amount ( )
Sales XXXXX
Less: All Expenses
(Purchase, Production, Marketing and Administration)
XXXX
Earnings Before Interest and Tax XXXX
Less: Interest on Borrowed Capital XXX
Earnings Before Tax XXXX
Less: Corporate Tax XXX
Earnings After Tax XXXX
Less: Dividend on Preference Shares Capital XXX
Earnings Available for Equity Shareholders XXXX

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At the time of winding up of the company
Sales of All Assets XXXXX
Less: Outside Liabilities XXXX
Amount Available for Share Capital XXXX
Less: Preference Share Capital XXX
Remaining for Equity Shareholders XXXX
4. Rights: Equity shareholders are real owners of the company and they enjoy all membership rights. They get various
rights such as get notice of meeting, attend the meeting, take active participation in meeting discussion, to vote on
resolution, to appoint proxy for voting, to elect as director and manage the company affairs, to get dividend, to
inspect the books of accounts and other statutory books, to transfer shares, to get bonus shares and right shares, to
get evidence of membership, to protect the corporation, etc.
5. Control: Company controlled by equity shareholders because they enjoy membership rights. They have unlimited
voice in management they exercise their control over the company through their voting privilege. Every equity
shareholder has the right to vote on every resolution placed before the general meetings of the company. Although
a company is managed by the Board of Director’s who control and direct the affairs of the company. Therefore
equity shareholders are considered as supreme controlling authority of the company.
6. Risk: Equity shareholder does not get guarantee from the company regarding rate of dividend and repayment of
capital. They get dividend as per profit. They do not get preference in payment of dividend and repayment of capital.
There is no any commitment and agreement regarding payment of dividend and repayment of capital. There is a risk
of not getting regular income and also the repayment of principal investment in the company. They do not make
demand regarding repayment of capital to the company. They bear risk of the organization. Therefore equity share
capital considers risky capital. Equity shareholders describe as ‘shock absorbers’ when company has financial crisis.
7. Residual Claimants: Every equity shareholders are owners of the company. They do not get preference in payment
of dividend and repayment of capital. They get remaining profit after payment of expenses, interest on borrowed
capital, corporate tax, and dividend for preference shares and also provision for future (retained earnings). Due to
this rate of dividend always change. At time of dissolution the Official Liquidator sell the all assets of the company
and pay all the outstanding liabilities, then pay the preference share capital and remaining amount distribute into
equity shareholders. Therefore in payment dividend they are last and also repayment of capital they are last. So
equity shareholders are residual claimants of the company.
8. Face Value: Face value of equity shares is low as compared to other types of securities. These face value mentioned
in the Memorandum of Association (MOA) and share certificate. On calculation of dividend and repayment of capital
Company consider only face value of shares. The face of equity shares is 10/-, 5/-, 2/- or even 1/-.
9. Market Value: This value of share is determined by demand and supply forces in the share market. The market value
of equity shares is always changes. The demand and supply of equity shares depend upon the company’s financial
position and profitability. Normally market value of equity shares is higher compared to other type of securities
10. Book Value: Book value means Total Assets minus All outstanding liabilities and preference share capital divided by
total numbers of equity shares. By the book value knows the current investment of equity shareholders in the
company. On this stage company sell in the market, how much amount gets by the Equity shareholders, it is
explained by the book value.

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Net Worth means All Assets minus Outstanding Liabilities and Preference Share Capital
Net Worth means Paid-up Equity share Capital plus Reserve Fund
11. Bonus and Right Issue: When company capitalizes the retained earnings that time issue the bonus shares. Equity
shareholders are real owners of the company. They sacrifices the profit (dividend) for creating retained earnings, so
they have right to get bonus shares from the company. Bonus shares are free of cost shares issued by the company
on the capitalization of profit or reserve fund. The bonus shares are fully paid and similar in nature of equity shares.
In the later stage company raise capital by the equity shares or debentures that time give the first priority to the
existing equity shareholders, it is known as Right Issue. By this issue equity shareholders can maintain the control on
company. The subscription for right issue is optional for equity shareholders.
12. No Charge on Assets: Equity shares do not carry any charge on the assets of the company, because company never
provides any security or mortgage assets for them only solvency is the security.
13. Types
a) With Normal Voting Rights: Those equity shares enjoy normal voting rights in the General Meetings of company,
these shares are known as Equity Shares with Normal Voting Rights. They get voting rights as per the holding of
shares (one share, one vote). They use voting rights either personally or through the proxy. They enjoy all
membership rights. They are electing as director and participate in the management of business.
b) With differential Rights: These type equity shares get some extra rights regarding dividend and voting in the
meetings. Normally these types of shares are issued to promoter of the company. As per Companies Act, company
may issue up to 25% of total capital. These shares are also known as ‘Founder Shares’.
c) Non-Voting Rights (Sec 43): A company issues equity shares without voting rights, these shareholders do not enjoy
any voting rights, and they never elected as a director and participate in the management of business. They
compensate by additional dividend. Normally these types of shares are issued by the Statutory Corporations and
Government Companies.
Preference Shares [Sec 43(b)]
A company collects capital by issuing shares to the public. Share is the smallest part of share capital. These
shares have two types: Equity Shares and Preference Shares
“Those shares which have priority (preference) regarding payment of dividend as well as repayment of capital at
the time of winding up of the company are known as Preference Shares”
“The shares which are enjoy preference over the equity shares are known as Preference shares”
From the above definition, it is clear that preference shares enjoy preference in the payment of dividend and
repayment of capital at the time of winding up of the company. They do not carry normal voting rights. They get
dividend at fixed rate. They bear less risk compared to equity shares, because they get preference in payment of
dividend and repayment of capital and also dividend rate is fixed, so it is considered as ‘safe capital’ with stable return.
Therefore they are co-owners of the organization, but not the controllers. Preference shares are a long-term source of
finance for a company. They are neither completely similar to equity nor equivalent to debt. The law treats them as
shares but they have elements of both equity shares and debt. For this reason, they are also called ‘hybrid financing
instruments’.
Features
1. Preferential Rights: Preference shares enjoy preference over the equity shares in the payment of dividend and
repayment of capital at the time of winding up of company. After payment of taxes company first pay dividend to
preference shareholders and then provide to equity shareholders. The same treatment on the winding up company
regarding repayment of capital.
2. Fixed Rate of Dividend: Preference shares keep getting dividend at a fixed rate throughout the tenure of their
investment, irrespective of company’s profit or loss. However, directors do not declare the rate of dividend.

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Dividend rate already fixed at the time of issue. In the loss period cumulative preference shareholders have right to
accumulate their dividend.
3. Nature of Capital: Preference shares capital does not use for permanent basis, because it is repay after specific
period. As per Companies (Amendment) Act, 1988 and Companies Act, 2013 a company cannot issue irredeemable
preference shares. The maximum period of preference shares is 20 years. They get fixed rate of dividend and also
preference in dividend and repayment at winding up of company. Preference share capital is considered as ‘safe
capital’ with stable return.
4. Risk: The investment in preference shares is less risky as compared to equity shares. They enjoy preference in
payment of dividend and repayment of capital. They get dividend at fixed rate. It is repaid after specific time period.
The investor who are cautious about investment, generally purchase preference shares.
5. No Voting Rights: Preference shareholders do not have any normal voting rights like equity shares. They do not have
right to attend the meetings, elect as directors and to participate in the management of the company. They can
attend the class meeting and vote on matters. They have to sacrifice their voting rights in exchange of the privileges
enjoyed by them. Cumulative preference shares have a right to vote on all resolutions of the company if their
dividends are not paid for two consecutive years.
6. Face Value: Face value of preference shares is higher compare to equity shares. Generally face value is 100, 500,
or even 1000.
7. Market Value: The market value of preference shares does not change according to any factors. The market value
and face value are always same.
8. Right Issue and Bonus Issue: Preference shares do not bear risk of the organization. They are co-owners, but not
controllers of the company. So they do not get right shares and bonus shares. They do not get capital appreciation
benefits in form of market value, right issue and bonus issue.
9. Redeemable shares: As per Companies (Amendment) Act, 1988 and Companies Act, 2013 a company cannot issue
irredeemable preference shares. They are redeemable after specific period of time. The maximum period of
preference shares is 20 years.
10. Substitute for Debentures: The preference shares are substitutes for debentures. Preference shares are some
features of equity shares and debentures. They provide long term capital without creating any obligation for
payment of return and repayment of capital. They get fixed rate of dividend but not create charge on assets. They
not get voting rights. Particularly when the earnings of the company are not stable, but average return justifies the
use of preference shares, they are always preferred.
11. No Dilution of Control: Preference shares are part of owned capital but it does not control the business. They have
to sacrifice their voting rights in exchange of the privileges enjoyed by them. Issue of preference shares does not
disturb the pattern of control. Because the preference shareholders are entitled to vote only on such resolutions
which directly affect their interest.
12. Trading on Equity: Preference shareholders receive fixed rate of dividend. When company earns profit that time
equity shareholders get more dividend, but preference dividend does not change. Therefore dividend to the equity
shareholders is at a higher rate than overall return on investment. It means company provides more return to the
equity shareholders by the issue of preference shares. It is a trading on equity.
Particulars If Equity Share Capital
( . 10,00,000) alone is used
If Equity Share Capital
( . 5,00, 000) along with
Preference Share Capital
( . 5,00,000) is used
Earnings After Tax 2,00,000 2,00,000
Less: Dividend of Pref. Shares @ 10% ---- 50,000
Earnings available for Equity Shareholders 2,00,000 1,50,000
Return on Equity Share Capital 2,00,000/10,00,00*100= 20% 1,50,000/5,00,000*100 = 30%

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13. Types
1. Cumulative & Non-Cumulative
Cumulative preference shares are those which get dividend for all the years, they enjoy the right of
accumulation of dividend. If company fails to pay dividend in any year due to loss or insufficient profit, that year’s
dividend will be paid in next year. The dividend of preference shares does not depend upon company’s financial
position. If company continuously does not pay dividend for two years, in the third year the cumulative preference
shares have a right to attend the general meeting of company and enjoy all membership rights as per equity
shareholders. All preference shares are assumed to be cumulative unless the company makes proper provisions in
the Articles of Association, regarding types of preference shares.
Non-cumulative preference shares are the shares on which the dividend does not go on accumulating. If there
are no profits or there are insufficient profits in any year, these shares get no dividend or get a partial dividend. They
cannot claim the arrears of dividends of any year out of the profits of the subsequent years. They only get current
year dividend.
E.g. L&T Company issued 10% preference shares as cumulative nature of 100,000/- and each share value
1000/-. In the 2015-16, 2016-17 the company does not paid dividend to shareholders due to insufficient profit. As
per company law in the 2017-18 company must pay the dividend for last year and current year. As per the law
preference shareholders get dividend in 2017-18 30,000/-.
2. Participating & Non-Participating
Those preference shares get fixed rate of dividend as well as they enjoy the right to participate in surplus profit
and surplus assets at the time of winding up of the company along with equity shareholders is known as
Participating Preference Shares. The surplus profit means any profit remain after payment of dividend to equity
shareholders. The Surplus assets means any assets remain after repayment of equity share capital at the time of
winding up of the company. These preference shares get more dividend than others shares.
When preference shares receives only a fixed rate of dividend ever year and does not enjoy the additional right
to participate in the surplus profit and surplus assets, then the type of shares held by the shares is known as non-
Participating Preference Shares. The all preference shares are deemed to be non-participating, if there is no clear
provision in Articles of Association.
Preference Shares
Cumulative
&
Non-Cumulative
Participating
&
Non-Participating
Convertible
&
Non-Convertible
Redeemable
&
Irredeemable

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Surplus Profit is divided into equity
shareholders and Participating
Preference shareholders.
Surplus Assets is distributed into
equity shareholders and
Participating Preference
shareholders.
3. Convertible & Non-Convertible
Which those convert into equity shares after specific period these shares are known as Convertible preference
shares. The conversion is option for shareholders. If they do not want to convert into equity shares, then they repay
by the company. After the conversion preference shareholders enjoys membership rights as per equity shares.
Non-convertible preference shares will not be converted into equity shares. They repay after the specific period.
If it is not mentioned in the Articles of Association, all preference shares are considered as Non-convertible
preference shares.
4. Redeemable & Irredeemable
Redeemable Preference Shares are those which are redeemed (repay back) after particular period along with
their dividend. Redemption can be made either out of distributable profit or out of the fresh issue of shares made
specifically for redemption purpose. Only fully paid up shares can be redeemed.
Irredeemable preference shares are those which cannot be paid back during the life time of the company. They
can be redeemed only at the time of winding up of the company. According to the Companies (Amendment) Act
1988 and Section 55 of the Companies Act, 2013 a company cannot issue irredeemable preference shares and all the
preference shares must be redeemed within a period not more than 20 years from the date of their issue (for
infrastructural company 30years).
Less: Reserve Fund XXX
Less: Dividend for Equity shareholders (Average of Last 3
years)
XXX
Surplus Profit XXXX
At the time of winding up of the company
Sales of All Assets XXXXX
Less: Outside Liabilities XXXX
Amount Available for Share Capital XXXX
Less: Preference Share Capital XXX
Remaining for Assets XXXX
Less: Equity Share Capital XXXX
Surplus Assets XXXX

12
Retained Earnings
A new company has only external sources of finance. However, an existing company can generate finance
through its internal sources. A company earns profit by the transactions. The whole profit is not distributed into owners
as a dividend; retain some part of profit as a saving for provision of future. This saving is known as retained earnings.
1. “The process of accumulating profits and their utilization in business is called retained earnings.”
2. “It is the portion of profits which is not distributed into equity shareholders, but retained and reinvested in the
business is known as retained earnings.”
3. “Retained Earnings means profits generated by a company that are not distributed to stockholders (shareholders) as
dividends but are either reinvested in the business or kept as a reserve for specific objectives (such as to pay off a
debt or purchase a capital asset).”
From the above definition, it is clear that retained earnings are internal source of finance. It is a part profit which
is not distributed into shareholders as dividend, is retained by company in the form of Reserve fund. The policy of using
such retained profit in the business is known as ‘Self-financing’ or ‘Ploughing back of Profit’. The management can
convert this retained profit into permanent capital which is known as ‘Capitalization of Profit’ by issuing bonus shares to
the existing equity shareholders at free of cost. It is cheapest and simplest source of finance.
Determinants of Retained Earnings
1. Total Earnings of the company: Company earns sufficient profit, that time save profit as a earnings. Economist Lord
J.M Keynes put forth the principle ‘Larger earning, Larger the saving’. It means if company earns more profit, that
time company pays all expenditures and maintains maximum reserve.
2. Taxation Policy: Tax is the revenue income of government. Govt. imposes various taxes on the business. Tax
minimizes the saving.
Tax Rate Retained Earnings
More Less
Less More
3. Dividend Policy: it is the policy of the board of directors in regards to distribution of profit. The dividend policy is
affected by many factors. The company changes the policy as per financial position and future development
programs.
Dividend Policy Dividend Retained Earnings
Conservative Less More
Liberal More Less
4. Government Control: Government is a regulatory body of economic system of the country. The government control
includes policy regarding rules and regulation for the business organization. Company must adjust their policies
according to government policy. If increase the government control increase expenditure of the company. Therefore
also reduce retained earnings. If minimize the government control decrease the expenditure and increase profit of
the company, therefore, increase retained earnings of the organization.
Advantages
1. Cheapest Source of Finance: When company use retained earnings as a source of finance that company does not
incur any expenditure. It is a less costly method as compared to others. For the use of retained earnings, a company
requires only to issue bonus shares to equity shareholders and approval from them in the general meeting.
2. Easy Method: It is very easy for the company to retained earnings as a source funds. For this purpose require
sufficient reserve fund and obtain approval from shareholders by passing special resolution in general meeting. For
raising finance does not require any major approval from other authorities.
3. No Fixed Obligation: When capitalize the profit, company issue bonus shares to equity shareholders as a free of
cost. The bonus shares are similar in nature as equity shares. They carry same features, so these do not create any
obligation regarding payment of dividend and repayment of capital.

13
4. No Dilute Control: Retained earnings no dilute the control of equity shareholders on the working of the company.
When company raise finance from this source that time issue the bonus shares to equity shareholders as a free of
cost. The bonus shares are similar in nature as equity shares. It means increase control of equity shareholders on the
business.
5. Increase Market Value: When company use retained earnings as a source of finance that time issue bonus shares to
equity shareholders. Huge retained earnings are a good signal of strong financial position of the organization. Due to
bonus shares increased the market of value of shares and increased the wealth of shareholders.
6. Goodwill: When organization use proper management, business policies and increase the profit of the organization
it is reflected in dividend and retained earnings. Huge retained earnings are a good signal of strong financial position
of the organization. When capitalize the profit, company issue bonus shares to equity shareholders as a free of cost.
It creates positive impact in the market and improves the reputation/goodwill/image of the organization.
7. Flexibility for Utilizing Funds: There is a lot of flexibility for utilizing the funds. The bonus shares are similar in nature
as equity shares. It does not create any obligation regarding use of funds for fixed capital or working capital
requirement.
Disadvantages
1. Misuse of Funds: Retained earnings do not create any obligation and also provide flexibility regarding utilization of
the funds. Therefore a lot of chance for the misuse of funds by the management. It may be used for unproductive
works.
2. Leads to Monopolies: When capitalize the profit, company issue bonus shares to equity shareholders as a free of
cost. The bonus shares are similar nature of equity shares. Due to bonus shares increase the voting power of equity
shareholders. They more control the organization. They get more dividend and capital appreciation. It is leads to
monopolies.
3. Over Capitalization: For creating retained earnings company adopt conservative dividend policy. Retained earnings
do not create any obligation and also provide flexibility regarding utilizes the funds. Due to misuse funds profit of
the company may be decrease, therefore is lot chance of overcapitalization. It is always dangerous.
4. Tax Evasion: For creating retained earnings a company tries to avoid or minimize tax. A company finds new ways for
minimization of tax. Due to this decrease the tax of government. It leads to tax evasion.
5. Dissatisfaction: For creating retained earnings company adopt conservative dividend policy. Shareholders get very
less dividends. It brings dissatisfaction in the equity shareholders. They may be opposing for this.
Earnings
Available for
Equity
Shareholders
Retained
Earnings
Dividend
Sales XXXXX
Less: All Expenses
(Purchase, Production, Marketing and Administration)
XXXX
Earnings Before Interest and Tax XXXX
Less: Interest on Borrowed Capital XXX
Earnings Before Tax XXXX
Less: Corporate Tax XXX

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Borrowed Capital
Borrowed capital consists of the amount raised by way of loan or credit. It creates fixed obligations regarding
payment of return and repayment of capital at a particular period. This capital cannot use up to dissolution of business;
it is repaid after specific period. They get fixed rate of interest on their investment. They not bear risk of the
organization. It is safe and temporary capital of the organization. They are creditor of the organization. They not enjoy
any voting and management rights in the organization. The borrowed capital collects by issue debentures, bonds and
obtains loans from financial institutions.
Debenture
If a company needs funds for extension and development purpose without increasing its share capital, it can
borrow from the general public by issuing loan certificates for a fixed period of time and at a fixed rate of interest. Such
a loan certificate is called a debenture. Debentures are offered to the public for subscription in the same way as for issue
of equity shares. Debenture is issued under the common seal of the company acknowledging the receipt of money
The word ‘debenture’ is derived from the Latin word ‘debre’ which means “to owe a debt”. It is a medium- to
long-term debt instrument used by large companies to borrow money, at a fixed rate of interest.
Definitions
1. “Debenture includes—debenture stock, bonds and any other securities of a company, whether constituting a charge
on the assets of the company or not.” ____Sec 2 (12) of Companies Act 1956
2. “Debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether
constituting a charge on the assets of the company or not. ____Sec 2 (30) of Companies Act 2013
3. “Debenture is a document given by the company as evidence of debt to holder usually arising out of loan and most
commonly secured by charge.” ______ Tophon
4. “Debenture is an instrument under seal evidencing debt, the essence of it being admission of indebtness.” _____
Palmar
5. “Debenture is a document which either creates a debt or acknowledges it.” —Justice Whity
6. “A debenture is an instrument issued by the company under its common seal acknowledging a debt and setting
forth the terms under which it is issued and is to be paid.” —Naidu and Datta
From the above definitions it is clear that a debenture is a document issued by a company as an evidence of a
debt due from the company with or without a charge on the assets of the company. A debenture is one of the capital
market instruments which are used to raise medium or long term funds from public. A debenture is essentially a debt
instrument that acknowledges a loan to the company and is executed under the common seal of the company. The
debenture document, called Debenture deed contains provisions as to payment, of interest and the repayment of
principal amount and giving a charge on the assets of such a company, which may give security for the payment over the
some or all the assets of the company. It acts as the external source of finance with prior rights of income and also
return of capital.

15
Features
1. Promise: Debenture certificate is given to debenture holder as an acknowledgement of debt. Debenture is a written
promise by the company that it is obtain loan of specific amount for specified period. It is a promise made by the
company to holder to pay interest (return) and repayment of capital on specific date. The certificate issue within six
months from the allotment of debentures.
2. Face Value: The face value of debenture is comparatively high than shares. The face value of debenture is 100/- ,
200/-, 500/-, 1,000/- or multiples of . 100/-. On maturity date Company only repay the face value of
debenture.
3. Time of Repayment: Debenture holders are creditors of the company. When company raise loan from the
debenture that time mention the time of repayment in the prospectus and debenture certificate. As per these
debentures are repaid on maturity date. The normal companies issue debenture up to 10 years and infrastructural
development companies issue up to 30 years.
4. Interest: Debenture is a borrowed/Loan/debt capital. The company provides interest as return on loan. The rate of
interest is fixed on the issue. The rate of interest does not change by company throughout the debenture period. It
never depends upon company’s financial position. It is an expenditure of the company; it is calculated and paid
before the tax. The interest is paid periodically-six monthly or yearly.
5. Assurance of repayment: Debenture is a borrowed capital of the company. It creates fixed obligations regarding
payment of interest and repayment of capital. Company gives the assurance for payment of interest and repayment
of capital on particular date. For the assurance company provide security for the debentures. These create charge
on the assets of the company.
6. Parties: In the issue of debentures involve three parties.
a) Company: It is an organization which collects funds by issue of debentures.
b) Trustee: If debenture holders are more than 50 that time company require appointing debenture trustees.
They give the approval for issue and allotment of debentures. Trustees are representatives of debentures
holders. They protect the rights of debentures. They act as middleman/link between company and
debenture holders. For this purpose company make agreement with trustees, it known as ‘Trust Deed’. It
includes the obligations of company, rights and duties of debenture holders, etc.
c) Debenture holder: A person who invests money in the debentures and receive debenture certificate from
the company.
7. Rights of Debenture holders: Debenture holders provides borrowed capital to the organizations, they are
considered creditors of the company. They do not enjoy any membership rights (voting and management).
8. Terms of Issue: Debentures can be issued by public as well as private companies. Private company only issue
debentures by private placement only. Public company issue debenture by the initial public offer or private
placement. In the company board of directors have power to issue debentures. It can be issue at par, at premium or
at discount but company never issue debentures with voting rights.
9. Security: As per companies Amendment Act, 2000 company only issue secured debentures. It means debentures
must create charge on the assets of the company. If company fails to repayment of capital on maturity date that
time debenture consult the trustee regarding this. Debenture trustees take charge of the assets; sell in the market
and repayment of debentures. It means investment in debentures is totally risk-free.
10. Listing: Listing means registering the securities to the particular stock exchange. Every company must be listed
either before issue securities or after the allotment of securities. The securities must be listed with at-least anyone
stock exchange of India. Listing increases marketability of securities and creates confidence in the minds of public.
11. Trading on equity: By issue of debentures a company use borrowed capital for the business, it means trading on
equity. In the profit situation issue of debentures is beneficial to company for providing maximum returns to equity
shareholders. In the loss situation it is danger. Due to trading on equity also no dilute control of equity shareholders.
They control over the organization.

16
12. Types: Debentures are classified on various basis
Types of Debentures
A. On the Basis of Security
Secured and Unsecured Debentures
Those debentures are secured by charge on assets of the company, these debentures are known as secured
debentures or mortgage debentures. When company issues the debentures that time provide security by the assets. The
charge may be on particular assets (fixed) or in general assets (floating). For the protection of Security Company appoint
debentures trustees by making ‘Trust Deed’ with them. These debentures have rights if company fails for payment of
return or repayment of capital on maturity period, that time these debenture holder consult this issue with debenture
trustees. They take a charge of assets and sales them in market and make payment of debenture holders. As per
Companies Act, 2013 A company only issue secured debentures to public.
Those debentures does not have any security or not create charge on the assets, these are known unsecured
debentures. A company’s solvency is the security to the debenture holders. The Companies Amendment Act, 2000 and
Companies Act, 2013, a company never issue unsecured debentures, but under the public deposits a company may issue
unsecured debentures up to 10% of net worth. They are issue by private placement and guaranteed by Board of
Directors.
Debentures
On the basis of
Security
Secured
Unsecured
On the basis of
Transfer
Registered
Bearer
On the basis of
Repayment
Redeemable
Irredeemable
On the basis of
Conversion
Convertible
Non-Convertible

17
B. On the basis of Transfer
Registered and Bearer Debentures
Registered debentures are those in respect of which names, addresses, face value, maturity period and
particulars of holding of the debenture holders are registered by the company in the ‘Register of Debenture holders’.
Only those debenture holders whose names appear in the register are entitled to interest and repayment of principal.
They can get interest by interest warrant. They can be transferred only as per the provisions of the articles of
association. In this case, debentures can be transferred by executing a regular transfer deed.
Bearer Debentures are the debentures which are not recorded in a register of the company. The company does
not maintain any records of holders. They are considered negotiable instruments. Such debentures are transferable
merely by hand delivery and not required any transfer deed. These debenture holders get interest by interest coupon.
These interest coupons attached with debenture warrant.
C. On the basis of Repayment
Redeemable and Irredeemable Debentures
Redeemable debentures are those debentures which will be repaid by the company at the end of a specified
period or in installments during the lifetime of the company. Repayment of principal sum is made in accordance with the
terms already made known at the time of its issue. For repayment of debentures Company make provision for out of
profit every year in the form Debenture Redemption Reserve Fund. Generally debentures are issued up to 10 years by
normal companies and up to 30 years by infrastructural development company.
Irredeemable debentures are those which are repaid only when the company goes into liquidation. These are
the debentures which are not redeemed in the life time of the company. The amount of such loan is repayable on the
happening of specified contingencies. They are repaid on the liquidation or as per the company’s financial positions.
Though irredeemable debentures were allowed under section 120 of the Companies Act 1956, no corresponding
provisions has been made under the Act of 2013.Thus, no fresh irredeemable debentures may be issued by the
companies. They are issued before Companies Act 2013 by companies.
D. On the basis of conversion
Convertible and Non-convertible Debentures
Convertible debentures are those which can be converted into equity shares either wholly or in part at the
option of the debenture holder. The terms and conditions of conversion are generally announced at the time of issue of
debentures. The idea is to attract investment in debentures with expectations of getting equity shares in future. It is
optional for debenture holders. The conversion period is after 18 months and before 36 months from the allotment of
debentures. For conversion company require obtain approval from the existing equity shareholders by passing special
resolution in the general meeting. Nowadays convertible debentures are very popular.
Non-convertible debentures are those which cannot be converted into equity shares. Usually they are
redeemable after the expiry of the stipulated time period. They carry an attractive interest rate as compared to
convertible debentures.
Bonds
The borrowed capital includes the amount raised by way of loans or credit. This capital is collected from issue of
debentures, bonds or loans obtain from financial institution.
Like debenture, bonds are popular in America for the long-term industrial finance. The companies Act not any
major provisions regarding issue of bonds, but SEBI’s provide guidelines for the issue of bonds. In India bond s are used
raising long term debt capital by corporate and government companies.

18
Definitions
 A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental)
which borrows the funds for a defined period of time at a variable or fixed interest rate.
 A bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under which the
issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the
coupon) and/or to repay the principal at a later date, termed the maturity date.
 “A bond is an interest bearing certificate issued by a government or business firm, promising to pay the holder a
specific sum at a specified date.” ___Webster Dictionary
 A written and signed promise to pay a certain sum of money on a certain date, or on fulfillment of a specified
condition. All documented contracts and loan agreements are bonds. ____Business Dictionary
From the above the definitions, it is clear that bond is a formal contract or written promise to repay borrowed
money with interest on particular date. The bond holders are creditors of the company. They are generally unsecured
but provide finance more than 10 years to business.
Features
1. Contract: - Bond is a formal contract between the company and bond holders. In this contract a company promises
to repay the borrowed amount with interest or without interest. This contract includes all terms and conditions
regarding interest payment as well as repayment of principal amount. If bonds are secured by assets that time in the
contract involve third party ‘Bond Trustee’
2. Nature of Finance: - Bond is a long term source of finance. Normally bonds are issued for more than 10 years. A
company uses bond capital to purchase fixed assets. Some bonds issued for 5 years. A bond a loan capital, therefore
it is less risky than share capital.
3. Status of Investor: - The bonds are one of the securities of borrowed capital. Therefore bondholders are creditors of
the company. They do not enjoy any membership rights such as voting and management rights.
4. Return on Bonds: - It is a borrowed capital, therefore company provide interest as a return on the bonds. The rate
interest may be fixed or floating. The interest may be paid annually or on maturity period.
5. Repayment: - It is a formal agreement between the company and bond holder to repay the principal amount on a
particular date. The maturity date of bond mention in the prospectus and bond certificate. If company fails to repay
the bond amount on maturity date, it considered default and it may be penalized by company law.
6. Guarantee by Government: - If bonds are issued by Government Company, then they are guaranteed by central
government or Reserve Bank of India. RBI always ready to purchase the Govt. bonds from the market. There is no
chance of risk in bond investment.
7. Tax Benefits: - When bond issued by infrastructural development companies. These bonds provide tax benefits to
holders. This investment not consider for income tax calculation.
8. Parties:
a) Corporation: - It is an organization that issued and collected money from bonds.
b) Bondholder: - A person who invests money in the bonds and receive bond certificate as an evidence to
provide loan to the company, is known as bondholders.
c) Trustee: - If bond are secured by assets that time trustee is involved. Trustees are representatives of
bondholders. They protect the rights of bonds. They act as middleman/link between company and
bondholders. For this purpose company make agreement with trustees, it known as ‘Trust Deed’. It includes
the obligations of company, rights and duties of bondholders, etc.

19
Types
A. Based on coupon / interest
1. Fixed rate bonds: - These bonds get fixed rate of interest throughout the bond period. The interest rate
never changes during the bond life.
2. Floating rate bonds: -These bonds have variable rate of interest. Interest rates are recalculated periodically.
The interest rate depends upon company’s financial position and RBI’s regulations. If company’s earns
profits increase rate of interests.
3. Zero coupon bonds: -These bonds are issued at normal discount (less than face value). No coupons/interest
is paid to zero coupon bonds. On the maturity these bonds are redeemed at par. The difference between
acquisition cost of bond and face value of bond is profit to investor.
4. Deep Discount bonds: -These bonds are similar to zero interest bonds but have huge discount and long
period of maturity i.e. 25 years and more. These bonds do not get interest. These bonds are redeemed at
par. The difference between acquisition cost and maturity value is profit for the investor.
5. Inflation-indexed bonds: -The principal amount of bond and the interest rate are changed as per index of
the inflation. The principal amount grows and payment of interest increases with the inflation. The inflation
index declared by RBI on every six months.
Bonds
Based on Coupon
Fixed –rate Bonds
Floating–rate Bonds
Zero Coupon Bonds
Deep discount
Bonds
Inflation-indexed
Bonds
Based on Option
Bond with Call
option
Bonds with Put
option
Based on
Redemption
Single
Redemption
Amortizing
Bonds

20
B. Based on option
1. Bond with call option (callable bonds): -This feature gives right to issuer, the right to redeem his issue of
bonds before maturity of bonds at the predetermined price and date. It is a repay by company before
maturity period.
2. Bond with put option (put table bond): -This feature gives bondholder the right to sell their bonds back to
issuer at the pre-determined price and date. It is surrender (return) by investor before maturity period.
C. Based on Redemption
1. Bonds with single redemption: -These bonds are also known as bullet bonds. They cannot be redeemed
before the maturity period. In this case, principal amount of bond is paid at the time of maturity only. There
is a single maturity date, and all the bonds issued to various investors are to be redeemed on that single
maturity date. These bonds may be issued at discount.
2. Amortizing Bonds: -In this case, payment is made by borrower on maturity, includes both interest and
principal. These bonds may be repaid annually in installments (principal of bond plus interest)
Loans from Financial Institutions
After the independence, India adopted mixed economic structure for the economic development. For this
purpose India use five year economic planning. Every plan was focus on specific sector for the development. But without
industrial development, India never achieves economic development so, first industrial policy was declared in 1948. As
per this policy, Indian government established some financial institutions for the providing finance for industrial
development. These organizations provide long term, medium-term and short-term loans to the companies for the
purpose of establishment of business, expansion, modernization, restructure, etc.
“A financial institution is an establishment that conducts financial transactions such as investments, loans and
deposits. Almost everyone deals with financial institutions on a regular basis. Everything from depositing money to
taking out loans and exchanging currencies must be done through financial institutions.”
“It refers to those institutions which provide financial assistance for industrial development.”
1. Banking Financial Institutions: These institutions accept the deposits from the public repayable on demand and lend
the money or investment. These include commercial banks and cooperative banks.
Financial Institutions
Banking
Financial
Institutions
Non-Banking
Financial
Institutions
Development
Bank
Financial
Institutions
Investment
Institutions
State- Level
Institutions

21
2. Non-Bank Financial Institutions: A non-bank financial institution (NBFI) is a financial institution that does not have a
full banking license or is not supervised by a national or international banking regulatory agency. NBFIs
facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market brokering.
These institutions do not accept any deposit from the public which is repayable on demand and not provide general
banking services to public.
1. Development Bank: IDBI (1964), IFCI (1948), IRBI (1985), ICICI (1955), SIDBI (1990)
2. Financial Institutions: RCTC (1988), TDICI (1988), TFCI (1989)
3. Investment Institutions: LIC (1956), GIC (1972), UTI (1963)
4. State Level Institutions: SFC (1951), SIDC (1960)
The IFCI (1948) is the first financial institution established at national level in India after independence. The ICICI
is established by the government on the recommendation of the World Bank in January, 1955. IDBI (1964) is the apex
bank for industrial finance and development banking. LIC & GIC provide insurance service to public and finance for
industrial development. UTI (1964) provide mutual fund service to public.
Functions
1. Granting Loans: The Financial Institution provides long-term and medium term loans to industrial organization for
the purpose of starting, developing, modernization and restructure of business.
2. Guarantee of Loans: They also provide guarantees for loans raised by business concerns from other sources. They
also provide guarantees for deferred payments for purchase of capital goods from foreign nations.
3. Subscription of Securities: The financial institution purchase the securities issued by the companies. They purchase
equity shares, preference shares, debentures and bonds.
4. Act as an Underwriter: Development banks also act as an underwriter in the capital market. They underwrite the
issue of shares, bonds or debentures of industrial organizations.
5. Other Activities: The financial institutions also perform other functions such as:
a. Acting as agent of government
b. Issue of letter of credit
c. Arrange Industrial Exhibitions
d. Discounting the bills
e. Guidance for management and marketing of business
f. Act as broker in the financial market.
g. Provide merchant banking services
Importance/ Role/ Need / Significance of Financial Institution
1. Develop sound capital Market: - In India stock exchange was established in 1875, but it was not properly
developed. People’s attitude towards the capital market was very conservative. They do not invest money in the
stock market. Therefore an industrial organization does not get finance for business. The financial institution
collect saving from the public and invest money in the capital market by purchasing shares and debentures.
Financial institutions also provide underwriting service to the industries. Due to this slowly-slowly developing
Indian capital market.
2. To mobilize financial resources: - after the independence India is considered as a backward country. Therefore
industrial development is very poor. Maximum people depend upon agriculture sector. People not provide
money to the industrial organization. The financial institutions collect saving from the people by providing
various services such as commercial banking, insurance products, mutual fund products etc. and this collected
money provide for industrial development
3. Capital formation: The financial institutions provide direct and indirect finance for industrial development. They
mobilize savings from the public. Savings leads to investment in all sectors of the economy. Investment leads to

22
capital formation in the country. They encourage the people to invest money in the capital market by acting as
underwriter and brokers.
4. Planned Economy: After independence, India was a backward country. Various sectors of economy were
undeveloped and not have huge for the development, so require proper planning for the development of
economy. Government established various financial institution for providing finance to industrial development
and the development of specific area such as
Financial Institution Areas
IFCI, IDBI, ICICI,IRBI Merchant Banking
LIC and GIC Insurance sector
UTI Mutual Fund
NABARD Agriculture and Rural Development
TFCI Tourism
5. Financing small business: After the New Economic Policy 1991 the small businesses faced various problems. For
solving these problems government established Small Industrial Development Bank of India for providing direct
finance for small business. SIDBI also provide refinance to commercial banks and cooperative banks that have
earlier provide finance to small industries.
6. Foreign Trade Needs: Financial institutions encourage the foreign trade. For instance EXIM bank provides
medium and long terms loans to exporters and importers. The other financial institutions also provide finance
for the exports and imports business. They provide guarantee for import capital goods from the foreign nations.
They issue letter credit for the trade.
7. Govt. Policy: The financial institutions work in specific areas for economy, therefore they have knowledge about
them. They advise to government for framing policies of these areas. E.g. EXIM bank ---- EXIM Policy.
8. Rate of Interest: These financial institutions charge uniform rate of interest for the loans. The industrial
organizations get loans at cheaper rate.
Short Term Finance
Financing is a very important part of every business. Firms often need financing to pay for their assets,
equipment, and other important items. Financing can be either long-term or short-term.
A company requires finance for day to day activities of business; this finance is known as short term finance. This
finance is raised for 1 year and used to satisfy working capital requirement. It is raised from borrowed sources. These
sources as follows.
Public Deposits
Public Deposit is an important source of financing short term requirement of the company. Public deposits refer
to the unsecured deposits invited by companies from the public mainly to finance working capital needs.
Definition
“Public deposits refer to the unsecured deposits invited by companies from the public mainly to finance working capital
needs”.
“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. ___Sec 2 (31)

23
From the above definition it is clear that public deposit is a loan capital raised by public. A company wishing to
invite public deposits makes an advertisement in the newspapers. Any member of the public can fill up the prescribed
form and deposit the money with the company. The company in return issues a deposit receipt. This receipt is an
acknowledgement of debt by the company. The terms and conditions of the deposit are printed on the back of the
receipt. The rate of interest on public deposits depends on the period of deposit and reputation of the company. A
company can invite public deposits for a period of six months to three years. Therefore, public deposits are primarily a
source of short-term finance. However, the deposits can be renewed from time-to-time. Renewal facility enables
companies to use public deposits as medium-term finance.
Rules regarding Public Deposit
1. Ceiling of Deposit: This provision provide guidelines regarding upper limit of amount of deposits. As per Companies
Act, 1956 and 2013 as follows.
2. Maturity of Deposit: Company can raise finance from public deposit for minimum 6 months and maximum 36
months. The company cannot receive any deposit which is repayable on demand.
3. Interest of Deposits: The interest on deposit must not be more than the maximum rate of interest prescribed by
RBI. This interest rate is similar to bank deposits.
4. Register of Deposits: Every company must maintain record of deposit holders. In this record company mention
name of holders, amount of deposit, rate of interest, repayment of deposit etc. This register must be kept in the
registered office of company and preserved by company for minimum period of 8 year from the last entry.
5. Status of Deposit Holders: Public Deposit is a source of short term borrowed capital therefore deposit holders are
creditors of the company. He does not enjoy any voting and management rights in the company.
Bank Credit
When organization obtain short term loan from the bank, which is repayable within one year and use for
satisfying working capital needs, it is known as Bank Credit.
A bank credit is the amount of credit available to a company or individual from the banking system. It is the
aggregate of the amount of funds financial institutions are willing to provide to an individual or organization. It is an
extension of credit by a bank to a customer or business; it has to be paid along with interest.
Bank credit is a primary institutional source of finance. Providing loan to the business sector is a primary function of
banks. Bank credit provides finance up to 1years to the organization. Bank credit may be granted by way of loans, cash
credit, overdraft and discounted bills.
1. Bank Overdraft: When a bank allows its depositors or account holders to withdraw money in excess of the balance
in his account up to a specified limit, it is known as overdraft facility. This limit is granted purely on the basis of
credit-worthiness of the borrower. Banks generally give the limit up to Rs.20, 000. In this system, the borrower has
to show a positive balance in his account on the last Friday of every month. Interest is charged only on the
overdrawn money. Rate of interest in case of overdraft is less than the rate charged under cash credit.
2. Cash Credit: It is an arrangement whereby banks allow the borrower to withdraw money up to a specified limit. This
limit is known as cash credit limit. Initially this limit is granted for one year. This limit can be extended after review
for another year. However, if the borrower still desires to continue the limit, it must be renewed after three years.
Company Ceiling of Deposit (Upper Limit)
Government Company Up to 35% of Net worth (Paid up Capital Plus Reserve Fund)
Public Company Up to 25% of Net worth (Paid up Capital Plus Reserve Fund) by Public Placement
Up to 10% of Net worth from existing shareholders and debenture holders by private
placement in form of Deposit or unsecured debentures which guaranteed by directors
Private Company Up to 25% of Net worth (Paid up Capital Plus Reserve Fund) but by private placement

24
Rate of interest varies depending upon the amount of limit. Banks ask for collateral security for the grant of cash
credit. In this arrangement, the borrower can draw, repay and again draw the amount within the sanctioned limit.
Interest is charged only on the amount actually withdrawn and not on the amount of entire limit.
3. Cash Loan: It is short term advance sanctioned by bank for specific period. It is one year loan provided by banks for
satisfying working capital requirement such as money at call, short notice etc.
Trade Credit
“Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade
credit facilitates the purchase of supplies without immediate payment.”
“A trade credit is an agreement where a customer can purchase goods on account (without paying cash), paying
the supplier at a later date.”
Trade credit is commonly used by business organizations as a source of short-term financing. It is granted to
those customers who have reasonable amount of financial standing and goodwill. It is an arrangement whereby supply
of raw material, components, stores and spare parts, finished goods etc. allow the customer to pay their outstanding
balance within the credit period. It is routine business function. For the trade credit does not require any formal
agreement between buyer and seller. The credit period depend upon trust. It is granted to those customers who have
ability to repay and good credit standing in the market. Usually when the goods are delivered, a trade credit is given for
a specific number of days – 30, 60 or 90. Jewelry businesses sometimes extend credit to 180 days or longer. Trade credit
is essentially a credit that a company gives to another for the purchase of goods and services.
Merits of Trade Credit
 Increase Sales: From the perspective of the creditor, or supplier, trade credit should induce more sales over time by
allowing customers to make purchases without immediate cash. This flexibility in purchasing methods also
encourages customers to make larger purchases when prices are right than they might if they had to pay cash up
front. Along with higher sales volume, trade credit often produces interest fees and late payment fees for creditors,
which increases revenue.
 Focus on Core Activities: From the point of view of buyer when purchase goods on credit. It is very beneficial to
focus on other activities of business. Credit purchase creates continuous flow of supply. The buyer focuses on other
activities such as research and development, marketing and management of business.
 No Formal Agreement: In the trade credit does not involve any formal and written agreement between buyer and
seller. It is depend upon mutual trust. Therefore trade credit is the cheapest and easiest method of financing.
Demerits of Trade Credit
 Bad Debts: The potential risk to the supplier when offering trade credit is bad debt. If buyers do not pay off their
debt, and in a timely manner, it has negative cash effects on the supplier. Companies eventually have to write off
unpaid accounts as bad debt, which lowers their profits. Accounts that remain unpaid for a long period of time still
have negative effects, though. This means the supplier has to wait to collect cash which it needs to pay its own bills.
 High Cost: If buyers are not careful in the way they use trade credit, they can end up paying much higher costs for
inventory. Many companies offer a 2-percent discount if you pay within 10 days, but payments received after 30
days usually include late-payment fees and interest that begins accruing. In its overview of trade credit,
"Entrepreneur" notes that purchases on account can cost between 12 to 24 percent extra in interest fees if the
business does not pay within the typical 30-day net payment term.
 Difficult for New Organization: Purchase goods on credit are difficult for new organizations because trade credit
depends upon trust and goodwill of organization. Newly established organization does not enjoy trust and goodwill
in the market.

25
Bills of Exchange
‘An unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring
the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a sum certain in money
to or to the order of a specified person, or to bearer.’
‘A bill of exchange is an instrument in writing containing an unconditional order signed by maker, directing a
certain person to pay a certain sum of money only to or to the order of certain person or to the bearer of instrument.’
__ Negotiable Instrument Act 1881
Bill of exchange is a definite promise in writing from buyer, for paying the amount on a specific date. It is a
negotiable instrument used in business for satisfying working capital requirements.
Discounting of Bills of Exchange
It is relatively of recent origin in India. Reserve Bank of India has introduced ‘New Bill Market Scheme’ in 1970.
Banks also advance money by discounting bills of exchange, promissory notes and hundies. When these documents are
presented before the bank for discounting, banks credit the amount to customer’s account after deducting discount. The
amount of discount is equal to the amount of interest for the period of bill. In such cases the banks deduct discount
while making payment. The amount of discount is generally equal to the amount of interest for the remaining period of
payment against the bill. This is known as discounting of bill.
Procedure of Discounting of Bills of Exchange
 Seller sells goods to Buyer on credit.
 Seller draw the bill on buyer
 Buyer make sign on bill and return to seller
 Seller (Drawer) discounted bill in bank.
Loans from Directors
Sometimes company obtain money from the directors apart from shares, debentures, bonds, deposits or any
other instruments, it is known as Loan from Directors. For this purpose of finance company must require provision in the
Articles of Association, without provision it is not allowed.

26
Advances from Customers
It is a short term source of finance. The advance from customers refers to money collected by company before
providing goods and services, at this time this advance considered as liability of the organization. The availability of
advance from customers depend upon various factors such as type of goods, nature of goods, elasticity of demand etc.
this type finance found in Gold, agricultural and construction business.
Native Money Lenders
Money lender is a person or group who typically offer small personal loans at higher rates of interest apart from
banks and financial institutions. Business sometimes obtain loan from the money lenders. It is very costly. Money
lenders charge interest per month on loan. Money lender provide loan with mortgage or without mortgage.
Government Assistance
Sometimes government provides finance to the specific business to satisfy working capital needs. Normally
infrastructural development companies get government assistance.
International Financing
Organization collects finance from their home nation as well as foreign nations. When company raise finance from
foreign nations that time require approval from SEBI, RBI, ED and Central Government. Without approval it is considered
as an illegal act. When organizations raise finance from the foreign nations, it is known as international financing.
1. Commercial Banks: Just like domestic loans some commercial banks provide banking services throughout the world.
They provide loan to industrial development. E.g. Citi bank, DBS, RSB, Standard Chartered Bank, American Express
Bank, etc.
2. International Agencies and Development Banks: These organizations provide long term and medium term finance
to developing nations for industrial development. E.g. IMF, World Bank, ADB, HSBC, BRICS Bank, etc.
3. International Capital Market: After the LPG Policy, the Indian government minimized the rules and regulations from
the international business due to this Indian Companies raise capital from foreign capital market. It include
Depository Receipts, Euro-issue, Foreign Currency Convertible Bonds
Depository Receipts
It is a negotiable financial instrument issued by a bank to represent a foreign company's publicly traded
securities. A Depositary Receipt is a negotiable security that represents an ownership interest in securities of a foreign
issuer typically trading outside its home market. Depositary Receipts are created when a broker purchases a foreign
International
Financing
Commercial Banks
International
Agencies and
Development Banks
International
Capital Market

27
company's shares on its home stock market and delivers the shares to the depositary's local custodian bank, and then
instructs the depositary bank to issue Depositary Receipts. In addition, Depositary Receipts may also be purchased in the
secondary trading market. They may trade freely, just like any other security, either on an exchange or in the over-the-
counter market and can be used to raise capital. ADRs were the first type of depositary receipt to evolve. They were
introduced in 1927 in response to a law passed in Britain, which prohibited British companies from registering shares
overseas without a British-based transfer agent. DRs are traded on Stock Exchanges in the US, Singapore, Luxembourg,
London, etc. DRs listed and traded in US markets are known as American Depository Receipts (ADRs) and those listed
and traded elsewhere are known as Global Depository Receipts (GDRs).
DR Issuance Process
 Investor contacts broker and requests the purchase of shares of a DR issuer of company. If existing DRs of that
company are not available, the issuance process begins.
 To issue new DRs, the broker contacts a local broker in the issuer’s home market.
 The local broker purchases ordinary shares on an exchange in the local market.
 Ordinary shares are deposited with a local custodian.
 The local custodian instructs the depositary to issue DRs that represent the shares received.
 The depositary issues DRs and delivers them in physical form or book entry form.
 The broker delivers DRs to the investor or credits the investor’s account.
American Depository Receipts
It is a negotiable security representing securities of a non- US company trading in the US financial markets It is
denominated in US dollars and may be traded like regular shares of stock Securities of a foreign company that are
represented by an ADR are called American depository Shares (ADSs). ADR is a dollar-denominated negotiable
certificate. It represents a non-US company’s publicly traded equity. It was devised in the late 1920s to help Americans
invest in overseas securities and to assist non-US companies wishing to have their stock traded in the American Markets.
ADR were introduced as a result of the complexities involved in buying shares in foreign countries and the difficulties

28
associated with trading at different prices and currency values. INFOSYS Technologies Ltd was the first Indian company
to issue ADRs
Global Depository Receipts
A global depository receipt (GDR) is also known as international depository receipt (IDR), is a certificate issued
by a depository bank, which purchases shares of foreign companies and deposits it on the account. It is issued by one
country’s bank as negotiable certificate and is traded on the stock exchange of another country against a certain number
of shares held in its custody. It is denominated in some freely convertible currency. GDRs are often listed in Luxembourg,
London, Frankfurt, Singapore and Dubai Stock Exchange. Reliance Industries were the first Indian company to issue
GDRs.
An Indian corporate can raise foreign currency resources abroad through the issue of Global Depository Receipts
(GDRs). Regulation 4 of Schedule I of FEMA Notification no. 20 allows an Indian company to issue its Rupee denominated
shares to a person resident outside India being a depository for the purpose of issuing GDRs.
Indian Depository Receipts
It is issued and traded in a similar manner as that ADR and GDR. A foreign company lists its shares in Indian
domestic market in INR terms while the underlying shares are listed and traded in any foreign exchange. Till date only
Standard Chartered Bank has issued IDRs. 10 IDRs represent one share of Standard Chartered PLC’s share listed in
London Stock Exchange.
Euro-Issue
Euro-issues mean the issue which is listed on European Stock Exchange although the subscriptions for the same
may come from any corner of the world other than India. Euro-issues in the form of ADR, GDR and FCCB
Foreign Currency Convertible Bonds (FCCBs)
FCCBs are very similar to bonds in nature and can be converted into an equity stock by the bond holder at a later
date at a pre-agreed price. These, like ADR and GDR, are issued by Indian companies outside the home country in
foreign currency. These enjoy higher preference as they are issued as bonds, but at the same time, do not dilute the
holding on an immediate basis and can help companies to raise money at a cheaper rate of interest. The FCCBs issued by
companies also have to be done within the set of guidelines permitted by the government of India.
A convertible bond is a mixture of debt and equity instrument. It acts like a bond by making regular coupon and
principal payments, but these bonds also give the bondholder the option to convert the bond into stock. They are debt
instruments issued in a currency different than the issuer’s domestic currency with an option to convert them in
common shares of the issuer company. The interest on FCCBs is generally 30% -40% less than on normal debt paper or
foreign currency loans. Maturity period of FCCB is 5 years but there is no restriction on time period for converting FCCB
into shares
ADR GDR
American depository receipt (ADR) is compulsory for non
–US companies to trade in stock market of USA.
Global depository receipt (GDR) is compulsory for foreign
company to access in any other country’s share market for
dealing in stock.
ADRs can get from level 1 to level 3. GDRs are already equal to high preference receipt of level
2 and level 3.
ADRs up to level –1 need to accept only general condition
of SEC of USA.
GDRs can only be issued under rule 144 A after accepting
strict rules of SEC of USA.
ADR is only negotiable in USA. GDR is negotiable instrument all over the world
Investors of USA can buy ADRs from New york stock
exchange (NYSE) or NASDAQ
Investors of UK can buy GDRs from London stock
exchange and Luxemburg stock exchange and invest in
Indian companies without any extra responsibilities.

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