Advantages And Limitations Of Each Source Of Finance Finance Essay

Advantages And Limitations Of each(prenominal) showmagazine Of Finance Finance EssayThis assignment covers all detail about openings of exile. The aim of the research is to identify various sources of finance like compendious- name finance, culture medium-term finance and colossal-term finance. The first part of the assignment gives you an introduction about sources of finance. The second part covers short-term sources of finance and their advantages and furbish upations. The deuce-ace part covers medium-term sources of finance and their advantages and disadvantages. And the last part covers long-term sources of finance and its merits and demerits.Sources of FinanceIntroductionAs you know food is necessary for human life. Similarly finance is the heart of every tune. It is most important for modern business, which films huge expectant. Finance could be needed for upstart businesses, when they recover a notes flow problem, clean machinery, set up a new plant or take over an some other business. Generally funds required for businesses argon classified into short term, medium term and long term. In this section we look at the different source of finance and see the advantages and limitations of distributively.BusinessLeasing semipublic DepositMortgage piece of lands-Equity Sh be-Preference Sh atomic number 18DebenturesRetained Earning commercialised deposit bestowBorrowing clientele Credit everyplacedraftBill DiscountingCustomers Advances member Credits impart from Co-operative conservations deponesShort Term SourceLong Term SourceMedium Term SourceSources of FinanceShort Term Sources of FinanceDefinitionWhen we want to establish a new business, it is essential to know the get of finance required. Some sources atomic number 18 overdraft, customer advances, add from co-operatives, bullion and trade credit and so forth that flummox money for short time. It is called short-term source of finance. Generally short-run is except for 1 co urse of study. In this section we learn about above source of finance and their relative advantages and limitations.Short-term sources of financeTrade Credit overdraftDiscounting of billsCustomers advancesInstalment CreditLoan from co-operative pious platitudeTrade Credit Providing business customers with time to arrange for the salary of keens they subscribe to already received. This period is one of the interest free credit. It is a costly source of finance. Trade credit is use when the buyer is not able to brook the factual cost of goods.1Trade credit refers to credit granted to manufactures and traders by the suppliers of the raw materials, finished goods, components etc. Usually business enterprises by supplies on a 30 to 90 days credit.Advantages of Trade CreditIf new business start up has trade credit, they testament not need much money in capital. It is a good idea to someone who want to start a new business with less money.You cease buy goods and make payment late r when you sell all the goods and get to some money or make a good utility. The time period whitethorn be after 25-30 days.Business throne look in good position without having any serious trouble in immediate payment, which whitethorn set them back.Trade Credit improve the cash flow and extend easy platform for business.With the trade credit, business can focus on other atomic number 18a like sales, marketing and other research.Trade credit is acquirable only with leverage of raw material or finished goods. The term and delineates of trade credit very according to the custom and employ of trade.Disadvantages of Trade CreditIf repayments argon not made by in time, the business will receive a very naughty credit history. They will not trusted in the future, if your business require any loan or trade credit.If companion has a good credit history, it will get trade credit but these can be hard to build up for new business.Overdraft It is a common source of short term finance because of its flexibility. When imbibeed fund atomic number 18 not require longer time they can pay easily and quick. The risks to the lender are less then a long term loan because it is very cheap.2When a bank allows its depositors or account holders to withdraw money in excess of the ratio in his account upto a specified limit, it is kn birth as overdraft facility. This limit is granted purely on the basis of credit-worthiness of the borrower.Advantages of OverdraftFlexible 3 An overdraft is in that location when you need it and cost is zero (in grimace of small fee) when you do not need. It allows you to make essential payments whilst chasing up your own payments, and attentions to maintain cash flow.Quick It is very easy and quick to arrange, providing a good cash flow backup with the minimum of fuss.It allow to make essential payment whilst chasing up your own payment and help to maintain cash flow. You only need to borrow what you need at that time.Disadvantages of OverdraftCost sometimes it carry very higher interest rates and fees then loan. This makes them very expensive.Recall The bank can take back the entire overdraft amount at any time if you have broken terms and conditions or it may happen if you crumble to make other payment.Security Overdraft may need to be secured against your business assets, which put them at risk if you fail in repayment.Bill Discounting Some bank provide short-term loan by discounting bill of exchange. In such cases bank deduct discount while making payment. The amount of discount is broadly equal to the amount of interest for the remaining period of payment. The advantages and disadvantages from this source are following.4When these document is presented before the bank for discounting, banks credit the amount to customers account after deducting discount. The amount of discount is equal to the amount of interest for the period of bill.Advantages of Bill DiscountingAvailability of cash The drawer gets c ash instanter by the discounting bill. He does not have to wait for the payment until the expiry of credit period mansion on the bill.Security swan normally do not ask for any other security while making payment against the bill discounted. However if customer is interested, banks also grant him limit for discounting of bill. This limit is identify as a limit against discounting bill.Nature of liability for repayment Repayment of money advanced against discounted bill is the responsibility of the drawee of bill of exchange. In case drawee does not pay or pass up the pay, the drawer who got payment after discounting the bill is held responsible for payment.Disadvantages of Bill DiscountingAdvance payment of interest While discounting a bill, bank deduct the discount and balance is credited in customers account. This discount is similar to the amount of interest for the remaining period of payment. Thus a person receiving money through discounting of bill has to oblation advanc e interest on the amount of bill.Facility is bow to the parties credit usually banks extend this facility after being satisfied with the credit of parties involved. Bank may be ask for some security. So, it is not a easy purchasable facility.Problem when non-payment Bills not pay upon maturity are to be certain by Notary Public and a certain amount in the form of nothing is paying. Thus it became an additional burden.Customers Advances The advance make by the customer against the honour of order placed. Thus the remaining amount of goods to be supplied later. Let see more details about the advantages and limitations.Advantages of Customers AdvancesInterest Free Amount offered as advance is interest free. because the funds are available without any involving problem.No Security The seller is not required to deposit any major security while demanding advance from the customer. Thus assets remain free of charge.Repayment Ones money received in advance will not be refunded . Hence on that point are no procedures for repayment.Disadvantages of Customers AdvancesLimited amount Amount received from a customer is subject to the value of order. Borrowers demand may be more then the advance amount.Limited Period The period of advance amount is only up to the delivery goods. It cannot be renewed.Penalty Normally advances are subject to the condition that if goods are not delivered on time then order would be cancelled and advance amount would be refunded with interest.Instalment Credit Instalment credit is a system under which a small payment is made at the time of taking the goods and remaining amount is stipendiary in instalment. Generally instalment amount is including of interest. The advantages and limitations of this system are as underAdvantages of Instalment CreditOwnership of asset Delivery of good is assured immediately on payment of down payment.Convenient payment of assets Costly assets which can not leverage directly with full payment ca n be purchase by instalment payment.Saving of one time investment If the price of asset is high and lumpsum amount is made then the business fund are blocked. In this case instalment credit leads to saving of one time investment. more facility for business If the facility of payment in instalment is available then business firm can afford to by new furniture, machinery or other necessary things. Thus, your business reputation looked in good condition by instalment credit.Disadvantages of Instalment CreditCommitment for payment Payment in instalment is a commitment. So you have to pay your instalment in whatever condition of your business.Necessary to pay interest Payment of interest is necessary in this system. Generally sellers charge very high rate of interest.More interest If buyer fail to pay the instalment, seller sometimes impose penalty or additional interest.Loan from Co-operative bank Co-operatives banks are good source of short-term finance. Membership is the primary condition for securing loan in this bank. This bank grant loans for personal and business purposes too. The advantages and limitations of this bank are as underAdvantages of Loan from Co-operative bankThese loans create a sense of thrift among the low-income group.Being a member of co-operative bank, the borrower can participate in the attention.Loan generally granted at a lower rate of interest.Loan from this banks are easily available.Loans are given for good purposes that help to develop the fiscal and social status of the people.Sometimes these banks organise training program for member to familiars them with the various avenues of the business and regarding proper utilisation of loan money.Disadvantages of Loan from Co-operative bankThese loans are available only to members.Loan from this bank is available only for limited purposes.Co-operative banks depend on the supports of the government. So, government rules and regulations sometimes may be makes in trouble to the borrowe rs.These bank find it operose to ensure repayment of loan money due to inadequate information about the need and utilisation of fund by the borrower. There is undersize test of the repaying capacity of the loan seeker at the time of granting loan.Medium Term Source of FinanceDefinitionMedium term source of finance way fund does not require more then 3 years. Normally medium term funds are require by business for repairing and sustainment of machinery or other equipment. So firm get this finance from bank or other kind of source.Medium term source of financeLeasingPublic DepositMortgageLeasing Leasing is the method of capital funding requirement. Leasing based on the principal that income is earned from the use of an asset. The advantages and limitations of leasing are followingAdvantages of LeasingReduced initial cash flow The big advantage of leasing equipment is that the cost is spread over a number of years. You have not to pay the entire amount upfront. This can help to m aintain cash flow. Poor cash flow is the main cause of small business and leasing can help you to keep it under better control.Budgeting Normally this is a puddleed contract. So the amount can be worked into your business budget much more easily.Tax Advantages lease rentals are considered as an operating(a) cost. So it is possible to deduct them from taxable profits. However, before the contract you should always check the equipment you are buying is eligible or not.Security When you lease the product, you are not owner of this product. It means the leasing partnership gives better security. You dont need any further security to be able to start a contract.Disadvantages of LeasingNo self-control Main disadvantage is that you are not the owner of the product. It means the leasing federation is the owner during and after the lease. As you do not own the product, you are ineffective to sell it in the levelt it is no longer needed, and you cannot upgrade to a newer or better p roduct without either paying off the remaining contract, or paying a large fee to cancel the contract.No sell As you are not owner of the product, you can not sell it. If you do not longer needed, you have to pay large fee to cancel the contract.Termination Leases are very difficult to terminate early.Long term disbursal Although leasing allow you to avoid paying a large amount, but after a long time it works out considerably more expensive. Over the period of standard lease, you pay the actual cost of product and other charges.Maintenance You are responsible for maintenance of the product. If you have not trained employee to fix the equipment, this could be more costly in the serious fault. Some leasing company will allow you to cover maintenance cost but you have to pay some extra amount.Commitment Once you signed a lease contract, you are committed to making payment for the entire lease period until now you stop using a property.Public Deposit It is very old and popular s ource of finance. When modern banks were not established, people used to deposit their saving with reputed business. The maturity period for public deposit is minimum 6 months and maximum 3 years. The advantages and disadvantages of public deposit are followingAdvantages of Public Deposit unaccented to deposit The method of borrowing money from public is very easy. It does not require many legal formalities. It has to be advertised to be newspaper.Easily available If companies have good reputation, they are able to obtain funds directly from public without any more financial difficulties.Income tax purpose Interest paid on this deposit is a deductible expenses for income tax.Fix rate The rate of interest on this deposit is fixed, it helps the company to play trading on faithfulness, if the company is earning more then the rate of interest paid on public deposit.Flexibility Public deposit bring more flexibility in the mental synthesis of the capital of the company. These can b e raised when needed and refunded when not needed.Disadvantages of Public DepositInsecurity Public deposits have no charge on the assets of the company. So it may be not safe to deposit saving in those companies which are not very popular.Uneconomical The rate of interest paid on public deposit may be low but there are other expenses like commission, which make it uneconomical.Short period Public deposits are available mainly for short period. So company cannot depend on it for a long time.Misuse The management may misuse your deposit. So in this case it is not secure.Bad effect on capital market It is an easy and cheaper source of raising money. Thus, more money deposited with the companies, there will be less investment in securities. Hence the capital market will not grow.Mortgage A mortgage is a loan specially for the purchase of property. The borrower can use theirs own property as security for the loan. The advantages and limitations of mortgage are followingAdvantages o f MortgageTax advantage The interest payment on the mortgage are tax deductible.Good cash flow With the use of mortgage, you are able to price of admission to capital that you would not normally have access with nominal up-front payment and the flexibility in management of repayment plan.Cash flow management Mortgage plan are pre-set, so you can make plan for future cash management.Disadvantages of MortgageCollateral The nature of a mortgage require you to pledge the purchased property to the lender. When the mortgage is repaid, the owner is obligated to emission the mortgage and is require to make available any government formalities.Defaults The lender may define a variety of events that will constitute a heedlessness on the mortgage, including failure to make any payment on time, bankruptcy, insolvency and breaches of any obligations in the mortgage agreement. Try to negotiate an advance written notice of any alleged default, with a reasonable amount of time to cure the d efault.Long Term Source of FinanceDefinition long source of finance are those that are need over a longer period of time. Generally time duration may be more then 5 years. Long-term finance are needed for fund expansion, set up new office, buying new business or fixed assets like furniture, building, machinery, land etc. Funds require for this business is called long-term finance. The amounts of long-term capital depend upon the scale of business and nature of business.Following various sources of long-term finance and advantages and disadvantages of each source.Long-term source of financeSharesEquity SharePreference ShareDebenturesRetained EarningCommercial Bank LoanBorrowingShares Shares is the main source of long-term finance. The joint line of credit companies issue shares to the general public. These shareholders are the owners of the company. There are two types of shares (1) Equity Share (2) Preference Share. Company divides its capital into units of particular value like 1 0 each or 200 each. Each unit is called share.Equity Share Dividend on these shares is paid after the fixed rate of dividend has been paid on the choice share. The rate of dividend is not fixed because it is depend upon the profit available. The impartiality shareholders control the affairs of the company and have an unlimited interest in the companys profit. The advantages and disadvantages of equity share are followingAdvantages of Equity Share For Shareholders Income Profit The equity shareholders are the residual claimants of the profit. The company may add to the profit by trading on equity. Thus equity capital may get dividend at high in good period.Rights Equity shareholders have redress for ballot to right persons as directors who can control and manage the affairs of the company.Transferable These shares are transferable units.The value of equity share goes up in the stock market with increase in profit of the concern.Advantages of Equity Share 5For Limited Company A company can raised fixed capital by issuing equity shares without creating any charge on its fixed assets.The capital raised by issuing equity shares is not required to be paid back during the life time of the company. It will be paid back only if the company is wound up.There is no liability on the company regarding payment of dividend on equity shares. The company may declare dividend only, if there are enough profits.If a company raise more capital by issuing equity shares, it leads to greater confidence among the investors and creditors.Disadvantages of Equity Share For Shareholders Irregular income The dividend on equity share is subject to availability of profit. If there are taste shareholders, they get first dividend before equity shareholders. Equity shareholders may get no dividend if company has not enough profit.Capital loss During recession period, the profit of the company come down and the rate of dividend also come down. Due to low rate of dividend the market value of equity shares goes down resulting in a capital loss to the investors.Dilution in control Each sale of equity shares dilutes the voting power of the existing equity shareholders. Equity shares are transferable and may bring about centralisation power in few hands.Impossible trading If equity shares alone are issued, the company cannot trade on equity.Over capitalisation If company issue more equity shares may result in over capitalisation. In that condition dividend per share is low which make bad effect on investor.High cost It cost more to finance with equity shares then with other securities as the selling costs and underwriting commission are paid at a higher rate on the issue of these shares.Speculation Equity shares of good companies are subject to hectic speculation in the stock market. Their prices change frequently which are not in the interest of the company.Disadvantages of Equity Share 6For Limited Company No trading on equity Trading on equity means abilit y of a company to raise fund through preference shares, debentures and bank loan etc. On such funds the company has to pay at a fixed rate. This enables equity shareholders to enjoy a higher rate of return when profits are large. The major part of the profit earned is paid to the equity shareholders because borrowed funds carry only a fixed rate of interest. But if a company has only equity shares and does not have their preference shares, debentures or loans, it can not have the advantage of trading on equity.Conflict of interests As the equity share holders carry voting rights, groups are formed to corner the pick outs and grab the control of the company. There develops conflict of interest which is harmful for the smooth functioning of a company.Preference Share Rising capital by issue of these shares is a most important method of rising long-term funds. Preference shares are the shares, which carry initial rights over the equity shares. These shares are receiving dividend at a fixed rate. All shareholders gets dividend regularly. The advantages and disadvantages of preference share are followingAdvantages of Preference Share mend income The dividend payable on preference shares is on fixed rates even if there is no profit.First right Preference shareholders have first right to get dividend. Thus they enjoy the minimum risk. slight capital losses As the initial right of repayment of their capital in case of involved up he company, it saves them from capital losses.Fair security Preference share are fair security for the shareholders during depression period when profit of the company are down.Disadvantages of Preference ShareNo Voting right Preference shareholders have no any voting rights in the company.Fixed income The dividend payable on preference shares is on fixed rates even if the company earns higher profit.No claim on surplus amount The shareholders have no rights to claim on surplus amount. They can only ask for the capital investment i n the company.Not secure They cannot be secure on the companys assets.Debentures Whenever company want to borrow a large amount of money for long but fixed period, it can borrow from the general public by issuing loan security measure called debenture. The holders of the debentures are the creditors of the company. The total amount is divided into units of fixed amount. These are offered to the genera public to subscribe in the same manner as in done in the case of share. A debenture is issued under the common seal of the company. It is a written acknowledgment of money borrowed. For example, if company need 5,000,000 for 10 years, it will issued debentures. Each cost of debenture may be 100.Advantages of DebenturesCreditors Debenture holders are the creditors of the company.Allowing control over the company Debenture holders have no right either to vote or take part in the management of the company.Reliable Source These are repayable after a fixed period of time, the company can make the best use of money. It helps long term planning.Tax benefit Interest paid on debenture is treated as a expense and is charged to the profit of the company. Thus the company saves income tax.Safety Debenture are more secure. When the company is winding up, they are repayable before any payment is made to the shareholders.Disadvantages of DebenturesMore finance more difficulty Debenture finance enables a company to trade on equity. But more finance leaves little for shareholders, as most of the profits may be require paying interest on debentures.Burden in time of depression During depression time the profit of the company decline. It may be difficult to pay interest on debenture. As interest goes on accumulating, it may lead to the closure of the company. slope borrow money Usually debentures are secure. The company creates a charge on its assets in favour of debenture holders. So the company, which does not have own enough assets, they cannot borrow money by issuing debentures.Burden As the interest on debenture have to be paid every year whether there are profits or loss. It becomes burden in case of company incurs loses.Retained Earning The part of the profit which is not distributed among the shareholders but is retained and is used in business is called retained earning. As per Indian company Act. Companies are require to transfer a part of their profit in reserves. The amount so kept in reserve may be used to buy fixed assets. This is called internal financing.Advantages of Retained EarningCheap There are no expenses lav earning capital from this source. There is no obligation on the part of the company either to pay interest or pay back the money. It can safely used for business.Financial Stability A company which has enough reserves can face ups and downs in business. Such companies can continue with their business even in depression, thus building up its goodwill.Good for shareholders Shareholders may get dividend out of reserves if the company does not earn enough profit. Due to reserve, there is capital appreciation, i.e. the value of shares go up in the share market.Disadvantages of Retained EarningIf Huge profit This method of financing is possible only then there are huge profits and that too for many years.Dissatisfaction When funds accumulate in reserves, bonus shares are issued to the shareholders to capitalise such funds. Hence the company has to pay more dividend. By retained earning the real capital does not increase while the liability increases. In case bonus shares are not issued, it may create a situation of under-capitalisation because the rate of dividend will be much higher as compared to other companies.Monopoly Through ploughing back of profits, companies increase their financial strength. Companies may throw out their competitors from the market and monopolize their position.Mis-management of funds Capital accumulated through retained earnings encourages management to spend careless ly.Commercial Bank Loan Some commercial banks giving loans for a long period. i.e. for more than ten year. The period of repayment of long is extended at intervals long period. Commercial banks provide long term finance to small scale units in the priority sector.Advantages of Commercial Banks Loan7It is a flexible source of finance as loans can be repaid when the need is met.Finance is available for a definite period, hence it is not a permanent burden.Banks keep the financial operations of their clients secret.Less time and cost is involved as compared to issue of shares, debentures etc.Banks do not interfere in the internal affairs of the borrowing concern, hence the management retains the control of the company.Loans can be paid-back in easy installments.In case of small-scale industries and industries in villages and backward areas, the interest charged is low.Disadvantages of Commercial Banks Loan Banks require personal guarantee or pledge of assets and business cannot raise further loans on these assets.In case the short-term loans are extended again and again, there is always uncertainty about this continuity.Too many formalities are to be fulfilled for getting term loans from banks. These formalities make the borrowings from banks time overpowering and inconvenient.Borrowing 8 Most business rely on borrowings as well as equity to finance operations. Lenders enter into a contract with the business in which the rate of interest, dates of interest payment, capital payments and security far the borrowing are clearly stated. In the event that the interest payment or capital payments are net made on the due dates, the lender will usually have the right, under the terms of the contract, to seize the asset on which the loan is secured and sell them in order to reply the amount outstanding, security for loan may take the form at a fixed charge on particular assets at the business or a fumbleing charge on the whole at its assets. A floating charge will floa t over the assets and will only fix on particular assets in the event that the business defaults on its borrowing obligations.Advantages of Borrowing9Local savers may provide less costly funds an important habit among clients and the public is rewarded.Lower interest loans provide experience for the company in borrowed fundsLocal bank become familiar with micro and small enterprise potentials.Access to larger sums more quickly based on track record.Allow longer term projections than grantsProvides a discipline similar to that of micro and small enterprise clients.Disadvantages of Borrowing Too many subsidized loans can retard move to market rate.Loans may be dollarized in inflationary situation.Local banks may not be willing to be cooperative.