Pros and cons of Equity shares and Debentures

Profin manufactures Ltd. want to raise finance for the expansion of business but the following conditions should not be violated a) It should not lead to dilution of control b) No mandatory payments of interest

Issuing Equity shares

Advantages No legal obligation to pay dividend No fixed maturity Provides cushion to lenders and increases the credit worthiness of the company A company can raise 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.

Disadvantages of Equity shares

Dilution of control (Two Systems of voting ) Majority and Proportionate Rule Voting Cost of equity capital is high- most expensive source of finance Equity dividends are paid out of profits after tax No trading on equity

Debentures
Advantages
Increase in profits need not be shared Funds raised without diluting control of equity share-holders Interest payable is a charge on profit and hence reduces tax liability Can adjust its debt-equity ratio In case of Irredeemable Debentures : These are also called perpetual debentures. A company is not bound to repay the amount during its life time. If the issuing company fails to pay the interest, it has to redeem such debentures. Reliable source of long term finance : Since debentures are ordinarily issued for a fixed period, the company can make the best use of the money. It helps long term planning.

Disadvantages
Obligatory to pay interest at regular intervals Necessity to make provision for repayment of cost on maturity Since it is long term it involves risk Debenture-finance enables a company to trade on equity.

Suggestion- Source of finance

Zero Coupon Bonds/Deep Discount Bonds/Zero interest(coupon) bond/Zero Bond It does not carry any coupon rate but is issued at a steep discount over its face value(623) For example, a bond with a face amount of 20,000, maturing in 20 years, may be purchased for roughly 9,060, if the interest rate were 4%. The interest is compounded automatically until the bond matures Zero coupon bonds-Face value and Inflation indexed Long term and short term Long term-Tax @ 10%

Advantage
The biggest advantage of a zero coupon bond is its predictability Zero coupon bonds are available for varying maturities Dont have to pay regular interest No dilution of control

Disadvantage
Needs to pay huge amount on maturity

 Companies issue more zero-coupon bonds to lure FIIs in last two months For the current financial year, the investment limit for FIIs in non-infrastructure corporate bonds is $20 billion, or Rs 99,777 crore According to data from the Clearing Corporation of India, 43 per cent of the total primary issuances in January were from the zero-coupon bonds category. The maturities of these instruments ranged between one and five years. In January, there was Rs 25,414 crore sales of zero coupon bonds. Data from the equity markets regulator showed Rs 22,685 crore worth of the FII investment limit was unused as on February 15

Current situation

Calculation
Let's look at how to calculate the price of a zerocoupon bond that is maturing in five years, has a par value of Rs.1,000 and a required yield of 6%. Zero coupon bond price =m/(1+i)n m=1000, i=6%/2=3,n=5*2=10 1000/(1+0.03)10 Rs.744.09

Retained earnings
It is that portion of equity earnings which are ploughed back in the firm Company normally retain 30% - 80% of of Profit after tax

Advantage
Readily available internally It effectively represent infusion of additional equity in the form No dilution of control

Disadvantage
Insufficient amount Opportunity cost is quite high It is considered as sub- optimal investment policy

Rights issue
A rights issue provides a way of raising new share capital by means of an offer to existing shareholders, inviting them to subscribe cash for new shares in proportion to their existing holdings. For example, a rights issue on a one-for-four basis at Rs.280 per share would mean that a company is inviting its existing shareholders to subscribe for one new share for every four shares they hold, at a price of Rs.280 per new share. A company making a rights issue must set a price which is low enough to secure the acceptance of shareholders, who are being asked to provide extra funds

Lines of Credit from Creditors

It refers to short term credit. By a 'line of credit' we mean that a creditor, such as a supplier of raw materials, will allow us to buy goods now and pay for them later. Why do we include lines of credit as a source of finance? Well, if we manage our creditors carefully we can use the line of credit they provide for us to finance other parts of our business

Credit cards
They're an easy and fast way to get and use money. But they're dependent on your personal (not business) credit-worthiness, affect your personal credit score, may have high interest rates. For e.g.- if a businessman can have 4 credit cards and the limit per card is Rs. 2lakh then he can used 8lakh for the given time.(Also one can technically used this amount for more days if he keep track on the dates of payment )

Take on a Partner
If there is someone interested in investing in your business, then taking on a partner could be a good way to finance your business expansion Work with an attorney to develop a partnership agreement, and use that agreement even if you are considering taking on a friend or family member as a business partner The agreement will outline the investment being made, the expected return and the role that the partner will play in the business

Friends and family

These are people who know you, believe in you, and want to help you succeed. They may offer loans or investments. But make sure that the financial relationship will not ruin the personal one, especially if the business does not succeed. Be careful, also, when a family member or friend makes you a "loan" that you don't have to pay any interest on. In the eyes of the taxman, that's a gift and may be taxable They(Businesses) Sometimes called us "friends, family and fools, so be careful while parking your surplus funds

Sale of Assets
The business can finance new activities or pay-off debts by selling its assets such as property, fixtures & fittings, machinery, vehicles etc. It is often used as a short term source of finance (e.g. selling a vehicle to pay debts) but could provide more longer term finance if the assets being sold are very valuable (e.g. land or buildings) If a business wants to use its assets, it may consider sale and lease-back where it may sell its assets and then rent or hire it from the business that now owns the assets. It may mean paying more money in the long run but it can provide cash in the short term to avoid a crisis.

References
Financial Management- Prasanna Chandra Financial Management- Ravi Kishore http://business-standard.com/india/news/companies-issuemore-zero-coupon-bonds-to-lure-fiis/466079/ http://www.fao.org/docrep/W4343E/w4343e08.htm#TopOfPag e http://www.bized.co.uk/learn/accounting/financial/sources/ind ex.htm http://www.usatoday.com/money/smallbusiness/columnist/abr ams/2007-10-18-finance-sources_N.htm http://www.entrepreneur.com/article/80204 http://www.nos.org/srsec319/319-19.pdf

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