Introduction

The sources of long term finance are those sources from where the funds are raised for a
longer period of time, usually more than a year. Long term financing is required for
modernization, expansion, diversification and development of business operations. Generally,
the companies resort to the sources of long-term finance when they have an inadequate cash
balance and need capital to carry out its operation for a longer period of time.

Objectives of Long-term Financing

 To purchase new asset or equipment
 To finance the permanent part of the working capital
 To enhance the cash flow in the firm
 To invest in R&D operations
 To construct or build new construction projects
 To develop a new product
 To design marketing strategies or increase facilities
 To expand business operations
The long term financing could be done internally, i.e. within the organization or externally,
i.e. from outside the organization.

Sources of Finance

(A) Ownership Capital

Ownership capital is defined as funds invested by owners of business for permanent

use, which entitle them to decide how the activities related to the business will be
managed and what will be their share in the profits. Individual owner, in case of sole
trader business, invests capital from his own savings. In case of a partnership firm,
each partner contributes capital as agreed mutually among partners. By issuing
shares, companies can raise their capitals. Ownership capital are:

 Equity Share Capital: Equity shares are also known as ordinary shares. They are the
form of fractional or part ownership in which the shareholder, as a fractional owner,
takes the maximum business risk. The holders of Equity shares are members of the
company and have voting rights. It is the vital source for raising long-term capital.
Equity shares represent the ownership of a company and capital raised by the issue of
such shares is known as ownership capital or owner’s funds. They are the foundation for
the creation of a company.

 Preference Share Capital: Preference shares are the shares which promise the holder a
fixed dividend, whose payment takes priority over that of ordinary share dividends.
Capital raised by the issue of preference shares is called preference share capital. The
preference shareholders are in superior position over equity shareholders in two ways:
first, receiving a fixed rate of dividend, out of the profits of the company, before any
dividend is declared for equity shareholder and second, receiving their capital after the
 claims of the company’s creditors have been settled, at the time of liquidation. In short,
the preference shareholders have a preferential claim over dividend and repayment of
capital as compared to equity shareholders. Preference shareholders generally do not
enjoy any voting rights.
 Retained Earnings: This is one of the most important sources business finance. It
represents the profits generated from sales after interest payments to lenders, taxes to
the government and payments to shareholders in the form of dividends. The
remaining profit is then retained or put back into the business and available for future
spending by the organization. A firm may retain a portion or whole of its profits and
utilize it for financing its projects.

(B) Borrowed Capital

Borrowed funds refer to the funds raised with the help of loans or borrowings. This is the
most common type of source of funds and is used the majority of the time. The sources
for raising borrowed funds include loans from commercial banks, loans from financial
institutions, issue of debentures, public deposits and trade credit which are as follows:

 Debentures: Debenture is a document given by a company under its common seal as

an evident of debt to the holder. It includes debenture stock, bonds and any other
security of the company whether charge on assets of the company or not. Company
can issue redeemable or irredeemable debentures. Redeemable providing specific date
of redemption whereas irredeemable providing no undertaking to repay. It is an
instrument for raising long-term debt. Debenture holders are the creditors of the
company. They have no voting rights in the company. Debenture may be issued by
mortgaging any asset or without mortgaging the asset, i.e., debentures may be secured
or unsecured.

 Term Loans: The term loan is a long term secured debt extended by banks or
financial institutions to the corporate sector for carrying out their long-term projects
maturing between 5 to 10 Years which is normally repaid in monthly or quarterly
equal installment. They are an external source of finance paid in installments
governed by loan agreement and covenants. All the capital requirements cannot be
fulfilled by the promoters or equity share issues and that is where the term loans come
into the picture.

Therefore, it can be concluded by an old saying that “you have to spend money to make
money” meaning if company has to raise funds at some point to develop products and expand
into new markets, it has to find some long term source. The company may sell its products
more than its cost to produce which in turn provide fund to a company but such source is not
sufficient to provide capital to a company, it has to look for an alternative.