Raising of Finance for a Company: 12 Methods

This article throws light upon the top twelve methods used for raising finance for a company. The methods are: 1. Shares 2. Debentures 3. Public Deposits 4. Managing Agents 5. Loans from Banks 6. Ploughing Back of Earnings 7. Hire Purchase 8. Leasing 9. Profit Flowback 10. Credit Facilities 11. Trade Credit 12. Short Term Loans.

Method # 1. Shares:

A big amount of capital required is collected through the shares issued to public. Shares can be issued at any time, generally these are issued at the time of starting of new business, ex­panding or reorganising the existing concern. Amount to be collected by shares is first decided. Then the value of shares issued to the public should not exceed this predetermined value.

Shares issued by the company may be of following types:

(a) Preference shares,

(b) Ordinary shares and

(c) Deferred shares.

(a) Preference Shares:

A person holding these shares is entitled to get fixed rate of dividend. He gets his rate of dividend before any amount paid to the ordinary share­holders. Thus as its name suggests, it gets preference over other shares for getting dividend.

Similarly these shares get preference over other shares, if repayment of capital is done. When these shareholders get above mentioned facility, these have limitation that they will not get more than the fixed rate of dividend even when profit is very large.

These preference shares are of the following two types:

(i) Cumulative Preference Shares:

In these shares, if the profits are not sufficient to pay the fixed dividend in any year then the deficit is paid up from the profits of the next year.

(ii) Non-Cumulative Preference Shares:

In these shares, the dividend is not transferred to the next year, if the profits of any year are insufficient to pay the fixed divi­dend.

(b) Ordinary Shares:

These shares get their dividend only after payment of the fixed dividend on preference shares. The advantage for the holders of the ordinary share is that there is no limit of dividend, and thus they may get higher dividend, if the profits are larger. If there is a loss, then ordinary shareholders do not get any dividend.

(c) Deferred Shares:

As the name suggests, these shares have their claim last of all. Holders of these shares get their dividend only after the payment of the dividend to all other classes of shares. Generally these shares are issued to the promoters and to the persons who have helped in the formation of the company.

Method # 2. Debentures:

When company desires to raise the required finance through loans instead of sale of shares, then debentures are issued. In this way, it is advantageous because debentures holder cannot claim for ownership and he is to be paid interest only.

Debentures may be issued either for initial needs of the enterprise or for the development and extensions. Debenture-holder has no liabilities. Debenture provides finance for a specified period and the company can adjust its financial plan accordingly.

Method # 3. Public Deposits:

Some of the concerns raise their capital by accepting the deposits direct from the public for fixed terms generally, 6 months to 7 years. Fixed capital is generally raised through long terms deposits while working capital by short period deposits. In India, this method was being employed by cotton mills specially those located at Ahmedabad, Mumbai and Sholapur.

The depos­its are taken for 6 months in the purchasing season when cotton has to be purchased and are repaid after 6 months when the clothes are sold. However this method has started gaining importance in other industries also.

This method has the advantage of enabling a company to keep its share capital low and to borrow at cheap rates (generally easy money is taken for this purpose). This facilitates payment of higher dividends than that would be possible if the entire money were taken in the shape of share capital. This system is also helpful as the banking assistance facilities are not adequate for industries.

This method cannot be relied upon, specially during the period of depression when the industry is on the downgrade. During such period, industry requires more money but the de­positors get panicky and withdraw their funds, which creates an embracive position for a concern.

Method # 4. Managing Agents:

This source has played a very important role in early days of industrial development in India for setting up and development of industries. Managing agents have provided fixed and working capital themselves and also arranged through other sources like inducing their friends and relatives to purchase the shares and debentures, arranging loans from banks and public deposits.

Managing agents had played an important role in promotion, financing and management of industrial concerns. The malpractices in management by some of the managing agents have come to light in recent years and the public have become very distrustful of managing agents as a class. Hence the financing of Indian Industries has become less dependent on them than before.

Method # 5. Loans from Banks:

Upto some years ago, commercial banks were providing finance only for the working capital requirement of industries and were avoiding long-term advances against fixed assets. This system was followed due to security reasons. But from this policy, small entrepreneur was most sufferer.

But now-a-days State Bank of India and other nationalised banks provide financial assis­tance also to the small scale industries under liberalised scheme. The loans are granted to these industries under liberalised scheme.

The loans are granted to these industries for fixed as well as working capital requirements. State Bank of India has a special scheme to assist engineers, craftsmen and other qualified persons who are in need of money for starting an industry.

Method # 6. Ploughing Back of Earnings:

Every developing industry requires capital for extensions and improvements. Ideal method of financing for extensions and improvements of an industry is reinvestment of a part of the profits, which is also known as ploughing back of earnings.

The reserve of capital built up during a continuous spell of prosperous period can be used as working capital. This system provides sound financial management. This helps in the depression periods in addition to that for expansion and improvements of concern.

Method # 7. Hire Purchase:

In hire purchase system, machinery etc. when required can be obtained for use and number of periodical money installments as agreed with the seller is to be made. At the end of the period when all the installments have been paid, the possession of the machinery or equipment passes to the hirer.

Method # 8. Leasing:

Fixed assets like land, machinery etc. can be obtained on lease for a number of years on rental basis.

Method # 9. Profit Flowback:

The profit is not distributed to the shareholders or owners and is retained for financial expansion and growth of the concern.

Method # 10. Credit Facilities:

This is an important source of short term financing. In this system, goods and services are obtained on credit. However, in case cash discount is offered, discount forgone becomes a cost of trade credit.

Method # 11. Trade Credit:

These are the financial assistance available from other firms from whom the business has dealings. Most important of them are suppliers of inventory.

Method # 12. Short Term Loans:

These are commercial bank loans as creditor revolving credit agreement. Accounts receiv­able and inventory are the principal assets used to secure short-term business loans.