• Explain The Following Types Of Long Term Sources Of Finance: 1. Equity Shares 2. Debentures

Mar 1, 2025 by ADMIN 97 views

Explaining Long-Term Sources of Finance: Equity Shares and Debentures

In the world of business, finance plays a crucial role in the growth and development of a company. Long-term sources of finance are essential for businesses to achieve their goals and objectives. Two popular long-term sources of finance are equity shares and debentures. In this article, we will delve into the details of these two sources of finance, explaining their characteristics, advantages, and disadvantages.

What are Equity Shares?

Equity shares, also known as ordinary shares, are a type of long-term source of finance where investors purchase a portion of the company's ownership. When a company issues equity shares, it raises capital by selling a portion of its ownership to investors. In return, the investors receive a share of the company's profits and assets.

Characteristics of Equity Shares

Equity shares have the following characteristics:

Ownership: Equity shares represent ownership in the company.
Risk: Equity shares are subject to market risks, meaning their value can fluctuate.
Return: Equity shareholders are entitled to a share of the company's profits.
Voting Rights: Equity shareholders have voting rights, allowing them to participate in decision-making.

Advantages of Equity Shares

The advantages of equity shares include:

Flexibility: Equity shares can be issued in various forms, such as common shares or preferred shares.
Low Cost: Equity shares are relatively low-cost compared to other sources of finance.
Tax Benefits: Equity shareholders can benefit from tax deductions on dividends received.
Long-Term Funding: Equity shares provide long-term funding, allowing companies to achieve their goals and objectives.

Disadvantages of Equity Shares

The disadvantages of equity shares include:

Dilution of Ownership: Issuing equity shares can dilute the ownership of existing shareholders.
Market Risks: Equity shares are subject to market risks, meaning their value can fluctuate.
Dividend Payments: Equity shareholders may not receive dividend payments if the company is not profitable.

What are Debentures?

Debentures are a type of long-term source of finance where a company issues bonds to raise capital. Debentures are essentially loans from investors, where the company promises to repay the principal amount with interest. In return, the investors receive a fixed rate of return and a priority claim on the company's assets.

Characteristics of Debentures

Debentures have the following characteristics:

Loan: Debentures are essentially loans from investors.
Fixed Rate of Return: Debentures offer a fixed rate of return, usually in the form of interest payments.
Priority Claim: Debenture holders have a priority claim on the company's assets.
Long-Term Funding: Debentures provide long-term funding, allowing companies to achieve their goals and objectives.

Advantages of Debentures

The advantages of debentures include:

Fixed Rate of Return: Debentures offer a fixed rate of return, providing a predictable income stream.
Priority Claim: Debenture holders have a priority claim on the company's assets.
Long-Term Funding: Debentures provide long-term funding, allowing companies to achieve their goals and objectives.
Low Risk: Debentures are generally considered low-risk, as they are secured by the company's assets.

Disadvantages of Debentures

The disadvantages of debentures include:

High Cost: Debentures can be expensive, as they require interest payments and principal repayment.
Restrictive Covenants: Debentures may come with restrictive covenants, limiting the company's ability to operate.
Loss of Control: Issuing debentures can lead to a loss of control, as debenture holders may have voting rights.

In conclusion, equity shares and debentures are two popular long-term sources of finance for businesses. While both sources have their advantages and disadvantages, they can provide the necessary funding for companies to achieve their goals and objectives. By understanding the characteristics, advantages, and disadvantages of equity shares and debentures, businesses can make informed decisions about their financing options.

Based on the discussion above, we recommend that businesses consider the following:

Equity Shares: Equity shares can be a suitable option for businesses looking for long-term funding and flexibility.
Debentures: Debentures can be a suitable option for businesses looking for fixed-rate returns and priority claims on assets.
Diversification: Businesses should consider diversifying their financing options to minimize risk and maximize returns.

In conclusion, equity shares and debentures are two essential long-term sources of finance for businesses. By understanding their characteristics, advantages, and disadvantages, businesses can make informed decisions about their financing options. We hope this article has provided valuable insights into the world of long-term finance and has helped businesses make informed decisions about their financial future.
Frequently Asked Questions: Equity Shares and Debentures

In our previous article, we discussed the characteristics, advantages, and disadvantages of equity shares and debentures. In this article, we will answer some frequently asked questions about these two long-term sources of finance.

Q: What is the difference between equity shares and ordinary shares?

A: Equity shares and ordinary shares are the same thing. They are a type of long-term source of finance where investors purchase a portion of the company's ownership.

Q: How do equity shareholders benefit from owning shares?

A: Equity shareholders benefit from owning shares by receiving a share of the company's profits and assets. They also have voting rights, allowing them to participate in decision-making.

Q: What are the risks associated with equity shares?

A: The risks associated with equity shares include market risks, meaning their value can fluctuate. Equity shareholders may also not receive dividend payments if the company is not profitable.

Q: Can equity shares be traded on the stock market?

A: Yes, equity shares can be traded on the stock market. This allows investors to buy and sell shares easily.

Q: What is the difference between common shares and preferred shares?

A: Common shares and preferred shares are both types of equity shares, but they have different characteristics. Common shares give shareholders voting rights and a share of the company's profits, while preferred shares do not give shareholders voting rights but do give them a fixed rate of return.

Q: Can a company issue both equity shares and debentures?

A: Yes, a company can issue both equity shares and debentures. This is known as a mixed capital structure.

Q: What is the difference between a rights issue and a public issue?

A: A rights issue is when a company issues new shares to existing shareholders, while a public issue is when a company issues new shares to the general public.

Q: What is the difference between a debenture and a loan?

A: A debenture is a type of loan where a company issues bonds to raise capital. The company promises to repay the principal amount with interest.

Q: How do debenture holders benefit from owning debentures?

A: Debenture holders benefit from owning debentures by receiving a fixed rate of return and a priority claim on the company's assets.

Q: What are the risks associated with debentures?

A: The risks associated with debentures include the risk of default, where the company fails to repay the principal amount or interest. Debenture holders may also lose their priority claim on assets if the company goes bankrupt.

Q: Can debentures be traded on the stock market?

A: No, debentures are not typically traded on the stock market. They are usually issued as a fixed-income investment.

Q: What is the difference between a secured debenture and an unsecured debenture?

A: A secured debenture is backed by collateral, such as assets or property, while an unsecured debenture is not backed by collateral.

Q: Can a company issue both debentures and equity shares?

A: Yes, a company can issue both debentures and equity shares. This is known as a mixed capital structure.

In conclusion, we hope this Q&A article has provided valuable insights into the world of equity shares and debentures. By understanding the characteristics, advantages, and disadvantages of these two long-term sources of finance, businesses can make informed decisions about their financing options.

Based on the discussion above, we recommend that businesses consider the following:

Equity Shares: Equity shares can be a suitable option for businesses looking for long-term funding and flexibility.
Debentures: Debentures can be a suitable option for businesses looking for fixed-rate returns and priority claims on assets.
Diversification: Businesses should consider diversifying their financing options to minimize risk and maximize returns.