7 Major Sources of Long -Term Finance

This article throws light upon the seven major sources of long-term finance. The sources are: 1. Equity and Loans from Government 2. Loan from Public Financial Institutions 3. Public Deposits 4. Internal Sources 5. Capital Markets 6. Bonds 7. International Sources.

Long -Term Finance: Source # 1. Equity and Loans from the Government:

We know the equity capital represents the interest free perpetual capital and as such, the right as well as control always go with the ownership of equity. In the case of public sector undertakings such right and control lies in the hands of Government or by a holding of apex bodies or partly by financial institutions and partly by the public.

Of course, usually the Government supplies only equity and/or loans and not the redeemable preference share capital although the later has been some distinct edges over the others, viz., a fixed return can be obtained when the sector earns profit.

Usually, out of the total capital, 50% is being financed by way of long-term loans although their rate of interest depends on the varying period of loans. Needless to say that such rate of interest is ascertained on the basis of the bank rate and Government of India Securities/Bonds.

No doubt, loan capital invites a problem public sector since the same must have to be repaid along with the interest. For this purpose, the same must be adjusted against the cash flow pattern of the sector, its earning capacity and many other related factors.

But, at present, the Government has decided to compose capital 50-50 i.e., equity and loan equally It is interesting to note that this acts in an adverse manner particularly to those which bears a long period of construction and gestation as well.

In 1968, a circular was issued by the Government which contained that loan capital had direct impact on the profitability of the enterprises and the same should be considered while preparing the feasibility studies and DPRs. For this, the debt-equity ratio should be ascertained.

Long -Term Finance: Source # 2. Loan from Public Financial Institutions:

In 1967 when the IDBI was set up it was decided by the Government that no public sector undertaking will take any loans either from 1FC or from IDBI since routine Government funds must not serve the required purposes of the public sector. They are primarily meant for private sector undertakings.

But in 1969, the Government changed its decisions and thought that a good tradition would be established if public sector undertakings utilize such resources from these financial institutions like private sector undertakings.

But the same will be possible after proper scrutiny about the financial needs of the enterprise by those institutions. However in 1971, the Government allowed the public sector undertakings to take loans from these financial institutions at par with the private sector undertakings. This is being continued till to date.

Long -Term Finance: Source # 3. Public Deposits:

Public deposit is a good source of finance for short-term working capital requirements of a private sector undertaking. In private sector undertaking, however, these are unsecured deposits taken for a short period, usually I to 3 years. But in public sector, they carry a hidden security.

In others words, if a public sector undertaking goes into liquidation, the lenders will be paid with the residue after meeting preferential creditors/secured creditors and naturally the Government will take initiative to rescue it. For this purpose, the Government does not encourage the public sector undertakings to take public deposits.

During 1980-81, the Government allowed the public sector to take unsecured public deposits for a maximum period of three years under cumulative and non-cumulative schemes. It may be mentioned here that some state Government enterprises take the advantages of public deposits.

Whenever the public sector undertakings desire to accept unsecured public deposits, they must have to maintain the prescribed norms suggested by the Companies Act, like private sector.

That is, the public sector undertaking has to pay service charges and brokerage in addition to interest on deposits No doubt, this is a cheaper source of finance. For this reason, public sector undertakings take thousands of crores of rupees from public deposits.

Long -Term Finance: Source # 4. Internal Sources:

Internal Sources is a very significant source of finance, it is needless to mention here that the primary source of finance for a firm should be its own source which is practiced by almost all the private sector undertakings.

A public sector undertaking should always go for such sources which arises out of the surplus of funds after meeting the costs and expenses and to reduce the claims on savings of the country. The internal sources consist of: Retained earnings, provision for depreciation etc.

Internal Sources and Dividend Policy:

It is noted that Reserves and Surplus which are held by the public sector undertaking are related with dividend policy for the same. It is known to us that reserve is created out of surplus profit by starving the dividends, i.e., if part of profit is paid by way of dividend, the firm cannot transfer such surplus to Reserves and naturally if entire amount of such surplus is transferred to Reserve, nothing can be paid as dividend.

For this reason, in March, 1992 the Ministry of Finance issued an order that all profit earning public sector undertakings must a minimum rate of dividend @ 20% of their post-tax profits from 1992- 93 onwards and the public sector undertakings who are already paying dividend must increase the rate by 50% subject to the minimum of 20% stated above.

Long -Term Finance: Source # 5. Capital Market:

Raising of funds by issuing equity in a common source of finance both for the private and public sector undertakings. It will be significant only when the firm takes its place in the capital market for such purposes.

The Government, after liberalization, allowed the public sector undertakings to raise funds by issuing equity since it went down for partial disinvestment of equity. But it was found that most of the public sector undertakings was failed to raise necessary funds by issuing equity. That is, it was not a successful venture.

Long -Term Finance: Source # 6. Bonds:

In 1985, the Finance Minister announced a scheme for flotation of bonds by the power sectors and telecommunication sectors.

The bonds may be issued for:

(i) Setting up new projects; or

(ii) For expansion and diversification of existing projects; or

(iii) Meeting capital expenditure for modernization; and

(iv) Augmenting the long-term resources for the requirements of working capital.

Moreover, the other significant features of the said scheme were as under:

(i) Bonds must not be redeemed before the expiry of 7 years but not later than 10 years;

(ii) Debt-equity ratio must not exceed 4:1;

(iii) There must not be any deduction of tax at source;

(iv) Interest on bonds income is qualified for deduction u/s 8OL of the Income-tax Act;

(v) The bonds are exempted from the wealth tax without any limit; and

(vi) Interest rate on bonds must not exceed 14%.

It may be stated that interest-free bonds was costlier to the Government comparatively than the rate of interest they carry due to the loss suffered on account income-tax and wealth tax foregone by the Government for issuing such bonds.

It was also revealed that as a single repayment after 7-10 years, it becomes difficult for the firm to accumulate adequate cash flows for such repayment for which either new bonds may be issued or needs budgetary support and as the funds have already used for capital projects

When the restriction on the rate of interest on the bonds and debentures are removed after the liberalization, some public sector undertakings are presenting to various institutional investors (e.g. various financial institutions and mutual funds) an interest rate of 17%.

Long -Term Finance: Source # 7. International Sources through Equity and Loans:

Raising of funds from foreign equity can be considered only when:

(i) The project is a very big one which requires foreign loan capital and the same is not accepted by the foreigners until and unless a foreign firm is associated with it;

(ii) The enterprise needs special technical knowledge, inputs etc. which cannot be secured.

However, the equity from the multinational companies may be considered from the standpoint of:

(i) Domestic managerial control,

(ii) Economic independence;

(iii) Ideology;

(iv) Micro grounds of financial needs; and

(v) Macro consideration of foreign exchange.

Although it is a significant source, but the Government does not prefer foreign equity participation in public sector undertakings. Sometimes in the past, the Government acquired from the collaborators a small share of equity, e.g., Indian Telephone Industries, Hindustan Steel Ltd. etc. But in some other venture, foreign equity participation was a must, e.g., Madras Refineries Ltd.

But, from the point of view of foreign loans, the points are to be carefully considered:

I. Cost of finance relating to rate of interest, charges for raising loans and the periods for repayment;

II. Repayment of principal and interest must be consistent with cash flow patterns;

III. Unnecessary delays for finance from some other sources must be adjusted against the apparent cost element:

IV. Procuring finance and purchases restrict the application of consultant suppliers etc.

V. True value of tied as against untied credit.