Sources of Fixed Capital or Long Term Finance
The main sources of fixed capital or long term finance are depicted below.
The sources of fixed capital or long term finance are:
- Issue of Equity and Preference shares.
- Issue of Right shares.
- Private placement of shares.
- Issue of debentures.
- Term loans.
- Retained earnings.
- Lease financing.
Now let's briefly discuss each source of fixed capital or long term finance.
Source 1. Issue of shares
Issue of shares is the most important source of fixed capital. Most companies collect fixed capital by issuing shares.
Generally, there are two types of shares, these are depicted below.
These two types of shares are briefly described as follows:
(i) Equity share:
- Equity share carries ownership rights of the company, and it doesn't carry a fixed rate of dividend.
- Equity shares are more popular than preference shares. The face value of an equity share is decided by the company.
- This share is also called ordinary share. This is because shareholders are the real owners of the company.
- The share capital is also called risky capital. This is so because there is no guarantee for getting a dividend. Similarly, if the company winds up or shut down, there is no guarantee for getting repayment of capital.
(ii) Preference share:
A preference share carries ownership rights of the company, and it carries a fixed rate of dividend.
A preference share has two main advantages over equity shares viz.;
- They get a fixed rate of dividend before the equity shares, and
- If the company winds up or shut down, they get repayment of capital before the equity shares.
Source 2. Issue of Right shares
Rights issue of shares means the company issues shares to its existing shareholders. According to provisions of law, a company must first issue shares to its existing-shareholders.
If the existing shareholders do not want to buy the shares, then the company can sell its shares to the outsiders.
The existing shareholders are given first preference to buy the company's fresh issue of shares.
In an event of rights issue of shares, the share capital increases but the numbers of shareholders do not increase.
Generally, rights issue is very economical to collect fixed capital.
Source 3. Private placement of shares
Here, the company does not sell the shares to the public.
It is a very simple and economical method as it does not involve issue of a prospectus, no need of brokers and underwriters, etc.
Fixed capital is also collected from private placement of shares.
Source 4. Issue of debentures
Debenture represents the borrowed capital of the company. Fixed capital is also collected from issue of debentures.
Debenture holders get interest for the capital contribution made by them to the company.
Debenture holders are the long-term lenders of the company.
Source 5. Term loans
Term loans are secured or unsecured loans obtained by the company. The company has to pay interest on these term loans.
The company gets term loans from banks and financial institutions like Deutsche, HSBC, YES, ICICI, HDFC, AXIS, and so on, by submitting its project analysis report.
The shareholders do not lose ownership control of the company by obtaining term loans. Fixed capital is also collected from term loans.
Source 6. Retained earnings
Retained earnings is a part of undistributed profits earned by the company. Since, the company does not distribute all of its profits to the shareholders.
Company saves a part of its profits. This saved profit is called retained earnings, self-financing or ploughing back of profits.
It is very economical because no interest payment is to be made.
Retained earnings is the cheapest source of fixed capital.
Source 7. Lease financing
In lease financing, there are two parties, viz;
- Lessor, who is the owner of an asset, and
- Lessee, who is the user of an asset.
The lessor is the owner of an asset. Lessor gives the asset on a lease-basis to the lessee. The lessee uses the asset and in return, pays rent for using that asset to the lessor.
The lessor and lessee enter into an agreement. This agreement is called lease-agreement.
The lessee need not spends money for purchasing the assets. Lessee hires (takes) the asset on a lease or rent so that he/she can use the available money for working capital requirements.
Lease financing is very simple and economical.
So, these are the sources of fixed capital or long term finance.