Long-Term Sources of Finance Essay Example | Topics and Well Written Essays - 2000 words

Long-Term Sources of Finance - Essay Example preference equity, common equity, debt and leasing. Long-term Finances A business needs funds for capital investments such as fixed assets like plant, machinery, land, building, furniture etc. These assets must be financed with long-term financing sources. The chief financial officer (CFO) is usually responsible for making suggestions to the senior management and board of directors related to financing issues. These suggestions and recommendations carefully analyze the advantages and disadvantages of each long-term financing option. After the decision is made by the senior management and the board, the CFO is responsible for obtaining the long-term finances. The common forms of long-term finances are preferred stock, common stock, long-term debt and leasing. A firm faces need of different types of finances through its various stages of development. A firm in its start-up generally avail funds from the banks for personal loans, government agencies and personal savings. During the rapi d growth phase a firm uses internally generated funds or direct financing. The direct financing includes loans from insurance company, commercial banks or pension funds and financing by venture capitalists. The maturity phase is financed by issuing equity or debt in primary markets. The firm in its final stage finances from internal sources while making debt repayments or buying back the common stock (Weaver & Weston, 2004, p.311-312). Figure 1: Financing Sources Source: (Weaver & Weston, 2004, p.312) Sources of Long-term Finance Sources of long-term finance differ with the type and size of the firm. There are mainly two categories of financing-Equity and Debt. The equity financing consists of two types of equity instruments, one is preference stock and the second is common stock. The debt financing can take two forms, first long-term debt from financial institutions and second in the form of leasing. Each financing option is discussed as follows: Preferred Stock Preference capital is a distinctive type of long-term financing which combines the features of both debt and equity. As a hybrid security it has a fixed rate of dividend and ranks higher than the common equity in terms of claims over the firm’s earnings. The preference shareholders do not have voting rights as the common shareholders have. Advantages: The preference dividends can be omitted in case of low or zero earnings. This provides the firm greater flexibility and chance of surviving a downturn. However skipping a dividend may reflect dim view of the firm in investors’ community and may affect the share price as investors lose confidence and sell. Preference share capital is an additional source of capital which does not provide voting rights to the preference shareholders and therefore do not dilute the influence of ordinary shareholders. Fixed and limited preference dividends mean that the firms can retain or distribute common dividends in case of extra-ordinary earnings in a fisc al year. In case of limits on raising debts under the debt covenants, the preference share capital is a good alternative if a firm wants to expand raising external finance. Disadvantages: The high risk associated with capital and annual returns leads the preference shareholders to demand higher return than debt holders. The preference dividends are regarded as distribution of profits. Therefore they are not tax deductible. In comparison to this the lenders are not owners and so their interests are regarded as the expense