BCom Notes Part II Banking and Finance Sources of Industrial Finance
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Sources of Industrial Finance
What are the various sources of industrial finances? OR
Write a short notes on Price Mechanism.
Sources of Industrial Finance
Industrial Finance may be required for short period or for long period. It may be raised by investment of proprietors as ownership funds or by borrowings. The various sources of finance may be broadly classified as under:
1. Ownership Funds
It includes owner’s investment as sole proprietor or partners of a firm. In companies it is raised by issue of shares, ploughing back of profits, depreciation policy, dividend policy, reorganization and price mechanism.
2. Borrowed Funds
There are external sources of business. It includes borrowings from relatives and other sources by sole owners and partners of business. In companies borrowed funds include debentures public deposits, banks, insurance companies and special financial institutions.
Ownership Funds
1. Shares
The share capital of a company is dividend into small units called shares. A person who buys a share is called the shareholder or member of the company.
The share capital forms a part of proprietary or ownership funds and used for financing the long-term requirements, the fixed capital and the fixed part of the regular working capital. It need not be repaid during the time of the company.
2. Ploughing Back of Profits
Like all individuals, companies also save a portion of their profits to be used to meet future needs. When the profits earned by a company, instead of being fully distributed to shareholders in the form of dividends, a portion is retained in the business as additional capital, it is known as ploughing back of profits.
Advantages of Ploughing Back Policy
(i). It improves the financial position of the company and frees it from the clutches of other financers.
(ii). This policy of self-financing enables the company to increase the profits by replacing its equipment. It can thus maintain a stable value of dividends in spite of the transfer of a portion of profits to reserve.
(iii). It also helps the company to earn more profits and pass on the benefits to the shareholders who can sell the shares at a premium.
Disadvantages of Ploughing Back Policy
The policy of ploughing back of profits must be implemented with cases. Otherwise, the company has to face the disadvantages of this policy.
(i). This may result in over capitalization, if the directors are over-zealous.
(ii). If the rate of dividend is reduced due to this policy, the shareholders get disappointed.
(iii). The retained profits may not be used for the benefits for the company and diverted to some other companies.
(iv). The directors may manipulate the value of shares in the stock exchange. The declaration of low rate of dividend result in the fell of values of shares. The directors may buy the shares by taking advantage of low prices. Later, they may increase the rate of dividend and dispose of the shares in the market, when the prices rise.
3. Depreciation Policy
Depreciation is permanent decrease in the value of an asset through wear and tear in use or passage of time. It represents permanent fall in the market value of the asset. A good management policy, provides for adequate depreciation on its assets. Adequate depreciation charge is made with a view to recover through current earnings the original investment in the assets.
4. Dividend Policy
A good company always provides for all its liabilities before paying dividend to its shareholders. It is a part of a sound financial policy that company must try to establish a stable dividend rate. Frequent charges in the rates are likely to affect the values of shares on the stock exchange and effects the reputation of company in due course. For maintaining a stable dividend rate, the management is justified if does not pay dividends during the first few years in the case of new company which requires funds for development and financial stability.
The dividend may be paid in cash or by issue of bonus shares according to the availability of liquid assets and the extent of under capitalization existing in the company.
5. Reorganization
Reorganization of a company is done when it is in financial difficulties or when it is desired to like advantage of certain favorable conditions in the market. Reorganization may be internal or external.
Internal Reorganization: In internal reorganization the share capital is reorganized. A portion of capital is also cancelled to wipe out the capital losses.
External Reorganization: It takes place when a company goes into liquidation and a new company is formed with the value of assets and liabilities suitable adjusted.
6. Price Mechanism
The selling prices of the product is so fixed as to include a small fractional sum to cover the cost of future expansion. The additional sum so collected while realizing the sale proceeds of the product, is allowed to accumulate and is set aside for meeting the additional capital requirements. Under this method, the product becomes costly. This policy can be successfully employed only by a concern or which has monopoly in the matter of production and sale. If this policy is carried to its extremes and permanently to earn maximum profits, the concern may loose even in existing market.
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