Secretarial Practice PDF - Standard XII

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SECRETARIAL SECRETARIAL PRACTICE PRACTICE STANDARD XII {MQ>{UgmMr H$m`©nX²YVr B`ËVm ~mamdr (B§J«Or _mÜ`_) Trade Credit e har ity S Equ anies re Comp Deb entu Act Eur o Is sue 2013 Preference Share sAAcct t , , 2 2 0 01133 s mppaannieie Coom C &Reach gy,Trust Financial Intermediaries : Savings eg. Banks, Insurance Companies, etc. Lending Technolo Savers: Borrowers: Households, Firms, Households, Firms, Governments Lending Governments & Overseas Residents & Overseas Residents Savings Financial Markets : Lending eg. Equity Markets,Debt Markets, etc. {MQ>{UgmMr H$m`©nX²YVr B`ËVm ~mamdr (B§J«Or _mÜ`_) 106.00 The Coordination Committee formed by GR No. Abhyas - 2116/(Pra.Kra.43/16) SD - 4 Dated 25.4.2016 has given approval to prescribe this textbook in its meeting held on 30.01.2020 and it has been decided to implement it from the educational year 2020-21. Secretarial Practice Standard : XII 2020 Maharashtra State Bureau of Textbook Production and Curriculum Research, Pune - 411 004 Download DIKSHA App on your smartphone. If you scan the Q.R.Code on this page of your textbook, you will be able to access full text and the audio-visual study material relevant to each lesson provided as teaching and learning aids.  First Edition : 2020 © Maharashtra State Bureau of Textbook Production and Curriculum Research, Pune- 411 004. Maharashtra State Bureau of Textbook Production and Curriculum Research reserves all rights relating to the book. No part of this book should be reproduced without the written permission of the Director, Maharashtra State Bureau of Textbook Production and curriculum Research, Pune. Commerce Stream Committee Members Cover, Illustrations and Computer Drawings Dr. Narendra Pathak Shri. Sandip Koli, Artist, Mumbai (Chairman of Commerce Committee) Typesetter Dr. Jyoti Gaikwad (Member) Shri Printers, Pune Dr. Mukund Tapkir (Member) Dr. Prashant Sathe (Member) CS. Mahesh Athawale (Member) Co-ordinator Shri. Surendra Nirgude (Member) Ujjwala Shrikant Godbole Shri. Narayan Patil (Member) I/C Special Officer for Mathematics Shri. Mohan Salvi (Member) Shri. Anil Kapre (Member) Production Smt. Anantlaxmi Kailasan (Member) Sachchitanand Aphale Smt. Laxmi Pillai (Member) Chief Production Officer Smt. Mrinal Phadke (Member) Sanjay Kamble Dr. Sangeeta Mandke (Member) Production Officer Smt. Ujjwala Godbole (Member-Secretary) Prashant Harne Asst. Production Officer Paper Secretarial Practice 70 GSM Cream wove Study Group Members Print Order No. Dr. Jyoti Gaikwad (Chariman and Coordinator) Printer Shri. Zubeida Surti Shri. Nitin Gujarathi Shri. Vijay Khude Shri. Omkar Prasade Shri. Prashant Shelke Shri. Govind Hare Publisher Smt. Nayana Padki Smt. Anjali Sawant Vivek Uttam Gosavi, Controller Maharashtra State Textbook Bureau, Prabhadevi Mumbai- 400 025  Preface Dear students, We take pleasure in introducing the textbook for Standard XII based on the revised syllabus from the academic year 2020-2021. Secretarial Practice is one of the subjects in the commerce stream which deals exclusively with the business world’s largest and the most popular form of commercial enterprises viz. the Joint Stock Company. The Standard XI syllabus covers topics like features of a company, incorporation of a company, its management, role of company secretary, etc. The syllabus for Standard XII further deals with the working of Joint Stock Company by focusing on the methods used by a company to raise capital by issuing Shares, Debentures, Public Deposits, etc. in the financial market. Chapters on the important sources of capital, viz. Shares, Debentures and Public Deposits, covers only the provisions and procedures related to raising such capital. These chapters are followed by chapters on correspondence with contributors of capital. The subject derives its contents from the Companies Act, 2013. Due care has been taken to present the matter in a simple language so that students can easily understand the legal and technical aspects of the Act. Charts and diagrams are given wherever necessary. Meaning of every new term or word has been explained in a box. Moreover, to make learning stimulating, additional information has been given in every chapter along with interesting activities for the students. Exercise given at the end of every chapter is exhaustive. Various types of questions have been asked to test conceptual clarity and encourage logical thinking and reasoning. Application-based questions have been included to enable students to apply theoretical knowledge to solve real life- like situations. Documents, Proformas, etc. have been given in the Q.R. Code on the title page. The new Companies Act has been amended many times since its enactment in 2013. This book includes all the amendments made in the Act and the various Rules and Regulations of SEBI upto November 2019. We are thankful to the subject committee members, study group members, translators, reviewers and all those who have contributed in designing this new version of the textbook. We hope the textbook meets all the expectations of the academicians, teachers and students. ( Vivek Gosavi) Pune Director Date : 21 February 2020 Maharashtra State Bureau of Textbook Bharatiya Saur : 2 Phalguna 1941 Production and Curriculum Research, Pune.  Competency Statements Unit Topic Competency Statements No. Understand the concept of Corporate Finance and its Importance. Understand meaning of capital Sources of 1 structure of a company Corporate Finance Understand various sources of owned and borrowed capital Compare different sources of finance. Understand the provisions and procedures 2 Capital raising related to Issue of Shares, Debentures and Acceptance of Public Deposits. Develop Communication skills related to Secretarial 3 Members, Debenture holders and Deposit Correspondence holders. Understand the concept of Depository system and its Importance. Know the constituents of Depository 4 Depository System System. Learn the Functioning of Depository System. Understand the concept of Dividend and Interest. Payment of Compare between Interim and Final 5 Dividend and Dividend. Interest Learn about provisions on sources and for Declaration and Payment of Dividend.  Understand the Meaning of Financial Market. Know the types of Financial Markets. Learn about the Different Types of Financial Instruments. Understand the Meaning and functions of 6 Financial Markets Stock Exchange. Know about BSE and NSE Understand the different terms related to stock exchange. Understand the role of SEBI in Capital Market.  INDEX Sr. No. Chapter Page No. 1. Introduction To Corporate Finance 1 2. Sources of Corporate Finance 14 3. Issue of Shares 39 4. Issue of Debentures 68 5. Deposits 80 6. Correspondence with Members 93 7. Correspondence with Debentureholders 104 8. Correspondence with Depositors 116 9. Depository System 127 10. Dividend and Interest 143 11. Financial Market 158 12. Stock Exchange 170 Answer Key 179  1 INTRODUCTION TO CORPORATE FINANCE 1.1 Meaning 1.2 Importance 1.3 Capital Requirements (A) Fixed Capital and (B) Working Capital 1.4 Capital Structure 1.4.1 Definition 1.4.2 Components 1.5 Distinction INTRODUCTION : The term finance is related to money and money management. It is related to inflow and outflow of money. Success of any business organisation depends upon the efficiency with which it is able to generate and use funds. Henry Ford righty said, “ Money is an arm or leg - use it or lose it.” This statement clearly brings out the significance of finance for the success of a business. 1.1 CORPORATE FINANCE : MEANING Corporate finance deals with the raising and using of finance by a corporation. It deals with financing the activities of the corporation, capital structuring and making investment decisions. MEANING : DEFINITION Henry Hoagland expresses the view that ‘‘corporate finance deals primarily with the acquisition and use of capital by business corporation.’’ The term corporate finance also includes financial planning, study of capital market, money market and share market. It also covers capital formation and foreign capital. Even financial organisations and banks play vital role in corporate financing. The finance manager of any corporation has to ensure that - a) the firm has adequate finance. b) they are using the right source of funds that have minimum cost. c) the firm utilises raised funds effectively. d) they are generating maximum returns for it’s owners. The following two decisions are the basis of corporate finance. 1) Financing Decision : The business firm has access to capital market to fulfill it’s financial needs. The firm has multiple choices of sources of financing. The firm can choose whether it wants to raise equity capital or debt capital. Firm can even opt for bank loan, public deposits, debentures etc. to raise funds. The finance manager ensures that the firm is well capitalised i.e. they have right amount of capital and that the firm has right combination of debt and equity. 1  Capital market is a market for long term debt instruments and equity shares. In this market, equity and debt instruments are issued and traded. 2) Investment Decision : Once the business firm has gained access to capital, the finance manager has to take decision regarding the use of the funds in systematic manner so that it will bring maximum return for its owners. For this, the firm has to take into consideration the cost of capital. Once they know the cost of capital, firm can deploy or use the funds in such a way that returns are more than cost of capital. Cost of capital is minimum return expected by it’s investors. Finding investments and deploying them successfully in the business is known as investing decision. It is also called as ‘capital budgeting’. 1.2 IMPORTANCE OF CORPORATE FINANCE : In the functional management of business enterprise, importance is given to production, finance, marketing and personnel activities. Among all these activities, utmost importance is given to financial activities. The importance of corporate finance may be discussed as follows - 1. Helps in decision making : Most of the important decisions of business enterprise are determined on the basis of availability of funds. It is difficult to perform any function of business enterprise independently without finance. Every decision in the business is needed to be taken keeping in view of it’s impact on profitability. There may be number of alternatives but the management is required to select the best one which will enhance profitability. Business organisation can give green signal to the project only when it is financially viable. Thus corporate finance plays significant role in decision making process. 2. Helps in Raising Capital for a project : Whenever a business firm wants to start a new venture, it needs to raise capital. Business firm can raise funds by issuing shares, debentures, bonds or even by taking loans from the banks. 3. Helps in Research and Development : Research and Development must be undertaken for the growth and expansion of business. Detailed technical work is essential for the execution of projects. Research and Development is lengthy process and therefore funds have to be made available through out the research work. This would require continuous financial support. Many a time, Company has to upgrade its old product or develop new product to attract the consumers. For this company has to conduct survey, market analysis, etc. which again requires financial support. 4. Helps in smooth running of business firm : A smooth flow of corporate finance is needed so that salaries of employees are paid on time, loans are cleared on time, raw material is purchased whenever required, sales promotion of existing products is carried out smoothly and new products can be launched effectively. 2  5. Brings co-ordination between various activities : Corporate finance plays significant role in control and co-ordination of all activities in an organisation. For e.g. Production will suffer, if finance department does not provide adequate finance for the purchase of raw materials and meeting other day-to-day financial requirements for smooth running of production unit. Due to this, sales will also suffer and consequently the income of concern as well as rate of profit will be affected. Thus efficiency of every department depends upon the effective financial management. 6. Promotes expansion and diversification : Modern machines and modern techniques are required for expansion and diversification. Corporate finance provides money to purchase modern machines and technologies. Therefore finance becomes mandatory for expansion and diversification of a company. 7. Managing Risk : Company has to manage several risks, such as sudden fall in sales, loss due to natural calamity, loss due to strikes, etc. Company needs financial aid to manage such risks. 8. Replace old assets : Assets such as plant and machinery become old and outdated over the years. They have to be replaced by new assets. Finance is required to purchase new assets. 9. Payment of dividend and interest : Finance is needed to pay dividend to shareholders, interest to creditors, banks, etc. 10. Payment of taxes/fees : Company has to pay taxes to Government such as Income Tax, Goods and Service Tax (GST) and fees to Registrar of Companies on various occasions. Finance is needed for paying these taxes and fees. 1.3 CAPITAL REQUIREMENTS : When a business entrepreneur conceives an idea of setting up a business enterprise, the commercial viability of the idea is investigated. Once the entrepreneur is satisfied with the feasibility of the project, serious steps are taken to start the project. The first and foremost step is to take decision on the amount of capital requirement to start and run the business. This task has to be performed with utmost care. Therefore financial plan should be drafted keeping in mind present and future requirement of the business. Thus while deciding about the volume of capital requirement, an entrepreneur has to take into consideration - fixed capital requirement and working capital requirement. We shall now discuss these capital requirements in detail. Financial plan refers to assessment of financial requirement and arranging sources of capital. (A) Fixed Capital : Fixed capital is the capital which is used for buying fixed assets which are used for a longer period of time in the business. These assets are not meant for resale. In simple words fixed capital refers to capital invested for acquiring fixed assets. It stays in the business for long period almost permanently. Examples of fixed capital are - capital used for purchasing land and building, furniture, plant and machinery etc. Such capital is required usually at the time of establishment of a new company. However, existing companies may also need such capital for their expansion and development, replacement of equipments, etc. 3  Initial planning of fixed capital requirement is made by company’s promoters. For this, they first prepare a list of fixed assets needed by the company and cost of these assets is estimated. They collect information regarding price of land, cost of construction of building, cost of plant and machinery, etc. The cost of different fixed assets is calculated and the resulting figure would be the total of fixed capital requirement of a new firm. In recent years, estimating fixed capital requirement has assumed great importance particularly because of modern industrial processes which require increased use of heavy and automated machineries.    An entrepreneur obtains funds for the purchase of fixed assets from capital market. Funding can come from issue of shares, debentures, bonds or obtaining even long term loans. Factors affecting fixed capital requirement : 1. Nature of business : Manufacturing industries and public utilities have to invest huge amount of funds to acquire fixed assets. While Trading business may not need huge investments in fixed assets. 2. Size of business : Where a business firm is set up to carry on large scale operations, its fixed capital requirements are likely to be high. It is because most of their production processes are based on automatic machines and equipments. 3. Scope of business : There are business firms which are formed to carry on production or distribution on a large scale. Such businesses would require more amount of fixed capital. 4. Extent of lease or rent : If entrepreneur decides to acquire assets on lease or on rental basis, less amount of funds for fixed assets will be needed for the business. Lease : A contract by which one person grants possession of some of his property especially land, building or machinery to another for a certain period of time. 5. Arrangement of sub-contract : If the business wants to sub-contract some processes of production to others, limited assets are required to carry out the production. It would minimise fixed capital requirement of business. 6. Acquisition of old assets : If old equipments and plants are available at low prices, then it would reduce the need for investment in fixed assets. 7. Acquisition of assets on concessional rate : With the view to foster industrial growth at regional level, the government may provide land and building, materials at concessional rates. Plants and equipments may also be made available on instalment basis. Such facilities will reduce the requirement of fixed assets. 8. International conditions : This factor is very significant particularly in large organisations carrying business on international level. For example : companies expecting war, may decide to invest large funds to expand fixed assets before there is shortage of materials. 4  9. Trend in economy : If the future of the company is anticipated to be bright, it gives green signal to business entrepreneur to carry out all sorts of expansion of business firm. In that case, large amount of funds are invested in fixed assets so as to reap the benefits in future. 10. Population trend : When the population is increasing at high rate, certain manufactures find this as an opportunity to expand business. For example- automobile industry, electronic goods manufacturing industry, ready-made garments, etc. which necessitates huge amount of fixed capital. 11. Consumer preference : Industries providing goods and services which are in good demand, will require large amount of fixed capital. For example - Mobile phone manufactures as well as mobile network providers. 12. Competitive factor : This factor is prime element in decision making regarding fixed capital requirements. If one of the competitor’s shifts to automation, the other companies in the same line of activity, will be compelled to follow that competitor. (B) Working Capital Working capital is the capital which is used to carry out the day to day business activities. After estimating fixed capital requirement of the business firm, it is necessary to estimate the amount of capital, that would be needed to ensure smooth functioning of the business firm. A business firm requires funds to store adequate raw material in stock. A firm would need capital to maintain sufficient stock of finished goods. In actual practice goods are sold out in cash or on credit. Goods sold on credit do not fetch cash immediately. Firm will have to arrange for funds till the amount is collected from the debtors. Cash is also required to pay overheads. Since uncertainty is always a feature of business, some excess cash also should be maintained to meet unexpected expenses. Overheads : Overhead means indirect cost or expenses required to run a business. Overhead expenses include accounting fees, advertising, insurance, interest, legal fees, rent, repairs, taxes, telephone bills, travel expenditure, etc. Thus, a business firm will have to arrange capital for the following : a) For building up inventories b) For financing receivables c) For covering day-to-day operating expenses. The capital invested in these assets is referred to as ‘Working capital’. The concept of working capital is viewed differently by leading authorities. Some authorities consider working capital as equivalent to excess of current assets over current liabilities. Gerstenbergh, defines it as, ‘‘The excess of current assets over current liabilities.’’ This approach refers to ‘Net Working Capital’. Gerstenbergh does not call it as working capital. He prefer to call it as ‘circulating capital’. Other authorities viewed working capital equivalent to current assets. According to J. S. Mill, “The sum of current assets is working capital.” This approach has broader application. It takes into consideration all current assets, of the company. It refers to ‘Gross Working Capital’. 5  Additional information : Cyclical flow of working capital : A business firm needs fund to finance it’s working capital needs. Prominent share of this fund Inventories n is used to buy raw materials and remaining part is kept available to pay wages and expenditures. tio Sa uc le Thus the working capital which was in the form of od s Pr cash is converted into inventories. Raw materials are converted into work-in-process and then to Operations Receivable finished goods. With the sale of finished goods they turn into account receivables, presuming the goods are sold on credit basis. Normally account O xp n io pe en receivables have maturities of specific days after E ct ra se le tin s ol billing date. Collection of the receivable brings C g CASH back the cycle to cash. A part of cash may be used to pay creditors, Cycle flow of Working Capital pay income tax and declare dividend and rest of it is put into circulation again. Factors affecting working capital requirement : There is no precise standards to measure working capital adequacy. Management has to determine the size of working capital in the light of certain aspects of business firm and economic environment within which the firm operates. 1. Nature of business : Firms engaged in manufacturing essential products of daily consumption would need relatively less working capital as there would be constant and sufficient cash inflow in the firm to take care of liabilities. Likewise public utility concerns have to maintain small working capital because of continuous flow of cash from their customers. Public utility concern : These concerns provide services such as transport, gas, electricity, etc. On the contrary, if the business is dealing in luxurious products, it requires huge amount of working capital, as sale of luxurious items are not frequent. Trading/merchandising firms which are concerned with distribution of goods have to carry big inventories of goods to meet customer’s demand and have to extend credit facilities to attract customers. Hence they need large amount of working capital. Merchandising firms are those which are concerned with buying and selling of goods, either as wholesaler or retailer, without altering the physical form of goods. 2. Size of business : The size of business also affects the requirement of working capital. A firm with large scale operations will require more working capital. 6  3. Volume of sales : This is the most important factor affecting size of working capital. The volume of sales and size of working capital are directly related with each other. If volume of sales increases, there is an increase in the amount of working capital and vice a versa. 4. Production cycle : The process of converting raw material into finished goods is called production cycle. If the period of production cycle is longer, then firm needs more amount of working capital. If manufacturing cycle is short, it requires less working capital. 5. Business cycle : When there is a boom in the economy, sales will increase. This will lead to increase in investment in stocks. This requires additional working capital. During recession, sales will decline and hence the need of working capital will also decline. 6. Terms of purchases and sales : If the firm does not get credit facility for purchases but adopts liberal credit policy for its sales, then it requires more working capital. On the other hand if credit terms of purchases are favourable and terms of credits sales are less liberal, then requirement of cash will be less. Thus working capital requirement will be reduced. 7. Credit control : Credit control includes the factors such as volume of credit sales, the terms of credit sales, the collection policy, etc. If credit control policy is sound, it is possible for the company to improve it’s cash flow. If credit policy is liberal, it creates a problem of collection of funds. It can increase possibility of bad debts. Therefore a firm requires more working capital. The firm making cash sales requires less working capital. 8. Growth and Expansion : The working capital requirement of a firm will increase with growth of a firm. A growing company needs funds continuously to support large scale operations. 9. Management ability : The requirement of working capital is reduced if there is proper co-ordination between production and distribution of goods. A firm stocking on heavy inventory calls for higher level for working capital. 10. External factors : If financial institutions and banks provide funds to the firm as and when required, the need for working capital is reduced. 1.4 CAPITAL STRUCTURE : A company can raise its capital from different sources. i.e. owned capital or borrowed capital or both. The owned capital consists of equity share capital, preference share capital, reserves and surplus. On the other hand, borrowed sources are debentures, loans, etc. A combination of different sources are used in capital structure. It is nothing but ‘security mix.’ 7  Capital structure means ‘mix up of various sources of funds in desired proportion’. To decide capital structure means, to decide upon the ratio of different types of capital. 1.4.1 Definition R. H. Wessel : “ The long term sources of funds employed in a business enterprise”. John Hampton : “A firm’s capital structure is the relation between the debt and equity securities that makes up the firm’s financing of it’s assets”. Thus capital structure is composed of owned funds and borrowed funds. Owned funds includes share capital, free reserves and surplus, whereas, borrowed funds represent debentures, Bank loans and long term loans provided by financial institutions. Additional information : Principles of Capital Structure : Two basic principles are observed while taking decision about capital structure. (1) The ratio of ‘debt to equity’ should always be geared to the degree of stability of earning. (2) The capital structure must be balanced with adequate ‘equity cushion’ to absorb the shocks of the business cycle and to afford flexibility. 1.4.2 Components of Capital Structure : There are four basic components of capital structure. They are as follows : (1) Equity share capital : It is the basic source of financing activities of business. Equity shares are shares which get dividend and repayment of capital after it is paid to preference shares. They own the company. They bear ultimate risk associated with ownership. They carry dividend at fluctuating rate depending upon the profits. (2) Preference share capital : Preference shares carry preferential right as to payment of dividend and have priority over equity shares for return of capital when the company is liquidated. These shares carry dividend at fixed rate. (3) Retained earnings : It is internal source of financing. It is nothing but ploughing back of profit. (4) Borrowed capital : It comprises the following : a) Debenture : It is acknowledgement of loans raised by company. Company has to pay interest at an agreed rate. b) Term loan : Term loans are provided by bank and other financial institutions. They carry fixed rate of interest. To understand the above concept, we shall consider following Balance sheet and calculate the values : 8  Balance sheet of ABC Company Ltd. as on 31st March, 2019 Liabilities Amount ` Assets Amount ` Share Capital Fixed Assets 10,000 equity shares of Building 4,00,000 ` 10 each fully paid 1,00,000 Plant and Machinery 2,00,000 5,000 preference shares Current Assets of ` 100 each fully paid. 5,00,000 Sundry Debtors 1,00,000 Reserves and Surplus 50,000 Inventories 50,000 Liabilities Cash in hand 10,000 1000, 10% Debentures Cash at bank 40,000 of ` 100 each fully paid 1,00,000 Sundry creditors 30,000 Bills payable 20,000 8,00,000 8,00,000 Capital Structure = Equity Share Capital + Pref. Share Capital + Reserves + Debentures       = 1,00,000 + 5,00,000 + 50,000 + 1,00,000       = 7,50,000 Activity : Visit website of any public limited company and find out details of its capital structure. 1.5 Distinction : Points Fixed capital Working capital 1) Meaning Fixed capital refers to any kind of Working capital refers to the sum physical asset i.e. fixed assets. of current assets. 2) Nature It stays in the business almost Working capital is circulating permanently. capital. It keeps changing. 3) Purpose It is invested in fixed assets such Working capital is invested in short as land, building, equipments, etc. term assets such as cash, account receivable, inventory, etc. 4) Sources Fixed capital funding can come Working capital can be funded from selling shares, debentures, with short term loans, deposits, bonds, long term loans, etc. trade credit, etc. 5) Objectives Investors invest money in fixed Investors invest money in working of Investors capital hoping to make future capital for getting immediate profit. returns. 6) Risk Investment in fixed capital implies Investment in working capital is more risk. less risky. 9  SUMMARY  Corporate finance deals with the acquisition and use of capital by business corporation.  Fixed capital is that portion of capital which is invested in fixed assets such as land, building, equipments, etc.  Working capital refers to a firm’s investment in current assets such as cash, account receivable and inventories.  Capital structure refers to the proportion of different sources of funds raised by a firm for long term finance. EXERCISE Q.1 A) Select the correct answer from the options given below and rewrite the statements. 1................... is related to money and money management. a) Production b) Marketing c) Finance 2. Finance is the management of................. affairs of the company. a) monetary b) marketing c) production 3. Corporation finance deals with the acquisition and use of................. by business corporation. a) goods b) capital c) land 4. Company has to pay................. to government. a) taxes b) dividend c) interest 5.................. refers to any kind of fixed assets. a) Authorised capital b) Issued capital c) Fixed capital 6.................. refers to the excess of current assets over current liabilities. a) Working capital b) Paid-up capital c) Subscribed capital 7. Manufacturing industries have to invest................. amount of funds to acquire fixed assets. a) huge b) less c) minimal 8. When the population is increasing at high rate, certain manufacturers find this as an opportunity to................. business. a) close b) expand c) contract 9. The sum of all................. is gross working capital. a) expenses b) current assets c) current liabilities 10.................. means mix up of various sources of funds in desired proportion. a) Capital budgeting b) Capital structure c) Capital goods 10 B) Match the pairs. Group ‘A’ Group ‘B’ a) Capital budgeting 1) Sum of current assets b) Fixed capital 2) Deals with acquisition and use of capital c) Working capital 3) Fixed liabilities d) Capital structure 4) Sum of current liabilities e) Corporate finance 5) Fixed assets 6) Investment decision 7) Financing decision 8) Deals with acquisition and use of assets 9) Mix up of various sources of funds 10) Product mix C) Write a word or a term or a phrase which can substitute each of the following statements. 1. A key determinant of success of any business function. 2. The decision of finance manager which ensures that firm is well capitalised. 3. The decision of finance manager to deploy the funds in systematic manner. 4. Capital needed to acquire fixed assets which are used for longer period of time. 5. The sum of current assets. 6. The excess of current assets over current liabilities. 7. The process of converting raw material into finished goods. 8. The boom and recession cycle in the economy. 9. The ratio of different sources of funds in the total capital. 10. The internal source of financing. D) State whether the following statements are true or false. 1. Finance is related to money and money management. 2. Business firm gives green signal to the project only when it is profitable. 3. Corporate finance brings co-ordination between various business activities. 4. Fixed capital is also referred as circulating capital. 5. Working capital stays in the business almost permanently. 6. The business will require huge funds, if assets are acquired on lease basis. 7. The business dealing in luxurious products will require huge amount of working capital. 11  8. A firm with large scale operations, will require more working capital. 9. Liberal credit policy creates a problem of bad debts. 10. Financial institutions and banks cater to the working capital requirement of business. E) Find the odd one. 1. Land and Building, Plant and Machinery, Cash. 2. Debenture Capital, Equity Share Capital, Preference Share Capital. 3. Fixed Capital, Capital Structure, Working Capital. F) Complete the sentences. 1. Initial planning of capital requirement is made by........................... 2. When there is boom in economy, sales will........................... 3. The process of converting raw material into finished goods is called........................... 4. During recession period sales will........................... G) Select the correct option from the bracket. Group ‘A’ Group ‘B’ a) Financing decision 1)..................................................... b).................................. 2) Longer period of time. c) Investment decision 3)..................................................... d).................................. 4) Circulating capital Combination of various e) 5)..................................................... sources of funds ( To have right amount of capital, Deploy funds in systematic manner, Fixed capital, Working capital, Capital structure ) H) Answer in one sentence. 1. Define corporate finance. 2. What is fixed capital ? 3. Define working capital. 4. What is production cycle ? 5. Define capital structure. I) Correct the underlined word/s and rewrite the following sentences. 1. Finance is needed to pay dividend to debentureholders. 2. When there is recession in economy sales will increase. 3. Share is an acknowledgement of loan raised by company. 4. Equity shares carry dividend at fixed rate. 12 Q.2 Explain the following terms / concepts. 1. Financing decision 2. Investment decision 3. Fixed capital 4. Working capital Q.3 Study the following case / situation and express your opinion. (1) The management of ‘Maharashtra State Road Transport Corporation’, wants to determine the size of working capital. a. Being a public utility service provider, will it need less working capital or more ? b. Being a public utility service provider, will it need more Fixed Capital ? c. Give one example of public utility service that you come across on day-to-day basis. (2) A company is planning to enhance it’s production capacity and is evaluating the possibility of purchasing new machinery whose cost is ` 2 crore or has alternative of machinery available on lease basis. a. What type of asset is machinery ? b. Capital used for purchase of machinery is fixed capital or working capital ? c. Does the size of a business determine the fixed capital requirement ? Q.4 Distinguish between the following. 1. Fixed Capital and Working Capital. Q.5 Answer in brief. 1. Define capital structure and state it’s components. 2. State any four factors affecting fixed capital requirement. 3. What is corporate finance and state two decisions which are basis of corporate finance. Q.6 Justify the following statements. 1. The firm has multiple choices of sources of financing. 2. There are various factors affecting the requirement of fixed capital. 3. Fixed capital stays in the business almost permanently. 4. Capital structure is composed of owned funds and borrowed funds. 5. There are various factors affecting the requirement of working capital. Q.7 Answer the following questions. 1. Discuss the importance of corporate finance. 2. Discuss the factors determining working capital requirement.  13  2 SOURCES OF CORPORATE FINANCE 2.1 Sources of Owned Capital 2.1.1 Shares 2.1.2 Retained earnings 2.2 Sources of Borrowed Capital 2.2.1 Debentures 2.2.2 Acceptance of deposits 2.2.3 Bonds 2.2.4 ADR / GDR 2.2.5 Commercial Banks 2.2.6 Financial Institutions 2.2.7 Trade Credit 2.3 Distinction INTRODUCTION : Finance holds the key to all business activities. No business activity can ever be pursued without financial support. Finance is necessary through out the activities of promotion, organisation and regular operations of business. All functions of business are ultimately dependent on finance. The Finance needed by business organisation is termed as ‘Capital’. Every business organisation needs certain capital for its activities. A joint stock company, which is a modern form of business organisation and being a large undertaking, requires huge capital for business. This huge capital collection or capital formation has special significance in the management of joint stock company. Capital formation is a process of collection of capital from various sources according to financial plan of company. A joint stock company collects huge funds through different sources. These various sources of finance available to business may be explained with the following chart : Sources of Finance based on Types of Capital Owned Capital Borrowed Capital Debentures, Public Deposits, Shares Retained Earning Bonds, ADR / GDR, Banks, Financial Institutions, Equity Shares Preference Shares Trade Credit The above sources of finance may be external or internal. External Source : When capital is raised from outsiders. Internal Source : When capital is made available from within the organisation. 14 2.1 SOURCES OF OWNED CAPITAL The capital raised by company with the help of owners (shareholders) is called owned capital or ownership capital. The shareholders purchase shares of the company and supply necessary capital. It is one form of owned capital. Another form of owned capital is retained earnings. It is also known as ploughing back of profit. It is reinvestment of profit in the business by the company itself. Retained earning is an internal source of finance. Owned capital is regarded as a permanent capital, as it is returned only at the time of winding up of the company. Owned capital in the form of share capital, provides initial source of capital for a new company. It can be raised any time later to satisfy additional capital needs of a company. However, retained earnings cannot be an initial source of capital but it can be important source of capital when company runs it’s business profitably during it’s existence. Promoters decide the share capital required by a company. This amount of share capital is known as authorised capital. It is stated in the Capital clause of Memorandum of Association of the company. Let us learn in detail the various sources of owned capital. 2.1.1 Shares The term share is defined by Section 2 (84) of the Companies Act 2013, ‘Share means a share in the share capital of a company and includes stock’. Share is a unit by which the share capital is divided. The total capital of company is divided into small parts and each part is called share and the value of each part / unit is known as face value. Share is a small unit of capital of a company. It facilitates the public to subscribe to the capital in smaller amount. A person can purchase any number of shares as he wishes. A person who purchases shares of a company is known as a shareholder or a member of that company.  Features of Shares : 1. Meaning : Share is a smallest unit in the total share capital of a company. 2. Ownership : The owner of share is called as shareholder. It shows the ownership of a shareholder in the company. 3. Distinctive Number : Unless dematerialised, each share has distinct number for identification. It is mentioned in the Share Certificate. 4. Evidence of title : A share certificate is issued by a company under it’s common seal. It is a document of title of ownership of shares. A share is not any visible thing. It is shown by share certificate or in the form of Demat share. 5. Value of a Share : Each share has a value expressed in terms of money. There may be : (a) Face value : This value is written on the share certificate and mentioned in the Memorandum of Association. (b) Issue price : It is the price at which company sells it’s shares. 15  (c) Market Value : This value of share is determined by demand and supply forces in the share market. 6. Rights : A share confers certain rights on its holder such as right to receive dividend, right to inspect statutory books, right to attend shareholders’ meetings and right to vote at such meetings, etc. 7. Income : A shareholder is entitled to get a share in the net profit of the company. It is called dividend. 8. Transferability : The shares of public limited company are freely transferable in the manner provided in the Articles of Association. 9. Property of Shareholder : Share is a movable property of a shareholder. 10. Kinds of Shares : A company can issue two kinds of shares : (a) Equity shares. (b) Preference shares.  Kinds of Shares (As per Section 43 of the Companies Act 2013 A company can issue different types of shares depending upon right to control, income and risk. The following chart shows different kinds of shares. Shares (A) Equity Shares (B) Preference Shares 1) Equity Shares with voting right. 1) Cumulative Preference Shares. 2) Equity Shares with differential 2) Non Cumulative Preference Shares. voting right. 3) Participating Preference Shares. 4) Non-participating Preference Shares. 5) Convertible Preference Shares. 6) Non Convertible Preference Shares. 7) Redeemable Preference Shares. 8) Irredeemable Preference Shares. A. Equity Shares : Equity shares are also known as ordinary shares. Companies Act defines equity shares as ‘those shares which are not preference shares’. The above definition reveals that : a) The equity shares do not enjoy preference for dividend. b) The equity shares do not have priority for repayment of capital at the time of winding up of the company. Equity shares are fundamental source of financing business activities. Equity share holders own the company and bear ultimate risk associated with the ownership. 16  After paying claims of all other investors the remaining funds belong to equity shareholders. Thus equity shareholders are ‘residual claimants’ of the income and assets. Equity shareholders do not carry any fixed commitment of dividend. They are paid dividend at the rate recommended by Board of Directors. If there is no profit, no dividend will be payable. Similarly if there is less profit, lesser dividend will be paid. Thus the fortune of equity shareholders is tied up with the ups and downs of the company. If the company is successful, they enjoy great financial rewards and if the company fails, the risk falls mainly on them. It is exactly because of this position equity share capital is known as ‘venture capital’ or ‘risk capital’. The owners of equity shares are real risk bearers. However, equity shareholders participate in the management of their company. They are invited to attend general meetings. They are allowed to vote on all matters discussed at the general meeting. They elect their representatives to manage the company. Equity shareholders are thus real owners of the company. Features of Equity Shares : 1. Permanent Capital : Equity shares are irredeemable shares. The amount received from equity shares is not refundable by the company during its life time. Equity shares become refundable only in the event of winding up of the company or company decides to buyback shares. Thus equity share capital is long term and permanent capital of the company. 2. Fluctuating Dividend : Equity shares do not have a fixed rate of dividend. The rate of dividend depends upon amount of profit earned by company. If company earns more profit, dividend is paid at higher rate. On the other hand if there is insufficient profit or loss, Board of Directors may postpone the payment of dividend. Equity shareholders cannot compel them to declare and pay dividend. The income of equity shares is uncertain and irregular. The equity shares get dividend at fluctuating rate. 3. Rights : Equity Shareholders enjoy certain rights : a) Right to vote : It is the basic right of equity shareholders through which they elect directors, alter Memorandum and Articles of Association, etc. b) Right to share in profit : It is an important right of equity shareholders. They have right to share in profit, when distributed as dividend. If the company is successful and makes handsome profit, they have advantage of getting large dividend. c) Right to inspect books : Equity shareholders have right to inspect statutory books of their company. d) Right to transfer shares : The equity shareholders enjoy the right to transfer shares as per the procedure laid down in the Articles of Association. 4. No preferential right : Equity shareholders do not enjoy preferential right in respect of payment of dividend. They are paid dividend only after dividend on preference shares has been paid. 17  Similarly, at the time of winding up of the company, the equity shareholders are paid last. Further, if no surplus amount is available, equity shareholders will not get anything. 5. Controlling power : The control of company is vested with the equity shareholders. They are often described as ‘real masters’ of the company. It is because they enjoy exclusive voting rights. The Act provides the right to cast vote in proportion to share holding. They can exercise their voting right by proxies, without even attending meeting in person. By exercising voting right they can participate in the management and affairs of the company. They elect their representatives called Directors for management of the company. They are allowed to vote on all matters discussed at the general meeting. Thus equity shareholders enjoy control over the company. 6. Risk : Equity shareholders bear maximum risk in the company. They are described as ‘shock absorbers’ when company has financial crisis. If the income of company falls, the rate of dividend also comes down. Due to this, market value of equity shares comes down resulting into capital loss. Thus equity shareholders are main risk takers. 7. Residual claimant : Equity shareholders as owners are residual claimants to all earnings after expenses, taxes, etc. are paid. A residual claim means the last claim on the earnings of company. Although equity shareholders come last, they have advantage of receiving entire earnings that is left over. 8. No charge on assets : The equity shares do not create any charge over assets of the company. Charge on assets : Means an interest or lien created on assets of the company in favour of creditors. In case company fails to pay the debt, creditors can claim it from the company's assets. 9. Bonus Issue : Bonus shares are issued as gift to equity shareholders. These shares are issued free of cost to existing equity shareholders. These are issued out of accumulated profits. Bonus shares are issued in proportion to the shares held. Thus capital investment of (ordinary) equity shareholder tends to grow on its own. This benefit is available only to the equity shareholder. 10. Right Issue : When a company needs more funds for expansion purpose and raises further capital by issue of shares, the existing equity shareholders may be given priority to get newly offered shares. This is called ‘Right Issue’. The shares are offered to equity shareholder first, in proportion to their existing shareholding. 11. Face Value : The face value of equity shares is low. It can be generally ` 10 per share or even ` 1 per share. 12. Market Value : Market value of equity shares fluctuates according to the demand and supply of these shares. The demand and supply of equity shares depend on profits earned and dividend declared. When a company earns huge profit, market value of its shares increases. On the other hand when it incurs loss, the market value of it’s shares decreases. There are frequent fluctuations in the market value of equity shares 18  in comparison to other securities. Therefore equity shares are more appealing to the speculator. Speculator tries to make profit from a security’s price change. 13. Capital Appreciation : Share Capital appreciation takes place when market value of shares increases in the share market. Profitability and prosperity of the company enhances reputation of company in the share market and it facilitates appreciation of market value of equity shares. Types of Equity Shares : The equity share can be of two types : a) with voting rights. b) with differential voting right. a) Equity shares with normal voting right : Voting right of such equity holders is in proportion to his share holdings. b) Equity shares with differential voting right : Such equity holders shall have varying rights regarding dividend, voting or otherwise in accordance with Rule 4 of Companies (Share Capital and Debentures) Rules 2014. Thus company can issue shares with limited voting rights or no voting rights. They may be entitled to extra rate of dividend, if any. B. Preference Shares : As the name indicates, these shares have certain preferential rights distinct from those attached to equity shares. The shares which carry following preferential rights are termed as preference shares : a) A preferential right as to payment of dividend during the life time of company. b) A preferential right as to the return of capital in the event of winding up of company. The holder of preference share have a prior right to receive fixed rate of dividend before any dividend is paid to equity shares. The rate of dividend is prescribed at the time of issue. Normally preference shares do not carry any voting power. They have voting right only on matters which affect their interest, such as selling of undertaking or changing rights of preference shares, etc. or they get voting rights if dividend remains unpaid. The preference shareholders are co-owners of the company but not controllers. These shares are purchased by cautious investors who are interested in safety of investment and who want steady returns on investments. Features of Preference Shares : 1. Preference for dividend : Preference shares have the first charge on the distributable amount of annual net profit. The dividend is payable to preference shareholders before it is paid to equity shareholders. 19  2. Preference for repayment of capital : Preference shareholders have a preference over equity shareholders in respect of return of capital when the company is liquidated. It saves preference shareholders from capital losses. 3. Fixed Return : These shares carry dividend at fixed rate. The rate of dividend is pre-determined at the time of issue. It may be in the form of fixed sum or may be calculated at fixed rate. The preference shareholders are entitled to dividend which can be paid only out of profits. If the directors, in financial crisis, decide not to pay dividend, the preference shareholders have no claim for dividend. 4. Nature of Capital : Preference shares do not provide permanent share capital. They are redeemed after certain period of time. A company can not issue irredeemable preference shares. Preference capital is generally raised at a later stage, when the company gets established. These shares are issued to satisfy the need for additional capital of the company. Preference share capital is safe capital as the rate of dividend and market value does not fluctuate. 5. Market Value : The market value of preference share does not change as the rate of dividend payable to them is fixed. The capital appreciation is considered to be low as compared with equity shares. 6. Voting rights : The preference shares do not have normal voting rights. They do not enjoy right of control on the affairs of the company. They have voting rights on any resolution of the company directly affecting their rights e.g. : Change in terms of repayment of capital, dividend payable to them are in arrears for last two consecutive years, etc. 7. Risk : The investors who are cautious, generally purchase preference shares. Safety of capital and steady return on investment are advantages attached with preference shares. These shares are boon for shareholders during depression period when interest rate is continuously falling. 8. Face Value : Face value of preference shares is relatively higher than equity shares. They are normally issued at a face value of Rs. 100/-. 9. Rights or Bonus Issue : Preference shareholders are not entitled for Rights or Bonus issues. 10. Nature of Investor : Preference shares attract moderate type of investors. Investors who are conservative, cautious, interested in safety of capital and who want steady return on investment generally purchase preference shares. 20  Types of Preference Shares. Types of Preference Shares Cumulative and Participating and Convertible and Redeemable and Non-cumulative Nonparticipating Non convertible Irredeemable Preference Shares Preference Shares Preference Shares Preference Shares 1. Cumulative Preference Shares : Cumulative Preference Shares are those shares on which dividend goes on accumulating until it is fully paid. This means, if the dividend is not paid in one or more years due to inadequate profits, then this unpaid dividend gets accumulated. This accumulated dividend is paid when company performs well. The arrears of dividend are paid before making payment to equity shareholders. The preference shares are always cumulative unless otherwise stated in the Articles of Association. It means that if dividend is not paid any year, the unpaid amount is carried forward to the next year and so on, until all arrears have been paid. 2. Non-cumulative Preference Shares : Dividend on these shares does not get accumulated. This means, the dividend on shares can be paid only out of profits of that year. The right to claim dividend will lapse, if company does not make profit in that particular year. If dividend is not paid in any year, it is lost forever. 3. Participating Preference Shares : The holders of these shares are entitled to participate in surplus profit besides preferential dividend. The surplus profit which remains after the dividend has been paid to equity shareholders, up to certain limit, is distributed to preference shareholders. 4. Non-participating Preference Shares : The preference shares are deemed to be non-participating, if there is no clear provision in the Articles of Association. These shareholders are entitled to fixed rate of divided, prescribed at the time of issue. 5. Convertible Preference Shares : The holders of these shares have a right to convert their preference shares into equity shares. The conversion takes place within a certain fixed period. 6. Non-convertible Preference Shares : These shares cannot be converted into equity shares. 7. Redeemable Preference Shares : Shares which can be redeemed after certain fixed period of time are called redeemable preference shares. A company limited by shares, if authorised by Articles of Association, issues redeemable preference shares. Such shares must be fully paid. These shares are redeemed out of divisible profit only or out of fresh issue of shares made for this purpose. 8. Irredeemable Preference Shares : Shares which are not redeemable i.e. payable only on winding up of the company are called irredeemable preference shares. As per Section 55(1) of the Companies Act 2013, a company cannot issue irredeemable preference shares. 21 2.1.2 Retained Earnings : Business organisations are subject to variation in earnings. It would be a wise decision to keep aside a part of earning during a period of high profit. A prudent company does not distribute the entire profit earned among shareholders. A part of profit is retained by company in the form of reserve fund. These reserves are the retained earnings of the company. The sum total of retained earnings gets accumulated over the years. This accumulated profits are reinvested in the business rather than distributed as dividend. ''The process of accumulating corporate profits and their utilisation in business is called retained earnings.'' In simple words, a part of net profit, which is not distributed to shareholders as dividend is retained by company in the form of ‘Reserve Fund’. Company converts it’s reserves into ‘bonus share capital’ and capitalise it’s profit. This capitalisation of profit by issue of bonus shares is known as ploughing back of profit or self financing. Bonus shares are issued free of cost to the existing equity shareholders out of the retained earnings. The Management can convert retained earnings into permanent share capital by issuing bonus shares. It is an important source of raising long term capital. It is simple and cheapest method of raising finance. It is used by established companies. It is an internal source of finance. Determinants of retained earnings. : 1. Total earnings of company : If there is ample profit, company can save and retain some parts of profit. More the earnings, a company can save more. Attitude of top management also determines the amount of retained earnings. 2. Taxation Policy : The taxation policy of government is also an important determinant of corporate savings. If the taxes levied are at high rates, company cannot save much of the profits in the form of reserves. 3. Dividend Policy : It is a policy of Board of Directors in regards to distribution of profits. A conservative dividend policy is needed for having good accumulation of profit. But this policy affects shareholders as they get dividend at a lower rate. 4. Government Control : A government is regulatory body of economic system of the country. It’s policies, rules and regulations ensures that the companies work as per its regulations. Company has to formulate it’s dividend policy in accordance with the rules and regulations framed by the Government. 2.2 SOURCES OF BORROWED CAPITAL Only owned capital is not sufficient to carry on all business activities of a joint stock company. A company needs borrowed capital to supplement it’s owned capital. Every trading company is entitled to borrow money. However, it is a normal practice to have an express provision in the Memorandum of Association, enabling a company to borrow money. Memorandum authorises company to exercise borrowing powers where as Articles of Association provides as to how and by whom these powers shall be exercised. The power to borrow money is normally exercised by Board of Directors of the company. 22  A private company may exercise it’s borrowing powers immediately after incorporation. However public company cannot exercise it’s borrowing power until it secures certificate of commencement of business. The capital may be borrowed for short, medium or long term requirement. It is better to raise borrowed capital at a later stage of company’s business, when company want to expand or diversify it’s business and it requires additional capital. This additional capital can be raised by : a) issue of debentures b) Accepting deposits c) bonds d) Loans from commercial banks and Financial institutions, etc. Interest is paid on borrowed capital. It is paid at fixed rate. Borrowed capital is repayable after a specific period of time. 2.2.1 Debentures Debentures are one of the principal sources of raising borrowed capital to meet long and medium term financial needs. Over the years debentures have occupied a significant position in the financial structure of the companies. The term debenture has come from the latin word ‘debere’ which means to ‘owe’. The term debenture has not been defined clearly under Companies Act. Sec 2(30) of the Companies Act 2013, only states that, ‘the word debenture includes debenture stock, bonds and any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not’. Under the existing definition, debenture includes debenture stock. Debenture means a document which either creates or acknowledges debt. Ordinarily, debenture constitutes a charge on some property of company, but there may be a debenture without any such charge. Palmer defines : “A debenture as an instrument under seal evidencing debt, the essence of it being admission of indebtedness.” Topham defines : “A debenture is a document given by a company as evidence of debt to the holder, usually arising out of loan, and most commonly secured by charge.” According to the above definitions, debenture is an evidence of indebtedness. It is an instrument issued in the form of debenture certificate, under the common seal of the company.  Features 1. Promise : Debenture is a promise by company that it owes specified sum of money to holder of the debenture. 2. Face Value : The face value of debenture normally carries high denomination. It is ` 100 or in multiples of ` 100. 3. Time of Repayment : Debentures are issued with the due date stated in the debenture certificate. The principal amount of debenture is repaid on maturity date. 4. Priority of Repayment : Debentureholders have a priority in repayment of debenture capital over the other claimants of company. 5. Assurance of Repayment : Debenture constitutes a long term debt. They carry an assurance of repayment on due date. 23  6. Interest : A fixed rate of interest is agreed upon and is paid periodically in case of debentures. Payment of interest is a fixed liability of the company. It must be paid by company irrespective of the fact, whether the company makes profit or not. 7. Parties to Debentures : a) Company : This is the entity which borrows money. b) Trustees : A company has to appoint Debenture Trustee if it is offering Debentures to more than 500 people. This is a party through whom the company deals with debentureholders. The company makes an agreement with trustees, it is known as Trust Deed. It contains the obligations of company, rights of debentureholders, powers of Trustee, etc. c) Debentureholders : These are the parties who provide loan and receive, ‘Debenture Certificate’ as an evidence. 8. Authority to issue debentures : According to the Companies Act 2013, Section 179 (3), the Board of Directors has the power to issue debentures. 9. Status of Debentureholder : Debentureholder is a creditor of the company. Since debenture is a loan taken by company, interest is payable on it at fixed rate, at fixed interval until the debenture is redeemed. 10. No Voting Right : According to Section 71 (2) of the Companies Act 2013, no company shall issue any debentures carrying any voting right. Debentureholders have no right to vote at general meeting of the company. 11. Security : Debentures are generally secured by fixed or floating charge on assets of the company. If a company is not in a position to make payment of interest or repayment of capital, the debentureholder can sell off charged property of the company and recover their money. 12. Issuers : Debentures can be issued by both private company and public limited company. 13. Listing : Debentures must be listed with at least one recognised stock exchange. 14. Transferability : Debentures can be easily transferred, through the instrument of transfer.  Types of Debentures Debentures On the basis of On the basis On the basis of On the basis security transfer repayment conversion 1. Secured and 3. Registered and 5. Redeemable and 7. Convertible and 2. Unsecured 4. Bearer 6. Irredeemable 8. Non convertible Debentures. Debentures. Debenture. Debenture. 1. Secured debentures : The debentures can be secured. The property of company may be charged as security for loan. The security may be for some particular asset (fixed charge) or it may be the asset in general (floating charge). The debentures are secured through ‘Trust Deed’. 2. Unsecured debentures : These are the debentures that have no security. The issue of unsecured debentures is now prohibited by the Companies Act, 2013. 24  3. Registered Debentures : Registered debentures are those debentures on which the name of holders are recorded. A company maintains ‘Register of Debentureholders’ in which the name, address and particulars of holdings of debentureholders are entered. The transfer of registered debentures requires the execution of regular transfer deed. 4. Bearer Debentures : Name of holders are not recorded on the bearer debentures. Their names do not appear on the ‘Register of Debentureholders’. Such debentures are transferable by mere delivery. Payment of interest is made by means of coupons attached to debenture certificate. 5. Redeemable Debentures : Debentures are mostly redeemable i.e. Payable at the end of some fixed period, as mentioned on the debenture certificate. Repayment can be made at fixed date at the end of specific period or by instalment during the life time of the company. The provision of repayment is normally made in ‘Trust Deed’. 6. Irredeemable Debentures : These kind of debentures are not repayable during life time of the company. They are repayable only after the liquidation of the company, or when there is breach of any condition or when some contingency arises. 7. Convertible Debentures : Convertible debentures give right to holder to convert them into equity shares after a specific period of time. Such right is mentioned in the debenture certificate. The issue of convertible debenture must be approved by special resolution in general meeting before they are issued to public. These debentures are advantageous for the holder. Because of this conversion right, convertible debentureholder is entitled to equity shares at a rate lower than market value. 8. Non-convertible Debentures : Non-convertible debentures are not convertible into equity shares on maturity. These debentures are redeemed on maturity date. These debentures suffer from the disadvantage that there is no appreciation in value. 2.2.2 Acceptance of Deposit Public deposit is an important source of financing short term requirements of company. Companies receive fixed deposits from the public for the period ranging from 6 months to 36 months. Such deposits are called as Public Deposits. Under this method, general public is invited to deposit their savings with the company for varied period. Interest is paid by companies on such deposits. The company issues ‘Deposit Receipt’ to depositor. The terms of deposit are mentioned in the ‘Deposit Receipt’. Deposit Receipt is an acknowledgement of debt/loan by the company. Deposits are either secured or unsecured loans offered to the company. Meaning : As per section 2 (31) of Companies Act, 2013, ‘deposit’ includes any receipt of money by way of deposit or loan or in any other form by a company, but does not include such categories of amount as may be prescribed in consultation with the Reserve Bank of India. The above expression has been further elaborated by Rule 2 (1)(c) of Companies (Acceptance of Deposits) Rules 2014. This Rule provides that ‘deposit’ means any receipt 25  of money, in the form of deposit or loan by a company. However, ‘deposit’ does not include following : 1. Any amount received from Central Government or a State Government. 2. Any amount received as loan from any banking company. 3. Any amount received from foreign government or international banks. 4. Any amount received by a company from any other company. 5. Any amount raised by issuing commercial paper. 6. Any amount raised by issue of bonds. 7. Any amount received in trust. 8. Any amount received by way of subscription to any shares or debentures. (Terms and conditions of acceptance of Deposits are discussed in detail in Chapter 5.) 2.2.3 Bond Bond is a debt security. It is a formal contract to repay borrowed money with interest. Bond is a loan. The holder of bond is a lender to the institution. He is a creditor of the company. He gets fixed rate of interest. All bonds have maturity date and is paid in cash at certain date in future. According to Webster Dictionary, ‘A bond is an interest bearing certificate issued by the government or business firm, promising to pay the holder a specific sum at a specified date.’ Thus a company borrows money and issues bonds as an evidence of debt. Interest is payable on bonds at fixed interval or on maturity of bonds. Features 1. Nature of Finance : It is a debt Finance. It provides long term finance. The bonds can be issued for longer period i.e. 5 years, 10 years, 25 years, 50 years. 2. Status of bondholder : The bondholders are creditors. Since they are creditors and non-owners they are not entitled to participate in general meeting. They have no voting right and hence no participation in the management. 3. Return on bonds : The bondholder gets a fixed rate of interest. It is payable at regular interval or on the maturity of bond. 4. Repayment : Bonds have specific maturity date on when the principal amount is repaid. 2.2.4 American Depository Receipt (ADR) and Global Depository Receipt (GDR) In India, the shares of public company are listed and traded on various stock exchanges like Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). With adoption of free economic policy and due to globalization some of the Indian company's shares are also listed and traded on foreign stock exchanges like New York Stock Exchange (NYSE) or National Association of Securities Dealer Automated Quotation (NASDAQ). To list shares on these stock exchanges, company has to comply with policies of those stock exchanges. The policies of these stock exchanges are different than the policies of Indian Stock Exchanges. Therefore, those Indian companies which can not list their shares directly on foreign stock exchanges, get listed indirectly using ADR and GDR. 26  ADR and GDR are Dollar/Euro denominated instrument traded in USA and Europe Stock Exchanges. Indian Company issues shares to an intermediary called ‘Depository’. Bank of New York, Citigroup etc. act as foreign Depository Bank. This Depository bank issues ADR and GDR to investors against these shares. The ADR / GDR represent fixed number of shares. These ADR / GDR are then sold to people in foreign country. The ADR / GDR are traded like regular shares. They are listed on stock exchanges. The prices fluctuate depending on demand and supply. Both ADR and GDR are depository receipts, but only difference is the location where they are traded. If the Depository Receipt is traded in USA, it is called American Depository Receipts (ADR) and if it is traded in a country other than USA is called Global Depository Receipts (GDR). Non-Resident Indians (NRI) and Foreign nationals can invest their money in India by purchasing ADR and GDR. They can buy ADR / GDR using their regular equity trading Account. The company pays dividend in home currency to the depository bank and the depository bank converts it into the currency of investor and pays dividend. The exchanges on which GDR is traded are as follows : 1) London stock exchange. 2) Luxembourg Stock exchange. 3) NASDAQ Dubai. 4) Singapore Stock exchange. 5) Hongkong Stock exchange. Activity : Find out Indian Companies who have issued ADR as well as GDR. 2.2.5 Commercial Banks There are number of sources of financing short and medium term business requirements. Among these, commercial bank constitute the most predominant source. Commercial banks play significant role in corporate financing in India. Commercial banks, by introducing variety of deposit schemes tailored to individual depositor’s need, mop up savings of people and make use of these savings to meet varied requirements of corporate enterprises. Commercial banks assist corporate enterprises - 1) By Granting term loans to companies. 2) By subscribing to shares and debentures of companies. 3) By underwriting the issue of securities of the Company. Commercial banks also play an important role in providing short term finance. They have become primary source of financing working capital of the business. In India, primary source of financing working capital are bank credit and trade credit. 27 Banks have introduced many innovative schemes for disbursement of credit. They are as follows : 1. Overdraft : A company having current account with bank is allowed overdraft facility. The borrower can withdraw funds as and when needed. He is allowed to overdraw on his current account, up to the credit limit which is sanctioned by bank. Within this stipulated limit any number of drawings are permitted. Repayments can be made whenever required during the time period. The interest is determined on the basis of actual amount withdrawn. 2. Cash Credit : It is also an important and popular form of financial aid. This form of credit is operated in same manner as overdraft facility. The borrower can withdraw amount from his cash credit account up to a stipulated limit based on security margin. Cash credit is given against pledge or hypothecation of goods or by providing alternative securities. Interest is charged on outstanding amount borrowed and not on the credit limit sanctioned. 3. Cash loans : Under this, the total amount of loan is credited by bank to the borrowers account. Interest is payable on actual balance outstanding. 4. Discounting bills of exchange : The drawer of the bill i.e. (seller) can receive money from drawee (i.e. buyer) on due date or after the due date. Drawer can receive money before due date by discounting the bill with the bank. This is nothing but selling the bill to the bank. The bank gives money to drawer less than the face value of the bill. Thus bill of exchange are trade bills. They are accepted by bank and cash is advanced against them. 2.2.6 Financial Institutions First industrial policy was declared in 1948 for rapid industrial development in the country. The Central Government and State Government have established special financial institutions for providing industrial finance. These institutions provide medium and long term finance. The assistance of these institutions has become important for new companies as well as going concerns. Financial Institutions are classified into four categories as follows. Financial Institutions in India Development Financial Investment State Level Banks Institutions Institutions Institutions LIC UTI GIC SFC SIDC RCTC TDICI TFCI IDBI IFCI ICICI SIDBI IRBI 28  I. Development Banks 1. Industrial Development Bank of India (IDBI). 2. Industrial Finance Corporation of India Ltd. (IFCI) 3. Industrial Credit and Investment Corporation of India (ICICI) 4. Small Industries Development Bank of India (SIDBI) 5. Industrial Reconstruction Bank of India (IRBI) II. Financial Institutions 1. Risk Capital and Technology Finance Corporation Ltd. (RCTC) 2. Technology Development and Information Companyof India Ltd. (TDICI) 3. Tourism Finance Corporation of India Ltd. (TFCI) III. Investment Institutions 1. Life Insurance Corporation of India (LIC) 2. Unit Trust of India (UTI) 3. General Insurance Corporation of India (GIC) IV. State Level Institutions 1. State Finance Corporations (SFC) 2. State Industrial Development Corporation (SIDC) Above mentioned institutions provide financial assistance in the following forms : 1. To provide term lending facilities. 2. To subscribe to shares and debentures. 3. To underwrite the issue of securities. 4. To lend money. 5. To guarantee term loans raised by company. Activity : Study the role of different financial institutions in raising funds for companies. 2.2.7 Trade Credit No business can be run without ‘credit’. Credit is the soul of business. Trade credit financing is major source of short term financing. Manufacturers, wholesalers and suppliers of goods or materials are called ‘trade creditors’. They sell tangible goods to other business concerns on the basis of deferred payment i.e. future payment credit is extended by these business concerns with an intention to increase their sales. The business firm extends credit, also because of custom that has been built up overtime. Trade credit is not cash loan. It results from a credit sale of goods / services, which has to be paid at a future date after the sale takes place. In other words, when goods are delivered by supplier to a customer and the payment is made after some time, it is called as trade credit. 29  In distributive trade this kind of credit has great significance. The small retailers, to large extent rely on obtaining trade credit from supplier. It is an easy kind of credit which can be obtained without signing any debt instrument. It is readily available and is cheap method of financing. Suppliers sell goods and willingly allow 30 days or more, for bill to be paid. They even offer discount, if bills are cleared within a short period such as 10 days or 15 days, etc. The terms of trade credit are not rigid. 2.3 DISTINCTION 1. Shares and Debentures Points Shares Debentures 1. Meaning A share is a part of share capital A debenture is a certificate of loan of a company. It is known as taken by a company. They are also ownership securities. known as creditorship securities. 2. Status A holder of shares is the owner of A holder of debenture is creditor