Page 41 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 3: Sources of Finance

3.2.1 Owners’ Capital or Equity Notes

A public limited company may raise funds from promoters or from the investing public by way
of owners’ capital or equity capital by issuing ordinary equity shares. Ordinary shareholders
are owners of the company and they undertake the risks inherent in business. They elect the
directors to run the company and have the optimum control over the management of the
company. Since equity shares can be paid off only in the event of liquidation, this source has the
least risk involved. This is more so due to the fact that equity shareholders can be paid dividends
only when there are distributable profits. However, the cost of ordinary shares is usually the
highest. This is due to the fact that such shareholders expect a higher rate of return on their
investment as compared to other suppliers of long-term funds. Further, the dividend payable on
shares is an appropriation of profits and not a charge against profits. This means that it has to be
paid only out of profits after tax.
Ordinary share capital also provides a security to other suppliers of funds. Thus, a company
having substantial ordinary share capital may find it easier to raise further funds, in view of the
fact that share capital provides a security to other suppliers of funds.

Did u know? What are the governing acts for share capital?
The Companies Act, 1956 and SEBI Guidelines for disclosure and investors’ protections
and the clarifications there to lay down a number of provisions regarding the issue and
management of equity shares capital.

Advantages of raising funds by issue of equity shares are:

1. It is a permanent source of finance.
2. The issue of new equity shares increases flexibility of the company.
3. The company can make further issue of share capital by making a right issue.
4. There are no mandatory payments to shareholders of equity shares.

3.2.2 Preference Share Capital

These are a special kind of shares, the holders of such shares enjoy priority, both as regards to the
payment of a fixed amount of dividend and repayment of capital on winding up of the company.
Long-term funds from preference shares can be raised through a public issue of shares. Such
shares are normally cumulative i.e., the dividend payable in a year of loss gets carried over to
the next year till there is an adequate profit to pay the cumulative dividends. The rate of dividend
on preference shares is normally higher than the rate of interest on debentures, loans, etc. Most
of preference shares these days carry a stipulation of period and the funds have to be repaid at
the end of a stipulated period.
Preference share capital is a hybrid form of financing that partakes some characteristics of
equity capital and some attributes of debt capital. It is similar to equity because preference
dividend, like equity dividend is not a tax-deductible payment. It resembles debt capital because
the rate of preference dividend is fixed. Typically, when preference dividend is skipped it is
payable in future because of the cumulative feature associated with most of preference shares.
Cumulative Convertible Preference Shares (CCPS) may also be offered, under which the shares
would carry a cumulative dividend of specified limit for a period of say three years, after which the
shares are converted into equity shares. These shares are attractive for projects with a long gestation
period. For normal preference shares, the maximum permissible rate of dividend is 14%.

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