Page 26 - DMGT409Basic Financial Management

Unit 2: Source of Finance

Reasons for Raising Funds from Fixed Deposits Notes

The following are the key reasons for raising funds from fi xed deposits:
1. Company point of view:

(a) Simple procedure involved in issuing public deposits.
(b) No restrictive covenants are involved.
(c) No security is offered against public deposits.
(d) Cheaper (post-tax cost is fairly reasonable).

2. Investors point of view:
(a) Higher interest rates when compared to other investment avenues.
(b) Short maturity period.

2.2.5 Retention of Profi t

Retained earnings are an important source of internal fi nancing of well-established companies.
Retained earnings are the portion of earnings available to equity shareholders, which are ploughed
back in the company. In other words, a part of earnings available to equity shareholders that are
retained for future investment. Hence, the process of accumulating company profi ts regularly
and their utilisation in the business is known as retained earnings or ploughing back of profi ts or

internal financing or self-investment.

Note Retained earnings are part of equity, since they are part of equity, which are

sacrificed by equity shareholders. In this source of finance companies, generally retained or
ploughed back about 20 per cent to 70 per cent of earnings available to equity shareholders
for the purpose of financing of the growth of the company. This becomes a main source of

long-term finance, when the management capitalizes profits. It is known as capitalization

of profits or issue of bonus shares.
Merits of Retained Earnings
Following are the benefits of retention of profi t.

1. Cheap source of capital: No expenses are incurred when capital is available from this
source. There is no obligation on the part of the company either to pay interest or pay back
the money. It can safely be used for expansion and modernisation of business.
2. Financial stability: A company which has enough reserves can face ups and downs
in business. Such companies can continue with their business even in depression, thus
building up its goodwill.
3. Benefits to the shareholders: Shareholders are assured of a stable dividend. When

the company does not earn enough profit it can draw upon its reserves for payment of

dividends. Not only that their holding size can improve with issue of bonus shares.
Due to reserves, there is capital appreciation, i.e., the value of shares may go up in the share
market.

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