Page 27 - DMGT409Basic Financial Management

Basic Financial Management

Notes Demerits of Retained Earnings

The following are the important disadvantages of retained earnings:
1. Limited funds available by way of retained earnings.

2. Continuous retention of profits may lead to over capitalization.

3. Creation of monopolies, since retained earnings in bigger organisations helps to grow
bigger which may lead to the monopoly.

4. Loss to shareholders, when a firm pays less dividends or no dividends due to retained
earnings, shareholders may sell their shares for meeting their expenditure.
5. The management may misuse the retained earnings, which is not helpful to maximize
shareholders wealth.
6. The cost of retained earnings is high, retained earnings are the dividends foregone by
ordinary shareholders, which involve an opportunity cost.

7. Retained earnings leads to evasion of super profit tax, which is the revenue loss to the

Government.
2.2.6 Term Loans

Traditionally, commercial banks in India do not grant long-term loans.
They grant loans only for short period not extending one year. But recently they have started
giving loans for a long period. Commercial banks give term loans i.e. for more than one year. The
period of repayment of short-term loan is extended at intervals and in some cases loan is given

directly for a long period. Commercial banks provide long-term finance to small scale units in
the priority sector.
Merits of Long-term Borrowings from Commercial Banks

The merits of long-term borrowing from banks are as follows:
1. It is a flexible source of finance as loans can be repaid when the need is met.

2. Finance is available for a definite period, hence it is not a permanent burden.
3. Banks keep the financial operations of their clients secret.

4. Less time and cost is involved as compared to issue of shares, debentures etc.
5. Banks do not interfere in the internal affairs of the borrowing concern, hence the management
retains the control of the company.
6. Loans can be paid-back in easy instalments.
7. In case of small-scale industries and industries in villages and backward areas, the interest
charged is low.

Demerits

Following are the demerits of borrowing from commercial banks:
1. Banks require personal guarantee or pledge of assets and business cannot raise further
loans on these assets.
2. In case the short-term loans are extended again and again, there is always uncertainty
about this continuity.

20 LOVELY PROFESSIONAL UNIVERSITY