UNIT 25 FINANCING THROUGH EQUITY
Structure
25.0 Objcctives
25.1 Illtroduction
25.2 Classification of Capital
25.3 Balance Sheet and Flow of Funds
25.4 Capital Structure and its Relevance
25.5 Equity Shares
25.6 Non-voting Shares
25.7 Preference Shares
25.8 Venture Capital
25.9 Let Us Sun1 Up
25.10 Key Words
25.11 Some Useful Books and References
25.12 Answers or Hints to Check Your Progress Ilxercises
25.0 OBJECTIVES
The unit will enable you to:
undcrstand what is capital and what are the differcnt sources of raising capital;
appreciatc the balance sheet and the concept of flow of funds;
distinguish between different flows.of funds; and
familiarise with the different equity sources of raising capital.
25.1 INTRODUCTION
You need nloney to replenish your raw material, and to pay day-to-day wages of
your employees. A well planned and thought out strategy is required to satisfy
scvcral such needs, from the various sources of financing. This is necessary because
any wrong decisions made in this area leads to increase in cost of capital and in
turn reduces the profits.
In any company, management of funds include raising of funds, and investing of
funds. A third area i.e. paynlcnt of Dividends or Dividend decisions ir also relevant
whiIe inanaging the funds of a firm, Dividend decisions are important because they
are paid from the earnings of the firm. It is a common practice in the corporate
world that a portion of the earnings is reinvesked in assets, when the companies
have profitable Project proposals and when they can maximise the wealth of the
sharehol~crs.Therefore, undistributed profits are one of the important sources of
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25.2 CLASSIFICATION OF CAPITAL
Moncy that finances business is called 'Capital '. The sources of capital can be
divided into sub-groups on the basis of the period for which it was raised or by the
source from where it was raised or by the instruments by which it was raised. Bank
loans approved for day-to-day business operations are called working capital loans
or short-term loans whereas the loans raised for the purchase of fixed assets like
land and building, plant and machinery, etc. are called long-term caljital loans or
capital assct loans. Both these types of loans have different characteristics and
thercforc, it is wrong or unhealthy practice to use the money raised for the purposes
5
othcr than the one for which the monev was raisetl.'
Financing o f Industry
(Rs. in crores)
Schedule As on As on
31-3-2001 31.3.2000
Part -A
SOURCES OF FUNDS
Shareholders funds
Share Capital 170.05 170.05
Reserves and Surplus 819.78 999.05
989.93 999.05
Loan Funds
Secure Loans 3 1323.32 1183.28
Unsecured Loans 4 1003.50 804.90
2326.82 1988.18
Total 3316.6 2987.23
Part -B
APPLICATION OF FUNDS
Fixed Assets 5
Gross Block 2004.52 2445.80
Less Depreciation 220.72 5 14.45
Net Block 1783:80 1931.35
capital Work in Progress - 13.79 77.60
1797.59 2008.95
Investments 6 264.96 241.14
Current Assets, Loans & 7
Advances
Inventories ,227.99 200.38 -
Sundry Debtors 209.96 198.29
Cash and Bank Balances 79.16 27.50
Other Current Assets 23.04 25'.48
Loans and Advances 492.56 580.03
1032.71 1031.68
Less:
Current Liabilities 8
and Provisions
-
Liabilities 371.12 ' 384.19
Provisions 5.79 18.39
376.91 402.58
.Net Current Assets
e.
655.80 629.10
Debit Balance in Profit & Loss Account 630.89 140.63
Less: Adjusted against the balance in 32.59 32.59
General Reserve per contra 598.30 108.04
Total 3316.65 2987.23
AS ON AS ON
31.3.2001 31.3.2000
SCHEDULE -'I' SHARE CAPITAL
Authorised
23,00,00,000 Equity Shares (Previous Year 11,00,00,000)
Of Rs. 101- each
230.00 110.00
90,00,000 preferences shares of Rs. 1001- each 90.00 90.00
Unclassified Shares of Rs. 101- each
(Previous Year 6,00,00,000) 60.00
320.0 260.00
Issued & Subsckibed Equity Shares
10,05,49,945 Equity shares of Rs. 101- each 100.55 100.55
Fully paidup (ofthe above shares 39,44,950
Equity shares have been allotted as fully paid
Bonus shares by way of capitalization of Reserves,
and 16,12,2268 equity shares
allotted as fully paid in terms of scheme
of amalgamation without payment being
received in cash)
Preference Slaares
30,00,000 - 6.00% Redeemable
Cumulative Non-Convertible - 30.00
Preference shares of Rs. 1001- each
(Redeemed duriag the year)
38,50,000- 13.5% Redeemable 38.50 38.50
Cumulative Non-Convertible
Preference Shares of Rs. 1001- each
50,000 -12% Redcemable Cumulative 0.50 0.50
Non-Convertible Preference shares
of Rs. 1001- each
50,000 -1 1.5% Redeemable Cumulative 0.50 0.50
Non-Convertible Preference shares
of Rs. 1001- each
30,00,000 - 6.00°! Redeemable Cumulative 30.00 -
Non-Convertible Preference Shares of Rs.1001-each 69.50 69.50
Financing o f Industry
Add interest accrued and due
Fixed Deposit Frorn
Add: Interest ac'crued and due
Loans Front Banks
Financial Institutions & Others
Add: interest accrued and due
1003.50 804.90
a Flexibility Principles: According to this principle, the management should Financing Through Equity
strive for such combinittions of securities that the management finds it easier
to manoeuvre the sources of funds in response to major changes in need for
a Timiilg Principle: Timing srinciple is very important for a firm. If the company's
receipts do not properly match the repayment of debt capital it can result in
disasters.
Therefore, designing capital Ftr~ctureis a very crucial and critical issue for a firm.
In the next section, we shall try and understand what is financing through equity,
what are the instrunlents that are brotadly covered under this heading, what are the
advantages1 strengths and weaknesses of these instruments, etc.
Check Your Progress 1
I ) What do you mean by 'Capital'? Describe various sources of raising capital.
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2) Explain the different flows of funds in detail.
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25.5 EQUITY SHARES.-
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According to the Con~paniesAct, 1956, a share is a part or unit by which the share
capital of a company is divided. This Act makes provision for two classes of shaie
capital: Equity shares and Preference Shares. Equity capital is value of assets, after
all the debts and other charges have becm paid or provided for. Thus equity share
capital is also called as Residua.] Capita,'.
Financing of Industry Equity shares are the certificates of ownership, which give the holder the ownership
of the company to the extent of their holding. Companies issuerthese shares to the
general public (known as "Public Issue") and also to the existing shareholders
(known as "Right Issue"). The share issued to the existing shareholders could be
for a price (called "Right Issue") or could be for free of cost (called "Bonus
Issue"). In case of Bonus issue the company shall not be receiving any additional
capital.
Equity capital is also known as Risk Capital, as the holders of equity shares are
exposed to greater risk. Many companies may not be able to pay any dividends or
may pay very little dividends for many years. In case of some companies even the
capital invested in the form of equity shares may be lost because of bad performance
of the companies.
Advantages
a ) Equity shares are not repayable to the shareholders as these are non-refundable.
As a result of this, companies get permanent capital and they need not look for
capital time and again. This saves lot of money and time to companies and they
need not spend their energies on these issues.
b) A company with a strong equity base would be able to raise further capita.1 through
debt 'sources.
c) Companies have no specific obligation to pay dividend in case of equity shares.
As a result of this, companies can retain profits from the business operations and
can reinvest it in profitable expansion and diversification project. If dividend is not
paid, it may be difficult to raise funds through new issues. Companies then have to
turn to debt capital, for which interest has to be paid.
Disadvantages
a) The cost of raising equity capital is high, as it linvolves flotation costs. Also the
dividend paid is not deductible as an expenditure of the company before arriving
at a final profit for tax purposes. Moreover dividend paid is taxable to the company.
In addition to this, equity holders expect more return as they take more risk.
b) Raising of equity capital from the public may not result in enhanced profits in
the short-term but it dilutes the Earnings Per Share.
c ) Sometimes, raising of fresh equity capital from the public may result in dilution
of controlling n ~ l v e rof a'-e promoters and it may happen thht the existing
management of the company may neeil to lose their control because of its
diluted voting power.
There are three ways in whi;h a company can raise equity capital by way of
issuing equity shares. They ar:: Public Issu!:, Rights Issue, and Private Placement.
Let us know little more about each of thesf: ways.
a) Public issue: With this issuc:, Companies approach the general public to subscribe
to their shares, so that the companies con get share capital. Securities and
Exchange Board of India (SEBI) and the C;ompanies Act, 1956, have laid down
certain rules and procedures to be followetd by the companies, which desire to go
for a public issue. Many activities are involved for making a public issue successful.
Some of these activities are:
i) Preparing a detailed projpct report f o r which the funds are intended.
I
ii) Preparation of prospectus and filing with SEBI and other Statuary Bodies.
iii) Appointing Registrars, Merchant Bankers, underwrite;;, and Bankers to the Financing Through Equity
IV)Finalisation ofthe basis of allotment, and
v) Transmitting of the shares to the allottees, as per the basis of allotment.
b) Rights issue : As per the Companies Act, existing companies can issue shares
only to the existing shareholders on rights basis in addition to public issue. This
issue is known as rights issue and companies can raise additional resources in this
form as well. The shareholders can acquire the rights shares or can sell and
transfer these rights to someone if they desire so. This issue is a good method of
raising resources without any dilution of the controlling power.
c) Private placement : In Private Placement shares are issued to a very limited
number of persons or organisations. In this method, companies issue shares in
bulk to issuing house through financial intermediaries, investment companies,
etc. Under SEBI guidelines a company cannot issue shares to more than 99
persons under the private placement method. The companies, which buy shares
in private placement, may sell these shares in the secondary market and earn
25.6 NON-VOTING SHARES
It ispossible for a company to issue equity shares without voting rights. This kind
of shares are very useful for existing managements, to protect their control on the
company and allow no dilution of voting rights. These non-votilig shares are similar
to equity shares in all respects except in the voting power. These shareholders get
slightly a higher rate of dividend in return to their loss of voting rights. If a company
fails to pay dividend for a stipulated period these non-voting shares shall automatically
get converted as ordinary equity shares.
25.7 PREFERENCE SHARES
Preference shares are those, which have certain preferential rights as compared to
other types of securities. These shareholders have specially two preferential rights
in relation to the payment of dividend and repayment of money invested in these
shares. These shareholders have preference in payment of dividend compared to
any other type of shareholders. However, the dividend payment to these shareholders
is not an obligation on the part of the company. But whenever a dividend payment
is contemplated these shareholders have to be paid before paying to the ofdinary
equity shareholders. Similarly, in case of liquidation of a company the preference
shareholders get priority over the equity shareholders in repayment of the capital.
Ordinarily, these shareholders have no voting rights in the company.
Preference shares are of different types. Some of these types are: redeemable
preference shares, cumulative preference shares, and convertible preference shares.
Redeemable preference shares are redeemed as per the terms and conditions
agreed upon. The dividend on the cumulative preference shares is not paid to the
holders every year but it is accumulated over the years and paid as per the agreed
terms and conditions. Cdnvertible preference shares are converted as equity shares
as per the agreed termland conditions.
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Cumulative Convertible4"Peference Shares are another variety of preference shares
introduced by G o v e r n ~ n in
t 1985. These shares are meant for raising funds for
new projects, expansion and diversification of existing projects. These shares carry
10% dividend and convertible in 3 to 5 years time into equity shares. However,
these shares have not become popular.
3) Write a short notes on the Venture Capital Funds. Financing Tlhrough Equity
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25.9 LET US SUM UP
From the above discussion, you are made familiar with various sources of financing
through Equity. In this unit, you have learnt about balance sheet and flow of funds,
capital structure, various kinds of shares and venture capital. In unit 26, you will be
familiarised with the various sources of financing through Debt.
There exists a relatively new source of funding assets of a company, which is
neither a source of debt nor a source of equity financing. This is known as Lease
Financing. This is an arrangement between two parties; one who owns a particular
asset and the other who desires to use it for a consideration. The person who owns
the assets is known i s "Leaser" and the person who wants to use it is knwon as
"Lessee". The consideration agreed up between then for using the assets is known
as "Lease Rentals". To illustrate with an example, if a company needs a building
for housing its office and does not want to buy a building for this purpose, it can
hire a suitable building on lease and pay lease rentals. This is a convenient
arrangement for the company, as it need not struggle for raising the required funds
for purchasing building. This method of acquiring assets reduces the pressure of
raising the funds on the company.
0
25.10 KEY WORDS
Long-term Loan : The loans raised for the purchase of fixed assets
like land and building, plant and machinery, etc. are
called long-term capital loans or capital asset loans.
Revised Capital : Another name for equity share capital; which is
value of assets after all the debts and other charges
have been paid or provided for.
Short-term Loan : Bank loans approved for day-to-day business
operations are called working capital loans or short-
term loans.
25.11 SOME USEFUL BOOKS AND REFERENCES
Bhalla, V.K., (2001). Working Capital Management: Text and Case, Anmol
Publications Pvt. Ltd., Delhi.
Machiraju, H.R., (2002). Introduction to Project Finance: An Analytical
Perspectives, Vikas Publishing House Pvt. Ltd., New Delhi.
Pandey, 1.M; (1 999). Financial Management, Vikas Publishing House Pvt. Ltd.,
New Delhi.
15
Financing of Industry
