Q. Ms. Priya is running a small restaurant by the name of Deliciousness. It is earning profits and she wishes to expand her business by opening a bigger outlet. She needs additional funds for the same but she does not wish to rely on borrowed funds to expand her business. Name and briefly explain two sources of finance which she can use. Also state two reasons why she does not want to raise borrowed funds.
Ans: The two sources of finance she can use to expand her business are:
1. Equity Shares: Equity shares is the most important source of raising long term capital by a company.
Equity shares represent the ownership of a company and thus the capital raised by issue of such shares is known as ownership capital or owner’s funds.
2. Preference Shares: The capital raised by issue of preference shares is called preference share capital.
The preference shareholders enjoy a preferential position over equity shareholders in two ways: (i) receiving a fixed rate of dividend, out of the net profits of the company, before any dividend is declared for equity shareholders; and (ii) receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.
Limitations of raising money through borrowed funds:
1. As fixed charge instruments, borrowed funds put a permanent burden on the earnings of a company. There is a greater risk when earnings of the company fluctuate.
2. Banks make detailed investigation of the company’s affairs, financial structure etc., and may also ask for security of assets and personal sureties. This makes the procedure of obtaining funds slightly difficult.
Q. The management of Sedan Limited has decided to raise capital through equity shares as it would help to serves as a permanent capital as it is to be repaid only at the time of liquidation of a company. But on the other hand, Mr. Ram, one of the director of the company was against it. Discuss any four reasons why Mr. Ram is not ready to prefer for equity Shares.
Ans: The major limitations of raising funds through issue of equity shares are as follow:
1. Investors who want steady income may not prefer equity shares as equity shares get fluctuating returns.
2. The cost of equity shares is generally more as compared to the cost of raising funds
through other sources
3. Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders.
4. More formalities and procedural delays are involved while raising funds through issue of equity shares.