Long-Term Sources of Finance: Strategies & Capital Structure
Explore long-term financing options like equity, debt, and retained earnings to build a sustainable capital structure and optimize business growth.
Long Term Sources of Finance
Strategies for Sustainable Capital Structure
What is Long Term Finance?
Long-term finance refers to funding obtained for a period exceeding one year, typically ranging from 5 to 20 years. It is essential for modernizing operations, expanding capacity, and structural development.
Classifications of Funding
Ownership Capital (Equity): Funds provided by the owners of the company.
Borrowed Capital (Debt): Funds raised from outsiders like banks and public.
Internal Sources: Retained earnings and depreciation funds.
Equity Shares
Equity shares represent the ownership of a company. Equity shareholders have voting rights and control the management. Dividends are not fixed and depend on the company's profitability. It is a permanent source of capital.
Risk vs. Cost: Capital Comparison
Debt is generally cheaper but carries higher financial risk due to mandatory payments. Equity is more expensive (due to higher expected returns) but carries less risk of bankruptcy.
Debentures & Bonds
Debentures are instruments for raising long-term debt capital. They carry a fixed rate of interest which must be paid regardless of profit. They are often secured against the company's assets, providing safety to investors.
Preference Shares
A hybrid financing instrument. Preference shareholders receive a fixed dividend rate and have priority over equity shareholders during liquidation, but generally possess no voting rights.
Retained Earnings
Concept: Ploughing back of profits into the business.
Cost: No explicit cost (interest), but implies opportunity cost.
Benefit: No dilution of control and increases financial strength.
A company must balance the low cost of debt with the safety of equity to achieve an optimal capital structure.
Principles of Financial Management
Factors Affecting Choice
Cost: Interest rates vs. dividend expectations.
Risk: Degree of financial leverage the firm can handle.
Control: Desire to maintain voting power (favors debt over equity).
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- corporate-finance
- capital-structure
- equity-shares
- debt-financing
- financial-management
- business-funding