Business Finance and Sources of Capital
Fixed and working capital
Fixed capital is invested in long-term assets - land, plant, machinery - and is recovered slowly. Working capital finances day-to-day operations - stock, wages, debtors - and circulates within the operating cycle. A trading firm needs mostly working capital; a manufacturing firm needs both.
Owner's funds
Equity shares carry voting rights, a residual claim on profit and repayment, and no fixed dividend; they are permanent capital. Preference shares carry a fixed dividend, priority over equity in dividend and repayment, usually no voting, and must be redeemed within 20 years under the Companies Act, 2013. Retained earnings (ploughing back of profit) are cost-free but limited and uncertain.
Borrowed funds
Debentures are creditorship securities: interest is a charge against profit and is paid whether or not profit is earned. Bank term loans, cash credit, overdrafts, trade credit, public deposits and commercial paper are other sources. Financial institutions such as IFCI, SIDBI, NABARD and IDBI provide long-term project finance, while SEBI regulates the capital market.
Worked example
A small unit needs ₹20 lakh for machinery and ₹5 lakh for raw material. Reasoning: machinery is a fixed asset with a long life, so a term loan repayable over five to seven years suits it; raw material turns over in weeks, so a cash credit limit that can be drawn and repaid suits it. Funding machinery from an overdraft creates a repayment mismatch.
Traps that cost marks
- Calling equity dividend a charge on profit; it is an appropriation.
- Saying preference shareholders always vote.
- Treating trade credit as a long-term source.
- Mixing "capital" (money invested) with "capital expenditure" (spending on fixed assets).