Meaning and Classification of Sources of Corporate Finance

A joint stock company is, by its very nature, a large-scale form of business organisation, and running one — buying land and machinery, employing people, holding stock, extending credit to buyers — needs money at every stage. In Secretarial Practice this money is called corporate finance, and the process of raising it from wherever it can genuinely be raised is called capital formation. No single source is ever enough for a growing company, so every company draws on several sources together, and a Secretarial Practice student following the Maharashtra HSC Secretarial Practice syllabus needs a clear map of what those sources are before studying any one of them in depth.

The most basic classification separates sources by the period for which the funds are needed. Long-term sources — shares, debentures, retained earnings, long-term institutional loans — finance the purchase of fixed assets such as land, buildings and plant, and are expected to stay invested in the business for many years. Medium-term sources — public deposits, medium-term bank loans, some categories of debentures — meet needs that fall somewhere between a few months and a few years, such as modernising equipment. Short-term sources — bank overdraft and cash credit, trade credit from suppliers, discounting of bills of exchange — meet the day-to-day working-capital needs of the business, such as buying raw material or paying wages, and are expected to be repaid quickly out of the cash the business itself generates.

A second, and for this chapter more central, classification separates sources by ownership. Owned capital (also called ownership capital) is money contributed by the people who own the company — its shareholders — through the purchase of shares, or generated by the company itself and ploughed back rather than distributed, as retained earnings. Owned capital is treated as permanent capital because the company is under no obligation to return it to the contributor during its lifetime; it is returned, if at all, only when the company is wound up. Borrowed capital (also called loan capital or debt capital), by contrast, is money the company takes on loan from outsiders — through debentures, bonds, public deposits, bank credit, loans from financial institutions, or trade credit — on a promise to pay interest at a fixed rate and to repay the principal by an agreed date. Borrowed capital is temporary capital: however long its term, it always falls due for repayment, and the company owes it whether or not the year has been profitable.

A third classification looks at where the capital is generated from. An external source is one where capital comes into the company from outside — a new shareholder subscribing to shares, a debenture-holder lending money, a bank sanctioning a loan. An internal source is one where capital is made available from within the organisation itself — the clearest example being retained earnings, where the company simply chooses not to distribute part of a year's profit and uses it instead to fund future growth.

These three classifications are not rival systems competing with each other — they are three different lenses applied to the same underlying sources, and the rest of this chapter is organised around the ownership-based lens: first the sources of owned capital (shares and retained earnings), and then the sources of borrowed capital (debentures, public deposits, bonds, ADR/GDR, bank credit, financial-institution loans, and trade credit).