Question

List the two types of sources of​ funds; list first the type having the stronger claim on an​ entity's assets:



Stronger claim

Lesser claim

Answer 1

Sources of funds refer to all the mediums by which an organisation raises its long term capital and working capital. An entity will decide the source of funds depending upon the need. Now the sources of funds will be broadly categorized into 2 types based on their claim on its entity’s assets. It mean the fund provider will have right to claim from the assets of the company in case of any default done by the company at the time of redemption.

The following are 2 types of sources of funds listed based on above:

Stronger Claim:

                Basically the capital borrowed from outside sources will come into this category. In this type of capital, the fund provider has a charge on assets of the business which means the company will pay to the fund provider by selling the assets in case of liquidation. Some of the sources of funds under this category are:

1.Issue of Debentures: In this case, debenture holders will be having a claim on entity’s assets in case of default/liquidation by the company.

2.Working Capital Loan from Banks/Financial Institutions: Banks and Financial Institutions will have charge on current assets like receivables and inventory of the company. Usually Cash Credit and Term loans will be granted by considering the current assets as security. So in case of default by the company, banks/financial institutions will have claim on the current assets of the company.

3.Long Term loans from Banks/Financial Institutions: Banks and financial institutions will have claim on assets of the company in case of default done by the company.

  Lesser Claim:

                Internal sources of funds and some other external sources will come under this category. After settling all the claims of the above fund providers, the remaining net assets of the company will be realised and paid. So they will be having lesser claim when compared to above fund providers. The following will come under this category:

1.Issue of Equity Shares: Equity Financing is done by selling part of their ownership interest in the business. They will come under the category of not having claim on assets of the company.

2.Preference Shares: Preference Shareholders will be having right to receive fixed dividend to be paid. If not it will be accumulated and will be paid later. However preference shares cannot be secured on company’s assets. They will be paid prior to equity shareholders at the time liquidation.

3.Retained Earnings: Unused profits of the business. It will act as one of the source of funding to company. Since they are internally generated funds, no one will be having claim entity’s assets except where company might be having restrictions in its use since it is having an obligation to pay dividends with them.