Almost all trading companies, in the course of their operation, stand in need of money over and above their paid-up capital. They satisfy their financial needs by borrowing from various sources. Such borrowings may be either for a temporary purpose or for more or less permanent requirements.
A company can adopt a number of methods to satisfy its long-term and short-term financial needs. The Short-Term Borrowing and Long-Term Borrowing of a company are briefly explained as below.
Short- Term Methods of Borrowing
1. By arranging an Overdraft, Cash Credit or Loan from Bankers
An overdraft is an arrangement by which a company is allowed to draw more than what is to the credit of its account at the bank.
Cash credit is an arrangement by which a company borrows from its bankers up to a certain limit against a bond of credit by one or more securities or some other security. The company is charged interest on the amount actually utilized and not on the limit sanctioned.
In a loan arrangement, the full amount of the loan sanctioned is placed to the credit of the company and the loan account of the party is debited with the full amount. The company has to pay interest on the full amount of the loan whether it makes use of the full amount or not.
2. By issuing a Bill of Exchange, Hundi or Promissory Note
This is another method of obtaining short-term finance. Here an officer authorized by the company draws or executes a bill of exchange, hundi or promissory note on behalf of the company, and gets the same discounted, either with a banker or a financier.
3. By Pledging any Movable Property
Securities can be pledged by lodging them with the banker along with a blank transfer and the relative scrips and executing in favour of the banker a document called the “Memorandum of Charge“, giving necessary power to the Banker to complete the transfer, and to dispose of the securities, if and when necessary.
Similarly, goods lying in the godown of the company may be pledged by handing over the key of the godown to the banker together with a letter of hypothecation.
4. By Mortgaging Immovable Property
Under this form, the securities are the lands and buildings belonging to the company. These securities can be mortgaged in which the whole legal interest in a property is conveyed to the mortgagee subject to the right to redeem. The mortgagee is given the power to sell the security in case of default.
Equitable mortgage is created by deposit of the title deeds of the property with the mortgagee, along with an undertaking to execute a legal mortgage, when called upon.
Long-Term Methods of Borrowing
1. By Charging the Uncalled Share Capital and Book Debts
This is a long-term method of obtaining finance. In this method, the company may create a charge on its uncalled capital, if it is allowed to do so by its Articles of Association. A company, however, is not allowed to borrow on the security of its reserve capital, as the reserve capital is not capable of being called up, except when the company is wound up.
A company may also create a charge on its book debts. The expression “Book Debts” refers to those debts which become due to the company in the ordinary course of its business and which are entered in the books of the company as such.
2. By Creating a Floating Charge on the Property
A company may borrow by giving, what is called, a floating charge on its property or assets. It is an arrangement in which the company gives security-its assets, present as well as future. However, the company is not prevented from dealing with such assets, as it pleases, as long as it goes on paying the interest.
3. By the Issue of Debentures or Debenture Stock
This is the most important method of obtaining loan for a longer period. The difference between “Debenture Stock” and “Debenture Bonds” is very much like the difference between “Stock” and “Shares”. In case of debenture stock, each lender is given a certificate called Debenture Stock Certificate for the amount he lends.