Finance is a vast subject with several branches. The modern business world is changing rapidly in terms of its functioning. One has to be familiar with the terminologies associated with the finance world. By understanding various financial terms and the mechanism in which it functions, one can reach great heights.
This website, ‘Simplified Fiscal Affairs’ presents to you the various topics/concepts in the form of series and imparts the knowledge in a simplified way.
A company form of business organisation requires funds on a regular basis to expand and diversify its activities. There are many sources through which the company generates the revenue. It is classified as owned funds and the borrowed funds. Share capital represents the owned or ownership capital of the company, whereas, the money raised through the issue of debentures, loans, deposits and bonds is considered to be the borrowed capital, which is to be repayed along with the interest.
The Non-Performing Assets (NPAs) is a result of various loans and advances sanctioned or approved by the organisation. A loan is considered to be an NPA (non performing asset) after 90 days delay in the payment of interest and repayment of principal. NPA is a result or a by product of a bad loan.
What are Shares?
Section 2(84) of the Companies Act 2013, defines “ Share means a share in the share capital of a company and includes stock”.
- It is the division of capital into smaller yet equal units. It facilitates the investors to subscribe to the capital in smaller amount.
- These units then are further referred to as ‘shares’. It is the smallest unit in the total share capital of a company. The people who invest and hold such securities are known as shareholders.
- Shares are also known as ownership securities. Shares represent the ownership capital of the company.
Features:
- Share is the smallest value in the total share capital of company.
- In case of physical shares, each share possesses a distinctive number for identification as mentioned in the share certificate.
- Share represents a movable property.
- Entitled to get a share in the net profits of the company by the way of dividend.
- The shares are entitled to certain rights such as right to receive dividend, right to attend shareholders’ meetings, right to inspect statutory books and right to vote.
- Share certificate is a document issued by the company, under the common seal as an evidence of ownership.
- A company can issue two type of shares: Equity equity shares do not enjoy preference for dividend and do not have priority for repayment of capital at the time of winding up.They are also known as ordinary shares, shares that are not preference shares are called equity shares. Preference shares are those shares which carry preferential right as to payment of dividend and repayment of capital.
What are Debentures?
Sec 2(30) of the Companies Act 2013, only states that, ‘the word debenture includes debenture stock, bonds and other instruments of the company evidencing a debt, whether constituting a charge on the assets of the company or not’.
Topham defines: “A debenture is a document given by a company as evidence of debt to the holder, usually arising out of loan and most commonly secured by charge”.
Palmer defines: “A debenture is an instrument under seal evidencing debt, the essence of it being admission of indebtedness”.
- Debentures are also known as creditorship securities. They are one of the primary sources of raising borrowed capital. Debentures have acquired a significant position in the financial structure of the organisations.
- Debentures is a form of corporate loan, divided into many units called “Debentures”.
- Debentures are issued to a huge number of investors. The person who purchases a debenture is known as a debenture holder.
- The organisation issues a debenture certificate under its seal as an evidence of or acknowledgement of loan.
- The term debenture has come from the latin word ‘debere’ which means to ‘owe’.
- Under the existing definition, debenture includes debenture stock, debenture means a document which either creates or acknowledges debt. Generally, debenture constitutes a lien on some property of company but there may be a debenture without such lien.
- It is a debt tool, finance raised through debentures is considered as a loan. Is an acknowledgement from the company that it has taken a loan from the public. Debentures are issued by analysing the creditworthiness of the company.
- A debenture is an instrument of debt executed by the company acknowledging its obligation to repay the sum at a specified rate and also carrying a fixed rate of interest.
- Debentures are the borrowed capital of the company. The people holding debentures are known as debenture holders. A trust deed is executed when debentures are issued to protect the interest of the debenture holders.
Features:
- Debenture is an evidence of debt by company that it owes specified sum of money to the holder of the debenture.
- The face value of debenture normally carries high denomination.
- The principle amount of debenture is repaired on maturity date.
- Debenture holders have a priority in repayment over the other claimants of company.
- A fixed rate of interest is paid to debenture holders, whether, the company makes profit or not.
- Debenture holder is a creditor of the company.
- Generally secured by a fixed or floating charge on assets of the company.
What are NPAs-Non Performing Assets?
The Reserve Bank of India defines, Non Performing Assets as any advance or loan that is overdue for more than 90 days.
- NPA stands for Non-performing Asset.
- A loan is considered to be an NPA (non performing asset) after 90 days delay in the payment of interest and repayment of principal.
- NPA is a result or a by product of a bad loan. A bad loan is defined as the loan which has not been ‘serviced’ for a significant period of time.
- Servicing of a loan means to pay back the interest and a certain percentage of principal amount as per the agreement between the borrower and the lender.
- All the advances and loans sanctioned by financial institutions are considered to be ‘assets’ as they are capable of earning revenue for the lender by the way of generating interest income. However, things do not always work out as planned, a loan is considered bad when it is unable to generate interest, non-payment of principle and doesn’t serve its purpose.
Classification of NPAs:
- Substandard Asset: Assets which have been an NPA for a period less than or equal to 12 months.
- Doubtful Asset: Assets which have remained in the substandard category for a period of 12 months.
- Loss Asset: Assets which has been identified as a probable loss by the lender but not written off yet.
Reasons for the Growth of NPAs:
- Over Optimism: Majority of the loans are sanctioned during the period of robust economic growth, which may turn bad due to over optimism.
- Provision: Financial institutions have to compulsorily maintain a provision for doubtful debts, which results in the decrease in the amount of credit it can sanction. For example, A company has the ability to sanction a credit of Rs 100 crores but it has to maintain a certain provision as per the law. If it sets aside Rs 10 crores it can now lend Rs 90 crores to the borrowers.
- Thorough Checking: Loans sanctioned through NBFCs do not required much paper work which leads to dispute in the long run.
- Over running of Expenditure: Contract delays, over running of costs, result in the growth of NPAs.
- Credit to MSMEs: Increase in the approval of loan to MSME for development, result in the growth of NPAs.
- Structural Inefficiencies: Lack of analysis, monitoring, stringent rules and regulations result in the evergreening of loans (further issue of loan in order to repay an existing loan) instead of restructuring, taking strict action to recognise the asset.
How NPAs Affect the Financial Institutions?
- Financial Performance: The growth of NPAs result in the non-payment of interest and principal amount which cause financial losses and further affects the balance sheet of the financial institution. The financial performance decline to a great extend due to the increase in NPAs.
- Provision: Banks have to maintain a provision for NPAs, which further reduce the capital base.
- Liquidity: Setting aside a certain percentage of capital base for provision affects liquidity, it refrains banks from lending.
- High Interest Rate: To keep up with the profit percentage, financial institutions increase the Interest rate which further affects the economy.