Equity vs. Preference Shares: A Comparison

The amount of capital that an owner has brought to the business, plus which he has collected in the credits when all is mixed is called business finance. The amount of capital that a company holds, whether it is from owner funds or borrowed funds, is included in business finance. How to do the planning, how to raise, how to issue, how to manage it, business finance is an umbrella term for all these things. So business finance is a branch of business studies where we monitor both cash flow, inflow and outflow, of the money. 

Nature and Significance of Business Finance

Why business requires finance-

i. There is a requirement of fixed assets to run a business such as the furniture, machinery, etc. Money is needed to buy that asset, this requirement is met through our business finance and the small expenses which are incurred in business meetings or in all other things, there is also a need for money, which is fulfilled through our business finance.

ii. When your production process is long, like if you are making a product that is taking you 1 to 2 months to produce, then you will need a lot of things during that time. If you do not have the money to make this product, then you cannot buy that raw material, due to which you will not be able to manufacture the product. Money is the most important aspect to manufacture products and this money comes through our business finance only.

iii. If you want to open a new branch of a business or you have to improve the infrastructure of your existing business or get new machinery in the building, then money plays a vital role in these purchases. Your company has a requirement of money for growth and expansion and that requirement is fulfilled with business finance.

Benefits of Adequate Finance

• The firm can meet its liability on time.

• The firm can carry on its business smoothly.

•  The firm can adopt the latest technology and innovative method of production.

•  The firm can make use of its business opportunities.

•  The firm can face competition more strongly.

•  The firm can replace its Assets and machinery whenever it required or necessary.

• The firm can face recession and depression periods of the trade cycle more strongly.

 Equity Shares -

Equity shares do not carry any special rights or preferential rights. A person holding equity shares is called an equity holder. Equity holders do not have any special rights at the time of dividend and at the time of repayment. The last right is of the equity shareholders’. If they are in loss then they get nothing and if there is a profit then they get paid whatever is left after everyone gets paid. They do not have any fixed rate of return but these are primary risk barrels plus whatever profit they make is also the highest.

Features

i. Primary Risk Barrel- In these cases, companies lose, then the first loser to bear is the equity shareholder. Equity shares never get returns at the time of loss, they have to take a loss.

ii. Claim over residual income- Residual means leftover income. The income that remains after giving everyone’s share, is called residual income. The claim over residential income means when a small amount of income is left after giving it to everyone, the money goes to the equity shareholders.

iii. The basis for loans- Equity share capital is the basis on which loans can be raised to control equity shareholders.

iv. Control-Equity shareholders manage the affairs of the company. They are actively participating in important decisions, in important meetings, plus they also have the power to cast their votes. This voting can also be done in the decision of the company.

v. Higher profit-Equity shareholders hold the highest profit at the time of profit and there is no limit to their rate of return. Whichever company gets a lot of profit, they get a good return which is not fixed.

vi. Primitive rights- Whenever the company shares new equity for the general public or the shareholders, the equity is held by the existing equity holders first. Equity Shareholders get primitive rights.

Advantages 

i. Permanent capital- there is no fixed commitment to return the money for the payment of a fixed rate of dividend.

ii. No charge- on fixed assets, a company is not required to mortgage its assets.

iii. Credit standing- a company with more equity share capital enjoys hiring credit standings.

iv. Huge funds- people from on income groups can invest in equity share capital.

Disadvantages

i. Risk of fluctuating returns- at the time of adversity equity shareholders suffer loss and get no return.

ii. Inflexibility- equity share capital cannot be returned even when it is lying idle.

iii. Legal formalities- a company has to complete too many legal formalities before the issue of equity shares to the general public.

iv. Issues depend on market condition- equity shares are risky security and these are demanded during the boom period only during recession and people have hesitated to invest in equity share capital.

Preference Shares -

Preference shares are those which get more preference than equity shares, they get more imports in time of dividend and repayment of investment amount during winding up.

Features

i. Fixed-rate of dividend- preference shareholders get a fixed rate of dividends before payment to equity shareholders.

ii. No security- companies do not offer any security against preference share.

iii. Voting rights- the preference shareholder does not get voting rights under general conditions.

iv. Hybrid security- like equity share, preference share get dividend only when the company is earning profit and like debentures, preference share gets a fixed rate of return.

Advantages

i. Helps to collect a large number of funds- preference shares attract more public due to the fixed rate of return.

ii. No fixed liabilities- during the lost period there is no fixed liability to pay dividends as in the case of loans on borrowings.

iii. No interference- with preference share in capital structure the equity shareholder retains exclusive control over the company.

iv. No charge on assets- preference shares are not issued against any security.

v. Trading on equity- in years of prosperity and more profit equity shareholder in joy high rate of earning.

Disadvantages

i. Fluctuating and low return- the preference shareholders get a return only when a company is earning profit.

ii. A dividend is not treated as an expense- the company pays the income for and income tax on the income which is distributed to preference shareholders.

iii. No voting rights- they generally do not carry voting rights these shareholders have no say in management.

iv. Fixed obligations- during the time of low profit also a company has to pay a fixed rate of dividend to its preference shareholders.