Important role of Debentures as a source of finance

Important role of Debentures as a source of finance

Debentures are a long-term source of finance. Debentures as a source of finance suit companies that have regular earnings to service the debt have a higher proportion of fixed assets in the structure of their assets which offers adequate security and motivates investors. A debenture is a form of bond or long-term loan which is issued by the company. The company has to ensure the maintenance of a prudent debt-equity ratio. The debenture typically carries a fixed rate of interest over the course of the loan.

Recent trend in the issue of debentures has been quite encouraging and important because of the following factors viz.

(1) Support from investment institutions is adequately available. Debenture is a most suitable form of long term source of financing. LIC, UTI, GIC and others have been in field to invest public funds in the debenture issues.

(2) Emergence of institutions acting as trustees for debentures holders have reposed confidence in the investing public for the security of their money and safeguard of their interest as creditors. Debenture is less costly source of financing for the company. Cost of debenture is lower than the cost of equity.

(3) Institutional underwriters, merchant banks in public and private sector have come up to render successful underwriting services to the investor as well as the needy companies. Investing in debentures involves less risk than other options of investment.

(4) Investors preference to high yielding securities with minimum risk has encouraged issue of debentures by the companies.

(5) Cost of raising money through debenture is minimum as against the cost involved in other sources of finance. Earnings per share can be maximized because of the benefit of financial leverage.

(6) Debenture issuing company is obliged now to create a debenture redemption fund to protect the interest of debenture holders. It helps to mobilize public savings and funds in the form of investment.

(7) Debenture helps to minimize the tax burden of the firm because amount of interest is deducted from the income.

If a company borrows money, it will give its creditor a document to evidence the existence and terms of the loan. This document is called a debenture. Accordingly, although there is no requirement that a debenture must be secured by a charge over some or all of the company’s assets, most debentures will include some form of security for practical reasons.

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