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What are Debentures?

Meaning

If any firm needs additional funds for enhancement or developing the business further without increasing the share capital value of its shares then it has the freedom to borrow the funds from the public by issuing the certificates. The period of time and fixed rate of interest is mentioned in the certificate. The loan certificates are also given to the local public in the similar format as the equity shares are issued. The debentures are issued using the common seal of the company once the money is received.

 

Features

Important debentures details:

  1. The public which has lent money to the company is the debenture holders who are also the creditors of the company, who have lent money on a fixed rate of interest.
  2. The debenture can be cashed-in after a some time.
  3. There are two types of debentures – secured and unsecured.
  4. As the interest is payable on the debenture, the charges on the profit so it is considered as a taxable income.
  5. The creditors or debenture do not have the right of voting.
  6. Even if the company faces losses, it has to pay the interest on debentures

 

The advantage of Debentures:

Following are major advantages of debentures:

(i) Issuing debentures do not mean that the interest of the equity shareholders is diluted as the creditors do not have the right to vote or be part of the company’s management.

(ii) As the interest is paid on debentures, it is considered as the deductible (tax) expenditure and save the income tax.

(iii) Cost wise debenture have are lesser than the most preferred shares or equity shares.

(iv) Debentures result advantageous when it is inflation.

(v) Even if the company incurs losses it is liable to make the payment for the debenture holders. So ultimately the creditors have no risk to bear.

 

Disadvantages of Debentures

Major disadvantages of debentures:

  • Interest on debentures is mandatory even if the company is incurring loss so it becomes a liability for the company.

 

Difference Between Bonds and Debentures

Financial strength is the core thing that every small to large companies needs.  There are different options to raise funds including debt or equity instruments. There are majorly two options of debt instruments which are selected by the companies, i.e. Bonds and Debentures. In most of the countries, Bonds and Debentures are supposed to be the same but both differ in many regards. Some of the basic differences are bonded are issued by the government organizations and large companies while the debentures are issued by the public companies. Both the financial tools, i.e. Bonds and debentures, are issued by the borrowing company for the price which is equal or less than the actual face value. As both of the tools are different from each, below table highlights the same:

 

Content: Bonds Vs Debentures

  1. The below chart includes definitions, differences, and conclusion

Comparison Chart

BASIS FOR COMPARISON

BONDS

DEBENTURES

Meaning Bond showcases the indebtedness of the company which is issuing the instrument. Debentures are debt instruments which are issued to raise funds for longer period.
Collateral Bonds are sort of secured instruments for generating funds Debentures can be either secured or unsecured
Interest Rate Less More
Issued by Government Concerns, financial institutions, corporations, etc. Companies, Firms, Private Organizations
Payment Accrued Periodical
Owners Bondholders Debenture holders
Risk factor Minimal Maximum
Priority in repayment at the time of liquidation First Second

Definition of Debentures

A debenture is a debt instrument which is used for generating capital for any company. It is a kind of certificate or agreement given by the company which shows the amount owed by the company against the debentures. The kind of capital generated from the debentures is considered under the borrowed capital, by which the status of the debenture holders becomes creditors of the company.

Interest has to be paid on the debentures at the regular intervals to the debenture holders by the issuing company. As the amount is borrowed from the public, it is repaid after a stipulated time period, as per the terms of redemption. The issuing company should have credit ratings to issue the debentures publicly. Debentures are classified into the following categories:

  • On the basis of Security
    • Secured Debentures
    • Unsecured Debentures
  • On the basis of Convertibility
    • Convertible Debentures
    • Nonconvertible Debentures
  • On the basis of Negotiability
    • Registered Debentures
    • Bearer Debentures
  • On the basis of Permanence
    • Redeemable Debentures
    • Irredeemable Debentures
  • On the basis of Priority
    • First Mortgage Debentures
    • Second Mortgage Debentures

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