Financial Management and Business Data Analytics · Sources of Finance

Debentures and Long-Term Borrowings as Sources of Debt Finance

Updated 10 October 2026 · Fact-checked

A debenture is a written acknowledgement of a company's debt, issued for a fixed sum at a stated interest rate and repayable on a set date. Term loans and bonds are other long-term debt. To answer questions, state the meaning, classify the type, list features, then give merits and demerits.

Understand Debentures and Long-Term Borrowings

Long-term borrowing means raising money that the company will repay after a long period, usually more than one year and often five to ten years or more. The lender does not become an owner. The company promises to pay interest and return the principal. This is why borrowing is called debt finance, while equity shares are owners' funds.

A debenture is an instrument issued by a company, acknowledging a debt. The holder is a creditor. The holder gets interest at a fixed rate, whether the company earns a profit or not. Debentures are usually issued to the public or to institutions, and may be secured or unsecured. A bond is similar in nature. In practice the term is more common for instruments issued by government, public sector undertakings and financial institutions, but exam answers treat both as long-term debt instruments.

A term loan is a loan from a bank or financial institution for a fixed period, with a set repayment schedule. It is mostly used to buy fixed assets or fund expansion. Terms are negotiated directly with the lender, so no public issue is needed. Lenders often ask for security over assets and add conditions called covenants, such as limits on further borrowing or dividend payout.

Debentures are classified in several ways:

By security: secured (charge on assets) and unsecured (naked).
By convertibility: non-convertible (NCD), fully convertible, and partly convertible into equity shares.
By redemption: redeemable (repaid on a date or in instalments) and irredeemable or perpetual.
By registration: registered (holder's name recorded with the company) and bearer (transferable by delivery).
By coupon: fixed rate, floating rate, and zero-coupon (issued at a discount, redeemed at face value).

The main reason firms use debt is that interest is a tax-deductible expense and lenders do not share control. The main risk is that interest and principal are a fixed obligation. Failure to pay can lead to legal action and enforcement of security. Exams usually test the types, features, and the merits and demerits, and often ask you to compare shares with debentures or convertible with non-convertible debentures.

Key rules to remember

Annual interest on a debenture: Interest = Face value × Coupon rate; Interest is on face value, not on issue price or market price.
Issue at discount or premium: Issue price = Face value − Discount, or Face value + Premium; Net proceeds also fall by issue costs. Interest is still on face value.
Post-tax interest cost (simple view): Post-tax interest = Interest × (1 − Tax rate); Applies when the company has taxable profits against which interest can be deducted.
Redemption value of a debenture: Redemption value = Face value (+ Premium on redemption, if any); Convertible debentures are instead exchanged for shares at a stated conversion ratio.
Number of shares on conversion: Shares received = Debentures held × Conversion ratio; Conversion ratio is the number of shares per debenture, as stated in the terms of issue.

How to solve Debentures and Long-Term Borrowings questions

Use this method for theory questions (types, features, merits, differences) and for short numerical questions on debentures and term loans.

1Read the command word. 'Explain' needs meaning and detail, 'distinguish' needs a point-wise comparison, 'discuss' needs merits and demerits.
2Define the instrument in one or two lines, stating that the holder or lender is a creditor and not an owner.
3Classify it using a clear basis, such as security, convertibility, redemption, registration or coupon. Name each type and give a one-line description.
4List features: fixed interest, fixed maturity, charge on assets if secured, no voting rights, priority over shareholders on winding up.
5Give merits and demerits from the company's view. Add the lender's view if the question asks for it.
6For numbers, compute interest on face value, then adjust for discount, premium, issue costs and tax in that order.
7Close with a one-line conclusion, such as when a company should prefer debt over equity.

Quickest way: Compare in a two-column table of points

When to use it: Use for 'difference between' or 'convertible vs non-convertible' questions, and for MCQs asking which statement is correct.

Pick four to six standard bases: status of holder, return, repayment, voting rights, risk, tax treatment.
Write the point for each side in the same order so marks are easy to award.
For MCQs, check the key test: creditor or owner? Fixed or variable return? Convertible into shares or not?
Eliminate options that give debenture holders voting rights or say interest is paid only from profits.

Common mistakes in Debentures and Long-Term Borrowings

Saying debenture holders are owners of the company.
Both shares and debentures are sold to investors, so they seem alike.
Fix: Remember that debenture holders are creditors. They lend money, earn interest and have no voting rights.
Calculating interest on issue price or market price.
Students see a discounted issue price and use it as the base.
Fix: Interest always uses face value and the coupon rate. The issue price only affects the cash received.
Saying interest must be paid only out of profits.
It is mixed up with dividends on shares.
Fix: Interest is a fixed charge payable even in a loss. Dividend is a distribution of profit.
Treating convertible debentures as equity from the start.
The word 'convertible' suggests shares straight away.
Fix: Until conversion the holder is a creditor and gets interest. Only after conversion does the holder become a shareholder.
Listing only merits and forgetting demerits of debt.
Debt looks cheaper than equity, so the risks are skipped.
Fix: Always give both sides. Mention fixed burden, covenants, charge on assets, and risk of insolvency.
Mixing up term loans and debentures.
Both are long-term debt with interest.
Fix: Term loans are negotiated with a lender, usually repaid in instalments. Debentures are issued as securities to many investors and can often be traded.

Worked examples

Example 1

Distinguish between shares and debentures. Give any five points.

Show the solution

Decide the bases: status, return, repayment, voting, risk.
Write the point for each side in the same order.

Answer: 1. Status: a shareholder is an owner; a debenture holder is a creditor. 2. Return: shareholders get dividend, which depends on profit and the board's decision; debenture holders get fixed interest. 3. Repayment: share capital is not repaid in the normal course while the company runs; debentures are repaid on maturity, unless irredeemable. 4. Voting: equity shareholders vote on company matters; debenture holders have no voting rights. 5. Risk: shareholders bear higher risk and are paid last on winding up; debenture holders have lower risk and are paid before shareholders, with secured holders ahead of unsecured creditors.

Example 2

Nirmal Textiles Ltd issues 10,000 debentures of ₹1,000 each at a 9% coupon, at a 2% discount. Issue costs are ₹1,00,000 in total. Compute the annual interest, the cash received from the issue, and the interest after tax at a 25% tax rate.

Show the solution

Face value = 10,000 × ₹1,000 = ₹1,00,00,000.
Annual interest = ₹1,00,00,000 × 9% = ₹9,00,000.
Discount = ₹1,00,00,000 × 2% = ₹2,00,000. Issue proceeds = ₹1,00,00,000 − ₹2,00,000 = ₹98,00,000.
Net cash after issue costs = ₹98,00,000 − ₹1,00,000 = ₹97,00,000.
Interest after tax = ₹9,00,000 × (1 − 0.25) = ₹6,75,000.

Answer: Annual interest is ₹9,00,000. Net cash received is ₹97,00,000. Interest after tax is ₹6,75,000.

Exam tips

For 'types of debentures', state the basis of classification first, then the types. It reads better and earns structured marks.
For MCQs, test each statement against creditor versus owner and fixed versus variable return.
In numerical questions, show face value, interest and discount as separate lines to earn step marks.
Always write merits and demerits for debt, and connect them to tax-deductible interest and fixed repayment burden.
Learn one clear comparison each for shares vs debentures and convertible vs non-convertible debentures.

Practice questions from Sources of Finance

Debentures and Long-Term Borrowings in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Debentures and Long-Term Borrowings: frequently asked questions

What is the difference between convertible and non-convertible debentures?

Convertible debentures can be exchanged for equity shares, fully or partly, on terms fixed at issue. Non-convertible debentures stay as debt until repaid. Convertible ones usually carry a lower interest rate because the holder gets the chance to become a shareholder.

What are the main advantages of term loans as a source of finance?

Term loans are arranged quickly with a lender, so no public issue is needed. Terms can be tailored and interest is tax-deductible. The lender gets no ownership or voting rights, so control stays with existing owners.

What are the main disadvantages of debentures?

Interest and principal are fixed obligations payable whatever the profit. Secured debentures tie up assets, and heavy debt raises financial risk. If the company defaults, holders can enforce their security.

Are bonds different from debentures?

Both are long-term debt instruments carrying interest and repayment on maturity. The term bond is commonly used for issues by government, public sector units and financial institutions. For exam answers, treat the features and merits as largely the same.