This document discusses various modes of finance, including debt finance and Islamic finance. It defines debt finance as raising money through bonds, bills or notes that must be repaid with interest. The merits of debt finance include maintaining ownership, tax deductions on interest payments, and flexibility. However, debt finance also requires repayment of principal and interest, can impact credit ratings, and requires sufficient cash on hand. The document then outlines various Islamic modes of finance, including rental-based financing like leasing, participatory models like mudarabah and musharakah, and trade-based models like murabahah, salam and istisnaa.
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Lecture 11 debt finace m&dm df islamic modes of financing
1.
2. What is Debt finance. Merits and demerits of
debt finance.
What are the Islamic modes of finance.
By: Zara Ahsan
THE SUPERIOR COLLEGE LAHORE
ASSOCIATE DEGREE IN
ACCOUNTING AND FINANCE
3. What is debt finance
Debt Financing means when a firm raises money
for working capital or capital expenditures by
selling bonds, bills, or notes to individual and/or
institutional investors. In return for lending the
money, the individuals or institutions become
creditors and receive a promise to repay principal
and interest on the debt.
4. Merits of debt finance
1. Maintain Company Ownership
2. Tax Deductions for Interest Paid
3. Greater Freedom and Flexibility
5. 1-Maintain Company
Ownership
O A primary advantage of issuing bonds and
borrowing money from lenders is that a
company maintains complete ownership. This
is not the case with equity financing because
stockholders have ownership rights in a
company.
O The benefit of maintaining ownership is that
management has complete control over the
decisions made on behalf of the company.
Management also has the ability to choose its
own board members. The only obligation a
debtor has to a lender is to pay back the
principal and interest.
6. 2-Tax Deductions for Interest
Paid
O Another advantage of debt financing is
that companies receive tax deductions for
the interest paid on debt. In most cases,
the Internal Revenue Service considers
the interest paid a business expense and
allows businesses to deduct the payments
from their corporate income taxes. This is
beneficial for businesses because it
allows them to use the money saved to
grow the business.
7. 3-Greater Freedom and
Flexibility
O Businesses using debt financing to raise
capital have more flexibility than those using
equity financing because they are only
obligated to the investor or lender for the
repayment period.
O After all money is paid back, the business is
completely free from its obligation. Companies
also have greater flexibility because the
paperwork to obtain debt financing is less
complicated and less expensive than equity
financing.
8. Demerits of debt finance
1. Repayment of Principal and Interest
2. Impacts on Credit Rating
3. Cash on Hand Requirements
9. 1-Repayment of Principal and
Interest
O A disadvantage of debt financing is that
businesses are obligated to pay back the
principal borrowed along with interest.
Businesses suffering from cash flow
problems may have a difficult time
repaying the money. Penalties are given
to companies who fail to pay their debts
on time.
10. 2-Impacts on Credit Rating
O Another disadvantage is that debt financing
affects the credit rating of a business. A
company that has a significantly greater
amount of debt than equity financing is
considered risky.
O A company with a lower credit rating that
issues bonds typically will have to pay a
higher interest rate to attract investors.
Companies who have to pay more in interest
may experience a cash flow problem in the
future.
11. 3-Cash on Hand Requirements
Companies seeking debt financing must
meet the lender’s cash requirement, which
means companies must have sufficient cash
on hand. This is difficult for businesses
depending on debt financing for a cash
infusion. Some companies may have to put
up collateral to qualify for financing, which
puts assets at risk if they fail to repay the
debt.
12. Islamic Modes Of Financing
O Islamic modes of financing mean the
way of supplying funds that is
acceptable to Islam.
O There are three type of financing
available under Islamic concept of
funds supply
1. Rental-based mode of financing and
2. Participation-based of financing.
3. Trade-based modes of financing;
14. IJARA/LEASING:
O Ijara is an Arabic word used for leasing
O Leasing is an agreement that permits
one party (the lessee) to use an asset
or property owned by another party
(the lessor) for an agreed-upon price
over a fixed period of time.
O It is a form of asset finance which has
the benefit of using assets without the
requirements of ownership.
19. DEFINITION
A joint enterprise or partnership
structure with profit/loss sharing
implications that is used in Islamic
finance instead of interest-bearing
loans.
Musharakah allows each party
involved in a business to share in the
profits and risks.
20. 3-Trade Base Mode Of
Finance
There are four kinds of Trade based
modes of financing which are very
common.
1. MURABAHAHA
2. MUSAWAMAH
3. SALAM
4. ISTISNAA
21. MURABAHAH.
OMurabahah means selling a
commodity or asset on disclosure of
cost and profit. So the
distinguishing feature of Murabahah
from ordinary sale is that the seller
is bound to discloses the cost and
profit both to the buyer
22. MUSAWAMAH
OThe difference is that the quoted
price does not require any breakup
of cost and profit All other details
are same as for Murabahah The
process flow is also same and the
payment method may also be of
same nature.
23. SALAM
Salam is a sale whereby the seller
undertakes to supply some specific goods to
the buyer at a future date in exchange of an
advanced price fully paid at spot.
24. QUR’AN
O you who believe! When you deal with
each other in transactions involving future
obligations in a fixed period of time, put
them in writing” [2:282]
HADITH
O The Holy Prophet (PBUH) said:
“ Whoever wishes to enter into a contract of
salam, he must effect the Salam according
to the specified measure and the specified
weight and the specified date of delivery.
25. ISTISNAA
Istisnaa is an order from purchaser to
a manufacturer to produce a specific
good for him against mutually agreed
price and period for manufacturing
and delivery.
Example
If we order a tailor to stitch for us
according to my requirements
