by Before redeeming preference shares or debentures, a company must ensure that sufficient cash balance is available. Redemption requires payment of face value and sometimes a premium, therefore careful financial planning is essential. Companies generally arrange funds in advance so that the redemption can be completed smoothly without disturbing normal operations. The main methods are explained below:
- Issue of Fresh Shares
A company may arrange cash by issuing fresh equity or preference shares to the public or existing shareholders. Investors subscribe to the new issue and pay cash to the company. This cash is then used to redeem the existing preference shares or debentures. This method is widely preferred because it does not reduce working capital or disturb routine business activities. It also helps maintain the capital base of the company, since old capital is replaced by new capital. Additionally, it improves liquidity and ensures the company can make timely payment to security holders without financial pressure.
- Issue of New Debentures
Another method is issuing new debentures to the public or financial institutions. In this case, the company replaces an old liability with a new one. The amount collected from new debenture holders is used to redeem the existing securities. This method is especially useful when the company does not want to dilute ownership control by issuing equity shares. It also allows the company to restructure its debt by changing interest rates or repayment terms. Although the liability continues, the company obtains immediate cash required for redemption, ensuring timely payment and maintaining financial stability.
- Utilization of Accumulated Profits
The company may utilize its retained earnings, general reserve, or surplus in profit and loss account for redemption. Profits accumulated over the years are converted into cash and used for payment to shareholders or debenture holders. However, when preference shares are redeemed out of profits, the company must transfer an equivalent amount to the Capital Redemption Reserve (CRR). This ensures that the capital base of the company is maintained. Although this method does not create new liabilities, it reduces available reserves and may limit dividend distribution or expansion plans.
- Sale of Investments
Companies often hold investments such as government securities or bonds. These investments can be sold before the redemption date to generate the required cash. If a sinking fund investment exists, it is specifically created for redemption and can be liquidated easily. This method is safe because funds are already accumulated and earmarked for redemption purposes. By selling investments, the company avoids borrowing or disturbing working capital. However, if investments are sold during unfavorable market conditions, the company may incur losses. Therefore, careful timing and financial planning are necessary.
- Debenture Redemption Fund / Sinking Fund
A company may create a Debenture Redemption Fund (Sinking Fund) by setting aside a fixed amount of profits every year and investing it in securities. Over time, the investment and accumulated interest grow to a sufficient amount. On the redemption date, these investments are sold and converted into cash to pay debenture holders. This is one of the most systematic and secure methods because the company gradually builds funds instead of arranging a large amount suddenly. It also spreads the financial burden over several years and ensures that redemption does not affect liquidity.
- Bank Loan or Overdraft
If immediate funds are required and other sources are insufficient, the company may take a bank loan or overdraft facility. The borrowed amount is used to redeem shares or debentures on the due date. This method is usually temporary and suitable when the company expects future income to repay the loan. It helps avoid default and maintains goodwill. However, the company must pay interest on the borrowed funds, increasing financial cost. Therefore, this method is generally used only as a last resort or short-term arrangement.
- Call on Uncalled Capital
When shares are partly paid, the company may demand the uncalled portion of share capital from shareholders. By making a call, shareholders are required to pay the remaining amount due on their shares. This provides additional cash inflow without issuing new securities or borrowing money. The collected amount can be used for redemption purposes. This method is legally permissible and useful when a significant portion of capital remains unpaid. However, it depends on shareholders’ ability to pay and may cause dissatisfaction if called suddenly.
- Sale of Fixed Assets
In certain situations, the company may sell non-essential or idle fixed assets such as unused land, old machinery, or buildings. The proceeds from the sale are converted into cash and utilized for redemption. This method helps the company meet obligations when other sources are insufficient. However, it is generally considered a last option because selling productive assets may affect operational capacity and long-term profitability. Companies usually dispose only surplus or obsolete assets so that regular production and business activities are not adversely affected.
