Download SOURCES OF BUSINESS FINANCE Introduction

SOURCES OF BUSINESS FINANCE
Introduction:
Business cannot be run without money. Funds required to carry out business is
called Business Finance. This chapter throws light on how the finances for the
business can be arranged, what are the sources of funding and what terms and
conditions are governed with each type of funding.
FINANCE IS THE LIFE BLOOD OF BUSINESS.
Finance is the money available to spend on business needs.
Right from the moment someone thinks of a business idea, there needs to be
cash. As the business grows there are inevitably greater calls for more money
to finance expansion. The day to day running of the business also needs
money.
The main reasons a business needs finance are to:
 Start a business
 Finance expansions to production capacity
 To develop market and new products
 To enter new market
 Takeover or Acquisition
 Moving to new premises
 To pay for day to day running of business
Sources of Funds :
METHODS OF RAISING FINANCE :LONG TERM FINANCE:
Issue of Share : The capital obtained by issue of shares is known as share capital.
The capital of a company is divided into small units called share. If a company
issue 10,000 shares of Rs. 10/- each then the share capital of company is 1,00,000.
The person holding the share is known as shareholder. There are two types of
share
(I)
Equity share
(II)
preference share.
A
rights.
EQUITY SHARES are those which do not carry any special or preferential
EQUITY SHARES
Merits
Convenience
No charge on assets
No obligation
Dependable
Growth and Expansion
Demerits
1. Low dividend
2. Uncertain
3. Unbalanced growth
4. Misuse and Speculation
B. PREFERENCE SHARE : Preference shares are safe in investment. They receive dividend at a fixed rate.
Preference shareholder are like creditors. They have no voting right.
 Types of preference shares :1 .Cumulative preference shares.
2 .Non cumulative preference shares.
3.Participating preference shares.
4.Non participating preference shares.
5.Convertible preference shares.
6.Non Convertible preference shares
PREFERENCE SHARES
MERITS
 Investment is safe
 No charge on assets
 Does not affect control
 Fixed dividend policy
DEMERITS
Costly
No tax saving
DEBENTURES:
It constitutes the borrowed funds of the company. It is an acknowledgement of
debt. Debenture capital may be called DEBT CAPITAL.
TYPES OF DEBENTURES
Secured
Unsecured
Redeemable
Irredeemable
Convertible
Non- Convertible
Registered
Bearer
DEBENTURES
Merits
1.Regular return
2.Safety of investment
3.Economic sources
4.Flexibility
Demerits
1.Charge on assets
2.No voting rights
3.Permanent burden of interests
5.Tax relief
Differences between Shares and Debentures
BASIS
1.Types of funds
SHARES
Owner’s fund
DEBENTURES
Borrowed funds
2.Return
Flexible
Fixed
3.Voting rights
Available
No voting rights
4.Status of holders
Owners of the company Creditors of the company
5. Redemption
Not redeemable
Mostly Redeemable
6.Charge
No charge on assets
Charge on assets
7. Degree of risk for
holders
High
Low
MEDIUM TERM FINANCE:
 Public deposits:
Refers to the unsecured deposits invited by companies from the public. It can
invite for a period of six months to 3 years. Public deposit cannot exceed 25% of
its share capital & resources
MERITS
Simplicity
Economical
No charge on assets
No loss on control
DEMERITS
1. Uncertainty
2. Temporary finance
3.Unsuitable for new
company
.
 FINANCIAL INSTITUTIONS:
The state and central government have establised many financial institutions to
provide finance to companies. They are called development Bank. These are IFCI,
ICICI, IDBI and LIC, UTI.
FINANCIAL INSTITUTIONS
MERITS
Long term finance
Managerial advice
Easy installments
DEMERITS
More time consuming
Restrictions
 Loans From Commercial Banks
Business can raise finance from commercial banks in the following ways
TERM LOAN:
For
MEDIUM
TERM
CASH CREDIT:
Intrest is
charged on
the amount
actually
withdrawn.
DISCOUNT OF
BILL: Banks
provide short
term finance
in exchange
for Bill
OVERDRAFT:
Current account
holders is allowed
to overdraw his
account.
SHORT TERM FINANCE:
Trade credit:
refers to the credit extended by one trader to another for purchasing goods or
service. Small and new firms are usually more dependent on trade credit.
Factoring:
It has emerged as a popular source of short term finance. It is a financial service
where by the factor responsible for all credit control and debt collection from the
buyers and provides protection against any bad debt losses to the firm.
Two methods of Factoring
Recourse factoring
Non- Recourse factoring
3.Commercial Paper (C.P.):
It is an unsecured promissory note issued by firm to raise funds for a short period
says 90 days to 364 days. Only firms having good credit rating can issue the C.P.
 International Sources of Finance:
Commercial Bank :
1. Commercial Bank all over the world provide foreign currency loan for business.
Standard chartered is a major source of foreign currency loan to the Indian
industry.
2International Agencies and development Bank : Many number of international
agencies and development Bank e.g. IFC, ADB provide long term loan.
3International capital market: GDR ; ADR; FCCB
INTERNATIONAL SOURCES OF FINANCE
ADR
(American Depository Receipt)
 Rose from equity markets in USA.
 Funds from ADR are available in
U.S Dollar
GDR
(Global Depository Receipt)
Traded on a stock exchange
FUNDS from GDR are available in
European dollar as well as U.S
Dollar.
1.GDR :
When the local currency shares of a company are delivered to the depository bank, which
issues depository receipt against shares, these receipt denominated in US doller are caller
GDR s.
Feature of GDR :GDR can be listed and traded on a stock exchange of any foreign country other than America.
It is negotiable instrument.
A holder of GDR can convert it into the shares.
Holder get dividends.
Holder does not have voting rights.
Many Indian companies such as Reliance, Wipro and ICICI have issue GDR.
2.ADR :
The depository receipt issued by a company in USA are known as ADR s
Feature of ADR:It can be issued only to American Citizens.
It can be listed and traded is American stock exchange.
Indian companies such as Infosys, Reliance issued ADR DIFFERENCE BETWEEN ADR & GDR
1.
2.
3.
Basis
Listing
ADR
Only in American Stock
Exchange
Liquidity
More liquid
Share Holder Only American Citizens
GDR
Anywhere in the world
Less liquid.
All over the World
Citizens.
3.FCCB s : The FCCB s are issued in a foreign currency and carry a fixed interest rate. These are listed
and traded in foreign stock exchange and similar to the debenture.
 Indian Depository Receipts (IDRs)
IDRs are like GDR or ADR except that the issuer is a foreign company raising funds from
Indian Market. IDRs are rupee dominated. They can be listed on any Indian stock Exchange.
Issue Procedure of IDRs
Issuing co.
Foreign
Features of IDRs
IDRs are issued by any foreign company
Overseas
custodian bank
Indian
depository
Indian investor
The IDRs can be listed on any Indian stock exchange.
A single IDR can represent more than one share, such as one IDR = 10 shares.
The holders of IDR have no right to vote in the company.
The IDRs are in rupee denomination.
Advantages of IDR
It provides an additional investment opportunity to Indian Investors for overseas investment.
It satisfies the capital need of foreign companies.
It provides listing facility to foreign companies to list on Indian Equity Market.
It reduces the risk of Indian Investors who want to take their money abroad.
 Inter-Corporate Deposits (ICD)
Inter-Corporate Deposits are unsecured short term deposits made by one company with
another company. These deposits are essentially brokered deposited, which led the
involvement of brokers. The rate of interest on their deposits is higher than that of banks
and other markets. The biggest advantage of ICDs is that the transaction is free from legal
hassles.
Type of ICDs
Three Months Deposits - These deposits are most populer type of ICDs. These deposits are
generally considered by borrowers to solve problems of short term capital adequacy. The
annual rate of interest for these deposits is around 12%.
Six months Deposits - It is usually made first class borrowers. The annual rate of interest for
these deposits is around 15%
Call deposits - This deposit can be withdrawn by the lender on a day s notice. The annual rate
of interest on call deposits is around 10%
Features of ICDs
These transactions takes place between two companies.
There are short term deposits.
These are unsecured deposits.
These transactions are generally completed through brokers.
These deposits have no organised market.
These deposits have no legal formalities.
These are risky deposits from the point of view of lenders.
Gist of the Lesson:
Finance is the life blood of business.
Business finance is of three types – Long term, Medium term, Short term
There are two sources of business finance – Owned funds, Borrowed funds
Shares are of two types – Equity and Preference shares
Retained profits refer to the undistributed profits which are re-invested in
business.
Debentures are creditor ship security.
ADRS and GDRS are the main International sources of finance
Gist of the Lesson:
Finance is the life blood of business.
Business finance is of three types – Long term, Medium term, Short term
There are two sources of business finance – Owned funds, Borrowed funds
Shares are of two types – Equity and Preference shares
Retained profits refer to the undistributed profits which are re-invested in business.
Debentures are creditor ship security.
ADRS and GDRS are the main International sources of finance.