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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.