Download - 34 34 Sources of Finance
-
8/8/2019 34 34 Sources of Finance
1/23
Sources of FinanceSources of Finance
An Overview
-
8/8/2019 34 34 Sources of Finance
2/23
Subject IndexSubject Index General Classification
Equity Capital
Debentures
Preference Share Capital
Banks
Capital Financing Venture Capital Financing
Debt Securitisation
Lease Financing
Negotiable Instruments
Factoring Short term sources
Foreign Investments
Derivative & New Instruments
Ideal Capital Structure
-
8/8/2019 34 34 Sources of Finance
3/23
Corporate FinancingCorporate Financing
Internal Sources
Retained earnings
PromotersContribution
External Sources
Long Term Medium
TermShort Term
Bank Loans
Security Financing
Financial Instruments
Leasing
Other Sources
-
8/8/2019 34 34 Sources of Finance
4/23
Equity Share CapitalEquity Share Capital
Permanent Source of Finance
Raised from common public or internal sources as per the goodwill of concern
Signifies part ownership & prime risk element in an enterprise
Merits:
A basic investment in business providing security to other investors and
suppliers of money Low risk element:
- Redemption only on the liquidation of the business entity
- Payment of dividend when sufficient profits are generated
Flexibility:
- Options of bonus and right issue
- Non- voting equity shares can also be issued
- Company can buyback its own shares from the market
Security to the Shareholders of maintaining control over company
More aggressive market dealings and high market price
-
8/8/2019 34 34 Sources of Finance
5/23
Equity Share CapitalEquity Share Capital
Demerits: More cost to the payer company:
- Dividends are paid out of the post tax profits
- A Dividend distribution tax of 12.5% is additionally payable
Administrative and procedural compliances for serving the equity iscomplicated
Risk of dilution of Control of Management in the company
Conclusion:
- Cost: High
- Repayment terms: Flexible
- Control: High risk of dilution
An Inevitable Source of Finance
-
8/8/2019 34 34 Sources of Finance
6/23
DebenturesDebentures
Derived from the latin word Debre meaning to owe
Serves as an acknowledgement of debt to the investor
Fixed rate of interest paid and redemption as per commitments
Enjoys priority in Dissolution of the Company
Generally secured against assets. Can be convertible into equity
Merits: No dilution of control since Debenture holders are never given voting rights
Cost Effective:
- Tax Shield on the interest paid on debentures
Flexibility:- Scheme of Debt can be framed as per the companys needs
* Due consideration to the Paari Passu clause
- No complicated compliances serving the debt
- Own Debentures
-
8/8/2019 34 34 Sources of Finance
7/23
DebenturesDebentures Convertible Debentures:
- Effective substitute when the equity market is not very effective
Demerits:
Very High Risk:
- Interest payments at fixed rates
- Redemption as per the commitments
Effect on Equity Capital:- With increase in the financial risk, expected rate of return rises and resultantly, the
cost of equity
- Capitalization rate rises reducing the market price of the Equity share capital
Effect on Companys Assets:
- Debentures are generally secured against the companys assets, hence, the
borrowing capacity is substantially affected
Conclusion:
- Cost: Moderate
- Repayments Terms: Rigid
- Control: Not Affected
-
8/8/2019 34 34 Sources of Finance
8/23
Preference Share CapitalPreference Share Capital
Special type of shares enjoying priority over payment of dividends andredemption
Should be redeemed in a period of maximum 20 years
A fixed rate of dividends paid before equity shareholders
A hybrid of both debt and equity mix
Merits: A part of share capital of the company, hence a favorable debt equity ratio
can be maintained
Preference Capital carries no voting rights
Payment of dividend only if sufficient profits are generated
An attractive investment scheme for the investors:- A more secured investment
- A fixed rate of dividends is paid on priority basis
- Speculation tends to be generally less
-
8/8/2019 34 34 Sources of Finance
9/23
Preference Share CapitalPreference Share Capital
Demerits: High cost of serving the capital:
- Administrative and legal compliances
- Fixed rate of dividends payable at priority basis
- No tax shield on dividends. Further, a dividend distribution tax of 12.5%.
Can acquire voting rights if dividends not paid for over certain years
The unpaid dividends accumulate over the years of lower profits and aconsolidated liability is discharged when sufficient profits are generated
Conclusion:
- Cost: High
- Repayments Terms: Negotiable- Control: Moderate risk
An emerging source of finance
-
8/8/2019 34 34 Sources of Finance
10/23
Banks FinancingBanks Financing
Loans
A single advance
disbursed entirely
at one time
Interest charged
on the amount
sanctioned
Recovery of loan
at specified time
Can be secured or
unsecured
Not a running
account
Cash Credits
Bank credits a
fixed sum to loan
account
Withdrawal as
per needs
Secured against
stock
Interest charged
on the sum
withdrawn
Overdrafts
Customers
allowed to draw
in excess of their
bank accountbalances
Interest charged
on Daily balance
Secured by
Fixed Depositreceipts, stock
etc.
Can be
unsecured (Clean
OD)
SecuredAdvances
Advances given
on security of
confirmed orders,government
tenders etc.
Letter of credit
can also be given
Interest &Repayment terms
as per standards
Government
agencies also
provide such loans
-
8/8/2019 34 34 Sources of Finance
11/23
Capital FinancingCapital Financing
Seed Capital Assistance
Provided by all recognized banks
By means of loans and grants
Terms of loans sanction and repayments etc. are specified
Mainly for small and medium scale projects costing up to 1-2 Crores. A minimum
10% of promoters contribution is generally kept
A nominal interest along with a service charge varying with the volume of business
Capital Incentives
An economy promotion tool employed by the Government
Mainly for the promotion of the backward areas
Assistance is provided to the new undertakings either by way of a lumpsum subsidy
or exemption from taxes Mechanism is governed through State Finance Corporations and the provisions of the
applicable tax laws
Normally takes 1-2 years for the release of revenue. So, bridge finances can be
availed up to 85% of the sanction
-
8/8/2019 34 34 Sources of Finance
12/23
Venture Capital FinancingVenture Capital Financing
Started in 1987-88 by creation of Technology Development Fund and
guidelines for venture capital companies
To finance the upcoming modern and risky projects in sunrise sectors
Mainly in the fields of IT, Energy conservation, Quality up gradation
Main financing agencies are Asset Management Companies, FII, State
Finance Corporations, banks and private companies Common Methods of Financing:
- Equity Financing: Generally up to 49% of the total capital
- Conditional loans: Repayable as royalty ranging between 2-15%
- Income Note: Both Interest and Royalties are charged at lower rates
- Participating Debentures: Varying interest as per the operations
Venture Capital companies can claim income tax exemption under section
10(23FB) of the Income Tax Act, 1961
RB I and SEBI guidelines for registration and operations of venture capital
companies to be observed
-
8/8/2019 34 34 Sources of Finance
13/23
Debt SecuritisationDebt Securitisation Mainly a function of Non banking finance corporations (NBFC)
Recycling of funds by issue of securities against the pools of assets generatingsteady cash flow
Securitisation Process
- Locating the borrower as per credit worthiness and efficiency
-P
ooling Function:* Clubbing the receivables & advances into pools
* Structuring the pools with specific terms and conditions
* Transferring the pools to Special purpose vehicle (SPV)
- SPV to issue securities based on the Asset pool
Generally SPVs are Merchant bankers and Investors in such scheme are mutualfunds, insurance companies etc.
Transfer of ownership of Assets( Receivables) to SPV and the risk of non
payment to the investors of such schemes
-
8/8/2019 34 34 Sources of Finance
14/23
Lease/FranchiseLease/FranchiseLeasing:
An arrangement with the leasing company wherein particular assets are providedagainst periodic rent
Can be an effective alternative to purchasing the asset out of owned or borrowed
funds
Tax benefits on depreciation and lease rentals can be claimed by the respective
parties to agreement
Provisions of Hire Purchase Act, 1972 to be observed
Franchising:
A method of expanding business on less capital than would otherwise be needed
Under a franchising agreement, a franchisee pays a franchisor for the right to operate
a local business, under the franchisors trade name
The Franchisor bears all initial establishment costs
The franchisee makes regular payments to the franchisor based on the turnover &
after the agreed number of years, the ownership of business is transferred to
franchisee
-
8/8/2019 34 34 Sources of Finance
15/23
Negotiable InstrumentsNegotiable InstrumentsDiscountingofBills
Trade bills acknowledging the dues can be obtained from the customers
Credit worthiness of the parties can be exploited effectively
Banks discount the trade bills so obtained for a nominal charge
The payment due after 2-3 months can be obtained instantly
Drafting an operation of the promissory notes or bills receivable to be governed
by Indian Negotiable Instrument Act, 1881Commercial Papers
An unsecured promissory note issued as per provisions of Indian Negotiable
Instruments Act,1881
Can be issued to any extent but in the multiples of Rs. 5 Lakhs. An individual
investor cannot invest more than 25 Lakhs
Issued for a period of 30-180 days
No RBI restrictions or section 58Aof the Companies Act shall apply
Only for the companies having stock exchange lisitng and a tangible net worth of
5 crores or more
Issuer to bear all the preliminary charges
-
8/8/2019 34 34 Sources of Finance
16/23
FactoringFactoringFactoring
Provision of specialized services of credit investigation, sales management, creditcollection etc. by factor to the client under an agreement
In the agreement, the receivable accounts are sold to the factors who charges
commission & bear all the risks associated with it
For every account, factor assumes all the responsibilities and pays to the client at the
end of credit period or when the account is settled
Generally on recourse basis
Asset ReconstructionCompanies (ARC)
Asset Reconstruction Companies acquires bad loans/NPAs from Banks at a steep
discount and sell them eventually to the bidders
Banks and Financial Institutions sell their NPAs to take them out of their loan books &
improve their balance sheets This move is different from the Corporate Debt Restructuring
The borrower cannot oppose the sell of by the Banks and Finance Institutions
Generally the ARC issues security receipts as pass through certificates of certain rights
& entitlements to the investors in the assets held by the ARC
Arcil is the only functional Asset Reconstruction Company in the country
-
8/8/2019 34 34 Sources of Finance
17/23
Short Term SourcesShort Term Sources
Tradecredit
Credit period for
payment
Granted by
supplier of goods By Customers
before placing the
order
15-90 days
No cost of debt
Varies with
business volume
Regional &
Industry Standard
Inter-corporatedeposits
Flow of funds
between entities
Not Public Deposits
u/s 58A
Interest as per terms
agreed
Can be secured by
personal guarantee
Generally up to 6
months
Restrictions under
section 372A of the
Co. Act
PublicDeposits
Unsecured
Deposits
From 6 months
to 3 years
Renewable on
maturity
Covered under
section 58A
Maximum limit
of borrowing,
Interest etc. is
prescribed
Shortterm
unsecuredDebentures
For less than 18
months
A higher rate of
interest charged
No credit rating
is required
Terms should be
as per acceptable
standards
-
8/8/2019 34 34 Sources of Finance
18/23
Foreign InvestmentsForeign Investments Foreign Direct and Institutional Investment is allowed subject to the sectoral caps
Investment through Portfolio investment, foreign technology agreements, Externalcommercial borrowings
Active Involvement of FIPB, RBI and SEBI
Investor can take automatic route for simplified procedures
ADRs are traded in American Markets and GDRs worldwide
Mechanism ofADR/GDR:
Indian Co. issues shares to an overseas depository bank having office in India
Physical shares remain in India with custodian who acts as agent of the depository
bank
Against the underlying shares, depository issues receipts to foreign investors
Depository receives dividends from Indian co. in rupees and pass on to the investors
in Dollars
Foreign investor can sell the depository receipts in foreign stock exchange or can sent
back to depository & get the shares of underlying Rupee denomination
Depository receipts are convertible into equity not vice-versa
Investors in ADR/GDR are entitled to benefits of dividends, right and bonus issue
Voting rights remain with the depository who can exercise it on behalf of investors
-
8/8/2019 34 34 Sources of Finance
19/23
Derivative MarketDerivative Market Derivative: A financial instrument whose pay off depend on another financial instrument or
security. Derivatives can be used effectively for Hedging the payment risk and also for the speculation
purpose. Derivatives are of various types.
Forwards: It involves a contract initiated at one time and its performance in accordance withthe terms of contract at a subsequent time
Futures: A highly standardized & closely specified contract. They are traded on the stock
exchanges with an active involvement of the clearing houses Options: Trading of the right to buy or not to buy the underlying goods. Call option &
currency options are its types.
Swaps: An agreement between two or more parties to exchange sequence of cash flow over aperiod of time in the future.
Spot Contracts: To cover the exposure on the date of receipt/payment. Premium / discount
is already included in exchange rate & risk of currency fluctuations is to the companys accounts
RollOver Contracts: To cover the long term foreign exchange liabilities/ assets.Premium/discount is a function of interest rate differentials between US Dollar and other currency
Arbitrage: The process of buying a financial instrument in one market & selling the same inanother market. A method of making profits in an unstable market that brings the market to
equilibrium
-
8/8/2019 34 34 Sources of Finance
20/23
New InstrumentsNew InstrumentsSecured Premium Notes
Issued with a Detachable warrant Redeemable after 4-7 years. Can be convertible into equity
Option Bonds For Principal or Interest sum or both
Redemption premium is offered
Investor has the option to sell the bonds as per market situations
Junk Bonds For organizations with lower credit ratings and high risk projects
3-5% more than the normal market interest is charged
Wide usage in takeovers & buyouts
DeepDiscount Bonds Issued by IDBI in 1992
Zero interest bonds sold at a nominal sum
Redeemable after 25 years at Rs. 1 lakh with the exit option to investor in 5th, 10th, 15th
& 20th year
Inflationand floating rate bonds
Prior agreement for interest payment subject to inflation or market conditions
-
8/8/2019 34 34 Sources of Finance
21/23
Miscellaneous sourcesMiscellaneous sources
Bridge Financing:
Short term loans provided on the basis of loans pending disbursements
Repaid after the sanction of original loan
Generally provided against the Hypothecation of Current Assets, personal guarantee
& promissory notes
Generally a higher rate of interest is charged
Provided by both Banks and NBFC
Underwriting:
An agreement with the parties known as underwriters to secure the realization of
minimum subscription of the public issue of shares
Underwriters can help finding the potential investors for the issuing company
The underwriters charge a nominal commission to arrange the requisite funds
Generally Banks & Pvt. Cos. Are active as underwriters in the market
With their market contacts, underwriters can also help in proper allotment of units and
arranging other sources of finance as well
-
8/8/2019 34 34 Sources of Finance
22/23
Ideal Debt Equity MixIdeal Debt Equity Mix
Cost ofFinance: With a lower arrangement cost and being a tax deductible item, isusually cheaper than equity finance
Capital GearingofBusiness: Though debt is a cheaper source of finance, itcarries a fixed repayment obligation for interest & principal amounts
Security available: Money lenders require certain assets to be pledged against theborrowings. In the absence of good asset security, further borrowings may not be an option
Votingcontrol: Shareholders often deny those sources which tends to dilute theircontrol
Business risk: Companies with highly volatile profits should avoid heavyborrowings. High risk ventures are normally financed by the equity as there is no legal
obligation of repayment
Operating Gearing: It refers to the proportion of a companys fixed operatingcosts against its variable costs. Higher operating gearing signify a higher fixed cost element
& a more volatile operating profits.
Market State: Bearish run in the market often results in lesser returns to the entity
Currency ofBorrowing: Currency fluctuations may add to the cost of the loan
-
8/8/2019 34 34 Sources of Finance
23/23
Thank You