Sources of finance

Entrepreneurship

1. Sources of finance

2. Introduction:

3. Parameter for choosing sources of fund Cost of source of fund. Tenure. Leverage planned by the company. Financial condition prevalent in the economy. Risk profile of both the company as well as the industry in which the company operates.

4. Types of finance

5. Classification according to term finance Short term finance. Medium term finance. Long term finance.

6. Short Terms Finance Short term finance are required primarily to meet working capital requirements. The focus is on maintaining liquidity at a reasonable cost.

7. Working Capital Finance By Commercial Banks Commercial banks grants short terms finance to business firms which is known as “Bank Credit”. Bank Credit may be granted in the following ways:- Loans Purchase/ Discounting of bills. Cash Credit Over draft

8. Trade Credit Trade credit represents credit granted by the suppliers of goods, etc. as an incident of sale. Merits Demerits Credit for the purpose of raw material or finished goods. Less flexible No security No interest payable

9. Inter Corporate deposits A deposit made by one company to another is called as inter-corporate deposit. It is generally for working capital funding & is for period not exceeding six months.

10. Factoring Factoring is an agreement in which receivable arising out of sale are sold by a firm (client) to the factor (a financial intermediary).

11. Advantages Establish a strong foundation. Maximize profitability. Capture growth opportunities. Disadvantages Cost. Possible harm to customer relation. Company image distortion.

12. Commercial Paper (CP) Commercial paper is an unsecured money market instrument issued in the form of a promissory note.

13. A dvantages High credit ratings Flexibility. Provides exit options. Disadvantages Limited applicability. Low bank credit limits. A high degree of control.

14. Medium Term Finance Medium term finance is defined as money raised for a p eriod for 1 to 5 years. The medium term funds are required by a business mostly for the repaired and modernizing of machinery.

15. Lease financing It is a contract In which the assets is purchased initially by the lessor (leasing company) and thereafter leased to the user( leasee company) who pays a specified rent at periodical intervals.

16. Advantages & Disadvantage The holder only pays for use. B etter liquidity. Fixed rate. Minimal sales risk. Commitment to contract for entire valid period. Higher fixed cost per month. More expensive than purchase.

17. H ire Purchasing Hire purchase transaction, the goods are delivered by the owner to another person the agreement that such person pays the agreed amount in the periodical installment.

18. Advantage Cheaper than a (‘unsecured’) personal loan. relatively quick. Deposits are lower than with personal loans.  Disadvantages Higher monthly payment; hidden fees

19. EXTERNAL COMMERCIAL BORROWING::-- ECB’s refer to commercial loan in the form of bank loans, buyers credit, suppliers credit, securitized instruments.(E.g. Floating rates notes and Fixed rates bonds) availed from non-resident lenders with minimum average maturity years. 2. ECBs mean foreign currency loan raised by residents from recognized lenders . Financial leases and Foreign Currency Convertible Bonds are also covered by ECB guidelines .

20. Euro bonds::-- Definition of Euro Bond::-- “ A bond issued in a currency other than the currency of the country or market in which it is issued.” Eurobonds are attractive to investors as they have small par values and high liquidity.

21. Advantages Increased liquidity of European bond markets. Protection from large market shocks and erratic market. Discipline, guaranteed funding for all EMU countries.

22. Disadvantages The main disadvantages are : Possible free-riding problems. Tensions with the no-bailout clause. Credibility and political viability.

23. Foreign Bonds::-- Definition::--Foreign bonds are the debt instruments issued by foreign corporation or foreign government.

24. Long Term Finance Long term finance refer to those requirements of funds which are for a period exceeding 5-10 years.

25. SHARES A shares indicates a smaller unit into which the overall requirement of a company is subdivided. TYPES OF SHARES THERE ARE TWO TYPES: E quity shares Preference shares

26. Equity Shares Equity shares are the main source of finance of a firm. It is issued to the general public. Equity share­holders do not enjoy any preferential rights with regard to repayment of capital and dividend. They are entitled to residual income of the company, but they enjoy the right to control the affairs of the business and all the shareholders collectively are the owners of the company.

27. Preference Shares Preference shares allow an investor to own a stake at the issuing company with a condition that whenever the company decides to pay dividends, the holders of the preference shares will be the first to be paid

28. DEBENTURES If a company needs funds for extension and development purpose without increasing its share capital, it can borrow from the general public by issuing certificates for a fixed period of time and at a fixed rate of interest. Such a loan certificate is called a debenture. Debentures are offered to the public for subscrip­tion in the same way as for issue of equity shares. Debenture is issued under the common seal of the company acknowledging the receipt of money

29. NEW DEBT INSTRUMENT Document that serves as a legally enforceable evidence of a debt and the promise of its timely repayment. Banker's acceptance, bills of exchange, bonds, certificates of deposit , debentures, and promissory notes, all are debt instruments.

30. Retained Earnings Retained earnings means that part of trading profits which is not distributed in the form of dividends but retained by directors for future expansion of the company.

31. Merits & Demerits Of Retained Earnings Merits :- Ready Availability Cheaper than External Equity No Ownership Dilution Positive Connotation Demerits :- Limited Finance High Opportunity Cost

32. Global/ American/ Indian Depository Receipts GDRs :- A negotiable certificate held in the bank of one country representing no. of shares traded on the exchange of another country. ADRs :- It allows US investors to buy shares of ADS companies without the cost of investing directly in Foreign Stock Exchange. IDRs :- It allows foreign companies to raise the funds from Indian markets.

33. Venture Capital Start up companies with a potential to grow need a certain amount of investment. Wealthy investors like to invest their capital in such businesses with a long-term growth perspective. This capital is known as venture capital and the investors are called venture capitalists

34. Securitization Securitization is a process in which illiquid assets are pooled into marketable securities that can be sold to investors. Advantages Disadvantages Reduces assets liability mismatch Cost Locking in profits Size limitation Liquidity Risk

35. Some Important Sources Of Finance Seed capital assistance. Certificate of deposit. Internal cash accrual

36. Seed capital assistance Designed by IDBI. 1% service charge for 5 years.

37. Certificate of deposit CD is a document of title similar to a time deposit receipt issued by a bank exepct that there is no prescribe interest rate on such funds. The main advantage of cd is the baker is not required to encash the deposit before maturity period and the investor is assured of liquidity because he can sell the cd in secondary market.

38. Internal cash Accruals Existing profit making companies which undertake an expansion programe may be permitted to invest a part of their accumulated reserves or cash profit for creation of capital assets.

39. Example Of Long Term & Short Term Finance Standard Chartered Bank Mahindra Finance Equity capital = 58% Equity capital = 42% Internal accrual (reserve & surplus) =24% Internal accrual (reserve & surplus) =12% Debentures (bonds) = 20% Debentures (bonds) = 33% Term (long term) = 8% Term (long & short term) = 13%

40. Comparison Between both the companies More hold on the companies proceedings & company is having high goodwill in the market. Less hold as compare to SCB but have a good hold and goodwill in the market. Company can skip dividends on equity shares more than Mahindra finance. Company can skip dividends on equity shares but less as compared to SCB. The company is having low tax deductible income. More debentures means more tax deductible income. Low debt contract means less restrictions on the company. High debt contract can lead to impose restrictions. Low percentage of term loans means company is having less dependence on the outside sources of finance. High percentage of term loans means company is having high dependence on the outside sources of finance.