Financial Management

Sources of Company Finance

&

Role of Financial Institutions

Introduction

There are several sources of finance available to any company.

An effective appraisal of various sources of finance available to a

company must be done to achieve its main objectives. Some of the

parameters that need to be considered while choosing a source of

fund are:-

Cost of source of fund

Tenure

Leverage planned by the company

Financial conditions prevalent in the economy

Risk profile of both the company as well as the industry in which the

company operates.

Each and every source of fund has some advantages as well as

disadvantages.

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Need for Corporate Financing

A Company requires Finance to meet their different types of

requirements in the short-term, medium term and long term.

Long term finance Medium term

finance

Short term finance

It is needed for fixed

capital requirements

such as purchase of

land , machinery,

building etc. which is

generally for a

period exceeding 5-

10 years. Funds

required to finance

permanent or hard

core working capital

should also be

procured from long

term sources

It is needed to fund

extensive publicity

and advertisement

campaign expenses

which may be

written off over a

period of 3 to 5

years. These funds

are generally

required for a period

exceeding one year

but not exceeding 5

years.

It is need for funding

day-to-day activities

i,e. Working capital –

payment of wages,

payments to

suppliers etc. These

requirements are

typically for a short

period of time not

exceeding the

accounting period

i.e. one year.

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Sources of Finance

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Long Term Sources of Finance Share capital or Equity share

A public limited company may raise funds from promoters or from the investingpublic by way of owners capital or equity capital

It is a source of permanent capital

The cost of ordinary shares is usually the highest. This is due to the fact that suchshareholders expect a higher rate of return (as their risk is the highest) on theirinvestment as compared to other suppliers of long-term funds.

Preference shares

Special kind of shares, the holders of such shares enjoy priority, both as regards tothe payment of a fixed amount of dividend and repayment of capital on winding upof the company

Retained earnings

Long-term funds may also be provided ploughing accumulated profits back into thebusiness

Such funds entail no risk and owners control is also not diluted

Debentures/Bonds of different types

Loans can be raised from public by issuing secured or unsecured debentures or bondsby public limited companies.

The cost of capital raised through debentures is quite low since the interest payableon debentures can be charged as an expense before tax.

From the investors' point of view, debentures offer a more attractive prospect thanthe preference shares since interest on debentures is payable whether or not thecompany makes profits

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Long Term Sources of Finance

Loans from Financial Institutions & Commercial Banks

In India specialised institutions provide long- term financial assistance to

industry. Commercial banks also provide long term loans for the purpose

of expansion or setting up of new units

Such loans are available at different rates of interest under different

schemes of financial institutions and are to be repaid according to a

stipulated repayment schedule.

Commercial Banks grant Loans based on the anticipated income of the

borrower

Venture capital funding

The venture capitalist makes investment to purchase equity or debt

securities from inexperienced entrepreneurs who undertake highly risky

ventures with a potential of success to give shape to their ideas.

The investor also provides support in form of sales strategy, business

networking and management expertise, enabling the growth of the

entrepreneur

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Medium Term Sources of Finance Preference shares

Debentures/Bonds

Loans from Financial institutions & Commercial banks

Public deposits/fixed deposits for duration of three years

Public deposits are very important source of short-term and medium termfinances particularly due to credit squeeze by the Reserve Bank of India.

A company can accept public deposits subject to the stipulations ofReserve Bank of India from time to time maximum up to 35 per cent of itspaid up capital and reserves, from the public and shareholders.

These deposits may be accepted for a period of six months to three years.

Public deposits are unsecured loans; they should not be used for acquiringfixed assets since they are to be repaid within a period of 3 years.

Lease financing

Leasing is a general contract between the owner and user of the assetover a specified period of time. The asset is purchased initially by thelessor (leasing company) and thereafter leased to the user (lesseecompany) which pays a specified rent at periodical intervals. Thus, leasingis an alternative to the purchase of an asset out of own or borrowedfunds. Moreover, lease finance can be arranged much faster as comparedto term loans from financial institutions

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Short Term Sources of Finance Trade credit

It represents credit granted by suppliers of goods, etc., It can be in the form of'bills payable'.

Accrued expenses and deferred income

Accrued expenses represent liabilities which a company has to pay for theservices which it has already received.

Deferred income reflects the amount of funds received by a company in lieu ofgoods and services to be provided in the future. These receipts increasecompany’s liquidity

Advances received from customers

Manufacturers and contractors engaged in producing or constructing costlygoods involving considerable length of manufacturing or construction timeusually demand advance money from their customers at the time of acceptingtheir orders for executing their contracts or supplying the goods. This is a costfree source of finance and really useful.

Commercial Paper

Commercial Paper is an unsecured money market instrument issued in the formof a promissory note.

Inter-Corporate Deposits

The companies can borrow funds for a short period say 6 months from othercompanies which have surplus liquidity. The rate of interest on inter corporatedeposits varies depending upon the amount involved and time period.

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Role of Financial Institutions

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Financial Institutions in India The financial institutions assist in the proper allocation of resources,

sourcing from businesses that have a surplus and distributing toothers who have deficits.

This ensures the continued circulation of money in the economy.

The financial institutions act as an intermediary between borrowersand final lenders, providing safety and liquidity.

The process subsequently ensures earnings on the investments andsavings

1. The Reserve Bank of India

2. Commercial bank

3. Industrial Finance Corporations of India (IFCI)

4. Industrial Development Bank of India (IDBI)

5. Industrial credit and Investment Corporation of India (ICICI)

6. Small Industries Development Bank of India(SIDBI)

7. State Financial Corporations (SFCs)

8. Venture capital funding10

The Reserve Bank of India

The Reserve Bank of India was established in the year 1935 with a

view to organize the financial frame work and facilitate fiscal stability

in India.

Acts as the regulatory authority with regard to the functioning of the

various commercial bank and the other financial institutions in India.

Formulates different rates and policies for the overall improvement of

the banking sector.

It issue currency notes and offers aids to the central governments.

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Commercial Banks

Commercial Banks are banking institutions that accept deposits and

grant short/medium/long term loans and advances to their

customers.

There are 2 types of Commercial Banks

Public Sector

These are banks where majority stake is held by the Government of India

or Reserve Bank of India. Mainly all the Nationalized Banks

Private Sector

In case of private sector banks majority of share capital of the Bank is

held by private individuals. These banks are registered as companies with

limited Liability.

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Industrial Development Bank of India (IDBI)

As an apex financial institution, it coordinates development,

regulation and supervises the working of other financial institutions

such as such as IFCI , ICICI, UTI, LIC, Commercial Banks and SFCs

It provides credit to large industrial concerns directly.

It undertakes other activities for the development of industry.

To act as trustee for the holders of debentures or other securities

It underwrites and subscribes directly to shares/debentures of the

industrial companies.

It sanctions of foreign currency loans for import of equipment or

capital goods.

It provides short term working capital loans to the corporates for

meeting their working capital requirements.

Refinance to banks and other institutions against loans granted by

them.

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Industrial Finance Corporation of India

(IFCI)The main object is to provide medium and long term credit to eligible

industrial concerns in corporate sectors of the economy, particularly to

those industries to which banking facilities are not available.

The primary role of IFCI is to provide ‘direct financial assistance’ on

medium and long term basis to industrial projects in the corporate and

co-operative sectors for undertaking new projects, expansion,

modernisation, diversification etc.

Subscription and underwriting of public issues of shares and

debentures.

Guaranteeing of foreign currency loans and also deferred payment

guarantees.

Merchant banking, leasing and equipment finance

Providing technical, legal, marketing and administrative assistance to

any industrial concern for the promotion, management and expansion

of the industrial concern

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Industrial Credit and Investment

Corporation of India (ICICI)

It assist in the formation, expansion and modernization of industrial

units in the private sector

It stimulates and promotes the participation of private capital (both

Indian and foreign) in industrial units

It helps in furnishing technical and managerial aid so as to increase

production and expand employment opportunities

It provides medium and long-term loans in Indian and foreign currency

for importing capital equipment and technical services.

It subscribes to new issues of shares, generally by underwriting them.

It guarantees loans raised from private sources including deferred

payment

It directly subscribes to shares and debentures

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SMALL INDUSTRIES DEVELOPMENT BANK OF

INDIA (SIDBI)SIDBI was established with an objective to strengthen and broad-base

the existing institutional arrangement to meet the requirement of SSI

and tiny industries.

Administration of SIDF and NEF for development and equity support to

small and tiny industry.

providing working capital through single window scheme

providing refinance support to banks/development finance institutions.

undertaking direct financing of SSI units.

coordination of functions of various institutions engaged in finance to SSI

and tiny units.

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State Financial Corporations (SFCs)

To meet the financial needs of small and medium enterprises, the

government of India passed the State Financial Corporation Act in

1951, empowering the State governments to establish development

banks for their respective regions.

These industrial concerns may be from corporate or co-operative

sectors or may be partnership, individual or joint Hindu family

business. Under SFCs Act, “industrial concern” means any concern

engaged not only in the manufacture, preservation or processing of

goods, but also mining, hotel industry, transport maintenance of

machinery, setting up or development of an industrial area or

industrial estate, etc.

It provides long and medium-term loan repayable ordinarily within a

period not exceeding 20 years.

It guarantees loans raised by industrial concerns which are repayable

within a period not exceeding 20 years.

Guarantees deferred payments due from an industrial concern for

purchase of capital goods in India.

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EXPORT IMPORT BANK OF INDIA (EXIM)

It is apex institution for co-ordinating the working of institutions in

India engaged in financing exports and import of goods and services.

It raises funds by way of bonds and debentures, borrowing from RBI or

other institutions, raising foreign deposits.

The Functions are

direct finance to exporter of goods.

direct finance to software exports and consultancy services.

finance for overseas joint ventures and turnkey construction project

finance for import and export of machinery and equipment on lease basis

finance for deferred payment facility

issue of guarantees

multi-currency financing facility to project exporters.

export bills re-discounting

refinance to commercial banks in India

guaranteeing the obligations.

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Thank You

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