Introduction: Decide which assets to buy To decide Determining what is total sources to tap the total Decision investment required for investment. making buying assets. How much working capital required.
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.
Classification according to term finance• Short term finance.• Medium term finance.• Long term finance.
Short Terms Finance• Short term finance are required primarily to meet working capital requirements.• The focus is on maintaining liquidity at a reasonable cost.
Working Capital financeCommercial Trade Credit Paper Short Term Finance Inter- Factoring Corporate Deposits
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
Trade Credit• Trade credit represents credit granted by the suppliers of goods, etc. as an incident of sale.Merits DemeritsCredit for the purpose Less flexibleof raw material orfinished goods.No securityNo interest payable
Inter Corporate deposits• A deposit made by one company to another iscalled as inter-corporate deposit.• It is generally for working capital funding & isfor period not exceeding six months.
FactoringFactoring is an agreement in which receivablearising out of sale are sold by a firm (client) tothe factor (a financial intermediary).
Advantages• Establish a strong foundation.• Maximize profitability.• Capture growth opportunities. Disadvantages• Cost.• Possible harm to customer relation.• Company image distortion.
Commercial Paper (CP)Commercial paper is an unsecured moneymarket instrument issued in the form of apromissory note.
Advantages• High credit ratings• Flexibility.• Provides exit options. Disadvantages• Limited applicability.• Low bank credit limits.• A high degree of control.
Medium Term FinanceMedium term finance is defined as money raised for a period for 1 to 5 years.The medium term funds are required by a business mostly for the repaired and modernizing of machinery.
Medium Term FinanceCommercial Banks & External Euro & Lease Hire State Commercial Foreign Financing Purchase Financial Borrowings BondsInstitutions
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.
Advantages & Disadvantage The holder only pays Commitment to contract for use. for entire valid period. Better liquidity. Higher fixed cost per month. Fixed rate. More expensive than Minimal sales risk. purchase.
Hire 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.
Advantage Disadvantages• Cheaper than a • Higher monthly (‘unsecured’) personal payment; loan.• relatively quick. • hidden fees• Deposits are lower than with personal loans.
EXTERNAL COMMERCIAL BORROWING::--1. 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.
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.
Advantages• Increased liquidity of European bond markets.• Protection from large market shocks and erratic market.• Discipline, guaranteed funding for all EMU countries.
DisadvantagesThe main disadvantages are :• Possible free-riding problems.• Tensions with the no-bailout clause.• Credibility and political viability.
Foreign Bonds::--Definition::--Foreign bonds are the debt instruments issued by foreign corporation or foreign government.Types::--
Long Term Finance• Long term finance refer to those requirements of funds which are for a period exceeding 5-10 years.
Share Securitization Debentures LongVenture term New DebtCapital finance Instruments Depository Retained Schemes Earnings
SHARES A shares indicates a smaller unit into which the overall requirement of a company is subdivided. TYPES OF SHARESTHERE ARE TWO TYPES:Equity sharesPreference shares
DEBENTURES• It means a document containing acknowledgement of indebtedness issued by a company and giving an undertaking to repay the debt at a specified date.
NEW DEBT INSTRUMENT• Zero interest bond (ZIB)• Deep discount bonds (DDB)• Junk bonds• Convertible debenture
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.
Merits & Demerits Of Retained EarningsMerits :-Ready AvailabilityCheaper than External EquityNo Ownership DilutionPositive ConnotationDemerits :-Limited FinanceHigh Opportunity Cost
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.
Venture Capital• The venture capital financing refers to financing & funding of the small scale enterprises, high technology & risky volumes.
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 Cost mismatch Locking in profits Size limitation Liquidity Risk
Some Important Sources Of Finance• Seed capital assistance.• Certificate of deposit.• Internal cash accrual
Seed capital assistance• Designed by IDBI.• 1% service charge for 5 years.
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.
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.
Example Of Long Term & Short Term FinanceStandard Chartered Bank Mahindra FinanceEquity 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%
Comparison Between both the companiesMore hold on the companies proceedings & Less hold as compare to SCB but have acompany is having high goodwill in the good hold and goodwill in the market.market.Company can skip dividends on equity shares Company can skip dividends on equity sharesmore than Mahindra finance. but less as compared to SCB.The company is having low tax deductible More debentures means more tax deductibleincome. income.Low debt contract means less restrictions on High debt contract can lead to imposethe company. restrictions.Low percentage of term loans means High percentage of term loans meanscompany is having less dependence on the company is having high dependence on theoutside sources of finance. outside sources of finance.