SOURCES OF FINANCE

Role Of Financial Markets

Financial markets

channelize the resources from the surplus units to the deficit units. Such a transfer enables the surplus units to park their funds fruitfully. The deficit units get the necessary funds to meet their investment requirements A well-functioning and efficient financial market benefits the economy by channelizing the funds towards the most productive avenues of investments.

Sources of Finance

Role Of Financial Markets

Sources of Finance

Financial Markets 4 Segments, Products And Services

Sources of Finance

INTRODUCTION
5

Ordinary

shares provide ownership rights to

investors. Debentures or bonds provide loan capital to the company, and investors get the status of lenders. Loan capital is also directly available from the financial institutions to the companies.

Ordinary SharesFeatures
6

Claim

on Income Claim on Assets Right to Control Voting Rights Pre-Emptive Rights Limited Liability

Reporting of Ordinary Shares

Tata Motors' Share Capital as on 31 March 2008

Public Issue of Equity

Public

issue of equity means raising of share capital directly from the public. As per the existing norms, a company with a track record is free to determine the issue price for its shares.

Underwriting of Issues
9

It

is legally obligatory to underwrite a public and a rights issue. In an underwriting, the underwritersgenerally banks, financial institution, brokers, etc.guarantee to buy the shares if the issue is not fully subscribed by the public. The agreement may provide for a firm buying by the underwriters. The company has to pay an underwriting commission to the underwriter for their services.

Private Placement
10

Private

placement involves sale of shares (or other securities) by the company to few selected investors, particularly the institutional investors.

Right Issue of Equity Shares

Selling of Ordinary Shares to the existing shareholders of the company. Value of Right

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Effect on Shareholders Wealth

shareholder has three options:

(i) he exercises his rights, (ii) he sells his rights, or (iii) he does not exercise or sell his rights.

He

will lose under the third option.

Preference SharesFeatures
13

1. 2. 3. 4. 5. 6. 7.

Claims on Income and Assets Fixed Dividend Cumulative Dividend Redemption Sinking Fund Participation Feature Convertibility

DEBENTURES
14

debenture is a long-term promissory note for raising loan capital. The firm promises to pay interest and principal as stipulated. The purchasers of debentures are called debenture holders. An alternative form of debenture in India is a bond. Mostly public sector companies in India issue bonds.

DebenturesFeatures
15

Interest Rate
Maturity Redemption

Sinking Fund
Buy-back Security

(call) provisions

Yield
Claims

on Assets and Income

Term LoansFeatures
16

Maturity Direct Negotiations Security Repayment Schedule

WORKING CAPITAL FINANCE/ Short term sources of finance

Purpose
After

establishment of a business, funds are required to meet its day to day expenses

Raw

material Wages Power and supply.

LEARNING OBJECTIVES
19

Explain

the benefits and costs of trade credit Focus on the norms used by banks in financing a firms working capital need Emphasize the importance of commercial paper as a method of working capital finance in India

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Short-term Sources of Finance

Credit Accrued Expenses and Deferred Income Bank Borrowings Factoring of receivables Commercial Paper

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Trade Credit and Credit Terms

to the credit that the customer gets from supplier of goods in normal course of business. An informal arrangement, granted on an open account basis, not formally acknowledge as a debt. Trade credit may also take the form of bills payable. Credit Terms refers to the conditions of due date and cash discount.

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Benefits and Costs of Trade Credit

Benefits
1. 2. 3.

Easy Availability. Flexibility. Informality.

Costs
1. 2.

Suppliers sometimes offer cash discount to buyers for making prompt payment. Buyer should calculate the cost of foregoing cash discount to decide whether or not cash discount should be availed. The following formula can be used:

Implicit Cost. Stretching A/P can prove to be very costly.

Cost of cash discount

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ACCRUED EXPENSES AND DEFERRED INCOME

Accrued Expenses
expenses represent a liability that a firm has to pay for the services which it has already received. 1. Accrued Wages and Salaries. 2. Accrued taxes and Interest.

Accrued

Deferred Income
income represents funds received by the firm for goods and services which it has agreed to supply in future. 1. Advance Payments.

Deferred

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Bank Finance for Working Capital

Cash

Credit Purchase or Discounting of Bills Letter of Credit Working Capital Loan

COMMERCIAL PAPER
26

Unsecured promissory notes issued by firms to raise short-term funds. In India, it was introduced in 1989 on recommendation of the Vaghul Working Group. Commercial papers sell at a discount from face value.

Merits
27

1. 2.

3.

It is an alternative source of raising short-term finance. It is a cheaper source of finance in comparison to the bank credit. From an investors point of view, it provides an opportunity to make a safe, short-term investment of surplus funds.

Demerits
28

It is an impersonal method of financing. 2. A firm facing temporary liquidity problems may not be able to raise funds by issuing new paper. 3. The amount of loanable funds available in the commercial paper market is limited to the amount of excess liquidity of the various purchasers of commercial paper. 4. It cannot be redeemed until maturity.
1.

VENTURE CAPITAL FINANCING

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NOTION OF VENTURE CAPITAL

capital (VC) is a significant financial innovation of the twentieth century. capital is the investment of long-term equity finance where the venture capitalist earns his return primarily in the form of capital gains. underlying assumption is that the entrepreneur and the venture capitalist would act together in the interest of the enterprise as partners.

Venture

The

Features of Venture Capital

Equity

Participation. Long-term Investments. Participation in Management. Venture capitalist combines the qualities of bankers, stock market investors and entrepreneur in one.

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Stages in Venture Financing

DEVELOPMENT OF VENTURE CAPITAL IN INDIA

The

concept of venture capital was formally introduced in India in 1987, when the government announced the creation of a venture fund, to be operated by the Industrial Development Bank of India (IDBI). VCFs in India can be categorized into the following groups:
1.

2. 3.

VCFs promoted by the central (federal) government-controlled development finance institutions VCFs promoted by the public sector banks VCFs promoted by the foreign banks and private sector companies and financial institutions

Future Prospects of Venture Financing

Rehabilitation

of sick units. Assist small ancillary units to upgrade their technologies. Provide financial assistance to people coming out of universities etc. VCFs can play a significant role in the service sector including tourism, publishing, health care, etc.

Lease Defined
35

Lease

is a contract under which a lessor, the owner of the assets, gives right to use the asset to a lessee, the user of the assets, for an agreed period of time for a consideration called the lease rentals. In up-fronted leases, more rentals are charged in the initial years and less in the later years of the contract. The opposite happens in back ended leases. Primary lease provides for the recovery of the cost of the assets and profit through lease rentals during a period of about 4 or 5 years. It may be followed by a perpetual, secondary lease on nominal lease rentals.

Types of Leases
36

1.

2.
3.

Operating Lease Financial Lease Sale-and-lease-back

Operating Lease
37

Short-term,

cancelable lease agreements are called operating lease. Tourist renting a car, lease contracts for computers, office equipments and hotel rooms. The Lessor is generally responsible for maintenance and insurance. Risk of obsolescence remains with the lessor.

Financial Lease
38

Long-term,

non-cancelable lease contracts are known as financial lease. Examples are plant, machinery, land, building, ships and aircrafts. Amortise the cost of the asset over the terms of the leaseCapital or Full pay-out leases.

Sale and Lease Back

Sometimes,

a user may sell an (existing) asset owned by him to the lessor (leasing company) and lease it back from him. Such sale and lease back arrangements may provide substantial tax benefits. In April 1989, Shipping Credit and Investment Corporation of India purchased Great Eastern Shipping Company bulk carrier, Jag Lata, for Rs 12.5 Cr and then leased it back to GESC on a 5 years lease, the rentals being Rs 28.13 Lakh per month. The ships WDV was Rs 2.5 Cr.