SOURCES OF FINANCE

LONG-TERM MEDIUM-TERM SHORT-TERM

a) CASH CREDIT
a) EQUITY SHARE b) OVERDRAFT
b) PREFERENCE a) MEDIUM-TERM c) BILL DISCOUNTING
SHARE LOAN d) COMMERCIAL
c) DEBENTURES b) DEFERRED CREDIT PAPERS
d) LONG-TERM LOAN c) PUBLIC DEPOSIT e) EXPORT CREDIT
e) SEED CAPITAL d) LEASING AND HIRE f) TRADE CREDIT
PURCHASE g) FACTORING AND
f) RETAINED
FORFAITING
EARNINGS h) ADVANCES
g) VENTURE CAPITAL i) CREDIT CARDS
BASICS SHORT-TERM MEDIUM-TERM LONG-TERM
PERIOD Minimum Period one to five Requirement
requirement of one years between 5 to 25 yrs
day to maximum one
year
SOURCES OF Trade credit, Fixed deposit from Reserves , shares,
FINANCE factoring, advances, public, bank loan debentures, loan
overdraft etc. venture capital etc.
USE OF FUNDS Financing seasonal Financing purchase Financing long term
fluctuation and of stock and debtors assets
working capital of company
VOLUME OF small Higher than short high
FUNDS term
SECURITY Security through Security in the form Security in the form
debtors and stock of asset and property of property and high
value assets
SECURITY FINANCING
Security financing is through external sources of finance for the
company.
A) Equity shares
i. Bonus shares
ii. Right issue
iii. Sweat equity share
B) Preference share
i. Redeemable and irredeemable
ii. Cumulative and non cumulative
iii. Participating and non- participating
iv. Convertible and non convertible
Shares
Issue of shares is the main source of long term finance. Shares
are issued by joint stock companies to the public. A company
divides its capital into units of a definite face value, say of Rs.
10 each or Rs. 100 each. Each unit is called a share. A person
holding shares is called a shareholder.
Investors are of different habits and temperaments. Some
want to take lesser risk and are interested in a regular
income. There are others who may take greater risking
anticipation of huge profits in future. In order to tap the
savings of different types of people, a company may issue
different types of shares. These are: 1.Preference shares,
and 2. Equity Shares.
Preference Shares
— Preference Shares are the shares which carry preferential
rights over the equity shares. These rights are(a) receiving
dividends at a fixed rate,(b) getting back the capital in case
the company is wound-up.
— Investment in these shares are safe, and a preference
shareholder also gets dividend regularly.
Equity shares
— Equity shares are shares which do not enjoy any preferential
right in the matter of payment of dividend or repayment of
capital. The equity shareholder gets dividend only after the
payment of dividends to the preference shares. There is no
fixed rate of dividend for equity shareholders. The rate of
dividend depends upon the surplus profits. In case of winding
up of a company, the equity share capital is refunded only
after refunding the preference share capital. Equity
shareholders have the right to take part in the management of
the company. However, equity shares also carry more risk.
characteristics of shares
— The main characteristics of shares are following:
1. It is a unit of capital of the company.
2. Each share is of a definite face value.
3. A share certificate is issued to a shareholder indicating the
number of shares and the amount.
4. Each share has a distinct number.
5. The face value of a share indicates the interest of a person in
the company and the extent of his liability.
6. Shares are transferable units.
Debentures.
Whenever a company wants to borrow a large amount of fund
for a long but fixed period, it can borrow from the general
public by issuing loan certificates called Debentures. The
total amount to be borrowed is divided into units of fixed
amount say of Rs.100 each. These units are called
Debentures. These are offered to the public to subscribe in
the same manner as isdone in the case of shares. A debenture
is issued under the common seal of the company. It is a
written acknowledgement of money borrowed. It specifies
the terms and conditions, such as rate of interest, time
repayment, security offered, etc.
characteristics of Debentures
— Following are the characteristics of Debentures 1)Debenture
holders are the creditors of the company. They are entitled to
periodic payment of interest at a fixed rate.
2) Debentures are repayable after a fixed period of time, say
five years or seven years as per agreed terms.
3) Debenture holders do not carry voting rights.
4) Ordinarily, debentures are secured. In case the company fails
to pay interest on debentures or repay the principal amount,
the debenture holders can recover it from the sale of the
assets of the company
C) Debentures/Bonds
i. Redeemable and irredeemable
ii. Secured and unsecured
iii. Financial engineering securities
iv. Tax- free bonds
v. Deep discount bonds
vi. Participating debentures
vii. Convertible debentures
viii. Floating rate bonds
ix. Regular income bonds
x. Warrants
xi. Inflation bonds
xii. retirement bonds
xiii. Double option bonds
Retained earning or ploughing back of
profits
Like an individual, companies also set aside a part of their
profits to meet future requirements of capital. Companies
keep these savings in various accounts such as General
Reserve, Debenture Redemption Reserve and Dividend
Equalization Reserve etc. These reserves can be used to meet
long term financial requirements.The portion of the profits
which is not distributed among the shareholders but is
retained and is used in business is called retained earnings or
ploughing back of profits. As per Indian Companies Act.,
companies are required to transfer a part of their profits in
reserves. The amount so kept in reserve may be used to buy
fixed assets. This is called internal financing.
Short term sources
— Trade credit
Trade credit facilitates the purchase of supplies without
immediate payment. Such credit appears in the records of the
buyer of goods as ‘sundry creditors’ or ‘accounts payable’.
Trade credit is commonly used by business organisations as a
source of short-term financing. It is granted to those
customers who have reasonable amount of financial standing
and goodwill.
Other topics
— 1. PROJECT FINANCING

It refers to managing and financing the economic activities of

large infrastructural projects. High cost with large volume of
funds such as power stations , fertilizer plants , satellites , oil
, gas and hotel projects are some infrastructure related
project
ADVANTAGES OF PROJECT FINANCING
1. Financing of large projects
2. Impact of project finance
3. Benefits to equity holders
4. Risk of the project
DISADVANTAGES OF PROJECT
FINANCING
1. High risk involved
2. Much costly
3. Miscellaneous expenses
4. Surrender of interest to another company
Loan syndication
— Loan syndication is a service provided by merchant bankers for financing
a project or for working capital requirements of a company. Financial
institutions like IDBI,ICICI,UTI etc. are suppliers of finance for loan
syndication. The merchant bankers undertake the entire service of loan
procurement till loan sanctioning.
Steps involved in loan syndication are
1. Merchant bankers prepare a detailed project report
2. Identification of lenders
3. Meetings and discussions
4. Loan application
5. Submission to financial institution
6. Letter of intent
7. Negotiations
8. Disbursement of loan to borrower
Venture capital
— It is a private equity investment fund through which funds are borrowed by
investors who have the technical know-how. The venture capitalist make an
agreement whereby they support the project and fund it , in return for
monetary gains, shareholding and acquisition rights in the business financed by
them.
Features
1. It is for long term period
2. It is based on equity contributions in small and medium sized
companies
3. Venture capitalists provides funds and business skills to the
companies in which they invest
4. They do not interfere in the management of the firm
5. It is based on new ideas and focus on new growth oriented
companiesc
6. The objective is to earn high rate of interest on the investment
made.
— Factoring
Factoring is a financial service under which the ‘factor’ renders
various services which includes:
Discounting of bills (with or without recourse) and collection
of the client’s debts. Under this, the receivables on account of
sale of goods or services are sold to the factor at a certain
discount. The factor becomes responsible for all credit
control and debt collection from the buyer and provides
protection against any bad debt losses to the firm. The factor
charges fees for the services rendered.
Commercial paper is an unsecured promissory note issued
by a firm to raise funds for a short period, varying from 90 days to
364 days. It is issued by one firm to other business firms,
insurance companies, pension funds and banks. The amount
raised by CP is generally very large. As the debt is totally unsecured,
the firms having good credit rating can issue the
CP. Its regulation comes under the purview of the Reserve Bank of
India.
Features
1. No collateral is required
2. Guarantee is based on the credit worthiness of the
firm.
3. Very less documentation is required
4. Important source of fulfilling short term requirement
of funds
Bank Credit
Commercial banks grant short-term finance to business firms
which is known as bank credit. When bank credit is granted,
the borrower gets a right to draw the amount of credit at one
time or in instalments as and when needed. Bank credit may
be granted by way of loans, cash credit, overdraft and
discounted bills.
Loans
When a certain amount is advanced by a bank repayable after a
specified period, it is known as bank loan. Such advance is credited
to a separate loan account and the borrower has to pay interest on
the whole amount of loan irrespective of the amount of loan
actually drawn. Usually loans are granted against security of assets.
(ii) Cash Credit
It is an arrangement whereby banks allow the borrower to withdraw
money upto a specified limit. This limit is known as cash credit
limit. Initially this limit is granted for one year. This limit can be
extended after review for another year. Interest is charged only on the
amount actually withdrawn and not on the amount of entire limit.
iii) Overdraft
— When a bank allows its depositors or account holders to
withdraw money in excess of the balance in his account upto
a specified limit, it is known as overdraft facility. This limit is
granted purely on the basis of credit-worthiness of the
borrower. Interest is charged only on the overdrawn money.
Rate of interest in case of overdraft is less than the rate
charged under cash credit.
Certificate of Deposits
A certificate of deposit is a promissory note issued by a bank
during the period of low liquidity. This liquidity gap is met by
banks by issuing CDs for short term A CD bears a maturity
date, a specified fixed interest rate and can be issued in any
denomination. CDs are generally issued by commercial
banks. The rate of interest is determined by yhe market. It
can also be traded at stock exchange.
Book building
— Book building is a process of generating, capturing, and recording
investor demand for shares during an initial public offering (IPO), or
other securities during their issuance process, in order to support
efficient price discovery. Usually, the issuer appoints a major investment
bank to act as a major securities underwriter or bookrunner.
— Book Building is an alternative method of making a public issue in which
applications are accepted from large buyers such as financial institutions,
corporations or high net-worth individual, almost on firm allotment
basis, instead of asking them to apply in public offer.
— The price at which new shares are issued is determined after the book is
closed at the discretion of the bookrunner in consultation with the
issuer. Generally, bidding is by invitation only to high-net-worth clients
of the bookrunne
International Depository reciepts
Companies are permitted to raise foreign currency resources through two main
sources: a) issue of foreign currency convertible bonds more commonly known
as ‘Euro’ issues and b) issue of ordinary shares through depository receipts
namely ‘Global Depository Receipts (GDRs)/American Depository Receipts
(ADRs)’ to foreign investors i.e. to the institutional investors or individual
investors.
An American Depositary Receipt (“ADR”) is a physical certificate evidencing
ownership of American Depositary Shares (“ADSs”).It is method of raising
funds from US stock market. The term is often used to refer to the ADSs
themselves.
— One or several ADSs can be represented by a physical ADR certificate. The
terms ADR and ADS are often used interchangeably. ADSs provide U.S.
investors with a convenient way to invest in overseas securities and to trade
non-U.S. securities in the U.S. ADSs are issued by a depository bank, such as
JPMorgan Chase Bank. They are traded in the same manner as shares in U.S.
companies, on the New York Stock Exchange (NYSE) and the American Stock
Exchange (AMEX) or quoted on NASDAQ and the over-the-counter (OTC)
market.
What is meant by Global Depository Receipts?

— Global depository receipts:

A global depository receipt(GDR) is a certificate issued by a depository bank,
which purchases shares of foreign companies and deposit it on the account. GDRs
represents ownership of an underlying number of shares.
Global depository receipts facilitates trade of shares, and are commonly used to
invest in companies from developing or emerging markets.
Price of global depository receipts are often close to values of related shares, but
they are traded and settled independently of the underlying share.
— Global Depository Receipts (GDRs) may be defined as a global finance vehicle
that allows an issuer to raise capital simultaneously in two or more markets
through a global offering. GDRs may be used in public or private markets inside
or outside US. GDR, a negotiable certificate usually represents company’s
traded equity/debt. The underlying shares correspond to the GDRs in a fixed
ratio say 1 GDR=10 share