INSTITUTIONAL .PROCUREMENT OF FINANCE-3 Commerce std 1 & 12 GSEB

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CHAPTER – 15 : INSTITUTIONAL .PROCUREMENT OF FINANCE-3

Institutional Procurement of finance

Businessmen get finance from people. This finance is inadequate and costly (it means, having high rate of interest). So, businessmen procure finance from institutions too. Com­pany, Co-operative society, Public enterprise and Joint enterprise units and institutional forms of business units like them are obtaining finance mostly from financial institution, e.g. lending from Industrial Development Bank of India (I.D.B.I.) is an institutional pro­curement of finance.

Purposes

(1)       Financial institutions are studying, business activities professionally and provide finance to businessmen who are taking risk calculatively.

(2)       Institutes provide finance for the purpose of remunerative capital creation.

(3)       Financial institutes provide finance to remove the inadequacy of financial resources.

(4)       institutional finance is given with the purpose of developing small but profitable business units.

(5)       Institutes provide finance to businessmen to spread the advantages of government policies.

Types of finance provided by financial institution

Types of finance are as follow

(1)       Through shares : Financial institutes provide financial resources by subscribing for the shares of the big amount at the time of the incorporation of companies, by taking that many shares which can make the collection of minimum capital possible through under­writing, by subscribing for shares of present companies at the time of their expansion, development and diversification.

(2)       Through Debentures / Bonds : By assuring about the safety of money, financial institutes take secured debentures / bonds so as to provide financial resources. As financial institutes subscribe for. big amount they assume the charge of representatives-trustees on behalf of debenture / bond holders and remain acquainted with the working of business unit. If required, they work as an effective factor in the management of the company.

(3)       Through loans : Financial institutes provide long-term finance especially through secured lending. Financial institutes provide unsecured loans in very rare cases. Financial institutes get personal security of businessmen in the event of providing this type of loan.

(4)       In the form of service : Sometimes business units do not get technical and expert services. For that, they have to spend big amount. Business units may earn high profit if they get these services. Financial institutes pay directly to those persons or institutes who provide these services and see that they give the required services to the business units.

(5)       In the form of security : Financial institutes sometimes manage to provide finance indirectly to the companies. Financial institutes take care of their safety and then give guar­antee to the other institutes who are providing finance to the business units.

Finance company

We have seen that finance is an instrument for business. Businessman procures finance by carrying the burden of interest for the payment of debts as he is purchasing machinery or loose tools. Companies supplying finance is also in existence like those for machines and loose tools. Banks provide lion’s share in providing this instrument, viz. finance. We have discussed in detail the banking finance companies. There are finance companies also which do not provide banking services. They are known as non-banking finance companies. These companies also are providing this instrument namely finance. The types and forms of finance companies are just like other companies but finance is such an instrument which can lead business unit and economy to serious and long-term implications. So the forms and working methods of finance companies become distinct. The distinguishing features are as under :

(1)       Central bank of the country continuously and minutely watch the financial compa­nies. It regulates them, if required.

(2)       Central bank takes care for utilising the financial sources for desirable ways and means.

(3)       Financial institutes have to maintain equilibrium between profitability and safety as they are tempted to earn more profit at, the cost of safety.

(4)       Financial companies have their own shareholders and lenders. They ask for more return than the current rate. On the other side, financial companies have to maintain equi­librium between profitability and safety, so they require experts in management.

Non-Banking Finance Companies : NBFC :These companies, as their name suggests are providing required finance to businessmen but do not provide banking services. Banking services are providing liquidity to businessmen and society and are managing paper money like cheques, drafts. These services are not provided by non-banking finance companies. It works purely for finance. They lend through policies of hire-purchase sys­tem, installment system, secured loans or personal securities to those citizens who want to purchase durables like vehicles, buildings, televisions. For increasing their business and for providing safety to their lending non-financial services are rendered. The transactions of non-banking financial companies are distinct, as stated above. So, the central bank of the country keeps watch over their working. These institutes are of various types from various viewpoints, out of which we will study Investment Trusts and Mutual Fund companies. Besides, lending to small businesses by finance companies will also be seen.

Investment Trusts : Trusts are formulated mostly for non-business purposes. Some trusts are formulated for business purposes. Trust is such a form in which confidentiality can be maintained. Comparatively, they are run by fewer persons. Investment trusts are investing for long-term in business units and elsewhere as their name suggests. For this they get finance from persons and institutes which want to invest for long-term. In countries like India, investment trusts are established by the big industrial houses. They invest for long­-term in their controlled companies through these trusts. The surplus funds of any company controlled by them are. invested in these investment trusts. After that, trusts invest funds in those controlled companies which are in need of finance. Unit Trust of India is an invest­ment trust.

Mutual Funds : Most of the investment trusts are investing in long-term securities by accepting money through mutual funds from those who want to invest for long term. Today, ­five hundred plus mutual funds are active in India. Investment is made in equity shares, long-term maturing but high rate of interest yielding debentures / bonds, government loans and other long-term securities. Small investors are unable to understand which long-term securities are safe and remunerative. Mutual funds give guarantee and trust to these inves­tors that they will invest in safe and reliable securities by collecting money from them. It is inevitable that mutual funds are managed very’ efficiently, dynamically and on professional standards.

Institutional lending for small business

The needs of small business are few. So, financial institutes do not get enough return on ending to pay for managerial expenditure and profit. So, they are eager to lend to big businessmen if chances are there. Government wants to fulfill the purpose of equal distribution ­of wealth which is expected of a welfare state government by developing the small businessmen. In this situation, government gives incentives to finance institutes for lending to small business. Institutes are coming forward to lend to small businesses for getting gains of incentives.

As a businessman runs a small business he comes under the control of finance insti­tutes. So, non-performing assets which means in accounting language bad or doubtful debts are created at low level. Small businessmen are regular in interest payment on borrowings. If the amount of installments is kept small for the repayment on borrowings. small businessman ­pays them regularly. Finance institutes provide services of book keeping and financial management if small businessman has inadequate skill of them. By providing these ser­vices, on one side small businessmen become capable and on the other side, their lending become safe and remunerative.

Special financial help rendered to the industries in rural, backward and hilly areas

Industrialists don’t start industries on their own in rural, backward and hilly areas as they are depending upon market forces. There are no attractive profit making markets in these areas. Capable personnel required to run industries which are available in a very few number in these areas. The facilities of roads, water, electricity-supply are less in these areas. One of the many purposes of welfare state is to have equal economic development of all the areas of a country. So, to reduce the lop-sided development, government gives spe­cial financial help to start and to support the existing industries in these areas. The help mainly is of the following types:

(1)       The rate of interest on borrowings is kept at a very low rate.          

(2)       Government sees to it that easy availability of financial resources to purchase mostly and, factory shades and other properties is made possible and their sales prices are kept low. By this way, it gives financial help.

(3)       By giving relief in taxes government gives special financial help to industries.

(4)       Sometimes, government sees that the financial management of industries is run efficiently by providing experts for financial management and book-keeping to the industries established in these areas.

(5)       Special financial help is also given by arranging for low amount of installments for the repayment of borrowings and various types of relief and simplicity for the payment of installments are also arranged.

(6)       Many a time Government society, if industries are established in rural, backward and hilly areas.

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SOURCES OF BUSINESS FINANCE – 2 commerce GSEB std 11 7 12

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CHAPTER – 14 : SOURCES OF BUSINESS FINANCE – 2

Introduction : During the industrial revolution, many innovations in the fields of sci­ence and technology were made. Mechanism in production field was implemented. Large scale production was made possible. Each work. in the unit has become a specialised job. The size of unit increased and capital investment on a big scale became inevitable. It turned to be impossible for a person or a group of persons to take risk so company form was developed along with this, and various sources of finance have come into existence.

We shall get information of certain important sources of business finance in this chapter.

(1)       Share Capital : Share means a part or a division. Generally, owner’s capital of a company is of big amount. This capital is divided into small parts. This each part is known as a share. So, this capital is known as a share capital. This source is able to fulfill the long­-term or permanent needs of business unit.

As for example, Total share capital of a company is Rs. 1,00,00,000 (Rs. One Crore), which has been divided into one million shares of Rs. 10 each. This means that the price of one share (Part) of this company is Rs. .10 and share capital is divided into one million shares. It is convenient for the small investors to subscribe for one or more shares of Rs. 10 each and only for this reason a number of investors can subscribe for these shares and by this way big industrial units can procure capital on a big scale.

                                    Types of shares

  

Equity Shares                                  Preference Shares

With reference to the right          With reference to the      With reference to the      With reference to

of Dividend                                       share in surplus profit    refund of the amount      the conversion

into equity Shares

- Cumulative Pref. Share                      - Participating Pref. Share     - Redeemable Pref. share      - Convertible Pref. share

- Non Cumulative Pref. Shares            - Non Participating                - Irredeemable Pre. Share      - Non-Convertible Pre.

                                                                                                                                                      Shares

Equity Share

Equity shareholders are the real owners of the company. Business unit is not possible without the owners. So, it is inevitable for a company to issue these shares. Excess of liability over the assets leads to the reduction of this share capital. When the company goes into liquidation or dissolve, the company makes payment to the preference shareholders after paying for debt from the sales of assets, profit and receipts. After that, if any disbursable balance remains, that balance is distributed amongst the equity shareholders on the basis of ratio of equity shares.

Characteristics of Equity Share

(1)       Profit can be disbursed to the equity shareholders only after dividend is paid to the preference shareholders.

(2)       At the time of liquidation of the company also surplus balance is disbursed to the equity shareholders only after the payment of preference share capital.

(3)       Equity shareholders have the franchise of voting in the general meeting. This fran­chise is not per person but per share.

(4)       It is not compulsory to pay dividend to the equity shareholders and the rate of dividend is-also not fixed.

(5)       As equity shares are of ownership, their holders have to be called for the general meeting at least once in a year and accounts are to be approved in this meeting and certain policy decisions are taken.

(6)       As these shareholders are the real owners they carry more risk than preference shareholders.

(7)       Generally, these shares are listed on the approved stock exchanges and they can be bought and sold at market price.

(8)       Equity shareholders are entitled for bonus shares.

(9)       The working of the company affects the value of equity share.

Preference Shares : Dividend is disbursed on equity shares only after the dividend at predetermined rate is paid on preference shares. In the same way, at the time of liquidation of the company the preference shareholders are paid their amount after the payment of all debts but before the payment to equity shareholders. They are given preference over equity shareholders in the refund of share capital also. That is why this type of shares is known as preference share.

Characteristics of Preference Shares

(1)       Dividend is paid to the preference shareholders before disbursing it to the equity shareholders. The rate of dividend is fixed.

(2)       Share capital of this type of shares is fully paid at the time of dissolution of the company (but before paid to the equity shareholder).

(3)       Voting franchise to the preference shareholders is limited for certain matters only.

Types of Preference Shares

We shall understand the meaning of various types of preference shares as mentioned previously.

(1)       Cumulative Preference Share : When a company during any year has not earned profit or suffered a loss or earned profit and if dividend is not paid, then that dividend is carried forward to the next year. It means that when a company earns profit it will pay dividend of past years for which dividend was not paid. This type of preference shares is known as cumulative preference shares.

(2)       Non-cumulative Preference Share : In this type of preference shares dividend is paid in those years only when the company earns profit sufficiently. However, non-cumulative preference shareholders & not got right to get dividend for non-profit years.

(3)       Participating Preference Share : This type of preference shares firstly get the fixed raw of dividend. Then, out of the remaining profit me equity shareholders gets the dividend. If after disbursement to the equity shareholders the remaining profit will be Distributed amongst the participating preference shareholder.

(4)       Non-participating Preference Share : The type of preference shares which doe not participate in profit as stated in (3) above is known as non-participating preference share.

(5)       Redeemable Preference Shares : The preference share which has been issued for a fixed duration and with the completion of that duration, share capital is refunded is know as redeemable preference share. This source is useful for the requirement of finance for certain time period.

(6)       Irredeemable Preference Share : The preference share in which time for repayment is not determined is known as irredeemable preference share. This owner’s capital is useful for permanent or long-term procurement of finance.

(7)       Convertible Preference Share : The preference share which is converted fully or partly into equity share is known as convertible preference share.

(8)       Non-convertible Preference share : The preference share which is not converted  into equity share is known as non-convertible preference share.

(2)       Debenture

Meaning : The company invites the public to purchase debenture as it invites the public to subscribe for shares. Debenture (And) is a debt to it company. Debenture is one type of loan. It is divided into small parts of equal price Q getting funds of certain amount as being done through shares. This each part is known as debenture. The small investors can also purchase debentures as this loan is divided in small parts. Debenture-holders are the creditors of a company but not the owners. They are paid interest at a fixed rate on the money invested in debentures. This alternative is useful for long-term and medium-term procurement of finance. Amount of debentures is refunded at the completion of duration.

Characteristics of debentures

(1)       Debenture-holders are the creditors of the company

(2)       Interest at fixed rate is to be paid on debentures.

(3)       Mostly, title on assets against debentures is bestowed.

(4)       Money is to be refunded at the completion of duration of debentures.

(5)       Debentures are the sources of long or medium-term finance.

(6)       Sometimes, debentures are listed on stock exchanges. So they can be bought and sold like shares.

(7)       The amount of debentures can be refunded in installments also, e.g. 25 % of the face value installment of 10-year debentures can be refunded yearly at the end of 7th, 8th, 9th and 10th year of their issue year or total face value can be refunded also.

(8)       As debentures are the debt of the company their amount is refunded before the payment of share capital at the time of dissolution of the company.

Types of debentures : We shall study following types of debentures out of its various types :

(A)      Classification on the basis of security

(1) Secured debentures

(2) Unsecured debentures

(B)       Classification on the basis of conversion into shares

(1) Convertible debentures

(2) Non-convertible debentures

(A)      (1)       Secured Debentures

Those debentures are secured of which total amount was secured by pledging the company’s assets of me same amount. At the time of dissolution of the company or at the time of repayment of debentures, if the company does not have enough funds to repay the debentures, amount of debentures will be repaid even by selling the mortgaged assets. Thus, the debenture-holders can protect their interest against risk and can feel secured.

(2)       Unsecured Debentures : Those debentures are unsecured of which amount was unsecured as no pledging of company’s assets is made.

  

(B)       (1)       Convertible Debentures :

If company has announced that after the specific time certain debentures will be con­verted fully or partly into equity shares, those debentures are known as convertible deben­tures. Holders of this type of debentures are paid predetermined share/s in exchange of certain part of debentures of specific price at the end of specific time. Due to this, deben­ture-holders become both-Creditors and owners, if debentures are partly convertible but in the case of fully convertible they cease to be the creditors from the declared date and be­come shareholders-owners.

(2)       Non-convertible Debentures : This type of debentures is not converted into equity shares. The amount of debentures is paid at the specific time.

(3)       Bonds : Bonds are the debt of the company. Generally, the face value of a bond is more than a debenture. Bond-holders also get interest at the specific rate and at the specific time like debenture-holders.

This source is useful for long-term needs. Bonds are issued by government, municipali­ties and even by the companies. This type of bonds is known as government bond.

Bonds can be of 10 years or more. At the end of its duration money is to be refunded.

Bond as a source of finance is more favourable in the circumstances of tide needs for undertaking big plans requiring big amount for long time.

4.         Retained Profit or Ploughing Back of Profit

This is an internal source of finance for providing long-term capital and working capital. Profit, which has been retained in business for fulfilling the liabilities which have been estimated for the future and for the development, expansion and modernisation of business and for the protection against risk is ploughed back in business.

Sometimes, profit might not be disbursed in the initial years of establishment of com­pany and shareholders are also not expecting for it. Profit can be utilised for future needs, by retaining it.

Advantages

(1)       This source of finance is very much useful at the time of fluctuations in market and during depression.

(2)       Retained profit is favourable for the implementation of development, expansion and modernisation of business plans.

(3)       If the provision for depreciation on assets is inadequate, this source is useful for purchasing new assets.

(4)       Ploughing back of profit is useful also for maintaining rate of dividend disbursed to shareholders.

(5)       Due to ploughing. back of profit, efforts and expenses spent for other sources are not made. So the working of business can fun smoothly.

(6)       If finance is borrowed from other sources, interest is to be paid and assets are to be pledged. These are not necessary for the alternative of ploughing back in business.

(7)       Retained profit proves to be useful against the time of changes in the business and risks.

(8)       National capital creation is enhanced due to ploughing back of profit in business.

Limitations

(1)       Business. unit’s economic power increases through this source.

(2)       Monopoly increases due to increase in economic power.

(3)       Many a time directors / managers disburse low rate of dividend and retain the remaining profit and then resort to malpractices.

(4)       Cheating may take place by not paying part of profit to the investors and by re-investing profit in various ways.

(5)       Many a time small investors do not get any gain by retained profit.

Public Deposits

For satisfying the short-term needs of finance, the company accepts deposits from the public which is known as public deposits. The company accepts finance from the investors for specified time-period through public deposits. This duration may be from 6 months to 36 months (3 years). Monthly, quarterly, half-yearly or yearly interest of fixed rate is paid on invested money for this duration or interest may be paid along with original amount at the due date.

             Advantages

(1)       If the company has a good image amongst investors, it is very easy for it to get finance.

(2)       The cost of procurement of finance through this source is comparatively low, whereas, the procedure for getting money through other sources of finance is longer, complicated and costly.

(3)       No security is necessary against public deposits.

(4)       The interest paid on public deposits is considered as an expense so tax-burden on the company is lessened.

Limitations

(1)       This source is very much uncertain because the response of the investors cannot be judged beforehand. (Over and above, it has no provision of underwriters like Shares)

(2)       As there is no security given for public deposits the investors face much risk.

(3)       Public deposits are ‘fair weather friends’. During the financial crisis of company or its rumor investors rush for its premature payment of deposits. This rush increases the eco­nomic crisis of company. So, it is known as fair weather friends also.

The importance of international sources of finance

Introduction

Foreign investment has increased after the implementation of liberalisation policies in India. Procurement of finance is made possible through Foreign Direct Investment (FDI), loans from international institutes, investment in Indian companies by foreign personal and institutional investors and by Non-Resident Indians Deposits (NRI Deposits)

Importance

(1)       Investment in Indiahas increased by Non-Residential Indians, personal and institutional foreign investors and by foreign companies through their subsidiary compa­nies which are in India.

(2)       Indian subsidiary company of foreign origin will get information of technology and patents along with direct foreign investments.

(3)       Indian subsidiary company gets financial help by the guarantee of payment by the foreign company.

(4)       Speedy development has become possible in the fields of production, technology and infrastructure of the country due to foreign investments.

(5)       Employment opportunities have also increased due to increase in foreign investments.

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