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Sources of Finance

Emerging trends in source of finance for national and international companies:



The Long-Term Finance may be Raised by the Companies from the following
Sources :-
Capital Market:
Capital market denotes an arrangement whereby transactions involving the
procurement and supply of long-term funds take place among various
organizations. In the capital market, the companies raise funds by issuing shares
and debentures of different types. When long-term capital is initially raised by new
companies or by existing companies by issuing additional shares or debentures, the
transactions are said to take place in the market for new capital called, as 'New
Issue Market'.
Retained Profits or Reinvestment of Profits:
An important source of long-term finance for ongoing profitable companies is the
amount of profit which is accumulated as general reserve from year to year. To the
extent profits are not distributed as dividend to the shareholders, the retained
amount can be reinvested for expansion or diversification of business activities.
Retained profit is an internal source of finance. Hence it does not involve any cost
of floatation which has to be incurred to raise finance from external sources.

Special Financial Institutions:
A large number of financial institutions have been established in India for
providing long-term financial assistance to industrial enterprises.
There are many all-India institutions like
a. Industrial Finance Corporation of India (IFCI);
b. Industrial Credit and Investment Corporation of India (ICICI);
c. Industrial Development Bank of India(IDBI) , etc.


At the State level, there are
a. State Financial Corporations (SFCs)
b. State Industrial Development Corporations (SIDCs).
These national and state level institutions are known as 'Development
Banks'.
Leasing Companies:
Manufacturing companies can secure long-term funds from leasing companies. For
this purpose a lease agreement is made whereby plant, machinery and fixed assets
may be purchased by the leasing company and allowed to be used by the
manufacturing concern for a specified period on payment of an annual rental. At
the end of the period the manufacturing company may have the option of
purchasing the asset at a reduced price. The lease rent includes an element of
interest besides expenses and profits of the leasing company.
Seed Capital Assistance:

The seed capital assistance has been designed by
IDBI for professionally or technically qualified entrepreneurs. All the projects
eligible for financial assistance from IDBI, directly or indirectly through refinance
are eligible under the scheme. The project cost should not exceed Rs. 2 crores and
the maximum assistance under the project will be restricted to 50% of the required
promoters contribution or Rs 15 lacs whichever is lower.
The seed capital Assistance is interest free but carries a security charge of one
percent per annum for the first five years and an increasing rate thereafter.


Bond financing;

A bond is an instrument of indebtedness of the bond issuer to the holders. It is a
debt security, under which the issuer owes the holders a debt and, depending on the
terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the
principal at a later date, termed the maturity date.Interest is usually payable at fixed
intervals (semiannual, annual, sometimes monthly). Very often the bond is
negotiable, i.e. the ownership of the instrument can be transferred in the secondary
market.
Bonds provide the borrower with external funds to finance long-term investments,
or, in the case of government bonds, to finance current expenditure
Debt Securitization :
Securitization of debt or asset refers to the process of liquidating the illiquid and
long term assets like loans and receivables of financial institutions like banks by
issuing marketable securities against them. In other worlds, debt securitization is a
method of recycling of funds. It is a process whereby loans and other receivables
are underwritten and sold in form of asset. It is thus a process of transforming the
assets of a lending institution into negotiable instrument for generation of funds.

Institutional investors;
Institutional investors are organizations which pool large sums of money and
invest those sums in securities, real property and other investment assets. They can
also include operating companies which decide to invest their profits to some
degree in these types of assets.
Typical investors include banks, insurance companies, retirement or pension
funds, hedge funds, investment advisors and mutual funds. Their role in the
economy is to act as highly specialized investors on behalf of others.
There are several other institutions called as 'Investment Companies' or 'Investment
Trusts' which subscribe to the shares and debentures offered to the public by
companies.
These include the
a. Life Insurance Corporation of India (LIC)
b. General Insurance Corporation of India (GIC);
c. Unit Trust of India (UTI) etc.

Short-Term Finance may be Raised by the Companies from the following
Sources :-
Trade Credit
It is the credit which the firms get from its suppliers. It does not make available the
funds in cash, but it facilitates the purchase of supplies without immediate
payment. No interest is payable on the trade credits. The period of trade credit
depends upon the nature of product, location of the customer, degree of
competition in the market, financial resources of the suppliers and the eagerness of
suppliers to sell his stocks.
Installment Credit
Firms may get credit from equipment suppliers. The supplier may allow the
purchase of equipment with payments extended over a period of 12 months or
more. Some portion of the cost price of the asset is paid at the time of delivery and
the balance is paid in a number of installments. The supplier charges interest on the
installment credit which is included in the amount of installment. The ownership of
the equipment remains with the supplier until all the installments have been paid
by the buyer.
Accounts Receivable Financing
Under it, the accounts receivable of a business concern are purchased by a
financing company or money is advanced on security of accounts receivable. The
finance companies usually make advances up to 60 per cent of the value of the
accounts receivable pledged. The debtors of the business concern make payment to
it which in turn forwards to the finance company.
Customer Advance
Manufacturers of goods may insist the customers to make a part of the payment in
advance, particularly in cases of special order or big orders. The customer advance
represents a part of the price of the products that have been ordered by the
customer and which will be delivered at a later date.
Bank Credit
Commercial Banks play an important role in financing the short-term
requirements of business concerns. They provide finance in the following ways :-
Loans: - When a bank makes an advance in lump sum, the whole of which
is withdrawn to cash immediately by the borrower who undertakes to repay
it in one single installment, it is called a loan. The borrower is required to
pay the interest on the whole amount.

Cash credit: - It is the most popular method of financing by commercial
banks. When a borrower is allowed to borrow up to a certain limit against
the security of tangible assets or guarantees, it is known as secured credit but
if the cash credit is not backed by any security, it is known as clean cash
credit. In case of clean cash credit the borrower gives a promissory note
which is signed by two or more sureties. The borrower has to pay interest
only on the amount actually utilized.

Overdrafts: - Under this, the commercial bank allows its customer to
overdraw his current account so that it shows the debit balance. The
customer is charged interest on the account actually overdrawn and not on
the limit sanctioned.

Discounting of bills :-
Commercial banks finance the business concern by
discounting their credit instruments like bills of exchange, promissory notes and
hundies. These documents are discounted by the bank at a price lower than their
face value.
Bridge Finance:
Bridge finance means loans taken by the business firm from
commercial banks for a short period, pending disbursement of term loans by
financial institutions, normally it takes time for the financial institution to finalize
procedures of creation of security, tie-up participation with other institutions etc.
once the loans are approved in principle, firms in order not to lose further time in
starting their projects arrange for bridge finance. Such temporary loan is normally
repaid out of the proceeds of the principal term loans.
It is secured by hypothecation of moveable assets, personal guarantees and demand
promissory notes. Generally rate of interest on bridge finance is higher as
compared with that on term loans.





Foreign Sources:
Funds can also be collected from foreign sources which usually consists of :-
Foreign Collaborators: - If approved by the Government of India, the
Indian companies may secure capital from abroad through the subscription
of foreign collaborator to their share capital or by way of supply of technical
knowledge, patents, drawings and designs of plants or supply of machinery.

Non-Resident Indians: - persons of Indian origin and nationality living
abroad are also permitted to subscribe to the shares and debentures issued by
the companies in India.

External Commercial Borrowings (ECB):
Foreign currency borrowings raised by the Indian companies from sources outside
India are called External Commercial Borrowings (ECBs). These are commercial
loans with minimum average maturity of 3 years. The ECBs include:-
Bank Loans
Buyers Credit
Suppliers Credit
Securitized instruments (e.g. floating rate notes and fixed rate bonds)
Credit from official export credit agencies
Commercial borrowings from the private sector window of multilateral financial
institutions
Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds.




Source of finance for multinational companies:
Commercial Papers:
Commercial Paper (CP) is an unsecured promissory note issued by a firm to raise
funds for a short period, generally, varying from a few days to a few months. For
example, in India, the maturity period of CP varies between 15 days to 1 year. It is
a money market instrument and generally purchased by Commercial Banks, money
market mutual funds and other financial institutions desirous to invest their funds
for a short period. As the CP is unsecured, the firms having good credit rating can
only issue the CP. The interest cost of the CP depends upon the amount involved,
maturity period and the prime lending rates of Commercial Banks. The main
advantage of CP is that the cost involved is lower than the prime lending rates. In
addition to this cost, the borrowing firm has to bear another cost in the form of
placement fees payable to the dealer of CP who arranges the sale.

Inter-corporate Deposits (ICDs):
The companies borrow funds for a short-term period, say up
to six months, from other companies which have surplus liquidity for the time
being. The ICDs are generally unsecured and are arranged by a financier. The
ICDs are very common and popular in practice as these are not marred by the legal
hassles. The convenience is the basic virtue of this method of financing. There is
no regulation at present in India to regulate these ICDs. Moreover, these are not
covered by the Section 58A of the Companies Act, 1956, as the ICDs are not for
long term. The transactions in the ICD are generally not disclosed as the borrowing
under the ICDs implies a liquidity shortage of the borrower. The rate of interest on
ICDs varies depending upon the amount involved and the time period. The entire
working of ICDs market is based upon the personal connections of the lenders,
borrowers and the financiers.



Certificate of deposits:
A CD is a negotiable money market instrument issued by a commercial bank in
dematerialized form for a specified period of time at a market determined discount
rate. The face value is payable on maturity by the issuing bank. The maturity
period of CDs issued by a bank should be not less than 7 days and not more than a
year. Discount is calculated on actual/365 day (rear-ended) basis. CDs are freely
transferable by endorsement and delivery.
Corporate Debt Market:
A corporate debt market can supplement banks by providing funds to
companies for long term capital investment. It also provides a stable source of
funds when the equity market becomes volatile.
Commercial Banks:
Commercial Banks all over the world provide foreign currency loans for
international operations as they do for domestic operations. These banks also
provided facility to overdraw, over and above the loan amount.
Discounting of Trade Bills:
This method is used as a short-term financing method. It is widely used
in Europe and Asia to finance both domestic and international trade. In this case
companies holding bills of exchange, gets the bills enchased before their scheduled
maturity through the bank. The bills are enchased at a discount.
Euro-currency Market:
When the currency is deposited outside the country of origin. It is termed
as Eurocurrency. For example, US $ deposited outside United States is termed as
Euro-dollar. These deposits are largely outside the control of national banking
activities. Thus, euro-currency market is another attractive source for borrowing
foreign currency.


Euro-bond Markets:
Like euro-currency market, euro-bond market has emerged as another
significant source of capital. Euro-bonds are also primarily sold in countries other
than that of the country in whose currency the bond is denominated. Thus, bonds
denominated in yen but sold in US, Britain etc., are known as euro-bonds.
Development Banks:
Many countries have development banks which offer long and medium-term
loans. Many agencies at the national level offer incentives for firms to invest
within their country or to finance exports.
International Agencies:
Many international agencies have come into being for financing
specific category of projects. For example, international finance corporation and
World Bank assist developing countries by financing projects in private and public
sectors. Regional Development Banks provide finance for priority projects for
economic development of the countries of their finance for priority projects for
economic development of the countries of their regions.
External Commercial Borrowings (ECB):
Foreign currency borrowings raised by the Indian companies from sources outside
India are called External Commercial Borrowings (ECBs). These are commercial
loans with minimum average maturity of 3 years. The ECBs include:-
Bank Loans
Buyers Credit
Suppliers Credit
Securitized instruments (e.g. floating rate notes and fixed rate bonds)
Credit from official export credit agencies
Commercial borrowings from the private sector window of multilateral financial
institutions
Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds.

Global Depository Receipts (GDRs):
It is a negotiable certificate denominated in
US dollars which represents a Non-US companys publically traded local currency
equity shares. GDRs are created when the local currency shares of an Indian
company are delivered to Depositorys local custodian Bank against which the
Depository bank issues depository receipts in US dollars. The GDRs may be traded
freely in the overseas market like any other dollar-expressed security either on a
foreign stock exchange or in the over the- counter market or among qualified
institutional buyers.
By issue of GDRs Indian companies are able to tap global equity market to raise
foreign currency funds by way of equity. It has distinct advantage over debt as
there is no repayment of the principal and service costs are lower.

American Depository Receipts (ADRs):
These are depository receipts issued by a
company in USA and are governed by the provisions of Securities and Exchange
Commission of USA. As the regulations are severe, Indian companies tap the
American market through private debt placement of GDRs listed in London and
Luxemburg stock exchanges. Apart from legal impediments, ADRs are costlier
than Global Depository Receipts (GDRs). Legal fees are considerably high for US
listing. Registration fee in USA is also substantial. Hence ADRs are less popular
than GDRs.

Diasporas Bonds:
A diaspora bond is a debt instrument issued by a country - or potentially, a sub-
sovereign entity or a private corporation - to raise financing from its overseas
diaspora. Diaspora bonds can be issued for raising external development finance
Euro Convertible Bond:
Euro Convertible bonds are quasi-debt securities (unsecured) which can be
converted into depository receipts or local shares. ECBs offer the investor an
option to convert the bond into equity at a fixed price after the minimum lock in
period. The price of equity shares at the time of conversion will have a premium
element. The bonds carry a fixed rate of interest. These are bearer securities and
generally the issue of such bonds may carry two options viz. call option and put
option. A call option allows the company to force conversion if the market price of
the shares exceeds a particular percentage of the conversion price. A put option
allows the investors to get his money back before maturity. In the case of ECBs,
the payment of interest and the redemption of the bonds will be made by the issuer
company in US dollars. ECBs issues are listed at London or Luxemburg stock
exchanges.