UNIT 4

CLASSIFICATION OF SOURCES OF FINANCE

A source of finance can be classified under different categories mentioned as follows
(A) Classification according to period
In this case a source of finance is classified based on the time period for which it is arranged.
It is further classified into short term medium term and long term source of finance.
1) Short term sources of Finance
It is the finance available from 1 day upto 1 year. Such a source of finance has to be returned
back within one year. It is therefore also termed as sources of finance in order to meet the
working capital requirement. E.g.
- Trade Credit
- Commercial paper
- Public Deposits
- Advance from Dealers
2) Medium term sources of Finance
A medium term sources of finance is available for more than one year but upto 3 or 5 years. It
can be use for financing short to medium purposes. E.g.
- Company fixed deposits raised from public
- Medium Term Loans, etc.
3) Long term Sources of Finance
A long term sources of finance is a source available for more than 5 or 6 years. It may range
to 10 or 50 years also. It is used to meet the funding needs oflong term requirements such as
purchase of fixed assets, funding expansion, diversification etc. E.g.
- Capital Market / Stock Market
- Lease Financing
- Venture Capital Financing
(B) Classification according to ownership
According to ownership a source of finance may be classified into ownership funds and
borrowed funds.
1) Owned Funds
Such funds are contributed by the owners in a business and they are available, in most of the
cases, till the winding up of the business. Owners funds act as a base on which its borrowing
ability depends. E.g.
- Equity Share Capital
- Preference Share Capital
- Retained Earning
2) Borrowed Funds
It is the loan funds which the business firm has arranged in order to meet its requirement.
1

Borrowed funds may be for short term or long term. E.g.

- Debentures
- Long Term Loans
(C) Classification according to source of generation
1) Internal Source
Internal Source is a source of funds arranged internally within the business organization.
Such a source does not bring in the cash but it conserves the cash outflows (generated from
sales) within the business firm. E.g.
- Retained Profits
- Depreciation
2) External Source
An External Source of funds actually brings in the cash within the business firm. Such a
source may be raised by way of owners funds or borrowed funds as well as for short term or
long term basis. E.g.
- Equity Share Capital
- Term Loans
- Commercial Paper
- Public Deposits
(D) Classification on the basis of convenience
1. Security financing (shares, debentures etc),
2. Internal financing (Depreciation funds, retained earnings, reserves etc),
3. Loan Financing (short term loans, medium term loans and long term loans)

SECURITY FINANCING
Security: A document; historically, a physical certificate but increasingly electronic, showing
that one owns a portion of a publicly-traded company or is owed a portion of a debt issue.
Securities are tradable.
Securities are broadly categorized into:

Debt securities (such as banknotes, bonds and debentures),

Shares, e.g., equity and preference shares ; and,

Derivative contracts, such as forwards, futures, options and swaps.

Debenture: A type of long-term secured/unsecured bond (loan), taken out by a company,

which it agrees to repay at a specified future date. The company will usually pay a fixed rate
of interest to debenture holders each year until maturity, and if it fails to pay either the
interest or the principal amount of the loan when the time comes, the debenture holders can
force the company into liquidation and try to recover, along with other creditors, their money
from a sale of its assets.
Equity shares: Equity shares are issued to the owners of a company.
Preference shares: Preference shares have a fixed percentage dividend before any dividend is
paid to the ordinary shareholders.

LOAN FINANCING
1. Short term loans
a. Trade credit
b. Loan from commercial banks
c. Public deposits
d. Loan from finance companies
i.
Leasing and hire purchase
ii.
Merchant banking
e. Accrual accounts
f. Indigenous bankers
g. Advances from customers
h. Miscellaneous sources eg loan from directors or sister concerns.
2. Long term loans from financial institutions, banks etc.
Short term loans:(a) Trade Credits:- form of short term source of finance, generally made available to the
buyer on an informal basis without creating any charge on assets. Trade credit
arrangements usually carry stipulations of allowing a cash discount to the buyer for
prompt payment.
(b) Commercial banks:- Banks provide following facilities to the customers
(1) Loans
(2) Cash Credits
(3) Hypothecation
(4) Pledge
(5) Overdrafts
(6) Bills discounted and purchase
(c) Public Deposits: - Public deposits are deposits of money accepted by companies in
India
from
the public for specified period ranging between 3 months and 36
months. These deposits are accepted within the limit and subject to terms prescribed
under Companies (Acceptance of Deposits) Rule, 1975.

(c) Business finance companies: - there are the companies established for providing short
term and medium term loans to firms known to them, Since these firms have limited
financial resources, their lending is also limited only to the firms which are of
medium and small size. Mainly provide finance for special purpose eg financing of
customer durables, financing of transport vehicles etc.
(d) Accrual accounting:- The most commonly accrual accounts are wages and taxes. In
both the cases the amount become due but not paid immediately. Usually the date is
fixed for the payment. Similarly the payment of tax is created out of the profit of the
company but the tax is paid only after the assessment is finalized. Thus the time lag
between the receipt of income and making payment for the expenditure incurred in
earning that income helps the business in meeting some of its short term financial
requirements.
(e) Advances from customers:- This is cost free source of finance, and really useful for
those businesses where it has become customary to receive advance payment from the
customers.
(f) Misc sources:- Loans from sister concerned, and other business units.
Long term sources of finance:- The term loans is used for both medium as well as long term
loans. Medium-term loans are for periods ranging from 1 to 5 years while long term finance
are for the period from 5 to 10 or 15 years.
LOAN SYNDICATION
It is the process of involving several different lenders (banks or financial institutions) in
providing various portions of a loan. Loan syndication most often occurs in situations where
a borrower requires a large sum of capital that may either be too much for a single lender to
provide, or may be outside the scope of a lender's risk exposure levels. Thus, multiple lenders
will work together to provide the borrower with the capital needed, at an appropriate rate
agreed upon by all the lenders.
Loan syndication is common in mergers, acquisitions and buyouts, where borrowers often
need very large sums of capital to complete a transaction, often more than a single lender is
able or willing to provide.
Methods of loan syndication
1. The borrower may approach or make an application to a lead financial institution
which in turn gets in touch with other financial institutions.
2. The borrower may approach merchant bank to arrange for a loan syndication for him.
Steps in loan syndication
1. Preparation of project report
2. Preparation of loan syndication application.
3. Selection of financial institutions for loan syndication.
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4.
5.
6.
7.

Receipt of sanction letter or letter of intent from the financial institutions.

Compliance of terms and conditions of the loan agreement by the borrower.
Documentation
Disbursement of loan.

BOOK BUILDING
Corporates may raise capital in the primary market by way of an initial public offer, rights
issue or private placement. An Initial Public Offer (IPO) is the selling of securities to the
public in the primary market. This Initial Public Offering can be made through the fixed price
method, book building method or a combination of both.
Book building is actually a price discovery method. It is the process by which an underwriter
attempts to determine at what price to offer an IPO based on demand from institutional
investors. An underwriter "builds a book" by accepting orders from fund managers indicating
the number of shares they desire and the price they are willing to pay.
The issue price is not determined in advance rather the issue price is determined after the bid
closure based on the demand generated from investors at various prices.
In this method, the company doesn't fix up a particular price for the shares, but instead gives
a
price
range,
e.g.
Rs
80-100.
When bidding for the shares, investors have to decide at which price they would like to bid
for the shares, for e.g. Rs 80, Rs 90 or Rs 100. They can bid for the shares at any price within
this
range.
Based on the demand and supply of the shares, the final price is fixed. The lowest price (Rs
80) is known as the floor price and the highest price (Rs 100) is known as cap price.
The price at which the shares are allotted is known as cut off price.
Process of Book Building
The entire process begins with the selection of the lead manager, an investment banker whose
job is to bring the issue to the public. The Issuer who is planning an offer nominates lead
merchant banker(s) as 'book runners'. The Issuer specifies the number of securities to be
issued and the price band for the bids. The Issuer also appoints syndicate members with
whom orders are to be placed by the investors. The syndicate members input the orders into
an 'electronic book'. This process is called 'bidding' and is similar to open auction. The book
normally remains open for a period of 5 days. Bids have to be entered within the specified
price band. Bids can be revised by the bidders before the book closes. On the close of the
book building period, the book runners evaluate the bids on the basis of the demand at

various price levels. The book runners and the Issuer decide the final price at which the
securities shall be issued.
Guidelines for Book Building
Rules governing Book building are covered in Chapter XI of the Securities and Exchange
Board of India (Disclosure and Investor Protection) Guidelines 2000. BSE's Book Building
System offers a book building platform through the Book Building software that runs on the
BSE Private network. This system is one of the largest electronic book building networks in
the world, spanning over 350 Indian cities through over 7000 Trader Work Stations via leased
lines, VSATs and Campus LANS.
PROJECT FINANCING
Definition of 'Project Finance' by the International Project Finance Association (IPFA) as the
following:
The financing of long-term infrastructure, industrial projects and public services based upon a
non-recourse or limited recourse financial structure where project debt and equity used to
finance the project are paid back from the cash flow generated by the project.
Project finance is especially attractive to the private sector because they can fund major
projects off balance sheet based on the cash flows of the project. The financiers usually have
little or no recourse to the non-project assets of the borrower.
Key characteristics of Project Financing
1. Financing of long term infrastructure and/or industrial projects using debt and equity.
2. Debt is typically repaid using cash flows generated from the operations of the project.
Limited recourse to project sponsors. ( Higher risk projects may require the
surety/guarantees of the project sponsors)
3. Debt is typically secured by projects assets, including revenue producing contracts.
First priority on project cash flows is given to the Lender.
Consent of the Lender is required to disburse any surplus cash flows to project
sponsors
Advantages of Project Financing
1.
2.
3.
4.
5.
6.
7.
8.

Eliminate or reduce the lenders recourse to the sponsors.

Permit an off-balance sheet treatment of the debt financing.
Maximize the leverage of a project.
Avoid any restrictions or covenants binding the sponsors under their respective
financial obligations.
Avoid any negative impact of a project on the credit standing of the sponsors.
Obtain better financial conditions when the credit risk of the project is better than the
credit standing of the sponsors.
Allow the lenders to appraise the project on a segregated and stand-alone basis.
Obtain a better tax treatment for the benefit of the project, the sponsors or both.
6

Disadvantages of Project Financing

1.
2.
3.
4.
5.

Often takes longer to structure than equivalent size corporate finance.

Higher transaction costs due to creation of an independent entity.
Project debt is substantially more expensive due to its non-recourse nature.
Extensive contracting restricts managerial decision making.
Project finance requires greater disclosure of proprietary information and strategic
deals.

Stages in Project Financing

I.

II.

III.

Pre Financing Stage

Project identification
Risk identification & minimizing
Technical and financial feasibility
Financing Stage
Equity arrangement
Negotiation and syndication
Commitments and documentation
Disbursement.
Post Financing Stage
Monitoring and review
Financial Closure / Project Closure
Repayments & Subsequent monitoring.

NEW FINANCIAL INSTITUTIONS AND INSTRUMENTS:

COMMERCIAL PAPERS (CP): Commercial Paper (CP) is an unsecured money market

instrument issued in the form of a promissory note. It was introduced in India in 1990. These
are issued mainly by the corporate businessmen to fund their working capital needs.
Commercial Papers are issued generally for short-term maturities. Commercial papers are not
secure and subject to market risks, so those corporate bodies that have a good credit history
will only be able to use this financial instrument.
Features:
1. CP is thus an unsecured promissory note privately placed with investors at a discount
rate to face value determined by market forces.
2. CP is freely negotiable by endorsement and delivery.
3. Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are
eligible to issue CP.
4. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other
agencies.
5. A company shall be eligible to issue CP provided
(a) the tangible net worth of the company, as per the latest audited balance sheet,
is not less than Rs. 4 crore;
(b) the working capital (fund-based) limit of the company from the banking
system is not less than Rs.4 crore and
(c) the borrowal account of the company is classified as a Standard Asset by the
financing bank/s.
6. CP can be issued for maturities between a minimum of 15 days and a maximum up to
one year from the date of Issue.
7. CP can be issued in denominations of Rs.5 lakh or multiples thereof.
8. Individuals, banking companies, other corporate bodies registered or incorporated in
India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign
Institutional Investors (FIIs) etc. can invest in CPs. However, amount invested by
single investor should not be less than Rs.5 lakh (face value).
CERTIFICATE OF DEPOSITS
These are very similar to the Commercial papers. But the CDs are issued mainly by the
commercial banks.
Certificates of Deposit (CDs) is a negotiable money market instrument and issued in
dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other
eligible financial institution for a specified time period. Guidelines for issue of CDs are
presently governed by various directives issued by the Reserve Bank of India, as amended
from time to time.

Features:
1.

CDs can be issued by:

8

2.
3.

4.

a) scheduled commercial banks excluding Regional Rural Banks (RRBs) and

Local Area Banks (LABs); and
b) select all-India Financial Institutions that have been permitted by RBI to raise
short-term resources within the umbrella limit fixed by RBI.
Banks have the freedom to issue CDs depending on their requirements.
An FI may issue CDs within the overall umbrella limit fixed by RBI, (i.e., issue of
CD together with other instruments viz., term money, term deposits, commercial
papers and inter-corporate deposits should not exceed 100 per cent of its net
owned funds, as per the latest audited balance sheet.)
Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum deposit that
could be accepted from a single subscriber should not be less than Rs.1 lakh, and
in multiples of Rs. 1 lakh thereafter.

5.

CDs can be issued to individuals, corporations, companies (including banks and

PDs), trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also
subscribe to CDs, but only on non-repatriable basis, which should be clearly stated
on the Certificate. Such CDs cannot be endorsed to another NRI in the secondary
market.

6.

The maturity period of CDs issued by banks should not be less than 7 days and not
more than one year, from the date of issue. The FIs can issue CDs for a period not
less than 1 year and not exceeding 3 years from the date of issue.
CDs may be issued at a discount on face value. The issuing bank / FI is free to
determine the discount / coupon rate.
Banks have to maintain appropriate reserve requirements, i.e., cash reserve ratio
(CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.

7.
8.

GLOBAL DEPOSITARY RECEIPT - GDR

GDR is a bank certificate issued in more than one country for shares in a foreign company.
The shares are held by a foreign branch of an international bank. The shares trade as domestic
shares, but are offered for sale globally through the various bank branches. It is a financial
instrument used by private markets to raise capital denominated in either U.S. dollars or
Euros.
Global depository receipts facilitate trade of shares, and are commonly used to invest in
companies from developing or emerging markets.
Definition
Negotiable certificate issued by one country's bank against a certain number of shares held in
its custody but traded on the stock exchange of another country. GDRs entitle the
shareholders to all associated dividends and capital gains, and can be bought and sold like
other securities. Thus they allow investors in any country to buy shares of any other country
without losing the income or trading flexibility. Also called international depository receipt
(IDR).

These are a class of investment which allows international investors to own shares in foreign
companies where the foreign market is hard to access for the retail investor, and without
having to worry about foreign currencies and tax treatments. Global Depositary Receipts are
issued by international investments banks as certificates (the GDR) which represents the
foreign shares but which can be traded on the local stock exchange. For example a UK
investor may be able to buy shares in a Vietnamese company via a GDR issued by a UK
investment. The GDR will be denominated in GB Pounds and will be tradable on the London
Stock Exchange. The investment bank takes care of currency exchange, foreign taxes etc. and
pays dividends on the GDR in GB Pounds.
The concept originally started in the USA with the creation of American Depositary Receipts
which were created so that US retail investors could buy shares in a foreign company without
having to worry about foreign exchange, or foreign taxes.
Characteristics of GDRs:
1. It is an unsecured security
2. A fixed rate of interest is paid on it
3. It may be converted into number of shares
4. Interest and redemption price is public in foreign agency
5. It is listed and traded in the share market
Several international banks issue GDRs, such as JPMorgan Chase, Citigroup, Deutsche Bank,
The Bank of New York Mellon. GDRs are often listed in the Frankfurt Stock Exchange,
Luxembourg Stock Exchange and in the London Stock Exchange.
Main benefits of GDRs issuance to the company are:
1. increased visibility in the target markets, which usually garners increased research
coverage in the new markets;
2. a larger and more diverse shareholder base; and
3. The ability to raise more capital in international markets.

STOCK INVEST
Stock invest instrument was introduced by the govt. on the suggestion made by the SEBI. It is
an additional facility available to an investor for payment of shares application money against
the shares applied by him. It is like an account payee cheque where investors actually could
buy them from an issuing bank that was participating in a primary market issue. The money
remained in the investors account until the allotments were made and only then were the
investors' accounts debited. The stock invest scheme has been discontinued by SEBI w.e.f.
Nov5, 2003.
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DEPOSITORIES
Background
The earlier settlement system on Indian stock exchanges was very inefficient as it was unable
to take care of the transfer of securities in a quick/speedy manner. Since, the securities were
in the form of physical certificates; their quick movement was again difficult. This led to
settlement delays, theft, forgery, mutilation and bad deliveries and also to added costs.
To wipe out these problems, the Depositories Act 1996 was passed. It was formed with the
purpose of ensuring free transferability of securities with speed, accuracy & security.
On the simplest level, depository is used to refer to any place where something is deposited
for storage or security purposes. Depositories allow brokers and other financial companies to
deposit securities where book entry and other services can be performed, like clearance,
settlement and securities borrowing and lending.
(Book entry system is a system under which no physical transfer of securities takes place. In
case of change of ownership rights, securities do not change hands physically. To facilitate
the change of name/ownership rights, merely a book entry is passed. Since, the securities are
fungible; transfer becomes easier)
Comparison of a Depository with a Bank
Depositories

Banks

Hold securities in an account

Hold funds in an account

Transfer securities between

accounts on the instruction of
the account holder

Transfers funds between

accounts on the instruction
of the account holder

Assist
in
transfer
of
ownership without having to
handle securities

Assist in transfers without

having to handle money

Facilitates
shares

Facilitates safekeeping of
money

safekeeping

of

Benefits of having a Depository are as follows:

Holds securities in electronic form, thus reducing paperwork

Transfers securities in an immediate manner

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Risks that are associated with physical certificates such as bad delivery and fake
securities, theft mutilation, forgery are absent

Reduces transaction cost No stamp duties

Direct transmission of securities by the DP to avoid correspondence with companies

Records any corporate actions automatically-eg dividend declaration

Depositories in India
There are 2 depositories in India

The National Securities Depository Limited [NSDL]

Central Depository for Securities Limited [CDSL]

National Securities Depository Limited (NSDL)

NSDL is the first depository to be set up in India. It was registered by SEBI on June 7,
1996.NSDL works for the trades done on NSE. It is a joint venture of: IDBI (Industrial
Development Bank of India Limited); NSE (National Stock Exchange); and UTI (Unit Trust
of India).
Central Depository Services Limited (CDSL)
The second depository Central Depository Services Limited (CDSL) has been promoted by
Bombay Stock Exchange and Bank of India. It was formed in February 1999.
Both depositories have a network of Depository participants (DPs) which are further
electronically connected to their clients. So, DPs act as a link between the depositories and
the clients.
Depository Participants
Services provided by NSDL and CDSL are carried out through their agents known as
Depository Participants [DPs]. DPs are appointed by depositories after an approval from
SEBI. According to SEBI regulations, 3 categories of entities such as banks, financial
institutions, and SEBI registered trading members qualify for becoming DPs
Presently, there are 327 DPs in India. Few of them are:

Bank of India

Bank of Baroda

Kotak securities

Motilal Oswal

12

Reliance Capital

UTI

Yes Bank

CREDIT RATING INSTITUTIONS

The Indian credit rating industry has evolved over a period of time. Credit rating agencies
play an important role in most modern capital markets. Despite their ubiquity in the financial
markets, credit ratings are often misunderstood. The rating represents an independent
professional and impartial opinion as to the likelihood that the borrower or issuer will meet
its contractual, financial obligations as they become due and is not a recommendation to buy
or sell a security. It also does not address market liquidity or volatility risk.
Therefore credit ratings are not:

A comment on the issuer's general performance

An indication of the potential price of the issuers' bonds or equity shares

Indicative of the suitability of the issue to the investor

A recommendation to buy/sell/hold a particular security

A statutory or non-statutory audit of the issuer

An opinion on the associates, affiliates, or group companies, or the promoters,

directors, or officers of the issuer

Role of credit rating agencies

1. Reducing information asymmetry or knowledge gap, between borrowers (issuers) and
lenders (investors) by providing independent opinions of creditworthiness.
2. Improving market function and efficiency by reducing the ability of one investor to
outperform another by making better judgments about creditworthiness. In this view,
ratings act as an equalizer in the fixed-income capital markets, helping to put
investors on more equal footing.
3. Credit ratings serve as an unbiased, independent "second opinion"
that an investor can use to confirm or refute his or her own analysis.

13

4.

Credit rating reduces uncertainty about creditworthiness of an

issuer, thus helping him achieve lower costs of borrowing than it
would otherwise have.

5. A larger role for credit ratings is in the form of promoting financial

stability or preventing asset bubbles and financial crises.
Indian credit rating industry
Indian credit rating industry mainly comprises of CRISIL, ICRA, CARE, ONICRA, FITCH
& SMERA.
CRISIL: CRISIL is the largest credit rating agency in India, with a market share of greater
than 60%. It was established in 1987. The worlds largest rating agency Standard & Poor's
now holds majority stake in CRISIL. So far, CRISIL has rated 30,000 debt instruments,
covering the entire debt market.
CARE Ratings: Incorporated in 1993, Credit Analysis and Research Limited (CARE) is a
credit rating, research and advisory committee promoted by Industrial Development Bank of
India (IDBI), Canara Bank, Unit Trust of India (UTI) and other financial and lending
institutions. CARE has completed over 7,564 rating assignments since its inception in 1993.
ONICRA Credit Rating Agency: ONICRA was established in 1993 by Mr. Sonu
Mirchandani as a rating agency. It analyzes data and provides rating solutions for Individuals
and Small and Medium Enterprises(SMEs). ONICRA has an extensive experience in
operating a wide range of business processes in areas such as Finance, Accounting, Back-end
Management, Application Processing, Analytics, and Customer Relations. It has rated more
than 2500 SMEs.
ICRA: ICRA was established in 1991 by leading Indian financial institutions and commercial
banks. International credit rating agency, Moodys, is the largest shareholder.
Small and Medium Enterprises Rating Agency (SMERA): SMERA a joint initiative by
SIDBI, Dun & Bradstreet Information Services India Private Limited (D&B) and several leading
banks in the country. SMERA is the country's first Rating agency that focuses primarily on the Indian
MSME segment. SMERA has completed 7000 ratings.

VENTURE CAPITAL INSTITUTIONS

Venture capital is a growing business of recent origin in the area of industrial financing in
India.
Concept
In a narrow sense, it refers to investment in new enterprises that are lacking a stable
record of growth.

14

In a broader sense, it refers to the commitment of capital as shareholding, for the

formulation and setting up of small firms specializing in new ideas or new
technologies.

Meaning of Venture capital

Venture capital is long-term risk capital to finance high technology projects which involve
risk but at the same time has strong potential for growth. Venture capitalists pool their
resources including managerial abilities to assist new entrepreneurs in the early years of
project. Once the project reaches the stage of profitability, they sell their equity holdings at
high premium.
Thus a venture capital company is defined as a financing institution which joins an
entrepreneur as a co-promoter in a project and shares the risk and rewards of the enterprise.
Features
Venture capital usually in the form of equity participation. It may also take the form of
convertible debt or long term loan
Investment is only made in high risk but high growth potential projects.
Venture capital is available only for commercialization of new ideas or new technologies.
Venture capitalist joins the entrepreneur as a co-promoter in projects and shares the risks
and rewards of the enterprise.
There is continuous involvement in business after making an investment by the investor.
Once the investor has reached the full potential, the venture capitalist sells his holdings
either to the promoters or in the market. The basic objective is not profit but capital
appreciation at the time of disinvestment.
Venture capital is not just injection of money but also an input needed to set up the firm,
design its market strategy and organize and manage it.
Investment is usually made in small and medium scale enterprise.
VC funds in India
1. Those promoted by the Central Government controlled development finance
institutions. For example: - ICICI Venture Funds Ltd., IFCI Venture Capital Funds
Ltd (IVCF),SIDBI Venture Capital Ltd (SVCL)
2. Those promoted by State Government controlled development finance
institutions. For example: - Punjab Infotech Venture Fund , Gujarat Venture Finance
Ltd (GVFL) , Kerala Venture Capital Fund Pvt Ltd.
3. Those promoted by public banks. For example: - Canbank Venture Capital Fund,
SBI Capital Market Ltd
4. Those promoted by private sector companies. For example: - IL&FS Trust
Company Ltd , Infinity Venture India Fund
5. Those established as an overseas venture capital fund. For example: - Walden
International Investment Group, HSBC Private Equity management Mauritius Ltd

FACTORING

15

Definition: Factoring is a financial transaction whereby a business sells its accounts

receivable (i.e., invoices) to a third party (called a factor) at a discount. The factoring
company (factor) pays the business a percentage of the value of the accounts receivable and
deducts a fee for the cost of collections. Then the factor collects the receivables.
One way to look at factoring is that a business is outsourcing its receivables collections
process.
Factoring may broadly be defined as the relationship, created by an agreement, between the
seller of goods/services and a financial institution called the factor, whereby the later
purchases the receivables of the former and also controls and administers the receivables of
the former.
(Factoring allows you to leverage your invoices to gain immediate access to cash)
For example, assume a factor has agreed to purchase an invoice of $1 million from Clothing
Manufacturers Inc., representing outstanding receivables from Behemoth Co. The factor may
discount the invoice by say 4%, and will advance $720,000 to Clothing Manufacturers Inc.
The balance of $240,000 will be forwarded by the factor to Clothing Manufacturers Inc. upon
receipt of the $1 million from Behemoth Co. The factor's fees and commissions from this
factoring
deal
amount
to
$40,000.
Note that the factor is more concerned with the creditworthiness of the invoiced party Behemoth Co. in the example above - rather than the company from which it has purchased
the receivables (Clothing Manufacturers Inc. in this case).
Factoring is designed for businesses that want to improve their cash flow by not waiting 30,
45, 60 days for a customer to pay. Widely accepted as an alternative financing source,
accounts receivable funding is used in almost every industry that sells business-to-business or
business-to-government. Factoring is not a loan and differs from borrowing in that the
accounts receivable are sold at a discount rather than merely offered as collateral.
Why would a company sell their receivables?
Companies that encounter a recurring cash flow problem often cant afford to have cash tied
up in receivables for 30-60-90 days. They need the cash to meet immediate present financial
demands of their business. Their current bank loan may not be adequate enough to fund
growth. Or they may not qualify for a bank loan, which has many limiting FDIC
requirements that must be met.
Advantages of Factoring
No new debt is created Off Balance Sheet financing
It is based on your customers creditworthiness
Fast & Easy Initial set up time from quote to funding can be done in as little as 7-10
business days.
After initial setup, invoice funding can be completed in 24 - 48 hours.
No long-term contracts are required.
Avoids giving up equity or control of company.

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Flexible business can choose which invoices it wants to offer for sale.... and within
limits, when.
Business can receive credit reports on prospective customers,
Continuous monitoring of the credit status of current customers.
Unlimited source of operating cash it grows as sales grow

Factoring Companies in India

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2.
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4.
5.
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7.
8.
9.

Canbank Factors Limited

SBI Factors and Commercial Services Pvt. Ltd
The Hong Kong and Shanghai Banking Corporation Ltd
Foremost Factors Limited
Global Trade Finance Limited
Export Credit Guarantee Corporation of India Ltd
Citibank NA,
India Small Industries Development Bank of India (SIDBI)
Standard Chartered Bank

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