Part -2 – BUSINESS FINANCE
Business Finance: - Finance is considered to be the life blood of business. When finance is used for some business activities, it may be called business finance. It refers to the money and credit employed in business. It may be defined as the process of raising, providing and managing of all funds to be used in connection with business activities.
According the B.O Wheeler, “Business finance is that business activity which is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of a business enterprise”.
Finance is required for the purchase of fixed assets, meeting the cost of current assets, acquiring intangible assets, meeting the day to day expenses, meeting the cost of raising finance, providing for the growth and expansion of business and so on. the capital required by a business is segregated into fixed capital and working capital.
Fixed Capital: - Fixed capital is represented by fixed assets like plant and machinery, land and buildings, furniture etc. Capital investment in such assets is more or less permanent in nature. It requires large amount of money for a long period of time. The return will derived over a long period of time. The amount of fixed capital required in an organization depends on nature of business, scale of operation, type of manufacturing process, mode of acquiring fixed assets etc.
Working Capital: - Working Capital is the amount of capital which is required for the day to day working of a business. It is the capital used for carrying out routine business operations of financing current assets. It is also known as circulating capital because of the fact that it keeps on revolving or circulating from cash to current assets and back. There are two concepts of working capital- Gross working Capital (Total funds invested in current assets) and Net working Capital (Difference between current assets and current liabilities.)
On the basis of period for which finance is required, business finance may be classified into:
Long term finance: – Funds which are required to be invested in the business for a long period generally exceeding five years are called long- term finance. Shares, debentures, loans etc are the main sources of this finance.
Medium – term finance: – Finance required for a period of one year to five years is known as medium term finance. Redeemable preference shares, debentures, loans etc are its main sources.
Short – term finance: - finance required for meeting day- to- day operations of a business or for meeting the working capital requirements are called short- term finance. Trade credit, short term loans, public deposits, accounts receivable financing etc are the main sources to it. This type of finance is required for a short period up to one year.
Sources of business finance: The term source implies the agencies from which funds are procured. To meet its requirements, the private corporate sector raises finance from different sources. These sources can be classified into two categories:
A. Owned funds: - The amount contributed by the owners is known as ownership capital. Owned funds consist of the amount contributed by owners as well as the profits reinvested in the business. It acts as a source of permanent capital, risk capital and affords a right to management and control with claim only on the residual profit.
B. Borrowed Capital: – Finance raised by way of loans and credit from the public, banks and financial institution is known as borrowed capital. Its major sources consist of debentures, public deposits, banks etc. It usually available only for a fixed period and involves payment of fixed rate of interest at regular intervals.
Difference between Ownership Capital and Creditorship Capital
1. Owned capital comprises the amounts contributed by the owners and their profits reinvested. Creditorship capital consists of funds available in the form of loans or credit.
2. Owned capital is permanently invested in business whereas borrowed capital is available only for a limited period of time.
3. Owned capital act as the risk capital of business but the borrowed capital is generally secured in nature.
The major sources of business finance are:
1. Share: - The capital of a company is usually divided into certain indivisible units of a definite sum. These units are called share. Shares represent the interest of a share holder in a company measured in terms of money. Those who subscribe shares are called shareholders. Different kinds of shares are:
Preference shares:- Those shares which carry preferential right in respect of dividend and repayment of capital in the event of winding up of the company. These shares may be of:
Cumulative and Non cumulative
Participating and Non Participating
Convertible and Non Convertible
Redeemable and Irredeemable
Equity shares or ordinary shares: - Shares which do not enjoy any of the preferences attached to the preference shares are known as equity shares. They are the real owners of the company and bear the risk of business. Dividend on equity shares is paid after the dividend on preference shares has been paid. In the event of winding up, equity capital can be repaid only after settling all other claims.
Debentures: - Debenture is a certificate issued by a company under its seal acknowledging a debt due to its holders. It is a creditor ship security entitled to get the periodical payment of interest at a fixed rate.
Retained Earning: - Profits which are not distributed among the shareholders and re-invested into business is called retained earnings. This process of ploughing back of profits is also known as ‘self financing’ because it is an internal source of finance
Public deposits: – The deposits made by the public with corporate are known as public deposits.
Leading Institutions for business finance
Institutional finance refers to an institutional source of finance to business enterprises. It generally consists of:
1.Banks and other public financial institutions
2.Non- Banking finance companies, and
3.Investment Trusts and Mutual funds
Commercial Banks:- Commercial banks play a very significant role in financing the short term requirements of corporates. They provide finance by way of loans, overdrafts, cash credit and discounting bills.
Loan is granted for a specific project or purpose. Under overdraft arrangement, a customer having a current account with the bank is allowed to overdraw his account. Under cash credit scheme, the bank fixes a cash credit limit for the customer, the customer can withdraw up to this limit any number of times. But interest is charged only on the amount actually utilized. Commercial banks extend credit to industries by discounting their bills and promissory notes at a price less than their face value, the difference is the amount of interest charged by the bank.
Lending is the primary source of income for banks. The RBI insisted that 40 % of the total lending of banks should be to priority sectors such as agriculture, small enterprises, retail trade, micro-credit, education loans and housing loans.
There are 3 constituents of commercial banking structure in India. They are Public Sector banks, private sector banks and foreign banks. Public sector banking in India consists of 19 nationalized banks besides the State Bank of India and its seven associate banks, one other public sector bank (IDBI Ltd) and 88 regional rural banks. The foreign banks in the private sector are those banks that are incorporated in foreign countries. There are 30 such banks with 279 branches.
Non- Banking Finance Companies (NBFCs): Non-banking finance companies are financial institutions that provide specific financial services to meet the requirements of specific segments of the industry. NBFC is defined as a company that is a financial institution and has as its business the receiving of deposits or lending under any scheme of arrangement. It resembles like banking company since it receives deposits and lends money. However, it is not a bank because it is not incorporated as a bank and is not governed by Banking Regulation Act 1947. RBI mentioned five kinds of NBFCs such as – leasing finance companies, hire-purchase finance companies, loan finance companies, investment finance companies and residuary non- banking companies.
International sources of business funds: With the globalization and liberalization of the economy, Indian companies have started generating funds from international markets. The international sources from where the funds can be procured include foreign currency loans, commercial banks, financial assistance from international agencies and issues of financial instruments like global depository receipts (GDR) American depository receipts (ADR) and foreign currency convertible bonds (FCCB).
GDR is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stock exchange. GDR is issued in the form of depository receipt or certificate created by the Overseas Depository Bank outside India and issued to non – resident investors against the issue of ordinary shares or foreign currency convertible debentures of the issuing company.
The depositary receipts issued by a company in the US to US citizens only and can be listed and traded on a stock exchange of US only is called ADR.
An FCCB is a bond issued by an Indian company subscribed by non-residents in foreign currency and convertible is to equity shares of issuing company.
Cost of Capital: - Cost of Capital means the minimum return expected by the suppliers of capital. It is the rate of return required by lenders and stockholders of lend or invest their funds in the firm. This expected return depends on the risk they have to undertake.
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