Business Finance

 

Business Finance

To run any business institution , one need a proper finance. Finance is a major function of any business enterprise. It deals with the arrangement of an adequate amount of capital to achieve the objectives of the enterprise. And, such kind of finance which helps a business to establish for a long-run , is called a business finance.

 

Business Finance refers to capital funds invested in the business. Financing means making money available when it is needed. Business may be defined as , planning, raising, managing and controlling all the money used or capital funds of any kind used in connection with business .

  

 

No Enterprise can run without adequate funds and capital. It requires lots and lots of money to survive and grow in the existing market competition .There are some important factors which can make a company or firm or business  exist in the long-run market competition which are as follows :

 

1.       Goodwill - An institution must have a goodwill in the market , in terms of its dealings, Employee behaviour and social obligations.

 

2.       Money - An institution must have a adequate capital and funds so that it can be operated effectively and can survive in the market.

3.       Quality work -  A company or firm must not compromise wit the quality of there product and services in which they are dealing in .

 

4.       Employee behaviour - Employees or labor are the one of the important factors of the production . So, there must be a good behaviour done with them like, proper salary wages on time , fixed working hours , medical facility and many more but also in return these employees has to work efficiently.

 

5.       Dividend Rate -  Rate that company is offering it’s investors and creditors on dividend and interest.

 

For every business enterprise, there are two sources of business finance :

v  Owner’s fund

v  Borrowed fund

 

Owner’s fund

Owner’s fund refers to the funds contributed by owners as well as the accumulated profit of the company. This fund remains with the company and it has no liability to return  this fund.

 

Main features of Owner’s funds :

1.       It is a permanent source of capital which is invested by the investor and is not refundable like borrowed funds. A large number of owner’s fund is used for acquiring the fixed assets.

 

2.       Owner’s fund is also called “ a risk capital of the business “ because it is not fixed that whether the owners were able to get any return or not, whether the company will be able to make any profit or not.

 

3.       In this kind of funds, there is no security required for the ownership capital. Investor can directly invest their money in the firm and can become a part owner of a company.

 

Ways in which owner’s fund can be raised (IRAGI) :

v  Issuing the shares  (Equity shares and Preference shares)

v  Retained Earnings

v  American depository Receipt (ADR)

v  Global depository Receipt (GDR)

v  International depository Receipt (IDR)

Issuing of shares :

Shares are the smallest unit in which owner’s capital of a company is divided. Shares directly shows the interest of a investor or a shareholder mean to say that in layman’s language if more no. of  is purchased so it shows that more the shareholders are interested in a company. Issuing of shares involves the issuing of two types of shares one is equity shares and the other one is Preference shares. 

 

Equity shareholders

Equity shares are long-term financing sources for any company. These shares are issued to the general public and are non-redeemable in nature. Investors in such shares hold the right to vote, share profits and claim assets of the company.

 

Main Features of Equity shareholders :

v  Primary risk bearers - They are the main risk bearer of the company. They all invest their money in the shares of the company knowing with the fact that they will only get their dividend when the company will make the profit otherwise no.

 

v  There profit margin is not fixed, if the company made higher profit then these shareholders will get higher rate of dividend.

 

v  Equity Shareholders has the major control of the company. They have the right to vote, they cant cast their votes and select the board of directors who control and manage the affairs of the company.

 

v  Pre-emptive right - The equity shareholders are given the pre-emptive rights by the provisions of companies act. According to this right, whenever a company is planning to issue new share ,it must offer the shares to the existing shareholders first. 

 

v  Equity shares is the permanent capital. They provide permanent funds of a company. There is no fixed commitment to return the money or a pay a fixed rate of dividend.

 

Preference Shareholders

Preference shareholders are those shareholders whose shares get preference over equity shares in respect to. These shareholders do not get any voting rights .These are also long-term financing sources for the company. They have the fixed rate of interest on dividend and hence, enjoy the  feature of hybrid security.

 

Main Features of Preference shareholders :

v  They all have a fixed rate of interest on dividend .They will also get the dividend when the company makes the accumulated profit.

 

v  The preference shareholders do not get the voting rights .However, the preference shareholders get voting rights if the dividends are not paid for two years and more.

 

v  No security - Companies do not offer any security  against preference shares. The preference share capital is a part of owners fund.

 

v  Preference shareholders enjoy hybrid securities, as these shares have the features of equity share  that they ill only get the dividend when the company will make accumulate profit as well as features of debentures that they will also get the dividend on fixed rate.

 

 

Retained earnings :

Retained Earnings are also known as ploughing back of profit, retained profits, self-financing or internal financing ,reserves or surplus. Retained Earnings refers to undistributed profits after payment of dividend and taxes. It  provides the basis of expansion and growth of companies ,It is considered to be the most important source of finance. Since ,it is internally generated this method of financing  is known as, Self financing .

 

Main Features of Retained earnings :

v  Retained earnings are also called “cushion of security” because they provide support in times of adversity, when a company finds it difficult  to arrange finances from any other source.

 

v  Retained profit is considered as an ownership fund. It serves the purpose of medium and long-term finance .

 

v  The retained earnings are a common source of funds for financing risky and innovative projects. This fund is generally used for research work, expansion projects.

 

v  Conversion into Ownership funds : The surplus retained earnings can be converted into share capital by issue of bonus shares. In bonus shares, there is no outflow of cash. Investors too are benefited by the issue of shares free of cost .

 

 

 

Global Depository Receipt (GDR):

Global Depository Receipt are issued against issue of equity shares in he global market. These are indirect equity offerings. The equity shares against GDR are held by an international bank called depository. Companies issue dividend notices, reports etc. Regarding these shares to a bank only. These shares are called Depository shares.

 

Main Features of Global Depository Receipt (GDR) :

v  Capital collected from the issue of GDR is in foreign currency.

v  The issue price of GDR is fixed on the basis of investor’s response.

v  No voting  rights are given to GDR holders

v  GDRs are easily  transferable at the stock exchange.

v  The first Indian company to issue GDR’s was Reliance Industries . It sold $150 million worth of GDR’s in 1992.

 

 

American depository Receipt (ADR) :

An ADR is just like a GDR except that it can be issued to a citizen of USA only and it can be listed in the US stock exchange. Shares issued by the company are held by an international bank called depository, which receives dividend notices and reports. ADRs  are subject to much stricter disclosure requirements than GDRs because regulations of US stock exchange are very strict. Annual legal and accounting cost of maintaining an ADR are much higher than GDR.

 

An ADR is an American dollar-denominated instrument. Any American bank functioning as a depository can issue ADR.

 

International depository Receipt (IDR) :

An IDR is also like GDR except that it is issued to citizen of India. Through IDR, foreign companies raise funds from Indian market. The foreign company IDRs will deposit shares to an Indian depository. The depository issues receipts to investors in India against these shares. Standard chartered bank was the global company to file for an issue of IDR in India.

 

Reservations to issue IDRs :

At least 50% of the issue is to be allocated to qualified institutional buyers, 30% of the issue to the retail individual investors and balance 20% of the issue to non-institutional investors and employees.

Eligibility of companies to issue IDRs :

1.       It must have net worth of Rs. One crore in each preceding three years.

2.       It has net tangible assets of at least three crores in three years continuously.

3.       The issuing company must be listed in its home country and is not prohibited to issue securities by any regulatory authority.

 

Borrowed funds

Borrowed funds refers to the money amount that is borrowed by someone or some firm. It is a liability of the business firm .These funds are different from the capital owned by the company called equity funds.

 

Main features of borrowed funds

1. Borrowed funds are raised by business for certain fixed time periods, it can be short-term, medium-term or long-term, based on the requirement of the business.

 

2. Borrowed funds can be obtained against securities of the fixed assets of the business.

 

3. Businesses need to make regular interest payment for the loans obtained as funds as well as need to pay the principal amount after a fixed time.

 

4. The security holders of the borrowed funds do not have control over the business activities of the firm. They can however sue the firm in case there is default in payment of loan.

 

The ways in which borrowed funds can be raised (TIPLCD)

v  Trade credits

v  ICD

v  Public deposits

v  Loans from a financial institutions

v  Commercial banks

v  Debentures/Bonds

 

 

 

 

Trade credits :

Trade credits refers to an arrangement whereby a manufacturer is granted credit from the supplier of raw materials, input, spare parts etc. The suppliers allow their customers to pay their outstanding balance within a credit period. Generally the duration of trade credit is three to six months and thus it is short-term financing facility. The availability of trade credit depends upon :

a)       Size of the firm

b)       Nature of the firm

c)        Status or creditworthiness of the firm

 

Main features of Trade credit :

v  Readily available - Trade credit is available without any special efforts on the part of a manufacturer or trader.

 

v  No flotation cost - No flotation cost is involved in arranging trade credit.

 

v  Increases in price - Sometimes, the supplier may increase the price of commodity or raw material supplied if he is selling goods on credit.

 

v  Legal action - In trade credit, the buyer generally issues a promissory note and in case he fails to meet his commitment , the supplier can take a legal action.

 

Public Deposits :

Public deposits refers to unsecured deposits invited from the public. A company wishing to invite public deposits places an advertisement in newspapers. Any member of the public can fill up the prescribed form and deposit money with the company.

 

Main features of Public deposits :

v  Unsecured - Companies mortgage no assets against the public deposits raised from general public  .

 

v  Time period- Public deposits can be invited by companies for a period of six months to three years.

 

v  Financial of working capital - The amount raised from public deposits is generally used by the company for meeting the requirements of working capital. Though they are a primary source short-term finance but by renewing these can be used for medium-term also.

 

v  Repayment - A company which has public  deposits is required to set  aside 10 percent of the deposits maturing b=y the end of the year. The amount so set aside can be used for repaying public deposits.

 

Debentures / Bonds :

Debentures includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

            It can also be defined as “Document or  a certificate” issued by a company under its seal as an acknowledgement of its debt. Holder of debenture certificate is called Debenture holder.

 

Main features of Debentures :

v  Borrowed funds - Debentures are part of borrowed fund capital as debenture-holders are considered as the creditors of the company.

 

v  Fixed rate of interest - The interest on debentures is paid at a fixed rate. The rate of interest is decided in the annual general meeting of the company.

 

v  Redeemable - Debentures are always redeemed or paid back on expiry of a fixed period of time.

 

v  No voting rights - Debenture holders have no say in the management as they are never granted voting rights in the company.

 

Commercial banks :

Commercial banks occupy a very important position as they provide funds for different purposes and different periods. Firms of all sizes can approach commercial banks. Generally commercial banks provide short-term and medium-term loans but nowadays they have started giving long-term loans against security.

 

Main features of Commercial banks :

v  Banks provide funds to firms as and when required

v  Funds are generally available for a short period.

v  In some cases, banks may put restrictions and difficult terms and conditions .

v  Banks make detailed investigations of the company’s affairs and financial structure before issue of loan.

v  It is very flexible source as loan amount can be increased as well as decreased.

v   The banks keep the information of borrower confidential and the business can maintain its secrecy.

v  No formalities of issue of prospectus etc. Are required. So, it is very easy and economical source of funds.

 

Loans from financial institutions :

Public financial institutions are referred to as lending institutions, development banks or financial institutions. After independence, the government of India realized that for economic development of a country only commercial banks  are not sufficient. There must be financial institutions to provide financial assistance and guidance to industries and business enterprises. The need for public financial institutions was felt due to the following reasons:

 

Features of Loans from financial institutions:

v  Long-term finance - Financial institutions provide long-term finance

v  Subscribers of securities - Financial institutions often subscribe to the shares and debentures of companies

v  Managerial advice- Financial institutions provide managerial as well as financial advice on various matters.

v  Underwriters - Financial institutions underwrite the public issue of shares and debentures by companies.

v   Guarantee loan: Financial institutions provide loan guarantees to industrial units from other banks and financial institutions.

Inter - corporate deposits (ICDs) :

It is the deposits made by one company with another company. This option of using finance is available to all public companies whether having share capital or not . It includes :

1.       When a company acquires security of another company.

2.       When a company gives loan to another company.

3.       When a company gives guarantee to any person or institutions who provides loan to another company. In general, we can say when companies arrange funds from another company it is known as Inter-corporate deposits .

 

Types of Inter-corporate Deposits :

1)       Three month’s Deposits - This is the most common deposits to overcome the short term finance problem. The annual rate of interest given for three month’s deposits is 12%.

 

2)       Six Month’s Deposits - These are made with first class borrowers. The annual interest rate is 15%.

 

3)       Call Deposits - This can be withdrawn by lender by giving one-day notice. The rate of interest is 10%.

 

Main features of ICDs :

v  Higher rate of interest than bank

v  High risk as ICD are unsecured deposits.

v  Not suitable for long term finance.

v  Secrecy-  The broker in this market never reveal their list of lenders and borrowers.