Meaning of sources of finance:
The requirements of funds by business to carry out its various activities is called business finance.
Balance sheet as at 31.3.2021
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1 |
Sources |
|
|
(i) |
Owners fund |
Equity share capital Preference share capital Reserve and surplus Net Retained Earning |
|
(ii) |
Borrowed Funds |
Debenture Long term loan or Debt Public Deposit Long term provisions |
|
(iii) |
Current liabilities |
Creditors Short-term borrowings, Short-term provisions |
|
2 |
Application |
|
|
(i) |
Non current – Tangible Assets |
Land , building , plant and Equipment’s, Furniture and fixture , Vehicles ,Office Equipment’s ,Long term investment |
|
(ii) |
Non Current – Intangible Assets |
Goodwill , Trade Marks , Patents |
|
(iii) |
Current Assets |
Raw material WIP Finished goods Debtors Stores and spares Cash Bank Short term investment |
Let us take a case studies :
Mr. Anil Singh has been running a restaurant for the last two years. The excellent quality of food has made the restaurant popular in no time. Motivated by the success of his business, Mr. Singh is now contemplating the idea of opening a chain of similar restaurants at different places. However, the money available with him from his personal sources is not sufficient to meet the expansion requirements of his business. His father told him that he can enter into a partnership with the owner of another restaurant, who will bring in more funds but it would also require sharing of profits and control of business. He is also thinking of getting a bank loan. He is worried and confused, as he has no idea as to how and from where he should obtain additional funds. He discusses the problem with his friend Ramesh, who tells him about some other methods like issue of shares and debentures, which are available only to a company form of organisation. He further cautions him that each method has its own advantages and limitations and his final choice should be based on factors like the purpose and period for which funds are required. He wants to learn about these methods.
Then what should he do; he should consult you. as u have read chapter 7 in class 11th. Now u can give him consulting, how to raise funds for company.
This chapter provides an overview of the various sources from where funds can be procured for starting as also for running a business.
It also discusses the advantages and limitations of various sources and points out the factors that determine the choice of a suitable source of business finance. It is important for any person who wants to start a business to know about the different sources from where money can be raised. It is also important to know the relative merits and demerits of different sources so that choice of an appropriate source can be made.
Meaning, Nature and Significance of Business Finance
Meaning of business finance
The requirements of funds by business to carry out its various activities is called business finance.
Business is concerned with the production and distribution of goods and services for the satisfaction of needs of society. For carrying out various activities, business requires money.
Nature of business Finance
The need for funds arises from the stage when an entrepreneur makes a decision to start a business. Some funds are needed immediately say for the purchase of plant and machinery, furniture, and other fixed assets. Similarly, some funds are required for day-to-day operations, say to purchase raw materials, pay salaries to employees, etc. Also when the business expands, it needs funds
Significance and important of business finance
Finance is called the life blood of any business.
A business cannot function unless adequate funds are made available to it.
The initial capital contributed by the entrepreneur is not always sufficient to take care of all financial requirements of the business. A business person, therefore, has to look for different other sources from where the need for funds can be met. A clear assessment of the financial needs and the identification of various sources of finance, therefore, is a significant aspect of running a business organization.
Reasons Of Financial Needs Or Why Finance Is Required For Business
The financial needs of a business can be categorised as follows:
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1 |
Fixed capital requirements |
|
2 |
Working capital requirements |
|
2 |
Application |
|
|
(i) |
Non current – Tangible Assets Fixed capital requirements |
Land , building , plant and Equipment’s, Furniture and fixture , Vehicles ,Office Equipment’s ,Long term investment |
|
(ii) |
Non Current – Intangible Assets |
Goodwill , Trade Marks , Patents |
|
(iii) |
Current Assets Working capital requirements |
Raw material WIP Finished goods Debtors Stores and spares Cash Bank Short term investment |
|
(iii) |
Current liabilities Working capital requirements |
Creditors Short-term borrowings, Short-term provisions |
The amount of working capital required varies from one business concern to another depending on various factors. A business unit selling goods on credit, or having a slow sales turnover, for example, would require more working capital as compared to a concern selling its goods and services on cash basis or having a speedier turnover.
The requirement for fixed and working capital increases with the growth and expansion of business. At times additional funds are required for upgrading the technology employed so that the cost of production or operations can be reduced. Similarly, larger funds may be required for building higher inventories for the festive season or to meet current debts or expand the business or to shift to a new location. It is, therefore, important to evaluate the different sources from where funds can be raised.
Classification Of Sources Of Funds On The Basis Of Ownership
On the basis of ownership, the sources can be classified into owner's funds' and 'borrowed funds'.
These sources can be
|
1 |
Owners funds |
|
2 |
Borrowed Funds |
Owners funds - Meaning, Sources, Time Period, Return, Security And Control Related To Owners Funds
Meaning of owners funds:
Owner's funds means funds that are provided by the owners of an enterprise, which may be a sole trader or partners or shareholders of a company. Apart from capital, it also includes profits reinvested in the business. Owners fund:
|
1 |
Sources |
Equity shares Preference shares Retained earnings GDR ADR IDR |
|
2 |
Time Period |
The owner's capital remains invested in the business for a longer duration and is not required to be refunded during the life period of the business. |
|
3 |
Return |
Return on Owner's funds (e.g. equity and preference shares) is called dividend, which is a part of profit after tax distributed among the shareholders. Dividend is payable only when there are profits available to the company. |
|
4 |
Security |
It does not require any security. |
|
5 |
Control |
Such capital forms the basis on which owners acquire their right of control of management. |
BORROWED FUNDS - Meaning, Sources, Time Period, Return, Security And Control Related To Borrowed Funds
Meaning of borrowed funds :
|
1 |
Sources |
Debentures and Bonds Loan from Financial Institutions Loan from Commercial Banks Public Deposits Trade Credit Inter Corporate Deposits (ICD) |
|
2 |
Time Period |
Such sources provide funds for a specified period, on certain terms and conditions and have to be repaid after the expiry of that period. |
|
3 |
Return |
fixed rate of interest is paid by the borrowers on such funds. At times it puts a lot of burden on the business as payment of interest is to be made even when the earnings are low or when loss is incurred. |
|
4 |
Security |
Generally, borrowed funds are provided on the security of some fixed assets. |
|
5 |
Control |
It does not carry any right of control or management. |
Sources of owners fund: Equity Shares, Preference Shares, Retained Earnings
|
1 |
Sources |
Equity shares Preference shares Retained earnings GDR ADR IDR |
Earning of Share Holder :
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S.NO. |
Particulars |
Amount |
|
|
Sales |
xxx |
|
|
Variables cost |
(xxx) |
|
|
Contribution |
XXX |
|
|
Operating Fixed cost |
(xxx) |
|
|
Earning before Interest and Tax-EBIT |
XXX |
|
|
Interest |
(xxx) |
|
|
Earning before Tax |
XXX |
|
|
Income Tax |
(xxx) |
|
|
Earning After Tax |
XXX |
|
|
Preference dividend |
(xxx) |
|
|
Earning available for equity share holder |
|
|
|
No of Equity Share |
xxx |
|
|
Earning per Share |
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Equity Shares
Equity shares is the most important source of raising long term capital by a company.
Equity shares represent the ownership of a company and thus the capital raised by issue of such shares is known as ownership capital or owner’s funds.
Equity share capital is a prerequisite to the creation of a company.
Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company.
They are referred to as ‘residual owners’ since they receive what is left after all other claims on the company’s income and assets have been settled.
They enjoy the reward as well as bear the risk of ownership.
Their liability, however, is limited to the extent of capital contributed by them in the company.
Through their right to vote, these shareholders have a right to participate in the management of the company.
Preference Shares
The capital raised by issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential position over equity shareholders in two ways:
Receiving a fixed rate of dividend, out of the net profits of the company, before any dividend is declared for equity shareholders; and receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.
In other words, as compared to the equity shareholders, the preference shareholders have a preferential claim over dividend and repayment of capital.
Preference shares resemble debentures as they bear fixed rate of return. Also as the dividend is payable only at the discretion of the directors and only out of profit after tax, to that extent, these resemble equity shares. Thus, preference shares have some characteristics of both equity shares and debentures.
Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.
A company can issue different types of preference share:
Retained Earnings
A company generally does not distribute all its earnings amongst the shareholders as dividends. A portion of the net earnings may be retained in the business for use in the future. This is known as retained earnings.
It is a source of internal financing or self financing or ‘ploughing back of profits’.
The profit available for ploughing back in an organisation depends on many factors like net profits, dividend policy and age of the organisation.
Sources of owners fund -American Depository Receipts (ADRs):
|
1 |
Sources |
Equity shares Preference shares Retained earnings GDR ADR IDR |
CASE STUDIES - TATA MOTORS ISSUING ADR
ADRs are issued by an approved American bank such as BONY, CITI bank etc or trust company. ADR are issued against the deposit of the original shares. These are deposited in a custodial account in the US.
Receipt are issued by bank or custodian to investors.
Such receipts have to be issued in accordance with the provisions stipulated by the Security Exchange Commission USA.
Each ADR represents a certain number of a company's regular shares.
ADRs allow US investors to buy shares of these companies without any risk of foreign exchange fluctuation.
ADRs can be traded either by trading existing ADRs or purchasing the shares in the issuer's home market based upon availability and market conditions. When trading in existing ADRs, then trading will be done in secondary market of the New York Stock Exchange (NYSE) through Depository Trust Company (DTC) without involvement from foreign brokers or custodians.
When transactions are made, the ADRs change hands, not the certificates. This eliminates the actual transfer of stock certificates between the US and foreign countries.
The Indian companies have preferred the GDRs to ADRs because the US market exposes them to a higher level or responsibility than a European listing in the areas of disclosure, costs, liabilities and timing.
The most strict aspect of a US listing for the companies is to provide full, half yearly and quarterly accounts in accordance with, US GAAPs.
It is similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of USA.
Sources of owners fund -Global Depository Receipts (GDR’s):
|
1 |
Sources |
Equity shares Preference shares Retained earnings GDR ADR IDR |
These financial instruments are used by companies to raise capital in either dollars or Euros. These are mainly traded in European countries and particularly in London.
GDR are negotiable certificate held in the bank of one country representing a specific number of shares of a stock traded on the exchange of another country.
Indian companies are shedding their reluctance to tap the US markets. Infosys Technologies was the first Indian company to be listed on Nasdaq in 1999. However, the first Indian firm to issue sponsored GDR or ADR was Reliance industries Limited. Beside, these two companies there are several other Indian firms are also listed in the overseas bourses. These are Wipro, MTNL, State Bank of India, Tata Motors, Dr. Reddy's Lab, Ranbaxy, Larsen & Toubro, ITC, ICICI Bank, Hindalco, HDFC Bank and Bajaj Auto.
The local currency shares of a company are delivered to the depository bank. The depository bank issues depository receipts against these shares. Such depository receipts denominated in US dollars are known as Global Depository Receipts (GDR).
GDR is a negotiable instrument and can be traded freely like any other security.
In the Indian context, a 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.
A holder of GDR can at any time convert it into the number of shares it represents.
The holders of GDRs do not carry any voting rights but only dividends and capital appreciation.
Many Indian companies such as Infosys, Reliance, Wipro and ICICI have raised money through issue of GDRs .
Sources of owners fund Indian Depository Receipt (IDRs):
|
1 |
Sources |
Equity shares Preference shares Retained earnings GDR ADR IDR |
The concept of the depository receipt mechanism which is used to raise funds in foreign currency has been applied in the Indian Capital Market through the issue of Indian Depository Receipts (IDRs). IDRs are similar to ADRs/GDRs in the sense that foreign companies can issue IDRs to raise funds from the Indian Capital Market in the same lines as an Indian company uses ADRs/GDRs to raise foreign capital. The IDRs are listed and traded in India in the same way as other Indian securities are traded.
An Indian Depository Receipt is a financial instrument denominated in Indian Rupees in the form of a Depository Receipt.
It is created by an Indian Depository to enable a foreign company to raise funds from the Indian securities market.
The IDR is a specific Indian version of the similar global depository receipts.
The foreign company issuing IDR deposits shares to an Indian Depository (custodian of securities registered with the Securities and Exchange Board of India). In turn, the depository issues receipts to investors in India against these shares.
The benefits of the underlying shares (like bonus, dividends, etc.) accrue to the IDR holders in India.
According to SEBI guidelines, IDRs are issued to Indian residents in the same way as domestic shares are issued. The issuer company makes a public offer in India, and residents can bid in exactly the same format and method as they bid for Indian shares.
‘Standard Chartered PLC’ was the first company that issued Indian Depository Receipt in Indian securities market in June 2010.
VARIOUS SOURCE SOURCES OF BORROWED FUNDS
|
1 |
Debentures and bonds |
|
2 |
Bonds |
|
3 |
Loan From Financial Institutions |
1 Debentures and bonds
|
1 |
Sources |
Debentures and Bonds Loan from Financial Institutions Loan from Commercial Banks Public Deposits Trade Credit Inter Corporate Deposits (ICD) |
Debentures are an important instrument for raising long term debt capital. A company can raise funds through issue of debentures, which bear a fixed rate of interest.
The debenture issued by a company is an acknowledgment that the company has borrowed a certain amount of money, which it promises to repay at a future date. Debenture holders are, therefore, termed as creditors of the company.
Debenture holders are paid a fixed stated amount of interest at specified intervals say six months or one year. For example, if X ltd. Has 8
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