finance 15

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Types of Capital

Following are two the types of capital required by a businessman:

. xe cap ta

Fixed capital is required to acquire fixed assets like land, building, plant, machinery, office

equipment, furniture and fixtures, erection and installation of machinery, etc.

In addition, fixed ca ital is also re uired for meetin the cost incurred on insurance, technical

know-how etc.

2.Working capital

Working capital is needed to meet day-to-day requirements of a business.

Types of Finance

1. Long term finance

Long term finance is used for investment in fixed assets such as land and building, plant and machinery

etc. It is used to meet the permanent needs of business. It can be raised through owned capital and

lon term loans. Such finance cannot be withdrawn from the business.

2.Short term finance

Short term finance is used for investment in working capital. It is used to meet the short term needs of

t e us ness. or examp e, purc ase o raw mater a , payment o wages etc. ese un s are norma y

required for a period ranging from three months to two years.

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SOURCES OF FINANCE

The sources of funds can be broadly divided into:

ii) borrowed capital.

¾Owned capital is the money brought in by the businessman himself

¾Borrowed capital is the money advanced by outside agencies.

However, sources can also be segregated into long term sources and short term

.

Sources for Long Term Finance

1. Owned capital

. e a ne ro s

3. Funds borrowed from friends and relatives.

4. Loans from Commercial banks

5. Loans from National-level Financial Institutions

6. Loans from various State-level Financial Institutions

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Short Term Sources of Finance

Short term finance is required for meeting the short term requirements of

business (like working capital). Short term loans are usually repayable within a

under:1. Bank Overdraft

2. Cash Credit

. scoun ng o s o xc ange

4. Short term loans

5. Trade Credit from suppliers6. Accounts Pa able

7. Advances from customers

8. Accruals

9. Factoring

. -11. Indigenous Bankers

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Let’s now discuss some of the important specialised financial institutions.

1. Industrial Develo ment Bank of India IDBI

IDBI was set up as a wholly owned subsidiary of Reserve Bank of India in July, 1964 by an Act of

Parliament. It serves as an apex level national institution for providing term finance to the industry.

In 1976, the ownership of IDBI was transferred to the Government and it was entrusted with the

a ona respons y o ac ng as pr nc pa nanc a ns u on or coor na ng e ac v es o

institutions engaged in the financing, promotion or development of industry.

Functions of IDBI

i) It provides direct financial assistance to industrial concerns by giving them long term loans.

ii) It provides technical and administrative assistance for promotion and expansion of industry.

iii) It guarantees loans raised by industrial concerns from other financial institutions.

.

v) It provides refinancing facilities.

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2. Small Industries Development Bank of India (SIDBI)

. . ,as a wholly-owned subsidiary of IDBI for re-financing, bills rediscounting, and equity support to the

small scale sector. It started functioning on April 2, 1990. SIDBI was de-linked from IDBI w.e.f. 27 th

March, 2000. It serves as an apex level national institution for promotion, finance and development

of industries in the small sector.

Functions of SIDBI i) It provides financial assistance through term loans and working capital.

ii It rovides finance throu h discountin and re-discountin of bills arisin from the sale of

machinery to small units.

iii) It providesVenture Capital support.

iv) It provides services like factoring, leasing etc.

3. National Bank for Agriculture and Rural Development (NABARD)

NABARD has been set up for the promotion of agriculture, small scale industries, cottage and

, . . .came into existence on July 12, 1982. It provides refinancing facilities. It has initiated Micro

Finance programme under which millions of poor people have been provided access to credit. It

has created special funds like Watershed Development Fund, Tribal Development Fund, Research

and Development Fund, Farm Innovations Fund, and Micro Finance Development and Equity

Fund to support innovations in neglected areas.

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4. Re ional Rural Banks RRBs

The object of setting up Regional Rural Banks was to bring the banking services to the doorsteps of

rural masses. Initially these banks were providing funds to target groups comprising weaker sections of

. ,

outside the target group also by classifying their advances into priority sector and non-priority sector.

5. State Financial Corporations (SFCs)

A special law known as State Financial Corporation Act, 1951 was passed by the Parliament to enable all.

are operating in different States and Union Territories.

The main objective of SFCs is to finance and promote small and medium enterprises and projects

costing up to Rs.5 crores for achieving balanced regional socio-economic growth and generating

employment opportunities. SFCs operate a number of schemes of refinance and equity type of assistanceformulated by IDBI, SIDBI which include schemes for artisans, SC/ST, women, ex- serviceman,

physically handicapped etc. and for transport operators, for setting up hotels, hospitals etc.

SFCs can rovide financial assistance to ro rietar concerns and artnershi firms u to Rs. 120 lacs.

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Functions of State Financial Corporations

Following are the functions of SFCs:

i The rovide term loans for ac uirin land buildin lant and machiner other

miscellaneous fixed assets etc.ii) They establish polytechnics or training institutes for imparting training to technically

qualified persons.

iii) They take up the development of lesser developed parts of the State and engage in

infrastructure development like electricity, road, water etc.

iv)They promote self-employment.v) They provide finance for expansion, modernization and up-gradation of technology in

the existing units.

vi)They identify and examine local problems.

v y v .viii)They provide deferred payment guarantees for purchasing plant and machinery.

ix)They provide foreign exchange loans to industrial units under World Bank Schemes.

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SIDCs were set up in 1960s and 1970s. These were established as wholly-owned

undertakings of the State Governments under the Companies Act, 1956 or autonomous

cor orations under s ecific State Acts. Different States have set u the State Industrial

Development Corporations with a view to improving the growth of industry in their

States. These corporations operate as per the Guidelines issued by State Governments.

There are 28 SIDCs operating in our country. They provide assistance to small and

medium units and projects costing up to Rs. 10 crores.

Functions of SIDCs

i) They promote and develop industries by activities like project identification,preparat on o pro ect report, se ect on an tra n ng o entrepreneurs.

ii) They provide term loans to industries.

iii) They grant incentives and subsidies on behalf of the Central and State

.iv) They act as agent of IDBI, SIDBI and thereby provide the benefit of seed capital

scheme.

v The rovide risk ca ital to entre reneurs b wa of e uit artici ation.

vi) They develop industrial area by providing infrastructural facilities.

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7. State Small Industries Development Corporations (SSIDCs)

,cottage industries in the States/Union Territories. They undertake a variety of activities for

development of the small sector.At present, there are 18 SSIDCs in operation.

Functions of SSIDCs

i)They extend seed capital assistance on behalf of the State Government.

ii)They procure and distribute scarce raw material.iii)They provide machinery on hire-purchase basis.

iv The rovide assistance for marketin of the roducts of small scale units.

v)They provide managerial assistance to production units.

8. District Industries Centres (DICs)

DICs have been established in every district. The objective of establishing such centres is to develop

small and village industries. They collect information about the availability of raw material and

make arrangements for machinery and equipment, marketing research, credit facilities etc. for the

.and sponsor their loan applications to the banks operating in the district. Under the Prime

Minister’s Rozgar Yojna Scheme (PMRY), DICs are assigned the task of identification of

beneficiaries and implementation of the Scheme in the district.

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EVALUATION OFTHE SOURCES OF FINANCE

Advantages of Owned Capital

i Su l o lon term ca ital:The businessman obtains unds on lon term basis.Owned ca ital rovides lon terminvestment.

ii) Control: The businessman maintains full control over his business. He has full rights to take decisions without

interference from any outside person.Thus, he commands control over his business.

o c arge on assets: e usinessman is not require to eep is assets as security wit any institution so ong is

own capital is used in the business. Consequently, he can offer the assets of the firm to other agencies for raising loanin case he is in need of additional capital besides his own.

iv) No re a ment o liabilit :Owned ca ital is not re uired to be returned to an bod as in the case o loan which

is required to be repaid over a period of time.

v) No fixed cost: Owned capital does not carry any fixed rate of return as in the case of a loan where interest is

required to be paid on periodical basis.

Disadvantages of Owned Capital

i) Investment of the personal savings: In case a businessman has invested his own money in the business, a large

chunk of his personal savings goes away.Therefore, not much is left for his rainy days.

ii) Limited scope of expansion: With his owned capital invested in the business, a businessman has limited scope of expansion. This is so because he can commit his own resources to a certain extent and beyond that he will have to

borrow from outside sources.

iii Dan er o over-ca italisation: Use o owned ca ital ma lead at times to ove -ca italisation. This is so because

the businessman is free to invest as much capital as he can. At times, the capital invested is more without being put

to productive use.In that case the rate of earning is less in comparison to the capital invested.

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Advantages of Borrowed Capital

i) Availability of funds:The businessman obtains the funds which are not available through owned capital.

assets.

iii) Scope for expansion: A businessman can think of expanding his business because with the help of borrowed

money further resources are available which can be used in modernization and diversification of the business.

iv) Tax Benefit: Interest paid on borrowed capital is an expenditure which is deducted from the profits liable to

income tax.The loans thus provide tax benefit to the businessman.v) Non-interference in the management:The banks generally do not interfere in the management of the business.

Disadvantages of Borrowed Capitalnanc a ur en: e us nessman s requ re to pay t e nterest on t e oan regu ar y at a xe rate. s resu ts

in the creation of financial burden if the enterprise is running at a loss.

ii) Charge on assets: The loans are generally secured by pledging the assets as security. Owing to the pledging the

assets do not remain free.

iii) Borrowing capacity: Ideal debt-equity ratio is 2:1. Excessive borrowing reduces capacity to borrow and thereforethe businessman is unable to borrow after a certain limit.

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Factors Affecting the Choice of the Source of Loan

Following are the factors which should be evaluated while making a choice about the source of availing

oan:

i) Rate of interest: Interest is an expense for the firm to be paid on regular basis whether the business earns

profit or not. This reduces the profits of the firm. Therefore, the businessman should enquire as to which

particular institution. He should opt for that source only where the interest burden is the lowest.ii) Repayment period: The businessman should evaluate the various sources of loan from the point of view

o re a ment terms. The banker/institution who rovides lon er re a ment eriod or the similar loan

should be preferred.

iii) Margin requirement: Every lender insists upon minimum contribution as margin from the side of

businessman. However, margin requirement may differ from bank to bank. Thus, a businessman should

negotiate the loan proceedings with the bank which offers lower margin requirements.

iv) Processing charges: Every financial institution imposes some charges for processing the loan proposal,

known as processing charges. It is also one of the factors which should be considered while evaluating a

loan. Lower processing charges should be preferred. At the same time, it should be seen that there is nohidden cost involved in a particular loan proposal.

v) Time-period involved in sanctioning the loan: The banker who takes lesser time in sanctioning and

s urs ng e oan s ou e pre erre . n e case o some an s even ranc managers are empowere o

sanction loans whereas in the case of others, the sanction comes from the higher authority.

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