Introduction:

Finance is considered as the life-force of industry. Without getting

adequate finance industrial development is not at all possible.
Due to the lack of adequate finance, industrial development in
India could not achieve a significant position and shape.
Industries require short term, medium term and long term finance
for meeting their requirements of fixed capital expenditure and
also to meet their working capital needs.

The Need for Industrial Finance:

A business firm, whether it is owned by an individual proprietor or
partners or shareholders, undertakes business in anticipation of
future gain or return from it. For setting up in business the firm
has to make advance expenditure before it receives any return.
The machines are to be purchased, the factory space is to be
purchased or leased, raw materials are to be bought and wages
and salaries arc to be paid to the employees for their services
Finance is needed to undertake all such activities in business.
The money which the firm commits on its business is expected to
come back to the firm in the form of return m due coursed of
time. The firm has to wait for this. A farmer ploughs and sows his
fields months before he reaps the harvest A transport company
has to buy trucks and motors and pay for petrol labour, etc.
before it gets paid for its haulage services.

Similarly, a manufactures has to produce goods be ore he can sell

them He can do only when he has adequate finances for
production of his goods. It is true that some industries goods are
sold before they are made but even in such industries the
entrepreneurs need finance to equip themselves for necessary
facilities of production of the goods and services. Finance is thus a
necessary precondition for business both for its initiation and
smooth running.
The requirement for finance depends on the type of business or
production and the kind of payment for which it is to be used.
Large scale production with capital-intensive technology would
require huge amount of money for initial investment and for
operating expenses.
Small scale products with relatively labor-intensive technology on
the other hand may need less money to start the businesses and
to operate it The nature of technology and the level of output to
be produced are natural determinants of the requirements of
finance.
In some business, it takes considerably long time to set the p ant
and to make it operative. In business terminology such length of
time is called gestation period. Longer the gestation period more
will be the requirement of finance. Steel mills, refineries, ship
building, power plants, etc. are a few examples of such business.

Apart from the gestation period, the length of operating cycle will
have considerable implications on requirement of finance.
Operating cycle is the speed w which the working capital
completes its round, i.e., conversion of cash into inventory of raw
materials and stores inventory of raw materials into inventory of
finished goods, inventory of finished goods into book debts or
accounts receivable from the customers and finally realization of
cash from the customer.
Longer the period for such cycle, more will be the requirement of
finance for business operations. The other factors that influence
the requirement of business finance can be cited as terms of
purchases and sales, growth and expansion policies of the firm,
dividend policy, production policies, business cycle fluctuations
and managerial efficiency of the firm.
In short, initially finance is needed to establish the business, i.e.
installation of plant and other facilities which we call Fixed Capital
Formation. Once such facilities are developed then money will be
needed/or meeting the requirements of Working Capital.

TYPES OF INDUSTRIAL FINANCE:

: Long-Term, Medium-Term and Short-Term Finance:
Long term finance for industries includes those financial resources
which are advanced to the industries by the banks for a period of
3 years and above. Long term finance is quite important for the
expansion and modernization of industrial projects and also to
meet its fixed capital expenditure requirement.

Long term finance is mostly available from the sale of shares and
debentures, and loan from term lending financial institutions like
IDBI, IFCI, and ICICI etc. Medium term loan is also available from
banks and other financial institutions for a period above 1 year
and up to 3 years.
Short-term finance for industries includes those financial
resources which are advanced by hanks to the industries for a
period varying between 1 month to 12 months. Short-term
finance is required to meet working capital needs and other
sundry expenses of the industrial projects. Commercial banks
offer short term loans on cash-credit basis on the security or
stocks and overdraft facilities to the industries. Industries can also
raise short term finance by raising public deposits for one to three
years.

Functions of industrial finance:

Starting Capital:
Every new venture needs seed money. Entrepreneurs only have
dreams and ideas until they have some capital to put their ideas
in motion. Whether it's a product or service, you will need a way
to create and deliver it -- as well as enough money and time to lay
the groundwork of selling and establishing important
relationships. Most business owners face the critical choice
between debt and equity financing. A small business loan leaves
you free to own and have absolute control over your company
while it also leaves you lasting financial obligations. Equity gives
you cash, but you have to share the success. The critical decision
in your financing will determine how your business will work from
that point onward.

Debt Ratios:
Finances are about more than money in your hand. While most
businesses have some amount of debt -- especially in the
beginning stages -- too much debt compared with revenues and
assets can leave your with more problems than making your loan
payments. Vendors and suppliers often run credit checks and may
limit what you can buy on credit or keep tight payment terms.
Debt ratios can affect your ability to attract investors including
venture capital firms and to acquire or lease commercial space.
Business Cycles:
No matter how well your business is doing, you have to prepare
for rainy days and even storms. Business and economic cycles
bring dark clouds you can't predict. That's why smart businesses
create financial plans for downturns. Cash savings, good credit,
smart investments, and favorable supply and real estate
arrangements can help a business stay afloat or even maintain
momentum when the business climate is unfavorable.
Growth:
Success can bring a business to a difficult crossroads. Sometimes
to take on more business and attain greater success, a company
needs significant financial investment to acquire new new capital,
staff or inventory. When business managers hit this juncture, they
have to wade through their financial options, which may involve
infusions of equity capitals -- perhaps from venture capitalists.
Every situation is different, but smart managers consider the cost
of success and their options for obtaining growth financing.
Payroll:
Nothing spells imminent death like a company being unable to
make payroll. Even the most dedicated staff won't stick around
long once the paychecks stop. The larger an organization gets,
the larger the labor costs. Above all, companies have to ensure
they have enough cash on hand to make payroll for at least two
payroll cycles ahead -- if not more. Financial planning to ensure

your payroll accounts are in strong shape are essential to the

integrity and longevity of your company

Internal Sources of Industrial Finance:

Following are some of the major sources from which
Indian industries are getting their necessary finance in a
regular manner:
(a) Shares and Debentures:
Indian industries are normally raising a major portion of their
capital by selling shares in low denominations of Rs. 10 each.
Share may be a preference share or an ordinary share.
Debentures are also issued in the capital market by the
companies and in recent years convertible debentures are
gradually becoming more popular.
(b) Public Deposits:
Another source of industrial finance is the deposit raised from the
public. Ahmedabad textile industry was primarily established on
the basis of public deposit. Besides, Cotton Mills of Mumbai and
Sholapur. Tea Gardens of Assam and Bengal have also raised their
fixed capital in sufficient quantity through public deposit.
In recent years, many industrial firms have joined hands in
inviting deposits from public for one to three years by offering
attractive rates of interest. The main defect of this source is that

these deposits may be withdrawn at any moment and cannot be

used for long-term investment projects.
(c) Commercial Banks:
Commercial banks are also offering short-term loans on cashcredit basis on the security of stock and on the additional
guarantee of the managing agent. The commercial banks are
generally advancing loan for meeting working capital needs of the
industries in the form of advancing loan, overdraft, and cash
credit facilities against government securities and pledge of
stocks. Commercial Banks, nowadays, have been advancing
medium term loan to the industries particularly since the
establishment of IDBI.

(d) Indigenous Bankers:

In India indigenous bankers have been rendering important
services to industry in time of their difficulty. In urban areas both
the small and medium size industries are getting sufficient
finance from indigenous bankers. But these Indigenous bankers
normally charge exorbitant rate of interest on such loan.
(e) Term-lending Institutions:
In view of the inadequacy of finance from the above mentioned
sources, various term lending institutions have been developed to
advance loan in order to meet financial requirement of these
industries. These institutions include Industrial Finance
Corporation of India (IFCI), Industrial Credit and Investment

Corporation of India (ICICI), Industrial Development Bank of India

(IDBI), Industrial Reconstruction Corporation of India (IRCI), State
Financial Corporations and State Industrial Development
Corporations (in different states). Besides,-Life Insurance
Corporation of India (LICI) and Unit Trust of India are also
providing a good amount of loan to Indian industries and emerged
as a most important source of industrial finance in recent years.
(f) Retained Profits:
Retained profits or undistributed profits of the industries are also
being ploughed back into the industry for meeting its
requirements of replacement, modernization and expansion.

External Sources of Industrial Finance:

This section is framed to identify the various sources of industrial
finance and growth. The relationship between these variables and
industrial production in Indian context has also been discussed.
Variables have been selected based on two aspects a) investment
b) credit. a) Domestic Capital Formation the planners, in the
fifties, had recognized that the material shortage of capital in
relation to labor was the principal constraint to the industrial
growth. It was envisioned that increased capital formation would
contribute for more industrial output & a 'virtues circle' of growth.
Gross Capital Formation (GCF) is estimated across three types of
assets, viz., construction, machinery and equipment. The GCF,
adjusted for errors and omissions, is termed as aggregate
investment or Gross Domestic Capital Formation (GDCF). A
positive association is hypothesized between the capital
formation and the industrial production.
b) Foreign Direct Investment:

Foreign investment can be classified as foreign direct investment

(FDI) and foreign portfolio investment. International investment in
financial assets such as shares, debentures and bonds, is called
portfolio investment. Foreign investment in real assets is called
foreign direct investment (FDI). Multinational corporations (MNC s)
are the chief source of foreign direct investment in real assets.
Real assets consist of physical things such as factories, land,
capital goods, infrastructure and inventories. Multinational may
collaborate in joint ventures with host country enterprises or may
have fully owned subsidiaries in host countries. Such investments
are called foreign direct investments. A few decades ago, many
countries considered FDI as the source of economic imperialism.
But things are quite different now. The argument is that FDI
contribute to the growth of host economies in many ways. E.g.
physical capital formation, technology transfer, human formation,
stimulation of productivity, augmentation of output, promotion of
foreign trade and improvement of competitiveness of indigenous
entrepreneurs. After weighing the prospects and consequences,
government of India seems keen to attract ever-increasing
amount of FDI, which can be evidenced by its efforts aimed at
deregulation, transparency and globalization. In brief, it can be
regarded as a source of industrial growth. As part of the economic
reforms introduced in 1991, in the wake of a sharp external
payments crisis, policies relating to foreign investment and
foreign technology agreements were radically changed. Foreign
Investment Promotion Board (FIPB) was specifically created to
invite and negotiate for substantially large investment by
international companies.
c) Primary Issues in the Capital Market:
Capital market constitutes primary (new issues market) and
secondary (stock) market. The primary market helps the public
and private sector companies in raising finance mainly for their
new projects, expansion, modernization, acquisition etc. The

secondary market provides liquidity for the financial instruments

(equity, preference shares and debentures/bonds) through
adequate marketability and price continuity. The array of financial
institutions also have played crucial role in meeting long-term
credit needs of the industrial sector. With the liberalization of the
Indian economy since 1991, the Government has provided a
number of additional fiscal and other incentives to foster capital
market development. The result has been an explosive growth of
the market. The magnitude of the growth has been rapid and
vivid in terms of fund mobilized, the amount of market
capitalization and the expansion of investor population. The
Indian market was opened up for investment by the foreign
institutional investors (FIIs) in Sept.1992 and the Indian
companies were allowed to raise resources abroad through Global
Depository Receipts (GDR) and Foreign Currency Convertible
Bonds (FCCB). Both the primary and secondary segments of the
capital market displayed rapid expansion and growth
accompanied by greater institutionalization and larger
participation of individual investors during the post-reform period.
Despite the structural transformation of the Indian capital market,
there are many problems which often come on the way of its
efficiency. These relate to investor protection, consolidation (after
massive expansion), integration with other market segments,
product innovation and technology, etc. which are critical and
need to be addressed. Reserve Bank of India has expressed
concern over continued sluggishness in the primary capital
market for the last two years (1996-97 and 1997-98), as long
term prospects for industrial development are critically dependent
on the revival of primary market.
d) Bank Credit:
Banks are the dominant financial intermediaries in developing
countries including India. Bank credit is considered as an
important source of industrial finance. The dependence on bank

for finance could vary according to the size of the companies. The
small-scale industrial units have increased their dependence on
banks for loans because they have virtually no access to the
capital markets. The Reserve Bank of Indias attempt at reforming
the financial sector was visible from the recommendations of the
Committee to Review the Working of the Monetary system (1985)
(referred to as Chakraborthy Committee Report).The Committee
advocated the necessity of moving away from quantitative
controls which, it felt, led to distortions in the credit market and
resulted in curbing the growth of the economy. But the impetus to
reforms in the financial sector was given by the Report of the
Committee on the financial system (Narasimham Committee). The
financial sector reforms, based on this report were mainly aimed
to provide credit to the industrial sector by reducing the Cash
Reserve Ratio and Statutory Liquidity Ratio. The liberalization
policy also called for increased efficiency of commercial banks by
encouraging them to compete in the market. The public sector
banks were given autonomy to frame their policies including
interest rate fixation. It may be noted that the bank credit to the
industrial sector has not increased during the post-reform period
(Data given as appendix), in spite of the various attempts.