FINANCING OF ENTERPRISE

Finance -the most important prerequiste to start an enterprise lubricant to process of production Land,labour,capital,entrepreneurship & organisation depend on each other Financial planning is How much money needed ? Where will money come from ? When does the money need to be available ?

Estimating the capital

1. To Pay purchase considerations 2. To support business operations upto 3 months 3. To meet unexpected/unplanned business expenses Sources : Internal : Owners own money equity External: Relatives,Commercial Banks

Classification of Financial needs

1. On the basis of Performance : a) Fixed Capital Fixed assets Land,Building,Machinery, Furniture b) Working Capital Current assets Raw material, finished goods, debts day-to-day operations 2. On the basis of Period of Use : a) Long-term Capital/Finance Repayment for more than 5 years b) Short-term Capital/Finance Repayment with in 1 year

CAPITAL STRUCTURE
INTERNAL SOURCES : EQUITY Owners own capital , deposits or loans by owner, the partners from personal assets like Provident fund , Life Insurance Policy, Buidings,Investments etc. EXTERNAL SOURCES : DEBT Deposits/borrowings from relatives, friends , Borrowings from commercial banks, Credit facilities from commercial banks,Term loans from financial institutions, Hire purchases , Subsidies from Govt. etc Personal funds/Loans /Mortgage loans/Term-loans/Subsidiaries CAPITAL STRUCTURE = EQUITY + DEBT It is the ratio between debt and equity capital

Factors determining Capital Structure

1. 2. 3. 4. 5. 6. Nature of Business - Consumer good / Luxury goods Size of Enterprise - Lending money to SSI is risky Trading on Equity - Rate of return > Rate of interest Cash flows - Fixed obligations depend on avail.cash Purpose of Financing Buying New M/cs, Emp.Welfare facilities Provision for future - To keep some of your best securities till the

last, Always think of rainy days/ Emergencies

TERM LOANS
1. Short term Loans 2. Long term Loans (term loans) Purpose : ( 5/10/15 years ) Land/site development , Building works, Replacing Plant machinery, Installation expenses, Fixed assets like furniture office equipments etc. Sources of Term loans : 1.Issue of Shares 2.Issue of Debentures 3.Loans from Financial Institutions 4.Loans from Commercial banks 5.Public deposits 6.Retention of profits

SHARES
As per Section 85 of companies act 1956 a Public limited company can issue two types of shares.

1. Preference Shares : Carry a preferential right over equity shares with reference to dividend and payment of capital at the time of winding up of business.
Cumulative-Non cumulative , Redeemable irredeemable, Participating-Non participating, Convertible Non convertible

Equity Shares : What is not a preference share is a Equity share. They are entitled of dividend and payment of capital only after payment to preference shares. 3. Types of Capital : Preference capital/Equity Capital
2.

Issue of SHARES
Issue of Prospectus : Info. about shares Receipt of Applications: 120 days Allotment of Shares :
After subscription is over and Minimum Subscription is received shares are allotted to applicants within 120 days of issue of prospectus. If minimum subscription is not received money is refunded with in 130 days of issue of prospectus.

DEBENTURES
Debenture includes debenture stock,bonds and any other securities of company whether constituting a charge on company assets or not.
Redeemable irredeemable, Registered Bearer, Secured Unsecured , Convertible Non convertible Allotment is Similar to Shares allotment procedure

Shares Vs Debentures
ASPECT 1. Representation 2. Status 3. Return SHARES Portion of Capital Shareholder is member of Company Shareholder is paid dividend DEBENTURES Portion of Debt Debenture holder is creditor to company Debenture holder is paid Interest

4. Right of Control
5. Purchase 6. Repayment 7. Order of Repayment

Share Holders have right of control over working of company

Company can not purchase its own shares from the market No repayment after specific period Last to get paid

Debenture Holders dont have such right

Can purchase its debentures & cancel Repaid after specified period Get Priority

Short term Finance

Sources :
Loans from commercial banks Public deposits Trade credit Discounting Bills of Exchange Bank overdraft and Cash credit Advances from customers Accrual accounts

CAPITALISATION
Total amount employed in business Meaning : Broad Sense: The quantity & Quality of finance Amount and modes of finance Narrow Sense: Determination quantum of longterm required to run the enterprise. Types: OverCapitalisation : When enterprise possess excess of assets in relation to its requirements. Under-Capitalisation : Actual capitalisation is less than proper capitalisation.

Over-Capitalisation
Actual earnings are lower than expected ones. Enterprise becomes unable to pay its fixed obligations, i.e interest & dividend. The enterprise fails to pay a fair return on its capital investments. Example : In case annual profit = Rs.50,000 for a capital investment of Rs.5,00,000. If expected return is 10% it is properly capitalised. If profit is Rs.40,000 & expectation is 10% then it is over capitalised bcos 8% would go for interest on capital investments.

Causes of Over-Capitalisation
1.Raising of more money by shares/debentures than required by enterprise 2.Borrowing more money at a rate of interest than the actual rate of return on its capital 3.Acquiring fixed assets on excessive amounts 4.Inadequate provision for depreciation & replacement of fixed assets. 5.Payment of dividend at a fairly high rate 6.High rate of Taxation imposed by Government 7.Over-estimation of earnings for enterprise concern.

Effects of Over-Capitalisation
1. On owners : Because of fall of dividends the shareholders/owners loss heavily. Owners will not be able to dispose their shares due to fall in shares values in market. Owners are biggest losers. 2. On Enterprise : Value of enterprise stock fall in market and it finds difficult to raise capital.The credit worthiness of enterprise is adversly affected 3.On Society : Over capitalised enterprises often come to societal rejection.Gradual withdrawal of acceptance of their products would result.

Remedies for Over-Capitalisation

1. To reduce the claims of shareholders , debentureholders and creditors 2. To reduce rate of interest on debentures and rate of return on preference shares. 3.To reduce number of equity shares 4. If possible, to reduce the par value of stock.

Under-Capitalisation
Actual capitalisation is less than Proper capitalisation Market value of shares are fairly higher than market value of shares of similar enterprises. An enterprise may be under capitalised when the rate of profit is exceptionally high in relation to the return enjoyed by similar enterprises in the same industry.

Causes of Under-Capitalisation
1. Under estimation of initial rate of earnings 2. Utilization of high efficiency for exploiting every possibility available. 3. Using lower rate of capitalisation 4. Under estimation of required funds. 5. Retaining profits because of conservative policy of enterprise. 6. After a recession the enterprise starts earning at an unusually high rate. 7. Because of heavy earning, enterprise is exposed to heavy burden of taxation.

Effects of Under-Capitalisation
1.It encourages cut-throat competition in market.High profit by Under capitalised enterprises lures the new entrepreneurs to plunge in to manufacturing. 2.High rate of dividend given to shareholders propels workers to demand higher wages/salary 3.Enables management to manipulate the value of shares 4.Government charges higher taxation.

Remedies for Under-Capitalisation

1.To split up the shares of the enterprise 2.To issue bonus shares 3.To increase the par value of shares/stock. 4.To declare dividend payable in stock,if large surplus is available.

Venture Capital
Financing for High technology,High Risk and perceived high reward projects Conventional financier funds projects with Proven technologies Venture capitalist funds to entrepreneurs pursuing new and hitherto unexplored avenues and ideas and helps to translate the new ideas in to production.

Venture Capital
International Finance Corporation, Washington (IFCW) defines Venture capital as equity or equity featured capital seeking investment in new ideas, new companies, new products, new processes or new services that offer the potential of high returns on investment. It may include investment in turn around situations

Venture Capital in India

1988 formally introduced in budget ICICI Industrial credit & Investment Corporation of India TDICI Technology Development & Information Company of India Immediately 5% cess was levied on all import of technology/know how resulting in the creation of sizeable Venture capital funds This is administered by IDBI Industrial Development Bank of India

Govt. of India Guidelines

SBI and other scheduled banks are Eligible to float Venture Capital funds Minimum size of fund should be Rs.10 crores In case public issue the promoters share should be 40% of capital Foreign holding allowed up to 25% NRIs investment allowed upto 74% of capital on Non-repartible basis & 25-40% on repartible basis Debt-Equity ratio should be limited to 1:1.5 Venture capital funds are not allowed to operate in money market operations ,bill re-discounting Venture capitalist to pay 20% tax on dividend income. But investor are exempted upto Rs.10,000 on dividends and to pay 10% on capital gains.

Export Financing
Export Finance refers to credit facilities and techniques at the pre-shipment & post-shipment stages. Foreign Commercial banks,All Indian Commercial banks refinanced by RBI & IDBI , EXIM bank Export-Import Bank of India provide Export finance.

Pre-Shipment Finance(PSF)
Financial assistance provided to the exporters before the actual shipment of goods PSF is provided for purchasing Raw materials, their processing & converting into finished goods & packing them. Pre-Shipment finances: 1.Packaging credit 2.Advance against Incentives 3.Advance against duty drawback. PSF are granted at 7.5% interest. PSF credits are extended upto a maximum of 6 months.

Post-Shipment Finance(PoSF)
Any loan or advance granted or any other credit provided by a bank to an exporter of goods from India from the date of extending the credit after shipment of goods to the date realisation of export proceeds PoSF serves like a bridge loan for the period between shipment of goods and realisation of proceeds. PoSF are granted at 8.65% interest. PSF credits are upto a maximum of 6 months.
ECGC Export Credit & Guarantee Corporation provides Insurance cover to Exporters EICI Export Inspection Council of India assists exporters for Quality control purposes.

FINANCIAL INSTITUTIONS
Reserve Bank of India (RBI) Scheduled commercial banks : i. State Bank of India (SBI) & associates ii. Nationalised Banks iii. Private sector Banks iv. Regional Rural Bank (RRB) v. Foreign Banks Industrial Development Bank of India (IDBI) 1964
Small Industries Development Fund (SIDF) 1986 National Equity Fund Scheme (NEFS) 1988 Voluntary Executive Corporation Cell (VECC) Narasimhan committee IDBI to do Promotional role for SFC & SIDBI etc.

FINANCIAL INSTITUTIONS
Industrial Finance Corporation of India Ltd (IFCI)
Extend assistance through Rupee & Foreign currency loans, Equipment finance,Buyers & Suppliers credit,merchant banking. IFCI promotes - Interest subsidy scheme for women entrepreneurs - Consultancy fee subsidy for SSIs - Modernisation of SSIs - Control of pollution in small & medium scale industries. Industrial Credit & Investment Corporation of India Ltd. (ICICI) - 1995 , To develop mainly small ,medium industries in the private sector.Offers financial services such as deferred credit,leasing credit, asset credit and venture capital.

FINANCIAL INSTITUTIONS
Industrial Reconstruction Corporation/Bank of India (IRCI/IRBI) - Mainly to look after the spl.problems of sick units & provides assistence for their speedy reconstruction and rehabilitation. Consultancy services ,Equipment leasing,Industrial revival. Life Insurance Corporation of India (LIC) - Offers a variety of insurance policies to extend social security to various segments of society. Provides term loans,shares/debentures issue of corporate sectors. Unit Trust of India (UTI) - 1964,Mobilises small investors savings through sale of units and channelises them into corporate investments. State Financial Corporations(SFCs) - 1948, Industrial Finance Corporation of India (IFCI) provides Financial assistance only to Large sized industrial undertakings . SFCs provide financial assistance to small,medium sized industries organised under all structures.

FINANCIAL INSTITUTIONS
State Industrial Development Corporations (SIDCs) - To provide term loans,subscription of shares/debentures & guarantees - To promote indstrial development. Small Industrial Development Bank of India(SIDBI) - 1989, To initiate technological upgradation, modernisation of existing units To expand marketing channels for SSIs To promote SSI in semi urban areas. Export-Import Bank of India (EXIM Bank) - 1982, International finance wing of IDBI
- 3 schemes Production Equipment finance,Export marketing finance,Export vendor development finance -Financing Export/Import goods & services both of India and of outside India,Joint ventures,Merchant Banking,Buyers credit to foreign banks,Business advisory services.

Working Capital
It is a fund which is required to carry out the day-to-day short term operations of an enterprise These operations consists of primarily such as raw materials,semi processed goods,sundry debtors,finished goods,finished products,short term investments etc. These short term operations are known as short term assets or Current assets. It is also called a circulating capital or revolving capital.

Working Capital Operating Cycle

Cash
Bills Receivable

Raw Material

Finished Goods

SemiFinished Goods

The average time intervening between the acquisition of material or

services entering the process and the final cash realisation

Working Capital (WC)

WC has two parts i) Fixed working capital - the amount needed at short intervals, to invest again and again in current assets. This is irreducible minimum & remains permanently sunk. ii) Variable working capital - this may vary due to fluctuations rise or fall in volume of business.

Working Capital (WC)

WC
(Rs)

WC Variable Fixed
(Rs)

Variable

Fixed

Time Developed Enterprise

Time Growing Enterprise

Gross working capital = Total Current assets Net working capital = Total Current assets Total Current liabilities

Working Capital (WC)

Net working capital = Current assets - Current liabilities

Current Assets
Current Liabilities
Net Working Capital

When the current assets are less than the current liabilities ,then the difference between the two will be called Working Capital Deficit

Working Capital Calculation

Liabilities Capital Profit Long term loans Sundry Creditors Bills payables Rs. 1,00,000 20,000 60,000 21,500 8,500 Assets Rs. Plant & M/c s 75,000 Land &Building 50,000 Furniture 25,000 Stock 20,000 Sundry Debtors 25,000 Bills Receivable 10,500 Semi-finished goods 4,500 Total 2,10,000

Total

2,10,000

Gross Working Capital = Rs.60,000 Net Working Capital = Total current assets Total current liabilities = Rs. 60,000 30,000 = Rs. 30,000

Significance of Working Capital

Necessary Liquidity during Operating cycle Maximisation of Profit - financial management depends on proper balance between fixed capital & working capital Working capital management strikes balance between Cash inflows & cash outflows Smooth Functioning Ensures timely purchase of inputs Increasing Firms Value - Good balance between assets & liabilities increases market value of equity shares, and enterprise value.

Assessment of Working Capital

Total operating expenses in last year Total Working Capital requirements = -----------------------------------------Number of operating cycles in the year

Other factors to be considered are..

i)Cost to be incurred on inputs like Raw materials, Labour charges etc. ii)Length of credit period allowed to debtors iii)Length of credit availed from creditors iv)Length of time involved in the payment of wages & overheads v)Size of the unit and volume of business vi)Seasonal requirements of the raw material.

Factors of Working Capital

1. Sales 2.Length of Operating cycle 3. Nature of Business 4.Terms of Credit 5.Seasonal Variations 6.Turnover of Inventories 7.Nature of Production Technology 8.Contingencies

Management of Working Capital

1.Management of Cash
- level of cash, inflows of cash, outflows of cash, use of surplus cash

2.Management of Inventory
-Raw material,Work-in-progress & Finished goods
-Transaction motive,Precautionery Motive,Speculative Motive

- Inventory holding results in Ordering & Carrying costs - EOQ,ABC analysis are used - Optimum inventory level.

3.Management of Accounts receivable

- Amounts of goods sold with a view of increasing volume of sales. - It constitutes a major porting of current assets. - It includes Capital ,administrative,collection & defaulting costs

4.Management of Accounts Payable

- Credit purchase policy Buy-now,Pay- later

Management of Working Capital

Profitability Cost & Benefit Point of Trade-Off Liquidity

Size of Accounts Receivable

Trade-Off between Profitability & Liquidity

Network Analysis Techniques

CPM Critical Path Method
CPM planning refers to determination of activities to be accomplished & Scheduling refers to time scheduling for each activity of the project. The duration of different activities in CPM are deterministic. Advantages :
1.Ascertains time schedule of activities having sequential relationship. 2.Makes control easier for the management. 3.Identifies the most critical elements in the project, thus the management is kept in constant alert about them. 4.Makes better and detailed planning possible.

Limitations :
1.The assumption on precise timing may not be true in practice. 2.Estimates are not based on statistical analysis 3.Cant be used as a dynamic controlling device since any change introduced will change the entire structure of the network.

Network Analysis Techniques

PERT Programme Evaluation & Review Technique
First used in 1958 in Polaris ballistic missile project in USA, PERT schedules the sequence of activities to be completed in order to accomplish the project within short period of time .The variability of the project duration and probability of the project completion in the given time period are calculated. Advantages :
1.It determines the expected time required for completing each activity . 2.Helps to complete the project within a given period of time. 3.Helps to identify uncertainties involved in the project,thus reduces risk elements. 4.Enables management to use optimum allocation of the resources. 5.Presses for right action,at the right place and right time.

Limitations :
1.Based on time estimates of activities.Wrong time estimates it makes highly unrealistic. 2.Does not consider the resources required at different stages of the project. 3.For effective control of project frequent updating is required which makes it a costlier affair.

CPM Vs PERT
CPM
1. 2. Origin is Industry Its an activity oriented approach

PERT
Origin is Military Its an Event oriented approach

3. 4.
5. 6. 7.

Does not allow uncertainty Its a deterministic model

Marks critical activities It is cost based & doesnt average time Suitable for reasonable precision projects Ex.Civil construction,Industrial Expansion projects

Allows Uncertainty Its a probabilistic model

Does not mark critical activities It is time based & averages time Suitable for high precision projects Ex. Defence projects.

Network Analysis Technique

3 days 2 days 4 days

3 4
3 days

1
3 days

CPM

6
5 days

Earliest Start time - Earliest Finish time Latest Start time - Latest Finish time

PERT

TAXATION
Income Tax :
It is an annual tax levied by the Central government, state governments, and some local panchayats, on an individual's or corporation's net profit. Excise Duty : It is the tax on the goods which are produced in the same country Customs duty :It is the tax on the goods from outside the country.

Need for Tax Benefits :

The first 1000 days are critical period for SSI. They incur more expenses, but returns are either nil or nominal. Therefore they need support to tide over the crucial initial stage to enable them to survive. Hence the government extends various benefits to SSIs.

TAX BENEFITS
Tax Holiday :
SSI are exempted from income tax on profits subject to a maximum of 6% per annum of capital.This is allowed for 1st 5 years of commencement of production. Conditions are : 1. Not an reformed existing unit 2. SSI should be 10 employees with power (or) 20 employees without power.

Depreciation :

An SSI is entitled to a deduction on depreciation on assets at the prescribed rate subject to a maximum Rs.20 lakhs.It is calculated by diminishing balance method. It is limited to Rs.7590 from 1991-92 onwards. Conditions are : 1.Assets must be owned by the assessee & used for business. 2.Depreciation is only allowed on Fixed assets.

TAX BENEFITS
Rehabilitation Allowance :
Rehabilitation allowance is granted to SSIs incase of.. Flood,typhoon,hurricane,cyclone,earthquake etc Riot or civil disturbances Accidental explosion Action by an enemy/when combating enemy Upto 60% of amount of deduction is allowed to the unit.

Investment Allowance :

Investment allowance was introduced in 1976 to replace depreciation allowance.It is allowed at the rate of 25% of the cost of acquisition of new plant or machinery installed. A SSI can avail the investment allowance provided it has put to use machinery or plant either in the year of installation or in the next year.

TAX BENEFITS
Expenditure on Scientific Research :
Certain expenditure on Scientific research are allowed under 35 of Income tax Act 1961. Any expenditure incurred on scientific research related to business, Any sum paid to scientific research association is exempted from income tax.

Amortisation of Preliminary expenses :

Under section 35D of Income tax Act 1961, companies are allowed to write off the preliminary and development expenses incurred by them in connection with setting up of a new industrial unit or expansion of an existing industrial unit. These include expenses on preparation of project report, Legal charges on drafting agreements. And Engineering expenses related to business.

TAX BENEFITS
Tax concessions to Rural area SSIs :
A tax deduction of 20% of the profits and gains is allowed by running SSIs in rural areas. This deduction is extended upto 10 years from the year of commencement of manufacturing. The SSIs that employs 10 or more workers with aid of power (or) 20 or more workers with out aid of power are eligible to avail this concession.

Tax concessions to Backward area :

The SSIs established in the backward areas are entitled to a deduction of 20% of their profits and gains from their gross total income.This deduction is allowed upto 10 years from the commencement of manufacture. The SSIs that employs 10 or more workers with aid of power (or) 20 or more workers with out aid of power are eligible to avail this concession.

TAX BENEFITS
Expenditure on Acquisition of Patents/Coyprights:
Any expenditure of a capital nature incurred inacquiring a patent or copyright by a SSI is deducible from its income.This expenditure can be deducted in 14 equal instalments.

Profits from business of Publications of books:

A 20% of profit is exempted for a total of 5 years . This includes Royalties from any company in India, Royalties from Foreign companies,Income of Co-operative Societies.

 End of Unit 4