sources of finance (mba subject)

7/28/2019 Sources of Finance (mba subject)

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Debts and EquityContractual set of cash flows ( P+I)

I paid are tax deductible

Debts have a fixed maturityDebtors plays a passive role to protectinterest.

Sources of Finance


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07/02/10Ms. Jyothi P.T Dept of Managment

Science MESCE 2

Sources of Finance

Classification of SourcesAccording to period

Long Terms Sources Shares, Debentures, LTLoans etc

Short Terms Sources- Loan from bank, TradeCredit, Customer advances, Public Deposits etc

According to Ownership Own Capital- Shares, RE, Surplus

Borrowed Capital-Debentures, Public DepositsAccording to Source of Generation

Internal Sources-

RE, Depreciation funds etc

External Sources- Shares, Debentures, Loans etc

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Science MESCE


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Science MESCE 3

General Classification

Security Financing- Financing throughShares and Debentures

Internal Financing- Depreciation funds andRE

Loan financing- Short Term and Long Term


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Science MESCE 4

Security Financing

1. Issue of Shares-

One of the units into which the sharecapital of a company has been divided.

It is a share in the capital of a companyand includes stock except where adistinction between stock and share is

expressed or implied.It is the most common method of raisinglong term capital.


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Science MESCE 5

Ordinary SharesFeatures

Claim on Income

Claim on Assets

Right to ControlVoting Rights

Pre-Emptive Rights

Limited Liability


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Science MESCE 6

Types1.

Preference Shares: These are the shares which

carry a preferential right over the other classes of

shares:

1. A preferential right in respect of a fixed

dividend as a fixed amount or rate

2.

A preferential right as to repayment of capitalin the case of winding up of a company in

priority to other class of shares.

Types:Cumulative or Non Cumulative

Participating or Non Participating

Redeemable or Irredeemable


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Ms. Jyothi P.T Dept of ManagmentScience MESCE 7

Merits Flexible arrangement since payment of

dividend is not a legal obligation

No final maturity date except forRedeemable PS and thus they are perpetual

in nature. Additional to equity base to the company

thereby increasing borrowing power

Cushion to the Debenture holders as theysave from paying higher interest rates

Issue of Preference shares do not create anysort of charge against assets of the company


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Fixed rate of dividend is paid and thushigher profit will enhance dividend to

equity shareholders

Cheaper than equity shares and higherreturn to investment for Preference share

holders

Demerits

1. It dilute the claim of the Equity

Holders over the assets of the Company


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Science MESCE 9

2. Equity Shares

These are shares which are not Preference shares.They do not carry any preference rights or any fixedreturns.

It is the most risky element in financing.Merits

1. Financing through Equity shares do not impose anyburden on Company since payment of return issubject to availability of profit.

2. Sort of Perpetual loan in nature3. Do not carry any charge on the assets of the

company4. Company have flexibility in operations and

utilisation of the capital since neither capital orreturn on Equity Share is obligatory.


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Demerits

1. High risk and hence high expectation ofreturns2. Control of company can be easily manipulated

through the cornering of shares3. Reservation on issue of shares to new holders

on account of loss of control4. Excessive reliance on equity share capital will

reduce the capacity of the company to tradeon equity, which may result in over

capitalisation5. Cost of Share capital handling is high

compared to others


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Science MESCE 11

Debentures

It is a document issued by a company as an evidence of adebt due from the company with or without a charge onthe assets of a company. It is a certificate issued by acompany under its seal.

Types:Naked Debentures: Which do not carry any charge on the

assets of Company

Mortgage Debentures: Secured by mortgage or charge on

the whole or part of the assets of the company.Redeemable and Irredeemable Debentures

Convertible and Non Convertible Debentures


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Science MESCE 12

Merits and DemeritsMerits:1 Specific period funding2 Long term funding without dilution of control3 Take advantage of the trading on equity and pay

equity holders dividend at the rate higher than theoverall return on investment

4 More suitable to investors who are conservative innature and stable rate is looking with little or no riskDemerits1. Raising fund through debentures is risky2. Not suitable to companies whose income is

fluctuating.3. Debenture issue is considered to be issued at a not

so better condition and hence debenture holdersmay ask for higher returns and subsequent sourcingof fund will be further difficult


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Science MESCE 13

Internal Sources

1. Depreciation as a source of finance

2. Financing through Retained earnings orPloughing Back of Profit


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Science MESCE 14

Loan Financing

1. Short Term Loans and Credits Trade Credit

Bank Credit or CC etc

Commercial Bank Loans Public Deposits

Finance Companies Customer Advances Accrual Accounts- Wages and other accrual accounts whose

payments are delayed on account of any reasons or whose fundsearmarked are used at specific dates only.

Term Loans Bridge Finance Loan Syndication Book Building- Method of Issue of Shares on price quotes Promoters Contribution


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Science MESCE 15

Special Features of Term Loans

1. Specific Objectives

2. Security

3. Time Period4. Formal Agreements

5. Participation or Syndication


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Science MESCE 16

New Financial Institutions

1. New Financial Institutions

1. Venture Capital Funds

2. Mutual Funds

3. Factoring Companies

4. Credit Rating Institutions

5. OTC Exchange of India- Over the Counter

Trading Exchange of India


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Science MESCE 17

New Financial Instruments

1. Commercial Papers: CP.It is a form of usance promissory note negotiable by

endorsement and delivery. It is normally issued by aHigh Net Worth company for meeting WC

requirements, and not more than 1 year period isapplicable to the CP. The maximum amount that canbe raised should be 75 %.

2. Certificate of Deposits- CD.

Issued for short term fund raising. No prescribedRate of Interest and can be issued at face value orat a discount. It is a bearer document.


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Science MESCE 18

New Financial Instruments

3.Securitisation of Debt: It is a financing technique wherebyloans and receivables are packaged underwritten and sold inthe form of asset backed securities.

4. SPN Secured Premium Notes with detachable warrants isredeemable after a notified period say 4-7 years.

5. NCD -Non Convertible Debentures with Detachable Warrants

6. ZCB- Zero Coupon Bonds. The bonds which are sold at adiscount but do not carry any rate of interest

7. FCD Zero Interest Fully Convertible Debentures

8. Stock Invest- It is a form of additional facility available to aninvestor for availing Share Application Money for applying forShares. It is a document issued by the Bank which can beused as Cheque or Cash for the Purpose.


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Science MESCE 19

9. Depository Receipts

ADR- American Depository Receipt. It is a NegotiableInstrument denominated in US $ and issued by a depository

Bank representing ownership in non US Securities. It helpsthe US Investor to subscribe for the shares of a foreigncompany offered in his country or in International Market, inthe form of Depository Receipts.

10. Euro Issues: An issue listed on a European stock Exchange.

1. Foreign Currency Convertible Bonds

2. EDR- European Depository Receipts issued only in Europe

3. GDR- Global Depository Receipts issued in Europe and USor Both

11. FRB- Floating Rate Bonds- Bonds issued without a CouponRate but linked to any benchmark rate.

12. Non voting Right Shares

13. Derivatives


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Science MESCE 20

Factoring

It is a financial service designed to help the firms tomanage the receivables better. It involves an outrightsale of receivables of a firm to a financial institution,called factor, which specialise in management of credit.

Advantages:1. Manufacturer of goods etc concentrates on the

production and marketing and not on the collection

2. Reduction in the cost of maintenance and collection ofbook debts

3. Saving in time, manpower, etc

4. Monitoring of book debts and prevention of bad debts


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Science MESCE 21

Functions of Factors

1. Credit recording2. Credit administration3. Credit protection

4. Credit financingFactoring Calculations:Cost of Factoring as Fee and Commission is judged

against the Saving in cost due to factoring andincreased collection of Money, lower Bad debtsand Advance payment from the FactorCompany.


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Leasing

Definition:

A contractual arrangement / transaction inwhich a party owing an asset / equipment(lessor) provides the asset for use to another

/ transfer the right to use the equipment tothe user (lessee) over a certain / for anagreed period of time for consideration in

form of / in return for periodic payment(rentals) with or without a further payment(premium)


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No exclusive law / legislation/ act /regulation / direction/ to govern

equipment leasing finance


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Divorce of ownership from theeconomic use of an asset /

equipment. Device of financing the cost of an

asset / money lending.

Lessor is the nominal owner

Lessee has the possession and use of

the asset on payment of the specifiedrentals over a predetermined periodof time


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Elements:

Parties to the contract :Individual

& owner / Lessor & Lessee

a. Individuals, Partnerships, Joint

Stock companies, Corporations,Financial Institutions

b. Joint Lessor/ Joint Lessee


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C. Lease Broker : who acts as anintermediary in arranging lease

0.5% - 1% Commission


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Asset : Property / Equipment

Automobile, P&M, L&B , Equipments, factory, Running business.

1. Ownership separated from user:

Ownership vests with lessor and itsuse is allowed to lessee.

On lease tenure , assets reverts tothe lessor


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n Terms of Use :Period for whichthe arrangement of lease remains inoperation.

Strech over the entire economiclife of the asset FinancialLease

Period shorter than useful life ofthe asset Operating Lease


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n Lease Rentals : The consideration

which the lessee pays to the lessorfor the lease transaction.

It is to ;

Compensate the lessor ( depreciation,interest on investment , repair )


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1. Mode of terminating lease :

Terminated at the end of lease period

The lease is renewed on a perpetual

basis or for a definite period The asset reverts to the lessor

The asset reverts to the lessor & the

lessor sells it to a third party

The lessor sells the assets to the lessee


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Risk :

Possibility of loss arising on account of

under-utilization or technologicalobsolescence of the equipment.

Reward:

The incremental net cash flows that aregenerated from the usage of the equipment

over its economic life and the realization ofanticipated residual value or expiry of theeconomic life.


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07/02/10 Ms. Jyothi P.T Dept of ManagmentScience MESCE 32

Advantages of Leasing

1. Permits alternate use of funds

2. Arrange faster and cheaper Credits

3. Increase the lessees capacity to borrow

4. Protect against obsolescence5. Boom for small firms

6. Tax shield

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Securitization

Securitization is the process of poolingand repacking of homogeneous long termilliquid financial assets and non-performingassets into marketable securities, whichcan be sold to investors

Securitization in India is regulated by the

SARFAESI Act 2002- (Securitization &Reconstruction of Financial Assets &Enforcement of Security Interest).


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Process of Securitization

Assets are originated through receivables,leases, housing loans/ any other form of debtby a company and funded on its balancesheet. (The company is normally referred toas the originator)

Once a suitable large portfolio of assets hasbeen originated, the assets are analyzed asportfolio and then sold to a third party, whichis normally a Special Purpose Vehicle

Company (SPV) formed for the purpose offunding the assets. SPV issues debt andpurchases receivables from the originator.The SPV will be owned by a trust or the

originator.


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The administration of the asset is then sub-contracted back to the originator by the SPV. It is

responsible for collecting the principal amount andinterest on the loans in the underlying pool ofassets.

The SPV issues tradable securities to fund thepurchase of assets. The performances of these

securities are directly linked to the performance ofthe assets.

The investors purchase the securities (becausethey are satisfied that the securities would be paidin full and on time from the cash flow availablefrom the asset pool).

As cash flow of arise on the assets they are usedby SPV to repay funds to the investors in thesecurities.


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Advantages

It provides liquidity to the originators (Non-Banking Finance Companies / Banks)

Better Credit Rating is possible.

Securitized debt is cheaper as the original

investors can beat the ratings given by therating agencies and thereby diversify theircredit risk.

Originators can plan their capital adequacy

requirements by using securitization toreduce the risk of weighted assets andthereby improve their capital adequacy.


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Process

Identifying and aggregating thereceivables of originator

Selling these receivables to SPV

SPV borrows money from investor SPV makes payment to the originator at

discount

Receivables are collected on behalf of SPV Repayment of principal and interest by

SPV to investor

sources of finance (mba subject)

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