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Starting a Business
Financing a Start Up Business:
Sources of Finance
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The Long-Term Finance may be Raised by the Companies from the following Sources :-

Capital Market

Capital market denotes an arrangement whereby transactions involving the procurement and supply of long-term funds takes place among individuals and various organisations. In the capital market, the companies raise funds by issuing shares and debentures of different types. When long-term capital is initially raised by new companies or by existing companies by issuing additional shares or debentures, the transactions are said to take place in the market for new capital called, as 'New Issue Market'. But, buying and selling of shares and debentures already issued by companies takes place in another type of market called as 'the Stock market'.

Individuals and institutions which contribute to the share capital of the company become its shareholders. They are also known as members of the company. Before shares are issued, the directors of the company have to decide on the following matters:-

  • The amount of capital which is to be raised by issue of shares.

  • The types of shares which will be issued.

  • The time of issuing shares.

When a company decides to issue additional shares at any time after its formation or after one year of the first allotment of shares, it is required under law that such shares must be first offered to the existing shareholders of the company. If the offer is declined by the existing shareholders, only then shares can be issued to the public. Such an issue is called 'rights issue' and these shares are known as 'right shares'. The Government controls the issue of shares and debentures under the Capital Issues (Control) Act, 1947.

Special Financial Institutions

A large number of financial institutions have been established in India for providing long-term financial assistance to industrial enterprises. There are many all-India institutions like Industrial Finance Corporation of India (IFCI); Industrial Credit and Investment Corporation of India (ICICI); Industrial Development Bank of India(IDBI) , etc. At the State level, there are State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs). These national and state level institutions are known as 'Development Banks'. Besides the development banks, there are several other institutions called as 'Investment Companies' or 'Investment Trusts' which subscribe to the shares and debentures offered to the public by companies. These include the Life Insurance Corporation of India (LIC); General Insurance Corporation of India (GIC); Unit Trust of India (UTI) , etc.

Leasing Companies

Manufacturing companies can secure long-term funds from leasing companies. For this purpose a lease agreement is made whereby plant, machinery and fixed assets may be purchased by the leasing company and allowed to be used by the manufacturing concern for a specified period on payment of an annual rental. At the end of the period the manufacturing company may have the option of purchasing the asset at a reduced price. The lease rent includes an element of interest besides expenses and profits of the leasing company.

Foreign Sources

Funds can also be collected from foreign sources which usually consists of :-

  • Foreign Collaborators :- If approved by the Government of India, the Indian companies may secure capital from abroad through the subscription of foreign collaborator to their share capital or by way of supply of technical knowledge, patents, drawings and designs of plants or supply of machinery.

  • International Financial Institutions :- like World Bank and International Finance Corporation (IFC) provide long-term funds for the industrial development all over the world. The World Bank grants loans only to the Governments of member countries or private enterprises with guarantee of the concerned Government. IFC was set up to assist the private undertakings without the guarantee of the member countries. It also provides them risk capital.

  • Non-Resident Indians :- persons of Indian origin and nationality living abroad are also permitted to subscribe to the shares and debentures issued by the companies in India.

Retained Profits or Reinvestment of Profits

An important source of long-term finance for ongoing profitable companies is the amount of profit which is accumulated as general reserve from year to year. To the extent profits are not distributed as dividend to the shareholders, the retained amount can be reinvested for expansion or diversification of business activities. Retained profit is an internal source of finance. Hence it does not involve any cost of floatation which has to be incurred to raise finance from external sources.

Short-Term Finance may be Raised by the Companies from the following Sources :-

Trade Credit

It is the credit which the firms get from its suppliers. It does not make available the funds in cash, but it facilitates the purchase of supplies without immediate payment. No interest is payable on the trade credits. The period of trade credit depends upon the nature of product, location of the customer, degree of competition in the market, financial resources of the suppliers and the eagerness of suppliers to sell his stocks.

Installment Credit

Firms may get credit from equipment suppliers. The supplier may allow the purchase of equipment with payments extended over a period of 12 months or more. Some portion of the cost price of the asset is paid at the time of delivery and the balance is paid in a number of installments. The supplier charges interest on the installment credit which is included in the amount of installment. The ownership of the equipment remains with the supplier until all the installments have been paid by the buyer.

Accounts Receivable Financing

Under it, the accounts receivable of a business concern are purchased by a financing company or money is advanced on security of accounts receivable. The finance companies usually make advances up to 60 per cent of the value of the accounts receivable pledged. The debtors of the business concern make payment to it which in turn forwards to the finance company.

Customer Advance

Manufacturers of goods may insist the customers to make a part of the payment in advance, particularly in cases of special order or big orders. The customer advance represents a part of the price of the products that have been ordered by the customer and which will be delivered at a later date.

Bank Credit

Commercial Banks play an important role in financing the short-term requirements of business concerns. They provide finance in the following ways :-

  • Loans :- When a bank makes an advance in lump sum, the whole of which is withdrawn to cash immediately by the borrower who undertakes to repay it in one single installment, it is called a loan. The borrower is required to pay the interest on the whole amount.

  • Cash credit :- It is the most popular method of financing by commercial banks. When a borrower is allowed to borrow up to a certain limit against the security of tangible assets or guarantees, it is known as secured credit but if the cash credit is not backed by any security, it is known as clean cash credit. In case of clean cash credit the borrower gives a promissory note which is signed by two or more sureties. The borrower has to pay interest only on the amount actually utilised.

  • Overdrafts :- Under this, the commercial bank allows its customer to overdraw his current account so that it shows the debit balance. The customer is charged interest on the account actually overdrawn and not on the limit sanctioned.

  • Discounting of bills :- Commercial banks finance the business concern by discounting their credit instruments like bills of exchange, promissory notes and hundies. These documents are discounted by the bank at a price lower than their face value.

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