CHAPTER-4

Cost of capital and sources of

finance
Contents:
1. Cost of common stock( equity);
cost of preferred stock; cost of debt
2. CAMP approach; dividend yield plus growth rate.
3. Adjusting the stock for floatation costs
Weighted average cost of capital
4. Long term source of finance
5. Short term source of finance.
COMMON STOCK (EQUITY).

Common stock is a type of security that represents ownership of equity in a company. There
are other terms – such as common share, ordinary share, or voting share. Holders of common
stock own the rights to claim a share in the company’s profits and exercise control over it by
participating in the elections of the board of directors, as well as in voting regarding
important corporate policies.

Moreover, common shareholders can participate in important corporate decisions through

voting. They can participate in the election of the board of directors and vote on different
corporate matters such as corporate objectives, policies, and stock splits.

This form of equity ownership typically yields higher rates of return long term. However, in
the event of liquidation, common shareholders have rights to a company's assets only after
bondholders, preferred shareholders, and other debt holders are paid in full. 

ADVANTAGES

 Common stock holders have benefits highest rate of return in the long term.

 These share holders have the voting rights in the company, while others do not.

 They act as the owners of the company and bear the maximum risk of the company.

 The common stock holders are permanent in nature.

LIMITATIONS

 It involves high risks in terms of winding up of the company.

 In terms of distribution of profits (dividend) the equity share holders get paid after all
others.

 The owner’s property used for recovering the debts of company.

 These share holders don’t expect higher returns for their investment.

COMMON STOCK FORMULA

 Common stock = total equity - retained earnings

 Common stock = total equity – preferred stock - additional paid up

capital - retained earnings + treasury stock

PROBLEMS
(a)Owners equity =50,000

Retained earnings =26,000

By the formula

Common stock =owners equity - retained earnings.

=50,000-26,000

Common stock=24,000

a) Equity= 1,000,000

Preferred stock=300,000

Additional paid up capital=200,000

Retained earnings =100,000

Treasury stock=100,000

BY THE FORMULA

Common stock =total equity-preferred stock-additional paid up capital –retained earnings+

treasury stock

=1,000,000-300,000-200,000-100,000+100,000

Common stock=500,000

Cost of preferred stock:

Cost of preferred stock is the rate of return required by holders of a company’s
preferred stock. Preferred stock lies in between common equity and debt
instruments, in terms of flexibility. It is calculated by dividing the annual preferred
dividend payment by preferred stock’s current market price.

Cost of preferred stock is an important input calculation of the weighted _average

cost of capital (WACC).

Advantages:
Preferred stocks are a hybrid type of security that includes properties of both
common stocks and bonds. One advantage of preferred stocks is their tendency to
higher and more regular dividends than the same company’s common
stock .Preferred stock typically comes with a sated dividend.

Formula:
The discount rate equals the required rate of return on preferred stock.

Cost of preferred stock=preferred dividend per share/price per share

Problem:
Smith company has 2500000 shares of $1000 par value non-cumulative series L
preferred stock. They carry annual fixed coupon rate 9.5%. The preferred stock has a
current market price on 27 December 2019 of $1224.55. Find the cost of preferred
stock.

Solution:

Annual dividend payment= 9.5% of $1000 = $95 per preferred stock

Cost of preferred stock = annual dividend payment ($95) /current market price
($1224.55)=7.7%

Cost of Debt:
Cost of debt is the required rate of return on debt capital of a company. The cost of
debt is the rate a company pays on its debt, such as bonds and loans. The effective
interest rate a company pays on its debts. The estimated based on yield on other
debts carrying the same bond rating. The yield to maturity approach is useful where
the market price of debt is available. Yield to maturity (YTM) equals the internal rate
of return of the debt.

Advantages:
Companies often use debt when constructing their capital structure because it has
certain advantages compared to equity financing. In general, using debt helps keep
profits within a company and helps secure tax savings. There are on going financial
liabilities to be managed, however, which may impact your cash flow.

Formula:
Cost of Debt = Interest Expense (1 – Tax Rate)

The effective interest rate is annual interest upon total debt obligation into 100.
Formula for same is below:

Effective Interest Rate / Interest Expenses = (Annual Interest / Total Debt

Obligation) * 100

Problem:
A company named Viz Pvt. Ltd took loan of $200,000 from a Bank at the rate of

interest of 8% to issue company bond of $200,000. Based on the loan amount

and rate of interest, interest expense will be $16,000 and the tax rate is 30%.

Cost of Debt is calculated Using below formula

Cost of Debt = Interest Expense (1- Tax Rate)

  Cost of Debt = $16,000(1-30%)

 Cost of Debt = $16000(0.7)

 Cost of Debt = $11,200

Cost of debt of the company is $11,200.

*CAMP APPROACH
*DIVIDEND YIELD PLUS GROWTH RATE

CAMP
What is CAPM?

The Capital Asset Pricing Model (CAPM) is a model that describes the
relationship between the expected return and risk of investing in a security. It
shows that the expected return on a security is equal to the risk-free return
plus a risk premium, which is based on the beta of that security. Below is an
illustration of the CAPM concept. The CAPM formula is used for calculating the
expected returns of an asset.
 

CAPM Formula and Calculation

CAPM is calculated according to the following formula:

Where:

Ra = Expected return on a security

Rrf = Risk-free rate
Ba = Beta of the security
Rm = Expected return of the market

Note: “Risk Premium” = (Rm – Rrf)

https://youtu.be/IJeYwx-cXyc link CAMP.

 CAPM Example – Calculation of Expected Return
Let’s calculate the expected return on a stock, using the Capital Asset Pricing Model (CAPM) formula.
Suppose the following information about a stock is known:

 It trades on the NYSE and its operations are based in the United States
  Current yield on a U.S. 10-year treasury is 2.5%

 The average excess historical annual return for U.S. stocks is 7.5%

 The beta of the stock is 1.25 (meaning its average return is 1.25x as volatile as the S&P500
over the last 2 years)

What is the expected return of the security using the CAPM formula?

Let’s break down the answer using the formula from above in the article:

 Expected return = Risk Free Rate + [Beta x Market Return Premium]

 Expected return = 2.5% + [1.25 x 7.5%]

 Expected return = 11.9%

*DIVIDEND YIELD PLUS GROWTH RATE

 Dividend Yield:
The Dividend Yield is a financial ratio that measures the annual value of dividends received relative
to the market value per share of a security. In other words, the dividend yield formula calculates the
percentage of a company’s market price of a share that is paid to shareholders in the form of
dividends. A high or low yield depends on factors such as the industry and the business life cycle of
the company

Dividend Yield Formula:

Dividend Yield = Dividend per share / Market value per share

Where:

Dividend per share is the company’s total annual dividend payment, divided by the total number of
shares outstanding

Market value per share is the current share price of the company

Example

Company A trades at a price of $45. Over the course of one year, the company paid consistent
quarterly dividends of $0.30 per share. The dividend yield ratio for Company A is calculated as
follows:
Dividend Yield Ratio = $0.30 + $0.30 + $0.30 + $0.30 / $45 = 0.02666 = 2.7%

The dividend yield ratio for Company A is 2.7%. Therefore, an investor would earn 2.7% on shares of
Company A in the form of dividends.

FORMULA:

Yield + Dividend Growth Estimate = Total Return Estimate

ADJUSTED STOCK FOR FLOATATION
COSTS
Introduction
In which incurred cost of the public trade of a
company when it issues new Fees,Securities,Expenses
,Legal Fees are to be done in the registration
company.
Company can rise from a new issue floatation costs,
expect return on equity, Dividend payments,
Percentage earnings , and past payments and the
retain past of the equartion.
formula:
Float In new equity is the dividend of the growth rate
Dividend growth rate =(D1/Po)+g
D1=Dividend in the next period
1. Po=Issue price of the share stock

g=Dividend growth rate

Advantages of stock market floatation:
• • giving access to new capital to develop the

business
• • making it easier for you and other investors -

including venture capitalists - to realise their investment

• • allowing you to offer employees extra incentives by

granting share options - this can encourage and

motivate your employees to work towards long-term
goals
• • placing a value on your business

• • increasing your public profile, and providing

reassurance to your customers and suppliers

• • allowing you to do business - eg acquisitions - by

using quoted shares as currency

• • creating a market for the company's shares
Disadvantages of the stock flotation
Market fluctuations - your business may become vulnerable
to market fluctuations beyond your control - including market
sentiment, economic conditions or developments in your sector.
• • Cost - the costs of flotation can be substantial and there
are also ongoing costs of being a public company, such as
higher professional fees.
• • Responsibilities to shareholders - in return for their
capital, you will have to consider shareholders' interests when
running the company - which may differ from your own
objectives.
• • The need for transparency - public companies must
comply with a wide range of additional regulatory requirements
and meet accepted standards of corporate governance
including transparency, and needing to make announcements
about new developments.
• • Demands on the management team - managers could
be distracted from running the business during the flotation
process and through needing to deal with investors afterwards.
• • Investor relations - to maximise the benefits of being a
public company and attract further investor interest in shares,
you will need to keep investors.

WEIGHTED AVERAGE
What Is a Weighted Average?
Weighted average is a calculation that takes into account the varying degrees of importance of the
numbers in a data set. In calculating a weighted average, each number in the data set is multiplied by a
predetermined weight before the final calculation is made.

A weighted average can be more accurate than a simple average in which all numbers in a data set are
assigned an identical weight.

Understanding Weighted Averages

In calculating a simple average, or arithmetic mean, all numbers are treated equally and assigned
equal weight. But a weighted average assigns weights that determine in advance the relative
importance of each data point.

However, values in a data set may be weighted for other reasons than the frequency of occurrence.
For example, if students in a dance class are graded on skill, attendance, and manners, the grade for
skill may be given greater weight than the other factors.

In any case, in a weighted average, each data point value is multiplied by the assigned weight which is
then summed and divided by the number of data points.

In a weighted average, the final average number reflects the relative importance of each observation
and is thus more descriptive than a simple average. It also has the effect of smoothing out the data and
enhancing its accuracy.

Examples of Weighted Averages

1. Weighted averages show up in many areas of finance besides the purchase price of shares,
including portfolio returns, inventory accounting, and valuation.
2. When a fund that holds multiple securities is up 10 percent on the year, that 10 percent
represents a weighted average of returns for the fund with respect to the value of each
position in the fund.
3. For inventory accounting, the weighted average value of inventory accounts for fluctuations
in commodity prices, for example, while LIFO (Last In First Out) or FIFO (First In First Out)
methods give more importance to time than value.

FORMULA:-

Weighted average = sum of weighted terms / total number terms

SOLVED PROBLEM

A class of 25 students took a science test. 10 students had an average

(arithmetic mean) score of 80. The other students had an average score of
60. What is the average score of the whole class?

Solution:

Step 1: To get the sum of weighted terms, multiply each average by the
number of students that had that average and then sum them up.

80 × 10 + 60 × 15 = 800 + 900 = 1700

Step 2: Total number of terms = Total number of students = 25

Step 3: Using the formula

Answer: The average score of the whole class is 68.

Be careful! You will get the wrong answer if you add the two average scores
and divide the answer by two.

Sources of Finance

Introduction:
It is important for any person who wants to start a business to know about
the different sources from where money can be raised. It is also important to
know the relative merits and demerits of different sources so that choice of an
appropriate source can be made.

Meaning, Nature and Significance of Finance:

 Business is concerned with the production and distribution of goods and
services for the satisfaction of needs of society. For carrying out various
activities, business requires money.
So, Finance is known as “Life Blood of Business”.
 The requirements of funds by business to carry out its various activities is
called Business Finance.
 A business cannot function unless adequate funds are made available to
it. So, business firms have to look for different sources from where the
need for funds can be met.
 A clear assessment of the financial needs and the identification of various
sources of finance is a significant aspect of running a business
organization.
The financial needs of a business can be categorized into:
 1. Fixed capital requirement.
2. Working capital requirement.

Fixed Capital Requirement:

 In order to start a business, funds are required to purchase fixed assets
like plant and machinery, land and building, furniture and fixtures etc.
This is known as fixed capital requirements of the enterprise.
 The funds required in fixed assets remain invested in the business for
a longer period of time.
 Amount and nature of fixed capital is different and depends on its
nature of business.

Working Capital Requirement:

 The financial requirements of an enterprise to meet the day-to-day
operations is known as working capital requirement, which is used
for holding current assets and for meeting current expenses.
 The amount of working capital required varies from one business
concern to another depending on various factors.
The requirement for fixed and working capital increases with the growth
and expansion of business.

Classification of Sources of Finance:

In case of proprietary and partnership concerns, the funds may be
raised either from personal sources or borrowings from banks, relatives
etc. In case of company form of organization, the different sources of
business finance which are available may be categorized as follows:

Sources of Finance

On the basis of On the basis of ownership On the basis of period

Source of generation Owner’s funds Long term

a) Equity shares a) Equity shares

b) Retained earnings b) Retained earnings
c) Preference shares
Borrowed funds
d) Debentures
Internal sources

a) Equity share capital

b) Retained earnings

External sources

a) Financial institutions
b) Loan from banks
c) Preference shares
d) Public deposits
e) Debentures
f) Lease financing
g) Commercial papers
h) Trade credit
i) factoring

Short term sources are those which are required for a period not more
than one year.

Medium term sources are those which are required for a period of more
than one year but less than five years.

Long term sources fulfill the financial requirements of an enterprise for a

period exceeding 5 years.

Long Term Sources of Finance:

Long term financing provides greater flexibility and resources to fund

various capital needs and reduces dependence on any one capital source.

The primary purpose of obtaining long term funds is to finance capital

projects and carrying out operations on an expansionary scale. Such funds are
normally invested into avenues from which greater economic benefits are
expected to arise in future.

Features of long-term sources of finance:

 It involves financing for fixed capital required for investment in

fixed assets.
 It is obtained from capital market.
  Long term sources of finance have a long-term impact on the
business.
 To finance the permanent part of working capital.
 To finance growth and expansion of business.
Factors Determining Long Term Financial Requirements:

The amount required to meet the long-term capital needs of a company depends
upon following factors:

 Nature and character of a business.

 Nature of goods produced.
 Technology used.
Sources of Long Term Finance:

1. Equity Shares: Equity shares is the most important source of raising

long term capital by a company. Equity shares represent the ownership of
a company and thus the capital raised by issue of such shares is known as
ownership capital or owner’s funds. Equity shareholders do not get a
fixed dividend but are paid on the basis of earnings by the company. They
are referred to as ‘residual owners’ since they receive what is left after all
other claims on the company’s income and assets have been settled.
Equity shareholders liability is limited to the extent of capital contributed
by them to the company. Equity shares are suitable for investors who are
willing to assume risk for higher returns.
Merits:
 Equity capital serves as permanent capital as it is to be repaid inly
at the time of liquidation of a company.
 Equity capital provides credit worthiness to the company and
confidence to prospective loan providers.
 Funds can be raised through equity issue without creating any
charge on the assets of the company. So, the assets of a company
are free to be mortgaged for the purpose of borrowings.
Limitations:

 Investors who want steady income may not prefer equity shares
because they are getting fluctuating returns if they invest in it.
 The cost of equity shares is generally more as compared to the cost
of raising funds through other sources.
  Issue of additional equity shares dilute the voting power and
reduces the earnings of existing equity shareholders.
2. Preference Shares:
The capital raised through issue of preference shares is called preference
share capital. The preference shareholders enjoy a preferential position over
equity shareholders in two ways: (i) receiving a fixed rate of dividend out of
the net profits of the company, before any dividend is declared for equity
shareholders; (ii) they receive their capital after the claims of the company’s
creditors have been settled, at the time of liquidation.

Merits:

 Preference shares are useful for those investors who want fixed rate
of return with comparatively low risk.
 Preference shareholders generally do not enjoy any voting rights. so,
they do not affect the company management.
 Payment of fixed rate of dividend to preference shares may enable a
company to declare higher rates of dividend when the company’s
having huge profits.
 Preference shareholders have a preferential right of repayment over
equity shareholders in the event of liquidation of a company.
Limitations:

 The dividend paid is not deductible from profits as expense. Thus, there is
no tax saving as in the case of interest on loans.
 Dilution of claim over assets: because of the very reason that preference
shareholders have preferential rights over the company assets in case of
winding up of the company, dilution of equity shareholders claim over
the assets take place.
 In case of preference shares, the credit worthiness of a company is
definitely reduced because they posses the right over the personal assets
of the company.
3. Debentures:
Debentures are an important instrument for raising long term debt capital.
The debenture issued by a company is an acknowledgment that the
company has borrowed a certain amount of money, which it promises to
repay at a future date. Debenture holders are termed as creditors of the
company. Debenture holders are paid a fixed stated amount of interest at
specified intervals. Public issue of debentures requires that the issue be
 rated by a credit rating agency like CRISIL on aspects like track record of
the company, its probability, debt serving capacity, credit worthiness and
the perceived risk of lending.

Merits:
 It is preferred by investors who want fixed income at lesser risk.
 Debentures are fixed charge funds and do not participate in profits
of the company.
 The issue of debentures is suitable in the situation when the sales
and earnings are relatively stable.
 As debentures do not carry voting rights, financing through
debentures does not dilute control of equity shareholders on
management.
 Financing through debentures is less costly as compared to cost of
preference or equity capital as the interest payment on debentures
is tax deductible.
Limitation:

 As a fixed charge instruments, debentures put a permanent

burden on the earnings of a company in the form of fixed
interest. It is risk when company facing low revenue or in
losses.
 In case of redeemable debentures, the company has to make
provisions for repayment on the specified date, even during
periods of financial difficulty.
 Each company has certain borrowing capacity. With the issue of
debentures, the capacity of a company to further borrow funds
reduce.
4. Loans from Financial Institutions:

The government has a established a number of financial institutions all

over the country to provide finance to business organizations. They
provide both owned capital and loan capital for long term and medium-
term requirements and supplement the traditional financial agencies like
commercial banks. This source of financing is considered suitable when
large funds for longer duration are required for expansion, reorganization
and modernization of an enterprise.
Merits:
  Financial institutions provide long-term finance, which are not
provided by commercial banks.
 These institutions also conduct market surveys and provide
technical assistance and managerial services to people who run the
enterprises.
 As repayment of loan can be made in easy instalments, it does not
prove to be much of a burden on the business.
 The funds are made available even during periods of depression,
when other sources of finance are not available.
Limitations:

 Financial institutions follow rigid criteria for grant of loans. Too

many formalities make the procedure time consuming and
expensive.
 Certain restrictions such as restriction on dividend payment are
imposed on the powers of the borrowing company by the
financial institutions.
 Financial institutions may have their nominees on the Board of
Directors of the borrowing company thereby restricting the
powers of the company.

5. Term Loans from Banks:

Many industrial development banks, cooperative banks and commercial
banks grant long term loans to the business organizations, only if they
grant loans more than 5 years.
Merits:
 Interest payable on term loan is a tax-deductible expenditure and
thus taxation benefits is available on interest.
 Flexible: term loans are negotiable loans between the borrowers
and lenders. So, terms and conditions of such type of loans are not
rigid and this provides some sort of flexibility.
 Term loans represent debt financing, the interest of the equity
shareholders is not diluted.
 Term loans are provided by banks and other financial institutions
against security, so term loans are secured.
  Banks may insist the borrower to convert the term loans into
equity.
Limitations:

 Yearly interest payment and repayment of principal is

obligatory on the part of borrower. Failure to meet these
payments raises a question on the liquidity position of the
borrower and its existence will be at stake.
 Like any other form of debt financing term loans also increases
the financial risk of the company. Debt financing is beneficial
only if the internal rate of return of the concern is greater than
its cost of capital; otherwise, it adversely affects the benefit of
shareholders.
 Term loans do not have any right to control the affairs of the
company.
6. Retained earnings:
A company generally does not distribute all its earnings amongst the
shareholders as dividends. A portion of the net earnings may be retained in
the business for use in the future. This is known as retained earnings.

It is a source of internal of internal financing or self-financing or ploughing

back of profits. The factors available for ploughing back in an organization
depends upon many factors like net profit, dividend policy etc.

Merits:

 Retained earnings is a permanent source of funds available to an

organization.
 It does not involve any explicit cost in the form of interest, dividend or
floatation cost.
 As the funds are generated internally, there is a greater degree of
operational freedom and flexibility.
 It enhances the capacity of the business to absorb unexpected losses.
Limitations:
  If the purpose for utilization of retained earnings is not clearly stated, it
may lead to careless spending of funds.
 Conservative dividend policy leads to huge accumulation of retained
earnings leading to over capitalization.
 Retained earnings do not allow shareholders to enjoy full benefits of the
actual earnings of the company.
 Through ploughing back of profits, company increase their financial
strength. Companies may throw out their competitors from the market
and monopolize their position.

SHORT TERM FINANCE SOURCES

Short-term financing may be defined as the credit or loan facility extended to an enterprise for a
period of less than one year. It is a credit arrangement provided to an enterprise to bridge the gap
between income and expenses in the short run. It helps the enterprise to manage its current liabilities,
such as payment of salaries and wages to labours and procurement of raw materials and inventory.
The availability of short-term funds ensures the sufficient liquidity in the enterprise. It facilitates the
smooth functioning of the enterprise’s day-to-day activities.
Any delay in the procurement of the short-term fund may hinder the operational activities of the
enterprise. An enterprise always strives to manage its short-term financing in the most efficient
manner. The prime objective of the short-term finance is to maintain the liquidity of the enterprise.

The short-term sources of finance for a firm

are:-
i. Trade Credit:- Trade credit is one of the traditional and common methods of raising
short-term capital from the market. It is an arrangement in which the supplier allows the
buyer to pay for goods and services at a later date in future. The decision to provide trade
credit depends on the mutual understanding of both the buyer and supplier. The trade
credit transactions are not always done in terms of cash but also in terms of kinds, such as
finished goods. For example, the supplier may provide raw material, machines, finished
goods, and services to the buyer instead of cash.
ii. Customer Advances:- Customer advances may be defined as the part of payment made in
advance by the customer to the enterprise for the procurement of goods and services in
the future. It is also called Cash before Delivery (CBD). The customers pay the amount of
advance, when they place the order of goods and services required by them. The method
 of procuring goods and services depends on the characteristic and value of the product.
Customer advances allow customers to defer their payment for some time and fulfil their
other obligation on priority.
iii. Instalment Credit:- Instalment credit is another source of short-term financing, in which
the borrowed amount is paid in equal instalments with interest. It is also called instalment
plan or hire-purchase plan. Instalment credit is granted to the enterprise by the suppliers
on the assurance that the repayment would be done in fixed instalment at regular intervals
of time. It is mostly used to acquire long-term assets used in production processes.
iv. Bank Loan:- Bank loan may be defined as the amount of money granted by the bank at a
specified rate of interest for a fixed period of time. The commercial bank needs to follow
certain guidelines to extend bank loans to a client. For example, the bank requires the
copy of identity and income proofs of the client and a guarantor to sanction bank loan.
The banks grant loan to a client against the security of assets so that, in case of default,
they can recover the loan amount. The securities used against the bank loan may be
tangible or intangible, such as goodwill, assets, inventory, and documents of title of
goods.
v. Cash Credit:- Cash credit can be defined as an arrangement made by the bank for the
clients to withdraw cash exceeding their account limit. The cash credit facility is
generally sanctioned for one year, but it may extend up to three years in some cases. In
case of special request by the client, the time limit can be further extended by the bank.
The extension of the allotted time depends on the consent of the bank and past
performance of the client. The rate of interest charged by the bank on cash credit depends
on the time duration for which the cash has been withdrawn and the amount of cash.
vi. Commercial Papers:- Commercial paper is a short-term financing instrument used by the
enterprise with high credit rating to raise money from the market. It is an unsecured
promissory note, which the enterprise offers to the investors either directly or indirectly
through the dealers. Commercial papers are generally sold by large enterprises, which
have strong goodwill in the market.
vii. Certificates of Deposit:- Certificate of deposit is a type of promissory note issued by the
bank to the investors for depositing funds in the bank for a fixed period of time. The
maturity period of certificates of deposit is designed in accordance with the necessity of
investors. For example, if an investor needs to deposit funds for three months, then the
maturity period of certificates of deposit would be three months. The maturity period of
certificates of deposit can range from three months to one year.
viii. Bill of exchange:- A bill of exchange is a document in which an individual asks the
recipient to make payment for goods and services received to a third party at a future
date. The individual who writes the bill is known as drawer and the individual who
receives the bill is known as drawee. The individual who pays the bill is known as payee.
 One of the popular forms of bills of exchange is check, which is widely used in the
market.
ix. Factoring:- The concept of factoring is new to the Indian financial market. The factoring
services were introduced in India by the State Bank of India Factoring and Commercial
Services Ltd. (SBIFACS) on 11th April 1991 for financing short-term projects. Over the
time, other financial institutions, such as Canara Bank Factors Limited, incorporated in
September 1991, have also started providing the factoring services. In the later stage,
Punjab National Bank and Allahabad Bank have also entered in the factoring business but
they limited their services to northern and eastern parts of India. Factoring comprises
complementary financial services, which is provided to the borrowers. The borrower has
freedom to select the set of services provided by the factoring enterprise. Factoring is a
transaction whereby a business sells its statement of receivable to a factor at a discount
rate, to raise fund for financing short-term projects.
x. Bank Overdraft:- Bank overdraft is a temporary arrangement with the bank that allows
the organization to overdraw from its current deposit account with the bank up to a
certain limit. The overdraft facility is granted against securities, such as promissory notes,
goods in stock, or marketable securities. The rate of interest charged on overdraft and
cash credit is comparatively much higher than the rate of interest on bank deposits.