FIN212 : Basic Financial

Management
Sources of Finance

Course Instructor: Gaurav Puri

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Sources of Finance
All the investment decisions lead to an outlay of
cash. A company can raise finance from various
sources to finance its projects/ investment
decisions. Finance may be required for LONG RUN
as well as for SHORT RUN. To match the long and
short-run cash requirements, a company uses both
the long and the short run sources of finance.
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Sources of Finance
Sources of
Finance

Long-Term Short-Term
Sources Sources

Ownership Debt-ship Sources

Sources

Debt-ship Sources
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Long-Term Sources of Finance (Ownership)

1. Equity Share Capital

2. Preference Share Capital
a. Redeemable Preference Share Capital
i. Cumulative Preference Capital

ii. Non-Cumulative Preference Capital

b. Irredeemable Preference Share Capital

i. Cumulative Preference Capital

ii. Non-Cumulative Preference Capital

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Long-Term Sources of Finance (Ownership)

3. Retained Earnings
4. Angel Investor
5. Venture Capital Firms
6. Corporate Investors
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Long-Term Sources of Finance (Debt-ship)

1. Long-Term Loans
2. Debentures
a. Convertible Debentures
b. Non-Convertible Debentures
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Long-Term Sources of Finance (Ownership)

Equity Share Capital:

The capital that gives ownership rights to the
shareholders. The capital is generally issued for the
lifetime of the company. It gives voting rights to the
shareholder in taking strategic decisions of the
company. Shareholders are not involved in the day-to-
day activities of the company.
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Long-Term Sources of Finance (Ownership)

Equity Share Capital:

Equity shareholders are termed as the company's actual owners as they
take all the risk and are the last ones to get their share of profit from the
company. They get their capital back only in two cases:

 Buyback of shares by the company

 Liquidation of the company

Their liability is limited to the face value of the shares. At any point, equity
shareholders can't be forced to pay more than the face value of the shares
purchased by them.
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Long-Term Sources of Finance (Ownership)

Preference Share Capital:

Preference Share Capital gives two preferences to the

shareholders:

 Preference as to payment of Dividend

 Preference as to Repayment of Capital at the
time of liquidation
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Long-Term Sources of Finance (Ownership)

Preference Share Capital:

Since the shareholders are given two preferences, so No
Voting Right is given to them. The rate of dividend is
fixed on the preference shares. It implies that whenever
the company declares divided, the preference shares get
that fixed percentage of dividend irrespective of the size
of profits earned by the company.
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Long-Term Sources of Finance (Ownership)

Preference Share Capital:

By nature, preference shares can be
 Redeemable or
 Irredeemable preference shares
Further, they can be subdivided as
Cumulative and Non-cumulative preference shares
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Long-Term Sources of Finance (Ownership)

Redeemable Preference Share Capital:

Preference shares issued for a fixed duration are known
as Redeemable Preference Shares. The company raises
funds for a fixed period through redeemable preference
shares, and the capital is returned/ redeemed after the
stipulated period.
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Long-Term Sources of Finance (Ownership)

Irredeemable Preference Share Capital:

Preference shares issued for the lifetime of the
company are known as Irredeemable Preference
Shares. The company raises funds on permanent basis
through irredeemable preference shares, and the capital
is returned only in case of liquidation of the company.
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Long-Term Sources of Finance (Ownership)

Cumulative Preference Share Capital:

The preference shares on which dividend keeps on accumulating
until it is paid are known as cumulative preference shares. It
further implies that payment of dividend every year is not an
obligation for the company. However, these shares give the
shareholders the right to receive divided for all the years of their
investment provided company declares dividend during the
tenure of their investment. These shares can be issued as
redeemable or irredeemable preference shares.
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Long-Term Sources of Finance (Ownership)

Cumulative Preference Share Capital:

Example: ABB Limited suffered a loss of 20 bn in 1 st year, 30 bn in 2nd year, 30 bn in
3rd year and earned a profit of 100bn in 4th year and a profit of 200bn in 5th year. The
balance sheet of the company shows that there are Rs. 500bn, 10% cumulative
preference shares are pending. How much dividend the shareholders will get every
year. In first three years when company suffered a loss, it was not able to declare
dividend; however, in the fourth year the company earned profits, but the
shareholders decided to retain the profits in the business and no dividend was
declared. In the fifth-year company declared the divided of 5% for equity
shareholders.
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Long-Term Sources of Finance (Ownership)

Cumulative Preference Share Capital:

Solution: Dividend due every year = 10% of 500 bn, i.e., 50 bn p.a. It implies that the
shareholders should get a divided of 500bn*10%*5 = 250 bn in years provided the
company declares divided. If in 5 years company does not declare dividend then they will
not get anything. However, the company declared a dividend of 5% for the equity
shareholders.

As per rule before making any payment of dividend to the equity shareholders
preference shareholders must be paid their dues. In the given case the company must
FIRST pay dividend due to the cumulative preference shares then any payment can be
made to equity share holders. The cumulative preference shareholders will get a divided
of Rs. 250 bn in the 5th year for all 5 years.
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Long-Term Sources of Finance (Ownership)

Non-Cumulative Preference Share Capital:

The preference shares on which dividend does not accumulate are
known as non-cumulative preference shares. It further implies that
payment of dividend every year is not an obligation for the
company. However, these shares give the shareholders the right
to receive divided before equity shares for the year in which
divided is declared by the company. These shares can be issued as
redeemable or irredeemable preference shares.
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Long-Term Sources of Finance (Ownership)

Non-Cumulative Preference Share Capital:

Example: ABB Limited suffered a loss of 20 bn in 1 st year, 30 bn in 2nd year, 30 bn in
3rd year and earned a profit of 100bn in 4th year and a profit of 200bn in 5th year. The
balance sheet of the company shows that there are Rs. 500bn, 10% non-cumulative
preference shares are pending. How much dividend the shareholders will get every
year. In first three years when company suffered a loss, it was not able to declare
dividend; however, in the fourth year the company earned profits, but the
shareholders decided to retain the profits in the business and no dividend was
declared. In the fifth-year company declared the divided of 5% for equity
shareholders.
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Long-Term Sources of Finance (Ownership)

Non-Cumulative Preference Share Capital:

Solution: Dividend due every year = 10% of 500 bn, i.e., 50 bn p.a. It implies that the
shareholders should get this amount in all those years when the company declares
dividend. If the company does not declare any dividend in any year, the shareholders will
get nothing in that year. However, the company declared a dividend of 5% for the equity
shareholders.

As per rule before making any payment of dividend to the equity shareholders
preference shareholders must be paid their dues. In the given case the company must
FIRST pay dividend due to the non-cumulative preference shares then any payment can be
made to equity share holders. The non-cumulative preference shareholders will
get a divided of Rs. 50 bn in the 5th year only for the 5th year when dividend was
declared by the company.
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Long-Term Sources of Finance (Ownership)

Retained Earnings/ Ploughing Back of Profits:

A company may retain its earnings and may decide, not to declare any dividend to the
shareholders. A company generally retains dividend generally in three cases:
1. It has good investment opportunities and can generate returns more than
the expectations of the existing shareholder.
2. It needs cash pay debt
3. It wants to improve its cash position
When the company makes new investments from its retained earnings then it is also
known as Ploughing Back of Profits. In all such cases (above mentioned), the
Retained earnings serve as a Long-Term Source of Finance.
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Long-Term Sources of Finance (Ownership)

Angel Investor:
An angel investor (also known as a business angel, informal investor,
angel funder, private investor, or seed investor) is an individual who
provides capital for a business or businesses start-up, usually in
exchange for convertible debt or ownership equity. Angel investors
usually give support to start-ups at the initial moments (where risks
of the start-ups failing are relatively high) and when most investors
are not prepared to back them.
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Long-Term Sources of Finance (Ownership)

Venture Capital Firms:

Venture capital (VC) is a form of private equity and a type of financing that investors
provide to startup companies and small businesses that are believed to have long-term
growth potential.

Venture capital generally comes from well-off investors, investment banks, and any other
financial institutions. However, it does not always take a monetary form; it can also be
provided in the form of technical or managerial expertise. Venture capital is typically
allocated to small companies with exceptional growth potential, or to companies that have
grown quickly and appear poised to continue to expand.
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Long-Term Sources of Finance (Ownership)

Corporate Investors:
When a Limited or Private Limited company chooses to invest in
another company then such investment is known as corporate
investment and the investing company is referred to as corporate
investor.

A company may invest in other company sheerly for investment

purpose or to take control of that business.
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Long-Term Sources of Finance (Debt-ship)

Long Term Loans:

A company may take long term loans from Commercial Banks or
Non-Banking Financial Corporations to meet its long-run cash
requirements. Generally, the duration of such loans varies from
SEVEN to TEN years or more. However, the bank generally seeks
security while lending money and security is given as collateral and
by a personal guarantee. The loan raised giving security is known as
SECURED LOANS, whereas if no security is given, such loans
are known as UNSECURED LOANS.
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Long-Term Sources of Finance (Debt-ship)

Debentures:
A public limited company may also raise finance from the public by issuing
Debentures. A debenture is a debt instrument issued by a company to the provider
of the loan given in acknowledgement of debt raised by the company. The
company gives a fixed percentage of interest on the debentures every year, and at
the end of the duration of the debentures, it repays the principal amount. In India, a
public limited company can issue debentures either as Convertible Debentures or
Non-Convertible Debentures. However, at any point, a company can NEVER
convert or offer to convert the debentures into another debt-ship security.
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Long-Term Sources of Finance (Debt-ship)

Convertible Debentures:
The convertible debentures can be converted into shares towards the expiry of
the debt/ debentures. The company issues these debentures as convertible at
the time of issue. Debenture holders are given an option to convert their
debentures in shares (equity or preference as decided upon at the time of issue
and communicated to the debenture holders at the time of purchase of
debentures) before the expiry of the stipulated period of debt. If the debenture
holders exercise the offer, then their debentures are converted into shares; else,
the borrowed sum is returned.
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Long-Term Sources of Finance (Debt-ship)

Non-Convertible Debentures:
A non-convertible debenture can never be converted into shares
during the life of the debentures. The company's only option is to
repay the debt raised through debentures at the expiry of the
stipulated period.
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Short-Term Sources of Finance

1. Trade Creditors 7. Certificate of Deposit
2. Short Term Loans 8. Commercial Paper
3. Public Deposits 9. Letter of Credit
4. Bank Overdraft 10. Outstanding Expenses
5. Cash Credit 11. Advances
6. Treasury Bill 12. Bill Discounting

13. Factoring
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Short-Term Sources of Finance

Trade Creditors:
A trade creditor is a supplier who has sent your business goods or
supplied them with services, who you haven’t yet paid. They are
also known as sundry creditors, accounts payable.

In business accounting applications, trade creditors and the

amounts owed are listed in the company’s balance sheet as
liabilities.
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Short-Term Sources of Finance

Short-Term Loans:
A company may take short term loans from Commercial Banks or
Non-Banking Financial Corporations to meet its short-run cash
requirements. Generally, the duration of such loans varies from
ONE to THREE years.
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Short-Term Sources of Finance

Public Deposits:

These are the unsecured deposits invited by companies from the public
mainly to finance working capital needs. In India, a company can raise
money through public deposits MAXIMUM for THREE years.

A company wishing to invite public deposits makes an advertisement in

the newspapers. Any member of the public can fill up the prescribed form
and deposit the money with the company.
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Short-Term Sources of Finance

Bank Overdraft:
An overdraft occurs when there isn't enough money in an account to cover
a transaction or withdrawal, but the bank allows the transaction
anyway. Essentially, it's an extension of credit from the financial
institution that is granted when an account reaches zero. The overdraft
allows the account holder to continue withdrawing money even when the
account has no funds in it or has insufficient funds to cover the amount of
the withdrawal.
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Short-Term Sources of Finance

Cash Credit:
A Cash Credit (CC) is a short-term source of financing for a
company. In other words, a cash credit is a short-term loan
extended to a company by a bank. It enables a company to
withdraw money from a bank account without keeping a credit
balance. The account is limited to only borrowing up to the
borrowing limit. Also, interest is charged on the amount borrowed
and not the borrowing limit.
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Short-Term Sources of Finance

Treasury Bills:
Treasury bills are money market instruments issued by the Government of
India as a promissory note with guaranteed repayment at a later date.
Funds collected through such tools are typically used to meet short term
requirements of the government, hence, to reduce the overall fiscal deficit
of a country.

Companies can not issue treasury notes.

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Short-Term Sources of Finance

Certificate of Deposit:
A certificate of deposit (CD) is a product offered by banks and credit unions
that provides an interest rate premium in exchange for the customer
agreeing to leave a lump-sum deposit untouched for a predetermined
period. Almost all consumer financial institutions offer CDs, although it’s up
to each bank to decide the terms it which it wants to offer.
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Short-Term Sources of Finance

Commercial Paper:
Commercial paper is a money-market security issued (sold) by
large corporations to obtain funds to meet short-term debt
obligations (for example, salaries) and is backed only by an issuing
bank or company promising to pay the face amount on the
maturity date specified on the note.
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Short-Term Sources of Finance

Letter of Credit:
A letter of credit, or "credit letter," is a letter from a bank guaranteeing that a
buyer's payment to a seller will be received on time and for the correct amount. If
the buyer is unable to make a payment on the purchase, the bank will be required to
cover the full or remaining amount of the purchase. It may be offered as a facility.

Due to the nature of international dealings, including factors such as distance,

differing laws in each country, and difficulty in knowing each party personally, the
use of letters of credit has become a very important aspect of international trade.
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Short-Term Sources of Finance

Outstanding Expenses:
An Outstanding Expense is a type of expense that is due but has
not been paid. This expense becomes outstanding to the company
when, this has taken the benefit, but the related payment has not
been made simultaneously. Examples for Outstanding Expenses –
Electricity charges due but not yet paid.
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Short-Term Sources of Finance

Advances:
The term advances from customers refers to money collected by a company prior to
providing a product or service. Advances from customers are oftentimes collected
when businesses sell prepaid subscriptions or gift certificates.

When companies collect this money, the intention is to eventually provide the
product or service paid for by the customer. Following the receipt of this cash, the
company would classify the advance as a current liability on the balance sheet.
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Short-Term Sources of Finance

Bill Discounting:
Bill discounting is a source of working capital finance for the seller, who is
providing goods on credit. It is an arrangement between the seller and a
financial institution. Here the seller sells the sales bill to the institution
before it becomes due. Once due, the institution recovers the amount from
the buyer.
In between if the seller needs money, it may discount the bill for cash from
bank and the bank will receive the payment towards maturity of the bill
from the buyer of the goods.
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Short-Term Sources of Finance

Factoring:
Factoring is a financial transaction and a type of debtor finance in which a
business sells its accounts receivable (i.e., invoices) to a third party (called a
factor) at a discount. A business will sometimes factor its receivable assets
to meet its present and immediate cash needs. Forfaiting is a factoring
arrangement used in international trade finance by exporters who wish to
sell their receivables to a forfaiter. Factoring is commonly referred to as
accounts receivable factoring, invoice factoring, and sometimes accounts
receivable financing.
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Treasury Management and Treasury Operations in Corporate

Treasury Operations oversees the day-to-day management of Company’s

working capital, cash, prepares a daily forecast of cash receipts,
disbursements and expected closing balances.

Treasury management services provide businesses with several unique

benefits. One of the biggest benefits is time efficiency. By implementing a
treasury management system, businesses can streamline the payment
process and reduce the time spent on payment authorization and initiation.
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External Commercial Borrowings

External commercial borrowing (ECBs) are loans in India made by non-resident lenders in
foreign currency to Indian borrowers. They are used widely in India to facilitate access to
foreign money by Indian corporations and PSUs (public sector undertakings). ECBs
include commercial bank loans, buyers' credit, suppliers' credit, securitized instruments
such as floating rate notes and fixed rate bonds etc., credit from official export credit
agencies and commercial borrowings from the private sector window of multilateral
financial Institutions such as International Finance Corporation (Washington), ADB, AFIC,
CDC, etc.

ECBs cannot be used for investment in stock market or speculation in real estate. The
DEA (Department of Economic Affairs), Ministry of Finance, Government of India along
with Reserve Bank of India, monitors and regulates ECB guidelines and policies.
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Financing for MSME’s

Micro, Small, and Medium Enterprise (MSME) loans are unsecured
loans offered by several financial institutions to meet various
business-related expenses on credit by MSMEs. These loans are
defined by the Indian Government and RBI as loans for business
enterprises for support in terms of finance, infrastructure and
other areas.