Chapter 7 : SOURCES OF BUSINESS FINANCE
Notes given in the copy for the following topics at a glance:
Business finance
Owner’s find
Borrowed fund
Issue of shares: equity shares and preference shares
Retained earnings
Trade credit
Public deposits
Debentures
Difference between :
1. owner’s fund and borrowed fund
2. equity and preference
3. shares and debentures
(FROM BOOK)
Notes given in the copy for the following topics:
Borrowed fund:
1. Trade credit
2. Public deposits
3. Debentures
4. Commercial Banks:
Commercial banks are major sources of borrowing for businesses. Businesses
often borrow from commercial banks for their daily expenses, expansion, or to
buy equipment.
Features of Commercial Banks:
1. Banks typically provide loans for short (up to 1 year) or medium-term (1 to 5
years) needs.
Example: A business needing money to buy new machinery might take a 3-year
loan from a bank.
2. Interest Rates: Banks charge interest on the money borrowed, which is the main
cost for the business.
3. Repayment Periods: Banks set fixed repayment schedules where businesses pay
back the loan in monthly or yearly installments.
4. Collateral Requirement: Banks often ask for security (collateral) to protect the
loan.
Example: A business might use its property or inventory as collateral for a bank
loan.
5.Processing Fees: Banks charge a fee to process and approve the loan.
6. Detailed investigation is done about company’s working and financial structure
by the bank.
# Security Taken: Banks usually ask for collateral, like property, equipment, or
inventory, which they can take if the loan is not repaid.
5. Loans from Financial Institutions :
Financial institutions are government or private organizations that lend money for
specific purposes, such as industrial development or infrastructure. Examples
include NABARD, SIDBI, and LIC Housing Finance – provide financial assistance and
guidance to industries and business.
Features of Financial Institutions:
1. Long-Term Loans: These loans are usually for a longer period, ideal for big
projects or expansion.
2. Project-Specific Funding: Financial institutions often fund specific types of
projects, such as agriculture, housing, or industry.
3. Lower Interest Rates: Financial institutions might offer lower rates compared to
commercial banks for long-term projects.
4. Government Support: Many financial institutions get support from the
government, making their loans more accessible and affordable. (promote
renewable energy.)
5. Large Loan Amounts: Financial institutions provide big loans for large-scale
projects
6. Act as Subscribers for securities and even act as an Underwriter for company’s
shares and debentures.
7. Provide loan guarantees to industrial units.
# Security Taken: They usually require project assets as collateral, such as the land,
buildings, or machinery being financed.
6. Inter-Corporate Deposits (ICDs)
Inter-corporate deposits are loans that one company gives to another or when the
companies arrange funds from another company. These are short-term and used
by companies to meet urgent or temporary fund requirements. It includes
securities, loan, guarantee
Features of Inter-Corporate Deposits:
1. Short-Term Loans: ICDs are usually given for a short period, typically 3 to 6
months.
2. Unsecured Loans: ICDs usually don’t require collateral. They’re based on trust
and the financial strength of the borrowing company.
3. Flexible Terms: The loan terms (interest rate, repayment date) can be
customized between the two companies.
5. Quick Funds: ICDs are processed quickly as they involve fewer formalities than
bank loans.
6. Used for Temporary Needs: ICDs are ideal for short-term financial needs, not for
long-term projects.
7. Direct Company-to-Company Lending: These loans are between companies,
without banks or other intermediaries
8. 3 months deposits- 12%, 6 months – 15%, call deposits- 10%( can be withdrawn
by the lender by providing 1 day notice)
# Bond?
A bond is a type of loan that investors give to a company or government. When
you buy a bond, you're lending money to the issuer (the company or
government), and in return, they promise to pay back the amount with interest on
specific dates.
Example: The government may issue bonds to raise money for projects like
building roads or schools. Investors buy these bonds, lending money to the
government, which then repays the amount with interest over time.
Debenture?
A debenture is also a type of loan taken by companies but is typically unsecured,
meaning it doesn’t require any specific asset as collateral. Debentures rely on the
creditworthiness and reputation of the company.
Example: A well-known, financially stable company may issue debentures to raise
funds for expansion. Investors trust that the company will repay based on its good
financial health, even though no specific asset backs the loan.
Key points:
1. Security: Bonds are often secured with assets as collateral
2. Issuers: Bonds are issued by both governments and companies
3. Risk: Bonds are considered safer due to asset backing and are often issued by
governments, while debentures can be riskier as they are unsecured and rely on
the issuer’s financial health.
4. Interest Rates: Bonds generally have lower interest rates since they are secured,
whereas debentures may offer higher rates to attract investors due to the higher
risk.
Owner’s fund:
1. ADR (American Depository Receipt)
An ADR is a way for a non-U.S. company to trade its shares in the U.S. stock
market.
Example: An American investor can buy Infosys shares without buying directly
from the Indian stock exchange. Instead, they buy an ADR listed on a U.S. stock
exchange like the NYSE. This makes it easier for Americans to invest in foreign
companies.
2. GDR (Global Depository Receipt)
A GDR is similar to an ADR but is used to trade a company’s shares in multiple
countries outside its home country.
Example: A European investor can buy Reliance GDRs on the London exchange,
giving them an indirect stake in Reliance without using the Indian stock market
3. IDR (Indian Depository Receipt)
An IDR lets an international company trade its shares on the Indian stock market.
How it works: Suppose Microsoft, a U.S. company, wants Indian investors to buy
its shares easily. Microsoft issues IDRs through an Indian bank, which holds shares
of Microsoft and issues IDRs in India.
Example: An Indian investor can buy Microsoft IDRs on the BSE or NSE in India.
This allows them to invest in Microsoft without trading on the U.S. market.
Concept of GDR in brief:
Indian co. Tata , raised money in India but now need more money
It surrenders the required no. Of shares to the Depository Banks
Depository Banks are situated outside India and are like normal banks
dealing in depository receipts
They hold the share in their country’s stock exchange where foreigner’s can
buy the shares
