FINANCING OF ENTERPRISE
In any emerging economy across the globe, the SME sector is seen as one where
innovation and growth takes place. They are a major provider of employment
and are the nuts, bolts and wheels of the economy. The SME sector needs timely
finance for its vibrant growth.
Finance is a key input of production, distribution and development. It is,
therefore, aptly described as the ‘life-blood’ of industry and is a pre-requisite for
accelerating the process of industrial development.
A growing economy needs the support of a financial structure which is
responsive to the needs of development. In India, in the process of financial
deepening, commercial banks had to shoulder special responsibilities for meeting
the financial needs of diverse sectors of the economy, at various stages of
development. In the process, they have evolved various modes and instruments
of financing, fashioned various organisational innovations, moved away from
traditional commercial banking and evolved into development banks, responsive
to socio-economic needs.
Finance is now made available to entrepreneurs on a totality basis by commercial
bank, except in cases where the State Financial Corporation (SFCs) and other
similar financing agencies step in to meet their medium-term requirements.
Financing a New Enterprise
Every enterprise requires finance for establishing its business and carrying out
various related activities. Financing a new enterprise essentially involve two
parts, viz, estimating the funds/capital requirement and deciding sources. An
enterprise has two types of financial requirements, namely, fixed capital and
working capital, which are discussed as follows:
Working Capital: It is that capital which is invested in current or short-term
assets. It covers expenses, such as buying the raw material, payment of wages
and salaries, rent, fuel, electricityand water,repairs and maintenance and
advertising. The prepaid expenses, cash, inventory and the bills receivable are
regarded as current assets. The funds invested in current assets are recovered
by realizing cash. Therefore, working capital is also regarded as revolving
capital or circulating capital.
Fixed Capital: The fixed capital helps in purchasing fixed or durable assets, such
as land, building, machinery, equipment and furniture. The fixed capital is also
known as long term capital. The amount of fixed capital depends mainly upon
the nature and size of the business. The manufacturing industries requires huge
amount of investment whereas the trading concerns require comparatively lesser
investments.
Estimating Financial Requirements
An enterprise can raise funds only, if it clearly determines its financial
requirements. Estimating the financial requirements for an enterprise involves
determining the total amount of capital required for various needs of the
business and deciding the sources and methods to raise it. The financial needs
can be fulfilled though the owned capital or the borrowed capital. The financial
requirements on the basis of period of use are classified into three types, which
are as follows:
Long-Term Capital: Long termcapital is required to finance the fixed capital and
permanent part of the working capital. It is raised through various sources, such
as by issuing debentures and shares and taking loans and advances from banks
and financial institutions. It is the capital which is required for a period of five
years or more.
Medium-Term Capital: This kind of capital is required for performing different
activities viz. renovation of buildings, expenditure on advertising and
modernization of machinery. This capital can be raised from different sources
such as issuing of debentures and shares and reinvestment of accumulated
profits. The medium-termcapital is required for a period of two to five years.
Short-Term Capital: Short term capital is required to finance the current assets
and to meet day-to-day expenses. It can be raised from various sources such
as banks, instalment credit and trade credit. The short-term capital is needed
for a period of less than a year.
5. Sources of Arranging Finance for the Enterprise
An enterprise raises funds for different purposes depending on the time period
ranging from short to long duration. The total amount of financial needs of an
enterprise depends on the nature and size of the business. On the other hand,
the aim of raising funds depends on the objectives of the enterprise. An
enterprise can opt for various sources of financing, which are mainly three types
and are discussed in detail as follows:
Sources of Long-Term Financing
An enterprise needs long term finance
for expansion, diversification,
technological innovation and research
and development projects. It can be
raised through different sources
depending upon the amount of capital
required to complete the project and is
explained as follows:
Equity Financing: Equity financing refers to a method of raising long term
funds by selling the common and preferred stock of the enterprise to the
investors. The investors get ownership interests in the enterprise in return of
amount paid by them for purchasing the common and preferred stock of the
enterprise. It can be raised through shares. Shares are easily transferable and
involve limited liability of shareholders to the face value of the shares. The
shares are basically of two types viz. equity shares and preference shares.
Debt Financing: Debt financing is a form of financial instrument that provides
long term debt to an enterprise. It can be raised through debenture capital, a
source to raise debt capital. Debt financing is an agreement between the
enterprise and a debenture holder. It clearly indicates that the enterprise would
repay the debt at a specified date to debenture holders. If an enterprise raises
funds through issuing debentures, it needs to pay a fixed rate of interest at
regular intervals. Debenture holders of an enterprise are known as creditors.
Term Loans: Term loans are the types of long-term loans that are raised for the
duration of 3 to 10 years from banks and financial institutions. Term loans
carries floating rate of interest and have pre-determined maturity period. The
main sources of these loans are IDBI, ICICI, Commercial Banks, and IFCI etc. An
enterprise uses term loans to purchase fixed assets and fund projects having
long gestation period.
Sources of Medium-Term Financing
Medium term financing is required for performing different activities viz.
renovation of buildings, expenditure on advertising and modernization of
machinery. This capital can be raised from different sources such as issuing of
debentures and shares and reinvestment of accumulated profits. The medium-
term capital is required for a period of two to five years. An enterprise can avail
medium term finance through various sources including lease finance and hire
purchase, venture capital finance, public deposits and retained earnings. The
following figure shows the sources medium term finance:
Retained Earnings: In retained earnings, the enterprise uses its accumulated
profits for future investments, which can be long term and short term in nature.
At the end of each financial year, some of the undistributed profits are left with
the enterprise. These profits are transferred to reserve funds each year and this
funds is known as retained earnings.
Lease Finance: Lease finance is an agreement between the owner of assets,
called the lessor and the user of assets called the lessee. In lease finance, only
possession of asset is transferred to a lessee and ownership of the title remains
with the lessor. Lessee makes payment to the lessor after a specified period of
time to use the asset. This periodical payment is called as lease rent.
Hire Purchase: In hire purchase, there is an agreement between a hiree who is
the owner of the property and a hirer who is the user of the asset. As per this
agreement, the hiree transfers his/her asset to the hirer keeping ownership of
title with himself/herself and the hirer gets the possession of the asset. In
hire purchase, the beneficiary receives the payment from the hirer
periodically. The payment made to the hiree is divided into two parts viz. capital
repayment and interest.
Public Deposits: Public deposits are a significant way of raising medium term
fund. It can be defined as funds and loans raised from general public,
employees and other similar kind of depositors. These are treated as one of the
easiest way of raising funds during credit crisis as public is always ready to
invest in the profitable projects of different enterprises.
Venture Capital Financing: It is one of the widely used sources of
medium term finance. It is also called risky capital, as it requires to be
paid even in case of loss. Venture capital is a form of quasi equity and is
generally required by newly established enterprises. The capitalist who invests
in venture capital is not similar to bankers and Medium Term Sources of Finance
Retained Earnings Public Deposits Hire Purchase Lease Finance Venture Capital
Finance equity shareholders. A venture capitalist acts as a partner, manager and
advisor to the enterprise. This type of capital is required at the time of
incorporation, expansion and acquisition of a project.
Sources of Short Term Financing 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 expenditure in a short period of time. 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. The important
sources of short term financing are:
Trade Credit: Trade credit 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 supplier takes the decision to extend trade credit after taking
into consideration creditworthiness, goodwill and record of previous
transactions of the buyer.
Instalment Credit: Instalment credit is another source of short term financing,
in which the amount that is borrowed is repaid with interest in equal instalments.
It is also called instalment plan or hire-purchase plan. It helps an enterprise in
purchasing the new plant and machinery in the absence of funds for a time
period.
Cash Credit: Cash credit is defined as an agreement between the bank and the
customers to withdraw cash exceeding their account limit. Cash credit is one of
the most importantinstruments of short term financing. The time limit granted is
generally one year which can be further extended by the bank in case of special
request by the customer.
Commercial Papers: It is an 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 dealer. Commercial papers are generally sold by large enterprises, which
have strong goodwill in the market.
Bank Loan: Bank loan is the amount of money granted by the bank at a
specified rate of interest for a fixed period of time. It requires minimum
document and legal formalities to pass a loan. Various banks are required to
follow certain guidelines to extend bank loans to the customers. For this
purpose the bank requires the copy of income proofs and identity of the
client and a guarantor to sanction bank loan.
Certificates of Deposit: This deposit is a type of promissory note which is
issued by the bank to the clients for depositing funds in the concerned bank for a
fixed time period. The maturity of certificates of deposit is designed in
accordance with the necessity of investors. The maturity period of certificates of
deposit can range from three months to one year.
Bills of Exchange: A bill of exchange is a document in which an individual
demands the receiver to give payment for services and goods received to a third
party at a future date. The individual who writes the bill is known as drawer and
t he individual who receives the bill is known as drawee. The individual who pays
the bill is known as payee.
Customer Advances: It may be defined as a part of payment which is given in
advance to the enterprise by the customer for the procurement of goods and
services in the future. It is also called as Cash Before Delivery (CBD). The
enterprise is free to decide whether to refund the money, if the order is cancelled
by the customers and it does not require paying interest on customer advances.
Factoring:
Factoring comprises complementary financial services, which is provided to the
borrower. The borrower has the freedom to select the set of services provided by
the factoring enterprise. Factoring ensures that the services will be given to the
clients at a faster pace and with good quality.
Bank Overdraft: It is a temporary arrangement between the bank that
allows the organization to overdraw from its current deposit account with the
concerned bank up to a specified limit. This facility is granted against securities,
such as promissory notes, goods in stock, or marketable securities. The interest
rate which is charged on cash credit and bank overdraft is very high as compared
with the rate of interest on bank deposits.
Role of Agencies for Financial Support to Enterprises
The financial institutions fund only term loans required for creating fixed assets.
The agencies which aid entrepreneurs include State Financial Corporations (SFCs)
which are 18 in number in India, Industrial Development Bank of India (IDBI),
Small Industries Development Bank of India (SIDBI), Industrial Finance
Corporation of India (IFCI) and State Industrial DevelopmentCorporations (SIDCs)
etc. IDBI, IFCI and SIDBI were only refinancing loan extended to SMEs at the time
of their incorporation. IDBI and IFCI were funding large scale industries in
addition to underwriting the shares and promoting joint sector ventures.
Later their functions have changed and today all of them extend term
loan to small scale industries directly and also refinance the loan given by
the banks to entrepreneurs. SFCs and SIDCs operate at state level and provide
funds for industrial development and are involved in joint sector ventures
and underwriting shares. Some of the major agencies which provide
financial assistant to entrepreneurs are discussed as follows:
Small Industries Development Organization (SIDO): For the promotion
and development of small scale industries SIDO is the apex authority and the
schemes launched by this agency are as follows:
Credit Linked Capital Subsidy Scheme for Technology Upgradation: It gives
capital subsidy at the rate of 15 per cent up to Rs one crore for the technology
upgradation for small and medium term organizations in the specified products
and sub sectors. Integrated Infrastructure Development Scheme: The
scheme provides help up to 80 percent or Rs four crore for the state
governments, NGOs and industry associations. But initially this assistance was
upto 45 percent or Rs two crore, whichever is less for setting up a new industrial
undertaking.
Credit Guarantee Scheme: Under this scheme the loans are given up to a limit of
Rs 25 lakhs.
Small Scale Industries MDA scheme: The scheme provided funds up to 25 per
cent of costs for producing publicity material upto Rs two lakh for sector specific
subsidies and 90 percent for to and fro air fare to the small entrepreneurs for
attending in fairs and exhibitions abroad.
ISO 9000/ISO 14001 Certification Reimbursement Scheme: This facility is given
for obtaining ISO 9000 to the limit of 75 percent or Rs 75000, whichever is less.
Micro Finance Programme: This facility is given for graduate the entrepreneurs
from consumption and production credit to start a small new venture.
Help to Entrepreneurship Development Institutes: For developing the
training infrastructure 50 per cent or Rs one crore, whichever is lower is
given to the state governments.
National Small Industries Corporation Limited (NSIC): This is a creative
agency and an initiative of the central government of India. It is a government
organization which provides credit support, technology support, marketing
support and other support services for the growth and development of
entrepreneurs and their organizations and these are.
Credit Support Schemes: The credit requirements of small scale industries are
facilitated by NSIC such as:
Financing for Procurement of Raw Material: The agency takes care of all the
procedures, documents and issue of letter of credit and other bank related
documents in case of imports required for the purchase for raw materials. Heavy
discounts are given to SSIs for bulk purchases.
Financing through Syndication with Banks: With the help of strategic alliances
between the commercial banks and the small enterprises facility of funds
are provided.
Equipment Financing: By availing the facility of installment purchase,
hire purchase and term loan the finance is given to SSIs for purchasing
equipments. o Financing for Marketing Activities: Various .marketing facilities
such as internal marketing, rural marketing, exports and bill discounting facilities
are given.
Technology Support Scheme: The services provided under this scheme
are the recommendations on application of new techniques, material testing
facilities in the special laboratories, environment and energy services at
selected centres, practical as well as theoretical training for the upgradation of
skill.
Marketing Support Scheme: NSIC promote small industries products and has
introduced a number of schemes to support small enterprises in their
marketing activities and enhance its market share.
Performance and Credit Rating Schemes for Small Industries: The credit
rating agencies enable the small enterprises to conduct the SWOT analysis
of their current activities and take prompt action. All the financial institutions
are government owned and controlled and hence promote industrialization
in the country by implementing the schemes of the government and provide
refinance on the advances given to the entrepreneurs.
