BUSINESS FINANCE MANISH KUMAR MANISHATMARKETINGGMAIL COM IN THIS

BUSINESS FINANCE MANISH KUMAR MANISHATMARKETING@GMAIL. COM

IN THIS UNIT WE WILL STUDY ABOUT • Business finance- financial need of business • Methods and sources of finance • Security market • Money market • Study of stock exchange and SEBI

MEANING OF BUSINESS FINANCE • Business finance refers to money and credit employed in business. • It involves procurement and utilization of funds so that business firms may be able to carry out their operations efficiently. • It encompasses a wide range of activities and disciplines revolving around the management of money and other valuable assets.

CHARACTERISTICS OF BUSINESS FINANCE • Business finance includes all type of funds used in business. • Business finance is needed in all types of organisation- large or small, manufacturing or trading • The amount of business finance differs from one business firm to another depending upon its nature and size. It also varies from time to time • Business finance involves estimation of funds. It is concerned with raising funds from different sources as well as investment of funds for different purposes.

FINANCIAL NEED OF BUSINESS To purchase fixed assets To funds business growth To meet contingencies To meet day to day expenses To bridge the time gap between production and sales To avail of business opportunities

IMPORTANCE OF BUSINESS FINANCE Promotion of sales Use of modern Technolog y Need for largescale operation

TYPES OF BUSINESS FINANCE Types of finance Period of Repayment Purpose Short Term Medium term Long-Term less than a year Purchase of raw materials, payments of wages, rent, insurance etc. One year to five years Expenditure on modernization, renovation, heavy advertising etc. more than five years purchase of land building, plant and machineries etc.

FIXED CAPITAL AND WORKING CAPITAL • Fixed capital refers to the total value of assets in a business which is of durable nature and used in a business over a considerable period of time. It comprises of assets like land, building, machinery, furniture etc. • The capital invested in these assets is fixed in the sense that these are required for permanent use in business and not for sale. • Working capital consist of those assets which are either in the form of cash or can easily be converted into cash, e. g. , cash and bank balances, debtors, bills receivables, stock, etc. These assets are also knows as ‘current assets’. • Working capital is needed for day to day operations of business. However a part of working capital is required at all times to maintain minimum level of stock and cash to pay wages and salaries, etc. This part of working capital is called ‘permanent working capital’.

DIFFERENCE BETWEEN FIXED CAPITAL AND WORKING FIXED CAPITAL WORKING CAPITAL Fixed capital may be defined as capital invested in Working capital may be defined as capital invested long-term assets. in current assets Requirement Fixed capital is required for establishment of Working capital is required to utilize fixed assets of business. the company. Sources of Funds The industrial units mobilize fixed capital from The industrial units mobilize working capital from the various sources like shares, debentures, banks etc. commercial bank loans, profits retained, etc. which are to be repaid over long time period. are repayable before one year. Conversion The fixed capital which is used for fixed assets is not The working capital investments have high liquidity easily convertible into cash. and can be easily convertible into cash. Nature Fixed capital is a one-time investment to purchase Working capital is required constantly for day to day fixed assets for starting a business or for expanding business activities of the organization. a business. Duration Fixed capital in long-term investment i. e it is Working capital is usually a short term investment invested at the for long periods of time. for running of businesses day to day operations.

METHOD AND SOURCES OF FINANCE

METHODS AND SOURCE OF FINANCE Externa l Source Internal sources

re Loa from ns FIs Re ear tained nin gs Pre e s feren har c es De s bentu Eq sha uity res LONG TERM SOURCE OF FINANCE

EQUITY SHARES • Equity shareholders are the real owners of the company as they have the voting rights and enjoy decision making authority on important matters, related to the company. • The shareholders’ return is in the form of dividend, which is dependent on the profits of the company and capital gain/loss, at the time of their sale. • They enjoy higher returns if the company performs well and may not get any dividend at all, if the company does not do well or when the board of directors do not recommend any dividend for payment.

FEATURES OF EQUITY SHARES Control Maturity Claims on Income Cost of Equity Claims on Asset Pre. Emptive Right

ADVANTAGES OF EQUITY SHARES Capital profit Interest in the company’s activities Best for investment More income Right to interfere in management

ADVANTAGES TO COMPANY No-fixed burden of dividend No outflow of cash Bear the risk Simple and cheap source Increase in debt capacity Availability of fixed capital

DISADVANTAGES OF EQUITY SHARES Uncertainty of income Irregular income Capital loss Less attractive to modest investors Loss in the case of liquidation

DISADVANTAGES TO COMPANY Difficult to remove over capitalization Centralization of control Change in management policy Speculation

PREFERENCE SHARES • Preference shares are those shares which carry certain special or priority rights. Firstly, dividend at a fixed rate is payable on these shares before any dividend is paid on equity shares. • Secondly, at the time of winding up of the company, capital is repaid to preference shareholders prior to the return of equity capital. • Preference shares do not carry voting rights. However, holders of preference shares may claim voting rights if the dividends are not paid for two years or more on cumulative preference shares and three years or more on non-cumulative preference shares.

FEATURES OF PREFERENCE SHARES Accumulation of dividends Call-ability Convertibility Redeem ability Participation in surplus profits and assets Voting power

ADVANTAGES OF PREFERENCE SHARES TO INVESTORS Less risk Regular and fixed income Best security Priority in repayme nt of capital Safety of interest

ADVANTAGES OF PREFERENCE SHARES TO INVESTORS No interferenc e in manageme nt Economical financing Availability of wide capital market No change in assets

DISADVANTAGES OF PREFERENCE SHARES TO INVESTORS Dividend at fixed rate Uncertain position of redeemable preference shares Limited voting right

DISADVANTAGES OF PREFERENCE SHARES TO COMPANY Fixed economic burden Disadvanta ge to equity shareholder s High cost of capital Difficult to receive additional capital

DIFFERENCE BETWEEN PREFERENCE SHARES AND EQUITY SHARES

DEBENTURES • A debenture is an instrument executed by the company under its common seal acknowledging indebtedness to some person or persons to secure the sum advanced. • It is thus a security issued by a company against the debt. • In India, a public limited company is allowed to raise debt capital through debentures after getting certificate of commencement of business, if permitted by its memorandum of association • Debenture is defined as an instrument issued by the company under its common seal acknowledging a debt and setting forth the terms under which they are issued and are to be paid.

FEATURES OF DEBENTURES Maturity Fixed interest rate No voting right Secured assets

TYPES OF DEBENTURES From security point of view From permanenc e point of view From records point of view From convertibilit y point of view From priority point of view

FROM SECURITY POINT OF VIEW Mortgage Debenture Simple Debenture

FROM PERMANENCE POINT OF VIEW Redeemabl e Debentures Irredeemabl e Debentures

FROM RECORD POINT OF VIEW Bearer Debenture s Registered Debenture s

FROM CONVERTIBILITY POINT OF VIEW Convertible Debentures Non. Convertible Debentures

FROM PRIORITY POINT OF VIEW First Debenture s Second Debenture s

ADVANTAGES OF DEBENTURES Advantag es to Investors Advantages of the company

ADVANTAGES OF THE COMPANY Lower rate of interest Trading on equity Freedom in management Tax benefits Certainty of finance Capital from moderate investors Boon during depression Controlling over capitalization Consolidation of debt

ADVANTAGES OF THE INVESTORS Safety investment Fixed and stable income Liquidity fixed maturity period Conversio n of loan

DISADVANTAGES OF DEBENTURES Disadvantag es to Investors Disadvantages of the company

DISADVANTAGES TO COMPANY Risk of windin g Up Fixed burde n Fixed charge on Assets

DISADVANTAGES TO INVESTORS Uncertainty No extra profits No Control

RETAINED EARNINGS • Retained earnings is also referred as ploughing back of profits means the reinvestments by concern of its surplus earnings in its business. • It is an external source of finance and is most suitable for an established firm for its expansion, modernization and replacement etc.

ADVANTAGES OF RETAINED EARNING TO THE COMPANY • Cushion to absorb the shock of economy • Economical method of financing • Aids in smooth and undisturbed running of business • Helps on following stable dividend policy • Flexible financial structure • Makes the company self dependent • Helps in making good the deficiencies of depreciation • Enables the redeem long term liabilities

ADVANTAGES OF RETAINED EARNING TO THE SHAREHOLDERS • Increase in value of shareholders • Safety of investment • Enhanced earning capacity • No dilution of control • Evasion of super tax

ADVANTAGES OF RETAINED EARNING TO THE SOCIETY AND NATION • Increase the rate of capital formation • Stimulates industrialization • Increase productivity • Decreases the rate of industrial failure • Higher standard of living

DISADVANTAGE OF RETAINED EARNING • Over capitalization • Creation of monopolies • Depriving the freedom of the investors • Misuse of retained earnings • Manipulation in the value of shares • Evasion of taxes • Dissatisfaction among the shareholders

LOANS FROM FINANCIAL INSTITUTIONS • Financial institutions such as commercial banks, life insurance corporations, industrial finance corporations, industrial development bank of India etc. , also provide short-term, medium term, and long term loans. • This source of finance is more suitable to meet the medium term demands of working capital. • Interest is charged on such loans at a fixed rate and the amount of the loan is to be repaid by way of instalments in a number of years.

FEATURES OF LOANS FROM FI Restrictive covenants Interest payment and principal repayment Security

ADVANTAGES OF LOAN FROM FI Borrowers point of view Lender’s point of view

BORROWERS POINT OF VIEW • In post-tax terms, the cost of term loans is lower than the cost of equity capital or preference capital. • Term loans do not result in dilution of control, as lenders do not have the right to vote

LENDER’S POINT OF VIEW • Term loans earns a fixed rate of interest and have a definite maturity period. • Term loans represent secured loans • Term loans carry several restrictive covenants to protect the interest if the lender

DISADVANTAGES OF LOAN FROM FI Borrowers point of view Lender’s point of view

BORROWERS POINT OF VIEW • The interest and principal repayment are obligatory payments. Failur to meet these payments may threaten the existence of the firm. • Term loans contracts carry restrictive covenants which may reduce managerial freedom. Further , they entitle the lenders to put their nominee on the board of the borrowing company. • Term loans increase the financial risk of the firm. This, in turn, tend to raise the cost of equity capital

LENDER’S POINT OF VIEW • Term loans do not carry the right to vote • Term loans are not represented by negotiable securities.

SHORT TERM SOURCES OF FINANCE Installment credit Trade credit Commercial banks Commercial paper Advances Certificates of deposits Factoring Public deposits

INSTALMENT CREDIT • Instalment credit is the method by which the assets are purchased and the possession of goods is taken immediately but the payment is made in instalments over a predetermined period of time. • Generally, interest is charged on the unpaid price or it may be adjusted in the price. • But, in any case, it provides funds for sometime and is used as a source of short term working capital by many business houses which have difficult fund position.

ADVANTAGE OF INSTALMENT CREDIT Immediate possession of assets Convenient payment for assets and equipment's Saving of one time investment Facilitates expansion and modernization of business and office

DISADVANTAGE OF INSTALMENT CREDIT Committed expenditur e Obligation to pay interest Additional burden in case of default Cash does not flow

ADVANCES • Some business houses get advances from their customers and agents against orders and this source is a short term source of finance of them. • It is a cheap source of finance and in order to minimize their investment in working capital, some firms having long production cycle, especially the firms manufacturing industrial products prefer to take advances from their customers.

ADVANTAGES OF ADVANCES No repayme nt obligation No tangible security Interest free

DISADVANTAGES OF ADVANCES Limited amount Limited period Penalty in case of non-delivery of goods

TRADE CREDIT • Trade credit refers to the credit extended by the suppliers of goods in the normal course of business. As present day commerce is build upon credit, the trade credit arrangement of a firm with its suppliers in an important source of short term finance. • The credit worthiness of a firm and the confidence of its suppliers are the main basis of securing trade credit. It is mostly granted on an open account basis whereby supplier sends goods to the buyer for the payment to be received in future as per terms of the sales invoice. • It may also take the form of bills payable whereby the buyer signs a bill of exchanges payable on a specified future date.

ADVANTAGES OF TRADE CREDIT Easy availabilit y flexibility informality

DISADVANTAGES OF TRADE CREDIT • Finance is charging of higher prices by the suppliers • Loss of cash discount

CERTIFICATE OF DEPOSIT • The certificate is a document evidencing the existence of a bank deposit and it is tradable, so that, in effect, the bank deposit can be transferred between different owners before it comes o be repaid. • This is one money market security which does not operate on the basis of discounts. • Interest is paid in the normal way on the bank deposit but the price of the certificate of deposit will vary in the market depending on how the rate of interest on the deposit, which is fixed, compares with general interest rates. • Certificates of deposits are issued by banks as a means of encouraging the making of shortterm deposits.

ADVANTAGES OF CERTIFICATE OF DEPOSIT Better return Good and long term effect Safe return

DISADVANTAGES OF CERTIFICATE OF DEPOSIT Penalty Loss return Long maturity period Need patienc e

COMMERCIAL PAPER • Commercial papers are those unsecured promissory notes which are issued by well-reputed companies. Their buyers are bank, insurance companies, unit trust, and firms • They can be sold in two ways-directly and indirectly. • In other words, the company can directly sell the commercial paper to the buyer or can take the help of some agency.

ADVANTAGES OF COMMERCIAL PAPER • The advantage of CPs lies on the simplicity they offer, as large amounts can be raised without having aby underlying transaction • CPs provide flexibility to the company to raise funds in the money market wherever it is favourable • CPs can raise fund from inter-corporate market which is not under the control of any monetary authority • CPs provide cheaper finance to the borrowers and at the same time offer good rate of return to the investors.

DISADVANTAGES OF COMMERCIAL PAPER • It is impersonal method of financing. If a firm is unable to redeem its paper due to financial difficulties, it may not be possible for it to get the maturity of paper extended. • It is available always to financially sound and highest rated companies. A firm facing temporary liquidity problems may not be able to raise funds by issuing new paper. • The mount of loanable funds available in the commercial paper market is limited to the amount of excess liquidity of the various purchasers f commercial paper • It can not redeemed until maturity. Thus if a firm no more needs the funds, it cannot repay until maturity and will have to incur interest costs.

FACTORING • Credit management is a specialised activity and involves a lot of time and effort f a company collection of receivables poses a problem, particularly for small-scale enterprises. Banks have the policy of financing receivable. • However, this support is available for a limited period and the seller of goods and services has to bear the risk of default by debtors. A company can assign its credit management and collection of specialist organisation called factoring organization.

ADVANTAGES OF FACTORING Advantage s to banks Advantag es to the customer Advantages to clients

ADVANTAGES TO THE CLIENT • The client can offer competitive credit terms to his buyers which, in turn, enable him to increase his sales and profits • The cash realized from credit sales can be used to accelerate the production cycle. • The client is free from the tensions of monitoring his sales ledger and can concentrate on production, marketing, and other aspects. This results in a reduction in overhead expenses and an increase in sales and profit. • Factoring results in a close alteration among working capital components of the business. Efficient management of one component can have positive impact on other components.

ADVANTAGES TO THE CUSTOMERS • Factoring facilitates the credit purchases o the customers as they get adequate credit period • Customers save on bank charges and expenses • The customers has not to furnish any documents. He has merely to acknowledge the notification letter, . i. e. , an undertaking to make payment of the invoices to the factor. • Factoring does not impinge on the customer’s rights vis a vis the suppliers in respect of quality of goods, contractual obligations, and so on

ADVANTAGES TO BANKS • Factoring improves liquidity of the clients and thereby, improves the quality of advances of banks. Factoring is not a threat to banking; it is a financial service complementary to hat of the banks.

LIMITATIONS Reliance on factor Difficult to exit the agreement Credit limits on trade costlier Deleterious effect on the creditworthines s

COMMERCIAL BANKS • Commercial banks are the main institutional sources of working capital finance in India. After trade credit, bank credit is the most important source of financing working capital requirements in India. • Commercial banks are those banks which perform all kinds of banking functions such as accepting deposits, advancing loans, credit creation, and agency function • In India 20 major commercial banks have been nationalised, whereas in developed countries they run like joint stock companies in the private sector. • Some of the commercial banks in India are Andra Bank, Canara Bank, Indian bank etc.

ADVANTAGES OF COMMERCIAL BANKS Financial assistance Agency service Attractive rate of interest General utility services Provides documentary proof Smooth functioning of foreign trade

DISADVANTAGES OF COMMERCIAL BANKS Insufficien t growth Regional imbalance Increasing overdues Lower efficiency Declining trends in profitabilit y Lack of expert

PUBLIC DEPOSITS • Public deposits are the fixed deposits accepted by a business enterprise directly from the public. • This source of raising short-term and medium-term finance was very popular in the absence of banking facilities. • Many firms, large and small, have solicited unsecured deposits from the public in recent years, mainly to finance their working capital requirements.

ADVANTAGES OF PUBLIC DEPOSITS Flexibility Economic al No charge on assets Simple and easy

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FINANCIAL MARKETS

FINANCIAL MARKET • A financial market is a mechanism that allows people to buy and sell financial securities (such as stock and bonds), commodities and other fungible items of value at low transaction costs and at prices that reflect the efficient-market hypothesis

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TYPES OF FINANCIAL MARKET Types of financial market Money Market Capital market Primary Market Secondary market

MONEY MARKET

MONEY MARKET • The term money market is used in a composite sense to mean financial institutions which deal with short term funds in the economy. • It refers to the institutional arrangements facilitating borrowings and lending of short term funds. • The money market brings together the lenders who have surplus short term investible funds and the borrowers who are in need of short term funds. In a money market, funds can be borrowed for a short period varying from a day, a week, a month, or 3 to 6 months and against different types of instruments, such as bill of exchange, bankers’, acceptance, bonds, etc. , called ‘near money’.

DEFINITION • The center for dealings mainly of a short term character, in monetary assets; it meets the shortterm requirements of borrowers and provides liquidity or cash to the lenders Reserve bank of India

NATURE AND CHARACTERISTICS OF MONEY MARKET • Highly organised commercial banking system • Apex central bank • Adequate availability of credit instruments • Number of dealers • Existence of a large number of sub-markets • Integrated interest structures • Responsive • Remittance facilities • other factors

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ADVANTAGES OF MONEY MARKET Source of capital Effective monetary managemen t Ideal investment Efficient banking system Economic developmen t Helpful to government Facilitating trade

DISADVANTAGES OF MONEY MARKET • Purchasing power of investors money goes down, in case of increase in inflation • Irrational structure of interest rates • Highly volatile market • Seasonal stringency of loanable funds • Lack of funds in the money market • Inadequate banking facilities

CAPITAL/SECURITIE S MARKET

CAPITAL/ SECURITIES MARKET • Where a security is traded (primary or secondary trading) is called a market. • The capital market refers to the institutional arrangements for facilitating the borrowing and lending of long-term funds • In the widest sense, it consists of a series of channels through which the savings of the community are made available for industrial and commercial enterprises and public authorities. • It is concerned with those private savings, individual as well as corporate, that are turned in investments through new capital issues and also new public loans floated by government and semi government bodies.

NATURE OF CAPITAL MARKET • The Indian capital market consists of organised and unorganised sector • The demand for funds in the organised sector is mostly for productive investment, a large part of the demand for funds in the unorganised market is for consumption purposes • The demand for funds comes mostly from corporate enterprises, government and semi government institutions. • The supply of funds comes from households savings and institutional investors like banks, investments trusts, insurance companies, finance corporations, government and international financing agencies. • The Indian capital market is characterized by the existence of multiplicity of interest rate, exorbitant rates o interest and lack of uniformity in the business dealings.

FEATURES OF CAPITAL MARKET Location Security market Security prices Participant s

FUNCTION OF CAPITAL MARKET Allocation function Liquidity function Indicative function Savings and investmen t function Transfer function Merger function

IMPORTANCE OF CAPITAL MARKET • Capital market serves as reliable guide to the performance and financial position of company • A continuous valuation of companies as reflected in the share price and the implied possibility of in merger and takeovers • Stock market promotes growth through the creation of liquidity • Stock market attracts foreign investment, which leads to improved accounting, reporting standards and exposes domestic companies to advances managerial techniques • Stock market at times helps companies to obtain equity finance in the absence of loans from money market.

CONSTITUENTS OF CAPITAL/SECURITY MARKET Primary market Secondary market

PRIMARY MARKET • The primary market represents the new issue market where new securities, i. e. , shares or bonds that have never been previously issued, are offered. Both the new companies and the existing ones can raise capital on the new issue market. • The prime function of the new issue market is to facilitate the transfer of funds from the willing investors to the entrepreneurs, setting up new corporate enterprises or going in for expansion, diversification, growth or modernization

FEATURES OF PRIMARY MARKET • Primary market concerns new long-term capital • Securities are sold for the first time in this market • It is also known as new issue market • Securities are issued directly to investors • Security certificates are issued to investors • Securities are issued by companies for setting new business and for expanding or modernization existing business. • It facilitates capital formation in the economy • Funds generated in this market are utilized for the purchase of fixed assets • It does not include long-term loans from financial institutions

ROLE AND FUNCTION OF PRIMARY MARKET Distribution Underwriting Origination

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STOCK EXCHANGES/ SECONDARY MARKET

STOCK EXCHANGE/ SECONDARY MARKET • The secondary market, also known as ‘aftermarket’, is the financial market where previously issued securities and financial instruments such as stock, bonds, options and futures are bought and sold. • The term secondary market is also used to refer to the market for any used goods or assets or an alternative use for an existing product or asset where the customer base is the second market. • Stock exchanges are organised and regulated markets are various securities issued by corporate sector and other institutions. The stock exchanges enable free purchase and sale of securities as commodity exchange allow trading in commodities

FEATURES OF STOCK EXCHANGE • Stock exchange deals in previously issued securities. • This market is not the place of the origin of the security. • Securities are not issued directly by the company to investors. • Securities are sold by the existing investors to other investors • The intending buyer and seller can buy and sell securities through brokers • Stock exchange provides liquidity to the investment and enhances the marketability of securities • Stock exchange merely transfers existing securities between buyers and sellers.

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PROCEDURE FOR DEALING AT SECONDARY MARKET/STOCK EXCHANGE Selection of broker Placing an order Marketing the contract Contract note Settleme nt

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STOCK EXCHANGE IN INDIA • Indian stock exchanges are a structures marketplace for the proper conduct of trading in company stock and other securities • There are twenty three recognised stock exchanges in India. • The main service of the Indian stock exchanges all over the country are to provide nation-wide services to investors and to facilitate the issue and redemption of securities and other financial instruments • The two most important exchange houses of the Indian stock market are the National Stock Exchange and the Bombay stock Exchange.

BOMBAY STOCK EXCHANGE (BSE) • Bombay stock exchange is the oldest stock exchange in Asia and what is now popularly known as the BSE. It was established as ‘The Native Share and Stock Brokers’ Association in 1875. • Over the past 135 years, BSE has facilitated the growth of the Indian corporate sector by providing it with efficient capital raising platform. • BSE is the first exchange in India, and the second in the world to obtain an ISO 9001: 2000 certifications. It is also the first exchange in the country and second in the world to receive information security management system.

FEATURES OF BSE • It is the oldest and largest stock exchange in Asia • It is fifth largest stock market in the world • Approximately 6, 000 Indian companies are listed with Bombay Stock Exchange. • It is the first stock exchange that introduced equity derivates in India. • Free Float Index, US$ version of BSE Sensex and internet trading platform wre launched initially by Bombay Stock exchange in India • It is the first amongst all stock exchange in the country to collect ISO certification from Surveillance, clearing and settlement

NATIONAL STOCK EXCHANGE (NSE) • The national stock exchange (NSE) is India’s largest securities exchange in terms of daily trade numbers. • It offers automated electronic trading of a variety of securities, including equity, corporate debt, Central and state government securities, commercial paper, certificate of deposits and exchange traded funds. • The exchange has more than 1, 000 listed members. Owned by more than twenty different financial and insurance institutions. NSE specialize in three market segments-wholesale debt, spatial market and future options

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) • In 1988, the securities and exchange board of India (SEBI) was established by the Government of India through an executive resolution, and was subsequently upgraded as a fully autonomous body in the year 1992 with the passing of SEBI Act on 30 January 1992.

OBJECTIVES OF SEBI ACT • To protect the interests of investors in securities • To promote the development of the securities market • To regulate the securities market • For matters connected there with or incidental thereto.

FUNCTIONS OF SEBI • To register and regulate the working of stockbrokers • To register and regulate the working of bankers to an issue • To control and regulates securities market • To exercise the powers under SEBI Act. • To regulate the working of mutual funds • To perform such other functions as may be prescribed • To control fraudulent and unfair trade practices relating to securities market.