financing is the means of finance employed for meeting the
cost of project. The long-term sources of finance used for
meeting the cost of project are known as the means of finance.
To meet the cost of project, the following sources of finance
may be available:
currency term loans
line of credit
tax deferment and exemption
loans and deposits
and hire purchase finance
is the contribution made by the owners of business, the equity
shareholders, who enjoy the rewards and bears the risks of
ownership. However, their liability is limited to their capital
contribution. From the point of view of the issuing firm,
equity capital offers two important advantages:
a)It represents permanent capital. Hence,
there is no liability for repayment.
b)It does not involve any fixed obligation
for payment of dividends.
disadvantages of raising funds by way of equity capital are:
cost of equity capital is high because equity dividends are
not tax-deductible expenses.
cost of issuing equity capital is high.
is hybrid form of financing. Preference capital partakes some
characteristics of equity capital and some attributes of debt
capital. It is similar to equity capital because preference
dividend, like equity dividend, is not a tax-deductible payment.
It resembles debt capital because the rate of preference dividend
is fixed. When preference dividend is skipped it is payable
in future because of the cumulative feature associated with
it. The near-fixity of preference dividend payment renders
preference capital, unattractive as a source of finance. It
is, however, unattractive when the promoters do not want a
reduction in their share of equity and yet there is need for
widening the net worth base to satisfy the requirements of
financial institutions. In addition to the conventional preference
shares, a company may issue Cumulative Convertible Preference
Shares (CCPS). These shares carry a dividend rate of 10 percent
and are compulsorily convertible into equity shares between
three and five years from the date of issue.
the last few years, debenture capital has emerged as an important
source for project financing. Three types of debentures are
used in India:
1.Non-Convertible Debentures (NCDs)
2.Partially Convertible Debentures (PCDs)
3.Fully Convertible Debentures (FCDs)
Akin to promissory notes, NCDs are used by companies for raising
debt that is retired over a period of 5 to 10 years. They
are secured by a charge on the assets of the issuing company.
PCDs are partly convertible into equity shares as per pre-determined
terms of conversion. The unconverted portion of PCDs remains
like NCD. FCDs are converted wholly into equity shares as
per pre-determined terms of conversion. Hence, FCDs may be
regarded as delayed equity instruments.
by financial institutions and commercial banks, rupee term
loans are a very important source for financing new projects
as well as expansion, modernization, and renovation schemes
of existing units. These loans are repayable over a period
of 8-10 years, which includes a moratorium period of 1-3 years.
CURRENCY TERM LOANS:
institutions provide foreign currency term loans for meeting
the foreign currency expenditures towards import of plant,
machinery, and equipment and towards payment of foreign technical
know-how fees. Under the general scheme, the periodical liability
towards interest and principal remains in the currency of
the loan and is translated into rupees at the prevailing rate
of exchange for making payments to the financial institutions.
Apart from approaching financial institutions, companies can
directly obtain foreign currency loans from international
with Reliance Industries’ Global Depository Receipts
issue of approximately $150 million in May 1992, a number
of companies have been making euro issues. They have employed
two types of securities: Global Depository Receipts (GDRs)
and Euro-convertible Bonds (ECBs). Denominated in US dollars,
a GDR is a negotiable certificate that represents the publicly
traded local currency equity shares of a non-US company. GDRs
are issued by the Depository Bank against the local currency
shares, which are delivered to the depository’s local
custodian banks. GDRs trade freely in the overseas markets.
A Euro convertible Bond (ECB) is an equity-linked debt security.
The holder of an ECB has the option to convert it into equity
shares at a pre-determined conversion ratio during a specified
period. ECBs are regarded as advantageous by the issuing company
because (a) they carry a lower rate of interest compared to
a straight debt security, (b) they do not lead to dilution
of earnings per share in the near future, and (c) they carry
very few restrictive covenants.
a time the suppliers of machinery provide deferred credit
facility under which payment for the purchase of machinery
is made over a period. The interest rate on deferred credit
and the period of payment vary rather widely. Normally, the
supplier of machinery when he offers deferred credit facility
insists that the bank guarantee should be furnished by the
by the IDBI, the bills rediscounting scheme is meant to promote
the sale of indigenous machinery on deferred payment basis.
Under this scheme, the seller realizes the sale proceeds by
discounting the bills or promissory notes accepted by the
buyer with a commercial bank, which in turn rediscounts them
with the IDBI. This scheme is meant for balancing equipments
and machinery required for expansion, modernization, and replacement
LINE OF CREDIT:
by the ICICI, the Suppliers’ Line of Credit is quite
similar to the IDBI’s Bill Rediscounting Scheme. Under
this arrangement, ICICI directly pays to the machinery manufacturer
against usance bills duly accepted or guaranteed by the bank
of the purchaser.
institutions are also known as “Seed Capital Assistance
Scheme”. They supplement the resources of the promoters
of the small and medium scale industrial units, which are
eligible for assistance from all-India financial institutions
and state-level financial institutions. Three schemes have
Seed Capital Assistance Scheme
The quantum of assistance under this scheme is Rs. 0.2 million,
or 20 percent of the project cost, whichever is lower. This
scheme is administered by the State Financial Corporations.
Capital Assistance Scheme
The assistance under this scheme is applicable to projects
costing not more than Rs. 20 million. The assistance per project
is restricted to Rs. 1.5 million. The assistance is provided
by IDBI through state level financial institutions. In special
cases, the IDBI may provide the assistance directly.
Capital Foundation Scheme
Under this scheme, the Risk Capital Foundation, an autonomous
foundation set up and funded by the IFCI, assists promoters
of projects costing between Rs. 20 million and Rs. 150 million.
The ceiling on the assistance provided between Rs. 1.5 million
and Rs. 4 million depending on the number of applicant promoters.
the past the central government as well as the state government
provided subsidies to industrial units located in backward
areas. The central subsidy has been discontinued but the state
subsidies still continues. The state subsidies vary from 5
percent to 25 percent of the fixed capital investment in the
project, subject to a ceiling varying between Rs. 0.5 million
and Rs. 2.5 million depending on the location.
TAX DEFERMENTS AND EXEMPTIONS:
attract industries, the states provide incentives, inter alia,
in the form of sales tax deferments and sales tax exemptions.
Under the sales tax deferment scheme, the payment of sales
tax on the sale of finished goods may be deferred for a period
ranging between five to twelve years. It implies that the
project gets an interest-free loan, represented by the quantum
of sales tax deferred, during the deferment period. Under
the sales tax exemption scheme, some states exempt the payment
of sales tax applicable on purchases of raw materials, consumables,
packing, and processing materials from within the state, which
are used for manufacturing purposes. The period of exemption
ranges from three to nine years depending upon the state and
the specific location of the project within the state.
LOANS AND DEPOSITS:
loans are provided by the promoters to fill the gap between
the promoters’ contribution required by financial institutions
and the equity capital subscribed by the promoters. These
loans are subsidiary to the institutional loans. The rate
of interest on these loans is less than the rate of interest
on the institutional loans. Finally, these loans cannot be
taken back without the prior approval of financial institutions.
Public Deposits represent unsecured borrowing of two to three
years’ duration. Many existing companies prefer to raise
public deposits instead of term loans from financial institutions
because restrictive covenants do not accompany public deposits.
However, it may not be possible for a new company to raise
public deposits. It may be difficult for it to repay public
deposits within three years.
AND HIRE PURCHASE FINANCE:
the emergence of scores of finance companies engaged in the
business of leasing and hire purchase finance, it may be possible
to get a portion, albeit a small portion, of the asset financed
under a lease or a hire purchase arrangement. A project is
financed partly by financial institutions and partly through
the resources raised from the capital market. Hence, in finalizing
the financing scheme for a project, you should bear in mind
the norms and policies of financial institutions and the guidelines
of Securities Exchange Board of India and the requirements
of the Securities Contracts Regulation Act (SCRA).