Types of Capital
Following are two the types of capital required by a businessman:
1 Fixed
1. Fi d capital
i l
Fixed capital is required to acquire fixed assets like land, building, plant, machinery, office
equipment, furniture and fixtures, erection and installation of machinery, etc.
In addition, fixed capital
p is also required
q for meetingg the cost incurred on insurance, technical
know-how etc.
2.Working capital
Working capital is needed to meet day-to-day requirements of a business.
Types of Finance
1. Long term finance
Long term finance is used for investment in fixed assets such as land and building, plant and machinery
etc. It is used to meet the permanent needs of business. It can be raised through owned capital and
longg term loans.. Such finance cannot be withdrawn from the business..
2. Short term finance
Short term finance is used for investment in working capital. It is used to meet the short term needs of
the
h business.
b i F example,
For l purchase
h off raw material,
i l payment off wages etc. These
Th fundsf d are normally
ll
required for a period ranging from three months to two years.
SOURCES OF FINANCE
The sources of funds can be broadly divided into:
i) owned capital; and
ii) borrowed capital.
¾Owned capital is the money brought in by the businessman himself
¾Borrowed capital is the money advanced by outside agencies.
However, sources can also be segregated into long term sources and short term
sources These sources are explained below:
sources.
Sources for Long Term Finance
1. Owned capital
2 Retained
2. R t i d Profits
P fit
3. Funds borrowed from friends and relatives.
4. Loans from Commercial banks
5. Loans from National-level Financial Institutions
6. Loans from various State-level Financial Institutions
Short Term Sources of Finance
Short term finance is required for meeting the short term requirements of
business (like working capital). Short term loans are usually repayable within a
period of one to three years. The important sources of short term finance are as
under:
1. Bank Overdraft
2. Cash Credit
3 Discounting
3. Di ti off Bills
Bill off Exchange
E h
4. Short term loans
5. Trade Credit from suppliers
6. Accounts Payable
y
7. Advances from customers
8. Accruals
9. Factoring
10 Co-operative
10. Co operative Credit Societies
11. Indigenous Bankers
Let’s now discuss some of the important specialised financial institutions.
1. Industrial Development
p Bank of India (IDBI)
( )
IDBI was set up as a wholly owned subsidiary of Reserve Bank of India in July, 1964 by an Act of
Parliament. It serves as an apex level national institution for providing term finance to the industry.
In 1976, the ownership of IDBI was transferred to the Government and it was entrusted with the
additional responsibility of acting as principal financial institution for coordinating the activities of
institutions engaged in the financing, promotion or development of industry.
Functions of IDBI
i) It provides direct financial assistance to industrial concerns by giving them long term loans.
ii) It provides technical and administrative assistance for promotion and expansion of industry.
iii) It guarantees loans raised by industrial concerns from other financial institutions.
iv) It accepts bills of exchange of industrial concerns and also discounts and rediscounts them.
them
v) It provides refinancing facilities.
2. Small Industries Development Bank of India (SIDBI)
SIDBI was set up by an Act of Parliament i.e. i e Small Industries Development Bank of India Act,
Act 1989
as a wholly-owned subsidiary of IDBI for re-financing, bills rediscounting, and equity support to the
small scale sector. It started functioning on April 2, 1990. SIDBI was de-linked from IDBI w.e.f. 27th
March, 2000. It serves as an apex level national institution for promotion, finance and development
of industries in the small sector.
Functions of SIDBI
i) It provides financial assistance through term loans and working capital.
ii) It provides finance through discounting and re re-discounting
discounting of bills arising from the sale of
machinery to small units.
iii) It provides Venture Capital support.
iv) It provides services like factoring, leasing etc.
3. National Bank for Agriculture and Rural Development (NABARD)
NABARD has been set up for the promotion of agriculture, small scale industries, cottage and
village industries,
industries handicrafts etc.
etc in the rural sector.
sector It is an apex bank for agricultural finance.
finance It
came into existence on July 12, 1982. It provides refinancing facilities. It has initiated Micro
Finance programme under which millions of poor people have been provided access to credit. It
has created special funds like Watershed Development Fund, Tribal Development Fund, Research
and Development Fund, Farm Innovations Fund, and Micro Finance Development and Equity
Fund to support innovations in neglected areas.
4. Regional
g Rural Banks ((RRBs))
The object of setting up Regional Rural Banks was to bring the banking services to the doorsteps of
rural masses. Initially these banks were providing funds to target groups comprising weaker sections of
the society at a concessional rate of interest.
interest However,
However since 1997 the RRBs have been allowed to lend
outside the target group also by classifying their advances into priority sector and non-priority sector.
5. State Financial Corporations (SFCs)
A special law known as State Financial Corporation Act, 1951 was passed by the Parliament to enable all
the states except Jammu and Kashmir to set up their own State Financial Corporations.
Corporations So far 18 SFCs
are operating in different States and Union Territories.
The main objective of SFCs is to finance and promote small and medium enterprises and projects
costing up to Rs.5 crores for achieving balanced regional socio-economic growth and generating
employment opportunities. SFCs operate a number of schemes of refinance and equity type of assistance
formulated by IDBI, SIDBI which include schemes for artisans, SC/ST, women, ex- serviceman,
physically handicapped etc. and for transport operators, for setting up hotels, hospitals etc.
SFCs can pprovide financial assistance to pproprietary
p y concerns and ppartnershipp firms upp to Rs. 120 lacs.
Functions of State Financial Corporations
Following are the functions of SFCs:
i)) Theyy pprovide term loans for acquiring
q g land,, building,
g, pplant and machinery,y, other
miscellaneous fixed assets etc.
ii) They establish polytechnics or training institutes for imparting training to technically
qualified persons.
iii) They take up the development of lesser developed parts of the State and engage in
infrastructure development like electricity, road, water etc.
iv) They promote self-employment.
v) Theyh provided finance
f f expansion, modernization
for d andd up-gradation
d off technology
h l in
the existing units.
vi) They identify and examine local problems.
vii)
ii) They
The provide
pro ide seed capital assistance under the schemes of IDBI.
IDBI
viii) They provide deferred payment guarantees for purchasing plant and machinery.
ix) They provide foreign exchange loans to industrial units underWorld Bank Schemes.
6. State Industrial Development Corporations (SIDCs)
SIDCs were set up in 1960s and 1970s. These were established as wholly-owned
undertakings of the State Governments under the Companies Act, 1956 or autonomous
corporations
p under specific
p State Acts. Different States have set upp the State Industrial
Development Corporations with a view to improving the growth of industry in their
States. These corporations operate as per the Guidelines issued by State Governments.
There are 28 SIDCs operating in our country. They provide assistance to small and
medium units and projects costing up to Rs. 10 crores.
Functions of SIDCs
i) They promote and develop industries by activities like project identification,
preparation
i off project
j report, selection
l i andd training
i i off entrepreneurs.
ii) They provide term loans to industries.
iii) They grant incentives and subsidies on behalf of the Central and State
Governments.
Governments
iv) They act as agent of IDBI, SIDBI and thereby provide the benefit of seed capital
scheme.
v)) Theyy provide
p risk capital
p to entrepreneurs
p byy wayy of equity
q y pparticipation.
p .
vi) They develop industrial area by providing infrastructural facilities.
7. State Small Industries Development Corporations (SSIDCs)
SSIDCs are State Government undertakings responsible for catering to the needs of the small,
small tiny and
cottage industries in the States/Union Territories. They undertake a variety of activities for
development of the small sector. At present, there are 18 SSIDCs in operation.
Functions of SSIDCs
i)They extend seed capital assistance on behalf of the State Government.
ii)They procure and distribute scarce raw material.
iii)They provide machinery on hire-purchase basis.
iv)They provide assistance for marketing of the products of small scale units.
v)They provide managerial assistance to production units.
8. District Industries Centres (DICs)
DICs have been established in every district. The objective of establishing such centres is to develop
small and village industries. They collect information about the availability of raw material and
make arrangements for machinery and equipment, marketing research, credit facilities etc. for the
development of small units in the district.
district They identify the potential borrowers in the small sector
and sponsor their loan applications to the banks operating in the district. Under the Prime
Minister’s Rozgar Yojna Scheme (PMRY), DICs are assigned the task of identification of
beneficiaries and implementation of the Scheme in the district.
EVALUATION OF THE SOURCES OF FINANCE
Advantages of Owned Capital
i)) Supply
pp y off longg term capital:
p The businessman obtains ffunds on longg term basis. Owned capital
p pprovides longg term
investment.
ii) Control: The businessman maintains full control over his business. He has full rights to take decisions without
interference from any outside person.Thus, he commands control over his business.
iii) No
N charge
h on assets: The
Th businessman
b is not requiredd to keep
k hish assets as security withh any institution so long
l his
h
own capital is used in the business. Consequently, he can offer the assets of the firm to other agencies for raising loan
in case he is in need of additional capital besides his own.
iv)) No repayment
py off liability:
y Owned capital
p is not required
q to be returned to anyy bodyy as in the case off loan which
is required to be repaid over a period of time.
v) No fixed cost: Owned capital does not carry any fixed rate of return as in the case of a loan where interest is
required to be paid on periodical basis.
Disadvantages of Owned Capital
i) Investment of the personal savings: In case a businessman has invested his own money in the business, a large
chunk of his personal savings goes away.Therefore, not much is left for his rainy days.
ii) Limited scope of expansion: With his owned capital invested in the business, a businessman has limited scope of
expansion. This is so because he can commit his own resources to a certain extent and beyond that he will have to
borrow from outside sources.
iii) Danger of over
over-capitalisation:
capitalisation: Use of owned capital may lead, at times, to over
over-capitalisation.
capitalisation. This is so because
the businessman is free to invest as much capital as he can. At times, the capital invested is more without being put
to productive use. In that case the rate of earning is less in comparison to the capital invested.
Advantages of Borrowed Capital
i) Availability of funds:The businessman obtains the funds which are not available through owned capital.
ii) Long term source: Outside funds such as long term loans from banks serve as the source for investing in fixed
assets.
iii) Scope for expansion: A businessman can think of expanding his business because with the help of borrowed
money further resources are available which can be used in modernization and diversification of the business.
iv) Tax Benefit: Interest paid on borrowed capital is an expenditure which is deducted from the profits liable to
income tax.The loans thus provide tax benefit to the businessman.
v) Non-interference in the management:The banks generally do not interfere in the management of the business.
Disadvantages of Borrowed Capital
i) Financial
Fi i l burden:
b d The Th businessman
b i isi required
i d to pay the
h interest
i on the
h loan
l regularly
l l at a fixed
fi d rate. This
Thi results
l
in the creation of financial burden if the enterprise is running at a loss.
ii) Charge on assets: The loans are generally secured by pledging the assets as security. Owing to the pledging the
assets do not remain free.
f
iii) Borrowing capacity: Ideal debt-equity ratio is 2:1. Excessive borrowing reduces capacity to borrow and therefore
the businessman is unable to borrow after a certain limit.
Factors Affecting the Choice of the Source of Loan
Following are the factors which should be evaluated while making a choice about the source of availing
lloan:
i) Rate of interest: Interest is an expense for the firm to be paid on regular basis whether the business earns
profit or not.This reduces the profits of the firm.Therefore, the businessman should enquire as to which
financial institution is charging the lowest rate of interest before taking a decision to avail of loan from a
particular institution. He should opt for that source only where the interest burden is the lowest.
ii) Repayment period:The businessman should evaluate the various sources of loan from the point of view
off repayment
py terms.The banker/institution who pprovides longer g repayment
py pperiod ffor the similar loan
should be preferred.
iii) Margin requirement: Every lender insists upon minimum contribution as margin from the side of
businessman. However, margin requirement may differ from bank to bank.Thus, a businessman should
negotiate the loan proceedings with the bank which offers lower margin requirements.
iv) Processing charges: Every financial institution imposes some charges for processing the loan proposal,
known as processing charges. It is also one of the factors which should be considered while evaluating a
loan. Lower processing charges should be preferred.
f At the same time, it should be seen that there is no
hidden cost involved in a particular loan proposal.
v) Time-period involved in sanctioning the loan:The banker who takes lesser time in sanctioning and
di b i th
disbursing the lloan should
h ld bbe preferred.
f d IIn ththe case off some bbanks
k even bbranchh managers are empoweredd tto
sanction loans whereas in the case of others, the sanction comes from the higher authority.
