Financial Markets &Financial

Services
Hire Purchase
By:Kavita Vijay
Meaning
• Hire purchase system is a system of purchase under which possession
of the goods is offered by the seller to buyer immediately on the
condition that the price of the goods should be paid by the purchaser
in a certain number of instalments, and the legal ownership of the
goods will be passed on to the hire purchaser on after all the
instalments are paid
Hire Purchase Agreement

• Hire purchase agreement means an agreement under which goods are

let on hire and under which the hirer has option to buy the goods as
per agreement and includes the following stipulations:
• Possession of goods is delivered by the owner thereof to a person on
condition that such person pays the agreed amount in periodical
installments.
• The property in the goods is to be transferred to hirer on payment of
last installments.
• Such a person has a terminate the agreement at any time before the
property is so transferred.
Features of Hire Purchase System

• Following are the main features of the hire purchase system:

• Agreement: there is an agreement between the seller and purchaser.
• Possession: the possession of goods immediately passes from the seller to the buyer on signing the
agreement.
• Instalments: the buyer will make payment in instatements over a period of time.
• Ownership: the ownership of the goods will remain with seller and passes to the buyer on
• the payment of last instalment.
• Constituents of Hire Purchase: each instalment is treated as hire charge till the last
• installment is paid.
• Option to returning goods: the buyer has an option to return the goods to the seller and can terminate the
agreement if he does not want to pay the rest of the instilments.
• Repossession: if there is any default in payment of any instalment, the seller has a right to repossess the goods
sold on hire purchase and forfeit the amount already received either as down payment or in installments.
Important Terms
• Cash Price
• Hire Purchase Price
• Down Payment
• Installment
• Hire Purchaser
• Hire Vendor
• Goods Repossessed
Accounting Treatment
Entries in the books of hire purchaser

• Credit Purchase with Interest Method

• For recording the credit purchase of the asset from hire seller.
Asset A/c (with cash price ) Dr
To Hire Seller’s A/c
• For recording of down payment , if any
Hire seller’s A/c Dr
To Cash/Bank A/c
Cont…
Enteries in books of Hire Vendor
Assets Accrual Method
Ledger Accounts in Hire Purchaser
Cont…
Illustration
• Cash price of the asset is Rs.2,73,000, Down payment Rs.60,000
Rs.60,000 annual installment for four years , Interest rate 5% PA.
Calculate the interest for each installment.
• On 1st Jan. 2004 Mahesh Bros. bought four Hero Honda bike from
Honda Co. on hire purchase system. The cash price of each bike was
Rs.25,000. It was agreed that Rs.25,000 should be paid immediately
and the balance in three installments of Rs. 30,000 each at the end of
each year. The Honda Co. charged at 10% p.a. the buyer depreciates
bike at 20% p.a. on the WDV method.
Problem
• On 1 January 2016, Scooter Ltd., sold a scooter on hire purchase basis for `
1,00,000 to be paid as follows.
• On signing the agreement Rs.12,000
• At the end of first year Rs.17,000
• At the end of second year Rs.16,000
• At the end of the third year Rs.55,000
• Interest included in Rs.1,00,000 being charged on cash value at 10% per annum.
• You are required to,
(1) Ascertain cash value of the scooter.
(2) Pass journal entries in the books of the hire purchaser.
Problem
• Malnad Coffee Works Ltd., bought coffee drying machine costing ` 6,56,000
from Xavier Ltd on 1 January 2016 on hire purchase basis. ` 2,00,000 was
paid on signing the contract and the balance in three annual instalments of
` 2,00,000 (each) by the end of December every year. Interest was charged
at 15% per annum. Life of the machine was expected to be four years. You
are required to pass the journal entries and necessary ledger accounts in
the books of (a) Malnad Coffee Works Ltd., and (b) Xavier Ltd.
• Cash price of an asset is Rs 56,000, and the hire purchase price of the same
asset is Rs.60,000 payable Rs 15,000 as down payment and the balance in
three equal instalments at Rs 15,000. Calculate instalment interest and split
the instalment amount into instalment cash price and instalment interest.
Factoring
• Factoring is a financial service covering the financing and collection of
accounts receivables in domestic as well as in international trade.
• Basically factoring is an arrangement in which receivables on account
of sale of goods or services are sold to the factor at a certain discount.
• As the factor gets title to the receivables on account of the factoring
contract, he becomes responsible for all credit control, sales ledger
administration and debt collection from the customers.
Functions of the Factor
• To provide finance against book debts, say upto 90 per cent of the invoice value
immediately. Thus the client gets funds immediately for his working capital.
• To collect cash against receivables on due date from the customers of the clients and
furnish reports to the client.
• To undertake sales ledger administration (i.e. accounting work) for the client in respect of
client's transactions with its customers.
• Under the non-recourse factoring arrangement, if the customer become financially
insolvent and cannot pay up, the Factor provides protection to the client against bad debts
on all approved invoices. Thus the Factor provides debt insurance facility to the client
against possible losses arising from insolvency or bankruptcy of the customer.
• Factor also provides other information such as sales analysis and overdue invoice analysis
which enable the client to run the business more effectively. Besides, the Factor also
provides relevant expertise in the areas of marketing,finance etc.
Parties to Factoring Contract
• There are three parties involved generally in a factoring contract, viz.,
• Buyer ofgoods (i.e. customer) who has purchased goods or services
on credit and as such has to pay for the same once the credit period
gets over.
• Seller of goods (i.e. client) who has supplied goods or provided
services to the customers on credit terms.
• 'Factor' who purchase the invoices (receivable) from seller of goods
and collect the money from the customers of his clients.
Types of factoring
• Full Servicing Factoring: This is also known as without recourse factoring
service. It is the most comprehensive type of factoring arrangement offering
all types of services, namely: (a) Finance, (b) Sales ledger administration, (c)
Collection, (d) Debt protection, and (e) Advisory services. The most important
characteristic of this type of factoring service is that it gives protection against
bad debts to the. client. In other words, in case the customer fails to pay, the
factor will absorb the losses arising from insolvency or bankruptcy of the
client's customers.
• Recourse Factoring: In such a type of factoring arrangement, the factor
provides all types of facilities except debt protection. That means, in other
words, the client is responsible for any bad debts arising from insolvency of
the client's customers.
Cont..
• Maturity Factoring: Under this type of factoring arrangement, except for
providing finance, all other facilities are provided to the client. As far as
finance is concerned, the client is paid at the end of a predetermined date
or maturity date whether or not the customers have settled their dues in
respect of credit sales.
• Invoice Discounting: In such type of arrangement, only finance is provided,
and, hence, no other services are offered in respect of receivables.
• Agency Discounting: Under this arrangement, the facilities of finance and
protection against bad debt are provided by the factor. As against this, the
sales ledger administration and collection of book debts are came out by
the client himself.
Advantages
• There are many factoring companies, so prices are usually competitive.
• It can be a cost-effective way of outsourcing your sales ledger while freeing up your time to
manage the business.
• It assists smoother cashflow and financial planning.
• Some customers may respect factors and pay more quickly.
• Factors may give you useful information about the credit standing of your customers and
they can help you to negotiate better terms with your suppliers.
• Factors can prove an excellent strategic - as well as financial - resource when planning
business growth.
• You will be protected from bad debts if you choose non-recourse factoring.
• Cash is released as soon as orders are invoiced and is available for capital investment and
funding of your next orders.
• Factors will credit check your customers and can help your business trade with better quality
customers.
Disadvantages
• The cost will mean a reduction in your profit margin on each order or service
fulfilment.
• It may reduce the scope for other borrowing - book debts will not be available as
security.
• Factors will restrict funding against poor quality debtors or poor debtor spread,
so you will need to manage these funding fluctuations.
• To end an arrangement with a factor you will have to pay off any money they
have advanced you on invoices if the customer has not paid them yet. This may
require some business planning.
• Some customers may prefer to deal directly with you.
• How the factor deals with your customers will affect what your customers think of
you. Make sure you use a reputable company that will not damage your
reputation.
Process / Mechanism of Factoring
Cont…
1.The client orders goods or services on credit. Such services or goods are
delivered along with the invoice.
2.Client makes the assignment of the invoice to the factor.
3.Factors may up to 80 percent of the value of the invoices as advance to the
seller. 
4.The factor provides regular statement of accounts and follow-up. 
5.Customer pays the dues to factor.
6.Factor makes the remaining payment to the client at the time of actual
collection of the debt.
Venture Capital
• Venture Capital may be broadly defined as long-term investment in
business, which has potential for significant growth and financial returns.
• This is usually provided in the form of equity apart from conditional loans
and conventional loans.
• Venture Capitalists is thus not a financier only, but bears the risk as well.
• The most distinguishing feature of Venture Capital is that it meets the
needs of a business wherein the probability of loss is quite high because
of the uncertainties associated with the enterprise, but the returns
expected are also higher than normal.
Features
• Venture Capital can be distinguished from other forms of finance on the basis of its special characteristics which are as
follows:
• The most distinguishing feature of Venture Capital is that it is provided largely in the form of equity, when the investee
company is unable to float its equity shares independently in the market, or from other sources in the initial stage. Thus
risk capital is provided, which is not available otherwise due to the high degree of risk involved in the venture.
• The venture capitalist, though participates in the equity, does not intend to act as the owner of the enterprise. The
venture capitalist does not participate in the day-to-day management, but aids and guides the management by
providing the benefit of his skill, experience and expertise. He nurtures the new enterprise till it enters the profit-earning
stage.
• The Venture Capitalist does not intend to retain his investment in the investee company for ever. He intends to divest his
shares, as soon as the company becomes a profitable business and the returns from the business are high as per
expectations. At this stage he withdraws himself from the venture and in turn provides finance for another venture.
• A Venture Capitalist intends to earn largely by way of capital gains arising out of sale of his equity holdings, rather than
through regular returns in the form of interest on loans.
• A Venture Capitalist also provides conditional loans which entitles him to earn royalties on sales depending upon the
expected profitability of the business. (Such loan is partly or fully waived if the business enterprise does not prove to be
a success).
Stages
• A venture capital fund provides finance to the venture capital
undertaking at different stages of its life cycle according to
requirements. These stages are broadly classified into two, viz.
• Early stage financing, and
• Later stage financing.
• Each of them is further sub-divided into a number of stages.
Early Stage
• Seed Capital Stage
• Start up Stage
• Second Round Financing
Later Stage Financing
• Expansion Finance
• Replacement Finance
• Turn Around
• Buyout Deals
Mode of Financing
• Equity Instruments
• Debt Instruments: 1) Conditional Loans 2) Convertible loans 3)
Conventional loans
EXIT ROUTES
• Initial public offering
• Buy back of Shares by the Promoters
• Sale of Enterprise to another Company
• Sale to New Venture Capitalist
• Self-liquidating Process
• Liquidation of the Investee Company
Regulatory Framework
• The venture capital funds and venture capital companies in India were
regulated by the Guidelines issued by the Controller of Capital Issues,
Government of India, in 1988.
• In 1995, Securities and Exchange Board of India Act was amended
which empowered SEBI to register and regulate the Venture Capital
Funds in India.
• Subsequently, in December, 1996 SEBI issued its regulations in this
regard.
• These regulation replaced the Government Guidelines issued earlier.
The SEBI guidelines, as amended in 2000, are as follows:
Definition
• A Venture Capital Fund has been defined to mean a fund established
in the form of a trust or a company including a body corporate and
registered with SEBI which –
i) has a dedicated pool of capital, raised in the specified manner, and
ii) invests in venture capital undertakings in accordance with these
regulations.
A Venture Capital Fund may be set up either as a trust or as a company.
The purpose of raising funds should be to invest in Venture Capital
Undertakings in the specified manner
Registration of Venture Capital Funds
• A venture capital fund may be set up either by a company or by a trust. SEBI is
empowered to grant a certification of registration to the fund on an application
made to it. The applicant company or trust must fulfil the following conditions:
• The memorandum of association of the company must specify, as its main
objective, the carrying of the activity of a venture capital fund.
• It is prohibited by its memorandum of association and Articles of Association
from making an invitation to the public to subscribe to its securities.
• Its director, or principal officer or employee is not involved in any litigation
connected with the securities market.
• Its director, principal officer or employee has not been at any time convicted of
an offence involving moral turpitude or any economic offence.
Resources for Venture Capital Fund
• A Venture Capital Fund may raise moneys from any investor.
• It is essential that the venture capital fund shall not issue any
document or advertisement inviting offers from the public for
subscription to its securities/units.
Letter of Credit
• ‘Letters of Credit’ also known as ‘Documentary Credits’ is the most
commonly accepted instrument of settling international trade
payments.
• A Letter of Credit is an arrangement whereby Bank acting at the
request of a customer (Importer / Buyer), undertakes to pay for the
goods / services, to a third party (Exporter / Beneficiary) by a given
date, on documents being presented in compliance with the
conditions laid down.
PARTIES TO A LETTER OF CREDIT (LC)
• Applicant
• Issuing Bank
• Beneficiary
• Advising Bank
• Confirming Bank
• Nominated Bank
Types of LOC
• 1. Irrevocable LC. This LC cannot be cancelled or modified without consent of the beneficiary (Seller). This
LC reflects absolute liability of the Bank (issuer) to the other party.
• 2. Revocable LC. This LC type can be cancelled or modified by the Bank (issuer) at the customer's
instructions without prior agreement of the beneficiary (Seller). The Bank will not have any liabilities to the
beneficiary after revocation of the LC.
• 3. Stand-by LC. This LC is closer to the bank guarantee and gives more flexible collaboration opportunity to
Seller and Buyer. The Bank will honour the LC when the Buyer fails to fulfill payment liabilities to Seller.
• 4. Confirmed LC. In addition to the Bank guarantee of the LC issuer, this LC type is confirmed by the Seller's
bank or any other bank. Irrespective to the payment by the Bank issuing the LC (issuer), the Bank
confirming the LC is liable for performance of obligations.
• 5. Unconfirmed LC. Only the Bank issuing the LC will be liable for payment of this LC.
• 6. Transferable LC. This LC enables the Seller to assign part of the letter of credit to other party(ies). This LC
is especially beneficial in those cases when the Seller is not a sole manufacturer of the goods and
purchases some parts from other parties, as it eliminates the necessity of opening several LC's for other
parties.
Cont…
• 7. Back-to-Back LC. This LC type considers issuing the second LC on the basis of the first letter
of credit. LC is opened in favor of intermediary as per the Buyer's instructions and on the
basis of this LC and instructions of the intermediary a new LC is opened in favor of Seller of
the goods.
• 8. Payment at Sight LC. According to this LC, payment is made to the seller immediately
(maximum within 7 days) after the required documents have been submitted.
• 9. Deferred Payment LC. According to this LC the payment to the seller is not made when the
documents are submitted, but instead at a later period defined in the letter of credit. In most
cases the payment in favor of Seller under this LC is made upon receipt of goods by the Buyer.
• 10. Red Clause LC. The seller can request an advance for an agreed amount of the LC before
shipment of goods and submittal of required documents. This red clause is so termed because
it is usually printed in red on the document to draw attention to "advance payment" term of
the credit
Cont…
• 1. Seller and Buyer agree sales contract – with payment to be made by LC.
• 2. Buyer requests Issuing Bank to issue the LC – this is the Bank’s own irrevocable undertaking to pay the
Beneficiary on compliance with conditions. Buyer agrees to indemnify Bank and gives pledge over
documents.
• 3. LC issued and sent to Seller’s local bank (known as Advising Bank).
• 4. Advising Bank examines LC and informs Seller (and adds own undertaking if it is also Confirming Bank).
• 5. Seller ships goods to Buyer.
• 6. Seller presents documents under LC to Advising Bank (also called Nominated Bank if nominated as paying
bank).
• 7. (a&b) Documents are checked. If they are in order, payment is made and documents are forwarded to
Issuing Bank.
• 8. Documents are checked and reimbursement is made to Confirming Bank.
• 9. Documents are released against payment from Buyer (or other arrangements).
• 10. Buyer uses documents to obtain possession of goods.
Advantages of Letter of Credit for the Buyers
• Elimination of risk of losing money for the Buyer –
• Payments are made after fulfillment of the Seller's contractual
obligations
• Transfer of ownership over shipped goods to the Buyer within the
period indicated in the LC and according to other terms
Advantages of Letter of Credit for the Sellers
• Guarantee of payment independent of the Buyer (subject to the
fulfillment of contractual obligations)
• Possibility of payment before handing the goods over to the Buyer
• Possibility of execution of complex commercial contracts
Credit Rating
• Credit rating may be defined as an expression, through use of symbols, of
opinion about the quality of credit of the issuer of debt securities with
reference to a particular instrument.
• Rating is a measure of credit risk only and hence it does not communicate
anything about the degree of market risk.
• Credit rating is considered predominantly in respect of debt instruments
only.
• In addition to this, lenders like banks and non-banking finance companies
use internally developed credit rating score models in assessing credit
worthiness of their borrowers or depend on even rating agencies to get
rating for the same.
Feature
• Rating is based on information
• Many factors affect rating
• Rating by more than one agency
• Monitoring the already rated issues
• Publication of Ratings
• Right of appeal against assigned rating
• Rating of rating agencies
• Rating is for instrument and not for the issuer company
• Rating not applicable to equity shares
Benefits to Investors
• Safeguards against Bankruptcy
• Recognition of Risk
• Credibility of Issuer
• Rating Facilitates Quick Investment Decisions
• No Need to Depend on Investment Advisors or Professionals
• Choice of Investment
• Benefits of Rating Surveillance
Benefits of Credit Rating to Issuer Company
• Lower Cost of Borrowing
• Wider Audience for Borrowing
• Rating as Marketing Tool
• Self Discipline by Companies
• Reduction of Cost in Public Issues
• Motivation for Growth
Limitation
• Biased Rating and Misrepresentations
• Static study
• Concealment of material information
• Rating is no guarantee for soundness of the company