y Short term sources of finance y Medium term sources of finance y Trade credit y Public Deposits y Inter-corporate Deposits y Commercial Paper y Certificates of Deposits y Leasing & Hire Purchase
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Sources of funds
3
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Short Term Finance
4
y For smooth running of business operations y Enables firms to hold stock of raw materials y Goods can be sold on credit y Increase the volume of production at a short notice y Allow flow of cash during the operating cycle
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Merits of short term finance
5
y Economical y Flexibility y No interference in management y May also serve long term purpose
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Demerits of Short Term Finance
6
y Fixed Burden y Charge on Asset y Difficulty of raising finance y Legal Formalities
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Medium Term Sources of Finance
7
y Finance the business for up to 5 years y Medium-term financing can be raised from the following
sources: Preference shares Public deposits/fixed deposits for duration of three years Commercial banks Financial institutions State financial corporations Lease financing / hire purchase financing External commercial borrowings Foreign currency bonds
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SITM 2010-2012 Corporate Finance
Trade Credit
8
y An arrangement to buy goods or services on
account, that is, without making immediate cash payment.
y For example, Wal-Mart, the largest retailer in the
world, has used trade credit as a larger source of capital than bank borrowings; trade credit for WalMart is 8 times the amount of capital invested by shareholders
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Advantages
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y No security y No Interest y Varying terms and condition
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Public Deposit
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y Money received by a company through the deposits
or loans collected from the public.
y The public includes
General public Employees Shareholders of the company but excludes the money received in the form of shares and debentures
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Advantages
11
y The procedure of inviting public deposits is simpler
and involve lesser formalities
y The rate of interest payable by the company on
public deposits is lower than the interest on loans from banks and other financial institutions.
y There is no dilution of shareholders' control as the
depositors have no voting rights and cannot interfere with the internal management of the company.
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Limitations
12
y Public deposits with the companies may cause a
diversion of resources into non-priority and undesirable areas.
y Uncertain conditions may lead to withdrawal of
deposits if the company is not performing well.
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Inter Corporate deposits
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y Inter-corporate deposits are deposits made by one
company with another company, and usually carry a term of six months.
y The transaction is free from bureaucratic and legal
hassles.
y The market of inter-corporate deposits depends
crucially on personal contacts.
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Types of ICDs
14
y Three Month deposits
y y
To solve short term capital inadequacy due to tax payment, payment of dividends Six Month deposits etc. Six month deposits interest :12% Rate of are usually made with first class borrowers Call deposits Rate of interest :15% On giving a one day notice, this deposit can be withdrawn by the lender. Rate of interest: 10%
SITM 2010-2012 Corporate Finance
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Commercial Paper (CP)
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y Commercial Paper (CP) is an unsecured money
market instrument issued in the form of a promissory note.
y Used to generate working capital and for buying
inventories.
y Can be issued for a maturity for a minimum of 15
days and a maximum upto one year from the date of issue.
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Types of CP
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y Promissory Notes y Drafts y Checks y Certificates of Deposit
The maker is the individual who promises to pay while the payee or holder is the person to whom payment is promised. It is a three-party paper ordering the payment of money. The drawer is the individual issuing the order A check is a specific kind of to pay, while the drawee is draft, which is drawn on a the party to whom the order bank and payable on to pay is given. demand to a particular individual or to the bearer, in which case it can be written payable to "cash."
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Advantages
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y High credit ratings fetch a lower cost of capital. y Wide range of maturity provide more flexibility. y It does not create any lien on asset of the company. y Tradability of Commercial Paper provides investors
with exit options.
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Limitations
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y Its usage is limited to only blue chip companies. y Issuances of Commercial Paper bring down the bank
credit limits.
y A high degree of control is exercised on issue of
Commercial Paper.
y Stand-by credit may become necessary
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Certificate of deposit
19
y A certificate of Deposit or CD is a time deposit, a
financial product commonly offered to consumers by banks and credit unions.
y They are different from savings accounts ,CD has a
specific, fixed term (often three months, six months, or one to five years) and fixed interest rate.
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Different CDs
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y Callable CDs y Brokered CDs y Bump-up CDs y Liquid CDs y Step-up CD or step-down CDs y Zero-coupon CD y Add-on CDs y Variable-rate CDs
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Advantages
21
y Relative safety and the ability to know your return
ahead of time.
y Earn more than in a savings account, and no risk as
in case of the stock market.
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Limitations
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y The returns are smaller compared to many other
investments.
y Money is tied up for the length of the CD and
you won't be able to get it out without paying a penalty.
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Lease
23
y A lease is a contractual arrangement whereby one
party grants the other party the right to use the asset in return for a periodic payment i.e. lease rental.
y It is renting of an asset for a specific period. y Lessor - Owner of the asset y Lessee ± User of the asset
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Lease Operation
24
Sale Payment
Equipment Supplier
Delivery
Lessor
Lease Payment
Lease
Lessee
Standard lease operation
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Types of Lease
25
Finance Lease
Direct Lease Leveraged Lease Sale and Lease Back
Operating Lease
Finance lease which is medium to long term and where the asset is hired to only one lessee.
Operating lease which is short-term and where the asset may be hired to several lessees.
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Hire-purchase
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y The seller hands over the assets to the buyer but the
title to good is not transferred
y The buyer become the owner of the goods and
acquires the title to the goods only when he makes the payments of all the installments
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Advantages
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y Tax benefits y Risk of obsolescence y Convenience
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Limitations
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y Lease contract terms of lease may be inconvenient y If lessor winds up the business ,normal business of