Sources of Company Finance
Role of Financial Institutions
There are several sources of finance available to any company.
An effective appraisal of various sources of finance available to a
company must be done to achieve its main objectives. Some of the
parameters that need to be considered while choosing a source of
Cost of source of fund
Leverage planned by the company
Financial conditions prevalent in the economy
Risk profile of both the company as well as the industry in which the
Each and every source of fund has some advantages as well as
Need for Corporate Financing
A Company requires Finance to meet their different types of
requirements in the short-term, medium term and long term.
Long term finance Medium term
Short term finance
It is needed for fixed
such as purchase of
land , machinery,
building etc. which is
generally for a
period exceeding 5-
10 years. Funds
required to finance
permanent or hard
core working capital
should also be
procured from long
It is needed to fund
which may be
written off over a
period of 3 to 5
years. These funds
required for a period
exceeding one year
but not exceeding 5
It is need for funding
i,e. Working capital –
payment of wages,
suppliers etc. These
typically for a short
period of time not
i.e. one year.
Long Term Sources of Finance
Share capital or Equity share
A public limited company may raise funds from promoters or from the investing
public by way of owners capital or equity capital
It is a source of permanent capital
The cost of ordinary shares is usually the highest. This is due to the fact that such
shareholders expect a higher rate of return (as their risk is the highest) on their
investment as compared to other suppliers of long-term funds.
Special kind of shares, the holders of such shares enjoy priority, both as regards to
the payment of a fixed amount of dividend and repayment of capital on winding up
of the company
Long-term funds may also be provided ploughing accumulated profits back into the
Such funds entail no risk and owners control is also not diluted
Debentures/Bonds of different types
Loans can be raised from public by issuing secured or unsecured debentures or bonds
by public limited companies.
The cost of capital raised through debentures is quite low since the interest payable
on debentures can be charged as an expense before tax.
From the investors' point of view, debentures offer a more attractive prospect than
the preference shares since interest on debentures is payable whether or not the
company makes profits
Long Term Sources of Finance
Loans from Financial Institutions & Commercial Banks
In India specialised institutions provide long- term financial assistance to
industry. Commercial banks also provide long term loans for the purpose
of expansion or setting up of new units
Such loans are available at different rates of interest under different
schemes of financial institutions and are to be repaid according to a
stipulated repayment schedule.
Commercial Banks grant Loans based on the anticipated income of the
Venture capital funding
The venture capitalist makes investment to purchase equity or debt
securities from inexperienced entrepreneurs who undertake highly risky
ventures with a potential of success to give shape to their ideas.
The investor also provides support in form of sales strategy, business
networking and management expertise, enabling the growth of the
Medium Term Sources of Finance
Loans from Financial institutions & Commercial banks
Public deposits/fixed deposits for duration of three years
Public deposits are very important source of short-term and medium term
finances particularly due to credit squeeze by the Reserve Bank of India.
A company can accept public deposits subject to the stipulations of
Reserve Bank of India from time to time maximum up to 35 per cent of its
paid up capital and reserves, from the public and shareholders.
These deposits may be accepted for a period of six months to three years.
Public deposits are unsecured loans; they should not be used for acquiring
fixed assets since they are to be repaid within a period of 3 years.
Leasing is a general contract between the owner and user of the asset
over a specified period of time. The asset is purchased initially by the
lessor (leasing company) and thereafter leased to the user (lessee
company) which pays a specified rent at periodical intervals. Thus, leasing
is an alternative to the purchase of an asset out of own or borrowed
funds. Moreover, lease finance can be arranged much faster as compared
to term loans from financial institutions
Short Term Sources of Finance
It represents credit granted by suppliers of goods, etc., It can be in the form of
Accrued expenses and deferred income
Accrued expenses represent liabilities which a company has to pay for the
services which it has already received.
Deferred income reflects the amount of funds received by a company in lieu of
goods and services to be provided in the future. These receipts increase
Advances received from customers
Manufacturers and contractors engaged in producing or constructing costly
goods involving considerable length of manufacturing or construction time
usually demand advance money from their customers at the time of accepting
their orders for executing their contracts or supplying the goods. This is a cost
free source of finance and really useful.
Commercial Paper is an unsecured money market instrument issued in the form
of a promissory note.
The companies can borrow funds for a short period say 6 months from other
companies which have surplus liquidity. The rate of interest on inter corporate
deposits varies depending upon the amount involved and time period.
Financial Institutions in India
The financial institutions assist in the proper allocation of resources,
sourcing from businesses that have a surplus and distributing to
others who have deficits.
This ensures the continued circulation of money in the economy.
The financial institutions act as an intermediary between borrowers
and final lenders, providing safety and liquidity.
The process subsequently ensures earnings on the investments and
1. The Reserve Bank of India
2. Commercial bank
3. Industrial Finance Corporations of India (IFCI)
4. Industrial Development Bank of India (IDBI)
5. Industrial credit and Investment Corporation of India (ICICI)
6. Small Industries Development Bank of India(SIDBI)
7. State Financial Corporations (SFCs)
8. Venture capital funding
The Reserve Bank of India
The Reserve Bank of India was established in the year 1935 with a
view to organize the financial frame work and facilitate fiscal stability
Acts as the regulatory authority with regard to the functioning of the
various commercial bank and the other financial institutions in India.
Formulates different rates and policies for the overall improvement of
the banking sector.
It issue currency notes and offers aids to the central governments.
Commercial Banks are banking institutions that accept deposits and
grant short/medium/long term loans and advances to their
There are 2 types of Commercial Banks
These are banks where majority stake is held by the Government of India
or Reserve Bank of India. Mainly all the Nationalized Banks
In case of private sector banks majority of share capital of the Bank is
held by private individuals. These banks are registered as companies with
Industrial Development Bank of India (IDBI)
As an apex financial institution, it coordinates development,
regulation and supervises the working of other financial institutions
such as such as IFCI , ICICI, UTI, LIC, Commercial Banks and SFCs
It provides credit to large industrial concerns directly.
It undertakes other activities for the development of industry.
To act as trustee for the holders of debentures or other securities
It underwrites and subscribes directly to shares/debentures of the
It sanctions of foreign currency loans for import of equipment or
It provides short term working capital loans to the corporates for
meeting their working capital requirements.
Refinance to banks and other institutions against loans granted by
Industrial Finance Corporation of India
The main object is to provide medium and long term credit to eligible
industrial concerns in corporate sectors of the economy, particularly to
those industries to which banking facilities are not available.
The primary role of IFCI is to provide ‘direct financial assistance’ on
medium and long term basis to industrial projects in the corporate and
co-operative sectors for undertaking new projects, expansion,
modernisation, diversification etc.
Subscription and underwriting of public issues of shares and
Guaranteeing of foreign currency loans and also deferred payment
Merchant banking, leasing and equipment finance
Providing technical, legal, marketing and administrative assistance to
any industrial concern for the promotion, management and expansion
of the industrial concern
Industrial Credit and Investment
Corporation of India (ICICI)
It assist in the formation, expansion and modernization of industrial
units in the private sector
It stimulates and promotes the participation of private capital (both
Indian and foreign) in industrial units
It helps in furnishing technical and managerial aid so as to increase
production and expand employment opportunities
It provides medium and long-term loans in Indian and foreign currency
for importing capital equipment and technical services.
It subscribes to new issues of shares, generally by underwriting them.
It guarantees loans raised from private sources including deferred
It directly subscribes to shares and debentures
SMALL INDUSTRIES DEVELOPMENT BANK OF
SIDBI was established with an objective to strengthen and broad-base
the existing institutional arrangement to meet the requirement of SSI
and tiny industries.
Administration of SIDF and NEF for development and equity support to
small and tiny industry.
providing working capital through single window scheme
providing refinance support to banks/development finance institutions.
undertaking direct financing of SSI units.
coordination of functions of various institutions engaged in finance to SSI
and tiny units.
State Financial Corporations (SFCs)
To meet the financial needs of small and medium enterprises, the
government of India passed the State Financial Corporation Act in
1951, empowering the State governments to establish development
banks for their respective regions.
These industrial concerns may be from corporate or co-operative
sectors or may be partnership, individual or joint Hindu family
business. Under SFCs Act, “industrial concern” means any concern
engaged not only in the manufacture, preservation or processing of
goods, but also mining, hotel industry, transport maintenance of
machinery, setting up or development of an industrial area or
industrial estate, etc.
It provides long and medium-term loan repayable ordinarily within a
period not exceeding 20 years.
It guarantees loans raised by industrial concerns which are repayable
within a period not exceeding 20 years.
Guarantees deferred payments due from an industrial concern for
purchase of capital goods in India.
EXPORT IMPORT BANK OF INDIA (EXIM)
It is apex institution for co-ordinating the working of institutions in
India engaged in financing exports and import of goods and services.
It raises funds by way of bonds and debentures, borrowing from RBI or
other institutions, raising foreign deposits.
The Functions are
direct finance to exporter of goods.
direct finance to software exports and consultancy services.
finance for overseas joint ventures and turnkey construction project
finance for import and export of machinery and equipment on lease basis
finance for deferred payment facility
issue of guarantees
multi-currency financing facility to project exporters.
export bills re-discounting
refinance to commercial banks in India
guaranteeing the obligations.
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