Financing & Accounting

8/6/2019 Financing & Accounting

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FINANCING OF ENTERPRISE

Finance -the most important prerequiste to

start an enterpriselubricant to process of

production

Land,labour,capital,entrepreneurship &

organisation depend on each other

Financial planning is

How much money needed ?Where will money come from ?

When does the money need to be available ?


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Estimating the capital

1. To Pay purchase considerations

2. To support business operations upto

3 months

3. To meet unexpected/unplanned

business expenses

Sources :

Internal : Owners own money equity

External: Relatives,Commercial Banks


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Classification of Financial needs

1. On the basis of Performance :

a) Fixed CapitalFixed assets

Land,Building,Machinery, Furnitureb) Working CapitalCurrent assetsRaw

material, finished goods, debts day-to-day

operations

2. On the basis of Period of Use :

a) Long-term Capital/FinanceRepayment for

more than 5 years

b) Short-term Capital/FinanceRepayment

with in 1 year


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CAPITAL STRUCTUREINTERNAL SOURCES : EQUITY

Owners own capital , deposits or loans by owner, the

partners from personal assets like Provident fund , Life Insurance

Policy, Buidings,Investments etc.

EXTERNAL SOURCES : DEBT

Deposits/borrowings from relatives, friends , Borrowings

from commercial banks, Credit facilities from commercial

banks,Term loans from financial institutions, Hire purchases ,

Subsidies from Govt. etc

Personal funds/Loans /Mortgage loans/Term-loans/Subsidiaries

CAPITAL STRUCTURE = EQUITY + DEBT

It is the ratio between debt and equity capital


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Factors determining Capital Structure

1. Nature of Business - Consumer good / Luxury goods

2. Size of Enterprise - Lending money to SSI is risky

3. Trading on Equity - Rate of return > Rate of interest

4. Cash flows - Fixed obligations depend on avail.cash

5. Purpose of FinancingBuying New M/cs, Emp.Welfare facilities

6. Provision for future - To keep some of your best securities till thelast, Always think of rainy days/ Emergencies


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TERM LOANS1. Short term Loans 2. Long term Loans (term loans)

Purpose : ( 5/10/15 years )

Land/site development , Building works, Replacing

Plant machinery, Installation expenses, Fixed assets

like furnitureoffice equipments etc.

Sources of Term loans :

1.Issue of Shares

2.Issue of Debentures3.Loans from Financial Institutions

4.Loans from Commercial banks

5.Public deposits

6.Retention of profits


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SHARESAs per Section 85 of companies act 1956 a Public limited company can issue two types of shares.

1. Preference Shares :

Carry a preferential right over equity shares with

reference to dividend and payment of capital at the timeof winding up of business.

Cumulative-Non cumulative , Redeemable irredeemable,Participating-Non participating, Convertible Non convertible2. Equity Shares :

What is not a preference share is a Equity share.

They are entitled of dividend and payment of capital only

after payment to preference shares.

3. Types of Capital : Preference capital/Equity Capital


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Issue of SHARES

Issue of Prospectus : Info. about shares

Receipt of Applications: 120 days

Allotment of Shares :

After subscription is over andMinimum

Subscriptionis received shares are allotted toapplicants within 120 days of issue of prospectus.

If minimum subscription is not receivedmoney is refunded with in 130 days of issue ofprospectus.


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DEBENTURES

Debenture includes debenture stock,bonds andany other securities of company whetherconstituting a charge on company assets or not.

Redeemable irredeemable, RegisteredBearer,Secured Unsecured , Convertible Non convertible

Allotment is Similar to Shares allotment procedure


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Shares Vs Debentures

ASPECT SHARES DEBENTURES

1. Representation Portion of Capital Portion of Debt

2. Status Shareholder is member of Company

Debenture holder iscreditor to company

3. Return Shareholder is paid dividend Debenture holder ispaid Interest

4. Right of Control Share Holders have right ofcontrol over working of company

Debenture Holdersdont have such right

5. Purchase Company can not purchase its

own shares from the market

Can purchase its

debentures & cancel

6. Repayment No repayment after specificperiod

Repaid afterspecified period

7. Order of Repayment Last to get paid Get Priority


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Short term Finance

Sources :Loans from commercial banks

Public deposits

Trade credit

Discounting Bills of Exchange

Bank overdraft and Cash credit

Advances from customers

Accrual accounts


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CAPITALISATION

Total amount employed in business

Meaning :

Broad Sense: The quantity & Quality of financeAmount and modes of finance

Narrow Sense: Determination quantum of long-term required to run the enterprise.

Types:

OverCapitalisation : When enterprise possessexcess of assets in relation to its requirements.

Under-Capitalisation :Actual capitalisation is lessthan proper capitalisation.


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Over-Capitalisation

Actual earnings are lower than expected ones.

Enterprise becomes unable to pay its fixedobligations, i.e interest & dividend.

The enterprise fails to pay a fair return on itscapital investments.

Example :

In case annual profit = Rs.50,000 for a

capital investment of Rs.5,00,000. If expectedreturn is 10% it is properly capitalised.

If profit is Rs.40,000 & expectation is 10%then it is over capitalised bcos 8% would go forinterest on capital investments.


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Causes of Over-Capitalisation

1.Raising of more money by shares/debenturesthan required by enterprise

2.Borrowing more money at a rate of interestthan the actual rate of return on its capital

3.Acquiring fixed assets on excessive amounts

4.Inadequate provision for depreciation &replacement of fixed assets.

5.Payment of dividend at a fairly high rate

6.High rate of Taxation imposed by Government

7.Over-estimation of earnings for enterpriseconcern.


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Effects of Over-Capitalisation

1. On owners : Because of fall of dividends theshareholders/owners loss heavily. Owners willnot be able to dispose their shares due to fall inshares values in market. Owners are biggest

losers.

2. On Enterprise :Value of enterprise stock fall inmarket and it finds difficult to raise capital.Thecredit worthiness of enterprise is adversly

affected 3.On Society : Over capitalised enterprises often

come to societal rejection.Gradual withdrawal ofacceptance of their products would result.


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Remedies for Over-Capitalisation

1. To reduce the claims of shareholders ,debentureholders and creditors

2. To reduce rate of interest on

debentures and rate of return onpreference shares.

3.To reduce number of equity shares

4. If possible, to reduce the par value ofstock.


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Under-Capitalisation

Actual capitalisation is less than Propercapitalisation

Market value of shares are fairly higher thanmarket value of shares of similar enterprises.

An enterprise may be under capitalised when therate of profit is exceptionally high in relation tothe return enjoyed by similar enterprises in thesame industry.


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Causes of Under-Capitalisation

1. Under estimation of initial rate of earnings

2. Utilization of high efficiency for exploitingevery possibility available.

3. Using lower rate of capitalisation 4. Under estimation of required funds.

5. Retaining profits because of conservativepolicy of enterprise.

6. After a recession the enterprise starts earningat an unusually high rate.

7. Because of heavy earning, enterprise isexposed to heavy burden of taxation.


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Effects of Under-Capitalisation

1.It encourages cut-throat competition inmarket.High profit by Under capitalisedenterprises lures the new entrepreneurs toplunge in to manufacturing.

2.High rate of dividend given to shareholderspropels workers to demand higher wages/salary

3.Enables management to manipulate the valueof shares

4.Government charges higher taxation.


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Remedies for Under-Capitalisation

1.To split up the shares of the enterprise

2.To issue bonus shares

3.To increase the par value of shares/stock.

4.To declare dividend payable in stock,if largesurplus is available.


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Venture Capital

Financing for High technology,High Riskand perceived high reward projects

Conventional financier funds projects withProven technologies

Venture capitalist funds to entrepreneurspursuing new and hitherto unexplored

avenues and ideas and helps to translatethe new ideas in to production.


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Venture Capital

International Finance Corporation,Washington (IFCW) defines

Venture capital as equity or equityfeatured capital seeking investment innew ideas, new companies, new products,new processes or new services that offer

the potential of high returns oninvestment. It may include investment inturn around situations


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Venture Capital in India

1988 formally introduced in budget

ICICIIndustrial credit & InvestmentCorporation of India

TDICI Technology Development &Information Company of India

Immediately 5% cess was levied on allimport of technology/know how resultingin the creation of sizeable Venture capitalfunds

This is administered by IDBI Industrial

Development Bank of India


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Govt. of India Guidelines

SBI and other scheduled banks are Eligible

to float Venture Capital funds

Minimum size of fund should be Rs.10 crores

In case public issue the promoters share should be

40% of capital Foreign holding allowed up to 25%

NRIs investment allowed upto 74% of capital onNon-repartible basis & 25-40% on repartible basis

Debt-Equity ratio should be limited to 1:1.5 Venture capital funds are not allowed to operate in

money market operations ,bill re-discounting

Venture capitalist to pay 20% tax on dividendincome. But investor are exempted upto Rs.10,000 ondividends and to pay 10% on capital gains.


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Pre-Shipment Finance(PSF)

Financial assistance provided to the exportersbefore the actual shipment of goods

PSF is provided for purchasing Raw materials,their processing & converting into finished goods

& packing them.

Pre-Shipment finances:

1.Packaging credit

2.Advance against Incentives

3.Advance against duty drawback.

PSF are granted at 7.5% interest.

PSF credits are extended upto a maximum of 6

months.


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Post-Shipment Finance(PoSF)

Any loan or advance granted or any other creditprovided by a bank to an exporter of goods fromIndia from the date of extending the credit aftershipment of goods to the date realisation of

export proceeds PoSF serves like a bridge loan for the period

between shipment of goods and realisation ofproceeds.

PoSF are granted at 8.65% interest. PSF credits are upto a maximum of 6 months.

ECGC Export Credit & Guarantee Corporation providesInsurance cover to Exporters

EICI Export Inspection Council of India assists exportersfor Quality control purposes.


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FINANCIAL INSTITUTIONS

Reserve Bank of India (RBI)

Scheduled commercial banks :

i. State Bank of India (SBI) & associates

ii. Nationalised Banks

iii. Private sector Banks

iv. Regional Rural Bank (RRB)

v. Foreign Banks

Industrial Development Bank of India (IDBI) 1964Small Industries Development Fund (SIDF) 1986

National Equity Fund Scheme (NEFS) 1988

Voluntary Executive Corporation Cell (VECC)

Narasimhan committee IDBI to do Promotional role for SFC & SIDBI etc.


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Industrial Finance Corporation of India Ltd (IFCI)

Extend assistance through Rupee & Foreign currency loans,

Equipment finance,Buyers & Suppliers credit,merchant banking.IFCI promotes

- Interest subsidy scheme for women entrepreneurs

- Consultancy fee subsidy for SSIs

- Modernisation of SSIs

- Control of pollution in small & medium scale industries.

Industrial Credit & Investment Corporation of India Ltd. (ICICI)

- 1995 , To develop mainly small ,medium industries in the privatesector.Offers financial services such as deferred credit,leasingcredit, asset credit and venture capital.


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Industrial Reconstruction Corporation/Bank of India (IRCI/IRBI)- Mainly to look after the spl.problems of sick units & providesassistence for their speedy reconstruction and rehabilitation.

Consultancy services ,Equipment leasing,Industrial revival.

Life Insurance Corporation of India (LIC)

- Offers a variety of insurance policies to extend social security tovarious segments of society. Provides termloans,shares/debentures issue of corporate sectors.

Unit Trust of India (UTI)

- 1964,Mobilises small investors savings through sale of units and

channelises them into corporate investments. State Financial Corporations(SFCs)

- 1948, Industrial Finance Corporation of India (IFCI) providesFinancial assistance only to Large sized industrial undertakings .SFCs provide financial assistance to small,medium sized industriesorganised under all structures.


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State Industrial Development Corporations (SIDCs)- To provide term loans,subscription of

shares/debentures & guarantees - To promote indstrialdevelopment.

Small Industrial Development Bank of India(SIDBI)

- 1989, To initiate technological upgradation,modernisation of existing units To expand marketingchannels for SSIsTo promote SSI in semi urban areas.

Export-Import Bank of India (EXIM Bank)

- 1982, International finance wing of IDBI- 3 schemes Production Equipment finance,Export marketingfinance,Export vendor development finance

-Financing Export/Import goods & services both of India andof outside India,Joint ventures,Merchant Banking,Buyerscredit to foreign banks,Business advisory services.


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Working Capital

It is a fund which is required to carry out theday-to-day short term operations of anenterprise

These operations consists of primarily such asraw materials,semiprocessed goods,sundrydebtors,finished goods,finished products,shortterm investments etc.

These short term operations are known as short

term assets or Current assets.

It is also called a circulating capital or revolvingcapital.


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Working Capital Operating Cycle

The average time intervening between the acquisition of material orservices entering the process and the final cash realisation

Cash

RawMaterial

Semi-FinishedGoods

FinishedGoods

BillsReceivable


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Working Capital (WC)

WC has two parts

i) Fixed working capital

- the amount needed at short intervals, to invest

again and again in current assets. This isirreducible minimum & remains permanentlysunk.

ii) Variable working capital

- this may vary due to fluctuations rise or fallin volume of business.


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WC WC Variable

(Rs) Variable (Rs) Fixed

Fixed

Time Time

Developed Enterprise Growing Enterprise

Gross working capital = Total Current assets

Net working capital = Total Current assets Total Current liabilities


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Net working capital = Current assets - Current liabilities

When the current assets are less than the current liabilities ,then the

difference between the two will be called Working Capital Deficit

Current Assets

CurrentLiabilities

Net Working

Capital


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Assessment of Working Capital

Total operating expenses in last year

Total Working Capital requirements = ------------------------------------------

Number of operating cycles in the year

Other factors to be considered are..

i)Cost to be incurred on inputs like Raw materials, Labour charges etc.

ii)Length of credit period allowed to debtors

iii)Length of credit availed from creditors

iv)Length of time involved in the payment of wages & overheads

v)Size of the unit and volume of business

vi)Seasonal requirements of the raw material.


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Factors of Working Capital

1. Sales

2.Length of Operating cycle

3. Nature of Business 4.Terms of Credit

5.Seasonal Variations

6.Turnover of Inventories 7.Nature of Production Technology

8.Contingencies


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Management of Working Capital

1.Management of Cash- level of cash, inflows of cash, outflows of cash, use of surplus cash

2.Management of Inventory

-Raw material,Work-in-progress & Finished goods

-Transaction motive,Precautionery Motive,Speculative Motive- Inventory holding results in Ordering & Carrying costs

- EOQ,ABC analysis are used - Optimum inventory level.

3.Management of Accounts receivable- Amounts of goods sold with a view of increasing volume of sales.

- It constitutes a major porting of current assets.

- It includes Capital ,administrative,collection & defaulting costs

4.Management of Accounts Payable

- Credit purchase policy Buy-now,Pay- later


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Management of Working Capital

Point of Trade-Off

Profitability

Liquidity

Size of Accounts Receivable

Cost &

Benefit

Trade-Off between Profitability & Liquidity


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Network Analysis Techniques

CPM Critical Path MethodCPM planning refers to determination of activities to be

accomplished & Scheduling refers to time scheduling for eachactivity of the project. The duration of different activities in CPM

are deterministic.

Advantages :

1.Ascertains time schedule of activities having sequential relationship.

2.Makes control easier for the management.

3.Identifies the most critical elements in the project, thus the management is kept inconstant alert about them.

4.Makes better and detailed planning possible.

Limitations :

1.The assumption on precise timing may not be true in practice.

2.Estimates are not based on statistical analysis

3.Cant be used as a dynamic controlling device since any change introduced willchange the entire structure of the network.


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Network Analysis Techniques

PERT Programme Evaluation & Review TechniqueFirst used in 1958 in Polaris ballistic missile project in USA, PERT

schedules the sequence of activities to be completed in order toaccomplish the project within short period of time .The variability ofthe project duration and probability of the project completion in the

given time period are calculated.Advantages :

1.It determines the expected time required for completing each activity .

2.Helps to complete the project within a given period of time.

3.Helps to identify uncertainties involved in the project,thus reduces risk elements.

4.Enables management to use optimum allocation of the resources.

5.Presses for right action,at the right place and right time.

Limitations :

1.Based on time estimates of activities.Wrong time estimates it makes highly unrealistic.

2.Does not consider the resources required at different stages of the project.

3.For effective control of project frequent updating is required which makes it a costlieraffair.


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CPM Vs PERT

CPM PERT1. Origin is Industry Origin is Military

2. Its an activity oriented approach Its an Event oriented approach

3. Does not allow uncertainty Allows Uncertainty

4. Its a deterministic model Its a probabilistic model

5. Marks critical activities Does not mark critical activities

6. It is cost based & doesnt average time It is time based & averages time

7. Suitable for reasonable precision projectsEx.Civil construction,Industrial Expansionprojects

Suitable for high precision projectsEx. Defence projects.


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Network Analysis Technique

3 days 4 days

2 days

CPM

3 days 3 days

5 days

Earliest Start time - Earliest Finish time

Latest Start time - Latest Finish time PERT

1

2

5

3

6

4


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TAXATION

Income Tax : It is an annual tax levied by theCentral government, state governments, and some local

panchayats, on an individual's or corporation's net profit.

Excise Duty : It is the tax on the goods which areproduced in the same country

Customs duty :It is the tax on the goods from outsidethe country.

Need for Tax Benefits :The first 1000 days are critical period for SSI. They

incur more expenses, but returns are either nil ornominal. Therefore they need support to tide over the

crucial initial stage to enable them to survive. Hence the

government extends various benefits to SSIs.


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TAX BENEFITS

Tax Holiday : SSI are exempted from income tax onprofits subject to a maximum of 6% per annum of capital.This is

allowed for 1st 5 years of commencement of production.

Conditions are :

1. Not an reformed existing unit

2. SSI should be 10 employees with power (or) 20 employeeswithout power.

Depreciation : An SSI is entitled to a deduction ondepreciation on assets at the prescribed rate subject to a

maximum Rs.20 lakhs.It is calculated by diminishing balance

method. It is limited to Rs.7590 from 1991-92 onwards.Conditions are :

1.Assets must be owned by the assessee & used for business.

2.Depreciation is only allowed on Fixed assets.


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TAX BENEFITS

Rehabilitation Allowance :Rehabilitation allowance is granted to SSIs incase of..

Flood,typhoon,hurricane,cyclone,earthquake etc

Riot or civil disturbances

Accidental explosion

Action by an enemy/when combating enemyUpto 60% of amount of deduction is allowed to the unit.

Investment Allowance :Investment allowance was introduced in 1976 to

replace depreciation allowance.It is allowed at the rate

of 25% of the cost of acquisition of new plant or

machinery installed. A SSI can avail the investment

allowance provided it has put to use machinery or plant

either in the year of installation or in the next year.


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TAX BENEFITS

Expenditure on Scientific Research :Certain expenditure on Scientific research are

allowed under 35 of Income tax Act 1961. Any

expenditure incurred on scientific research related to

business, Any sum paid to scientific research

association is exempted from income tax.

Amortisation of Preliminary expenses :Under section 35D of Income tax Act 1961,

companies are allowed to write off the preliminary and

development expenses incurred by them in connection

with setting up of a new industrial unit or expansion ofan existing industrial unit. These include expenses on

preparation of project report, Legal charges on drafting

agreements. And Engineering expenses related to

business.


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TAX BENEFITS

Tax concessions to Rural area SSIs :A tax deduction of 20% of the profits and gains is

allowed by running SSIs in rural areas. This deduction is

extended upto 10 years from the year of commencement

of manufacturing. The SSIs that employs 10 or more

workers with aid of power (or) 20 or more workers without aid of power are eligible to avail this concession.

Tax concessions to Backward area :The SSIs established in the backward areas are

entitled to a deduction of 20% of their profits and gains

from their gross total income.This deduction is allowedupto 10 years from the commencement of manufacture.

The SSIs that employs 10 or more workers with aid of

power (or) 20 or more workers with out aid of power are

eligible to avail this concession.


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TAX BENEFITS

Expenditure on Acquisition of Patents/Coyprights:Any expenditure of a capital nature incurred

inacquiring a patent or copyright by a SSI is deducible

from its income.This expenditure can be deducted in 14

equal instalments.Profits from business of Publications of books:A 20% of profit is exempted for a total of 5 years .

This includes Royalties from any company in India,

Royalties from Foreign companies,Income of Co-operative

Societies.


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End of Unit 4

Financing & Accounting

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