UNIT 5 FINANCING OF ENTERPRISE Bhupendra Deshmukh.

UNIT 5

FINANCING OF ENTERPRISE

Bhupendra Deshmukh

NEED OF FINANCIAL PLANNING

Finance is one of the important prerequisite to start the enterprise.

In fact, it is availability of finance that facilitate an entrepreneur to bring together land, labour, machinery and raw material to combine them to produce good.

The decision taken by the entrepreneur in advance regarding the future financial aspects of his/her enterprise is called financial planning.

In a financial plan, the entrepreneur should clearly answer the following questions.

1. How much money is needed?

2. Where will money come from?

3. When does the money needed to be available?

The entrepreneur should take the following three things into consideration

1. There should be adequate money to pay the purchase considerations.

2. There should be sufficient capital at his/ her disposal to support the business operations up to three initial months of the enterprise.

3. Lastly, enough provision should be made to meet unexpected business expenses.

Thus the total of three amounts will constitute the total money needed to start the enterprise.

There are two ways of classifying the financial needs of an enterprise

1. On the basis of permanencea) Fixed capitalb) Working capital

2. On the basis of period of usec) Long- term financed) Short –term finance

Fixed capital :- the money invested in some fixed assets or durable assets like land, building, machinery, equipment, furniture, etc., is known as fixed capital. This capital are required for permanent use, that is, for a long period of time.

Working capital:- the money invested in currents assets like raw material, finished goods etc., is known as working capital. In other words money required for day to day operations of business is called working capital.

Long term capital: this is such money whose repayment is arranged for more than five year in future. The sources of long term finance could be owner’s equity, terms loan for financial institutions, credit facilities from commercial banks.

Short term capital:- this is borrowed money that is to be repaid within one year.

The shorts term finance include bank borrowing or borrowing from friends and relatives.

SOURCES OF FINANCE1. Internal sources

2. External sources

INTERNAL SOURCES The internal sources of financing could be

owner’s capital known as equity, deposits and loan given by the owner, the partner, the director, as the case to the enterprise.

One source for increasing funds internally may be personal loans taken by the entrepreneurs on his/her personal assets like provident fund, life insurance policy, building, investment etc.

EXTERNAL SOURCE1. Deposits or borrowing from relatives ,friend

and other.

2. Borrowing from the banks for working capital purposes.

3. Credit facility from the commercial banks.

4. Term-loans from financials institutions.

5. Hire purchase or leasing facilities from the national small industries corporation(NSIC) and state small industries corporations(SSICs)

Capital structure

CAPITAL STRUCTURE The composition of equity and debt in overall

capital of an enterprise is called capital structure.

Capital structure is the ratio between the debt and equity capital . Hence, it is also called as the debt-equity ratio.

It must be noted that the term capital structure differs from financial structure. Capital structure means the permanent financing of the enterprise represented primarily by long term sources of funds i.e., debt and equity. Thus it exclude funds raised from short term sources.

FACTOR DETERMINING CAPITAL STRUCTURE

1. Nature of business: the business subject to wide fluctuation in sale need to maintain smaller proportion of borrowed funds, i.e., debt capital.

Companies manufacturing television, refrigerators, machine tools and like are ex. Of businesses subject to fluctuations in the sales.

In case of ready –made garments industry, competition is mainly based on style and fashions which are subject to frequent and unpredictable changes. These firms have to depends less on borrowed capital and more on equity.

2. SIZE OF ENTERPRISE Small enterprise have to rely less on borrowed

capital and depends more on owner’s capital.

This is because the investors consider lending to small firms more risky. And large enterprise are consider less risky.

Therefore investors believe that their money is safe and, hence, prefer to lend money to large enterprises. This enables the large enterprises to raise funds from different sources.

3.TRADING ON EQUITY

In case the rate of return on capital employed is more than rate of interest on debentures, it is called as trade on equity . In such cases there is great dependence on borrowed capital in the capital structure

4.PURPOSE OF FINANCING The purpose of financing also affects the

capital structure of the enterprise.

In case funds are required for some directly productive purposes, for example, purchase of new machinery, the enterprise may rely on external sources for raising the required funds.

In case the enterprise required to raise funds for unproductive purposes like spending on the employees welfare facilities, it will have to depends on owner’s capital.

PROVISION FOR FUTURE The scope of changing the capital structure in

futures happens to be a basic consideration for determining the capital structure of an enterprise.

As a general principle, it will always be safe to keep the best security to be issued in the last instead of issuing all type of securities in one stroke only.

TERM LOANS

TERM LOANS Loans taken for a definite period of time are

called term loans. Based on period, loans are broadly classified into two types:

1. Short term loans

2. Long term loans

The term ‘ term loans’ is used for long- term loans. Therefore, we will study long term loans.

LONG TERM LOANS These are the loans taken for fairly long duration

of time ranging from 5 year to 10 or 15 years. Long term loans are raised to meet the financial

requirement of enterprise.Which include the following1. Land and site development2. Building and civil works3. Plant and machinery4. Installation expenses5. Miscellaneous fixed assets comprising vehicles,

furniture and fixtures, office equipment and so on.

CONTD… In case of units to be located in backward

areas, another element of miscellaneous fixed cost includes expenditure to be incurred in infrastructure like roads, railway sidings, water supply, power connections etc..

Term loans or long term loans are also required for expansion of productive capacity by replacing or adding to the existing equipment.

SOURCES OF TERM LOANS Issue of shares

Issue of debentures

Loans from financial institutions

Loan from commercial banks

Public deposits

Retention of Profits

DIFFERENCE BETWEEN SHARES AND DEBENTURES

1. Representation: a share represents a portion of capital and debentures represents a portion of debt of company.

2. Status: a shareholder is a member of company, but a debenture holder is a creditor of the company.

3. Return: a shareholder is paid dividend while a debentureholder is paid interest.

4. Right of control: the shareholders have a right of control over the working of company whereas the debentureholders don’t have such right.

VENTURE CAPITAL

VENTURE CAPITAL Venture capital is a form of financing

especially designed for funding high technology, high risk and perceived high reward project.

A venture capitalist provides funds to the entrepreneurs pursuing new and unexplored avenues and ideas.

Thus, venture capital helps the entrepreneurs translate their new ideas into commercial production.

It especially helps in financing of high technology projects and helps research and development into production.

NETWORK ANALYSIS

NETWORK ANALYSIS

A network is a set of symbols connected with each other with a sequential relationship with each step making the completion of a project.

A business plan or project involves various activities to be undertaken to convert it into an enterprise.

Delays in the completion of the activities cause, among other thing cost overruns.

Hence, there is a need for deciding the sequential order of all activities of the project so as to accomplish the project economically in the minimum available time with the limited resources.

CONTD…

A number of network techniques have been developed for project scheduling. Some of them are:

1. Program Evaluation and Review Technique(PERT)2. Critical Path Method (CPM)3. Graphical Evaluation and Review Technique

(GERT)4. Workshop Analysis Scheduling Programme

(WASP)5. Line of Balance (LOB)However the PERT and CPM are the two most commonly used method in the management.

PROGRAMME EVALUATION AND REVIEW TECHNIQUE (PERT) PERT was first developed as a management

Aid for completing Polaris Ballistic Missile Project in USA in October 1958.

It worked well in expediting the completion of project from 7 year to 5 years.

Since, then PERT has become more popular technique used for project planning and control.

It helps to reduce both time and cost of the project.

STEP INVOLVED IN PERT1. The activities involved in the project are

drawn up in a sequential relationship to show what activity follows what.

2. The time required for completing each activity of the project is estimated and noted on network.

3. The critical activities of the project are determined.

4. The variability of project duration and probability of the project completion in a given time period are calculated.

The Managing Director Of Xyz Ltd. Company Is Interested In Getting His Operating His Budget Prepared.

THE PROJECT IS DECOMPOSED IN FOLLOWING ACTIVITIES:

Job Identification

Job Discription

Activity Time required

A Forecasting of sales

1-2 10 days

B Sales pricing 2-4 8 daysC Production

scheduling2-3 9 days

D Cost determination

3-4 7 days

E Preparation of budget

4-5 12 days

Total 36 days

ADVANTAGES OF PERT

It determines the expected time required for completing each activity.

It helps complete the project within a given period of time.

It helps management handle uncertainties involved in the project and thus, reduce the risk element in the project.

It enables the management to make optimum allocation of limited resources.

It presses for the right action, at the right point and at the right time in the organization.

LIMITATION OF PERT PERT network is mainly based on time estimates

required for each activity. On account of wrong time estimate, the network is bound to become highly unrealistic.

This techniques also does not consider the resources required at different stages of the project.

For effective control of a project by using PERT techniques requires frequent updating and revising the PERT calculations. But, this proves quit a costly affair for the organization.

CRITICAL PATH METHOD (CPM) The critical path method was first developed in USA

by the E.I. Dupont Nemours and Co. in 1956 for doing periodic overhauling and maintenance of chemical plant.

It resulted in reducing the shutdown period from 130HR to 90HR. And saving the company $ 1 million.

The CPM differentiate between planning and scheduling of the project.

While planning refers to determinations of activities to be accomplished, scheduling refers to the introduction of time schedule for each active project.

The duration of different activities in CPM are deterministic. There is a precise known time that is activity in the project will take.

Let Us Illustrate The CPM Techniques With An Examples Of A

Research Project.

THE PROJECT IS DECOMPOSED IN FOLLOWING ACTIVITIES:

Job Identification

Job Description

Activity Time required

A Preparation of dealer questionnaire

1-2 10 days

B Preparation of consumer questionnaire

1-4 10 days

C Dealer survey 2-3 20 days D Consumers

survey4-5 60 days

E Processing and interpretation of dealer data

3-6 10 days

F Processing and interpretation of consumer survey data

5-6 30 days

ADVANTAGES OF CPM It helps ascertaining the time schedule of

activities having sequential relationship.

It makes control easier for the management.

It identifies the most critical element in the project. Thus, the management is kept alert and prepared to pay due attention to the critical activities of the project.

It makes better and detailed planning possible.

LIMITATION OF CPM CPM operates on the assumptions that there is a precise

known time that each activity in the project will take. But, it may not be true in real practice.

CPM time estimates are not based on statistical analysis.

It can not be used as a controlling device for the simple reason that any change introduced will change the entire structure of network.

In the words, CPM can not be used as a dynamic controlling device.

DIFFERENCES BETWEEN PERT &CPM

Thank you

Sr PERT CPM1 Its origin is military Its origin is Industry2 It is an event oriented approach It is an activity oriented approach

3 It allows uncertainty It does not allows uncertainty

4 It is a probabilistic model It is a deterministic model

5 It is a time based It is a cost based

6 It does not demarcate between critical and non critical activities

It marks critical activities

7 It averages time It does not average time

8 It is suitable when high precision is required in time estimate, ex. Defence projects

It is suitable when reasonable precision is, ex. Civil construction projects, industrial expansion schemes, etc..