FINANCIAL MANAGEMENT:

UNIT 1:

Define Financial Management “Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operation”- Joseph and Massie

“Financial management is the area of business management devoted to a judicious use of capital and a careful selection of sources of capital in order to enable a business firm to move in the direction of reaching its goals”- J F Bradley

“Financial management is the application of the planning and control functions to the finance function” Archer and Ambrosio

Meaning of Financial Management

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise in order to improve the return on investments and maximize the wealth of a firm. It involves reducing costs and planning of resources for its optimal use to generate high profits and withstand the threats arising on account of competition.

Objectives of Financial Management: Financial management refers to the efficient and effective management of money (funds) in such a manner as to accomplish the objectives of the organization. The main objective of any organization is to increase the profitability of the business. However the scope of activity in financial management extends beyond profitability and it includes:

Primary Objectives:

Profit Maximization: The main purpose of any kind of economic activity is earning profit. A business concern operates mainly for the purpose of making profit. Profit has become the yardstick to measure the business efficiency of a concern. The organizations maximize their profits by1. Increasing Revenue/ Turnover2. Controlling costs3. Managing Risks

Wealth Maximization: Wealth maximization is also known as value maximization or net present worth maximization. This objective is a universally accepted concept in the field of business. Wealth maximization is the concept of

increasing the value of a business in order to increase the value of the shares held by stockholders. The most direct evidence of wealth maximization is changes in the price of a company's shares.

Secondary Objectives:

Judicious planning of Funds: A finance manager has to estimate the financial needs with regards to capital requirements of the company. This will depend upon expected costs and profits and future programs and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise. Excess capital can result in idle resources and a shortage may interrupt the flow of operations.

Liquidity: Liquidity is the ability of a company to meet its liabilities as and when they arise. We often come across profitable companies that may not be liquid. The liquidity aspect of a company also improves the credit worthiness of a company in the market. A company should maintain its liquidity position in order to safeguard its position in the market.

Credit worthiness: A company deals with various players in the market in the course of business. Cash as well as credit transactions are transacted. Credibility engenders belief in your company. The temptation to stretch your promises is overwhelming when you are trying to raise capital or secure a partner, especially in today's economy. Credibility is more important in the long run companies that maintain the best credibility survive while others fail.

Cost Reduction and Cost Control: Cost control and reduction refers to the

efforts business managers make to monitor, evaluate, and trim expenditures. While cost control deals with not allowing the cost to rise beyond the planned levels, cost reduction involves a real and permanent reduction in unit cost of production rendered without impairing their suitability for the use intended.

Eliminating Competition: There exists cut throat competition in the market. Corporations are exposed to forces of threat of survival from competitors. One of the objectives of financial management is to plan activities that will give you an edge over your competitors.

Improving Financial Efficiency: Profitability is not the sole indicator of the financial well being of an enterprise. It is important the business houses are consistent and stable. Policies and Strategies are implemented for growth and development activities.

Uninterrupted flow of operations: Working Capital management is an important management function as it ensures the smooth flow of operations in an

enterprise. Estimating Working capital needs of the organization and a steady flow of resources will ensure an uninterrupted flow of activities of the business.

Avoiding Idle resources: An organization may sometimes possess excess resources. Although it is not a cost in itself, however it results in idle resources. Keeping resources idle means that the resources are not being used to its optimum levels and creates costs to the company.

Financial Discipline: Every day we hear of financial scams, fraudulent acts and misuse of funds for personal gain. Financial discipline includes incorporating financial controls to monitor and keep a check on the unproductive use of funds. Corporate social responsibility is gaining importance and businesses are expected to keep up its ethics and value systems high.

Growth and Development: Growth and development is a continuous process. Every business unit is expected to carry on its activities for an unexpected period of time in future. Therefore it invests its funds in the most profitable avenues and plans for expansion, growth and development activities while trying to keep pace with the changing environment of the market and consumer behavior.

Capital Budgeting: Capital budgeting is a required managerial tool. One duty of a financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives. To do this, a sound procedure to evaluate, compare, and select projects is needed. This procedure is called capital budgeting.

Managing Risks and Uncertainties: A business operates in an environment of risks and uncertainties. The task of a finance manager is to identify the risks and hedge those risks. Predicting risks and uncertainties and being prepared for the contingencies reflects sound business policies.

Functions performed by Financial Managers/ Scope of financial management:

1. Estimation of capital requirements: The primary function of a financial manager is to estimate the fund requirements. The estimation should be accurate bcos excess of funds can lead to idle resources and a shortage will affect the liquidity creditability and disrupt the smooth operations of the business. The estimation of funds for each business will depend upon the size , nature and risks associated with the business.

2. Determination of the capital structure: Once the estimation has been made, the capital structure has to be decided. This involves short- term and long-

term debt equity analysis. The proportion of Debt and Equity in the share capital needs to be decided upon. The capital structure is important is as the cost of capital can be managed by determining the capital structure.

3. Choice of sources of funds: For funds to be procured, a company has many choices like-

1. Issue of shares and debentures 2. Loans to be taken from banks and financial institutions 3. Public deposits to be drawn like in form of bonds.

4. Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is

possible. The choice of a viable business and most profitable investment proposal should be made in order to reap the highest return on Investments.

5. Disposal of surplus: The net profits decision has to be made by the finance manager. This can be done in two ways:

1. Dividend declaration - It includes identifying the rate of dividends to be paid to the shareholders.

2. Retained profits - A portion of the profits that is retained in the business in order for expansion, innovation, growth and development.

3. Reserves: A portion of the surplus is kept aside as reserves to serve as a cushion in times of emergencies.

6. Management of cash: Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials, etc. It affects the liquidity position of the company therefore cash management is important to maintain the creditability and liquidity position.

7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc. Cost control and minimizing wastages are important functions performed by the financial manager.

8. Financial Analysis and Interpretation: The analysis and interpretation of the financial performance of the business is done using several ratios to determine the liquidity, profitability and assets position of the business. The analysis of financial statements is important as it helps in taking important financial decisions and results in effective planning.

9. Capital Budgeting: Capital budgeting is the process of making investment

decisions in capital expenditure. The expenditure provides benefits over a period of time exceeding one year. Expenditure incurred for acquiring fixed assets is an example of capital expenditure. The planning of capital expenditure is crucial as it involves huge amount of funds and extends to longer periods of time.

10. Working Capital Management: Working capital refers to the capital required for day to day operations of the business. It is essential to have ideal working capital else it disrupts the smooth flow of operations in the business. Just as circulation of blood is essential to all parts of the body for life similarly working capital is required in the business for its survival and running of a business.

11. Dividend Policy: Dividend is the reward of the shareholders for investments made by them in the shares of the company. The investors of capital are interested in earning maximum return on their investments. The companies should decide what portion of the profits has to be distributed as dividends and what portion has to be retained in the business for expansion, growth and development activities.

12. Risk Management: Risk is inherent in any type of business activities. The risks may arise due to falling demand, competition or operational hiccups. The financial manager should be able to identify the risks associated with a business and should be able to set alternative plans in times of unexpected events.

13. Maintaining Liquidity: The liquidity position of a company suggests that a company is able to meet its obligations as and when it arises. The companies do not focus only on profitability but also make policies for maintaining its liquidity position in the market.

14. Credit Worthiness: Credit worthiness is an important trait of financially efficient companies who maintain good rapport with its clients and its customers. The organizations should build its creditability in the market as it improves the goodwill of the company.

IMPORTANT DECISONS TAKEN BY FINANCIAL MANAGERS:A number of decisions are taken by a financial manager concerning financial matters of the concern. There are many decisions that a financial manager takes and these decisions can be broadly classified as under: Investment Decisions Financing Decisions Dividend Decisions

A. Investment Decision (Capital Budgeting Decision):

This decision relates to careful selection of assets/projects/ business proposals in which funds will be invested by the firms. A firm has many options to invest their funds but firm has to select the most appropriate investment which will bring maximum benefit for the firm and deciding or selecting most appropriate proposal is investment decision. The firm invests its funds in acquiring fixed assets as well as current assets. When decision regarding fixed assets is taken it is also called capital

budgeting decision. Factors Affecting Investment/Capital Budgeting Decisions are as follows :

1.Cash inflows and cash outflows2.The most important criteria to decide the investment proposal is rate of return it will be able to bring back for the company in the form of income for, e.g., if project A is bringing 10% return and project В is bringing 15% return then we should prefer project B.3. The company must try to calculate the risk involved in every proposal and should prefer the investment proposal with moderate degree of risk only.4. The security aspects and growth opportunities5. The Payback period of the investment.

Investment decisions are considered very important decisions because of following reasons:

(i) They are long term decisions and therefore are irreversible; means once taken cannot be changed.

(ii) Involve huge amount of funds.

(iii) Affect the future earning capacity of the company.

B. Financing Decision:

The second important decision which finance manager has to take is deciding source of finance. A company can raise finance from various sources such as by issue of shares, debentures or by taking loan and advances. Deciding how much to raise from which source is concern of financing decision. Mainly sources of finance can be divided into two categories:

1. Owners fund.

2. Borrowed fund.

Share capital and retained earnings constitute owners’ fund and debentures, loans, bonds, etc. constitute borrowed fund. The main concern of finance manager is to decide how much to raise from owners’ fund and how much to raise from borrowed fund. While taking this decision the finance manager compares the costs and duration of different sources of finance. The borrowed funds have to be paid back and involve some degree of risk whereas in owners’ fund there is no fix commitment of repayment and there is no risk involved. But finance manager prefers a mix of both types. Factors Affecting Financing Decisions:

While taking financing decisions the finance manager keeps in mind the following factors:

1. The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.2. Finance manager compares the risk with the cost involved and prefers securities with moderate risk factor.3. With smooth and steady cash flow companies can easily afford borrowed fund securities but when companies have shortage of cash flow, then they must go for owner’s fund securities only.5. The cost involved in issue of securities such as broker’s commission, underwriters fees, expenses on prospectus, etc. Firm prefers securities which involve least floatation cost.6. If a company is having high fixed operating cost then they must prefer owner’s fund because due to high fixed operational cost, the company may not be able to pay interest on debt securities which can cause serious troubles for company.7. The conditions in capital market also help in deciding the type of securities to be raised. During boom period it is easy to sell equity shares as people are ready to take risk whereas during depression period there is more demand for debt securities in capital market.

 C. Dividend Decision:

This decision is concerned with distribution of surplus funds. The profit of the firm is distributed among various parties such as creditors, employees, debenture holders, shareholders, etc. Payment of interest to creditors, debenture holders, etc. is a fixed liability of the company, so what company or finance manager has to decide is what to do with the residual or left over profit of the company. The surplus profit is either distributed to equity shareholders in the form of dividend or kept aside in the form of retained earnings. Under dividend decision the finance manager decides how much to be distributed in the form of dividend and how much to keep aside as retained earnings. To take this decision finance manager keeps in mind the growth plans and investment opportunities. If more investment opportunities are available and company has growth plans then more is kept aside as retained earnings and less is given in the form of dividend, but if company wants to satisfy its shareholders and has less growth plans, then more is given in the form of dividend and less is kept aside as retained earnings. This decision is also called residual decision because it is concerned with distribution of residual or left over income. Generally new and upcoming companies keep aside more of retain earning and distribute fewer dividends whereas established companies prefer to give more dividend and keep aside less profit. Factors Affecting Dividend Decisions are as follows:

The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:

1. If there are more earnings then company declares high rate of dividend whereas during low earning period the rate of dividend is also low.2. Companies having stable or smooth earnings prefer to give high rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings.3.. Companies declare high rate of dividend only when they have surplus cash. In situation of shortage of cash companies declare no or very low dividend.4. The retained earnings are cheaper source of funds to the business as capital as they do not involve floatation cost and any legal formalities. If companies have no investment or growth plans then it would be better to distribute more in the form of dividend. Generally mature companies declare more dividends whereas growing companies keep aside more retained earnings.5. The expectation of the shareholders also determines the amount of dividend to be disbursed to the shareholders.

--------------------------------------------------------------------------------------------------------------------------------------------------------------------- Capitalization :

Capitalization is one of the most important constituents of financial plan. The term capitalization has been derived from the word capital and in common practice it refers to the total amount of capital employed in a business. Broadly speaking the term capitalization refers to the process of determining the plan of financing. It includes not merely the determination of the quantity of funds required by a company but also the decision of the capital structure. Therefore Capitalization involves the following:

Estimation of the capital requirements Determining the sources of funds

Determining the composition or proportion of the various securities to be issued

Capital and Capitalization:

They are two different terms. The term capital refers to the total investment of a company in money and tangible and intangible assets, It is the total wealth of a company. Although capital and capitalization are used interchangeably, capitalization refers to the par value of the securities that is shares or debentures plus the capitalized portion of profits and reserves appropriated for meeting contingencies or other needs of the company. The term capitalization should also be distinguished from Share capital which refers only to the paid up value of shares issued by a company but excludes bonds debentures and other forms of borrowings of a company.“ Capitalization is the sum of the par value of stocks and bonds outstanding” Guthman and Douglas

Thus Capitalization includes-

Share Capital Long term Debt Reserves and Surplus Short Term Debt

Capitalization is generally found to be of the following types-

Normal Capitalization Over Capitalization Under Capitalization

Overcapitalization

Overcapitalization is a situation in which its earnings are not sufficiently large enough to yield a fair return on the amount of stock and bonds that have been issued. It is the state of affairs where earnings of a company do not justify the amount of capital invested in the business. This situation arises when the company raises more capital than required. A part of capital always remains idle. With a result, the rate of return shows a declining trend. In simple terms it means more capital than what is actually required. Suppose a company earns Rs 5,00,000 and the normal rate of return is 10% then the capitalization at 10% would be Rs 50,00,000(500000*100/10). But suppose the capital employed is Rs 60,00,000 then we would say that the company is overcapitalized to the tune of Rs 10,00,000.The causes can be-

1. Over issue of capital: While floating a new company, the promoters estimate the financial requirements for a business and as a result, they raise more capital than what is actually required. Inability to estimate the capital requirements appropriately could also lead to over capitalization.

2. High promotion cost- When a company goes for high promotional expenditure, i.e., making contracts, canvassing, underwriting commission, drafting of documents, etc. and the actual returns are not adequate in proportion to high expenses, or the company is promoted during a period of inflation, the company is over-capitalized in such cases.

3. Purchase of assets at higher prices- When a company purchases assets at an inflated rate, the result is that the book value of assets is more than the actual returns. This situation gives rise to over-capitalization of company.

4. A company’s floatation in boom period- At times company has to secure it’s solvency and thereby float in boom periods. That is the time when the estimation of capital requirements is high to cope up with the boom period and increase economic gains. At times this may result in actual earnings lowering down and earnings per share declining.

5. Inadequate provision for depreciation- If the finance manager is unable to provide an adequate rate of depreciation, the result is that inadequate funds are

available when the assets have to be replaced or when they become obsolete. New assets have to be purchased at high prices which prove to be expensive.

6. Liberal dividend policy- When the directors of a company liberally divide the dividends to the shareholders, the result is inadequate retained profits which are essential for high earnings of the company. The result is deficiency in company. To fill up the deficiency, fresh capital is raised which proves to be a costlier affair and leaves the company to be over- capitalized.

7. Over-estimation of earnings- When the promoters of the company overestimate the earnings due to inadequate financial planning, the result is that company goes for borrowings which cannot be easily met and capital is not profitably invested. This results in consequent decrease in earnings per share.

8. High Rates of tax: High rates of tax result in lowering the profits. This will adversely affect the earnings of the business and thus lead to over capitalization.

9. Inadequate demand: If the company’s products and services register a decline, it will bring down the profitability of the firm and as a result the returns on capital employed will be low.

10. Higher costs: Higher costs will adversely affect the profitability of the company. One of the ways a company maximizes the profit is through cost control and minimizing the wastages.

=================================================================================================================

Effects of Overcapitalization

1. On Shareholders- The over capitalized companies have following disadvantages to shareholders:

1. Since the profitability decreases, the rate of earning of shareholders also decreases.

2. The market price of shares goes down because of low profitability. 3. The profitability going down has an effect on the shareholders. Their

earnings become uncertain and dividends are low. 4. With the decline in goodwill of the company, share prices decline. As a

result shares cannot be marketed in capital market.

2. On Company-

1. Because of low profitability, the company loses its reputation in the market.

2. The company’s shares cannot be easily marketed.

3. With the decline of earnings of company, goodwill of the company declines and the result is fresh borrowings are difficult to be made because of loss of credibility.

4. In order to retain the company’s image, the company indulges in malpractices like manipulation of accounts to show high earnings.

5. The company cuts down it’s expenditure on maintenance, replacement of assets, adequate depreciation, etc.

6. The company loses its creditability in the market.

3.On Public- An overcapitalized company has got many adverse effects on the public:

1. In order to cover up their earning capacity, the management indulges in tactics like increase in prices or decrease in quality.

2. Return on capital employed is low. This gives an impression to the public that their financial resources are not utilized properly.

3. Low earnings of the company affects the credibility of the company as the company is not able to pay it’s creditors on time.

4. It also has an effect on working conditions and payment of wages and salaries also lessen.

5. Prices charged are high 6. Can lead production of poor quality goods7. Tendency to cut down wages and welfare works for workers 8. Underutilization or misuse of resources

Undercapitalization

An undercapitalized company is one which incurs exceptionally high profits as compared to industry. It is the reverse phenomena of over capitalisation. An undercapitalized company situation arise when the earnings are exceptionally high in comparison to the capital employed in the business. The company then pays high dividend and the market value of its shares are much higher than its face value. The causes can be-

1. Under estimations: If the future capital requirements estimated for a company is quite low, then the company remains in a state of over capitalization coupled with a rise in the earnings of the business.

2. Under estimation of future earnings: While preparing the financial plan, if the future earnings of the business is under estimated, the company may realize that the actual profits are more than the estimates and this leads to a state of under capitalization.

3. Low promotion costs during Depression: Companies promoted during depression often experience undercapitalization when inflation sets in because of a rise in earnings.

4. Conservative dividend policy: If the payout ratio of the company is meager then the company is able to re invest its funds for generating higher profits and at times it may give rise to a situation of under capitalization.

5. High efficiency of directors: The high rate of return may directly be attributed to the efficient functioning and planning of the management.

6. Trading on equity: In many companies, the promoters desire to retain control over the company and raise less amount of share capital. When they require additional funds, they resort to trading on equity. This raising of funds at a lower rate of interest eventually leads to under capitalization.

Effects of Under Capitalization:

1. On Shareholders

1. Company’s profitability increases. As a result, rate of earnings go up. 2. Market value of share rises. 3. Financial reputation also increases. 4. Shareholders can expect a high dividend.

1. On company 1. With greater earnings, reputation becomes strong. 2. Higher rate of earnings attract competition in market. 3. Demand of workers may rise because of high profits. 4. The high profitability situation affects consumer interest as they think

that the company is overcharging on products. 2. On Society

1. With high earnings, high profitability, high market price of shares, there can be unhealthy speculation in stock market.

2. ‘Restlessness in general public is developed as they link high profits with high prices of product.

3. Secret reserves are maintained by the company which can result in paying lower taxes to government.

4. The general public inculcates high expectations of these companies as these companies can import innovations, high technology and thereby best quality of product.

The main disadvantages of under capitalization are as follows:

1. It leads to higher expectations of the shareholders in the form of dividends as the profits are seemingly high.

2. The marketability of shares increase. This may lead to issues like gambling and other fraudulent activities.

3. Pressing for higher wages can lead to a tiff between the workers and the shareholders giving rise to industrial unrest.

4. Burden of tax rises with increase in profits.5. Higher profits stimulate high risk activities and over trading in the midst of cut

throat competition.6. Ovr trading may be resorted to, with an aim to march towards aggressive gains.

TERMS DEFINED:

Over trading:

It means a situation where a company does more business than what its finances allow. It happens when a company expands its scale of operations with insufficient resources. Excessive trading than what its resources permit can lead to over trading. Over-trading arises only when the capital employed is inadequate in comparison with the volume of business. In other words, it is an expansion of sales without adequate support from capital. That is to say, the company with limited resources tries to increase the volume of business which, ultimately, suffers from acute shortage of liquid funds. Under this condition, the company does not maintain the adequate level of inventories and, as a result, it has to depend on regular supplies. On the other hand, payments of expenses (Wages, Salaries etc.) and Creditors including taxes cannot be made in time since there is a serious shortage of cash.

Under-Trading:

Under-trading is a condition contrary to over-trading.the funds of a company are not considered to be efficiently utilized due to inefficient management or due to the inability of the management for efficient utilization of resources. It may result in idle funds. .The consequences of under-trading are:

(a) Reduction in profits.(b) Reduction in the rates of return on capital employed.(c) Loss of Goodwill.(d) Fall in the prices of the shares in the market.

Sources of financeIntroduction Finance is defined as the provision of money at the time when it’s required any enterprise big or small requires capital long term or short term. In fact finance is so

indispensable today that it is rightly said that it is the life blood of an enterprise

Parameter for choosing sources of funds• Cost of source of fund.

• Tenure

• Leverage planned by the company.

• Financial condition prevalent in the economy.

• Risk profile of both the company as well as the industry in which the company operates.

Types of finances

Classification according to period is as follows:• Short term finance.

• Medium term finance.

• Long term finance.

Long term sources of funds Medium Term sources of funds

Short Term sources

SHARES DEBENTURES BANK CREDIT

DEBENTURES PREFERENCE SHARES CUSTOMER ADVANCES

BONDS BANL LOANS TRADE CREDIT

LONG TERM LOANS PUBLIC DEPOSITS FACTORING

PLOUGHING BACK OF PROFITS

BANK DEPOSITS ACCRUALS

MEDIUM TERM LOANS DEFERRED INCOMES

LEASE FINANCING COMMERCIAL PAPER

HIRE PURCHASE FINANCING

INSTALMENT CREDIT

LONG TERM SOURCES:

Long Term finance refers to those requirements of funds which are for a period exceeding 5-10 years.

Equity shares were earlier known as ordinary shares. The holders of these shares are the real owners of the company. They have a voting right in the meetings of holders of the company. They have a control over the working of the company. Equity shareholders are paid dividend after paying it to the preference shareholders.

The rate of dividend on these shares depends upon the profits of the company. They may be paid a higher rate of dividend or they may not get anything. These shareholders take more risk as compared to preference shareholders. k

Equity capital is paid after meeting all other claims including that of preference shareholders. They take risk both regarding dividend and return of capital. Equity share capital cannot be redeemed during the life time of the company.

Features of Equity Shares:

Equity shares have the following features:

(i) Equity share capital remains permanently with the company and cannot be redeemed during the life of the company. It is returned only when the company is wound up after meeting all other prior claims.

(ii) Equity shareholders have voting rights and elect the management of the company. They are the real owners of the company. The real control rests with the Directors of the company who are appointed by the equity shareholders of the company.

(iii) The rate of dividend on equity capital depends upon the availability of surplus funds. There is no fixed rate of dividend on equity capital.

(iv)Equity shareholders have a residual claim on the income of a company. They have a claim on income left after paying dividend to the Preference shareholders

(v)In case of further issue of capital, such shares must be first offered to the equity shareholders in proportion to the capital paid up on theses shares. Shares so offered to existing shareholders are called Right Shares and their prior rights are called pre-emptive right.

(vi) Their liability is limited to the value of the shares held by them. He cannot be held liable for any losses of the company even at the time of liquidation of the company, if the shares have been fully paid up.

Advantages of Equity Shares:

1. Equity shares do not create any obligation to pay a fixed rate of dividend.

2. Equity shares can be issued without creating any charge over the assets of the company.

3. It is a permanent source of capital and the company has to repay it except under liquidation.

4. Equity shareholders are the real owners of the company who have the voting rights.

5. In case of profits, equity shareholders are the real winners as they gain by way of increased dividends and appreciation in the value of shares.

Disadvantages of Equity Shares:

1. If only equity shares are issued, the company cannot take the advantage of trading on equity.

2. As equity capital cannot be redeemed, there is a danger of over capitalization.

3. Equity shareholders can put obstacles for management by manipulation and organizing themselves.

4. During prosperous periods higher dividends have to be paid leading to increase in the value of shares in the market and it leads to speculation.

5. Investors who desire to invest in safe securities with a fixed income have no attraction for such shares.

PREFERENCE SHARE CAPITAL: Preference shares are those shares which carry certain special or priority rights. Firstly, dividend at a fixed rate is payable on these shares before any dividend is paid on equity shares. Secondly, at the time of winding up of the company, capital is repaid to preference shareholders prior to the return of equity capital. Preference shares do not carry voting rights. However, holders of preference shares may claim voting rights if the dividends are not paid for two years or more on cumulative preference shares and three years or more on non-cumulative preference shares. Preference shares have the characteristics of both equity shares and debentures. Like equity shares, dividend on preference shares is payable only when there are profits and at the discretion of the Board of Directors. Preference shares are

similar to debentures in the sense that the rate of dividend is fixed and preference shareholders do not generally enjoy voting rights. Therefore, preference shares are a hybrid form of financing.

Therefore Preference shares are those, which enjoy the following two preferential rights:1. Dividend at a fixed rate or a fixed amount on these shares before any dividend on equity shares.2. Return of preference share capital before the return of equity share capital at the time of winding up of the company.

Types Of Preference SharesFollowing are the types of preference shares:1. Cumulative Preference SharesWhen unpaid dividends on preference shares are treated as arrears or in other words remain unpaid and are carried forward to subsequent years, then such preference shares are known as cumulative preference shares. It means unpaid dividend on such shares is accumulated till it is paid off in full.

2. Non-cumulative Preference SharesNon-cumulative preference shares are those types of preference shares, which have the right to a fixed rate of dividend out of the profits of current year only. They do not carry the right to receive arrears of dividend. If a company fails to pay dividend in a particular year then that need not to be paid out of future profits.

3. Redeemable Preference SharesThose preference shares, which can be redeemed or repaid after the expiry of a fixed period or after giving the prescribed notice as desired by the company, are known as redeemable preference shares. Terms of redemption are announced at the time of issue of such shares.

4. Non-redeemable Preference SharesThose preference shares, which cannot be redeemed during the life time of the company, are known as non-redeemable preference shares. The amount of such shares is paid at the time of liquidation of the company.

5. Participating Preference SharesThose preference shares, which have right to participate in any surplus profit of the company after paying the equity shareholders, in addition to the fixed rate of their

dividend, are called participating preference shares.

6. Non-participating Preference SharesPreference shares, which have no right to participate on the surplus profit or in any surplus on liquidation of the company, are called non-participating preference shares.

7. Convertible Preference SharesThose preference shares, which can be converted into equity shares at the option of the holders after a fixed period according to the terms and conditions of their issue, are known as convertible preference shares.

8. Non-convertible Preference SharesPreference shares, which are not convertible into equity shares, are called non-convertible preference shares.

Features of Preference Shares:

Preference share have the following features:

1. Preference shares are long-term source of finance. They resemble equity shares in respect of maturity. These are perpetual and the company is not required to repay the amount during the life time of the company.

2. The dividend payable on preference shares is generally higher than debenture interest. A fixed rate of dividend is paid on Preferences shares.

3. Preference shareholders get fixed rate of dividend irrespective of the volume of profit.

4. It is known as hybrid security because it also bears some characteristics of debentures.

5. Preference dividend is not tax deductible expenditure. It is an appropriation from profits

6. Preference shareholders do not have any voting rights and do not have any say in the management of the company.

7. Preference shareholders have the preferential right for repayment of capital in case of winding up of the company.

8. Preference shareholders also enjoy preferential right to receive dividend.

Advantages:

There are several benefits of a preference share from the point of view of a company which are discussed below:

No Legal Obligation for Dividend Payment: there arises no compulsion of payment of preference dividend because nonpayment of dividend does not amount to bankruptcy. This dividend is not a fixed liability like the interest on the debt which has to be paid in all circumstances.

Preference shares provide long term capital for the company.

The redemption of shares is done at the time of liquidation of the company.

Improves Borrowing Capacity: Preference shares become a part of net worth and therefore reduces debt to equity ratio. This is how the overall borrowing capacity of the company increases.

No dilution in control: Issue of preference share does not lead to dilution in control of existing equity shareholders because the voting rights are not attached to issue of preference share capital. The preference shareholders invest their capital with fixed dividend percentage but they do not get control rights with them.

No Charge on Assets: While taking a term loan security needs to be given to the financial institution in the form of primary security and collateral security. There are no such requirements and therefore the company gets the required money and the assets also remain free of any kind of charge on them.

DISADVANTAGES

Costly Source of Finance: Preference shares are considered a very costly source of finance which is apparently seen when they are compared with debt as a source of finance. The interest on debt is a tax deductible expense whereas the dividend of preference shares is paid out of the divisible profits of the company i.e. profit after taxes and all other expenses.

Cumulative Preference shares become a burden to the company as the dividend payable cumulates until paid off.

Skipping of dividend payment may not harm the company legally but it would always create a dent on the image of the company. While applying for some kind of debt or any other kind of finance, the company would lose its creditability in the market.

Preference shareholders enjoy similar situation like that of an equity shareholders but still gets a preference in both payment of their fixed dividend and claim on assets at the time of liquidation.

In some cases Preference shares carry voting rights and hence the control and management of the company may be diluted.

DEFERRED SHARES:These shares were earlier issued to promoters or founders of the company for services rendered to the company. These shares are known as founder shares because they are normally issued to founders. These shares rank last so far as dividend and repayment of capital is concerned. According to Companies Act, no public company or which is a subsidiary of a public company can issue deferred shares.

NO PAR STOCK/SHARES:

Share issued with no par value specified either on the share certificate or in the issuer firm's prospectus. When a company has no par value stock, there is effectively no minimum baseline from which to price the stock, so the price is instead determined by the amount that investors are willing to pay, based on their perceived value of the issuing entity; this may be based on a number of factors, such as cash flows, the competitiveness of the industry, and changes in technology. The advantages of issuing No Par value shares are as follows:It enables a company to depict its Balance Sheet depicting its true and correct positionThere is no need of capital reduction to reconstruct the Balance sheetMarketing of shares becomes easier.

SHARES WITH DIFFERENTIAL RIGHTS: The equity shares issued "with differential rights as to dividend, voting or

otherwise" would mean having rights different than the rights attached with the equity shares with voting rights. Such rights may be different in nature as regards dividend, as regards voting, or as regards "otherwise”. As per the Companies Act, 2013, when a Company issues equity shares with differential rights, they are required to adhere certain conditions.

The Companies (Share Capital and Debentures) Rules, 2014 lays down several conditions for a company to issue equity shares with differential voting rights. The Share with differential rights at any point of time shall not exceed 26% of the total post issue paid up equity share capital, including equity shares with differential rights issued.

SWEAT EQUITY:

Sweat equity shares” means such equity shares, which are issued by a Company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called. A company may issue sweat equity shares of a class of shares already issued if these conditions are met:

The issue of sweat equity shares should be authorized by a special resolution passed by the company in a general meeting The resolution should specify the number of shares, current market price, consideration, if any, and the section of directors /employees to whom they are to be issued As on the date of issue, a year should have elapsed since the company was entitled to commence business. The main purpose of issuing Sweat Equity Shares by a company is to retain the talent of the work-force.

DEBENTURES:In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Debentures are classified into various types. These are redeemable,  irredeemable, perpetual,  convertible, non convertible, fully, partly, secured, mortgage, unsecured, naked, first mortgaged, second mortgaged, bearer, fixed, floating rate, coupon rate, zero coupon,  secured premium notes, callable etc. Debentures are classified into different types based on their tenure, redemption, mode of redemption, convertibility, security, transferability, type of interest rate, coupon rate, etc. Following are the various types of debentures vis-a-vis their basis of classification.

Redeemable and Irredeemable (Perpetual) Debentures: Redeemable debentures carry a specific date of redemption on the certificate. The company is legally bound to repay the principal amount to the debenture holders on that date. On the other hand, irredeemable debentures, also known as perpetual debentures, do not carry any date of redemption. This means that there is no specific time of redemption of these debentures. They are redeemed either on the liquidation of the company or when the company chooses to pay them off to reduce their liability by issues a due notice to the debenture holders beforehand.

Convertible and Non Convertible Debentures: Convertible debenture holders have an option of converting their holdings into equity shares. The rate of conversion and the period after which the conversion will take effect are declared in the terms and conditions of the agreement of debentures at the time of issue. On the contrary, non convertible debentures are simple debentures with no such option of getting converted into equity. Their state will always remain of a debt and will not become equity at any point of time.

Fully and Partly Convertible Debentures: Convertible Debentures are further classified into two – Fully and Partly Convertible. Fully convertible debentures are completely converted into equity whereas the partly convertible debentures have two parts. Convertible part is converted into equity as per agreed rate of exchange based on agreement. Non convertible part becomes as good as redeemable debenture which is repaid after the expiry of the agreed period.

Secured (Mortgage) and Unsecured (Naked) Debentures: Debentures are secured in two ways. One when the debenture is secured by charge on some asset or set of assets which is known as secured or mortgage debenture and another when it is issued solely on the credibility of the issuer is known as naked or unsecured debenture. A trustee is appointed for holding the secured asset which is quite obvious as the title cannot be assigned to each and every debenture holder.

First Mortgaged and Second Mortgaged Debentures: Secured / Mortgaged debentures are further classified into two types – first and second mortgaged debentures. There is no restriction on issuing different types of debentures provided there is clarity on claims of those debenture holders on the profits and assets of the company at the time of liquidation. First mortgaged debentures have the first charge over the assets of the company whereas the second mortgage has the secondary

charge which means the realization from the assets will first fulfill obligation of first mortgage debentures and then will do for second ones.

Registered Unregistered Debentures (Bearer) Debenture: In the case of registered debentures, the name, address, and other holding details are registered with the issuing company and whenever such debenture is transferred by the holder; it has to be informed to the issuing company for updating in its records. Otherwise the interest and principal will go the previous holder because company will pay to the one who is registered. Whereas, the unregistered commonly known as bearer debenture. can be transferred by mere delivery to the new holder. They are considered as good as currency notes due to their easy transferability. The interest and principal is paid to the person who produces the coupons, which are attached to the debenture certificate. and the certificate respectively.

Fixed and Floating Rate Debentures: Fixed rate debentures have fixed interest rate over the life of the debentures. Contrarily, the floating rate debentures have floating rate of interest which is dependent on some benchmark rate say LIBOR etc.

Zero Coupon and Specific Rate Debentures: Zero coupon debentures do not carry any coupon rate or we can say that there is zero coupon rate. The debenture holder will not get any interest on these types of debentures. Need not to get surprised, for compensating against no interest, companies issue them at a discounted price which is very less compared to the face value of it. The implicit interest or benefit is the difference between the issue price and the face value of that debenture. These are also known as ‘Deep Discount Bonds’ .All other debentures with specified rate of interest are specific rate debentures which are just like a normal debenture.

Secured Premium Notes / Debentures: These are secured debentures which are redeemed at a premium over the face value of the debentures. They are similar to zero coupon bonds. The only difference is that the discount and premium. Zero coupon bonds are issued at discount and redeemed at par whereas the secured premium notes are issued at par and redeemed at premium.

Callable and Put Debentures / Bonds: Callable debentures have an option for the company to buyback and repay to the investors whereas in case of put debentures, the option lies with the investors. Put debenture holders can ask the company to redeem their debenture and ask for principal repayment.

Equity warrants: Warrant is a security that gives the warrant holder the right to purchase equity at a specific price, within a certain time frame. Without the warrants, the investor or lender would only receive the dividend yield or interest rate on his shares or loan, hardly compensating him for the risk of making the investment. This equity-kicker is what gets investors excited. Warrants are usually expressed as a

percentage of the "fully-diluted" common stock of the company, which then equates to a certain number of common equity shares.

Deep Discount Bonds: A deep discount bond is a type of bond that is sold at a much lower price than the par value. Since it is sold at a discount, its coupon rate is also considerably lower than the rates of fixed-income securities, even if their risk profiles happen to be similar. Usually, though, deep-discount bonds are seen to carry greater risk than similar bonds. On the other hand, these are usually long-term bonds which attract investors because there is a minimal risk that these will be called before the time of maturity. Deep discount bonds may sometimes be referred to as zero-coupon bonds.

Zero-coupon bonds, however, do not have coupons at all. This simply means that periodic interest payments are not available under the provisions of this type of bond. The compounded interest is paid in full at the time of maturity. In addition to this, the difference between the bond price and the redemption value is included in the computation. Zero-coupon bonds may either be long or short-term investments. Long-term bonds mature after ten to fifteen years, while short-term bonds mature in less than a year. Such short-term bonds are known as bills. U.S. Treasury bills and savings bonds are some examples of zero-coupon bonds.

Regular bonds, on the other hand, provide investors with regular income which comes in the form of coupon payments. Such payments are usually available on a semi-annual basis. The principal amount is then paid to the investor at the time of maturity.

Inflation Adjusted Bonds: These funds own Treasury Inflation Protected Securities—Treasury bonds and notes whose principal and coupon payments step up with the cost of living. That just about eliminates inflation risk. In other words these are the bonds on which both interest and principal are adjusted in line with the price level changes or the inflation rate.

Floating Rate Notes: Bond whose interest fluctuates in step with the market interest rates payable on the guilt edged securities.

Features of Debentures:

Debentures are offered to the public for subscription in the same way as for issue of equity shares. Debenture is issued under the common seal of the company acknowledging the receipt of money.

The important features of debentures are as follows:

1. Debenture holders are the creditors of the company carrying a fixed rate of interest.

2. Debenture is redeemed after a fixed period of time.

3. Debentures may be either secured or unsecured.

4. Interest payable on a debenture is a charge against profit and hence it is a tax deductible expenditure.

5. Debenture holders do not enjoy any voting right.

6. Interest on debenture is payable even if there is a loss.

Advantage of Debentures:

Following are some of the advantages of debentures:

(a) Issue of debenture does not result in dilution of interest of equity shareholders as they do not have right either to vote or take part in the management of the company.

(b) Interest on debenture is tax deductible expenditure and thus it saves income tax.

(c) Cost of debenture is relatively lower than preference shares and equity shares.

(d) Issue of debentures is advantageous during times of inflation.

(e) Interest on debenture is payable even if there is a loss, so debenture holders bear no risk.

Disadvantages of Debentures:

Following are the disadvantages of debentures:

(a) Payment of interest on debenture is obligatory and hence it becomes burden if the company incurs loss.

(b) Debentures are issued to trade on equity but too much dependence on debentures increases the financial risk of the company.

(c) Redemption of debenture involves a larger amount of cash outflow.

(d) During depression, the profit of the company goes on declining and it becomes difficult for the company to pay interest.

DIFFERENCE BETWEEN DEBENTURE AND SHARE

SHARES DEBENTURES

The holder of shares is called shareholders

The holder of Debenture is called Debenture holder

A share is a part of owned capital A part of debt capital

Dividend is paid to the shareholders Interest is paid to the Debenture holders

Dividend is an appropriation from Profits Interest is charged to Profit and Loss Account therefore there arises a tax benefit to the company

Shares are generally redeemed at the time of liquidation of the company

Debentures are redeemed at the time of maturity

Shares carry voting rights Do not carry any voting rights

Shareholders take part in the management and exercise control on the affairs of the company

Shareholders do not take part in the management and exercise control on the affairs of the company

At the time of winding up of the company shares rank last in priority of repayment

At the time of repayment Debentures are paid off in priority over Share capital

The shareholders take part in the surplus profits of the company

Debenture holders are entitled to a fixed rate of interest

Share are long term sources of funds for an organization

Debentures are a medium term source of funds for the business

RETAINED PROFITS OR PLOUGH BACK OF PROFITS:

Retained earnings is the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business, or to pay debt. It is recorded under shareholders' equity on the balance sheet. Profits generated by a company that are not distributed to stockholders (shareholders) as dividends but are either reinvested in the business. In other words, retained earnings represent the corporation's cumulative earnings that have not been distributed to its stockholders. Retained earnings are used to improve the company through investment in research and development, investment in plant and equipment, paying off debt, and serves as a

cushion to the company especially in times of crisis or when facing uncertainties. Such phenomena is also called Self Financing or Inter Financing. The need for Plough back of Profits arises due to the following reasons:

Profits can be reinvested in to the business as additional capital rather than increase the borrowings of the company.

For the expansion and growth of the business

For capital expenditure

For making the company financially sound and independent

For redemption of Loans and Debentures

For replacement of Assets that have become obsolete.

For contributing to the fixed capital and working capital needs of the company.

SHORT TERM LOANS AND ADVANCES:

INDIGENOUS BANKER: Indigenous bankers constitute the ancient banking system of India. They have been carrying on their age-old banking operations in different parts of the country under different names.In Chennai, these bankers are called Chettys ; in Northern India Sahukars, Mahajans and Khatnes; in Mumbai, Shroffs and Marwaris; and in Bengal, Seths and Banias. According to the Indian Central Banking Enquiry Committee, an indigenous banker or bank is defined as an individual or private firm which receives deposits, deals in hundies or engages itself in lending money. The indigenous banker is different from the moneylender. The moneylender is not a banker; his business is only to lend money from his own funds. The indigenous banker, on the other hand, lends and accepts funds from public

The indigenous bankers can be divided into three categories:

(a) Those who deal only in banking business (e.g., Multani bankers);

(b) Those who combine banking business with trade (e.g., Marwaris and Bengalies); and

(c) Those who deal mainly in trade and have limited banking business.

TRADE CREDIT: Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade credit facilitates the purchase of supplies

without immediate payment. Trade credit is offered by many suppliers to trade channel buyers to encourage more frequent and higher volume purchases. Smaller companies with limited cash on hand often rely on trade credit to make inventory purchases on a regular basis. Trade credit has benefits to both the buyer and seller. From the perspective of the creditor, or supplier, trade credit should induce more sales over time by allowing customers to make purchases without immediate cash. This flexibility in purchasing methods also encourages customers to make larger purchases when prices are right than they might if they had to pay cash up front. Along with higher sales volume, trade credit often produces interest fees and late payment fees for creditors, which increases revenue.

INSTALMENT CREDIT: Installment credit, also called Installment Plan, or Hire-purchase Plan,  in business, credit that is granted on condition of its repayment at regular intervals, or installments, over a specified period of time until paid in full. Installment credit is the means by which most durable goods such as automobiles and large home appliances are bought by individuals. Installment credit involves the extension of credit from a seller (and lender) to a purchaser; the purchaser gets physical possession and use of the goods he has bought, but the seller retains legal title to them until every installment has been paid. The purchaser usually is advanced the goods after making an initial fractional payment called a down payment. If the purchaser defaults on his payments at some point, all previous payments are forfeited to the seller, who may also take possession of the goods.

The appeal of installment buying is that it allows prospective purchasers to enjoy the advantages of owning a relatively expensive good while paying for it gradually out of their future income, instead of having to save the necessary purchase price out of their income first. Installment credit can thus greatly expand the purchasing power of ordinary consumers. Installment credit for the purchase of durable consumer goods first appeared in the furniture industry of the United States in the 19th century. But such credit arrangements only acquired great economic importance around the time of World War I, when they were adopted in the United States on a wide scale in the purchase of automobiles. Installment credit now accounts for the majority of purchases of automobiles, expensive home appliances, and furniture, among other consumer goods.

SHORT TERM ADVANCES: Customer Advances represents advances received from customers, for goods or services expected to be delivered within the following fiscal year. Advances from customers are commonplace in the airline, magazine or newspaper industries, whereby the customer usually pays for a seat on a plane, or a magazine subscription, prior to receiving the publications or flying on the airplane.  Gift certificates, also known as gift cards, are another common arrangement that involves the collection of money in advance of providing a product or service. Advances from customers are commonplace in the airline, magazine or newspaper industries, whereby the customer usually pays for a seat on a plane, or a magazine

subscription, prior to receiving the publications or flying on the airplane. It is a cheaper source of finance.

FACTORING: Cash flow is central to the success of every business. As a business grows and needs to speed up cash flows, small businesses typically first turn to banks for financing. However, with tough credit standards banks cannot always fully accommodate a company’s financing needs. Alternative financing options, such as accounts receivable factoring, may provide the working capital the business needs. Accounts receivable factoring is financing that comes from a business selling its accounts receivable to a factoring company or bank. The amount available generally depends upon the invoice volume. Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs. In invoice factoring, the factor provides financing to the seller of the accounts in the form of a cash “advance,” often 70-80% of the invoice face values, with the balance of the purchase price being paid, net of the factor’s discount fee (commission) and other charges, upon collection.

ACCRUED EXPENSE: Accrued expenses are expenses which have been incurred but not yet due and hence not yet paid also. They represent a liability that a firm has to pay for the services already received by it. The most important accruals are Wages and salaries, interest and taxes. An accrued expense refers to any expense incurred and reported during an accounting period, but for which payment has not yet been made. There are certain expenses which a company may incur over the course of an accounting period (usually a quarter), but which may not actually be paid until a later time. Such expenses are accounted for as short-term liabilities on a company's balance sheet and may include utilities, wages and salaries, rents, and periodic interest on outstanding loans..Though they are not yet paid, accrued expenses are reflected on the balance sheet for the period during which they are incurred. This is because they were accrued by a company's revenue-generating operations during a given period. Such accruals serve as a short term source of funds to the organization as the amount unpaid on such accruals is available with the company till such time it gets paid.

DEFERRED INCOMES: Deferred revenue is a payment from a customer for either services that have not yet been performed or goods that have not yet been shipped. The seller records this payment as a liability. Deferred revenue is common among software providers, who require up-front payments in exchange for service periods that may last for many months. The deferred revenue account is normally classified as a current liability on the balance sheet. It can be classified as a long-term liability if performance is not expected within the next 12 months. In other words, deferred incomes are incomes received in advance for which it has to supply goods or services.

Firms having great demand for its products and services and those companies having good reputation in the market can demand deferred incomes.

COMMERCIAL PAPER: It is an unsecured short-term instrument issued by a company for financing of accounts receivables, inventories and meeting short-term liabilities. It is a negotiable instrument. It is an unsecured instrument as it is not backed by any assets of the company. It can be sold by the issuing company, directly to the investors. In deposit terminology, the term Commercial Paper refers to an unregulated promissory note of short duration that is usually not secured by assets. Commercial Paper generally has a fixed maturity that might typically range from one to 270 days in length. In deposit terminology, the term Commercial Paper refers to an unregulated promissory note of short duration that is usually not secured by assets. Commercial Paper generally has a fixed maturity that might typically range from one to 270 days in length. Commercial paper is issued at discount to face value by well known companies that are financially strong and enjoy a high credit rating. However use of commercial paper is limited to only blue chip companies and from the point of view of investors though commercial paper provides higher returns for him they are unsecured and hence investor should invest in commercial paper according to his risk -return profile.

LETTER OF CREDIT: A letter of credit is a bank's written promise that it will make a customer's (the holder) payment to a VENDOR (called the beneficiary) if the customer does not. Letters of credit are most common in international transactions, where buyers and sellers may not know each other well or laws and conventions may make certain transactions difficult. For example, let's assume that Company XYZ sells widgets in Alabama and Company ABC manufactures widgets in Lithuania. Company XYZ wants to import $100,000 worth of widgets manufactured by Company ABC, but Company ABC is concerned about XYZ's ability to pay for them. To address this, Company XYZ gets a letter of credit from its bank, Bank of Alabama, indicating that Company XYZ will make good on the $100,000 payment in, say, 60 days, or Bank of Alabama will pay the bill itself. Bank of Alabama then sends the letter of credit to Company ABC, which then agrees to ship the widgets. After the shipment goes out, Company ABC (or Company ABC's bank) then asks for its $100,000 by presenting a written draft (also called a bill of exchange) to Bank of Alabama. Although letters of credit mostly benefit sellers, they also protect buyers, because Company ABC must present Bank of Alabama with written proof of the widget shipment in order to get paid. This proof usually includes a commercial invoice, bill of lading, or an airway bill. After Bank of Alabama pays Company ABC, it turns to Company XYZ for reimbursement (usually by debiting Company XYZ's bank account).Banks usually require a pledge of securities or cash collateral in order to issue a letter of credit to a holder. Banks also collect a fee for issuing letters of credit; the fee is usually a percentage of the size of the letter of credit.

PUBLIC DEPOSITS: Public deposits are an important source of financing the medium-term and long-term requirements of a company. The term 'public deposit' implies any money received by a company through the deposits or loans collected from the public. The public includes the general public, employees and shareholders of the company but excludes the money received in the form of shares and debentures. In India, this method of raising finance has gained a lot of importance because of the several advantages relating to public deposits. The public deposits are generally solicited by the firms in order to finance the working capital requirements of the firm. The companies offer interest to the investors over public deposits. The rate of interest, however, varies with the time period of the public deposits. The companies generally offer 8 to 9 percent interest rate on the deposits made for one year. The companies offer 9 to 10 percent interest rate over public deposits for two years while 10 to 11 percent interest rate is offered for the three year deposits. There are rules regulating the fixed deposits. The public deposits are regulated by the provisions of the Companies Act and the Companies (Acceptance of Deposit) Rules,1975.

TERM LOANS: A loan scheduled to be repaid in less than a year . When your business doesn't qualify for a line of credit from a bank, you might still have success in obtaining money from then in the form of a one-time, short-term loan (less than a year) to finance your temporary working capital needs. The major advantage of a term loan is that it is for a fixed period. It is granted on a formal agreement between the lender and the borrower. Term loans do not cause dilution of interest unlike share capital as no rights are vested on the Lending Company. Business houses require short term loans from time to time to meet their needs and Term loan is one such loan that offers them the convenience of acquiring short term funds with a periodical interest payment liability. This helps the business in ensuring a smooth flow of operations and maintains liquidity.

Some terms defined:

VENTURE CAPITAL: Venture capital (VC) is money provided to seed early-stage, emerging and emerging growth companies. Venture capital funds invest in companies in exchange for equity in the companies they invest in, which usually have a novel technology or business model in high technology industries, such as biotechnology and IT. Money provided by investors to startup firms and small businesses with perceived long-term growth potential. This is a very important source of funding for startups that do not have access to capital markets. Venture Capital is a form of "risk capital". In other words, capital that is invested in a business where there is a substantial element of risk relating to the future creation of profits and cash flows. Risk capital is invested as shares (equity) rather than as a loan and the investor requires a higher "rate of return" to compensate him for his risk. Venture Capital provides long-term, committed share capital, to help unquoted companies grow and succeed. If an entrepreneur is looking to start-up, expand, buy-into a business, buy-out

a business in which he works, turnaround or revitalize a company, venture capital could help do this.

SEED CAPITAL: Some capitals required to start a business. Seed capital often comes from the company founders' personal assets or from friends and family. The amount of money is usually relatively small because the business is still in the idea or conceptual stage. Seed money, sometimes known as seed funding or seed capital, is a form of securities offering in which an investor invests capital in exchange for an equity stake in the company. Seed capital is provided during the earliest stage of the company's formation, during the period of time when the company is involved a variety of early operations such as market research, product development, or prototype production.  During this early stage of investment, the company typically does not have revenues, or at least revenues that lead the company to be breakeven.

BRIDGE FINANCE:A bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing. It is usually called a bridging loan in the United Kingdom, also known as a "caveat loan," and also known in some applications as a swing loan. In investment banking terms, it is a method of financing used by companies before their IPO, to obtain necessary cash for the maintenance of operations. Bridge financing is designed to cover expenses associated with the IPO and is typically short-term in nature. A short-term loan that is used until a person or company secures permanent financing or removes an existing obligation.

LEASE FINANCING: Lease financing is one of the important sources of medium- and long-term financing where the owner of an asset gives another person, the right to use that asset against periodical payments. The owner of the asset is known as lessor and the user is called lessee. The periodical payment made by the lessee to the lessor is known as lease rental. Under lease financing, lessee is given the right to use the asset but the ownership lies with the lessor and at the end of the lease contract, the asset is returned to the lessor or an option is given to the lessee either to purchase the asset or to renew the lease agreement.

FINANCIAL MARKETS:

A financial market is a broad term describing any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Securities include stocks and bonds, and commodities include precious metals or agricultural products. In India, the financial markets can be divided into two markets. What Are the Various Types of Financial Markets in India? The capital markets and the debt markets. Apart from this there are also the forex markets.

Money Market: Money Market is a market that largely deals in various kinds of debt instruments. These debt instruments are largely short term in nature, which could also be for less than a year. This could include dealing in instruments of government dated securities and treasury bills. Apart from this it could also mean dealing in commercial paper more popularly known as CP, bankers’ acceptance, certificates of deposits, etc. Capital Markets: The Capital Market also deals in debt, but, more in the long term type. Apart from this the bulwark of the capital market remains the equity segment. In the capital market the players are both large and small sized individuals. Apart from individuals one would also include financial institutions, foreign institutional investors, non resident Indians etc. The capital market can also be divided into primary market and secondary market. In the primary market one deal with an initial public offering or IPO, this is the first time that a company issues shares. The secondary market is as the name suggests, stocks are traded after an initial public offering. The Securities and Exchange Board of India or SEBI regulates the capital markets in India. It ensures that all guidelines are in compliance with the SEBI Laws and Regulations. The types of instruments traded on the capital markets include shares issued through an IPO, rights shares, cumulative preference shares, government securities, debentures and bonds, commercial paper and treasury bills more popularly known as T-Bills.

A well-developed money market is essential for a modern economy. Though, historically, money market has developed as a result of industrial and commercial progress, it also has important role to play in the process of industrialization and economic development of a country. Importance of a developed money market and its various functions are discussed below:

1. Financing Trade: Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.

2. Financing Industry: Money market contributes to the growth of industries in two ways:

(a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc.

(b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.

3. Profitable Investment: Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity.

4. Self-Sufficiency of Commercial Bank: Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market.

5. Help to Central Bank: Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank.

Money market helps the central bank in two ways:

(a) The short-run interest rates of the money market serves as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy,

(b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy.

The basic function of money market is to facilitate adjustment of liquidity position of commercial banks, business corporations and other non bank financial institutions.

It provides outlets to commercial banks, business corporations, non bank financial concerns and other investors for their short term surplus funds.

Constituents of money market: Money market is not a homogeneous market. It is composed of heterogeneous sub-markets, each specializing in a specific short- term credit instrument. The following are the important constituents of money market:

1. Call Money Market:

The call money market deals with very short-period or call loans. Bill brokers and dealers in the stock exchange generally borrow money at call from the commercial banks.

These loans are granted for a very short period, not exceeding seven days in any case. The borrowers have to repay the loans immediately whenever the banks call them back. No collateral securities are required against these loans.

2. Collateral Loan Market:

Collateral loan market refers to a market for loans secured against collateral securities like stocks and bonds. The collateral is returned to the borrower at the time when he repays the loan. In case the borrower fails to repay the loan, the collateral becomes the property of the lender.

Collateral loans are mostly granted by the commercial banks to private parties in the market and for a short period of a few months. Sometimes smaller banks also receive collateral loans from bigger banks.

3. Acceptance Market:

Acceptance market is a market for bankers’ acceptances. A banker's acceptance is a draft drawn by a business firm upon a bank and accepted by it whereby the bank is required to pay to the order of a specific party or to the bearer a specific sum of money at a specific future date.Bankers’ acceptances are used mostly in financing the commercial transactions both within and outside the country. The banker's acceptance is different from a cheque, in that while the former is payable at a specified future date, the letter is payable on demand. Bankers’ acceptance can be easily sold or discounted in the money market, called acceptance market.

4. Bill Market:

Bill market specializes in the sale and purchase of different types of short-term papers or bills. The important types of bills are: (a) bills of exchange and (b) Treasury bills. Since discounting of bills is the main business in the bill market, it is also known as discount market.It should be noted that the bill market does not deal with long-term treasury bonds and other long-term papers which involve long-term lending,

(i) Bill of exchange:

The bill of exchange is a written unconditional order signed by the drawer (seller) requiring the drawee (buyer) to pay on demand or at a fixed future date a definite sum of money. After the bill has been drawn by the drawer (seller), it is accepted by the drawee (buyer).Once the buyer puts his acceptance on the bill, it becomes a legal document. Such bills of exchange are discounted and re-discounted by the

commercial banks for lending credit to the bill brokers or for borrowing from the central banks.

(ii) Treasury Bills:

While the bill of exchange is a commercial paper, the Treasury bill is government paper. The treasury bills are short-term government securities generally of three months' duration. They are sold by the central bank on behalf of the government. They bear no interest rate and are offered on the basis of competitive bidding. Thus those who are satisfied with the lowest interest rate will be allotted the bills. Treasury bills, being government papers, inspire greater confidence among the investors.

CAPITAL MARKETS: Capital market is a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. Capital market is a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals and institutions. Capital markets help channelize surplus funds from savers to institutions which then invest them into productive use. Generally, this market trades mostly in long-term securities. Capital market consists of primary markets and secondary markets. Primary markets deal with trade of new issues of stocks and other securities, whereas secondary market deals with the exchange of existing or previously-issued securities. Another important division in the capital market is made on the basis of the nature of security traded, i.e. stock market and bond market. Capital market plays an important role in mobilizing resources, and diverting them in productive channels. In this way, it facilitates and promotes the process of economic growth in the country.

Various functions and significance of capital market are discussed below:

1. Link between Savers and Investors:

The capital market functions as a link between savers and investors. It plays an important role in mobilizing the savings and diverting them in productive investment. In this way, capital market plays a vital role in transferring the financial resources from surplus and wasteful areas to deficit and productive areas, thus increasing the productivity and prosperity of the country.

2. Encouragement to Saving:

With the development of capital, market, the banking and non-banking institutions provide facilities, which encourage people to save more. In the less- developed countries, in the absence of a capital market, there are very little savings and those who save often invest their savings in unproductive and wasteful directions, i.e., in real estate (like land, gold, and jewellery) and conspicuous consumption.

3. Encouragement to Investment:

The capital market facilitates lending to the businessmen and the government and thus encourages investment. It provides facilities through banks and nonbank financial institutions. Various financial assets, e.g., shares, securities, bonds, etc., induce savers to lend to the government or invest in industry. With the development of financial institutions, capital becomes more mobile, interest rate falls and investment increases.

4. Promotes Economic Growth:

The capital market not only reflects the general condition of the economy, but also smoothens and accelerates the process of economic growth. Various institutions of the capital market, like nonbank financial intermediaries, allocate the resources rationally in accordance with the development needs of the country. The proper allocation of resources results in the expansion of trade and industry in both public and private sectors, thus promoting balanced economic growth in the country.

5. Stability in Security Prices:

The capital market tends to stabilize the values of stocks and securities and reduce the fluctuations in the prices to the minimum. The process of stabilization is facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative and unproductive activities.

6. Benefits to Investors:

The credit market helps the investors, i.e., those who have funds to invest in long-term financial assets, in many ways:

(a) It brings together the buyers and sellers of securities and thus ensures the marketability of investments,

(b) By advertising security prices, the Stock Exchange enables the investors to keep track of their investments and channelize them into most profitable lines,

(c) It safeguards the interests of the investors by compensating them from the Stock Exchange Compensating Fund in the event of fraud and default.