• Introduction:

Entrepreneurs- Corporates require funds for implementing new projects or undertaking expansion, diversification, modernization and rehabilitation scheme. Ascertaining the cost of project and the means of finance has become a very important consideration for the same. For the requirement of funds a variety of financial instruments are available in the domestic and global capital markets which are most suitable to a project in terms of flexibility in drawing fund and making payments.
The three major factors that determine the capital structure of a particular business are a proper balance of risk, cost of capital and control considerations. An effective analytical mechanism for various sources of funds available must be instituted to achieve its main objectives. Such a mechanism is required to evaluate risk, tenure and cost of each and every source of fund. The selection of source of fund is dependent on the financial strategy and the leverage planned by the Company, the financial conditions prevalent in the economy and the risk profile of both the Company as well as the industry in which the Company operates. Each and every source of fund has advantages as well as disadvantages.
With the Indian economy moving on to a high growth trajectory, consumption levels soaring and investment riding high, the Indian banking sector is at a watershed. Further, as Indian companies globalize and people of Indian origin increase their investment in India, several Indian banks are pursuing global strategies. The industry has been growing faster than the real economy, resulting in the ratio of assets of commercial banks to GDP increasing.
Today, in India there are many categories of banks viz. Nationalized Banks, Foreign Banks, Private Banks, Co-operative Banks and Financial Institutions providing financial assistance with many options for the business activities. Currently financial assistance is easily available at very competitive rates due to competition amongst banks. The trend has changed from sellers market to buyers market resulting in borrower having choice to select banks based on the terms offered by different types of banks.
  • Sources Of Finance:

The company can raise finance/ funds from a variety of sources that can be classified in different ways depending on its nature, tenure, time, etc. They may be as follows: -


A basic principle is that short-term financial needs should be met from short-term sources, medium term financial needs from medium term sources and long-term financial needs from long-term sources. Moreover a proper balance between loan funds and own funds has to be maintained. Sources of Finance on the basis of time can be classified as follows:

In addition to the aforesaid traditional source of finance, there are various avenues available to raise long-term finance like Venture Capital Finance, Private Equity and International Financing.
  • Venture Capital Financing V/s Private Equity Funding:

Feature
VCF
PEF
Investment Target
  • Early state businesses, expansion
  • Innovative products, Services, technologies
  • Heavily dependent on external financing
  • Unlisted companies
  • Later stage businesses, involves operational or financial restructuring, with or without management team and/or ownership changes
  • Mature products, services
  • Generally have large cash flows
  • May be listed or unlisted
Horizon
Medium to long term: 3 -8 years Medium : 2-5 years
Risks
May be one or more of technology, product development, market response to product/service, management, operational and illiquidity of investment Usually limited to product-market risks and does not involve the other elements listed in the case of VC
Structure

  • Equity or equity-type instruments such as convertible debt or preference shares
  • Syndication of investment, if any, among fellow VCs
  • Equity and debt combinations. Debt is usually high risk, of speculative grade.
  • Syndicate may include institutions such as insurance companies and banks, who are primarily lenders.
Post financing Engagement
Active as it encompasses board composition, top management team recruitment, strategy formulation and internal systems processes and controls Active, but less than their VC counterparts. Involvement mainly limited to ensuring high quality governance.
Investment Management Team
Former managers and entrepreneurs with tremendous experience and vast, powerful networks in professional and industrial circles, primarily keeping in mind the post financing engagement needs Primarily, former financial market professionals.
Prevalence
Largely in the US and to some extent in the UK, Canada, Singapore, Israel and Japan. What goes on in the name of VC elsewhere in the world is largely PE. Started as VC in India, evolved into distinct activities from late 90s. Prevalent in the US, Continental Europe, Asia Pacific, Japan and many emerging markets.
  • International Financing:

Thanks to the globalization of capital markets, Indian Firms can raise capital from Euromarkets or domestic markets of various countries or export credit agencies. Euro Issues, Global Depository Receipts (GDR), American Depository Receipts (ADR) and Foreign Currency Convertible Bonds (FCCB) are more popular in India.

  1. Euro Issues:

Euro Issues are listed on a European Stock Exchange.

  1. Euro Convertible Bonds:

A Convertible bond is a debt instrument, which carry a fixed rate of interest and gives the holders of the bond an option to convert the same into predetermined number of equity shares of the company. Such bonds may carry 2 options viz.
- Call Option (Issuer’s Option)
- Put Option (Holder’s Option)

  1. Global Depository Receipts (GDR):

GDR is negotiable certificate denominated in US dollar that represents a non-US company’s publicly traded in local currency equity shares.

  1. American Depository Receipts (ADR):

Depository receipt issued by a company in the USA is known as ADRs. Such receipts have to be issued in accordance with the provision of Security and Exchange Commission of USA.

  1. Foreign Currency Convertible Bonds (FCCB):

FCCB means bonds issued in accordance with a scheme and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments.


Presently, in addition to traditional products viz. Term Loans, Cash Credit & Overdraft Facilities etc. various types of products are available in market for financing each stage of business activity. A prudent financial manager is one who can take advantage of the products to minimize the cost of borrowing for the corporate. Sources other than the Traditional Lending


Sr. No.
Type of the Product
Purpose/
Meaning
Eligibility
Cost
Security Tenure
(A)
Bridge Loans/ Short-term Loans To meet temporary cash flow mismatches Corporate with good credit rating Available at MIBOR / LIBOR Current Assets Matching with Cash Flows
(B)
Commercial Paper Short-term borrowing Denomination of CP Note - Rs. 5 Lacs or multiples thereof Highly rated corporate having minimum net worth of Rs. 4.00 crores & Credit rating of P2 or equivalent of credit rating agencies approved by RBI, Primary Dealers, Satellite Dealers & FIs Sub-PLR depending on rating Unsecured 7 days to 1 year
(C)
Factoring Outright sales of the receivables of a firm to another agency specializing in the management of trade credit called the factor Corporate having large numbers of debtors Nominal service charges compensated by saving in managing receivables in-house Receivables Continuous process
(D)
Forfaiting Discounting export receivables Exporters Fixed rate basis discount Bills of Exchange Medium to long -term maturities
(E)
Securitization of Future Receivables Discounting certain or near certain cash flows Continuity of specific business and borrowers’ ability to perform consistently Sub-PLR depending on rating Quality of receivables Continuous process
(F)
Sales Bill Discounting To finance sales receivables Any Lower than CC/ WC Limit Bills of Exchange 90 days to 180 days
(G)
Supplier Bill Discounting Financing of receivables due from govt. Suppliers to Government corporations and govt. depts. Lower than CC/ WC Limit depending oncomfort Bills of Exchange, Power of Attorney registered with the govt. dept. Normally 90 to 180 days
(H)
Invoice Financing To facilitate direct collection of receivables Regular suppliers of reputed Corporate Lower than CC/ WC Limit Assignment of receivables in
favour of financing
banks
Normally 90 to 180 days
(I)
Export Finance Pre Shipment Finance Exporters who holds Export order or letter of credit in his own name. Concessional rates depends on credit rating subject to maximum rate of PLR minus 2.5 % Export orders Normally 90 to 180 days

Post Shipment Finance -Do- -Do- Export bills Normally 90 to 180 days
(J)
Channel Financing Purchase bill discounting wherein Bills of exchange
(BoE) rose by a Corporate on its distributors is discounted by the Bank & proceeds are directly paid to the seller (Corporate).
Distributors who purchases goods from reputed corporate Sub-PLR depending on rating Bill of Exchange, Post dated cheque (PDC),Invoice & Transport proof Continuous process
(K)
Cash Management Products Cheque collections deposited in banks are credited on the date of deposit or prior to the date of clearing as per the arrangement with the bank. This is done at a nominal fee for the service provided but it improves the cash flows considerably when collections against sales are spread over remote locations.
(L)
External Commercial Borrowings (ECBs) For investment in real/ industrial sector and infrastructure Corporate registered under the Companies Act except financial intermediaries (such as banks, financial institutions (FIs),housing finance companies and NBFCs) Maximum LIBOR plus 300 basis points for 3 to 5 years Choice of security to be provided to the lender/supplier is left to the borrower

More than 3 years

Maximum LIBOR plus 500 basis points More than 5 years
(M)
FCNR-B Loans Loans against FCNR Deposits (Foreign
Currency)
Generally to Corporate who have natural hedge due to exports LIBOR + Fixed/Current Assets








The above-mentioned products are mainly to meet the shortfall in working capital and working capital requirements of the business and are offered by Nationalized Banks, Private Banks and Foreign Banks. The SIDCs (State Industrial Development Corporations) and large Co-operative banks have also joined the bandwagon for providing structured products to the Corporate.
Banks are offering interest rates on financial assistance based on the credit rating of the individual borrowers. Credit rating is assessed based on the scoring system, which differ from bank to bank. All banks have their own credit rating system and considering the various parameters pertaining to risks attached like financial, business, management risk etc, assesses the same.
Generally, following parameters are considered while assessing the credit rating:

Sr. No.
Parameter
Acceptable Level
A.
Financial Risk:
Current Ratio 1.33:1
TOL/TNW (Total Outside Liabilities / Tangible Net Worth) Not more than 3:1
Debt/ Equity Ratio 1.50:1 to 2:1 sometime 3:1 depends on the nature of the project.
PAT/Net Sales (%) In excess of 5%
PBDIT/Interest There is no such level, more than 2.5 times will be satisfactory
Trends in Performance Upward Trend
Gross Average DSCR Minimum 1.75 to 2.00
Achievement in Projected Profitability Achievement of 80% - 90% is considered satisfactory
Collateral Security / Financial Standing Tangible Security – 0% to 25% of the banking facility
B.
Business Risk:
Technology Technology should be competent to beat the competition.
Capacity Utilization vs. Break Even Point Capacity Utilization should be 25% - 30% above the BEP
User / Product Profile Products should be well accepted by the users & should beat competition.
Consistency in Quality Quality should be consistent
Distribution Network Wide & Adequate Distribution channel
Consistency of Cash Flows Cash Flows should be consistent
C.
Industry Risk:

Under this broad parameter, various parameters are considered like facing of competition, Industry Outlook, Regulatory Risk and other important factors which need to be considered to evaluate the Risk.
D.
Management Risk:

Many factors are considered while evaluating management risk. Some of the factors are Integrity/Corporate Governance, track record, payment record, Managerial competence/commitment, expertise, structure & system, Experience in Industry, credibility, Strategic initiatives, length of relationship etc. considered while evaluating management risk.
E.
Qualitative Factors: Negative Parameter:

Factors like Contingent Liabilities, Auditors Qualifications, Accounting Policies as regards to Depreciation, inventory etc. are considered.
F.
Quantitative – Industry Comparison:

Borrower’s financial ratios should be compared with the standard industry norms to evaluate the risk.
There are several instances wherein a corporate may not be able to achieve the desired rating due to weightage given by Bank to certain parameters, which may reduce the scoring of the corporate. Despite this a fundamentally strong corporate can avail a pricing on the products much below the rating which however will depend on the negotiating skills of the corporate. An effective negotiation can be achieved through cultivation and nurturing of good banking relationship, understanding of theory and practices of term lending, timely repayments, planning and agreeing to the covenants. Though each bank/institution rates the corporate as per their rating parameter, but due to competition it still succumbs to the demands of the corporate for finer pricing. Though each bank/institution have set their PLR / Base Rate as a benchmark, in today’s scenario the same is irrelevant since most of the banks/institutions find it a deterrent for lending. Most of the banks have already started lending much below the PLR, which is more out of compulsion.
  • Base Rate introduction

The Reserve Bank of India introduced the new lending rate system called BASE RATE with effect from 1st July 2010. This system is applicable to all the scheduled commercial banks. The base rate system has replaced the existing lending rate system called BPLR (Benchmark Prime Lending Rate).
Base is defined as the minimum rate of interest a bank can charge on any of its loan. No loan can be sanctioned below the base rate decided by the bank, except few loans specifically excluded as notified by the RBI.
Prior to this all lending rates were pegged to a Bank's Prime Lending Rate or PLR. The banks were charging the customers an interest rate which was either above PLR or below PLR, thus PLR serving as an anchor rate. Base Rate has introduction has not only replaced the PLR as a benchmark rate but has also become the new floor rate below which no bank can lend. The current Base Rate of various banks is in the range of 9%~10%
Introduction of the base rate system in India’s banking system has enhanced competition in the short-term lending space. Issuance volumes in the debt capital markets are also increasing as the highly rated corporates are shifting towards these markets. However, competitive pressures are unlikely to impact the overall profitability of the banking system materially. The base rate system is enabling banks to respond more efficiently to monetary policy measures.