Business capital is basically just money
that is used for investing into projects or a business. Business capital is
extremely important for any business and ultimately will determine a businesses
success. If your business has easy access to business capital then you
have a serious advantage over your competitor. One of the great ways to get
capital for your business is through loans and financing. Any business owner
can tell you, the way to get approved for a loan is usually through the path of
assets and more importantly, building
business credit. Without assets or great business credit you basically stand no
chance of getting a business capital loan. Business capital is also known as
financial capital.
There are 2 markets which are considered important for
raising funds.
1].Capital market:- funds can be raised from long term
securities like shares, debentures, mutual funds, venture capital etc.
2].Money market:- funds can be raised for short term from
the sources like Bills receivbles.
I would like to explain the various sources briefly under
the heads of long term and short term.
Long term sources:- sources from where the funds can be
raised for a period of more than 5 years.
1]. Share capital:- Funds can be raised from the
public, by offering them shares through an initial public offerings.
Shares are of 2 types
Preference shares and equity shares. In equity shares the
shareholders are considered as the owner of the company and they enjoys a
voting rights. They gets dividend only if company earns profit and their
capital will be returned back only when the company is wind up. In case of
preference shares capital is returned back to the holders after a specified
period of time.
2].Debentures Companies generally have powers to borrow and
raise loans by issuing debentures. The rate of interest payable on debentures
is fixed at the time of issue and are recovered by a charge on the property or
assets of the company, which provide the necessary security for payment. The
company is liable to pay interest even if there are no profits. Debentures are
mostly issued to finance the long-term requirements of business and do not
carry any voting rights.
3].Mortagage loan:- Offered by Banking and other financial
institution like SBI against some security. Ex- house was given as security for
taking a loan of Rs.5 lakh.
Long-term and medium-term loans can be secured by companies
from financial institutions like the Industrial Finance Corporation of India,
Industrial Credit and Investment Corporation of India (ICICI) , State level
Industrial Development Corporations, etc. These financial institutions grant
loans for a maximum period of 25 years against approved schemes or projects.
Loans agreed to be sanctioned must be covered by securities by way of mortgage
of the company's property or assignment of stocks, shares, gold, etc.
4].Retained profit:- A profit of the business which is left over after
deducting tax, paying debenture holders, paying to preference as well as equity
shareholders can be used as a capital. Profitable companies do not generally
distribute the whole amount of profits as dividend but, transfer certain
proportion to reserves. This may be regarded as reinvestment of profits or
ploughing back of profits. As these retained profits actually belong to the
shareholders of the company, these are treated as a part of ownership capital. Retention
of profits is a sort of self financing of business. The reserves built up over
the years by ploughing back of profits may be utilised by the company for the
following purposes :-- Expansion of the undertaking
- Replacement of obsolete assets and modernisation.
- Meeting permanent or special working capital requirement.
- Redemption of old debts.
- It reduces the dependence on external sources of finance.
- It increases the credit worthiness of the company.
- It enables the company to withstand difficult situations.
- It enables the company to adopt a stable dividend policy.
5].Venture capital:- Some companies are pioneer in this
business. They invest money in small industries or any idea they like (the idea
or organisation in which they invest needs funds and were unable to raise funds
through any other sources like bank and public, so venture capitalists helps
them by investing money as a capital provider. Ex- Reliance venture capital business
invest in A small industry to provide them capital.)
Venture capitalist takes risk of investing because of the
motto that more risk more gain.
Ex- Reliance, ing.
Short term:-Sources which provides funds for short term:-
which is to be paid within one year.
1].Bank overdraft:- Bank offers this facility to some
customers where they can spend more than the amount available in their account
and can pay back the bank later on with certain amount of interst.
2].Bills receivables:- Certification offered by debtor to
creditor to be paid within a year.
Companies buy raw materials, components, stores and spare parts on credit from different suppliers. Generally suppliers grant credit for a period of 3 to 6 months, and thus provide short-term finance to the company. Availability of this type of finance is connected with the volume of business. When the production and sale of goods increase, there is automatic increase in the volume of purchases, and more of trade credit is available.
4].Factoring
The amounts due to a company from customers, on account of credit sale generally remains outstanding during the period of credit allowed i.e. till the dues are collected from the debtors. The book debts may be assigned to a bank and cash realised in advance from the bank. Thus, the responsibility of collecting the debtors' balance is taken over by the bank on payment of specified charges by the company. This method of raising short-term capital is known as factoring. The bank charges payable for the purpose is treated as the cost of raising funds.
Many frauds have occurred relating to short term sources.
Harshad Mehta is one of such example:-
Harshad Mehta
scam Harshad Mehta was a
registered broker in a stock exchange. He was indulged in buying and sharing of
securities on behalf of customers. New scheme was launched by the central bank
called ready forward (RF) which was a 15 day secured loan involving
transactions from Bank to Bank. One Bank could borrow a short term 15 days
finance from other bank by selling Government securities/shares or debentures,
and after 15 days the borrower bank would purchase back the securities from the
lender bank at a slightly higher price. These transactions are usually done
through an intermediary called as broker. Broker used to perform all the steps
on the behalf of both the bank, sometimes the borrower did not even know who
the lender would be. Borrower bank used to sell the security to the broker who
again sell it to the lender bank and in return the Borrower bank issues BR(bank
receipt) as a proof that the payment has been received by a bank. Broker
harshad Mehta made a profit out of this system. He got fake BR(bank receipt)
prepared from some local and small banks and sold the securities on his own to
the banks. He used the Bank finance to purchase securities heavily which
increased the Market price of the securities and strengthen the bull in the
sensex. Then he purchases the securities back from the bank after 15 day period
of RF scheme and used to sell the securities again in the market at a higher
market price. He succeed in channelizing funds from Banks. Sensex was rising
and prices of securities was increasing. No one paid heed to such unusual
thing. Then one day the scam exposed and market suffered a loss of Rs.4000
crore. Market crashed with a large amount, many banks were still holding the
fake BR(bank receipts) and did not know what to do next. Many bankers of small
banks who issued fake BRs committed suicide after the scam exposed. Harshad
Mehta died in 2002 when many suits were still pending against him.
That was the
biggest unethical scam India
could ever face.
In case of Not for profit organisations like Wikipedia,
wikileaks, their capital is charity and in some Government organisations their
capital is funds provided by Government.
Funds can also raised through amalgamation, merger, takeover
and acquisition. Where one company purchases another company. Ex- Air India merged
with Indian airlines and kingfisher acquired air deccan
Types of business capital:-
There are three categories of financial capital that are
important for you to know when analyzing your business or a potential
investment. They each have their own benefits and characteristics.
Equity Capital
Otherwise known as “net worth” or “book value”, this figure
represents assets minus liabilities. There are some businesses that are funded
entirely with equity capital (cash written by the shareholders or owners into
the company that have no offsetting liabilities.) Although it is the favored
form for most people because you cannot go bankrupt, it can be extraordinarily
expensive and require massive amounts of work to grow your enterprise.
Microsoft is an example of such an operation because it generates high enough
returns to justify a pure equity capital structure.
Debt Capital
This type of capital is infused into a business with the
understanding that it must be paid back at a predetermined future date. In the
meantime, the owner of the capital (typically a bank, bondholders, or a wealthy
individual), agree to accept interest in exchange for you using their money.
Think of interest expense as the cost of “renting” the capital to expand your
business; it is often known as the cost of capital. For many young businesses,
debt can be the easiest way to expand because it is relatively easy to access
and is understood by the average American worker thanks to widespread home
ownership and the community-based nature of banks. The profits for the owners
is the difference between the return on capital and the cost of capital; for
example, if you borrow $100,000 and pay 10% interest yet earn 15% after taxes,
the profit of 5%, or $5,000, would not have existed without the debt capital
infused into the business.
Specialty Capital
This is the gold standard. There are a few sources of
capital that have almost no economic cost and can take the limits off of
growth. They include things such as a negative cash conversion cycle (vendor
financing), insurance float, etc.
- Negative Cash Conversion
(Vendor Financing)
Imagine you own a retail store. To expand your business, you need $1 million in capital to open a new location. Most of this is the result of needing to go out, buy your inventory, and stock your shelves with merchandise. You wait and hope that one day customers come in and pay you. In the meantime, you have capital (either debt or equity capital) tied up in the business in the form of inventory.
Now, imagine if you could get your customers to
pay you before you had to pay for your merchandise. This would allow you to
carry far more merchandise than your capitalization structure would otherwise
allow. AutoZone is a great example; it has convinced its vendors to put their
products on its shelves and retain ownership until the moment that a customer
walks up to the front of one of AutoZone’s stores and pays for the goods. At
that precise second, the vendor sells it to AutoZone which in turn sells it to
the customer. This allows them to expand far more rapidly and return more money
to the owners of the business in the form of share repurchases (cash dividends
would also be an option) because they don’t have to tie up hundreds of millions
of dollars in inventory. In the meantime, the increased cash in the business as
a result of more favorable vendor terms and / or getting your customers to pay
you sooner allows you to generate more income than your equity or debt alone
would permit. Typically, vendor financing can be measured in part by looking at
the percentage of inventories to accounts payable (the higher the percentage,
the better), and analyzing the cash conversion cycle; the more days “negative”,
the better. Dell Computer was famous for its nearly two or three week negative
cash conversion cycle which allowed it to grow from a college dorm room to the
largest computer company in the world with little or no debt in less than a
single generation.
- Float
Insurance companies that collect money and can generate income by investing the funds before paying it them out in the future in the form of policyholder payouts when a car is damaged, or replacing a home when destroyed in a tornado, are in a very good place. As Buffett describes it, float is money that a company holds but does not own. It has all of the benefits of debt but none of the drawbacks; the most important consideration is the cost of capital – that is, how much money it costs the owners of a business to generate float. In exceptional cases, the cost can actually be negative; that is, you are paid to invest other people’s money plus you get to keep the income from the investments. Other businesses can develop forms of float but it can be very difficult.
Sweat Equity
There is also a form of capital known as sweat equity
which is when an owner bootstraps operations by putting in long hours at a low
rate of pay per hour making up for the lack of capital necessary to hire
sufficient employees to do the job well and let them work an ordinarily forty
hour workweek. Although it is largely intangible and does not count as
financial capital, it can be estimated as the cost of payroll saved as a result
of excess hours worked by the owners. The hope is that the business will grow
fast enough to compensate the owner for the low-pay, long-hour sweat equity
infused into the enterprise.
Advantages of Raising funds as owners funds(shares):-
-No interest burden on business as dividend payment on
shares is not an obligation and can skip if there is no profit.
-No tensions of repayment of the amount
- usually long-term patient capital that is not amortized
- local and international capital invested at often lower returns
- investors willing to take risks and be paid only if profitable
- can leverage more debt capital
- ultimately can grow systematically based on owner's resources
Disadvantages of raising owners funds:-
- must be not only sustainable but profitable cost of funds much closer to market rate
- requires strong financial controls and management
- social aims o diluted or may be lost
Advnatages
of raising borrowed funds:-
- local savers may provide less costly funds; an important habit among clients and the public is rewarded
- lower interest loans provide experience in borrowed funds
- local banks become familiar with MSE (micro and small enterprise) potentials
- access to larger sums more quickly based on track record
- allows longer term projections than grants
- provides a discipline similar to that of MSE clients
disadvantages of raising borrowed funds(debenture)
- higher financial costs force organizational decisions and changes
- substantial initial collateral requirements
- more risky as debt holders can force closure
- more tricky cash flow management as principal is repaid
- early negotiations require a new set of skills and contacts
- local banks may not be willing to be cooperative
- loans may be dollarized in an inflationary situation
- too many subsidized loans can retard move to market rate
Comments
Post a Comment