Planning for finance
What are the modes of finance ?
(…updated on 16.08.2020)
Now, start working on finances. By this time you have a business plan to be executed and started a few steps towards this. Now, you should plan for the next important thing “FINANCE”. In the business plan you have already estimated these. However, before finalising the business plan / project report, don’t forget to estimate the start-up costs / pre-operative expenses.
Normally, the start-up expenses would include, consultancy charges (legal, Accountant etc.), one time expenses like cost of registering the enterprise, Office rent, furniture and fixtures etc. These Pre-operative expenses depend on the type of business you select. Some may need very huge amounts and some may need very meager amounts as start-up expenses. You need to think innovatively and save on these expenses where ever possible.
Generally, all the expenses that are to be met till the cash generation is started by the enterprise will be treated as start-up costs. Therefore, estimate these expenses conservatively so that there will not be any sudden surprises and these surprises will not affect your future estimates.
Also, don’t forget to estimate your personal as well as household expenses. There should be sufficient cash to meet any unforeseen incidents.
You should also keep in mind the required margin money i.e. your stake in the project, which is required to be met if you are going for any financial support from any Bank / Financial Institutions.
It is good to cover the assets with Insurance coverage. Initially, these expenses also may be added as startup costs and you should provide for these. Shielding your assets with insurance coverage is a good idea. It protects not only your assets but also your future. Therefore, don’t forget to add the cost of insurance into startup cost.
These are some of the basic points to be kept in mind while preparing the business plan / project report.
What are the modes of finance ?
For any enterprise, funds are needed for meeting the long term liabilities / demands or Short term liabilities / demands. In case of need i.e. if the unit is not able to meet the requirement on its own, then, financial assistance is needed and your enterprise may not be an exception. Therefore, if you want to avail financial assistance from any Bank / Financial Institution (FI), then, you need to understand certain things before approaching a Bank / FI. There are many ways to raise funds for long term needs short term needs and short term needs. Some of theses are:
Long term needs
Long term loans from Banks / FIs:
- Banks / FIs extend long term loans to MSMEs. Generally these loans are extended for acquisition of plant and machinery, modernisation of machinery etc. These loans are generally secured by mortgage of the primary / collateral properties of the enterprise. These loans are to be repaid out of profits of the enterprise. Thus the repayment will be extended for longer tenures.
- One more alternative available to the enterprises is to raise public deposits. However, this would be little bit costly, as the rate of interest to be payable is expected to be higher than that of the interest rates on bank deposits. Unless it is lucrative people may not tend to deposit with the enterprise.
Public Issue of shares:
- This is one of the most common and famous methods of raising capital. However, this is available only for public limited companies only. Private limited companies can not raise capital through issue of share to general public.
Public issue of debentures:
- Debentures are nothing but the company raising loans from the general public. These debentures carries a fixed rate of interest and which is declared at the time of issuing itself. However, once the debentures are issued the interest is to be paid as per agreed terms even if the company posts loss.
Ploughing back profits / Reinvestment of profits:
- Stable MSMEs won’t prefer to distribute entire profits to the promoters / shareholders. Generally they reinvest the profits into the business itself. Thus, the financial strength of the enterprise is improved further. This can be compared as self financing of the enterprise. With this ploughing back of profits, the enterprise can consider expansion, can go for modernisation without going for additional loans, repaying existing / costly debts or it even improves the enterprise’s strength to raise additional debt for expansion etc. This reinvestment of profits gives an edge over their competitors.
Short term needs
Short term credit:
- One of the common methods of raising short term funds is raising working capital funds or overdraft against the security of Stock, Receivables, Bills etc. This arrangement is generally valid for a period of one year.
Trade Credit / Factoring / Discounting of Bills:
- To run their day to day operations enterprises need to purchase items like, raw materials, spares etc on credit from various suppliers. Some times they may need to purchase on credit form them and these are to be repaid within short period say 3 months to 6 months. When the enterprise is able to purchase on such conditions they can increase their sales as short term credit is available.
- As the enterprise is able to purchase on credit sometimes they need to sell on credit as well. In such scenarios the liquidity is reduced. As selling and purchasing on credit is common in business, the seller can assign the book debts to a bank and realise cash even before the bills are realised. Thus the banker will collect the bills and resolve the liquidity of the enterprise. The bills are discounted at 80 % to 90 % of the book debt. This is called factoring. Further the bill can be discounted at a bank and raise funds this is discounting of bills and this is also a very popular method of raising short term funds.
These are some of the commonly used modes of funding. Some may explore Venture capital / Strategic investment as well. We will look into these areas also shortly…
All the best