Question

What are the various sources of raising borrowed funds for a business?

An established company has decided to expand its production capacity. It does not have adequate reserves to finance the expansion. Suggest with reasons any two other sources of finance for the company.

Answer 1

1. Issue of Debentures: Debentures are a valuable tool for raising long-term debt finance. A firm can raise capital by issuing debentures with a fixed rate of interest. A debenture is a company's guarantee to repay a loan at a future date. Debenture holders are classified as creditors of the corporation. Debenture holders receive a fixed sum of interest every six months or a year. A credit rating agency like CRISIL (Credit Rating and Information Services of India Ltd.) must rate a public issue of debentures on factors like the company's track record, profitability, debt servicing capacity, creditworthiness, and perceived risk of lending. A company can issue different types of debentures (see Boxes C and D). The issue of zero-interest debts (ZID), which do not carry any explicit rate of interest, has also become popular in recent years. The difference between the face value of the debt and its purchase price is the return to the investor.
2. Commercial banks: Commercial banks play an important role in providing finances for a variety of objectives and time periods. Banks provide loans to businesses of all sizes and in a variety of forms, including cash credits, overdrafts, term loans, bill purchase/discounting, and letter of credit issuance. Banks charge interest rates based on a variety of criteria, including the firm's qualities and the level of interest rates in the economy. The loan is repayable in either a flat sum or in installments. Bank credit is not a permanent source of funding. Though banks have begun to extend loans for longer periods, such loans are mostly used for medium to short periods. Before a commercial bank will approve a loan, the borrower must provide security or place a charge on the firm's assets.
3. Public Deposits: Public deposits refer to unsecured deposits invited by companies from the public, mainly to finance working capital needs. A company wishing to invite public deposits advertises in the newspapers. A company can invite public deposits for a period of six months to three years. Therefore, public deposits are primarily a source of short-term finance.
   Companies can raise capital through this strategy by allowing shareholders, workers, and the general public to deposit their savings with the company. To attract customers, the company typically offers a higher rate of interest than the interest on bank deposits. The time for which firms receive public deposits varies from six to 36 months.
4. Loans from financial institutions: Since independence, a large number of financial institutions have been established in India with the primary objective of providing medium and long-term financial assistance to industrial enterprises. Institutions like the Industrial Finance Corporation of India (IFCis), Industrial Reconstruction Bank of India, State Financial Corporations (SFCs), and State Industrial Development Corporations (SIDCs) have been established to provide financial support to set up new enterprises as well as expansion and modernization of the existing enterprises.
   These financial firms provide loans for a maximum of 25 years. These loans are secured by a mortgage on the company's property or the hypothecation of stock shares. The main benefits of such loans are:

1. The rate of interest payable is lower than the market rate and
2. the amount of loan is large.