FINANCING

Long – term:-

### Capital Investment Decisions

Capital investment decisions involve making long-term
strategic choices about which projects or ventures should
receive funding. These decisions also encompass determining
the optimal financing method—whether through equity or debt
(capital structure)—and deciding when, and if, dividends should
be distributed to shareholders. The primary goal of corporate
management in making these decisions is to maximize the
value of the firm. This is typically achieved by investing in
projects that yield a positive **Net Present Value (NPV)** when
evaluated using an appropriate discount rate. Additionally, if no
profitable investment opportunities exist, management should
consider returning excess cash to shareholders to ensure
shareholder value is maximized.

Capital investment decisions can be categorized into three

main areas:
1. **Financing Decision**
2. **Investment Decision**
3. **Dividend Decision**

#### 1. **Financing Decision**

The financing decision determines the optimal capital structure
for the company—whether funds for investments and
operations will be raised through **debt financing (loans,
bonds)** or **equity financing (share capital)**. This decision
involves assessing the trade-offs between various sources of
capital, considering factors such as cost of capital, financial
risk, and control over the business.

Key aspects of the financing decision include:

- **Capital Structure**: Deciding the right balance between
debt and equity financing.
- **Debt Financing**: Involves borrowing funds that must be
repaid over time with interest. While this method may increase
the company’s financial leverage and potentially enhance
returns on equity, it also introduces financial risk due to interest
obligations.
- **Equity Financing**: Involves raising funds by issuing shares
of stock. This method does not require repayment, but it dilutes
the ownership of existing shareholders.
- **Long-term Financing Needs**: Ensuring the company has
sufficient long-term funds to invest in fixed assets,
infrastructure, and long-term growth opportunities, as well as
addressing working capital requirements.

#### 2. **Investment Decision (Project Financing)**

The investment decision involves selecting projects or
investments that the company should pursue. These decisions
are often referred to as **capital budgeting** and require
detailed financial analysis to determine whether a project will
add value to the company. Various capital budgeting techniques
are used to evaluate projects, including:

- **Payback Method**: Measures the time required for an

investment to generate cash flows sufficient to recover the
initial investment cost.
- **Accounting Rate of Return (ARR)**: Calculates the return on
investment based on accounting profits rather than cash flows.
- **Internal Rate of Return (IRR)**: Identifies the discount rate
at which the net present value of future cash flows equals zero,
indicating the project’s potential profitability.
- **Net Present Value (NPV)**: Assesses the profitability of a
project by discounting future cash flows to their present value
and subtracting the initial investment. A positive NPV indicates
that the project is expected to generate more value than its
cost.

Additionally, **asset management policies** play a critical role

in investment decisions. Effective management of current
assets—such as **accounts receivable**, **inventory**, and
**cash**—is essential to ensure liquidity and support ongoing
operations. These policies require coordination with various
departments, such as sales and production, to optimize working
capital and minimize costs.

#### 3. **Dividend Decision**

The dividend decision concerns how much of the company’s
earnings should be distributed to shareholders in the form of
dividends and how much should be retained for future growth.
This decision is influenced by several factors, including:

- **Earnings Trends**: The company’s profitability over time.

- **Stock Market Trends**: The potential impact of dividend
payouts on the company’s stock price.
- **Future Growth Requirements**: The need to retain earnings
for reinvestment in new projects or expansion plans.
- **Cash Flow Situation**: The availability of cash for
distribution after covering operational needs and investment
opportunities.
The dividend policy must strike a balance between rewarding
shareholders and ensuring the company has sufficient funds for
future growth and operational stability.

---

### Short-term Decisions: **Working Capital Management**

In contrast to long-term capital investment decisions, **working
capital management** focuses on short-term financial
decisions. The objective is to manage the company’s current
assets and liabilities to ensure smooth day-to-day operations
and maintain sufficient liquidity.

Key components of working capital management include:

- **Cash Management**: Ensuring that the company has
enough cash to meet its short-term obligations while
minimizing idle cash that could otherwise be invested.
- **Inventory Management**: Balancing the need to have
sufficient inventory to meet customer demand with the cost of
holding and storing excess inventory.
- **Receivables and Payables Management**: Managing the
terms of credit extended to customers (accounts receivable)
and the terms on which the company pays its suppliers
(accounts payable) to optimize cash flow.
- **Short-term Borrowing and Lending**: Managing short-term
financing options, such as lines of credit or short-term loans, to
cover temporary funding gaps.

By effectively managing working capital, companies can

improve their liquidity, reduce financial risks, and enhance
operational efficiency.
Summary
Capital investment decisions are essential for long-term
business success, involving strategic choices about financing,
investments, and dividend distribution. The goal is to maximize
shareholder value through careful project selection, efficient
capital structure management, and thoughtful dividend
policies. Short-term decisions focus on working capital
management, ensuring that the company can meet its
immediate financial obligations while supporting its long-term
goals.

### Management of Working Capital

**Working capital management** involves using policies and

techniques to effectively manage a company’s current assets
(such as cash, inventories, and debtors) and short-term
financing. The objective is to maintain acceptable cash flows
and returns while ensuring operational efficiency. This
management is crucial for sustaining day-to-day business
activities while minimizing costs associated with holding assets
or financing.

Key areas of working capital management include:

#### 1. **Cash Management**

- **Objective**: To determine the optimal cash balance that
allows the business to meet its day-to-day expenses without
holding excess cash that could be better invested elsewhere.
- **Goal**: Minimize the costs associated with holding idle
cash while ensuring the company can cover its immediate
obligations.

#### 2. **Inventory Management**

 - **Objective**: To maintain an inventory level that supports
uninterrupted production or service delivery, without tying up
too much capital in raw materials or finished goods.
- **Techniques**:
- **Just-In-Time (JIT)**: Minimizes inventory by receiving
goods only when needed in production.
- **Economic Order Quantity (EOQ)**: Optimizes the
quantity of stock ordered to minimize holding and ordering
costs.
- **Economic Production Quantity (EPQ)**: Focuses on
balancing production runs with demand to minimize production
and storage costs.

#### 3. **Debtors’ (Accounts Receivable) Management**

- **Objective**: To establish credit policies that attract
customers while balancing the impact on cash flows. Proper
management of receivables ensures that the cash conversion
cycle is optimized, enhancing liquidity.
- **Strategies**:
- **Credit Terms**: Setting terms that are attractive to
customers but ensure timely payments.
- **Discounts and Allowances**: Offering early payment
discounts to reduce the cash conversion cycle and improve
Return on Capital.

#### 4. **Short-term Financing**

- **Objective**: To identify the most suitable financing options
based on the company’s cash conversion cycle.
- **Options**:
- **Supplier Credit**: Ideally, inventory should be financed
by credit extended by suppliers.
 - **Bank Loans/Overdrafts**: If supplier credit is insufficient,
short-term bank loans or overdrafts can be utilized.
- **Factoring**: Converting receivables into cash by selling
them to a factoring company can be a quick way to improve
liquidity.

### Functions of a Finance Manager

The primary objective of the **Finance Manager** is to manage

funds efficiently, ensuring optimal utilization and minimizing
risks, costs, and loss of control in the process. The Finance
Manager performs several key functions that align with
forecasting, capital investment, and managing returns to
shareholders.

#### 1. **Forecasting and Planning (Budgeting)**

- **Objective**: To estimate the need for both short-term
(working capital) and long-term (capital investments) funds.
- **Techniques**:
- **Budgetary Control**: Monitoring and controlling
expenditures based on the budget.
- **Long-range Planning**: Forecasting long-term financial
needs and aligning investments with future growth objectives.

#### 2. **Capital Investment Decisions**

These decisions relate to the allocation of capital to long-term
projects, determining how these projects will be financed, and
making decisions about shareholder dividends.

- **Financing Decision**:
 - **Objective**: To decide the capital structure of the
company, i.e., whether to raise funds through equity (share
capital) or debt (loans/borrowings).
- **Key considerations**: Balancing long-term financing for
fixed assets and working capital while ensuring a low cost of
capital and maintaining financial control.

- **Investment Decision (Project Financing)**:

- **Objective**: To evaluate and select projects that add value
to the company using capital budgeting tools like:
- **Payback Method**: Measures how quickly the initial
investment is recovered.
- **Accounting Rate of Return (ARR)**: Evaluates profitability
based on accounting income.
- **Internal Rate of Return (IRR)**: Determines the rate of
return at which the project’s net present value is zero.
- **Net Present Value (NPV)**: Calculates the profitability of a
project by discounting future cash flows to their present value.
- **Asset Management Policies**: Coordinating with
departments (e.g., sales for receivables, production for
inventory) to optimize the use of current assets.

- **Dividend Decision**:
- **Objective**: To determine how much of the company’s
earnings should be distributed as dividends to shareholders,
and how much should be retained for future growth.
- **Key Factors**:
- **Earnings Trend**: Consistency in profitability.
- **Stock Market Price Trend**: Impact of dividend payments
on the company’s stock value.
- **Future Growth Requirements**: Retaining earnings to
fund future projects.
 - **Cash Flow**: Ensuring the company has adequate
liquidity to meet operational and growth needs.
### Short-term Financial Decisions: **Working Capital
Management**
The **short-term financial decisions** of a company revolve
around managing **current assets** (e.g., cash, receivables,
inventory) and **current liabilities** (e.g., short-term debt,
payables). These decisions are aimed at optimizing liquidity,
ensuring that the company can meet its immediate obligations
while minimizing unnecessary capital tie-ups.

- **Cash Management**: Ensuring sufficient liquidity to meet

daily operations.
- **Inventory Management**: Reducing excess stock while
avoiding production disruptions.
- **Receivables Management**: Improving cash flow through
effective credit policies.
- **Short-term Financing**: Identifying the best short-term
financing options, whether from suppliers, banks, or factoring.
### Conclusion
Effective working capital management and strategic capital
investment decisions are crucial for the financial health of a
company. The finance manager plays a pivotal role in ensuring
optimal utilization of funds, balancing risk and control, and
maximizing shareholder value through well-planned financing,
investment, and dividend policies. The ability to forecast,
budget, and manage both short-term and long-term financial
needs enables companies to remain agile and competitive in
dynamic markets.
### Cash Management (Working Capital)

The finance manager is tasked with ensuring that all divisions

within the organization have access to sufficient, timely, and
cost-effective funding. This involves maintaining an optimal
balance of cash inflows and outflows to prevent excessive
liquidity that could lead to idle cash resources. Effective cash
management is critical for maintaining operational efficiency
and achieving financial stability.

### Financial Negotiation

Financial negotiation is a crucial aspect of the finance

manager's responsibilities, particularly in securing favorable
terms for raising funds. This involves engaging in negotiations
with various financial institutions, banks, and public depositors.
The finance manager must leverage strong negotiation skills to
achieve optimal interest rates and terms that benefit the
organization. Additionally, analyzing market conditions and
understanding the financial landscape are essential for
successful negotiations.

### Monitoring and Evaluating Financial Performance

Ongoing monitoring and evaluation of financial performance

are vital for ensuring compliance with established financial
policies and strategic initiatives. The finance manager must
regularly assess the performance of different organizational
units, focusing on key performance indicators such as Return on
Investment (ROI). This comprehensive review process enables
management to determine how effectively funds are utilized
across various divisions and identify areas for improvement.
Utilizing financial metrics and benchmarking against industry
standards can further enhance decision-making processes.

### Engaging with Relevant Parties in the Financial Markets

For publicly traded companies, interaction with the Stock

Exchange is essential for maintaining transparency and
investor confidence. The finance manager must navigate the
complexities of money markets and capital markets to optimize
financing strategies and manage investments of surplus funds
effectively. Building and nurturing relationships with bankers,
investors, underwriters of equity and bond issuances, as well as
regulatory bodies, is critical for fostering a supportive financial
environment. Such relationships can provide access to valuable
resources, insights, and opportunities that can enhance the
organization's financial position and support long-term growth
objectives.

In conclusion, effective cash management, strategic financial

negotiation, continuous monitoring of financial performance,
and proactive engagement with relevant financial parties are
integral to achieving the organization's financial goals and
sustaining its competitive advantage in the market.
SOURCES OF FUNDS

### Long-Term Sources of Finance

Long-term financing can be secured through various avenues,

including:

- **Share Capital (Equity Shares):** This represents ownership

in the company and is a primary source of long-term finance.
- **Preference Shares:** These provide a fixed dividend and
have preferential rights over equity shares in asset distribution
upon liquidation.
- **Retained Earnings:** Profits that are reinvested in the
business rather than distributed as dividends contribute to
long-term financing.
- **Debentures/Bonds:** Different types of debentures and
bonds serve as a means for companies to raise long-term
capital from the public.
- **Loans from Financial Institutions:** These loans can be
sourced from various financial entities providing funding for
extended periods.
- **Loans from State Financial Corporations:** State-specific
financial institutions offer loans to support regional economic
growth.
- **Loans from Commercial Banks:** Long-term loans are
available from commercial banks to finance significant capital
expenditures.
- **Venture Capital Funding:** This type of financing is typically
provided by investors to startup companies and small
businesses with perceived long-term growth potential.
- **Asset Securitization:** This involves converting assets into
securities to raise capital, providing liquidity to the business.
- **International Financing:** Companies may seek funds from
foreign investors or through international capital markets.

### Medium-Term Sources of Finance

Medium-term financing can be acquired through:

- **Preference Shares:** Similar to long-term financing, these

shares can also be used to raise capital for medium-term
needs.
- **Debentures/Bonds:** These are also relevant for medium-
term financing, providing a structured repayment schedule.
- **Public Deposits/Fixed Deposits:** Funds can be raised
through deposits for a duration of three years.
- **Commercial Banks:** Medium-term loans can be secured
from commercial banks for various operational needs.
- **Financial Institutions:** These institutions offer financing
options that cater to medium-term requirements.
- **State Financial Corporations:** These organizations provide
financing for medium-term projects, especially in development
sectors.
- **Lease Financing/Hire Purchase Financing:** This option
allows companies to utilize assets while spreading the payment
over time.
- **External Commercial Borrowings:** Funds can be raised
from international markets to meet medium-term financing
needs.
- **Euro-Issues:** Companies may issue bonds in foreign
markets denominated in euros to attract international
investors.
- **Foreign Currency Bonds:** These bonds are issued in foreign
currencies to diversify funding sources.

### Short-Term Sources of Finance

Short-term financing can be raised from the following sources:
- **Trade Credit:** Businesses can leverage credit extended by
suppliers to finance short-term operational needs.
- **Commercial Banks:** Banks provide various short-term
financing solutions, including overdrafts and lines of credit.
- **Fixed Deposits for 1 Year or Less:** Short-term deposits can
be mobilized for immediate financing requirements.
- **Advances from Customers:** Prepayments received from
customers can serve as an essential source of short-term
finance.

### Descriptions of Some Major Financing Sources

#### Short-Term Financing:-
Short-term financing, primarily utilized for working capital
purposes, is typically provided by commercial banks through a
combination of cash credit and bills discounting facilities.
- An active short-term money market facilitates inter-corporate
borrowing for specific periods. The Reserve Bank of India (RBI)
permits the issuance of commercial paper by corporations
meeting specified conditions. The maximum maturity period for
commercial paper is six months, and it is sold at a discount,
redeemable at face value. Notably, commercial paper interest
rates are generally below the bank's prime lending rate.
- **Certificates of Deposit (CDs)** may be issued by scheduled
commercial banks at a discount from face value, with maturity
periods ranging from 3 months to 1 year.
- Commercial working capital finance for export activities is
provided by commercial banks, which are subsequently
refinanced by the Export-Import Bank of India (EXIM Bank).

#### Long-Term Financing

Long-term financing is accessible through various equity and
debt instruments:
- **Equity Instruments:** Common and preferred stock can be
issued to raise finance through public offerings, provided
requisite approvals are obtained. Compliance with guidelines
set by the Securities and Exchange Board of India (SEBI) for
disclosures and investor protection is mandatory.
- **Long-Term Debt Sources:** Development finance is offered
by all-India and state financial institutions, primarily focusing on
investments in priority sectors. Debentures, including
cumulative and non-cumulative options, serve as capital
market instruments. Typically, a debt-to-equity ratio of 1.5:1 is
deemed acceptable, and a minimum level of promoter
contribution is required, which must remain non-transferable
during a lock-in period of five years.
- **Medium-Term Finance for Non-Priority Sectors:** This is
provided by commercial banks, which also collaborate with
financial institutions to finance projects in priority sectors.
- **Foreign Currency Loans:** Companies can access foreign
currency loans through lines of credit offered by banks and
financial institutions.
- **Venture Capital Financing:** This type of funding is
increasingly available, particularly for high-technology or high-
risk ventures. Several public sector units have been established
to provide equity and loan support to such companies.

In summary, understanding the diverse sources of finance

available—whether long-term, medium-term, or short-term—is
crucial for effectively managing an organization's capital
structure and ensuring financial stability and growth.

FINANCING INSTITUTIONS
### National Financial Institutions
1. National Level Industrial Development Banks
- **Industrial Development Bank of India (IDBI)**
- Established in 1964, focuses on providing credit and facilities
for industrial development.
- Fourth largest bank in India and tenth largest development
bank globally.
- Key initiatives include the National Stock Exchange (NSE)
and National Securities Depository (NSDL).
- Expanded from medium/long-term credit to a full range of
financial services.

- **Industrial Finance Corporation of India (IFCI)**

- Offers diverse credit products:
- **Short-term Loans**: Up to 2 years for immediate needs
(e.g., bridge loans).
 - **Medium-term Loans**: 2-8 years for business expansion
and technology upgrades.
- **Long-term Loans**: 8-15 years for project finance and
acquisition financing.
- **Structured Products**: Includes IPO financing and
promoter funding.
- Activities include lending, leasing, consultancy, and
merchant banking.

- **Small Industries Development Bank of India (SIDBI)**

- Focuses on financing and promoting small-scale industries.

- **Industrial Reconstruction Bank of India (IRBI)**

- Aids in the revival of sick industries.

- **Shipping Credit and Investment Company of India (SCICI)**

- Provides financial support to the shipping sector.

#### 2. Specialized Financial Institutions

- **Technology Development & Information Company of India
Limited (TDICI)**
- **Risk Capital & Technology Finance Corporation Limited
(RCTC)**
- **Tourism Finance Corporation of India (TFCI)**

#### 3. Investment Institutions

- **Unit Trust of India (UTI)**
- First mutual fund in India, facilitating public investments in
the capital market.
 - Functions include buying/selling units and managing
securities.

- **General Insurance Corporation of India (GIC)**

- **Life Insurance Corporation of India (LIC)**

#### 4. State Corporations

- **State Industrial Development Corporations**
- **State Finance Corporations (SFCs)**
- Operate 18 SFCs to promote SMEs through loans and equity
investments.

### International Financial Institutions

1. International Monetary Fund (IMF)
- Provides:
- **Policy Advice**: Based on economic analysis and trends.
- **Research & Data**: Economic forecasts and statistics.
- **Loans**: To assist countries with economic difficulties and
to fight poverty.
- **Technical Assistance**: Training for better economic
management.

2. World Bank
- Comprises two main institutions:
- **International Bank for Reconstruction and Development
(IBRD)**: Focuses on middle-income and creditworthy
countries.
- **International Development Association (IDA)**: Targets the
poorest countries.
- Provides:
- Low-interest loans, interest-free credits, and grants for
development projects (education, infrastructure, health).

**World Bank Group (WBG)**:

- Includes:
1. IBRD
2. IDA
3. International Finance Corporation (IFC)
4. Multilateral Investment Guarantee Agency (MIGA)
5. International Centre for Settlement of Investment Disputes
(ICSID)

- **Focus Areas**:
- Human development (education, health), agriculture,
environmental protection, infrastructure, and governance.
- Loans often tied to policy reforms (e.g., environmental
management linked to new regulations).
Here are concise notes based on the provided information
about banking in India and the role of NABARD, followed by
answers to the self-check questions.

Banking in India
#### Overview
- **Regulator**: Reserve Bank of India (RBI).
- **Main Categories**:
- Commercial Banks
- Co-operative Banks
#### Commercial Banks
1. **Types**:
- **Public Sector Banks**:
- 28 banks (including State Bank of India and 7 associate
banks).
- Account for **90%** of total banking business.
- **Private Sector Banks**:
- Total of **38** private banks, including **18 large** ones.
- **Foreign Banks**:
- **24 banks** with **141 branches** focused on foreign
trade and international banking.
- **Regional Rural Banks (RRBs)**:
- **196 RRBs** serving rural needs.

#### Co-operative Banks

- Focus on:
- Agriculture
- Rural industries
- Urban trade and industry (to a lesser extent).

### National Bank for Agriculture and Rural Development

(NABARD)
- **Role**: Apex institution in organized rural credit.
- **Functions**:
1. **Refinance Facilities**: Supports financial intermediaries.
2. **Policy Development**: Enhances rural credit delivery
systems.
3. **Agricultural Financing**: Provides finance for:
 - Seasonal agricultural operations
- Minor irrigation
- Loans under Integrated Rural Development Programme
(IRDP)
- Dairy development
- Farm mechanization.
4. **Support to Commercial Banks**:
- Provides refinance for term loans under specific schemes.
- Encourages banks to manage short-term needs
independently.

### Self-check Questions

**5. Explain in detail the banking structure in India.**

The banking structure in India is primarily regulated by the
Reserve Bank of India (RBI) and consists of two main
categories: Commercial Banks and Co-operative Banks.

- **Commercial Banks** are divided into:

- **Public Sector Banks** (28 banks, 90% of banking business)
- **Private Sector Banks** (38 banks, 18 large ones)
- **Foreign Banks** (24 banks, 141 branches)
- **Regional Rural Banks** (196 banks).

- **Co-operative Banks** cater to agriculture, rural industries,

and urban trade.

**6. Discuss the role of NABARD towards rural development.**

NABARD serves as the apex institution in the organized rural
credit structure, focusing on rural development through various
functions:

1. Provides refinance facilities to financial intermediaries.

2. Develops policies to improve rural credit delivery systems.
3. Finances seasonal agricultural operations and projects
related to irrigation, dairy development, and farm
mechanization.
4. Supports commercial banks by offering refinance for specific
term loans, allowing banks to manage short-term credit needs
independently.