Financial Management
Financial Management
Financial Management
Redeemable Debentures
Redeemable debentures are those that will be repaid by the company under the term of issue at the end of a specified period or at any time within a specified period by giving them a notice of its intention to redeem them at the end of the notice period or by installments during the existence of the company. Redeemable debentures may be reissued even after they have been redeemed until they been cancelled.
RIGHTS DEBENTURES Under Section 81 of the Indian Companies Act 1956, there are specific provisions regarding the issue of rights shares by the public companies while no such specific provision has been made regarding the issue of rights debentures. Public companies are authorized to issue such debentures for raising long-term resources. The central government has formulated certain guidelines to regulate the issue of rights debentures by public companies for working capital requirements to be followed by a company, while seeking consent of the controller of capital issue
12. Allotment of Rights Debentures will be made only after a minimum subscription of 75% of the amount of debentures has been secured. 13. The company should ascertain beforehand the prospects of at least 75% of the issue being take up by the shareholders of the company and other categories of investors mentioned above.
10. Cautious Attitude of Indian Investors Indian investors are very cautions about the safety of their investment. They do not wish to earn more at the cost of safety. Only safety of investment attracts them to invest funds in giltedged securities. 11. Preference for Government Savings In recent years Indian government have initiated a number of attractive saving schemes and issued securities which carry income tax rebates and other benefits like withdrawals etc. Marginal investors prefer these schemes rather to invest funds in debentures. 12. Limited Control of Holders Debenture holders are given limited controlling power in the day to day affairs of the company unless their interests are affected. They have no vice in policy decision of the company unless they affect their interest. Hence those who desire to have a voice in the affairs of the company prefer to invest their money in equity shares.
Following are the circumstances of accepting debt capital. (1) The sales and earnings are relatively small (2) The marginal cost of debt is less than the cost of equity as it lower the average cost of capital or trading. (3) The general price level is expected to be high, resulting in higher profits in future. (4) The existing debt-ratio is relatively low. (5) Price earnings ratio on equity shares is low in relation to the level of interest rates. (6) Retention of existing control pattern because debentures carry no voting rights.
(7) Terms of debt-agreement are not burdensome on the cash position of the company. (8) Terms and conditions of debt agreement are not onerous and prejudicial to the interest of the firm and its shareholders.
(iii) Depreciation reduces taxable income and, therefore, income-tax liability for the period is reduces. This will be clear with the following example: Case I Rs. 75,000 Nil. 75,000 37,500 37,500 37,500 Case II Rs. 75,000 15,000 60,000 30,000 30,000 45,000
Income before depreciation Depreciation Income Taxable Income Income Tax say at 50% Net Income after tax (B) Net Flow of funds after tax (A) + (B)
The above example shows that in Case II, the net flow of funds is more by Rs. 7,500 as compared to Case I. This is because on account of depreciation charge being claimed as in expense, tax liability has been reduced by Rs. 7,500 in Case II. It may, therefore, by said that true funds flow from depreciation is the opportunity of saving cash outflow through taxation.
Trade Credit
Trade credit is a form of short-term financing common to almost all types of business firms. As a matter of fact, it is the largest source of short-term funds. In an advanced economy, most buyers are not required to pay for goods on delivery. They are allowed a short-term credit period before payment is due. This credit may take the form of (a) An Open Account Credit Arrangement (b) Acceptance Credit Arrangement. In case of an Open Account Credit Arrangement, the buyer does not sign a formal debt instrument as an evidence of the amount due by him to the seller. While in case of an Acceptance Credit Arrangement the buyer accepts a bill of exchange or gives a promissory note for the amount due by him to the seller. Thus, it is an arrangement by which the indebtedness of the buyer is recognized formally. Trade Credit Arrangement is generally made available to the buyer on an informal basis without creating any charge on assets. Trade Credit Arrangement usually carry stipulation of allowing a cash discount to the buyer for prompt payment. The volume of trade credit and its popularity as a means of short-term financing depends on the following factors. (i) The terms of trade credit, (ii) Reputation of the purchasing firm, (iii) Financial position of the seller, and (iv) Volume of purchase to be made by the buyer.
supplying goods on credit. As a matter of a fact, many firms utilize other sources of short-term financing in order to enable them to take advantage of cash discount. (ii) Availability of liberal trade credit facilities may induce a firm to over trading which may later prove to be disastrous for the firm. The firm must balance the advantages of trade credit as a discretionary source of financing without any explicit cost against the cost of losing of cash discount, the possibility of deterioration in reputation, if trade credit is stretched beyond agreed limits and the increased purchase price of the product.
Term Loans
A term loan is a business loan with a maturity of more than one year. There are exceptions to the rule, but ordinarily term loans are retained by systemic repayments over the life of the loan. The primary lenders on term credit are Commercial banks, life insurance corporation, financial institutions, general insurance companies, investment trusts and state and central government. Commercial banks and various financial institutions constitute the hard core of term financing in India. Term lending business of Commercial banks is recent innovation in India specially after 1958. It was in the year of 1958 only when a formal scheme of term loans was started. But, now-a-days these banks provide a larger share of tem finance to Indian Industries.
(c) For retiring bonds in order to reduce interest costs or to redeem preference shares so as to substitute tax deductible interest payment for non-deductible dividends. 2. Security Terms loans are usually secured. They have either a fixed or floating charge against the assets of the company. The lender bank usually prefers a first charge, however, in appropriate cases it accepts a second charge also. 3. Time period The term loans are granted for a period ranging from 1 to 15 years but generally from 8 to 15 years. The repayment is made in installments typically designed to fit the project capacity of the borrower to pay. The repayment starts 2 or 3 years after sanctioning of loan. The lending institution requires payment only in accordance with the specified schedule so long the borrower carries out his commitments under the loan agreement. In case of default in such commitment, the agreement provides for accelerating of the maturity of the loan. 4. Formal agreement The term loan is granted on the basis of a formal agreement. The agreement contains the terms of granting loan and provides for certain protective clauses for the benefit of the lender, e.g. limiting the dividend rate, the power to appoint directors, conversion of loan into share capital, etc. Then terms are settled through direct negotiation between the borrower and the lending institutions. 5. Participation basis- In case of term-loan being a substantial amount, different financial institutions participate in the credit on a syndicated basis. Such participation is done either because restrictions or for sharing the risk. The larger the loan, greater is the participation. 6. Introduces financial discipline Term loans introduce a proper financial discipline in the borrower. He has to forecast reasonable accuracy cash flows so that he can repay loan and interest as per the agreed schedule. This makes necessary for the borrower to prepare a projected cash flow statement. 7. Refinance facility Commercial banks are granted refinance facility from Industrial Development Bank of India on the terms loans granted by them. The risk, of course, continues of the lending commercial bank. 8. Project oriented approach Financial institution engaged in term lending do not do security-oriented lending any longer. They have detailed app of each project and asserts its own merits. The loan is sanctioned only when the project satisfies their tests. 9. Special Conditions In order to provide safeguards against time and cost overruns the loan agreements usually require the borrower to give undertaking in respect of the following matters : (i) (ii) (iii) No further long-term loan shall be taken The debt-equity ratio will not exceed the specified limit. Current ratio will be maintained at the desired level.
(iv) Selling commission sole selling agent shall not be disbursed unless interest and installments of loans are paid.
(v) rate.
Dividend shall not be declared for a specific period or shall not exceed the agreed
(vi) Financial data and other information as required by the lending institution will be supplied as and when desired. (vii) The directors will furnish personal guarantees for repayment of the loan in addition to the financial institutions charge on firms assets.
Working: At present CRISIL is restricting its rating only to debt instruments, viz., fixed deposits, debentures, and debenture portion of equity linked debentures. There is no compulsion for any company to obtain or publicize the rating obtained from CRISIL. However, once credit rating is made compulsory by the Government. CRISIL is planning to undertake credit rating of all types of securities. CRISIL has to evaluate and monitor the performance of a company through use of qualitative as well as quantitative criteria for evaluation. The qualitative criteria include the companys competitive position, its strengths and weakness, its management and business strategies, etc. while the quantitative criteria include the financial statements the accounting ratios, the cash flow and funds flow statements of the company concerned.
Progress of CRISIL, Since its inception till March 31, 1996, CRISIL has so far completed rating of 1,736 issues consisting of various types of debt Rs. 1,14,873 crores. Some of the companies which have used CRISIL rating are Indian Petro Chemicals Limited (IPCL), Sundaram Fiannce Limited (SFL), Mahindra Engine Steel Company Limited, Mukand Oil & Steel works Limited, Kirloskar Bros. Limited, Municipal Bonds of Ahmedabad Municipal Corporation etc. During the year 1992-94 CRISIL launched the RATINGDIGEST, which is a compilation in five volumes of CRISIL Rating Reports organized by industries categories. In 1995 96 it introduced CRISIL 500 Equity Index. Credit rating analysis is relatively, new development in India. It is expected that establishment of CRISIL, will provide a strong impetus to the systematic risk evaluation of specified corporate instruments as well as the companies issuing them.
(a) ICRA Ltd. ICRA formally known as the investment Information & Credit Rating Agency of India (ICRA) was promoted by the Industrial Finance Corporation of India (IFCI). It was incorporated on Jan. 16, 1991 as public limited company and started functioning with effect from September 1, 1991. The ICRA also performs credit rating functions and finalizes its rating norms and standards in consultation with Credit Rating Information & Services of India Ltd. (CRISIL) ICR A has an authorized Capital of Rs. 10 crores. Industrial Finance Corporation of India (IFCI), Unit Trust of India, Life Insurance Corporation of India, General Insurance Corporation of India, Housing Development Finance Corporation of India, Infrastructure Leasing and Financial Services, State Bank of India, and 17 commercial banks are its shareholders.
Progress of ICRA, Since its inception till end of March, 1996 ICRA has rated 778 debt instruments involving an amount of Rs. 93,380. The Government has already announced compulsory rating for all debentures end bonds expect the following :
1. Issue of non-convertible debentures upto Rs. 5 crores on private placement basis including with mutual funds. 2. All issues of fully convertible into equity shares within 18 months from the date of issue at per determined price. 3. Public sector bonds and private placement of debentures with financial institutions banks.