Financial Requirements of a New Enterprise Chapter-3 Financial Requirements of a New Enterprise Author: Alpana Trehan © 2011, Dreamtech Press :: Chapter 3

Financing a new enterprise An enterprise needs to determine its financing requirements, before its set up. An enterprise has two types of financial requirements: Fixed capital Helps in purchasing the fixed assets such as land, buildings and furniture Also called as long term capital Amount depends on the nature and size of the business Generates income and profits in long term Working Capital Implies the amount of money required for the day-to-day management of the business Covers expenses on raw materials, wages and salaries, advertising, rent, fuel, electricity and water Also called as revolving capital or circulating capital © 2011, Dreamtech Press :: Chapter 3

Financial Requirements on the Basis of Period of Use Long-Term Capital Refers to the capital required for a period of five years or more. Helps to finance the fixed capital and the permanent part of the working capital. Raised through various sources, such as by issuing shares and debentures and taking loans from financial institutions. Medium-Term Capital Refers to the capital required for a period of two to five years. Performs various activities, such as renovation of buildings, expenditure on advertising, and modernization of machinery. Raised through various sources, such as by issuing shares and debentures and reinvestment of profits. Short-Term Capital Refers to the capital required for a period of less than a year. Helps to finance the current assets and meet day-to-day expenses. Raised through various sources, such as banks, trade credit, and installment credit. © 2011, Dreamtech Press :: Chapter 3

© 2011, Dreamtech Press :: Chapter 3 Fixed cost The fixed cost includes the expenses of an enterprise that do not change with change in the levels of production. The following are the fixed cost of an enterprise: Land and Site Development Construction Cost Plant and Machinery Technical Knowhow Utility Cost Miscellaneous Fixed Assets © 2011, Dreamtech Press :: Chapter 3

Land and Site Development Purchase price of land Legal and registration charges Leveling of land Laying of internal and approach roads Boundary wall / fencing of land Gates and site office Tube well and electrification for project implementation Any other expense of similar nature © 2011, Dreamtech Press :: Chapter 3

Construction cost Factory buildings Production shed Boiler House Transformer room/ generator room Workshop Laboratory Non-factory buildings Ware house Stores Security house Workers’ rest room Parking Time office/ excise room Administrative block Essential quarters for workers Canteen © 2011, Dreamtech Press :: Chapter 3

Plant and Machinery Basic cost of equipment Excise/ custom duty and sales tax Transshipment cost (from vendor to site) and insurance during transportation Erection and foundation cost Piping cost © 2011, Dreamtech Press :: Chapter 3

Basic cost of technology development or purchase Technical Knowhow Basic cost of technology development or purchase Training cost for employees Royalty paid (if lump sum) © 2011, Dreamtech Press :: Chapter 3

Generator/ Transformer Utility Cost Boiler Compressor Generator/ Transformer Underground / overhead water tank Effluent treatment plant © 2011, Dreamtech Press :: Chapter 3

determinants of working capital Work in Progress Finished Goods Inventory Receivables Raw Material Inventory © 2011, Dreamtech Press :: Chapter 3

© 2011, Dreamtech Press :: Chapter 3 Sources of finance Long-term Finance Medium-term Finance Short-term Finance © 2011, Dreamtech Press :: Chapter 3

Sources of Long-Term Financing A method of raising long-term funds by selling the common and preferred stock of the enterprise to the investors Equity Financing An agreement between a debenture holder and the enterprise, which acknowledges that the enterprise would repay the debt at a specified date to debenture holders Debt Financing The long-term loans that are raised for the duration of 3 to 10 years from financial institutions Term Loans © 2011, Dreamtech Press :: Chapter 3

Sources of medium-Term Financing An agreement between the owner of assets, called the lessor, and the user of assets, called the lessee Lease Finance Funds and loans raised from general public, employees, and other similar kind of depositors Public Deposits The accumulated profit for future investments, which can be short-term or long-term in nature Retained Earnings An agreement between a hiree (the owner of assets) and a hirer (the user of the assets) Hire Purchase © 2011, Dreamtech Press :: Chapter 3

Sources of short-Term Financing An arrangement in which the supplier allows the buyer to pay for goods and services at a later date in future Trade Credit The art of payment made in advance by the customer to the enterprise for the procurement of goods and services in the future Customer Advances The borrowed amount is paid in equal installments with interest Installment Credit The amount of money granted by the bank at a specified rate of interest for a fixed period of time Bank Loan An arrangement made by the bank for the clients to withdraw cash exceeding their account limit Cash Credit An instrument used by the enterprise with high credit rating to raise money from the market Commercial Papers A promissory note issued by the bank to the investors for depositing funds in the bank for a fixed period of time Certificate of Deposits A document in which an individual asks the recipient to make payment for goods and services received to a third party at a future date Bills of Exchange A temporary arrangement with the bank that allows the organization to overdraw from its current deposit account with the bank up to a certain limit Bank Overdraft © 2011, Dreamtech Press :: Chapter 3

Institutions Providing Financial Assistance Reserve Bank of India State Bank of India Bank of Baroda Andhra Bank Small Industries Development Organization (SIDO) National Small Industries Corporation Ltd (NSIC) © 2011, Dreamtech Press :: Chapter 3

Venture Capital Funding It is a source of finance for newly established small and medium enterprises willing to raise funds. Independently managed, dedicated pools of capital that focus on equity-linked investments in privately held, high-growth companies. ---- Gompers and Lerner (1999: 11) Methods of Venture Funding in India: Equity Conditional Loans Income Note © 2011, Dreamtech Press :: Chapter 3

Venture Capital Funding Process Involves interaction between venture capitalists and entrepreneurs regarding the investments in business proposals Deal Initiation Involves an initial screening of all the projects on the basis of certain criteria, such as the size of investment, geographical location, and stage of financing Preliminary Screening Includes activities that are associated with evaluating an investment proposal Due Diligence Involves negotiation between the venture capitalist and the entrepreneur regarding the terms and conditions of the deal Deal Structuring Indicate the activities performed by venture capitalist after finalizing and completing the deal with the entrepreneur Post Investment Activities Refers to a stage when the venture capitalist wishes to exit from the business Exiting © 2011, Dreamtech Press :: Chapter 3

© 2011, Dreamtech Press :: Chapter 3 recap Finance is prerequisite for mobilizing the resources of an enterprise. Financing a new enterprise essentially involves two things, namely, estimating the funds/capital requirement and deciding sources. Estimating financial requirements for a startup enterprise involves determining the total amount of capital required for various needs of the business and deciding the sources and methods to raise it. Venture capital is an important source of finance for newly established small and medium enterprises willing to raise funds. © 2011, Dreamtech Press :: Chapter 3