Unit 4 Financing Projects o Fixed or variable interest, repaid

over time.
• Sources of finance o Requires good credit and may
When financing projects, especially in business or involve collateral.
large-scale operations, selecting the right source 2. Debentures
of finance is critical. Here’s a breakdown of the o Long-term loans from investors
main sources of finance: with a fixed return.
o Used by large companies, requires
Internal Sources of Finance paying interest regardless of
These come from within the business or profits.
organization. 3. Hire Purchase / Leasing
1. Retained Earnings o Used to finance equipment or
o Profits that are reinvested into the vehicles.
business. o Payments spread over time, no
o No interest or repayment large upfront cost.
obligations. 4. Grants and Subsidies
o Suitable for stable companies with o Provided by government or NGOs.
consistent profits. o No repayment, but often come with
2. Sale of Assets strict eligibility criteria.
o Selling non-essential assets to raise 5. Venture Capital / Angel Investors
capital. o Investors provide funds in
o Good for quick cash but may exchange for equity.
impact operations if key assets are o Useful for startups and high-risk
sold. projects.
3. Owner’s Capital / Equity 6. Crowdfunding
o Money invested by the owners or o Raising small amounts of money
shareholders. from many people, typically
o No interest, but dilutes ownership online.
if new shareholders are added. o Useful for creative, tech, or
community projects.
External Sources of Finance 7. Initial Public Offering (IPO)
o Selling shares to the public.
These involve money from outside the business.
o Suitable for large businesses
Short-term Sources (usually repaid within a
year): looking to expand.
1. Bank Overdrafts
o Quick access to extra cash up to a
limit.
o High interest rates, used for urgent
cash needs.
2. Trade Credit
o Buying now and paying later (often
30–90 days).
o Helps with cash flow but can affect
supplier relations if delayed.
3. Factoring
o Selling receivables (invoices) to a
third party.
o Quick cash but at a discounted rate.
Medium- to Long-term Sources:
1. Bank Loans
 • Equity Types of Debt Financing:
What is Equity Financing? 1. Bank Loans
Equity financing involves raising money by o Fixed amount borrowed, repaid in
selling shares of your company to investors. In installments with interest.
return, investors gain ownership interest in the o Suitable for medium to long-term
business. projects.
2. Debentures
Types of Equity Financing: o Long-term debt instruments issued
1. Owner’s Equity by companies to raise money from
o Money invested by the founders or the public or institutions.
business owners. o Interest is paid regularly, and the
2. Angel Investors principal is repaid at maturity.
o Wealthy individuals who invest 3. Bank Overdrafts
early in startups in exchange for o Short-term facility allowing
equity. businesses to withdraw more than
3. Venture Capitalists (VCs) they have in their account, up to a
o Firms that invest larger amounts in limit.
businesses with high growth 4. Trade Credit
potential. o Suppliers allow businesses to buy
4. Crowdfunding (Equity-Based) now and pay later.
o Small amounts raised from many 5. Factoring
individuals online, offering equity o Selling invoices to a third party at a
in return. discount to get immediate funds.
5. Initial Public Offering (IPO) 6. Hire Purchase / Leasing
o When a company offers its shares o Financing for purchasing
to the public for the first time on a equipment or vehicles, paid over
stock exchange. time with interest.

Advantages of Equity Financing: Advantages of Debt Financing:

• No repayment obligation like loans. • Ownership is retained (no equity dilution).
• Brings in expertise and networks from • Interest payments are tax-deductible.
investors. • Predictable repayment structure.
• Reduces financial stress during early
growth phases. Disadvantages of Debt Financing:
• Must be repaid with interest (even if the
Disadvantages of Equity Financing: project fails).
• Loss of ownership and control. • High debt can strain cash flow.
• Profit sharing (dividends) may be • May require collateral (in case of secured
expected. loans).
• Decisions might be influenced by
shareholders Securities
Securities are financial instruments that hold
Debit monetary value and can be traded. They are
What is Debt Financing? often used by companies and governments to
Debt financing involves raising capital by raise capital.
borrowing money from external sources such as Types of Securities:
banks, financial institutions, or private lenders. a) Equity Securities
The business retains ownership but must repay the • Represent ownership in a company.
borrowed amount with interest. • Example: Shares or stocks.
• Shareholders may receive dividends and
voting rights.
b) Debt Securities 3. Secured Debentures: Backed by company
• Represent borrowed money that must be assets.
repaid. 4. Unsecured Debentures: No specific
• Example: Bonds and debentures. collateral; higher risk for investors.
• Investors receive fixed interest payments Advantages:
and return of principal. • No ownership dilution.
c) Hybrid Securities • Tax-deductible interest payments.
• Combine features of both debt and equity. • Flexible terms for companies.
• Example: Convertible debentures (can be Disadvantages:
converted into shares). • Interest must be paid regardless of profits.
• May affect credit rating if not managed
Borrowings well.
Borrowings refer to any funds obtained through
loans that need to be repaid over time, usually Working Capital Requirement (WCR)
with interest. Working Capital Requirement refers to the
Types of Borrowings: amount of capital a business needs to cover its
a) Short-Term Borrowings day-to-day operational expenses such as paying
• Used to meet working capital needs. wages, buying raw materials, covering bills, and
• Examples: Bank overdrafts, trade credit, managing inventory.
short-term loans.
b) Long-Term Borrowings Definition
• Used for capital expenditure or large Working Capital Requirement (WCR)=Current As
projects. sets−Current Liabilities
• Examples: Term loans from banks, • Current Assets: Cash, inventory, accounts
external commercial borrowings (ECBs), receivable (debtors)
bonds. • Current Liabilities: Accounts payable
Advantages: (creditors), short-term loans, outstanding
• Faster access to large amounts. expenses
• Does not dilute ownership.
Disadvantages: Why is WCR Important?
• Fixed repayment schedule regardless of • Ensures smooth business operations
profits. • Avoids disruptions due to cash shortages
• May require collateral or creditworthiness. • Helps maintain good credit relationships
with suppliers
Debentures • Supports growth and expansion by
Debentures are a type of long-term debt enabling timely purchases and production
instrument companies use to borrow money from
investors. Factors Affecting Working Capital
Key Features: Requirement:
• Fixed interest rate (coupon rate). 1. Nature of Business
• Paid to investors periodically (e.g., o Manufacturing needs more
annually or semi-annually). working capital than service
• Principal repaid at the end of the term businesses.
(maturity). 2. Business Cycle
• May be secured or unsecured. o More capital is needed during
Types of Debentures: expansion than recession.
1. Convertible Debentures: Can be 3. Credit Policy
converted into equity shares. o Generous credit to customers
2. Non-Convertible Debentures (NCDs): increases WCR.
Cannot be converted into shares.
 oDelay in supplier payments reduces • Provide financial services similar to banks
WCR. but cannot accept demand deposits.
4. Inventory Management • Offer loans, hire purchase, leasing, and
o High inventory levels require more asset financing.
working capital. • Examples: Bajaj Finance, Shriram
5. Operating Cycle Transport Finance
o Longer the cycle (purchase to cash
collection), higher the WCR. 3. Investment Institutions
They help in mobilizing and investing public
How to Finance Working Capital: savings.
1. Internal Sources • LIC (Life Insurance Corporation) –
o Retained earnings insurance + investment
o Sale of surplus assets • UTI (Unit Trust of India) – mutual fund
2. External Sources investments
o Bank overdrafts • Mutual Funds – pool investor money to
o Short-term loans invest in diversified portfolios
o Trade credit
o Factoring 4. Insurance Companies
• Offer risk coverage through policies.
Financial Institutions – Explained • Examples: LIC, ICICI Lombard, HDFC
Financial institutions are organizations that Ergo
provide financial services such as loans, savings,
investments, insurance, and currency exchange. 5. Microfinance Institutions
They play a crucial role in mobilizing savings, • Provide small loans to the poor and
providing credit, and supporting economic underserved, especially in rural areas.
development. • Focus on financial inclusion.
• Example: SKS Microfinance
Types of Financial Institutions
1. Banking Institutions Functions of Financial Institutions
These accept deposits and provide credit and other • Mobilize public savings
financial services. • Provide credit to individuals and
a) Commercial Banks businesses
• Offer services like savings & checking • Facilitate trade and commerce
accounts, personal/business loans, credit • Promote rural and industrial development
cards. • Help in financial planning and wealth
• Examples: SBI, HDFC Bank, ICICI management
Bank
b) Cooperative Banks Direct and Indirect Financial Assistance
• Operate in rural and semi-urban areas. Financial assistance can be provided in two main
• Owned by members; serve small forms: direct and indirect. Both play a vital role
businesses and farmers. in supporting businesses, industries, and
c) Regional Rural Banks (RRBs) individuals, but they operate in different ways.
• Provide credit to rural and agricultural
sectors. 1. Direct Financial Assistance
d) Development Banks This refers to financial support given directly to
• Long-term finance for industry and businesses, industries, or individuals, usually by
infrastructure. banks, financial institutions, or the
• Examples: NABARD (agriculture), government.
SIDBI (small industries), IDBI Examples:
• Term Loans: Loans for buying machinery,
2. Non-Banking Financial Companies (NBFCs) equipment, or setting up infrastructure.
 • Working Capital Loans: Funds for daily Purpose For specific To support
operational expenses. needs/projects broader
• Equity Participation: When institutions financial
invest directly in the company's equity. access
• Grants/Subsidies: One-time financial Example Loans, grants, equity Refinance,
support that doesn’t need repayment. s investment guarantees,
• Venture Capital: Direct investment in interest
high-potential startups. subsidies
Features:
• Funds are given straight to the recipient.
• Meant for specific projects or purposes.
• Can be short-, medium-, or long-term.
• Comes with terms like interest rates and
repayment schedules.

2. Indirect Financial Assistance

This refers to support given to intermediaries
(like banks, NBFCs, or state finance bodies),
which is then passed on to the final users.
Examples:
• Refinance Schemes: Institutions like
NABARD or SIDBI lend to banks, which
then lend to farmers or small businesses.
• Guarantee Schemes: Government or
institutions guarantee loans taken by
MSMEs, reducing risk for banks.
• Interest Subsidies: A portion of the
interest is paid by the government to make
loans affordable.
• Export Credit Refinance: RBI provides
funds to banks for financing exporters.
Features:
• Given through intermediaries, not
directly to the end-user.
• Helps in risk-sharing and increasing
lending capacity of banks.
• Often used in priority sectors like
agriculture, MSMEs, exports.

Key Differences
Basis Direct Assistance Indirect
Assistance
Given End-users Intermediari
To (individuals/business es (banks,
es) NBFCs,
agencies)
Flow of Straight from Through
Funds provider to user intermediari
es