Each and every industrial undertaking and business concern needs loans and advances from time to time to meet its requirements. However, the duration of loan may vary depending upon the nature of the requirement to be met. Broadly, the financial requirements of a concern may be divided into three categories short-term, medium term and long-term. Short-term finance is required to meet the day-to-day working capital requirements. Long term finance is arranged for a far longer period often seven years or more.
Term Finance means a mid-term or intermediate loans arranged for a period ranging between three to seven years depending upon the nature of work for which they are sought. Such loans are required for replacements and additions to fixed assets or for meeting expansion or diversification requirements. They are repaid in regular periodic instalments, hence they may be called Amortised Loans. Term loans are sought by the borrowers not only for one single purpose. There are many purposes some of the important ones are:-
To install a new machinery or plant by arranging term loans in the hope that the increased installed capacity will enable the concern to repay the loans quickly.
To purchase a permanent asset or to make certain additions to existing property or asset.
To take advantage of rapid industrialisation and install a machinery equipped with modern techniques to start production of a new product or for modernisation of plants and machineries.
To refinance the funded debts or to pay off bonds or debentures bearing a high rate of interest. It will reduce the burden of interest on the profits of the company.
To rearrange maturities, eliminate the restrictive provisions of bond issues and in redeeming the preference shares.
The major sources of term finance in India are:-
This is the primary source of term finance in India. Many term lending institutions have been established, mostly in the public sector. Such institutions are Commercial Banks, Life Insurance Corporation, Finance Corporations established by the special acts of the central or state governments, investment trusts, etc. Commercial Banks and financial institutions constitute the hard core of term financing in India. They are generally repayable in more than one year but less than ten years. They are offered by the All India Financial Institutions. The interest rate on the term loans will be fixed after the financial institutions appraises the project and assesses the credit risk. Term loans can be either in rupee or foreign currency, are generally secured through a first mortgage of immovable properties or hypothecation of movable properties.
Besides commercial banks and financial institutions, public deposits also played an important role in providing term loans to industries in India. Companies collected a large amount and were able to attract a large section of individual's savings in public deposits.
Conditional Sales Contracts
This system is also known as Hire Purchase or Instalment Purchasing System. Here, machineries or any asset is purchased on deferred payment terms. A small part of the purchase consideration is paid immediately at the time of making contract and the balance is paid in easy instalments together with interest as agreed upon between the purchaser and the seller. Financing companies and/or banks take guarantee for such payments and sometimes, they arrange such sales.
Financing through internal accruals can be done through the depreciation charges and the retained earnings. While depreciation amount can be utilised for replacing old machinery, retained earnings can be utilised for funding other long-term objectives of the firm. The major advantages the company gets from using internal accruals are its easy availability, elimination of issue and administrative expenses and the problem of dilution of control.
This takes the form of Leasing or Hire Purchase. Leasing is a contractual agreement between the lessor and the lessee, wherein companies can enter into a lease deal with the manufacturer of the equipment or through some other intermediary. This will give the company the right to use the asset till the maturity of the lease and can later return the asset or buy it from the manufacturer. The company will have to pay lease rentals, which is at a negotiated rate and payable every month. Very similar is Hire Purchase, except that in this case, the ownership is transferred to the buyer after all the hire purchase instalments are paid up.
Commercial Paper & Public Note Issue
Long Term Commercial Papers (CPs) and Public Notes are usance promissory notes with a fixed maturity period, issued mostly by the leading, reputed, well established large corporations who have a high credit rating. It can be issued by body corporates whether financial or non-financial. These are usually for a period ranging from three to seven years.
This discussion thread is closed. If you want to continue this discussion or have a follow up question, please post it on the network. Add the url of this thread if you want to cite this discussion.