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P E S Institute of Technology

Department of MBA

100 Feet Ring Road, BSK III Stage, Bangalore560 085

A TERM PAPER

On

Long Term Financing for Working Capital

Submitted in fulfillment of the requirements for the 3rd SEM

MBA

ADVANCE FINANCIAL MANAGEMENT

Submitted to : Submitted By :

Prof. GV Sharma Soujanya.N

Dept Of MBA 1PB11MBA31

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Introduction

There are many reasons why a company may require long term financing,

such as if a failing company is confident that it will recover its loss by the next

fiscal year, a growing company that needs financing to expand its business,

working capital required to meet the customers huge order, etc.

Long term financing is normally desired by company running low on

their capital deficit business fund. The term of finance is more than a year, and

depending on the type of the company, non-Corporations are limited to using

debt finance while Corporations can use both debt and equity products in theirlong term financing strategies.

Objectives

Explain the meaning and purpose of long term finance. Identify the various sources of long term finance. Discuss the merits and demerits of long term borrowing from commercial

banks.

Long Term Finance Meaning

A business requires funds to purchase fixed assets like land and building, plant and

machinery, furniture etc. These assets may be regarded as the foundation of a

business. The capital required for these assets is called fixed capital. A part of the

working capital is also of a permanent nature. Funds required for this part of the

working capital and for fixed capital are called long term finance.

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Purpose of long term finance:

Long term finance is required for the following purposes:

1. To Finance fixed assets: Business requires fixed assets like machines,Building, furniture etc. Finance required to buy these assets is for a long

period, because such assets can be used for a long period and are not for

resale.

2. To finance the permanent part of working capital: Business is a continuingactivity. It must have a certain amount of working capital which would be

needed again and again. This part of working capital is of a fixed or

permanent nature. This requirement is also met from long term funds.

3. To finance growth and expansion of business: Expansion of businessrequires investment of a huge amount of capital permanently or for a long

period.

Factors determining long-term financial requirements :

The amount required to meet the long term capital needs of a company depend

upon many factors. These are:

(a) Nature of Business: The nature and character of a business determines the

amount of fixed capital. A manufacturing company requires land, building,

machines etc. So it has to invest a large amount of capital for a long period. But a

trading concern dealing in, say, washing machines will require a smaller amount of

long term fund because it does not have to buy building or machines.

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(b) Nature of goods produced: If a business is engaged in manufacturing small and

simple articles it will require a smaller amount of fixed capital as compared to one

manufacturing heavy machines or heavy consumer items like cars, refrigerators

etc. which will require more fixed capital.

(c) Technology used: In heavy industries like steel the fixed capital investment is

larger than in the case of a business producing plastic jars using simple technology

or producing goods using labour intensive technique.

Sources of long term finance

The main sources of long term finance are as follows:

1. Shares:These are issued to the general public. These may be of two types: (i) Equity

and (ii) Preference. The holders of shares are the owners of the business.

2. Debentures:These are also issued to the general public. The holders of debentures are the

creditors of the company.

3. Public Deposits :General public also like to deposit their savings with a popular and well

established company which can pay interest periodically and pay-back the

deposit when due.

4. Retained earnings:The company may not distribute the whole of its profits among its

shareholders. It may retain a part of the profits and utilize it as capital.

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5. Term loans from banks:Many industrial development banks, cooperative banks and commercial

banks grant medium term loans for a period of three to five years.

6. Loan from financial institutions:There are many specialized financial institutions established by the Central

and State governments which give long term loans at reasonable rate of

interest. Some of these institutions are: Industrial Finance Corporation of

India ( IFCI), Industrial Development Bank of India (IDBI), Industrial

Credit and Investment Corporation of India (ICICI), Unit Trust of India (

UTI ), State Finance Corporations etc. These sources of long term finance

will be discussed in the next lesson.

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Punjab National Bank

Credit is provided for: Financing stock in trade, book debts and other assets to be usedin the trade.

Acquiring of assets for furnishing of shop & show room like

partition, fixture and furnishing etc, purchase of air-

conditioners, other gadgets and delivery van required for

running the business.

Eligibility i) Traders, who are individuals, firms, HUFs, cooperative

societies registered under any law relating to cooperative

societies and companies etc. Promoters /co-obligants must have

existing satisfactory relationship of minimum at least six month

with the Bank.

ii) Traders should comply with applicable statutory

requirements, such as State/Central Sales Tax RegistrationCertificate, Licence under Shops & Commercial Establishment

Act, Registration with Excise Department, etc.

iii) Advances against goods or any other item prohibited by

RBI/Govt. from time to time will not be covered under this

scheme.

Extent of Loan for Working

Capital

Term Loan: 70% of the cost of assets to be purchased with a

maximum of Rs.100 lac for Metro and Urban centre and Rs. 25

lac for SU and rural centre.

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Security Primary Security: Legally enforceable charge by way of

hypothecation/pledge/assignment, etc. on stocks/book

debts/fixed assets/block assets of the borrower;

Collateral Security- Legally Enforceable Equitable/Registered

Mortgage of IP / pledge or creation of charge on liquid security

having realizable/ surrender value equal to the amount of

loan/credit facilities;

Loans /limits up to Rs.5 lac, advance should be collaterally

secured by way of suitable third party guarantee.

Repayment Working capital limit upto Rs.5 lac granted by way of term loan(WCTL) will be repayable in equal monthly/quarterly

instalments within a period of 3-5yr

The term loan for acquiring fixed assets will be repayable in

equal monthly/quarterly instalments within a period of 5 to 7

years including moratorium period of 3-6 months.

Disbursement For term loan for fixed assets and working capital, the loan

amount shall be payable directly to the suppliers of the assets by

draft/cash order.

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Birla Sun Life Insurance Company

Birla Sun Life Insurance Company also known as BSLI is one of the renowned

names in the field of insurance in India. This insurance company is a result of a

joint venture between Aditya Birla Group, a multinational company in India and

Sun Life Financial Inc, a leading global name in the field of insurance. Birla Sun

Life Insurance has to its credit of being the first company in the field of financial

solution to start the Business Continuity Plan. The vision of the group is to create

long term value together with market leaders.

The primary aim of the company is to help customers ease risks of life, accident,

health and money at every stage and under any circumstance. The company works

towards making the financial future and enterprises of the customers better than

what they currently are. All the works undertaken at Birla is done with integrity,

full commitment, passion and ample speed.

Silent features of BSLI

Birla Sun Life Insurance initiated the Unit Linked Life Insurance Solutions inIndia.

In 4 years, BSLI has made its position very strong as a leading player in theprivate Life Insurance Industry.

The company's focus has been on investment linked insurance products,supported with protection products to uphold leadership in product

modernization

Web-enabled IT systems for superior customer services First to have issued policies over the Internet

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Corporate governance and a high degree of transparency in all businesspractices and procedures

BSLI Solutions

Birla Sun Life Insurance Company provides individual and other solutions to

customers based on their varied needs. So whether the customer wants long term

protection or short term protection plans, the company has it all for their clients.

The insurance solutions offered by the company are:

Protection Solution Retirement Solutions Children's Future Solutions Health & Wellness Solutions Wealth with Protection Solutions

The protection solutions are ideal for someone who wishes to separate their

insurance and investment needs. The terms of the insurance are made in a way so

that it deals with the most basic need of life insurance, which is the provision of

life cover. The children's future solutions aim to take care of all the financial needs

of the child in the best way possible. The health and wellness solutions have

provisions to take care of any financial emergency that may come up in the

family.

Birla Sun Life Insurance Products

Birla Sun Life Insurance Term Plan is ideal for those who are seeking to get

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insurance benefits at a lower price. The plan covers all liabilities and provides

complete security to the clients. The minimum age of a customer seeking this

insurance must be 18 years and the maximum age must be 55 years. Premium

payment options range from monthly to annual to quarterly to semi annually

depending on the policies. Listed below is some of Birla Sun Life Insurance saving

policies:

1. Birla Sun Life Insurance Prime Life2. Birla Sun Life Insurance Dream Plan3. Birla Sun Life Insurance Gold-Plus II4. Birla Sun Life Insurance Simply Life5. Birla Sun Life Insurance Flexi Life Line6. Birla Sun Life Insurance Supreme-Life7. Birla Sun Life Insurance Life Companion8. Birla Sun Life Insurance Flexi Save Plus9. Birla Sun Life Insurance Flexi Cash Flow

Balance Sheet of Birla Sun Life

Sources Of FundsMar05

12 mths

Mar '06

12 mths

Mar '07

12 mths

Mar '08

12 mths

Mar '09

12 mths

Total Share Capital 124.40 124.40 124.49 124.49 124.49

Equity Share Capital 124.40 124.40 124.49 124.49 124.49

Share Application

Money0.00 0.09 0.00 0.77 1.68

Preference Share 0.00 0.00 0.00 0.00 0.00

Reserves 942.73 913.78 1,639.29 2,571.73 3,475.93

Revaluation Reserves 0.00 0.00 0.00 0.00 0.00

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Net worth 1,067.13 1,038.27 1,763.78 2,696.99 3,602.10

Secured Loans 1,253.35 1,221.93 1,151.25 982.66 1,175.80

Unsecured Loans 278.03 229.90 427.38 757.84 965.83

Total Debt 1,531.38 1,451.83 1,578.63 1,740.50 2,141.63

Total Liabilities 2,598.51 2,490.10 3,342.41 4,437.49 5,743.73

Gross Block 4,304.29 4,605.38 4,784.70 4,972.60 7,401.02

Less: Accum.

Depreciation1,755.39 2,068.21 2,267.42 2,472.14 2,765.33

Net Block 2,548.90 2,537.17 2,517.28 2,500.46 4,635.69Capital Work in

Progress48.18 141.03 696.95 2,283.15 677.28

Investments 184.79 172.39 483.45 170.90 1,034.80

Inventories 283.71 379.57 433.58 609.76 691.97

Sundry Debtors 171.95 172.55 183.50 216.61 186.18

Cash and Bank Balance 56.26 61.50 89.59 100.69 104.49

Total Current Assets 511.92 613.62 706.67 927.06 982.64

Loans and Advances 338.86 168.23 265.46 390.43 395.71

Fixed Deposits 0.00 0.10 0.00 0.00 0.00

Total CA, Loans &

Advances850.78 781.95 972.13 1,317.49 1,378.35

Deferred Credit 0.00 0.00 0.00 0.00 0.00

Current Liabilities 1,010.27 1,103.26 1,308.93 1,708.96 1,860.59

Provisions 23.87 39.18 18.47 125.55 121.80

Total CL & Provisions 1,034.14 1,142.44 1,327.40 1,834.51 1,982.39

Net Current Assets -183.36 -360.49 -355.27 -517.02 -604.04

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Miscellaneous

Expenses0.00 0.00 0.00 0.00 0.00

Total Assets 2,598.51 2,490.10 3,342.41 4,437.49 5,743.73

Contingent Liabilities 130.74 685.42 1,942.56 645.17 355.07

Book Value (Rs) 85.78 83.46 141.69 216.59 289.22

Net Working Capital = Current Assets Current Liabilities

Here,

Current Assets = Inventories + Sundry Debtors + Cash at Bank + Loans &

Advance

Particulars 2005 2006 2007 2008 2009

Inventories 283.71 379.57 433.58 609.76 691.97

Sundry Debtors 171.95 172.55 183.50 216.61 186.18

Cash At Bank 56.26 61.50 89.59 100.69 104.49

Loans And Advances 338.86 168.23 265.46 390.43 395.71

Total Current Assets 850.78 781.95 972.13 1317.49 1378.35

Assuming Loans and advances as Current Assets.

Current Liabilities = C.L + Provisions

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Particulars 2005 2006 2007 2008 2009

C.L 1010.27 1103.26 1308.93 1708.96 1860.59

Provision 23.87 39.18 18.47 125.55 121.80

Total of Current Liabilities 1034.14 1142.44 1327.40 1834.51 1982.39

Net Working Capital = CA CL

Particulars 2005 2006 2007 2008 2009

Current Assets 850.78 781.95 972.13 1317.49 1378.35

Current

Liabilities1034.14 1142.44 1327.40 1834.51 1982.39

Net Working Capital -183.26 -360.49 -355.27 -517.02 -604.04

Interpretation

When we analyse the Working Capital Management of the company, we can say

that the company is not in the good position because in all of the 5 years the

companys Net Working Capital is negative. The net working capital in the year

2005 was604.04 crore and in the year 2006 it was517.02. Then it slightly

improved to355.27 crore in the year 2007 and it was360. 49 in the year 2008

and finally in the year 2009 it was183.26 crore. Though the companys net

working capital is negative in all the five years, it seems to improving because the

negative balance in the working capital is decreasing. This implies that the

company is improving its net working capital management.

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This is a good sign for the companys management as they are able to check this

fault and the situation seems to be improving throughout the upcoming period.

Ratio Analysis

Ratios 2005 2006 2007 2008 2009

Current

Ratio

0.82 0.68 0.732 0.718 0.695

Quick

Ratio

0.54 0.35 0.40 0.38 0.34

Absolute

Ratio

0.38 0.20 0.54 0.50 0.44

Working notes:

Current Ratio = Current Assets/Current Liabilities Quick Ratio = Quick Assets/ Current Liabilities

(Quick Ratio = Current AssetsStockPrepaid Expenses)

Absolute Liquid Ratio = Quick AssetsStockBills ReceivablesDebtors

Standard for Ratios:

Current Ratio = 2:1 Quick Ratio = 1:1 Absolute Ratio = 0.5:1

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Interpretation

When we analyze the ratios of the company then we can find that the company isnot in the good position. The companys overall current ratio is not up to the

standard. The companys current ratio in the year 2005 was 0.82 which is far

below the standard that is 2:1. Again in the year 2006 its current ratio is 0.68,

which too is below the standard and it has also reduced from that which it was in

the year 2005. Further analysing the ratio we can say that the current ratio of the

company is not improving and is reduced to 0.695 in the year 2009.

When we analyse the Quick ratio of the company which should be 1:1, the

company is again not up to the standard. The Quick ratio of the company is 0.54 in

the year 2005, 0.35 in the year 2006, 0.40 in the year 2007 and the same was 0.38

in the year 2008 and finally it was 0.34 in the year 2009. What we can analyse

from this that in non of the five years the companys quick ratio is up to the

standard. In all those five years the company has its quick ratio less than the

required. This implies that the company is not up to the standard.

However when we analyse the absolute ratio of the companys absolute ratio is

near the standard. Since it should be in the ratio of 0.5:1, the company is able to

maintain the standard of its absolute ratio. In all the five years the companys

absolute ratio is near to the standard. Hence we can say that company is able to

maintain its standard in the absolute ratio

Finally when we analyse the overall Net Working Capital Management and Ratio

Analysis of the company then we can say that the company is not in the good

position. The company should pay attention towards the management of its

working capital and besides its liquidity management is also not good.

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The financial team can also consider long term financing for working capital and

should pay attention towards this problem if the company is to improve its

situation in the coming period of time.

Conclusion

Two very useful business tools to access risk management are the capital

asset pricing model and the discounted cash flow model. The best mix of

debt/equity will provide the investor with the best returns. A clear understanding of

the definition of debt, equity and dividends will definitely be a plus to anyone

wanting to start a business.

Debt instruments such as notes, bonds, certificates, mortgages, leases or

other agreements between a lender and a borrower are used to obtain long term

finance to sustain a business operation. Bond is another alternative to debt

financing. People who purchased bond will be paid a specific interest during the

term that they possessed the bond. Common and preferred stock are equity

financing. Leasing, another form of debt financing, allows the lessee to use the

property without buying it and usually useful for the company that do not have

fund even for the down payment. Long term financing of working capital is also

preferred.