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

2. 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

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

4. © 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

5. 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

6. 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

7. 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

8. 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

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

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

11. © 2011, Dreamtech Press :: Chapter 3
Sources of finance
Long-term Finance
Medium-term Finance
Short-term Finance
© 2011, Dreamtech Press :: Chapter 3

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. © 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