Page 52 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 3: Sources of Finance

Notes

Notes It has been presumed that both the concerns are good. Payment of interest has been
ignored. It has been presumed that cash credit limit is being enhanced gradually.

The above graphs clearly indicate that at the end of 1999 the term loan would be fully settled
whereas the cash credit limit might have been enhanced to over a lakh of rupees. It really
amounts to providing finances for the long-term.

This technique of providing long-term finance can be technically called "rolled over for periods
exceeding more than one year". Therefore, instead of indulging in term financing by the rolled
over method, banks can and should extend credit term after proper appraisal of applications for
terms loans. In fact, as stated above, the degree of liquidity in the provision for regular
amortization of term loans is more than some of these so-called demand loans that are renewed
from year-to-year. Actually, term financing disciplines both the banker and borrower as long-
term planning is required to ensure that cash inflow would be adequate to meet the instruments
of repayments and allow an active turnover of bank loans. The adoption of the formal term loan
lending by commercial banks will not in any way hamper the criteria of liquidity and as a
matter of fact, it will introduce flexibility in the operations of the banking system.
The real limitation to the scope of bank activities in this field is that all banks are not well
equipped to make appraisal of such loan proposals. Term loan proposals involve an element of
risk because of changes in the conditions affecting the borrower. The bank making such a loan,
therefore, has to assess the situation to make a proper appraisal. The decision in such cases
would depend on various factors affecting the conditions of the industry concerned and the
earning potential the borrower.

3.4.4 Commercial Papers (CPs)

Commercial paper represents a short-term unsecured promissory note issued by firms that
have a fairly high credit (standing) rating. It was first introduced in USA and it was an important
money market instruments. In India, Reserve Bank of India introduced CP on the
recommendations of the Vaghul Working Group on money market. CP is a source of short-term
finance to only large firms with sound financial position.

Features of CP

1. The maturity period of CP ranges from 15 to 365 day (but in India it ranges between 91 to
180 days).
2. It is sold at a discount from its face value and redeemed at its face value.
3. Return on CP is the difference between par value and redeemable value.

4. It may be sold directly to investors or indirectly (through) dealers.
5. There is no developed secondary market for CP.

Eligibility Criteria for Issuing CP

CP is unsecured promissory note, the issue of CP is being regulated by the Reserve Bank of
India. RBI has laid down the following conditions to determine the eligibility of a company that
wishes to raise funds through the issue of CPs.
1. The Tangible Net Worth (TNW) of the company, as per latest audited balance sheet should
not be less than 4 crore.

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