Page 55 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes factors of the enterprise. Some venture capital financiers give a choice to the enterprise of
paying a high rate of interest (which could be well above 20 per cent) instead of royalty on
sales, once it becomes commercially sounds.

3. Income note: It is a hybrid security, which combines the features of both conventional loan
and conditional loan. The entrepreneur has to pay both interest and royalty on sales but at
substantially low rates. IDBI's VCF provides funding equal to 80-87.50% of the projects
cost for commercial application of indigenous technology.
4. Participating debenture: Such security carries charges in three phases - in the start-up
phase, no interest is charged, in next stage a low rate of interest is charged up to a particular
level of operation, after that, a high rate of interest is required to be paid.

Self Assessment

Fill in the blanks:
10. A ………………. loan is repayable in the form of a royalty after the venture is able to
generate sales.
11. ………………. is a hybrid security, which combines the features of both conventional loan
and conditional loan.
3.6 Leasing and Hire Purchase as a Source of Finance

A lease is a contractual arrangement under which the owner of an asset (called the lessor) agrees
to allow the case of its asset by another party (lessee) in exchange of periodic payments (lease-
rental) for a specified period. The lessee pays the lease rent as a fixed payment over a period of
time at the beginning or at the end of a month, quarter, half year or year. Although generally
fixed, lease rents can be tailored both in terms of amount and tuning to the profits and cash flow
position of the lessee. At the end of the lease contract, the asset reverts back to the real owner i.e.,
the lessor. However, in long-term lease contract, the lessee is generally given the option to buy
or renew the lease.
Lease agreements are divided into two major ones – operating lease and financial lease.
Operating lease is for periods shorter than the useful life of the asset and is cancelable at the
option of the lessee. On the other hand, financial lease involves a relatively longer-term
commitment on the part of the lessee and non-cancelable during the entire period specified in
the contract. Operating lease is common among equipments/assets exposed to technological
obsolescence such as computers, data processing equipments.
Financial leases are commonly used for leasing land, buildings and large pieces of fixed
equipments.

Advantages of Leasing

1. Shifting the risk of technological obsolescence to the owner (lessor) the leasing company.
2. Easy source of finance: A lessee (user of the machine) avoids many of the restrictive
covenants that are normally in the long-term loan agreements while borrowing from
financial institution or commercial banks.
3. Enhance liquidity: A firm having shortage of working capital or forecasting liquidity
problem may exercise the option of the selling the owned asset to a lesser (leasing company)
and take it back on lease basis (the transaction is known as sale cum lease back).
4. Conserving borrowing capacity through off the balance-sheet financing.

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