Page 28 - DMGT409Basic Financial Management

Unit 2: Source of Finance

3. Too many formalities are to be fulfilled for getting term loans from banks. These formalities Notes
make the borrowings from banks time consuming and inconvenient.

2.2.7 Lease Financing

Lease is a contract whereby one can use the assets of the other with due permission of the owner
on payment of rent without purchasing them. The owner of the asset is called ‘lessor’ and the
user is called lessee. The period of use is called the lease period after which the lessee may opt
for purchase of the asset.
So leasing is an arrangement that enables a business enterprise to use and exercise complete
control over the assets without owning it. The owner gets rent in return and at any time as per the
terms of the contract he can cancel the agreement. This system helps the business to use the plants

and machinery and other fixed assets for a long period of time without investing a large amount
of money in purchasing them. At the end of the lease period the asset goes back to the owner. The
owner of the assets also has the option of selling it to the user at a reduced price. Sometimes the
user company may request the leasing company to purchase its existing assets and allow them to
use the same assets on lease basis. This enables the company to save the long-term funds that can
be utilised for other purposes. This is known as ‘sale and lease back’ system.

2.3 Instruments of Raising Short-term Finance

Sources of short-term funds have to be used (exclusively) for meeting the working capital

requirements only and not far fi nancing fixed assets and for meeting the margin money for
working capital loans.

The various sources of short-term financing are as follows:
2.3.1 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 fi nancial 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.

LOVELY PROFESSIONAL UNIVERSITY 21