RAISING AND DEPLOYMENT OF FUNDS

 Raising of Funds 

A business entity requires funds to run the business. A business entity has no fund on its own. Every business entity runs on borrowed funds. A business entity borrows funds in the form of : 

· Equity 

· Debt

The strategy for borrowing in the form of debt and equity has been covered in the capital structure decisions. 

Before we go into the details of different sources of funds, we have to first discuss the purpose of the fund. As we have discussed in the previous modules, business borrows funds mainly for three purposes: 

1. Purchase /building up of current asset 

2. Purchase/building up of non-current asset 

3. Repayment of liability 

Now we have to make some ground rule about how the financing of different assets would take place. These rules can change depending on the nature of borrower i.e. depending on the borrower’s level of operation.

Purpose	Type of Borrowing	Borrower nature
Non Current Asset	Equity; Long Term Loan	Start up; Small and Medium SME; Mid corporate ; Large Corporate
Current Asset	Equity ; Long term loan ; Short term loan	Start up; Small and Medium SME
Non Current Asset	Short term loan	Large Corporate

Besides, the stage of development of the business and nature of business would also decide the type of borrowing. This is explained with the help of the following table:

Stage	Nature of business	Sources of Funds
Early stage	High Uncertainty	Equity; mainly angel funds
Early stage	High to Moderate Uncertainty	Equity, Venture Capital and Debt
Growth Stage	Moderate to Low Uncertainty	Debt, Venture Capital and Private Equity
Stable Stage	Low Uncertainty	Debt

Almost all major traditional sources of funds have been covered in the paper of Financial Management (Intermediate Level) and some other sources have been covered in the Paper of Strategic Financial Management (Final Level) and in the chapter Nos. 5 and 10 of this Study Material.

Hence, we shall discuss one another source of funding is ‘Factoring’. 

Factoring 

Since Domestic Factoring is covered in the paper of Financial Management (Intermediate Level) under the topic of Receivable Management hence we shall discuss factoring in context of International Transactions. In international transactions, factoring of receivable is also a very important corporate banking product. In most of the international trade transactions, besides the normal credit risks, it involves additional concepts of country and therefore sovereign risks comes into play. 

Sovereign risks in international business are usually of three broad categories: 

· Transaction Risk: It is linked to a specific transaction that involves a specific amount within a specific time frame, such as an export sale on six month’s draft terms; 

· Translation Risk: It stems from the obligation of multinational companies to translate foreign currency assets and liabilities into the parent company’s accounting currency regularly, a process that can give rise to book- keeping gains and losses. 

· Economic Risk: In the broadest sense, it encompasses all changes in a company’s international operating environment that generate, real economic gains or losses. 

Export credit is quite distinct from the domestic counterpart in several respects. The principal characteristics of export credit which distinguish it from the domestic sales are as follows: 

· Longer time scales for delivery, funds transfer and credit period; 

· Extra time and distance require terms which provide a security for the risks perceived; 

· The expectation of local credit terms for each market 

· Competition from other countries having different money costs and government policies; 

· The use of international standard terminology. 

This feeling of insecurity and risks involved in international transactions has, therefore, resulted in various methods of payment system, the most secure of these being the Advance Payment or Cash with Order (CWO). The other two prevalent methods of receiving payments are through the mechanism of Bills of Exchange and Documentary Credit. In both these methods, the banking system is the channel through which the transactions are normally carried out. Though advantageous to the sellers, secured to a certain extent, except the concept of clean bills of exchange (here shipping documents are not enclosed), usually in a competitive environment, debtors are not inclined to open letters of credit because of the cost and time involved. Further, the entire mechanism of operations through letter of credit is gradually going out of favour throughout

the world primarily on account of what is known as Doctrine of Strict Compliance. The seriousness of the problems is evident from a survey conducted in United Kingdom which revealed that more than 50 percent of documents failed to comply with the terms of letter of credit in first presentation to the banks. 

In view of the constraints of the existing systems, open account transactions are also coming into existence in larger numbers than in the past. Under this system, there is direct arrangement between the exporter and the importer to complete the deal including the payment by a predetermined future date, usually between 60 days and 90 days from the date of invoice. The goods and the shipping documents are sent directly to the importer enabling him to take delivery of goods. The essential features of open account transaction are listed as follows: 

1. Complete confidence in the credit standing not only of the debtors but also of his country so that proceeds of the goods can be realized within the agreed period. 

2. An efficient sales ledger administration often in multi currencies coupled with credit control mechanism involving sound knowledge of trade practices, law and knowledge of the importer’s country. 

3. Sufficient liquidity source to grant competitive credit terms to the importer. 

In such a situation, export factoring can play a very important role not only in providing finance but also in providing a service package to exporters. Export factoring can broadly be defined as an agreement in which export receivables arising out of sale of goods/services are sold to the factor, as a result of which title to the goods/services represented by the said receivable passes on to the factor. Henceforth, the factor becomes responsible for all credit control, sales accounting and debt collection from the importers. 

Advantages of International Factoring 

The distinct advantages of a factoring transaction over other methods of finance/facilities provided to an exporter can be summarized as follows: 

1. Immediate finance up to a certain percentage (say 75-80 percent) of the eligible export receivable. This pre-payment facility s available without a letter of credit –simply on the strength of the invoice(s) representing the shipment of goods. 

2. Credit checking of all the prospective debtors in importing countries, through own databases of the export factor or by taking assistance from his counterpart(s) in importing countries known as import factor or established credit rating agencies. 

3. Maintenance of entire sales ledger of the exporter including undertaking asset management functions. Constant liaison is maintained with the debtors in importing countries and collections 

are effected in a diplomatic but efficient manner, ensuring faster payment and safeguarding of financial costs. 

1. Accordingly, bad debt protection up to full extent (100 percent) on all approved sales to agreed debtors ensuring total predictability of cash flows. 

2. Undertaking cover operations to minimize potential losses arising from possible exchange rate fluctuations. 

3. Efficient and fast communication system through letters, telex, telephone or in person in the buyer’s language and in line with the national business practices. 

4. Consultancy services in areas relating to special conditions and regulations as applicable to the importing countries. 

Two- Factor System 

The most important form of factoring is two- factor system. The transaction is based on operation of two factoring companies in two different countries involving in all, four parties: Exporter, Importer, export Factor in exporter’s country and import factor in importer’s country. The mechanics of operation in this arrangement works out as follows: 

1. The exporter approaches the export factor with relevant information which, inter alia, may include 

a) Type of business, 

b) Names and addresses of the debtors in various importing countries, 

c) Annual expected export turnover to each country, 

d) Number of invoices/credit notes per country, 

e) Payment terms and 

f) Line of credit required for each debtor. 

2. Based on the information furnished, the export factor would contact his counterpart (import factor) in different countries to assess the creditworthiness of the various debtors. 

3. The import factor makes a preliminary assessment as to his ability to give credit cover to the principal debtors. 

4. Based on the positive response of the import factor, the factoring agreement is signed between the exporter and export factor. 

5. Goods are sent by the exporter to the importer along with the original invoice which includes an assignment clause stipulating that the payment must be made to the import factor.

Simultaneously, two copies of the invoice along with notifications of the debt are sent to the export factor. At this stage, prepayment up to an agreed per cent (say 75-80 percent) of the invoice(s) is made to the exporter by the export factor. 

1. A copy of the invoice is sent by the export factor to his counterpart, that is the import factor. Henceforth, the responsibilities relating to book- keeping and collection of debts remain vested with the import factor. 

2. Having collected the debts, the import factor remits the proceeds to his counterpart, that is export factor. In case, payments are not received from any of the debtor(s) at the end of the previously agreed period on account of financial inability of the debtor concerned, the import factor has to pay the amount of the bill to his export counterpart from his own funds. However, this obligation will not apply in case of any dispute regarding quality, quantity, terms and conditions of supply etc. If any dispute arises, the same has to be settled between the parties concerned through the good offices of the factoring companies, otherwise legal action may have to be initiated by the import factor based on the instructions of the exporter/export factor. 

3. On receipt of the proceeds of the debts realized, the retention held (say 15-20 percent) is released to the exporter. The entire factoring fee is debited to the exporter’s account and the export factor remits the mutually agreed commission to his importing counterpart. 

Thus, the export factor undertakes the exporter risk whereas the importer risk is taken care of by the import factor. 

The main functions of the export factor relate to: 

· Assessment of the financial strength of the exporter 

· Prepayment to the exporter after proper documentation and regular audit and post sanction control 

· Follow- up with the import factor 

· Sharing of commission with the import factor The import factor is primarily engaged in the areas of: 

· Maintaining books of exporter in respect of sales to the debtors of his country 

· Collection of debts from the importers and remitting proceeds of the same to the export factor 

· Providing credit protection in case of financial inability on the part of any of the debtors. 

The two factor systems are by all means the best mode of providing the most effective factoring facilities to a prospective exporter. However, the system is also fraught with certain basic

disadvantages, i.e. delay in operations like credit decision, remittance of fund, etc., due to involvement of many parties. 

Deployment of Funds 

So far as the deployment of funds in commercial and corporate organisation is concerned same is governed by the various techniques such as capital budgeting, cost benefit analysis etc. 

The deployment of funds is an important area in context of banks. Apart from lending the money in normal business banks have to lend funds on priority basis for some Government sponsored schemes such as Prime Minister’s Rozgar Yojana (PMRY), Swarna Jayanti Shahari Rozgar Yojana (SSRY) and Swarnajayanthi Grama Swarozgar Yojana (SGSY). 

RBI fixes the target for these priority sector on time to time basis.