It is important that a business secures all the capital required to make it a viable and profitable proposition. The capital is required at different points of time, in different amounts. Capital can be brought from various sources which have various advantages and disadvantages. There is a limitation on how much capital the promoters themselves can bring in. There is a limitation on how much debt capital a company can raise from banks and other financial institutions.
Many small and medium enterprises in India do not take any long term loans, or take very small amount of long term loan. They prefer to be debt free companies. On one hand this reduces the risk of default and liquidation of the company, but this is not efficient. This reduces the return on investment for the shareholders. The shareholders equity capital should be coupled with an appropriate amount of loans from banks and other credit facilities. A business can do larger turnover with the bank funds and generate large cash flows.
Subject to the technical limitations, immediately after the commissioning of a manufacturing facility, the plant should start operating about break even operating capacity. Required working capital for operating beyond break even operating capacity, should be made available as a part of project management and not as a part of operations management. A manufacturing facility can reach hundred percent operating capacity from the break even capacity only if it starts operating beyond break even capacity right from the beginning. If a plant operate below break even capacity for a substantial period of time in the beginning, the company makes losses and subsequently may have to be closed. In the Indian small and medium enterprises, it has been observed that the working capital is misconstrued as short term capital. The banks provide cash credit and overdraft limits based on the existing level of inventory or any other security. A business cannot borrow working capital without providing existing inventory for new security. In the project planning, if provisions are not made for this, the plant starts operating at very low capacity in the initial period; pet me not be able to recover the fixed costs; it may not be able to to generate sufficient cash to serve the date of the banks. Can be termed as infant mortality e of a small and medium Enterprise.
Once the initial long term fixed component of working capital for operations level break even are taken care, the internal accruals of the operations can provide the increase in working capital every year to reach hundred percent operating capacity. If it is impossible for a business to make available all this working capital because it is too huge, then such business should negotiate a Moratorium of 6 months to a couple of years till the company starts operating beyond the break even operating capacity. Initial amount of working capital should be treated as part of the main capital in the process of capital structuring.
The cash credit and overdraft limits available from a bank are supposed to be used frugally
And should not be treated as if they are long term-capital. The rates for these loans are high and if a certain minimum amount is going to be permanently needed, it should be replaced with the long term loan.
Whether it is equity capital or state capital, they are not simple in nature and come in a wide variety of of instruments. They have hundreds of features and parameters. These aspects of the capital instruments play a very important role for the financial stability and sustainability of a company. They are also important from the the control perspective of the existing owners.
The important aspects in raising capital are:
1. It should be made available in sufficient quantity
2. The terms and conditions should be acceptable
3. The cost of capital should be low
4. The company should be able to generate required Returns
5. The company should be able to make timely repayments with sufficient safety margin
The three key elements of the financing strategy
1. Make available the capital which can predict your resources for efficient and effective operations
2. Reduce the cost of capital
3. Reduce the cost of raising capital
The number of resources and the types of resources today’s business capital come in a wide variety. The selection of the the type of capital, the specific company or refund should be made in line with the financial strategy of the company.
Apohan provides the services for structuring of the capital of a new project, of a new business are of an existing business.