Fund Based Activities

29/12/2020 0 By indiafreenotes
  1. Leasing:

Leasing is the most significant development as a method of procuring assets which has taken place in the field of finance during the past five decades although it was on real estate leasing at first During the past several years, various firms are granting lease almost all types of fixed assets.

There are two principal techniques of leasing, viz.:

(i) Leasing rather than purchasing the assets

(ii) Sale and Lease Back.

However, in the case of former, a firm makes a contract to rent an asset from another firm.

Advantages of Leasing:

There are some authorities who do not accept all the advantages of lease financing.

But the following advantages are accepted by them:

(i) Permits a lease to obtain the use of property that he cannot acquire in any other way;

(ii) Provides facilities that are needed only temporarily;

(iii) Avoids the risks of obsolescence;

(iv) Relieves the user of maintenance, service and administrative problems;

(v) Provides an additional source of financing; and

(vi) Gives the lease flexibility.

The following four advantages are not accepted unanimously by the authorities. They are:

(i) Lease frees working capital;

(ii) It yields a tax savings;

(iii) It improves the lessees’ apparent financial position; and

(iv) It spares management the need to review capital expenditure.

Disadvantages of leasing:

(i) High cost

(ii) Loss of residual values

(iii) The possibility that a premium will be demanded for vital equipment unless adequate care is taken when the lease is negotiated

(iv) Inadequate evaluation due to habitual leasing

(v) The lack of accumulation of equity, which could have some adverse effects on future financing; and

(vi) Various facilities may be lost at the end of the lease period.

However, the validity of the above disadvantage depends on the various alternatives which should carefully be chosen while negotiating lease agreement. Because, there are several factors which directly affect the leasing finance for alternations, e.g., rate of tax, the repayment schedule, the rate of interest, the method of depreciation etc.

Classification of Leases:

(a) Operating Lease:

Under the circumstances it does not impose any long-term obligation neither the lessor nor the lessee and it may be cancelled by either side after serving a stipulated notice, e.g., the rental of an office space on a 3-year lease cancellable on 30 days.

(b) Service Lease:

Under the circumstances, the lessor supplies both financing and servicing the asset during the lease period. Usually, capital assets, e.g., computers, trucks etc. are leased under this type of contract which provide maintenance or servicing of the assets

(c) Financial Lease:

Under the circumstance, the lease arrangement is considered as long- term lease on fixed assets which must not be cancelled either by the lessor or by the lessee. It is, practically, like long-term debt financing.

Characteristics of Leases:

(1) Service Leases:

Services leases are becoming popular as the modern machinery and equipment require frequent specialised maintenance and servicing.

Its significant characteristic are:

(i) Cost of Maintenance is included in Lease:

According to the terms, the lessor is liable for maintaining the equipment and supplying all routine services including repairs It actually protects the lessee from correcting major break-downs for the same,

(ii) Lease may be Cancelled:

Usually, the service lease is cancelled by the lessee. For this purpose, the lessee makes some provisions for a penalty if the lease is cancelled before its expiry date although a stipulated notice is necessary for cancellation.

(iii) Equipment Machinery may not totally he Amortized:

In case of amortization, usually a firm writes it off completely during the period under consideration. In this type of lease, however, the lease payment may be insufficient to allow the lessor to recover the original cost of such asset which implies that the lease period is comparatively less than the service life of the asset.

(2) Financial Leases:

The characteristic of financial leases is noted below:

(i) Long-Term Period:

These types of leases cover a long-time period, e.g., 1 to 10 years. At this period, the firm must have to satisfy lease requirements even if the equipment becomes obsolete or of no use.

(ii) Rigid Obligation:

It imposes certain obligations. It cannot be cancelable.

(iii) Fully Amortizing:

According to the terms of agreement the lease covers the service period i.e., if the expected life of the equipment/machinery is 10 years, the firm also takes the period of lease approximately 10 years.

It is interesting to note that if asset possess an indefinite life, like Land and Building, the lease will be written as even service life may be considered as 30 years. Under the circumstance, the Land and Building is totally amortized.

(iv) Profit earned during the period of lease:

This lease gives some profit to the lessor (i.e., total lease payment is more than the total cost of the assets) during the period of lease. If the asset possesses any residual value, the entire amount will be treated as an extra profit.

Sources of Funds for Leasing. It has been highlighted above that financial institutions, insurance companies, finance companies and institutional investors supply funds for leasing. In other words, a firm who seeks funds finds various institutions for the purpose.

Some of them are:

(a) Commercial Bank

At present commercial banks are increasingly interested in lease financing. The banks make necessary arrangement to buy equipment and lease the same to a customer either directly or through a company. As the additional service is provided by the bank it attracts the customers for other financial services.

(b) Financial Service Companies:

We know that there are some commercial finance companies/leasing companies who supply the necessary funds for specialised machinery or equipment. Usually these companies take expert staffs who are acquainted with the re-sale market for such specialised equipment or machinery and terms of the lease agreement is practically developed by them.

(c) Life Insurance Companies:

The Life Insurance Companies are quite known in long-term leasing, particularly in the case of real estate. Usually a life insurance company has a large cash inflow which can easily be invested as the amount is not immediately required for the payment of policies. As such, these excess cash can easily be invested by them in office-building, warehouse which can be leased to the occupants.

2. Hire-Purchase:

A line-put transaction is one when the seller owner of certain goods delivers has goods to a person (known as hire-purchase) with a condition that he (hire-purchaser) with repay the price of the goods which is inclusive of certain amount of interest) by different specified periodical instalments and acquires the property (goods) immediately but the same is transferred only when the last instalment is paid.

In other words, a hire purchase agreement is one under which a person takes delivery of goods promising to play the price by a certain number of instalments and. until full payment is made, to pay hire charges for using the goods. The law regaining the subject has been codified by the parliament in 1972 viz the Hire-Purchase Act (No 25 of 1972).

Generally a certain sum of money is paid at the time of taking delivery known as down payment’ or ‘initial payment’ and the instalment is paid at the end of the period, say, yearly, half-yearly or quarterly. Needless to mention here that the total payment made under hire purchase agreement should always be higher than the cash price since interest is charged with cash price of hire-purchase transactions.

Legal Position/Hire-Purchase Agreement:

The Hire-Purchase Act came into being on 1st Sept 1972. According to the Act, a hire-purchase agreement means “an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement and includes an agreement under which:

(i) Possession of goods is delivered by the owner thereof to a person on condition that such person pays the agreed amount in periodical installments

(ii) The property in the goods is to pass to such person on the payment of the last of such instalments

(iii) Such person has a right to terminate the agreement at any time before the property so passess” :Sec. 2 (c).

The following terms are widely used in hire-purchase transactions:

(a) Price:

The H. P. Act defines various terms in relation to prices which are noted below:

(i) Cash Price Installment:

An amount which bears to the net price the same proportion as the amount of the hire-purchase instalment bears to the total amount of hire- purchase price.

(ii) Hire-Purchase Price:

The total sum payable by the hirer as per hire-purchase terms in order to complete the transac­tions.

(iii) Net Hire-Purchase Charges:

The difference between the net hire-purchase price and the net cash price of the goods.

(iv) Net Cash Price:

Total cash price less any deposit.

(v) Down Payment:

The amount which is paid at the time of taking delivery of the goods.

(vi) Net Hire-Purchase Price:

Total amount of hire-purchase price minus:

(a) Delivery expenses, if any;

(b) Registration or other kinds of fees related to agreement; and

(c) Insurance expenses, if any.

(b) Hirer:

The person who obtains the possession of goods from the owner under a hire-purchase agreement.

(c) Hire:

The sum payable periodically by the hirer under the agreement.

(d) Installment:

The amount which is inclusive of interest together with principle paid at the end of the period.

According to Sec. 4 the contents of hire-purchase agreement which includes the following:

(i) The hire-purchase price of the goods to which the agreement relates;

(ii) The case price of the goods i.e., the price at which the goods may be purchased by the hirer for cash;

(iii) The date on which the agreement shall be deemed to have commenced;

(iv) the number of installments by which the hire-purchase price is to be paid, the amount of each of those instalments and the date, or the mode of determining the date, upon which it is payable, and the person to whom and the place where it is payable;

(v) The goods to which the agreement relates, in a manner sufficient to identify them;

(vi) where any part of the hire-purchase price is, to be paid otherwise than by cash or by cheque, the hire-purchase agreement shall contain a description of that part of the hire-purchase price; and

(vii) where any of the above requirements has not been complied with, the hirer may institute a suit for getting the hire-purchase agreement rescind, and the court may, if it is satisfied that the failure to comply with any such requirement has prejudiced the hirer, rescind the agreement on such terms as it thinks just, or pass such other order as it thinks fit in the circumstances of the case.”

  1. Bill Discounting:

When the holder of a bill wants to get the money before the due date, he can sell the bill to a bank against a small charge, known as discounting charges i.e., a supplier or creditor of goods discounts the incomes for sale of goods.

Discounting charge is imposed by the bank at a fixed rate present p. a from the date of discounting to the date of maturity. At present in our country, through the discounting of bills of exchange a major part of lending of money taken place by commercial banks.

However, a clean bill carries only the personal security of the drawer and drawee, but a documentary bill, however, accom­panied by Bill of Lading, Railway Receipt or other documents of title of goods, which provide extra security in addition to the personal security of the drawer and drawee.

It is needless to say that if the bill is dishonored by the drawee/drawer, the bank naturally will recover the amount from the drawer/creditor of the bill.

  1. Factoring:

A factor is a financial institution who takes the responsibility of financing and collecting debts that may arise out of credit sales. It is done on a continuous basis. Under the arrangement as soon as new bills receivables come in they are taken by the factor and the proceeds are credited to the accounts of the client correspondingly.

If there is no default or irregularities overdraft facility may also be allowed In Western country, factoring is well-established.

But in our country, factoring have been set up by nationalized banks only in four regions, viz:

(i) State Bank of India (in the West);

(ii) Canara Bank (in the south);

(iii) Punjab National Bank (in the north); and

(iv) Bank of Allahabad (in the east)

However, RBI Study Group suggested that there is greater scope of factoring in India and the demand has been estimated at about 4.000 crores. They also suggested that in the case of Textile, Engineering, Automobile Ancillaries, Chemicals and Consumer Durable industries factoring services are urgently needed.

Characteristics of a Factoring Arrangement:

(i) The factor takes the responsibility for realising/collecting the debts. It pays to the client when the amount is collected or at the end of the credit period which one is earlier for each and individual transaction.

(ii) Usually, the factors take a commission of 1% to 3% of the face value of the debt.

(iii) It may be on the following two basis:

(a) Recourse basis (when risk is borne by the client);

(b) Non-recourses basis (when risk is borne by the factor).

In our country, however the former one is taken into consideration.

(iv) The factor usually advanced 70% to 80% of the face value of the debt and the rate of interest becomes a slight higher than the prevailing bank rate although the factor advances the credit against not yet dud not yet collected debts to the clients.

  1. Venture Capital:

Venture capital implies the financial investment to high-tech growing companies (i.e., higher risk based) as equity capital with the expectation of a higher rate of return which is inclusive of initial as well as development capital for a company.

Although the concept is very old, it is not widely accepted. Sometimes, this capital is being introduced as a result of the product of any scientific improvement and technology and to bring it into real world situation. It also helps the new companies to issue shares who find it difficult.


It is to be noted that there is no such standard form on which venture capital will be supplied.

However, the following characteristics are denoted:

(i) In the first two years, the financial burden becomes negligible;

(ii) The venture capital firms take a high degree risk with the expectation of a high rate of return in future

(iii) Usually, the venture capital firms desires to liquidate its investment after 3 to 5 year

(iv) The Venture Capital firm takes the active participation in the management of the assisted firm including the help extended to procure fund