Paper 3.4: PROJECT FINANCING. Financial institutions of India Introduction Institutional framework Types of Assistance Project financing scheme IDBI

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1 Paper 3.4: PROJECT FINANCING UNIT 1 Financial institutions of India Introduction Institutional framework Types of Assistance Project financing scheme IDBI UNIT 2 Project Financing Estimating the Total Capital Requirements Factors Determining the Fixed Capital and Working Capital Judicious Financing Plan Capital Gearing Matching of Project Requirements with Available Financial Assistance from Various Sources. UNIT 3 Means of Project Financing: Public issue of Shares. Debentures, Public Deposits, Leasing, Internal Generation of Funds, Commercial Papers, Global Depository Receipts, Borrowings from Banks and FIS Venture Capital innovative in the capital Market. UNIT 4 Pre-sanctions Appraisal Evaluation of Commercial Aspects: Estimation of Demand supply Gap, Distribution Channels and Selling Arrangements Appraisal of Managerial and Technical aspects. Evaluation of Managerial Skills, Past Records, Management and working of other Group Companies Evaluation of Appropriateness of Technology, Availability of Raw Materials and Utilities and Safeguards Against Pollution. Effluent Disposal / Treatment. UNIT 5 Project Appraisal Evaluation and Financial Aspects: Debt Equity Ratio, Current Ratio, Debt Service Coverage Ratio, Return on investment, Security Margin, Internal Rate of Return and Break even Analysis. Project Appraisal Economic Analysis: Economies of Scale, Employment Generation, Social Cost Benefit Analysis, Contribution to Government Revenue, Political Stability, Priority and Evaluation of International Competitiveness. UNIT 6 Project Monitoring Post Sanction Supervision and Follow up Steps to improve Recovery Industrial Sickness: Warning Signals and Causes Rehabilitation of a Sick Industrial Unit Role of the Board for industrial and Financial Reconstruction (BIFR). REFERENCES: 1. Machiraju H.R, Project Finance, Vikas Publ. House P. Ltd. 2. Pahwa H P S, Project Financing: Policies, Procedure and Practice. 3. James C Van Horne, Financial Management and Policy, Prentice Hall.

2 Course Material Prepared by Dr. P. NATARAJAN Reader in International Business and Commerce & Additional Controller of Examination, Alagappa University, Karaikudi. 2

3 CONTENTS Lesson Title Page No. 1 Introduction to Project Finance 4 2 Institutional framework 13 3 Estimation of Funds Requirements 24 4 Working Capital Loan Assessment and Sanction 34 5 Sources of Project Finance 41 6 Venture Capital and Global Depository Receipt 49 7 Project Financing Procedure and Practices 56 8 Pre-sanctions Appraisal 61 9 Project Appraisal Financial Appraisal Economic Appraisal Documentation Disbursement, Supervision and Followup Recovery Industrial Sickness Rehabilitation of Sick Projects Board for Industrial Finance and Reconstruction. 171 LESSON 1 PROJECT FINANCING Objectives 1. To study the nature and significance of project financing. 2. To know the different sources of finance available to the industrial project. 3

4 3. To identify the role of institutional agencies is extending support facilities to the industrial projects. Structure Introduction Means of financing Importance of project financing Role of Institutional Agencies: Commercial Banks Development Banks IFCI: ICICI: IDBI: SFC: SIDC Investing Institutions Conclusion Investment Companies: UTI: LIC, GIC Self Assessment Questions INTRODUCTION Project is a proposal for investment to create, expand and/or develop certain facilities in order to increase the production of goods and/or services in a community during certain period of time. It is a plan of specific activity desired to achieve a specific objectives within a specified period of time. In involves investment of capital resources to create durable assets from which one can expect to realise benefits over an extended period of time. Project financing assumes a prominent place in he planned economy so as to translate the plan objectives into bankable propositions. To judge a project from the financial angle. One need information about the following. Cost of the project, projected financial conditions and flows, means of financing, profitability, tax burdens and flows. Normally the cost of any industrial project require the sum of the outlays on the following: Land and Buildings, Plant And Machinery, Preliminary Expenses, Provisions for Contingencies and Margin Money. Means of Financing To meet the cost of project the following sources of finance may be tapped. 1. Equity Capital 2. Preference Capital 3. Secured debentures 4

5 Equity Capital 4. Debenture capital 5. Term loans 6. Deferred credit 7. Capital subsidy and development loans/sales tax loans 8. Unsecured loans and deposits. This is the contribution made by the owners of business the equity shareholders, who enjoy the rewards and bear the risks of ownership. However, their liability is limited to their capital contribution. From the point of view of the issuing firm equity capital offers two important advantages: (i) It represents permanent capital. Hence there is no liability for repayment (ii) It does not involve any fixed obligation for payment of dividends. The disadvantages of raising funds by way of equity capital are: (i) (ii) The cost of equity capital is high because equity dividends are not tax deductible expenses The cost of issuing equity capital is high. Preference Capital A hybrid form of financing preference capital partakes some characteristics of equity capital and some attributes of debt capital. It is similar to equity capital because preference dividend like equity dividend is not a tax deductible payment. It resembles debt capital because the rate of preference dividend is fixed. Typically, when preference dividend is skipped it is payable in future because of the cumulative feature associated with most preference issues. The high cost associated with it and the near fixity of preference issues. The high cost associated with it and the near fixity of preference dividend payment render preference capital somewhat unattractive in general as a source of finance, it is however, attractive when the promoters do not want a reduction in their share of equity and yet there is need for a wider net worth base (net worth consists of equity and preference capital) to satisfy the requirements of financial institutions. Secured Debentures A kin to promissory notes, debentures are instruments for raising long-term debt capital. Secured debentures are protected by a charge on the properties of the issuing company. Which the secured debentures of a well-established company may have appeal to investors, secure debentures of a new company do not evoke interest in investing public financial institutions also prefer to grant term loans rather than to subscribe to debenture issue. However, Unit Trust of India subscribes to privately placed debentures because under the Unit Trust of India Act, It is not empowered to grant loans. Term Loans 5

6 Term loans which represent secured borrowings are presently the most important source of finance for new projects. They carry a fixed rate of interest and are repayable over a period of 6-10 years in equal annual (or) semi-annual instalments. Term-loans are provided by banks, state financial / development institutions and all India term-lending financial Institutions. Banks and State level Institutions normally provide term loans to project which have a capital cost less than Rs.1.5 crores. If the project cost is between Rs.1.5 crores and Rs.5.0 Crores term loans are normally provided by all India financial Institutions and state-level financial Institutions, but not by commercial banks. For larger projects, where project cost exceeds rs.5 crores, all-india financial Institutions and state-level financial Institutions, but not by commercial banks. For larger projects, where project cost exceeds Rs.5 cores, all-india financial Institutions provide the bulk of term finance-banks too may participate in providing term finance to supplement the efforts of financial institutions. Deferred Credits: Many a time suppliers of machinery provide deferred credit facility under which payment for the purchase of machinery can be made over a period of time. The interest rate on deferred credit and the period of payment vary rather widely. Normally the supplier of machinery when he offers, deferred credit facility insists that bank guarantee should be furnished by the buyers. Capital Subsidy and Development Loans / Sales Tax Loans: Central Government provides capital subsidy to industries set-up in notified backward districts. The amount of this subsidy is equal to 15 percent of the cost of fixed assets (or) Rs.15 lakhs whichever is lower many state government or state development agencies also provide development loans / sales tax loans. They provide this facility for districts which are considered backward by them but which are not classified as notified backward districts by the central government. Unsecured Loans and Deposits: Unsecured loans are typically provided by the promoters to fill the gap between the promoters contribution required by financial institutions and the equity capital subscribed to by the promoters. These loans are subsidiary to the institutional loans the rate of interest chargeable on these loans is than the rate of interest on the institutional loans. Finally these loans cannot be taken back without the prior approval of financial institutions. Deposits from public referred to as public deposits represent unsecured borrowing of one to three years duration. Many existing companies prefer to raise public deposits restrictive covenants do not accompany public deposits. Public deposits, however, are not a viable source of finance company to raise public deposits. Further, it may be difficult for it to repay public deposits within three years. These sources of finance may be categorised into two groups viz.., 1. Equity (Owned funds) and 2. Debts (borrowed funds) 6

7 Equity is the ownership commitment whereas debts are funds obtained for the project from persons other than the owners either on the security of the assets of the project of on the basis of its bankability. In India, financial assistance to industrial projects is granted by commercial Banks, State Financial Corporations, State Directorate of Industries, Industrial Development Bank of India and Industrial Financial Corporations etc. Financial assistance provided by them are in the form of: Direct financing: Indirect Financing: modernisation. Promotional work: Miscellaneous activities: schemes of the Government. Term loans, subscriptions to shares / bonds Concessional finance to project in backward areas, soft loans for Surveys, feasibility studies and project identification. Mutual Financing, Administration of Incentives and subsidy Whatever my be the form of financing the projects, the following ingredients must be followed. a. proper arrangement for man-power planning. b. Organisational structure to carryout and operate the project. c. Adequate supervision which brings about relationship between the financial institution and the borrowers with mutual trust. Importance of Project Financing After independence number of financial institutions which now represent the most important source of finance for Industrial Projects have been established. They are: IFCI, ICICI, LIC, UTI, SFC etc. A complex structure of financial institutions are emerged now to provide the bulk of finance required for industry. In order to fulfil larger social and economical objectives financial institutions today perform a variety of financing and promotional activities and have formulated special programmes which lay emphasis on development of industries in backward areas, encourage competent new entrepreneurs, support modernisation efforts and promote the development of small scale sector. A project passes through many stages from the time when it is first conceived and identified as financially viable entity until it gets implemented. The process of identification, selection, preparation, appraisal, implementation and evaluation is thus a multipronged attempt involving harmonious job specifications by the economists, engineers, bankers, and the governmental agencies. Hence, there is a paramount need for planning while attempting the project financing. Wherever be the planner of project financing, the deciding factor is to know whether the project is bankable i.e., whether the projects are economically viable and technically feasible. Role of Institutional Agencies 7

8 Since independence numerous developmental finance institutions have been established to meet the growing and diversified need of industrial project. A complex structure of financial institutions has emerged. These institutions may be categorised as follows: Commercial Banks All India Institutions IFCI IDBI ICICI Other all India Institutions State level Institutions State Financial Corporation State Industrial development Corporations Investing Institutions: The role of all these institutional agencies in financing the industrial projects are discussed below: COMMERCIAL BANKS Commercial banks in India constitute a vital segment of Indian financial system. Although these institutions have been major suppliers of working capital finance to business enterprises, after the advent of the second five year plan, commercial banks have expanded their area of business activity and have assumed the role of term institutions also. Previously a major part of the liabilities of the banks were demand liabilities. But now, terms liabilities represent the bulk of their liabilities. As term institutional agencies, commercial banks assist enterprises by granting term loans, subscribing to shares and debentures of corporate enterprises and under-writing security issues of these enterprises. They render help to entrepreneurs in raising long-term funds capital market through merchant banking activity let us briefly discuss the nature of project long term financing of business by commercial banks. TERM LENDING Term lending facilities are dispensed by commercial banks under refinancing schemes. In order to encourage the banks to provide term loans to industrial projects. Government of India sponsored a formal scheme of term loans in 1958, under which the banks were to be provided refinancing facilities against approved term loans from Refinance Corporation of India (RCI), which was set up in June 1958 for the purpose. With the establishment of Industrial Development Bank of India (IDBI). RCI has been merged with the former with effect from September Under the refinance scheme, a commercial Bank can grant term loans to an enterprises upto Rs.80 lakhs. The ceiling on cost of projects eligible for assistance has been fixed at Rs.3 crores. The ceiling on terms loans eligible for refinance is Rs.2 crores. IDBI refinance percent of the loans except in the case of small scale industrial unit small road transport operations, units in backward areas and certain other specified categories, where the refinance could be upto 90 per cent of the loan. 8

9 Besides the term loans under the refinance scheme, commercial banks grant medium term credit comprising both loans granted initially for periods exceeding one year and shortterm loans rolled over periods exceeding one year. In considering term loan applications particularly from priority sectors including farmers, artisans, small road transport operators, commercial banks are expected to give primary consideration to viability factor and not to security factor. Thus, these projects have to be judged on the basis of whether the incremental income likely to be generated would be sufficient to ensure the repayment of the loan. Banks are not expected to insist on security and personal guarantee particularly in the case of priority sector applicants. The role of the banks is very likely to assume significant proportion in view of the latest measure taken by Reserve Bank of India (RBI). In June, 1988, RBI issued guidelines empowering the commercial banks to participate in the term financing of new industrial projects as well as expansion/ diversification/ modernisation of the existing industrial units to the extent of 25 per cent of the total loan assistance on a pari passu basis with the term financial institutions. UNDERWRITING OF CAPITAL ISSUES A firm can also raise funds through a commercial bank by getting its security issue underwritten by the bank. Although commercial banks in India were engaged in underwriting work on a continuous basis. Commercial banks primary consideration while considering underwriting proposal of firm is its financial strength and reputation rather than the viability of the issue perhaps because they are not keen in acquiring the securities underwritten by them. DIRECT SUBSCRIPTION Commercial banks render financial support to industrial undertakings by investing directly in their shares and debentures. However, such investment has been of limited amount. Banks total investment in corporate securities during the period amounted to only crores which constituted not more than 1 per cent of their total investment. MERCHANT BANKING ACTIVITY In addition to the provision of direct financial support, commercial banks in India are now assisting the firms in raising desired funds from capital market by performing merchant banking functions. Thus, as a merchant banker, commercial banks in India sponsor the security issue and undertake credit syndication activity. For sponsoring issues, the banks obtain consent from controller of capital issues, help in preparation of the prospectus, engage in tying-up arrangements for underwriting for the appointment of brokers and bankers to the issue, for press publicity and compliance with stock exchange listing requirements. They also rend help to the firms in the preparation of project profiles and loan application for assistance from various term financing institutions. A number of nationalised banks of late have launched subsidiaries to take up these activities on full scale. SBI Capital Markets Ltd., Canbank financial service Ltd., PNB Financial Service Ltd., are only a few examples. However, Indian commercial banks have yet to assume other important merchant banking activities such as project counselling. Corporate counselling, portfolio management, management and tax consultancy. 9

10 LESSON 2 INSTITUTIONAL FRAMEWORK Development banks are the institutions which supply capital, knowledge and enterprise, the three major ingredients of development for business enterprises. These enterprises in turnby augmenting their productivity can help the nation to develop rapidly. Economic growth and just distribution of its benefits is the primary concern of development banks while assisting business enterprises. In India several development banks both at the national level and state level were set up during post independence period to act as gap fillers in the capital market and accelerate the pace of rapid industrialisation in the country. These institutions render long term financial support and entrepreneurial and managerial assistance to all the deserving projects where access to the existing facilities was limited. In the following paragraphs we shall discuss upon objectives and functions of three national development banks, viz., Industrial Finance Corporation of India, and Industrial Credit and Investment Corporation of India and Industrial Development bank of India and state level developments banks viz., state Financial Corporations and State Industrial Development Corporations, The modes of assistance rendered by these institutions and terms and conditions of such assistance are also discussed. INDUSTRIAL FINANCE CORPORATION OF INDIA (IFCI) IFCI was the first national level development bank set up in 1948 by an act of parliament to make medium and long-term funds readily available to industrial concerns particularly when the normal banking support is inappropriate or going to the capital market is impracticable. In furtherance of the above objective IFCI provides financial assistance by granting and guaranteeing loans, underwriting the issue of shares and debentures and subscribing to shares and debentures of industrial concerns. The corporation also helps business enterprise in raising shares capital from capital from market and procuring term loans from other financial institutions. 10

11 The assistance of the corporation is available to any limited company in the public, joint or private sectors or a co-operative society which is engaged or proposes to engage itself in the manufacturing preserving or processing of goods or in the shipping mining or hotel industry or in the generation or distribution of electricity or any other form or power., transport, setting up or development of industrial estates, fishing, maintenance repair, testing or servicing of machinery, equipment, vehicles, etc. The corporation extends financial support for setting up new industrial projects as also for the expansion diversification, renovation or modernisation of existing one. While considering assistance application of an enterprise IFCI looks into the detailed technical financial managerial and economic and social aspects of the project in addition to national priorities indicated in five year plans and policies of the Government. IFCI oaters to the needs of medium and large projects either singly or jointly with other all-india Financial Institutions. Normally, the corporation considers projects costing upto Rs.5 crore independently. In respect or projects costing over Rs.5 crores, the corporation invites other all-india institutions to finance such projects under the system of consortium financing. A firm can get loan from the corporation for a period up to 25 years, such facilities are provided against regular legal mortgage of fixed assets both present and future. The corporation adopts a uniform margin of 50 percent. It also requires that the assets to be mortgaged should be fully insured against fire, riot and civil commotion risks. Another important condition of lending by IFCI is conversion of a part of the rupee loans into equity capital of the assisted concerns in cases where the aggregate financial assistance exceeds Rs.1 crore, However, the conversion option will be exercised in such a way that the corporation will not be able to acquire more than 40% of the share capital. However, in case of persistent default in payment of loans or mismanagement of the assisted concern, the corporations shareholding could go up to 51% or more. The convertibility clause does not apply in respect of foreign currency loans, rupee loans to co-operative sector, loans under soft scheme, loans to public sector undertakings and to those set up in No-industry/special regions districts. Many companies prefer not to go for institutional loans because of this convertibility clause. This is more so after the escorts case of early 80s. To avoid the problems which arise out to the convertibility clause the companies are either going for debenture issue of splitting the companies to get small amounts of separate loans to each company. In order to help firms in raising funds from the market IFCI assumed merchant banking role in As a merchant banker, the corporation renders counselling services to the new entrepreneurs and new corporate entities in formulating and implementing their projects and helping them in availing financial assistance from various financial intermediaries expeditiously. In May,1988 IFCI took up leasing business so as to provide equipment on lease to existing industrial concerns in the corporate and co-operative sectors. It is also contemplating to expand its leasing activities. INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA (ICICI) 11

12 The basic idea underlying the creation of ICICI was to meet the needs of industry for permanent and long-term funds in the private sector. Thus the corporation aims at: Assisting the creation, expansion and modernisation of industrial enterprises within the private sector of industry in India. Encouraging and promoting participation of private capital, both internal and external in such enterprise: and Encouraging and promoting private ownership of industrial investment and expansion of investment markets. ICICI renders financial assistance to industrial undertakings by providing loans repayable over the period of 15 years, subscribing to equity shares, sponsoring and underwriting new issues of shares and securities, guaranteeing loans from the private investment sources providing loans in foreign currency towards the cost of imported capital equipment, providing lease financing and by acting as a merchant banker. Although the corporation does not seem to have adopted any scheme of priorities, its underhand policy is to assist sound but financially weak enterprises and to those enterprises entering in non-traditional industries viz., engineering, petro chemicals and machine making. It lays considerable emphasis on balanced growth of the country and provides assistance to entrepreneurs setting up enterprises in backward regions of the country on a priority basis. Further, the corporation studies merits of a project from technical, financial, economic and management points of view. The corporation entertains loan application of Rs.5 lakhs and above. Like IFCI, ICICI grants loans with or without security. It insists on legal mortgage of all fixed assets. It also accepts a charge over the movables subject to hypothecation in favour of the loans company s banks for securing cash credit and overdraft facilities for working capital. The corporation generally seeks a margin of 50% which can be relaxed in the case of highly capital intensive projects. Beside providing direct financial support to industrial enterprises, ICICI has assumed the role of a merchant banker to assist these who are facing problems in raising capital from the market. As a merchant banker, the corporation is assisting both public sector and private sector enterprises in floating shares and marketing these shares. A form can also get venture capital from the corporation for projects involving development and/or commercialisation of new technologies. The corporation provides this capital in the form of participation is share capital, conditional loans and normal loans. INDUSTRIAL DEVELOPMENT BANK OF INDIA (IDBI) IDBI was established in 1964 with a view to propelling the wheels of industrial sector to achieve maximum growth by eliminating gaps in the capital market and supplying sinews of development to all financial agencies engaged in this task. To achieve this basic objective, IDBI is empowered to perform the following functions: 12

13 a) Coordinating Function: IDBI coordinates operations of all miniature financial institutions including IFCI, ICICI, LIC and UTI into a single integrated financial structure so that each might contributed to the total effect as it could. b) Financing Function: As an industrial financier, IDBI can assist all deserving projects regardless of their size which are experiencing enormous problem in assembling funds from normal channels. Its main endeavour in this regard is to ensure that no worthwhile support. IDBI can assist an enterprise directly and indirectly. As direct financier, it renders assistance to business concerns in the following ways: Granting Term Loans and Advances Subscribing to purchasing, or underwriting the issue of shares or debentures. Guaranteeing deferred payment due from industrial concerns to third parties and loans raised by them in the open market or form financial institutions. Direct assistance is usually granted for acquisition of fixed assets for setting up new units as well as for expansion, modernisation of renovation of existing units. Direct assistance is provided to such large scale and medium sized projects as have not been able to obtain their full requirements from other term financing institutions. As an indirect financier IDBI assistance takes the following forms: 1. Refinancing of industrial loans provided by commercial banks and state financial corporations. 2. Providing financial assistance to shares and debentures of financial institutions. 3. Refinancing of medium-term credit granted by commercial banks to exporters. 4. Rediscounting of bills In addition, IBDI assists industrial undertakings through merchant banking activity. In considering applications seeking assistance, IDBI is mainly governed by overall national objectives and priorities, such as balanced development of different parts of the country, extension of the benefits of economic progress to the economically weaker sections and wide spread diffusion of ownership of industry. It also examines technical, economic, financial and management s viability of the project. Usually IDBI ENDEAVOURS TO ASSIST BIGGER PROJECTS LC By coordinating the operations of the existing institutions and supplementing their resources. However, in certain cases, it also assist giant projects directly. In 1985 it decided to restrict its direct involvement in financing of relatively smaller projects. Thus, all new projects involving investment up to Rs.5 crores will be taken by ICICI only. But in the case of projects being set up in the North Eastern Region, IDBI will continue to handle directly small and medium projects costing even less than Rs.5.crores. The Bank provides loans which are normally repayable over a period of 8-10 years after a grace period of 2-3 years. It requires loans to be secured by a first equitable mortgage of the borrower s fixed properties and hypothecation of all movables on the lines of ICICI. The bank follows the policy of uniform margin requirements of 50% but it relaxes in certain cases. 13

14 IDBI has brought out two Seed capital schemes to assist entrepreneurs who have skills but lack finance. The assistance under these schemes is provided to entrepreneurs to make up promoter s contribution to meet equity gap and also to meet cost over runs. The maximum limit of the assistance in Rs.3 crores and the minimum limit is Rs.15 lakhs. A land mark feature of these schemes is that assistance is interest free, with a service charge of 1% p.a. moratorium is available up to 5 years for repayment of loan, In 1986 IDBI introduced two new schemes, viz., scheme of assistance to women entrepreneurs and scheme for In-House quality testing facilities. Under the first scheme women entrepreneurs are made available an integrated package of assistance providing for identification, selection, training, and consultancy. In addition, they can get term loans on concessional terms. In the second scheme small entrepreneurs are rendered assistance for improving quality of their products. The scheme provides for refinance assistance up to Rs.7.5.lakhs at concessional rate of interest for the purpose of installing in house quality testing facilities. STATE FINANCIAL CORPORATIONS (SFCS) SFCS are the state level development banks set up in India under state financial corporations act for the purpose of providing financial assistance to new as well as existing industrial concerns for purpose of establishment, modernisation, renovation expansion and diversification. These institutions assist a concern in following ways: 1. Granting loans or advances or subscribing to debentures of industrial concerns repayable within 20 years. 2. Guaranteeing loans raised by industrial concerns on such terms and conditions as may be mutually agreed upon but they should be repayable with 20 years. 3. Guaranteeing such deferred payments of any industrial concern as are in connection with the purchase of capital goods within India. 4. Underwriting issue of stocks, bonds or debentures of industrial concerns subjects to their being disposed off in the market within 7 years. 5. Providing foreign exchange loans under world bank scheme. 6. Participating in equity capital of the small scale industrial units coming up in backward areas. A concern can get financial support from a state financial corporation upto Rs.6 lakhs. Only small scale units engaged in all industrial activities including mining. Transport by rope ways and development of industrial area are entitled to get assistance from this institution SFCs generally provide loans secured by way of legal mortgage of fixed assets and executed in favour of the institution. Forty per cent margin is usually maintained on loans. However, SFC s policy in this respect has been very flexible. In certain cases particularly those coming up in less developed regions, they lend without any margin. SFCs provide assistance to technically qualified entrepreneurs on concessional terms under special schemes. The assistance under the schemes ranges between Rs.2 lakhs and Rs.3 lakhs. Generally, graduate or diploma holders and certified technicians and/or those having adequate experience in the line are eligible for assistance under the scheme. 14

15 These institutions are provided seed capital assistance from their special share capital exclusive y subsidised by IDBI and the State Government. To the needy small entrepreneurs. The assistance is provided by way of equity or soft loans towards meeting the gap between the normal expected level of promoters contribution as envisaged by the SFC and the actual amount that the promoter could bring on his own, subject to a ceiling of 20% of the project cost or Rs.1 lakh whichever is lower. STATE INDUSTRIAL DEVELOPMENT CORPORATION (SIDCS) The SIDCs wholly owned by the state governments were set up under the Companies Act of under specific state acts during the sixties and early seventies for promotion and development of medium and large industries in their respective states. SIDCs promote medium and large industrial projects as joint sector units in collaboration with private entrepreneurs or as wholly owned subsidiaries and participate in risk capital. These institutions provide finance to medium sized industrial projects in the form of term loans or investment in equity / debentures. They generally entertain an application for a loan of more than Rs.60 lakhs but less than Rs.1 crore. Like SFCs, SIDCs also render seed capital on behalf of IDBI for widening entrepreneurial base. Bulk of the IDBI s total seed capital assistance is channelled through SIDCs. Investing Institutions Investing institutions represent those financial intermediaries which mobilise savings from different sections of the society mainly through sale of their securities and channelsie these savings in productive channels mainly through investment in share and debentures of business enterprises of the country. In this category of financial institutions. We can include investment companies. Unit Trust of India. Life Insurance Corporation and General Insurance Corporation, Investment Companies. In India there are 560 private sector investment companies belonging to different business houses. These companies hardly do any mobilisation work. They assist only those organisation in which the business house has vested interest. This they do by investing particularly in equity shares of the enterprise. The manor factor influencing the investment policy of these institution is the control factor. a. Unit Trust of India (UTI) The UTI was established in 1964 in public sector for the purpose of mobilisation of savings of the community and redirection of these pooled savings in profitable outlets. During 25 years of its operations UTI provided attractive saving opportunities to the community through sale of units under various schemes and thereby mobilise savings of the community. The UTI utilises these resources in assisting diverse needs of business organisations. The Trust assists the enterprises by investing in their shares and debenture and underwriting the security issues. In present years following an amendment the UTI has been empowered to grant term loans, rediscount bills, undertake equipment leasing, hire purchase financing and financing of housing projects. 15

16 The major considerations influencing the UTI s investment are safety of funds and reasonable return including capital appreciation on its units. In order to translate these considerations into action, the trust diffuses its investable resources over different types of securities of numerous units belonging to different industry groups. It has been clearly stipulated that: The investment by the UTI in anyone company should not exceed 5 per cent of the value of the total invested funds the Trust of 15 per cent of the value of the securities issued and outstanding of such company, whichever is less; Not more than 5 per cent of the investable funds should be invested in the initial issues of the securities of new industrial under takings. An important feature of underwriting policy of UTI is that it places great emphasis on the long term viability of the enterprise rather than on the immediate sale ability of its issue. Further, it underwrites the capital issues of companies by way of a firm commitment to invest upto the amount underwritten. It is thus the policy of the Trust to acquire securities for its investment portfolio by means of underwriting. Life Insurance Corporation of India (LIC) LIC was set up in 1957 as a wholly owned Corporation of the Government of India to carry on the business of life insurance and deploy the savings of the policy holders in the best possible way. The LIC assists public sector undertakings and public limited companies and abstains from assisting private companies. Its assists industrial enterprises by undertaking their capital issues, subscribing to shares and bonds and offering them long-term loans. The corporation accords priority to production and the generation of electricity, housing schemes, water supply and drainage schemes, and transport development 85% of the corporation s investable funds are to be invested in government approved programmes with poor yields. With view to participate actively in the industrial financing the corporation has launched a mutual fund in July General Insurance Corporation of India (GIC) The GIC and its four subsidiaries operate a number of Insurance Scheme to cater to the diverse needs of the society. The corporation and its subsidiaries assist enterprises by way of underwriting, subscription to securities and term loans. Conclusion Thus, these types of financial institutions now provide the bulk of financial assistance to the industrial projects by various forms such as direct financing, indirect financing, assistance financing, promotional work and miscellaneous activities. Financial institutions today perform a variety of financing and promotional activities and have designed and implemented special programmes and development of industries in backward areas, encourage competent new entrepreneurs support modernisation efforts and promote the development of small scale sector. 16

17 Self Assessment Questions: 1. What do you understand by project financing? 2. What factors would you consider in division it? 3. What are the different sources of finance available to industrial projects in India. 4. What the are the institutional agencies providing financing assistance to entrepreneur? 5. Explain the various steps involved in approaching an institution for project financial assistance. 6. Explain the various schemes of finance in operation with the IDBI. 17

18 LESSON 3 ESTIMATION OF FUNDS REQUIREMENTS Estimation of the capital cost of a project provides the basic information to decide its pattern of financing and viability. If cost of the project is not estimated exercise because the amount of depreciation, interest and dividend will change with the change in the capital cost of the project. An entrepreneur has to tie up the resources according to the estimates of the cost of the project. If there is an overrun in the cost of a project, the entrepreneur may find it difficult to arrange for additional resources and it may delay the implementation of the project which will lead to further overrun in the capital cost. Financial institutions and banks are taking an undertaking from entrepreneurs to meet the cost of overrun, if any, in the implementation of the project. But such an undertaking does not have much practical meaning. Many a times an entrepreneur is not in a position to bring additional resources to finance the overrun and ultimately financial institutions and banks have to provide additional resources to safeguard the money already invested in the project. Over estimation of the cost of the project is also equally bad as underestimation. If the cost of a project is overestimates, the financial institutions may have to make unnecessarily higher commitments and promoters may divert resources for other purposes. It is needless to state that estimation of capital cost of the project is necessary not only in the interest of entrepreneurs but also in the interest of financial institutions. Therefore, following guidelines have been prepared to give an idea to the entrepreneurs about the estimation of the capital cost and to the financial institutions for appraisal of the estimates given by the entrepreneurs. (a) Land and site development. (i) (ii) (iii) (iv) (v) (vi) Cost of land Legal charges for registration Cost of leveling Cost of laying roads Cost of fencing Cost of gates (b) Building (i) Main factory buildings (ii) Ancillary factory (iii) Administrative buildings. (iv) (v) Godowns. Canteen, Guest House etc. 18 (i) Ascertain from plant lay out and proposed construction of buildings that land is sufficient for the project and possible future expansion. (ii) Agreement for purchase of land (iii) Rates of legal charges (iv) Total area of roads and cost per square mtr. (v) Total area of fencing and the basis on which provision has been made. (i) (ii) (iii) Design of buildings. Different types of construction and area under each type of construction. Ascertain from plant lay out whether proposed construction of buildings is sufficient and also no unnecessary construction is

19 (vi) Quarters for essential staff. (vii) Silos tanks, wells, etc. (viii) Garages (ix) (x) Cost of sewers, drainages etc. Architects Fee. (iv) (v) (vi) done. Rate per sq. mtr. of each construction. Agreement with Building Contractor, if any. A note a past record of building contractor and Architect. (c) Plant and Machinery (a) Imported Plants (i) F.O.B. value of plant to be imported. (ii) Shipping, freight and insurance. (iii) Import duty (iv) Clearing, loading unloading and transportation charges. (i) (ii) (iii) (iv) Ensure that proposed import of plant is necessary. Ensure that necessary stores and spare are also imported. Quotations of plant to be imported. Orders, if already placed, of plant to be imported. (v) Import Licence. (vii) Report of an independent engineer, if second hand plant is being imported. (v) (vi) (vii) (viii) (ix) Indigenous Plants Main plant and other machineries. Machinery stores and spares. Sales-tax Transportation charges. (viii) (ix) List of main items of machinery to be purchased. Ensure that all items are included and they have proper balance of capacity. Quotations received from various machinery suppliers. (x) Foundation and Installation charges. (x) Cross-check with some reputable potential suppliers from whom the promoters could have asked, but have not asked to bid or quote. (xi) Selection should be done from various quotations on the basis of not only price but also technical sophistication, reputation of suppliers, delivery dates, credit terms etc., 19

20 (d) Engineering Consultancy fees (i) (ii) Expenses of foreign technicians. Expenses of training for Indian technicians (iii) Technical know-how fees. (iv) Expenses on drawings. (v) Consultancy fees for preparing project report. (xii) Orders for machinery if placed. (xiii) Contract entered between the company and machinery suppliers. (i) (ii) (iii) (iv) Contract between the company and foreign collaborators. Contract between the company and consultants. A note on past record of consultants. Relationship, if any, between promoters of a project and consultants. (e) Miscellaneous Fixed Assets (i) (ii) Furniture Office machinery and equipment. (i) Details of various items of furniture, office machinery, equipment etc. and cost thereof. (iii) (iv) (v) Vehicles Cars, trucks etc. Cost fo electric installation. Equipment and pipes for distribution of water, air and steam. (ii) Ascertain whether it is necessary, to invest in vehicles for the project estimate cost of maintaining Vehicle(s) and compare with transportation charges, to be paid, if outside vehicles are hired. (vi) Laboratory equipment. (vii) Workshop equipment. (viii) Fire fighting equipment (ix) Effluent collection treatment and disposal arrangements. (iii) (iv) Contract regarding electric installation, piping etc. Price list of laboratory equipment, workshop equipment etc. (x) Miscellaneous fixed assets. Items to be included Documents / particulars to be 20

21 (f) Preliminary and Preoperative expenses. (g) Provision for Contingencies (h) Margin Money for working capital. (i) (ii) (iii) (iv) (v) (vi) (vii) (i) (ii) (i) (ii) Brokerage and Commission on Capital issued. Other capital issue expenses. Commitment charges. Interest on terms loans during construction period. Mortgage expenses. Miscellaneous expenses during construction period. Cash losses, if any Probable increase in cost due to new additions. Probable increase in cost due to rise in prices, sales-tax, excise duty, transportation charges, fluctuation in foreign exchange rates etc. Indigenous raw materials. Imported raw materials. (iii) Consumables stores. (iv) Stock of goods in process. (v) Stock of finished goods. (vi) Outstanding debtors. Items to be included 21 scrutinized for appraisal. 1. Find the total amount of capital issue and calculate charges thereon. 2. Find the construction period and calculate interest for that period. 3. Calculate the amount of mortgage expenses. 4. Calculate the other expenses during construction period. (i) Divide total cost estimates into two groups-considered firm and non-firm. (ii) Make provision for contingencies on non-firm items of cost at the rate of 5% to 15% depending on inflationary trend and period of project implementation longer the implementation period, higher the contingencies required. (i) Calculate total requirement of working capital on the basis of expected production in first year. However, if profitability estimates of first year indicate cash loss, take working capital requirement on the basis of the production for second or third year when the project is likely to generate profit. Documents / particulars to be scrutinized for appraisal. (i) The level of raw materials, consumable stores, goods-inprocess, finished goods and debtors should be decided

22 22 keeping in view of production requirements, process time and practice prevailing in the industry. (ii) 25 per cent of total working capital requirement should be financed by long-term resources and included in the capital cost of the project. Each project is different from the other projects and cost of one project should not be blindly followed for other similar projects. However, it is worthwhile to have a cross-check with previous data on hand or other sources (other financial institution institutions and banks, government institutions, consultancy organizations, trade associations etc.,). If a major difference is observed regarding cost of any particular item, a detailed study should be done to identify the reasons for difference and to ascertain whether the difference is desirable. Institutions and banks should maintain a record of costs (estimated and actual) of past projects financed by them. Such record will help them to avoid the mistakes, if any, done in the past in appraisal work. If installed capacity of different projects in the same industry is different, the total capital cost of each project should be divided by its installed capacity to have a common factor to compare the capital cost of different projects in the same industry. If capital cost of a project is lower than the other project in the same industry, it is considered as a good sign. However, it is always not necessary that a project involving lower capital cost is better than the other projects involving higher cost. For example, capital cost in terms of per tonne installed capacity is lower for setting up a mini paper plant as compared to capital cost in terms of per tonne installed capacity for big size paper plants. But the manufacturing expenses of mini paper plants may be higher than the large size paper plants. Therefore the viability of a project should be decided after ascertaining manufacturing cost, selling price, demand for the product and other relevant matters. The cost of the project provides basis for making financial arrangements to finance the project and to prepare the cash flow and profitability estimates. viz., The capital requirements for a project can be broadly be divided into two categories (i) (ii) Fixed Capital Fixed capital requirements and Working capital requirements It means the capital which is meant for meeting the permanent or long-term needs of the business. In other words fixed capital is required for the acquisition of those assets that are to be used over a long period. The assessment fixed capital requirements for a project can be made by preparing a list of the fixed assets needed by the business. Having complied a list of the fixed assets required for the project, it will not be difficult to ascertain the total funds required for purchase of fixed assets. the price of land can be found out from the poverty agents, the information regarding the estimated cost of construction of building can be obtained from the building contractors, the suppliers of machines can be asked to give quotations for the plant and equipment to be installed. Similarly, the amounts to be paid for patents, trade marks, goodwill can also be ascertained. The factors determining fixed capital requirements are