Industrial Finance Related Terms


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

Corporation 

Firm that meets certain legal requirements to be recognized as having a legal existence, as an entity separate and distinct from its owners. Corporations are owned by their stockholders (shareholders) who share in profits and losses generated through the firm's operations, and have three distinct characteristics (1) Legal existence: a firm can (like a person) buy, sell, own, enter into a contract, and sue other persons and firms, and be sued by them. It can do good and be rewarded, and can commit offence and be punished.
(2) Limited liability: a firm and its owners are limited in their liability to the creditors and other obligors only up to the resources of the firm, unless the owners give personal-guaranties.
 (3) Continuity of existence: a firm can live beyond the life spans and capacity of its owners, because its ownership can be transferred through a sale or gift of shares.

A  corporation is created (incorporated) by a group of shareholders who have ownership of the corporation, represented by their holding of common stock. Shareholders elect a board of directors (generally receiving one vote per share) who appoint and oversee management of the corporation. Although a corporation does not necessarily have to be for profit, the vast majority of corporations are setup with the goal of providing a return for its shareholders.
 
Authorized Share Capital 


The maximum value of securities that a company can legally issue. This number is specified in the memorandum of association when a company is incorporated, but can be changed later with shareholders' approval.
 
Authorized share capital is often not fully used by management in order to leave room for future issuance of additional stock in case the company needs to raise capital quickly. Another reason to keep shares in the company treasury is to retain a controlling interest in the company. Stock exchanges may require companies to have a minimum amount of authorized share capital as a requirement of being listed on the exchange.
 
Authorized share capital may be divided into -
 
 (1) Issued capital: par value (face value) of the shares actually issued.
 
(2) Paid up capital: money received from the shareholders in exchange for shares.
 
 (3) Uncalled capital: money remaining unpaid by the shareholders for the shares they have bought.

The shares that have actually been issued to the public and to the company's employees are known as "outstanding shares.

Par Value

Apparent worth or the nominal value shown on the principal ('face' or 'head') side of a bill of exchange, currency, security (stock/share, bond), or other type of financial instrument. The par value of a loan stock (bond, preferred stock/preference share) is the value at which it will be redeemed. Some jurisdictions allow shares to be issued with no par value (see no par value share). Par value is typically different from the market price. If the market price is higher than the par value, the difference is called a 'premium;' if it is lower, the difference is called a 'discount.' Also called face value, nominal value, or redemption value.

Paid-up Capital

Paid-up capital is the amount of a company's capital that has been funded by shareholders. This would not include any shares that have been bid on, but not yet purchased. Paid-up capital can be less than a company's total capital because a company may not issue all of the shares that it has been authorized to sell. Paid-up capital can also reflect how a company depends on equity financing. A company that is fully paid-up has sold all available shares, and thus cannot increase its capital unless it borrows money through debt or is authorized to sell more shares.

Underwriting

 Underwriting may be defined as contract entered into by the company with the persons or institutions, called underwriters, who undertake to take the whole or a part of such of the offered shares or debentures, as may not be subscribed by the public, in consideration of remuneration, called “Underwriting Commission”. Thus, the underwriting is an undertaking or guarantee given by the underwriters to the company that the shares or debentures offered to the public will be subscribed in full, in case the response of the public is poor the underwriters will take the balance of the shares or debentures not subscribed by the public and will pay for them.
Types of Underwriting
 Underwriting may be of three types:-
1. Complete Underwriting: - If the whole of the issue of shares or debentures of a company is underwritten, it is to be said as “complete underwriting”. In such a case the whole of the issue of shares or debentures may be underwritten by firm or person who has agreed to take the risk.
2. Partial Underwriting: - If only a part of the issue of shares or debentures of a company is underwritten, it is to be said as “partial underwriting”. In such a case the part of the issue of shares or debentures may be underwritten by firm or person who has agreed to take the risk.
3. Firm Underwriting: - It refers to a definite commitment by the underwriter to take a specified number of shares, irrespective of the number of the shares subscribed by the public. Firm underwriting signifies a definite commitment to take a specified number of shares, irrespective of the number of shares subscribed by the public. In case of firm underwriting, underwriters take the agreed number of shares in addition to the unsubscribed shares, if any, whether the issue is fully subscribed or over subscribed. In such a case, unless it has been otherwise agreed, the underwriter’s liability is determined without taking into account the number of shares taken up “firm” by him, i.e. the underwriter is obliged to take : 1. the number of shares he has applied for “firm”; and 2. the number of shares he is obliged to take on the basis of the underwriting agreement.
Underwriting  Commission :- the consideration payable to the underwriter for underwriting the issue of shares or debentures of a company is called as “Underwriting Commission”. In general it can be paid with the following limits -  In case of Shares, 5 % of the issue price or such lower rate as provided by the Articles of the company.  In case of Debentures, 2.5 % of the issue price or such lower rate as provided by the Articles of the company.

Limited Companies

A limited company limits the amount of liability undertaken by the company's shareholders. This means that the shareholders’ (owners’) responsibilities for the company’s financial liabilities are limited to the value of shares that they own but haven’t paid for.
In a limited company, the debts of the company are separate from those of the shareholders. As a result, should the company experience financial distress because of normal business activity, the personal assets of shareholders will not be at risk of being seized by creditors. Ownership in the limited company can be easily transferred, and many of these companies have been passed down through generations.

Rediscounting a Bill


Cashing or trading a bill of exchange at less than its par value and before its maturity date. The cash thus realized varies according to the number of days until maturity and the risk involved. So, rediscounting is the act of discounting a bill of exchange (buying it before its normal payment date for less than it will be worth on that date) that has already been discounted once for someone else.



Banks may rediscount short-term debt securities to assist the movement of a market that has a high demand for loans. When there is low liquidity in the market, banks can generate cash by rediscounting short-term securities. A central bank's discount facility is often called a discount window.


The Central banks of most countries (RBI in case of India) have created so-called Discounting Windows which provide loans to commercial banks and other depository institutions at a rate of interest which is lower than the market interest rate  in lieu of Treasury bills, Class-A securities and other gilt. Now this low interest rate provided by Central banks is called the Discount Rate.
To maintain adequate liquidity in the market, the Central Banks re-discount the previous loan for a second time.
The interest rate for a second discounting on the loan is called a Re-discounting rate and the overall phenomenon is called re-discounting of bills by Central banks.

Share

A unit of ownership that represents an equal proportion of a company's capital. It entitles its holder (the shareholder) to an equal claim on the company's profits and an equal obligation for the company's debts and losses. In financial markets, a share is a unit of account for various investments. It often means the stock of a corporation, but is also used for collective investments such as mutual funds, limited partnerships, and real estate investment trusts.
Two major types of shares are (1) ordinary shares (common stock), which entitle the shareholder to share in the earnings of the company as and when they occur, and to vote at the company's annual general meetings and other official meetings, and (2) preference shares (preferred stock) which entitle the shareholder to a fixed periodic income (interest/ fixed dividends) but generally do not give him or her voting rights.

Bond

In general, a bond is a written and signed promise to pay a certain sum of money on a certain date, or on fulfillment of a specified condition. All documented contracts and loan agreements are bonds.

Regarding securities, a bond is a debt instrument that certifies a contract between the borrower (bond issuer) and the lender (bondholder) as spelled out in the bond indenture. The issuer (company, government, municipality) pledges to pay the loan principal (par value of the bond) to the bondholder on a fixed date (maturity date) as well as a fixed rate of interest for the life of the bond.
 
Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.
 
Alternatively, some bonds are sold at a price lower than their par value in lieu of the periodic interest. On maturity the full par value is paid to the bondholder. Bonds are issued in multiples of $1,000, usually for periods of five to twenty years, but some government bonds are issued for only 90 days. Most bonds are negotiable, and are freely traded over stock exchanges. Their market price depends mainly on the rating awarded by bond rating agencies on the basis of issuer's reputation and financial strength.
 
Investment in bonds offers two advantages: (1) known amount of interest income and, unlike other securities, (2) considerable pressure on the company to pay because the penalties for default are drastic. The major disadvantage is that the amount of income is fixed and may be eroded by inflation. Companies use bonds to finance acquisitions or capital investments. Governments use bonds to keep their election promises, fund long-term capital projects, or to raise money for special situations, such as natural calamities or war.
 
Debenture
 
Debentures are the most common form of long-term loans that can be taken by a company. It is a promissory note or a corporate bond which is backed generally only by the reputation and integrity of the borrower/ issuer and sometimes by the borrower's specific assets.
When unsecured, it is called a bare debenture or naked debenture; when secured by a charge on a specific property, it is called a mortgage debenture.
 
Bond buyers generally purchase debentures based on the belief that the bond issuer is unlikely to default on the repayment. An example of a government debenture would be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at worst, can print off more money or raise taxes to pay these type of debts.
Debentures are usually loans that are repayable on a fixed date, but some debentures are irredeemable securities (these are sometimes called perpetual debentures).

Most debentures pay a fixed rate of interest. It is required that this interest is paid prior to dividends being paid to shareholders. The interest paid to debenture holders is calculated as a charge against profit in the company's financial statements.
 
Debenture holders (investors) do not have any rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures.
 
The main advantage of debentures to companies is the fact that they have a lower interest rate than e.g. overdrafts. Also, they are usually repayable at a date far off in the future. For an investor, their main advantages are that they are often easy to sell in stock exchanges and they contain less risk than e.g. equities.
 
There are two types of debentures:

Convertible debentures: Convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time. Convertible bonds are more attractive to investors since the bonds have the ability to convert and also attractive to companies since they typically have lower interest rates than non-convertible corporate bonds.

Non-convertible debentures: regular debentures which cannot be converted into equity shares of the liable company. Since they are not able to convert, they usually carry higher interest rates than convertible debentures.
 
Refinance Facility
 
The facility provided by Central bank / Financial institutions to finance a finance is called refinance. Refinance by RBI is meant to help individuals, corporations as well as the overall economy of the country. There are various types of refinance offered by RBI. RBI has permitted the banks to offer refinance on various loans like home, auto etc. However, refinance companies have the restriction to use floating provisions instead of specific provisioning. Refinance by RBI is also offered to boost the growth of SMEs (Small and Medium Enterprises), especially those which are currently facing credit crunch. RBI also offers refinance facility to help out the exporters. RBI offers credit to Export-Import Bank of India (Exim Bank) to support the export sector.

Subsidiary Company

A subsidiary is a company that is partly or completely owned by another company that holds a controlling interest in the subsidiary company.
Definition
A subsidiary is a company that has been set up or acquired by another company that is usually either larger or better-known to the public as a result of its longevity or reputation. The acquiring company is called the parent corporation. If a parent corporation exists strictly to hold stock in other entities, it is referred to as a holding company.
Ownership
In a subsidiary situation, the parent corporation owns more than 50 percent of the voting stock of each of the companies it acquires. If it holds all of the voting stock, the smaller entity is said to be a wholly owned subsidiary. Parents and their subsidiaries are separate legal entities insofar as liability issues but sometimes file their financial statements as a single unit. Ownership of 80 percent or more of a subsidiary's stock is required for the parent corporation to submit consolidated tax returns.
Wholly Owned Subsidiary Company
A Wholly Owned Subsidiary company is an entity of which 100 per cent shares are held by another company. For example, if Company A owns 100 per cent shares of Company B. Then Company B becomes a wholly owned subsidiary company of Company A.
 
 Seed Capital


Comparatively small amount of capital contributed in the very beginning by a firm's founder(s). It is rarely provided by lenders or institutional investors because startup is the riskiest stage in a firm's life cycle with the highest chance of failure. Also called front end money, front money, or startup capital.
Seed capital often comes from the company founders' personal assets or from friends and family. It is considered a high-risk investment, but one that can reap major rewards if the company becomes a growth enterprise.

Factoring

Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs.
This is done so that the business can receive cash more quickly than it would by waiting 30 to 60 days for a customer payment. Factoring is sometimes called “accounts receivable financing.”
The terms and nature of factoring can differ among various industries and financial services providers. Most factoring companies will purchase your invoices and advance you money within 24 hours. The advance rate can range from 80% to as much as 95% depending on the industry, your customers’ credit histories and other criteria. The factor also provides you back-office support. Once it collects from your customers, the factor pays you the reserve balances of the invoices, minus a fee for assuming the collection risk. The benefit of factoring is that, instead of waiting one to two months for a customer payment, you now have that cash in hand to operate and grow your business.
Factoring is not a loan. No debt is assumed by factoring. The funds are unrestricted, providing a company more flexibility than with a traditional bank loan.

Deferred Payment

A loan arrangement in which the borrower is allowed to start making payments at some specified time in the future. Deferred payment arrangements are often used in retail settings where a person buys and receives and item with a commitment to begin making payments at a future date.

Deferred payment guarantees
The bank at request of customer issues such Bank Guarantee when he purchases goods or machinaries from a creditor on the terms of payment after a specified time in lump sum or in instalments. The creditor requires such deferred payment terms to be guaranteed by the bankers of the principal debtor. Such a Bank Guarantee contain an undertaking by the banker that that deferred payment shall be made by the principal debtor, failing which the banker shall pay the amount to the creditor. These types of guarantees normally arise in the case of purchases of machinery or such capital equipment by industries or other party/ies.
 


Tuesday, 05th Apr 2016, 07:34:11 AM

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