Sources of Business Finance

International Financing and Choice of Sources of Funds

Globalisation has opened doors and opportunities that were never explored before. Activities of companies are not limited to one region or a single country. And wherever there are activities of companies, there is money involved in them. Let’s understand the world of international financing.

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International Financing

International Financing is also known as International Macroeconomics as it deals with finance on a global level. There are various sources for organizations to raise funds. To raise funds internationally is one of them. With economies and the operations of the business organizations going global, Indian companies have an access to funds in the global capital market.

International finance helps organizations engage in cross-border transactions with foreign business partners, such as customers, investors, suppliers and lenders. Various international sources from where funds may be generated include the following.

International Financing and Choice of Sources of Funds

source: referenceforbusiness

(i) Commercial Banks

Global commercial banks all over provide loans in foreign currency to companies. They are crucial in financing non-trade international operations. The different types of loans and services provided by banks vary from country to country. One example of this is Standard Chartered emerged as a major source of foreign currency loans to the Indian industry. It is the most used source of international financing.

(ii) International Agencies and Development Banks

Many development banks and international agencies have come forth over the years for the purpose of international financing. These bodies are set up by the Governments of developed countries of the world at national, regional and international levels for funding various projects. The more industrious among them include International Finance Corporation (IFC), EXIM Bank and Asian Development Bank.

(iii) International Capital Markets

Emerging organizations including multinational companies depend upon fairly large loans in rupees as well as in foreign currency. The financial instruments used for this purpose are:

(a) American Depository Receipts (ADR’s)

This a tool often used for international financing. As the name suggests, depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs can be bought and sold in American markets like regular stocks. It is similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of the United States of America.

(b) Global Depository Receipts (GDR’s)

In the Indian context, a GDR is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stock exchange. A holder of GDR can at any time convert it into the number of shares it represents.

The holders of GDRs do not carry any voting rights but only dividends and capital appreciation. Many renowned Indian companies such as Infosys, Reliance, Wipro, and ICICI have raised money through issue of GDRs.

(c) Foreign Currency Convertible Bonds (FCCB’s)

Foreign currency convertible bonds are equity-linked debt securities that are to be converted into equity or depository receipts after a specific period. A holder of FCCB has the option of either converting them into equity shares at a predetermined price or exchange rate or retaining the bonds. The FCCB’s are issued in a foreign currency and carry a fixed interest rate which is lower than the rate of any other similar nonconvertible debt instrument.

FCCB’s resemble convertible debentures issued in India. It is true that businesses need funds but the funds required in business are of different types — long term, short term, fixed and fluctuating. That is the reason why business firms resort to different types of sources for raising funds.

Choice Of The Source Of Funds

Short-term borrowings offer the benefit of reduced cost due to the reduction of idle capital, but long-term borrowings are considered a necessity on many grounds. Equally, equity capital has a role to play in the scheme for raising funds in the corporate sector.

It is recommended to use combinations of sources as no source of funds is devoid of limitations, instead of relying only on a single source. The factors that affect the choice of source of finance are discussed below:

(i) Cost

There are two types of cost, the cost of obtaining of funds and cost of utilizing the funds. Both these costs should be considered while deciding about the source of funds that will be used by an organization.

(ii) Financial Strength

In the choice of source of funds, business should be in a good financial position to be able to repay the amount and interest on the borrowed amount. When the earnings of the organization are not stable, fixed charged funds like preference shares and debentures should be carefully selected as these add to the financial strain on the organization.

(iii) A form of Organization and Reputation

Type of business organization and reputation in the market influences the choice of a source for raising money. A partnership firm, for example, cannot raise money by issue of equity shares as these can be issued only by a joint stock company.

(iv) Purpose and Duration

Business needs to plan according to the time period for which the funds are required. A short-term need can be met through borrowing funds at a low rate of interest through trade credit, commercial paper, etc. For long-term finance, sources such as the issue of shares and debentures required. Also, the purpose for which funds have required the need to be considered so that the source is matched with the user.

(v) Risk Involved

Business evaluates each of the source of finance in terms of the risk involved while issuing them. For example, there is the least risk in equity as the share capital has to be repaid only at the time of winding up and dividends need not be paid if no profits are available. Whereas, a loan has a repayment schedule for both the principal and the interest. The interest is required to be paid irrespective of the firm earning a profit or going through loss.

(vi) Control over Management

A particular source of the fund may affect the control and power of the owners on the management of a firm. The issue of equity shares may mean a dilution of the control. For example, as equity shareholders enjoy voting rights, financial institutions may take control of the assets or impose conditions as part of the loan agreement.

(vii) Creditworthiness

The reliability of business on particular sources may affect its creditworthiness in the market. For example, issue of secured debentures may affect the interest of unsecured creditors of the company and may adversely affect their willingness to extend further loans to the company.

(viii) Flexibility

Another important aspect affecting the choice of finance is the flexibility and ease of obtaining funds. Restrictive provisions, detailed investigation, and documentation in case of borrowings from banks and financial institutions, for example, may be the reason that business organizations may not prefer it if other options are readily available.

(ix) Tax benefits

Various sources may also be weighed in terms of their tax benefits. For example, while the dividend on preference shares is not tax-deductible, interest paid on debentures and loan is tax deductible and may, therefore, be preferred by organizations seeking tax advantage.

Solved Question for You

Q: Discuss Foreign Currency Convertible Bonds (FCCB) used in international financing.

AnswerForeign currency convertible bonds are equity-linked debt securities that are to be converted into equity or depository receipts after a specific period. A holder of FCCB has the option of either converting them into equity shares at a predetermined price or exchange rate or retaining the bonds. The FCCB’s are issued in a foreign currency and carry a fixed interest rate which is lower than the rate of any other similar nonconvertible debt instrument. FCCB’s resemble convertible debentures issued in India.