Estimating financial Requirements

After becoming sure of the commercial feasibility of the project, the promoter has to proceed to make  estimates for the total capital needs of the company. In this exercise of total capital requirement calculations, the two most important underlying factors are the nature of business and size of business.  These two factors have to be remembered at every step in making capital calculations. The total capital requirement estimation should include the present needs and also provision for future developments. The total capital requirements have further to be estimated from the point of view of foreign currency. This type of analysis is very significant, especially in a country like ours where sophisticated machinery and technology has to be imported.

There are two approaches for estimating the total requirements. The first is to make detailed item-wise estimates and total them up. This is called the Estimation Method. The other method is the Comparison Method. According to this method-calculations are made on the basis of estimates of some other companies of the same type and same size. In this method the promoters have to make adjustments for price level changes.

The following items enter into the calculation of total capital estimates :

  1. Promotion expenses : incorporation fee, consultancy fee and other preliminary expenses.
  2. Cost of fixed assets : Land and building, tools, machinery, equipment, furniture and fixture, miscellaneous fixed assets.
  3. Working capital : Normal cash balances advisable to be kept in hand; inventories and funds to be tied in debtors and miscellaneous current assets.
  4. Cost of financing : brokerage and commission.
  5. Cost of establishing the business : operating losses other than depreciation, up to the time when the business will be financially self-sustaining.
  6. Cost of intangible assets : patents and goodwill.
  7. In addition to all these, some provision for contingencies.

The estimates for each of these figures should be supported by detailed schedules carefully and skilfully compiled. The importance of the various items varies among different types of business. A personal service business has little or no fixed property or inventory. Merchandising concerns may need only minor amounts for furniture and fixtures. Fixed investment is likely to be more important for the manufacturer, partly because of his greater investment in equipment and partly because of his greater difficulty in securing efficient housing except by constructing a building adapted to the particular needs of the enterprise. Fixed assets are particularly important for heavy industries like steel, fertilisers etc., and often a large percentage represents the total assets. Financial companies cannot really be said to have financial requirements in the same sense as other businesses. The bulk of the assets of such a concern, however, are its investments, which are in proportion to the volume of business with customers and deposits with the commercial bank.

From the above discussion, it is clear that every business enterprise will require capital broadly for the following three purposes :

  1. To finance fixed assets.
  2. To finance working capital or current assets needs.
  3. To finance improvements and extensions.

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