Unit 2

Notes
(i) Concessional finance: All India financial institutions namely,
Industrial Development Bank of India, Industrial Finance
Corporation of India and Industrial Credit and Investment
Corporation of India, extend financial assistance on concessional
terms to all, new and existing industrial projects having expansion
schemes irrespective of the project costs located in the 247 districts
selected by the government. The concessions given by these financial
institutions are in the form of lower interest rate, viz., 9.5% p.a.
against be normal rate of 11%, a reduced commitment charge of
0.5% (which could be waived in exceptional cases), lower
underwriting commission of 1.25% and 0.75% for shares and
debentures respectively, initial moratorium period upto five years,
longer amortizations of 15 to 20 years and participation in the risk
capital on selective basis. Besides these, the IDBI follows a flexible
attitude in respect of promoter’s contribution, margin requirements,
rescheduling of repayments during the currency of the loan.
Depending upon the merits of specific cases in respect of refinance,
the IDBI ch rges a special rate of 6% with the primary lender’s rate
being subject to a ceiling of 9.5%. The normal rate of refinance is
6% with ceiling of 12.5% by the primary lending institution.

(ii) Central Investment Subsidy: The granting of cash subsidy on the

capital investment is called capital investment subsidy. It will be
usually in the form of outright grant of 10% to 20% of the amount of
capital invested in the industrial units in areas specified to be
backward regions/districts. The government also fixes ceiling above
which they could not avail. It is offered by the Central Government.

Out of the 247 districts declared backward by the planning

commission, 101 districts/areas have been selected to qualify for Central
investment subsidy. These districts / areas have been selected on the pattern
of six districts / areas for industrially backward states and three districts /
areas for other states.

Machinery on Hire Purchase

Small scale industrial units including ancillaries are eligible to

procure machinery on hire purchase basis from the National Small

123
Notes
Industries Corporation Ltd, through its liberalized terms and conditions for
supplying machinery to small scale industries located in backward areas
which qualify for investment subsidy. According to the liberalized terms,
with effect from 1st October 1975, the earnest money payable by technocrats
and entrepreneurs from declared backward areas in 10% as against 15% in
other cases. The rate of interest is 11% p.a. in respect of technocrats and
entrepreneurs coming from backward areas and 13.5% in case of others.
These concessional rates are available to units having a total investment in
plant and machinery up to ` 2 lakhs. A rebate of 2% is allowed for prompt
payment.

Special Facilities for Import of Raw Materials

The Import Policy of 1978-79 has introduced special concession of

import of raw materials in the case of industrial units set up in backward
areas or by graduates / diploma holders in professional subjects or by ex-
servicemen/persons belonging to scheduled castes/scheduled tribes. The
maximum v lue of the licence shall be ` 5 lakhs in respect or new or
proposed small cale units instead of ` 3 lakhs. They will also be eligible for
preferential treatment in the matter of canalized items.

Transport Subsidy

The transport subsidy scheme, 1971 envisages gra t fo a transport

subsidy to industrial units in selected areas to the exte t of 50% of the
transport costs of raw materials which are brought into a d finished goods
which are taken out of the selected areas. The scheme has been exte d d up
to the end of March 1985.

The scheme covers the State of Jammu and Kashmir, Himachal

Pradesh, hilly areas of Uttar Pradesh and North Eastern Region comprising
States of Assam, Meghalaya, Nagaland, Tripura and the Union Territories
and Arunachal Pradesh, Andaman and Nicobar Islands, Mizoram and
Lakshadweep.

Subsidy is paid on transport costs between the selected railheads and

location of the industrial units in the above states / Union Territories.

124
 Notes
Summary

The different incentives scheme available for entrepreneurs to fulfil

their requirements are discussed thoroughly in this lesson. So it could create
an awareness among the entrepreneurs what are the incentives available?
and How to avail them?

Self Assessments Questions

1. Explain the need for motivation in promoting entrepreneurship.

2. What are the internal motivation factors promoting entrepreneurship.

3. Explain the significance of external motivation factors in inducing

entrepreneurial spirit among youth.
4. What is entrepreneurial Motivation? Discuss.
5. “Entrepreneurial beh viour is the result of interaction of several
internal and external f ctors”. Comment.
6. Discuss the various types of growth strategies which can be adopted
by the business firm.
7. ‘Entrepreneurs are made not born’ comment and give reasons for
your views.
8. What do you mean by entrepreneurship development?
9. Discuss the different strategies of entrepreneurial development
10. How to identify entrepreneurial skills among unemployed youth?
11. Explain the selection process adopted to choise participants in the
entrepreneurial development programme.
12. Briefly explain the need and content of entrepreneurial training
programme.
13. Explain the objectives of entrepreneurial training and development
programme
14. Discuss the services of NSTEDB (National Science and technology
Entrepreneurship Development Board)
15. Explain the services technical consultancy organisation
16. What is IIC? Explain its role.

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Notes
17. Explain the role of NGOs in promoting entrepreneurship
18. Discuss the contributions of CED in promoting entrepreneurship in
TamilNadu.
19. Define the term ‘Small Scale industry’.
20. Explain the provisions of SSI Policy.
21. Discuss the different types of government support for the
development small scale industry.
22. What is seed capital assistance? Explain its objectives.
23. What are the different tax concession available for promoting small
scale industries.
24. What is capital subsidy? How it promote entrepreneurship?
25. Discuss the different schemes of promoting entrepreneurship in
backward and rural

****

126
 Notes

UNIT – III

Unit Structure

Lesson 3.1 - Project Identification

Lesson 3.2 - Project Formulation feasibility study
Lesson 3.3 - Project Report
Lesson 3.4 - Project Appraisal – market, technical,
financial,
commercial, managerial and social aspects
Lesson 3.5 - Ownership Structure

Lesson 3.1 - Project Identification

Learning Objectives

Having gone through this lesson, you may be able to:

 To know the importance of conceiving a good of project idea

 To ascertain the different sources from which a project idea can be
generated
 To identify the steps involved in project identification and selection

Introduction

An entrepreneur has an infinitely wide choice with respect to his

project in different dimensions such as product/service, market, technolo-
gy, equipment, scale of production, time phasing and location. Hence, the
identification of investment opportunities (projects) calls for understand-ing
the environment in which one operates, sensitivity to emerging in-vestment
possibilities, imaginative analysis of a variety of factors and also chance of
luck. This chapter is concerned with the scouting and screening of project
ideas, steps in the project identification process and also consid-eration
involved in identifying the new projects by an existing company.

127
Notes
Project Ideas

It is the first and foremost task of an entrepreneur to find out suitable

business which is feasible and promising and which merit further
examination and appraisal. Therefore, he has to first search for a sound
workable business idea and give a practical shape to his idea. while doing
so, the entrepreneur has to tackle the various problems from time to time to
achieve the ultimate success. Since the good project ideas are elusive, a
variety of sources should be tapped to stimulate the generation of project
ideas.

Sources of Project Ideas

 Project ideas could originate from the various sources viz.,

 Success story of a friend/relatives
  xperience of others in manufacture/sale of product
  xamining the inputs and outputs of industries
 Plan outlays and government guidelines
 Suggestions of financial institutions and developmental agencies
 Investigation of local materials and resources
 Economic and social trend of the economy
 New technological developments
 Project profiles and industrial potential surveys
 Visits to trade fairs
 Unfulfilled psychological needs

 Possibility of reviving sick units

The various sources from which the project idea can be generated
are explained below:

Analyse the Performance of Existing Industries

A study of existing industries in terms of their profitability and

capacity utilisation is helpful. The analysis of profitability and break even
level of various industries indicates promising investment opportunities.
Opportunities which are profitable and relatively risk free. An examination
of capacity utilisation of various industries provides information about the

128
 Notes
potential for further investment. Such a study becomes more useful if it is
done regionwise, particularly for products which have high transportation
costs.

Examine the Inputs and Outputs Of Industries

An analysis of the inputs required for various industries may throw

up project ideas. Opportunities exist when (I) materials purchased parts, or
supplies are presently being procured from different sources with attendant
time lag and transportation costs and (ii) several firms produce internally
some components/parts which can be supplied at a lower cost by a single
manufactures who can enjoy economies of scale.

A study of the output structure of existing industries may reveal

opportunities for further processing of output or even processing of waste.

Examine Imports and xports

An analysis of import stati tics for a period of five to seven years is

helpful in understanding the trend of imports of various goods and the
potential for import substitution. Indige ous manufacture of goods currently
imported is advantageous for several reasons:

 it improves the balance of payments situation

 it provides market for supporting industries and services
 it generates employment

Likewise, an examination of export statistics is useful in learning

about the export possibilities of various products.

Plan Outlays and Government Guidelines

The government plays a very important role in our economy. Its

proposed outlays in different sector provides useful pointers toward
investment opportunities. They indicate the potential demand for goods and
service required by different sectors.

129
Notes
Suggestions of Financial Institutions and Developmental Agencies

In a bid to promote development of industries in their respective

states, state financial corporations state industrial development corpora-tions
and other developmental bodies conduct studies, prepare feasibility reports
and offer suggestions to potential entrepreneur. The suggestions of these
bodies are helpful in identifying promising projects.

Investigate Local Materials and Resources

A search for project ideas may begin with an investigation into local
resources and skills, various ways of adding value to locally available
materials may be examined. Similarly, the skills of local artisans may
suggest products that may be profitably produced and marketed.

Analyse conomic and Social Trends

A study of economic and social trends is helpful in projecting

demand for various goods and services. Changing economic conditions
provide new business opportu ities. A great awareness of the value of time
is dawning on the public. He ce the demand for time saving products like
prepared food items, ovens and powered v hicles has been increasing.
Another change that we are witnessing is that the desire for leisure and
recreational activities has been increasing. This has caused a growth in the
market for recreational products and services.

Identify Unfulfilled Psychological Needs

For well established, multi brand product groups like bathing soaps,
detergents, cosmetics and tooth pastes, the question to be asked is not
whether there is an opportunity to manufacture something to satisfy an
actual physical need but whether there are certain psychological needs of
consumers which are presently unfulfilled. To find whether such an op-
portunity exists, the technique of spectrum analysis may be followed. This
analysis is done somewhat as follows.

I) Important factors influencing brand choice are identified

(ii) respect of the factors identified in step
(iii) gaps which exist in relation to consumer psychological needs are
identified.

130
 Notes
Visit to Trade Fairs

Attending the National and International trade fairs provides an

excellent opportunity to know about new products and new development.

The abovesaid sources of project ideas may be generated by the

Government agencies, credit institutions, non governmental organisations
and also by public.

The Govt. have largest resources and have the necessary information
to generate project ideas and it plays a predominant role in this sphere. The
government has the required facilities and manpower to conduct detailed
studies which may lead to making investment decisions. Banks and other
financial institutions are actively involved in sharing the social
responsibility of achieving the national objectives of economic
development. The co-operatives and non governmental organisations as
well as individual entrepreneurs are now actively participated in
identification of projects.

The awareness of involving the people or the beneficiaries in project

identification is now increasing fast. Since the local people have the first
hand knowledge of the potentials and problems of the area to which they
belong, more realistic project identification has become possible with their
involvement. It needs no emphasis the project ideas would be gen rated n
better manner both in the qualitative as well as quantitative terms when the
knowledge and ideas of the Govt. functionaries, people, the financial
institutions and other experts are pooled together.

Purpose and Need for Project Identification

The entire economic management planning is based on two

fundamental assumptions. i.e. a) limited means and b) unlimited ends. A
planner has to select few important needs to cut it into size of his/her means.
This may be treated as fixing the priority is called identification of project.
It helps in elimination process. Identification and selection of a project is a
scientific process. This process is based on certain essential conditions. It
may differ from project to project. The essential conditions which should be
taken into consideration for identification and selection of production
projects are as follows:

131
Notes
i Project should be in conformity with the economic needs of the area.

ii It should take into account the depriving factors which might have
adverse impact.
iii The input-output ratio should be optimum.
iv The purpose of the project is to increase the production and
employment of the area.

Thus, the abovesaid conditions will differ due to resources

availability, use pattern and other relevant conditions of the area. Besides
that, project should also consider certain national priorities.

Steps in Project Identification

Project ideas are like other ideas which don’t take concrete shape
immediately. There are several stages of making propositions their
considerations and scrutiny for their soundness.

An idea is first bor , it is under incubation for sometime and

subsequently it begins to take some definite shape. The project ideas to
develop take almost the same course. This project identification may be
broadly divided into four stages, viz.,

A. Conceptual stage - where project ideas are generated

B. Screening stage - at which unviable ideas are eliminated
C. Identification stage - at which viable projects are selected
D. Pre-feasibility state - at which pre-feasibility studies are taking up.

Conceptual Stage

A number of project ideas may be generated either by those officials

or non-officials and entrepreneurs individually or collectively who are
conversant with the area. In this context, one has to examine the
potentialities of development and the problems, needs and aspirations of the
people of the concerned area.

132
 Notes
Screening Stage

In the second stage project ideas generated above are screened in a

preliminary exercise to weed out the bad or unviable ideas. All project ideas
would not pass the screening test. Some project ideas may be imaginary to
warrant any serious consideration.

The third & fourth stages may be called as investment opportunity

study. This study is necessarily preliminary and the broad one and has a
limited objective of providing planners with a choice of projects from which
they can make a selection. Pre-feasibility study is an intermediate stage
between an investment opportunity study and a detailed feasibility study and
these can be differentiated mainly on the basis of information required for
respective stages.

Screening of Project Ideas

After gathering the project ideas from the various sources as

aforesaid, it is essential to eliminate ideas which prima facie are not
promising. This process of eliminating the irrelevant and unviable ideas is
called screening of project ideas. It can be do e with the help of testing the
following conditions of the propositions.

a. Compatibility with the promoter

b. Consistency with governmental priorities
c. Availability of inputs
d. Adequacy of market
e. Reasonableness of cost
f. Acceptability of risk level etc.

The project idea must be compatible with interest personality and

resources of the entrepreneur. It should be accessible to him and also it
offers him the prospects of rapid growth and high return on invested capital.

The project idea must satisfy or go along with the governmental

priorities, National goals and governmental regulatory framework.

133
Notes
 No contrary environmental effects to governmental
  regulations
 Easily accommodating foreign exchange
requirements  No difficulty in obtaining license.

The resources and inputs required for the project must be reasonably
assured. This feature of the project can be assessed with the help of
determining the following points relating to a project.

 Capital requirement within manageable

limit  Obtaining technical know-how
 Availability of raw materials at a reasonable
cost  Obtaining power supply

Identifying the adequacy of market is the key factor to select, the

viable project idea. To judge the adequacy of market the following factors
have to be ex mined.

 Total present domestic market

 Competitors and their market
shares  Export market
 Quality price profile of the product
 Sale and distribution system
 Projected increase in consumption
 Barriers to the entry of new units
 Economic social and demographic trends favourable to increas d
consumption
 Patent protection

Reasonableness of cost is another factor to screen the project ideas.

The cost structure of the proposed project must enable it to realise an
acceptable profit with a competitive price. The following cost factors must
be carefully considered to design a viable cost structure.

 Cost of material inputs, labour costs, factory overheads.

 General administration expenses, selling and distribution costs.
 Service costs, economics of scale etc.

134
 Notes
Acceptability of risk level is another factor which helps to screen the
project ideas and hence determine the desirability of a project.

Methodology for Project Identification

To make a viable project it should be linked with the actual

circumstances prevailing in the area. Without knowing the basic information
relating to socio-economic conditions of the area, it is difficult to draw a
suitable project for the area. Development needs and potentials vary from
area to area. For specific area, before drawing a project, local condition and
other relevant factors must be taken into consideration. Most of the project
fail because they were not based on local problems. Assumptions based on
macro level information may fail to watch at micro level. Survey is a
technique to unearth the hidden information which are vital to identify the
basic requisites of project i.e. need, resources and priorities. It also helps in
making right choice between different alternatives. Secondly it presents lot
of information to be used as bench mark information which will help at the
later stage for evaluation of the project.

Project Identification for an Existing Company

Existing companies essentially large scale company form of

organisations are continuously developing various projects for their
developmental purposes. While doing so, the existing company has to make
a more intensive analysis of its resources and environment and conceive of
projects on the basis of its existing activities. An existing company which
seeks to identify new project opportunities should undertake a “SWOT”
analysis. It is an acronym law of strengths and weaknesses and opportunities
and threats. This analysis evaluate all these four characteristics of existing
company.

A brief summary of the points required for SWOT analysis is given below:

 Availability of internal financial reasons for new projects after

taking into account the need for replacement expenditure, increase in
working capital, repayment of borrowings and dividend payments.
 Capability of raising external financial
resources.  Availability of production facilities.
 Technological capabilities of the company.

135
Notes
 Availability of different sources of raw materials and its
utilisation.  Availability of infrastructural facilities.
 Cost structure and profit margins of the company.
 Distribution network of the company
 Market share of the company.
 Capability of top management of the company.
 State of industrial relations in the company.
 Impact of corporate laws on the growth of the company especially
(MRTP ACT) etc.,
 Likely changes in the governmental policies.
 Possibility of evolving new technology and its impact on the cost
structure of the company.
 Existence and severity of competition.
 Changes in the customers preferences, tastes etc.

By con idering the abovesaid information keenly the SWOT analysis

helps to provide the basis for the corporate strategy to be followed and
indicate the major areas of thrust. These may include expansion of the
capacity of existing product ran e, vertical integration, diversification in
related areas and mergers.

Summary

Thus this lesson has explained to you the significa ce and mode of
conceiving a good project idea. It also explains to you the various sourc s
from which the project ideas can be generated and how one should sel ct the
project idea.

****

136
 Notes

Lesson 3.2 - Project Formulation Feasibility Study

Learning Objectives

This lesson will throw light on the following objectives.

 To impart the need for projection formulation

 To describe the project formulation process
 To know the criteria to be followed in project formulation
 To explain the nature and significance feasibility study.
 To know the components of feasibility study in a detailed manner.
 To give a brief content of feasibility report and how it can be
checked?

Introduction

Project formulation is an investigating process which precedes

investment decision. The purpose is to present relevant facts b fore the
decision-makers to enable them to decide as to whether to go ah ad signal
should be given for the project or not.

Formulation of projects involves scientific procedure. The task of

any formidable project is too many. It has to present several information
subjective and objective in nature. It explains the objectives, goals and
justification for the acceptance of the project. The major task of a project is
to assess the financial, technical and managerial involvement and its
justification considering the resource constraint. The project formulation
stage involves the identification of investment options by the enterprise.

Project formulation is designed to bring the project sponsoring

authority and the agencies from whom it has to get concurrence, support
etc., on one wavelength. Project formulation by providing a scientifically
developed procedure for developing the content as well as the format of the
investment proposition, seeks to streamline the process of appraisal

137
Notes
of project at government and the aiding agencies level. So, the project
formulation is a process involving the joint effort of a team of experts
including the economists, the financial analysts and specialists in various
fields a well formulated project provides a medium which cut across
scientific, social and positional prejudices and provides a common meeting
ground for all those who have a contribution to make in successful
implementation of a project.

Stages in Project Formulation

The different stages in the project formulation process are briefly

described as follows:

A. Feasibility analysis
B. Techno-economic analysis
C Project design and network analysis
D. Input nalysis
E. Financial anal sis
F. Social cost-benefit a alysis and
G. Project appraisal.

Feasibility Analysis

Feasibility analysis is the first stage in the process of project

development. The purpose of the analysis is to examine the desirability of
investing in pre-investment studies. For this purpose it is esse tial to
examine project idea in the light of the available internal (inputs, resourc s
& outputs) and external constraints (environment). When a project idea is
taken up for developmental three situations can arise. The project may
appear to be feasible, project idea is taken up for development three
situations can arise.

The project may appear to be feasible, project may turn out to be not
feasible or the available data may not be adequate for arriving at reasonable
decision regarding further investment. In the last mentioned case,
investment in pre-investment studies will obviously have to be deferred till
such time as adequate data regarding the project feasibility is available. The
project sponsoring body will therefore have to invest in

138
 Notes
collecting additional data and refer the investment decision for the time
being. In the second situation when the project is found to be not feasible,
further investment in the project idea is completely ruled out. In the third
situation, when the project idea is found to be feasible, the decision-makers
can proceed to invest further resources in pre-investment studies and design
development.

Techno-Economic Analysis

Techno-economic analysis is primarily concerned with the

identification of project demand potential and the selection of the optimal
technology which can be used to achieve the project objectives. The
analysis provides necessary material on which the project design can be
based. It also indicates whether the economy is in a position to absorb the
output of the project or not.

Project Design and Network Analysis

Project design is the heart of the project entity. It defines the

individual activities which go into the corpus of the project and their inter-
relationship with each other. It identifies the flow of events which must take
place before a project can start yielding the results for which it has been set
up. The inter-relationship between various constitue t activities of a project
is most conveniently expressed in the form of a network diag am.

Project design and network analysis are concerned primarily with

the development of the detailed work plans of the project and its time
profile, and the presentation of this plan is the form of a detailed network
drawing. Project design and network analysis make available to the project
formulation team a clear picture of the work elements of the project and also
their sequential relationship. This presentation the way for detailed
identification and quantification of the project inputs, an essential step in the
development of the financial and cost-benefit profile of the project.

Input Analysis

The objective is to identify and quantify the project inputs and to

assess the feasibility of a sustained supply of these inputs all through the
effective life span of the project. Resources are consumed in project

139
Notes
constituent activities. The best method of identifying the project constituent
activities. The best method of identifying the project inputs is therefore to
identify these activities determine the resources which each activity will
consume individual requirements. Input analysis uses the network plans for
developing the input characteristics of the project. If thereafter proceeds to
evaluate the availability of the inputs both in quantitative as well as
qualitative terms.

Resources required for a successful implementation of a project

include not only the material inputs but also human resources which are
necessary both for the setting up of the project as also its successful
normalisation run. Resource requirements estimates form the basis of costs
estimates of the project and are, therefore, essential for developing the
financial profile and the cost-benefit profile of the project.

Financial Analysis

The objective of financial analysis is to develop the project from the

financial angle and to identify these characteristics. Financial analysis
concerns itself with the estimation of the project costs, estimation of project
funds requirements. It also involves and appraisal of the financial
characteristics of the project so as to establish the relative merits and
demerits of the project as compared to oth r investment opportunities.
Financial analysis reduces investment proposition n diverse fields of human
activity to one common scale, thereby simpl fy g the project is developing
project financial forecasts.

Cost Benefit Analysis

In judging the overall worth of the project, the effect which the
project will have on society as a whole is very material. While financial
analysis evaluates a project from the profitability point of view, social cost
benefit analysis views it from the point of view of rational viability, the
cost-benefit analysis however takes into account not only the direct costs
and benefits which will accrue to the project implementing body but also
total costs which all entities connected with the project will have to bear and
the benefits which will be enjoyed by all such entities. The idea here is to
evaluate the project in terms of absolute costs and benefits rather than in
terms apparent costs and benefits.

140
 Notes
Pre-Investment Appraisal

Pre investment appraisal is the process of consolidating the results of

feasibility analysis, the techno-economic analysis, the design and network
analysis, the input analysis, the financial analysis and the cost benefit
analysis, so as to give the investment proposition a final and formal shape.

It naturally involves selection of appraisal format, the material which

should go into pre-investment report and the form of presentation of various
conclusions. The sum total of the pre-investment appraisal is to present the
project idea in a form in which the project sponsoring body, the project
implementing body and the outside agencies can take investment decision
regarding the proposals.

Criteria to be Followed

The main criteria in the project formulation process are:

 Forecasting - understanding and precisely identifying the objec-

tives/needs/goals (regional/ state/ natio al/ international) of the
unit/society/economy on a sustained basis.

 Setting up priorities and choosing the goals that are more urgent

 Searching for alternations and carrying out feasibility studies to

pick up projects that appear most beneficial and desirable.

 Carrying out detailed studies of the project so selected.

 Estimating the needed resources (human and physical) and finding

the yearly cost and benefit of project.

 Arranging funds -both approval and allocation. The successful

implementation of any project depends upon the timely availability
of the required resources as per projections.

 Preparing of time schedule for all jobs so that the physical and
financial targets of the projects are phased appropriately.

 Distributing the works to various departments or agencies having

the appropriate technical expertise.

141
Notes
 Execution and controlling the project. This requires frequent
reviewing, updating and constant action to restore the operation to
its planned characteristics.

 Evaluating the performance of each project to ensure the worth of

good or service for each rupee to be spent.

Feasibility

A feasibility report is an investment proposal base on certain

information and factual data appraising the project. This type of feasibility
study may be required by the financing institutions, project sponsor, project
owner.

The feasibility report enables the project holder to know the inputs
required and if rightly prepared confirms to the convictions that he is
proceeding in the right direction. In other words, a project needs to be fully
defined in order to provide terms of reference for the management of the
project.

A project can be considered to have been fully established when the

following conditions are fulfilled.

 The technical configuration of the project has been fully defined.

 The performance requirement for the various tech ical system and
the key equipment have been specified.
 Cost estimate for the project is frozen.
 Techno-economic viability of the project has been examined,
appraised and approved.
 An overall schedule for implementation of the project has been
drawn-up.

The feasibility report is prepared during the definition phase of a

project. It lies in between project formulation stage and appraisal and
sanction stage. It is prepared to present an in-depth techno-commercial
analysis carried out on the project idea for consideration of the financial
institutions and other authorities empowered to take the investment
decision.

142
 Notes
Components of Feasibility Study

Project feasibility study comprises of market analysis, technical

analysis, financial analysis, and social profitability analysis. The analysis is
mainly interested only in the commercial profitability and thus examining
only the market, technical and financial aspects of the project. But,
generally the gamut of feasibility of a project covers the following areas.

1. Commercial and economic feasibility

2. Technical feasibility
3. Financial feasibility
4. Managerial feasibility
5. Social feasibility or acceptability

Commercial and Economic Feasibility

The economic feasibility a pect of a project relates to the earning

capacity of the project. Earnings of the project depends on the volume of
sales. If taken into consideration the following important indicators.

 Present demand of the goods produced through the project. i.e.

market facility (or) getting a feel of the market.
 Future demand: a projection may be made about the future d
mand. The period normally depend upon the scale of investment.
 Determining the extent of supply to meet the expected demand
and arriving at the gap.
 Deciding in what way the project under consideration will have a
reasonable chance to share the market.
 Anticipated rate of return on investment. If it is positive the
project justifies the economic norm in the relationship between cost
and demand.

Future demand can be estimated after failing into consideration the

potentialities of the export market, the charges in the income and prices, the
multiples use of the product, the probable expansion of industries and the
growth of new industries. The share of the proposed project in the market
could be identified by considering the factors affecting the supply

143
Notes
position such as competitive position of the unit, existing and potential
competitors, the extent of capacity utilisation, units costs advantages and
disadvantages, structural changes and technological innovations bringing
substitute into the market.

The commercial feasibility of a project involves a study of the

proposed arrangements for the purchase of raw materials and sale of
finished products etc. This study comprises the following two aspects.

 Arriving at the physical requirement of production input such as

raw materials, power, labour etc., at various level of output and
converting them into cost. In other words, deciding costing pattern.

 Matching costs with revenues with a view to estimating the

profitability of the project and the break-even point. The possibility
ultimately decides whether the project will be a feasible proposition.

Technical Fe sibility

The examination of this aspect requires a thorough assessment of the

various requirements of the actual production process and includes a
detailed estimate of the goods and services needed for the project. So, the
feasibility report should give a description of the project in terms of
technology to be used, requirement of equipm nt, labour and other inputs.
Location of the project should be given special attent on in relevance to
technical feasibility. Another important feature of tech ical feasibility relates
the types of technology to be adopted for the project. The exercise of
technical feasibility is not done in isolation. The scheme has also to be
viewed from economic considerations; otherwise, it may not be a practical
proportion however sound technically it may be.

The promoters of the project can approach the problem of

preparation of technical feasibility studies in the following order:

 Undertaking a preliminary study of technical requirements to have

a quick evaluation.

 If preliminary investigation indicate favourable prospects working

outfurtherdetailsoftheproject.Theexercisebeginswithengineering and
technical specifications and covers the requirements of the

144
 Notes
proposed project as to quality, quantity and specification type of
components of plant & machinery, accessories, raw materials,
labour, fuel, power, water, effluent disposal transportation etc.

Thus, the technical feasibility analysis is an attempt to study the

project basically from a technician’s angle. The main aspects to be
considered under this study are: technology of the project, size of the plant,
location of the project, pollution caused by the project production capacity
of the project, strength of the project. Emergency or stand-by facilities
required by the project sophistication such as automation, mechanical
handling etc. required collaboration agreements, production inputs and
implementation of the project.

Financial Feasibility

The main objective of this feasibility study is to assess the financial

viability of the project Here, the main emphasis is in the preparation of
financial statement, so that the project can be evaluated in terms of various
measures of commercial profitability and the magnitude of financing
required can be determined. The decision about the financial feasibility of a
project should be arrived at based on the following consideration:

 For existing companies, audited financial statem nts such as

balance sheets, income statements and cash flow statements.
 For projects that involve new companies, statements of total
project cost, initial capital requirements, and cash flow relative to the
projective time table.

 Financial projections for future time periods, including income

statements, cash flows and balance sheets.

 Supporting schedules for financial projections stating assumptions

used as to collection period of sales, inventory levels, payment
period of purchases and expenses and elements of production cost,
selling administrative and financial expenses.

 Financial analysis showing return on investment return on equity,

break-even volume and price analysis.

 If necessary sensibility analysis to identify items that have a large

impact on profitability or possibly a risk analysis.

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Notes
Managerial Feasibility

The success or failure of a project largely depends upon the ability

of the project holder to manage the project. Project is a bundle of activities
and each activity has its own role. For the success of a project, a project
holder has to co-ordinate all the activities in such a way that the additive
impact of different inputs can produce the desired result.

The ability to manage and organise all such inter related activities
come within the concept of management. If the person incharge of the
project, has the ability, has the ability to manage all such activities, the
desired result can be anticipated.

There are three ways to measure the managerial efficiency.

a Heredity skill
b Skill cquired through training.
c. Skill cquired in course of work.

Social Feasibility

A project may cross all the above barriers mentioned above and
found very suitable but it will lose its entire creditability, if it has no social
acceptance. Though the social customs, convent o s such as caste
community, regional influence etc. are creating hindrance for development
of a project should avoid all such social conflicts which will stand on the
successful implementation of the project.

(e.g) Considering the interests of the general public; projects which

offer large employment potential, which channelise the income from less
developed areas will stimulate small industries.

In a nut shell, the feasibility report should highlight on these five

testing stones before it can be declared as complete and only after judging
through these indicators a project can be declared as viable and can be
submitted for finance or any other assistance from any institutions.

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 Notes
Format of Feasibility Report

The sketch of feasibility report of project is given below:

1. Introduction
2. Summary and Recommendations
3. Product- Capacity, Chemistry of the product, specifications,
properties, application and uses.
4. Market potential
5. Process and know-how
6. Plant and machinery
7. Location of the unit
8. Plot plan and building
9. Raw materials availability
10. Utilities, requirements
11. Effluents treatment
12. Personnel requirement
13. Capital cost
14. Working capital
15. Mode of finance
16. Manufacturing cost
17. Financial analysis
18. Implementation schedule

Check List for Feasibility Report

The following key elements must be presented in the feasibility

report.

1. Examination of public policy with respect to the industry project

2. Broad specification of outputs and alternative techniques of
production.
3. Listing and description of alternative locations
4. Preliminary estimates of sales revenue, capital costs and operating
costs of different alternatives.

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Notes
5. Preliminary analysis of profitability for different alternatives.
6. Marketing analysis
7. Specification of product pattern and product price
8. Raw material investigation and specification of sources of raw
material supply.
9. Estimation of material energy, flow balance and input prices.
10. Listing of major equipment by type, size and cost.
11. Listing of auxiliary equipment by type, size and cost.
12. Specification of sources of supply for equipment and process know-
how.
13. Specification of site and completion of necessary investigation.
14. Listing of buildings, structures and yard facilities by type size and
cost.
15 Specification of supply sources connection costs and other costs for
tr n portation services, water supply and power
16. Preparation of layout.
17. Specification of skill-wise labour requirements and labour costs.
18. Estimation of working capital requir ments
19. Phasing of activities, and expenditure during construction
20. Analysis of profitability
21. Determination of measures of combating environmental problems
22. State the preparedness to implement the project rapidly.

Conclusion

Thus the process of project formulation involves a stage by stage

development of the project idea into an investment proposition. The
conclusion drawn at the end of each stage form the basis of development of
the ensuing stage. These conclusions also provide necessary materials for
re-checking of the initial premises from which a beginning was made. There
must be forward and backward look at the completion of every stage. So,
the project formulation team has to be ready to revise its opinions and
conclusions in the light of further evidence.

148
 Notes
It also narrates the very purpose of a feasibility report in a lucid
manner, covering components of feasibility reports, principal features of
project feasibility study and also checklist for feasibility study. It helps in
defining and analysing the alternative approaches to production processes
and outcomes. It focuses attention on the material inputs and various other
techno-economic variables. It describes the optimisation process, justifies
the assumptions and hypothesis set thereby selecting the better alternative
solutions and defines the clear boundaries of a project viability.

****

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Notes

Lesson 3.3 - Project Report

Learning Objectives

This lesson aims to impart understanding about

 The need for preparing a project report.

 The content of an ideal project report.

Introduction

A project at the outset must bear a logical appearance, which it can

get only fter the feasibility test. Project report is a document, which clearly
narr tes the various aspects of project in a prescribed form. Project report
preparation is a post investment decision exercise.

It involves the preparation of detailed specifications and designs for

the project premises, detailed des gn of the process or other equipment and
time schedules for the impleme tation of the project. Hence, the detailed
project report is the work plan for the implementation of a project once an
investment decision is arrived at.

A project report is meant to provide the necessary information,

which may be required for the purpose of processing and assessing the
proposal for getting the financial assistance from the financial institutions.

This is essentially prepared in order to provide a complete

information with proximate values of the project and presented to the
financial institution for appraisal. A project report prepared with utmost care
would not only give a clear idea to the banker but also it relives the
entrepreneur from the normal objections and formal queries of the banker.

In a developing economy like India, where the development banking

is vigorous, an entrepreneur gets a lot of published materials with data
relating to various feasibilities and promotional institutions engaged in

150
 Notes
entrepreneurship development produce good literature covering various
aspects of producing a project or products in the country. The Director
General of Technical Development (DGTD), National Small Industries
Corporations (NSIC) are some of the pioneer institutions providing variety
of information for small scale entrepreneurs to manufacture. They give
guidelines for industries indicating those items, in which good scope exists
for manufacturing.

With these available informations, an entrepreneur has to do the

following for starting an industrial unit:

 To decide the type and level of industrial production

 To compare the requirements of funds with his personal
availability of finance.
 To prepare a nice project report containing all relevant information

Many of the institutions like SISI, State Financial Institutions also

help in preparation of project report and later on recommend them to the
banks. Besides these institutions, several commercial banks help the
entrepreneurs to get a good project report.

Components of Project Report

The following are the important headings under which the complete
information on relevant aspects should be included for a small scale
industry’s project report.

 General information
 Rationale
 Project description
 Market potential
 Capital expenditure and sources of finance
 Assessment of working capital
requirements  Other financial factors
 Government and other statutory approvals
 Economic and social variables

151
Notes
1. General Information

The following aspects should be given in the stage, which are of

general Nature

 Name and address of the entrepreneur

 The qualifications, experience and other capabilities of the
entrepreneur. If it is a partnership firm, these informations of other
members should also be given.
 A small reference of analysis of industry to which the project
belongs e.g. past performance, present status, the way of
organisation, the problems etc.
 The organisational structure of the enterprise
 The utility of the product and the range of products to be
manufactured

2. Rationale

As mentioned earlier a project may have several objectives

subsidiary to the prime objective of maki g prof t. As a first step in project
evaluation, it is essential that one looks at the broad rationale of the project
proposal to ensure that the project is appropriate a d justified. As an
example, one could say that modernisation or pollution control may be fully
justified on grounds of survival and environmental protection even if, in the
short-term, the project expenditure may adversely affect the financial
criteria of project evaluation. On the other hand, a project which would
improve the earnings per share or the debt service cover or the production
efficiency may not necessarily be justified if all this is to be achieved at the
expense of national interest or public interest.

3. Project Description

A brief description of the project covering the following aspects

should be given in the project report.

SITE: Location (Town, Complete address) whether owned or

leasehold land, whether the site is approved industrial area? Is it suitable for
the product under review.

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 Notes
4. Input Factors

Raw materials: What are the sources of raw materials? Are they
locally available? Whether imported raw material is also required? If so,
whether license has been obtained? Is it suitable to get quality raw materials
continuously at reasonable prices?

The availability, quality critically and quality compatibility of the

raw material with the technology as well as the plant and machinery are
important factors to be clearly understood while evaluating a project
especially those in hi-tech area.

This element is also intimately linked to many other elements in a

project and can force necessary changes in them to ensure the viability of
the project.

As a simple example, one can easily surmise that a raw material

with a high volume to weight ratio will indicate the plant is located near the
source of raw material. e.g. Cement, power (coal based).

On the other hand, if the value added in such a case is very high,
then it may be possible or even necessary to locate the pla t away from the
source of raw materials. Textiles, power (gas based of oil bas d), processed
foods like snack foods, ice creams are some the pertinent exampl s.

The characteristics of the raw materials are multivariate and not just
on the volume weight ratio. It is imperative therefore that this element gets a
careful consideration while assessing a project. The market, the
management, and the utility needs of the projects also influence the
locational decisions.

Labour: What is the type of labour required? Whether skilled or

unskilled? Are they available in that area? If not, what arrangement have
been made to recruit and train the labour in various skills?

Power: Inadequate supply and high cost of electricity is a major

problem now-a-days. So, the project report should contain the information
regarding the power requirements, the load sanctioned, stability of supply of
power and the price at different consumption level.

153
Notes
Fuel & water: Whether the fuel systems like coal, coke, oil or gas
are required and if yes, then state their availability position. Similarly water
is an important factor. The source and the quality of water should be clearly
stated.

Waste discharge: Most of the plants produce waste material or

emissions that may result in many health problems to the public. The
emissions and discharge may be various types like (a) gaseous (smoke,
fumes, dust etc.) by physical (noise, hear, vibration etc.) or (c) liquid or
solid discharged through pumps and sewers. Hence, it should be clearly
stated that the arrangements made from these things.

Communication and Transport Facilities

Availability of communication facilities like telephone, telex and

post and telegraph department, should be stated in the report. Similarly,
transport is basic necessity for industries. Raw materials as well as finished
products has to reach destination only through a good transport systems
available. So, the various transport facilities available in that should be
clearly stated. Similarly availability of facilities like machine shops,
welding shops and electrical repair shops etc., should also be stated.

List of Machinery & Equipments

A complete list of items of machinery and other equipments

indicating their type, size and cost should be stated. Source of supply of
capital equipment and the construction services should also be given.

The source of plant and machinery as also the specification for the
same can often make or break a project. It is, therefore, equally important to
evaluate the plant and machinery which is to be installed at the project. The
reputation of the supplier and references to place where such/similar plant
and machinery are installed is a good starting point while assessing this
element.

Capacity & Technology

The installed and licensed should be stated and the number of shifts
likely to follow should be stated. Similarly, Is the technology upto date and

154
 Notes
appropriate? Which other units are using the same technology and with
what results? How the required know-how is proposed to be arranged?

The level of technology in terms of its “state of art” or obsolescence,

adaptability to the local conditions, maintenance and repairability,
sophistication in management and control are elements which have a
significant impact on the quality and quantity of production that is
envisaged in the project. It is thus necessary to have a clear understanding
about the technology which is to be utilised in the project.

It is pertinent to note that there are no hard and fast rules but
“appropriateness” and “relevance” are the two key operative words while
assessing a technology proposed for the project. It is ridiculous to propose a
highly sophisticated, push button control technology in a place where
electricity supply follows its own rules or where a simpler technology is
better understood and more manageable. Equally, it would be disastrous to
recommend an obsolete technology on account of its durability or time
tested proof of performance when everyone else is fast discarding it.

This technology elements is linked to every other element in the

project proposal and these linkages also need to be looked into as an
essential step in assessing the technology. One of the tech ologi s available
may necessitate creation of large capacity not necessarily advisable given
the current raw material supply or the market size for the product.

For example, a capacity of 100 tpa for manufacture of peer starting

from pulp or even hard wood or bamboo could be considered an or even the
“minimum economic” size leading to acceptance of a particular technology
which gives maximum efficiency at 10 tpa. But if raw material proposed is
“agricultural waste” a whole lot of new considerations starting from
collection and storage or raw materials come into play necessitating
appropriate changes in the plant size and even perhaps the technology.
Similar situations can arise in linkages of technology to management,
availability of utilities, and cost of the project.

Quality Control

What is the system arranged for to check the quality of products on

continuous basis? The quality marks like ISI, Agmark will enhance the

155
Notes
values of the product as well as confidence among the consumers. If it is
desired to get quality markings, the fact should be included in the project
report.

5. Market Potential

Estimation of Demand & Supply

Facts regarding the anticipated demand for product and the level of
supply, should be clearly stated. An estimate of manufacturing and
administrative expenses together with the price expected along with the
margin of profit should be stated.

Marketing strategy: What is the strategy adopted for marketing the

product should be stated. Whether the products are to be supplied to the
reputed sellers directly or distributors? Is there any possibility of getting a
contract from the reputed concerns should also be stated in this project
report. Simil rly whether after sales service has been arranged and how to
fill the gap of demand if there is fluctuations in the sales seasonal demand
arrangements made for warehousing the products.

6. Capital Expenditure and Sources of Finance

Cost of the project: Since each proj ct is profit motivate it is

important that cost of the project is carefully ass ssed and evaluated. One of
the most important factors in this assessment is the level of accuracy in the
cost estimates, which in addition to proper data collection also depends
upon the approach and the attitude of the evaluator hims lf. Some evaluators
tend to see all cost estimates as “too high” leading to unnecessary under
estimation of the project cost and consequent problems in project
implementation and even project viability. On the other hand some
evaluators tend to provide “cushions” at all levels of cost estimates which
may erode the viability of the project on paper leading to a wrong decision
on the issue of project selection and implementation.

An estimate regarding this various capital inputs required by the

industry should be given. Those capital items include the following:

1. Land & Building

2. Plant and machinery

156
 Notes
3. Preliminary expenses
4. Miscellaneous assets
5. Price escalation
6. Working capital limit

Means of financing: Having established the cost of a project as

justified and reasonable, it is necessary to evolve the means of financing the
project. It should be acceptable within the framework of the financial
system and sufficiently attractive/or safe enough for the investor lender to
come forward and extend the necessary assistance.

During the last decade, financial scenario in India has undergone

substantive, qualitative as well as quantitative change almost amounting to a
metamorphosis. As a result the project prosperity has a fairly wide range of
means of finance available to him to choose from. Instead of a standard
debt-equity ratio of 2:1, the promoter taking up 50% to 75% of the equity,
the balance being offered to the public and the financial institutions and
banks picking up the tap for the debt component.

The promoter can now think of a variety of instruments like equity

cumulative convertible preference shares fully or partly or on-convertible
debentures, as means of financing and also many other sources of funds like
mutual finds, venture finance and lease finance. A clear und rstanding of the
various elements and the various institutions operating in the financ al
system would help to assess the appropriateness of the means of finance.
The cost of raising and servicing funds, and other terms and conditions
accompanying funds, as all these have a direct impact on the viability of the
project. At this juncture, it is worthwhile nothing that the project evaluation
should also pay due attention to the ethics of fund raising especially if the
means of finance involves premium carrying instruments.

7. Assessment of Working Capital Requirements

Many industries fail due to improper estimate of working capital

requirements. It is very crucial to an entrepreneur. The unit could function
only if the working capital limit is maintained properly. So, the working
capital requirements should be very carefully calculated and stated in the
project report.

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Notes
8. Other Financial Aspects

It should be found out that the product taken up for production is

profitable. For this, profit & Loss A/c an estimated one should be prepared,
which shows sales revenue, cost of production and other costs and profit.
Similarly a projected balance sheet and cash flow statement should be
prepared to indicate financial position and financial requirements.

There should be always availability of funds for the smooth

functioning of the unit. Next the break-even analysis must be given break-
even point is that level of production sales where the industrial enterprise
shall make no profit no loss. This break even analysis facilitates knowing
the gestation period and the likely moratorium required for repayment of
loan.

The return from a project is a very essence of evaluating a project

especially s the prime motive for setting up a project is its profitability. The
project return is to be assessed in terms of cost of production realisable
selling price, financial charges, depreciation taxes and host of other
financial and non-fina cial variables.

9. Government and Other Statutory Approvals

The project is not put up in a vacuum but in the real world which is
subject not only to procedural requirements but also to policy guidelines and
stipulations. These requirements, guidelines and stipulation could begin
with the very permission to establish a project and go across various
economic statutes of a country governing several aspects of a project. The
project evaluation must take all these into account, not merely as an element
of feasibility or otherwise of setting up the project but as part of the plan
extending over the economic life of the project.

10. Economic and Social Variables

Among other things, what will be the abatement costs to control

pollution and treating for the effluents and emissions, should be stated.
Added to this, whether the project derives home some social benefits like
the following:

158
 Notes
 It promotes an increases the employment potential in that area
 It promotes an encourages smaller units (tiny sector) to grow
 It effects overall development of that area

Economic and National Significance of the Project

Many projects have an economic and/or a national significance

especially if they are in the area of hi-tech, import substitution, export
orientation, defence and/or involve substantive outflow of foreign currency
either for technology know-how or for raw materials. It is necessary to
evaluate the economic and the national significance of a project is to be
made acceptable in the prevalent economic scenario.

Social and Environmental Consideration

While setting up a project, issues not necessarily connected with the

financial profitability of the project but to the environment and society as a
whole have become important in more than one case. These issues relate to
environmental pollution and safety as also different segments of the society
coming in contact with the activities of the project.

Two models of project report are given at the end of this lesson.

Project Report Vs. Feasibility Report

The detailed project report differs from feasibility report in the

following manner:

Objective: Feasibility report’s aim is to serve the top management in

arriving at feasible and viable project alternatives. Detailed Project Report’s
focus is to communicate formally about the project sponsor’s decision on a
specific project to the government departments and financial institutions for
seeking their approvals and funding.

Scope of information Management: The interests of the management

can be met by collecting relevant information in vital areas of technical,
economic, commercial and environmental areas at the onset. However,
about 70-80% information may be collected and analysed in feasibility
studies based on which certain reliable forecasts are made and decisions are
taken by the management.

159
Notes
Time span: These studies are subjected to an exploratory type of
research and hence consume a span of 6 to 15 months. A lot of care and
diligence is inevitable on the part of the estimator while preparing the
official document and hence may consume time within the range of 1 year
to 2 years after the decision is taken by the top management.

Costs involved: The cost of feasibility studies varies on the type of

project. As an average for any project the costs may range approximately
between 1.5-3% of the project costs. The cost of preparing a detailed project
report is little higher than that of feasibility studies. The total costs may
range between 5%-7.5% of the expected investment.

Reliability: These studies are reliable for a short period of time (till
the decisions are made about a project). In the long run they serve only as a
data bank as the information stinks. The detailed reports help in guiding the
entire project and even if any variation is there in the project data it can be
comp red and observed. However, this acts as a major signpost for all
practical purposes in the project development and for future reference.
Depth of analy i : The depth and magnitude of the feasibility studies are
obviously reflected through costs and time consumed in conducting studies.
The level of information furn shed in these reports is clear, yet some
secondary issues are perfunctorily ma ag d. The depth and magnitude is
perfectly maintained by furnishing i tricate d tails of the project. The report
is prepared with diligence taking all precautions to avoid ambiguity and
mystery concerning issues of the project.

Summary

Thus, Project report is a precise formal document of commitment

prepared and presented by sponsors of a project. On the basis of this report,
the Project Investment Board and Cabinet Committee on economic affairs
of the concerned Ministry Proffer their exoneration of the project proposals.
The preparation of detailed project report is the preliminary phase of a
project life cycle. The preparation of project report starts only after the
investment decision is made on the basis of the technical, economic and
financial feasibility studies, so that expensive efforts involved in the
preparation of report are not wasted. To prepare the project report from a
techno-economic feasibility study, we have to

160
 Notes
 Break-down all project components, time phase and schedule
them minutely and prepare accurate cost estimates, furnishing with
necessary and relevant assumptions and calculations.
 Develop baselines for controlling time and costs that help the
implementation of the project.
 Resources to implement the project.

****

161
Notes

Lesson 3.4 - Project Appraisal – Market, Technical, Financial,

Commercial, Managerial and Social Aspects

Learning Objectives

This lesson will give an insight to the learners on the following:

 The nature and significance of project appraisal.

 The general information required for project appraisal.
 The process of project appraisal followed by the financial
institutions.

Introduction

The exercise of project appraisal simply means the assessment of a

project in terms of its economic, social and financial viability. This exercise
basically aimed at determi i g the v ability of a project and sometimes also
in reshaping the project so as to upgrade its viability i.e. it aims at sizing up
the quality of projects and their long-t rm profitability.

Appraisal of term loan proposals (projects) is an mportant exercise

for the financial institutions and investing companies in credit decisions.
The art of project appraisal puts more emphasis on the economic and
technical soundness of the project and it earning potential than on the
adequacy and liquidity of the security offered. Hence, the process of
appraisal should require more dynamic approach as it is linked with a sense
of uncertainty.

Appraisal Process

Project appraisal is a scientific tool. It follows specific pattern. This

process usually involves six areas of appraisal such as market appraisal,
technical appraisal, financial appraisal, profitability appraisal, managerial,
and social appraisal.

162
 Notes
Market and Demand Appraisal

Appraisal of commercial viability means assessment of

marketability of the end-product. Therefore, at the time of assessment of
commercial viability, the following points require careful consideration.

 Size and prospective growth of the market which the unit is

required to cater like nature of population, their purchasing power,
their educational background, fashion etc.
 Demand and supply position of the product in the national and
international market
 Nature of competition
 Pricing policy including prospective prices vis-a-vis the quality of
the product
 Marketing strategy and selling arrangements made by the unit
adequacy of sales fore:
 Export potential
 If the product is an important-substitute, the position regarding
existing imports in the country along with the C.I.F value of the
imported goods, vis-a-vis cost of product of the u it.

Technical Appraisal

A project is considered to be technically feasible, if it is found to be

‘sound’ from technical and engineering point of view. It is an attempt to
find out how well the technical requirements of the unit can be met, which
location would be most suitable and what the size of plant and machinery
should be.

Objectives of Technological Appraisal

The fundamental objective of appraising a project from the

technology point of view is to justify the present choice and provide an
insight into future technological developments. Other objectives are:

 To justify the goal compatibility of a project with the preferred

technology;

163
Notes
 To seek a better available alternative technology which is both
cost effective and efficiently manageable;
 To seek such a technology that can go with existing skill levels of
team members or requires little orientation and training programmes;

 To seek a better technology that is not detrimental to the overall

environment.

The technology that is used in projects can be classified on the basis of:

 Purpose for which it is applied;

 Level at which it is used;

 Nature of skills applied while using the technology. On the basis

of purpose, the technology can be:
 Manufacturing technology which is generally used in
manufacturing industries like textiles industries like textile
industries, steel industrie , etc.,
 Extraction technology which is used in extraction of basic raw
materials such as oils, petroleum products, coal and pig iron, etc.,
 Conversion technology which is us d in process industries like
cement, sugar, etc.

Pre-fabricated technology which is used in construction industries

like roads, bridges, and buildings, sheds etc., On the basis of the level at
which technology is used the classification is as follows:

Core technology which is a base for any industrial activity like basic
plant and machinery that is erected. For example, Lakshmi Machine works
textile machine installed in a textile firm.

Engineering and design technology which supports the core

technology by providing basic layouts and helps in erecting the plant at the
required site. Considering the above example, the machine has to be linked
with essential spindless and spools through which the yarn is supplied to the
machine on which the yarn will be warped and weft.

Intermediate technology which supports both core technology and

engineering and design program with sufficient intermediaries such as

164
 Notes
heavy machine tools and devices to mobilize input and output and output of
firm and continue to operate the machinery.

Component technology which is labelled as supplied or consumable

for the core, engineering and even intermediate technology. For example,
spare parts of a machine, screws lubricating oil, belts, electrical connections
and other engineering fittings, etc.,

Appraisal of Managerial Competence

This is the most difficult job to evaluate the “ MAN or MEN”

behind the project. It has been the practical experience of the bank/ financial
institutions that even the most technically feasible and
financially/commercially viable project has been a total failure because of
lack of management experience. The problem may become all the more
serious if the management is dishonest/delinquent rather than inefficient and
ineffective. Unfortunately, there is no scientific yardstick by which
managerial competence can be judged objectively. For an established group
of industrialists floating a new company unit, the banker can have at least,
an idea of the background of the promoters. Much also depends whether the
existing promoters belong to the ‘Blue Chip’ group or not. But, in case of a
new promoter floating a new project, the problem of judging managerial
competence induces some kind of subj ctivity in the decision of the
banks/financial institutions. In appraisal parlanc , such evaluation is known
as ‘Principle of three Cs’ i.e. Character, Capacity and Credit worthiness.
The following table will show some principles of credit evaluation in terms
of Cs of credit.

Financial Appraisal

The basic purpose of financial appraisal is to assess whether the unit

will generate sufficient surplus so as to meet the outside obligations.
Financial appraisal usually examines two aspects of finance:

The cost of the project i.e., the amount required to complete the
project and bring it to normal operation

The means of financing the cost i.e. the sources from which the
required funds are to be raised.

165
Notes
After computing the cost of the project and means of finance, the
various factors required for assessment of financial viability which a banker
should carefully examine, are as under:

Reasonableness of Cost of Project

The project cost should be reasonable: However, assessing

reasonableness of the project cost is a very difficult and delicate task. Here,
generally, the technique of inter-firm comparison is used which compares
the project cost estimates with the cost of comparable units in the same
industry.

Debt-Equity ratio: This is a very important consideration as there

should not be mismatch between the external debt (long-term) and the
equity of the enterprise.

Long Term Debt

Sensitivity Study: This is carried out to see that the unit would be
able to serve its debts & give reasonable return under less optimistic
conditions. For determini g, prof tability of the project generally projections
are obtained over the ent re r payment period (say 7 to 10 years) in the
following functional areas:

 Cost of Production
 Profitability
 Cash flow
 Debt service coverage
ratio  Break even point

The appraiser should satisfy himself about the reasonableness of the

basic assumption on which the above projections are made The important
assumptions generally looked into are:

 Capacity build up
 Cost of raw materials
 Estimates of salaries & wages
 Estimates of administrative expenses

166
 Notes
 Expected selling price
 Provisions made for depreciation
 Provisions for various taxation liabilities

The assumptions should be reasonable and realistic. In case, the

assumption are not pragmatic, the same can be got changed by the bank and
fresh figures can be compiled. But the basic consideration the banker should
have it that the cash generation position of the unit should be quite
comfortable throughout the repayment period. An ideal debt service
coverage aimed at is 2:1.

A model problem for ascertaining cash flow projection and the

financial viability of the project are given below:

Illustration

Sai enterprises is interested in assessing the cash flows associated

with replacement of an old m chine by a new machine. The old machine has
a book value of ` 90,000 and it can be sold for ` 90,000. It has a remaining
life of 5 years after which the salvage value is expected to be nil. It is being
depreciated annually at the rate of 10% usi g written down value method.
The new machine costs ` 4 lakhs. It s exp ct d to fetch
` 2.5 lakhs after 5 years when it will no longer be required. It will also be
depreciated annually @ 10% using W.d.v method. The new machine s
expected to save ` 1 lakh in manufacturing costs. Investment in work ng
capital would remain unaffected. The tax rate applicable to the firm is 50%.

You as a project analyst are required to work out the incremental

cash flows associated with the replacement of old machine and prepare a
statement to be presented to the management for consideration.

Answer

The above case refers to a replacement project. In such cases, one

must take the following points into consideration:

 comparison of new machine with the old machine from the overall
cash flows point of view;

167
Notes
 comparison of net impact of the ‘replacement’ or ‘retaining the
old machine’ over the cash flows;
 financing mix used for the replacement and its impact on the
interest rates to observe the effect on the profit after interest and tax.

At least two of the above factors should be applied here to analyse

the position and present the analysis for managerial consideration. The
following cash flow statement will help present the situation better.

Cash flows for the Replacement of machinery of Sai Enterprises

(Rs in crores)

Years 0 1 2 3 4 5
1.Net Investment (3.10)
in the m chine

2.Savings in 1 1 1 1 1
manufacturing
costs

3.Depreciation on 0.09 0.081 0.0729 0.0656 0.0590

the old machine

4.Depreciation 0.4 0.36 0.324 0.2916 0.2624

on the new
machine

5.Incremental 0.31 0.279 0.2511 0.2259 0.2033

Depreciation

6.Incremental 0.69 0.721 0.7489 0.7740 0.7966

taxable profit

7.Incremental tax 0.345 0.3605 0.3744 0.3870 0.3983

8.Incremental 0.345 0.3605 0.3744 0.3870 0.3983

profit after tax

9.Net incremental 2.50

salvage value

168
 Notes

Years 0 1 2 3 4 5
(a) Initial (3.10)
investment (1)

(b) Operating 0.655 0.6395 0.6255 0.6129 0.6061

cash flows
(5+8)

(c) Terminal cash (3.10) 0.655 0.6395 0.6255 0.6129 3.1061

flows (a+b+c)

Working Notes:

1. Net investment (` 4 lakhs less ` 90,000) = ` 3.1 lakhs

2. Savings of the new machine are given in the problem, i.e. 1 lakh
3. Incremental depreciation is derived by considering depreciation of
the new machine less depreciation of the old machine.
4. Operating cash flows = Incremental depreciation + Incremental
profit after tax.

Profitability Analysis

The financial projection such as profitability estimat s, cashflow

estimates and projected balance sheets are the basis for assessing the
viability of the project. Therefore, verification of profitability estimates is
highly important for the proper appraisal of a term loan proposal.

The profitability estimate should always accompany the assumptions

based on which the profitability estimates have been prepared.

Ratio Analysis

Many important parameters such as sales, operating profit, net profit,

equity, debt, current assets. Current liabilities, etc. do not give much
information if figure is studied in isolation. If a ratio is calculated between
related items, the ratio indicates the relationship between two or more than
two variable, thus giving meaningful information for taking decision. Some
of the ratio useful for banks are discussed below.

169
Notes
A. Loan Safety Ratio

This indicates the relationship between term liabilities and owned

funds and helps in assessing the capital gearing. The debt shall include long
term loans, debentures, deferred payment preference shares due for
redemption between 1 to 3 years. The equity includes ordinary share capital,
preference share capital due for redemption after 3 years, investment
subsidy, unsecured loans subordinated to the term loan, internal accruals,
non refundable deposits in the case of cooperatives.

B. Current Ratio

(Current assets to current liabilities)

The ratio indicates the liquidity position of the company. Current

assets should be more than current liabilities. The acceptable ratio should be
between 1.5 to 2.1. The ratio beyond 2.1 will indicate that either the
inventories re tocked unnecessarily or the products produced are not sold.
The current ratio will indicate the necessity for proper inventory control.

C. Debt Service Coverage Ratio(dscr)

The ratio indicates the capacity of the unit to repay the term loan
liabilities and interest thereon. It is important ratio for le ding institution as
the repayment period has to be suitably fixed based on this ratio. This ratio
indicates the cash generation the term liabilities to be paid out of this and
balance left for the company’s use. Repayment of term loan without
generating sufficient cash will lead to reduction in working in the working
capital, tight liquidity position and further deterioration in the working of
the unit. The acceptable ratio should not be less than 1.5: 1 which indicates
that 1.5 times cash is generated to pay the term, loan liabilities of one time.
The formula calculation of the DSCR is given below.

Net profit + Depreciation + Interest on term

Loan liabilities
DSCR = --------------------------------------------------
Payment of term loans + interest on loans

170
 Notes
The DSCR should be calculated for each year of operation and also
for the entire repayment period as an advance.

D. Margin of Security

The term loans are generally sanctioned against the security of fixed
assets. The excess of fixed assets over the term loans provides margin for
the term loans.

Value of fixed assets – term loans

Margin of security = ------------------------------------------- × 100
Value of fixed assets

Productivity Ratio are:

1. Capital employed to Value of output sales

2. Capital employed to Net value added
3. Investment per worker
4. Productivity per worker

Profitability Ratio are:

a. percentage of raw material to value of output

b. percentage of wages and salaries to value of output
c. Percentage of interest to value of output
d. Percentage of operating profit to sales
e. Percentage of profit after tax equity

A list showing the method of calculation of above ratios and their

usefulness is given separately.

Break Even Point (Bep)

The manufacturing cost consists of two costs viz. fixed costs and
variable costs. Certain type costs viz. depreciation, interest on term loan,
repair and maintenance, rent and insurance, wages and salaries,
administrative expenses etc. has to be incurred by the unit irrespective of the
level of operation. This cost will not change with the level of operation and
they are called fixed costs. All the other costs viz. cost of raw material

171
Notes
consumables, power, water, stores, packing charges, selling expenses etc.
which vary with the level of operation is called variable cost. The BEP is
the level at which the unit should operate to meet the fixed costs. It is level
of operation, where there is no profit or loss for the unit. The BEP is
calculated using the following formula

Fixed cost Fixed cost

BEP = ---------------------- × ----------------
Sales-variable cost Contribution

% BEP in terms Fixed cost Max. capacity utilisation

of installed capacity = ----------------- × ----------------------------- × 100
Contribution 100

The appraising officer should follow uniform policy to divide the

total cost into fixed cost and variable cost as certain cost neither remain
fixed nor ch nged in the same proportion in which the level of production
changes.

Discounted Cash Flow Tech iques

A project should earn sufficient return which should be at least equal

to the cost of capital invested in it. The following evaluation techniques
helps to identify the best investment proposal amongst the available.

 Pay back method

 Average Rate of Return Method
 Net present value method
 Internal rate of return

a) Pay Back Method

The period required for recovering the entire investment made the
project is calculated. The shorter is the period better return. The cash flow
(operating profit + depreciation + other non cash write off-tax) is
accumulated year by year until it equals the original investment. However,
this method ignores the cash inflow received after crossing the pay back
period. This method is best suited where the emphasis is on avoidance of
long term risk.

172
 Notes
b) Average Rate of Return

Unlike the pay back period method, the entire life of the project is
taken into account. The average annual net operating profit (after
depreciation) for the entire life of the project is calculated and the rate of
return of original investment in an year is calculated by taking the average
of opening and closing book values of the investment in the year. The grand
average of such average investment of all years is obtained to know the
average investment of the project gives the average rate of return. This
method does not give any importance to the time value of the money and
also the life differential of the projects.

c) Net Present Value Method (NPV)

Pay back method and average rate of return method does not give
importance to the time value of money. The money invested today will not
be equal to the money received in the future. Therefore, the time value of
the money also should be taken into account while determining the return
for the present investment.

Under this method, the future cashflow of all the years during the
expected life of the project are discounted at a predetermi ed cut-off rate and
the net present value is obtained. The cut-off rate should be either equal to
or more than the cost of the funds. The present investm nt is an outflow of
funds and hence treated as having minus value. If the difference between the
present investment and the net present value of cash inflow is positive than
it indicates that the profit is greater than the cost of the capital.

d) Internal Rate of Return (IRR)

NPV method indicates, the net present value of the future cash flows
at a predetermined discount rate and the project is accepted for investment if
the return of a project, the net cashflow in each year are discounted at
various discounting rates till the sum of net present value of cashflow equal
the cash outflow. Such a rate of discount which would equate the present
value of investments to the present value of future benefits over the life of
the projects.

173
Notes
Problem 1

NMH Industries is considering proposal involving procurement of a

special machine to produce a new product. The technical team furnished
two alternative machines whose investment costs are ` 50,000 each and life
span is 4 years. After the expire of its useful life, the vendors guaranteed to
buy back at ` 5,000 each. The management of the company uses certainly
equivalent approach to evaluate risky investments. The company’s risk
adjusted discount rate is 16% and the risk-free rate is 10%. The expected
values of net cash flows (CFAT) with their respective certainly equivalents
are as follows:

Year Machine A Machine B

CFAT CFAT
CE CE
` `

1 30,000 0.8 18,000 0.9

2 30,000 0.7 36,000 0.8

3 30,000 0.6 24,000 0.7

4 30,000 0.5 32,000 0.4

Which machine should be purchased, out of the above, by the company?

Answer

NPV Under Certainly Equivalent Approach:

Machine A Machine B
Year PV ECFAT CE ACFAT PV ECFAT CE ACFAT PV
factor
amount amount
at 10%
0 1.000 -50,000 1 -50,000 -50,000 -50,000 1 -50,000 -50,000

1 0.909 30,000 0.8 24,000 21,716 18,000 0.9 16,200 14,725.80

2 0.826 30,000 0.7 21,000 1,7346 36,000 0.8 28,800 23,788.80

3 0.751 30,000 0.6 18,000 1,3518 24,000 0.7 16,800 12,616.80

174
 Notes

Machine A Machine B
Year PV ECFAT CE ACFAT PV ECFAT CE ACFAT PV
factor
amount amount
at 10%
4 (i) 0.683 30,000 0.5 16,000 1,0245 32,000 0.4 12,800 8,742.40

(ii) 0.683 5,000 1 5,000 3,415 5,000 1 5,000 3,415.00

NPV 16,240 NPV 13,288.80

The above analysis clears the fog surrounding investment

possibilities.

Machine A is resulting in higher NPV compared to Machine B.

Therefore, machine A should be purchased having the highest NPV at risk
free rate.

Problem 2

Sastha Ltd is considering a project with the following cash flows.

Year 0 1 2
Purchase of Plant (` 7,000)

Running Costs ` 2s,000 ` 2,500

Savings ` 6,000 ` 7000

The costs of capital is 8%. Measure the sensitivity of the project to

changes in the levels of plant value, running costs and savings (considering
each factor at a time) so that NPV becomes zero. Which factor is most
sensitive to affect the acceptability of the project.

The PV factors at 8% discount rate are:

0 1.000
1 0.926
2 0.857

175
Notes
Answer

The Net present value of Cashflows:

Year PV factor Plant Running Saving NCF

(8%) Cost Cost
0 1.000 (7,000) - - (7,000)

1 0.926 - (2,000 x (6,000 x 3,704

0.926) 0.926)
1,852 5,556

2 0.857 - (2,500 x (7,000 x 3,856.5

0.857) 0.857)
2,142.5 5,999

(7,000) (3,994.5) 11,555 Nov = 560.5

The project a may be accepted as it is having a positive NPV of `

560.5.

The sensitivity of project towards various costs can be performed as

under.

Sensitivity Analysis

(1) Plant costs may need to be increased by a PV of 560.

i.e. 560.5
7,000 x 5 = 8.007% or by 8%

(2) Running Costs may need to increased by

i.e. 560.5
3,994.5 x 100 = 14.03% or by 14%

(3) Savings may be reduced by

i.e. 560.5
11,555 x 100 = 4.85%

According to this analysis, it is clear that savings having a lowest

sensitivity ratio gets affected most while accepting the project.

176
 Notes
Social Cost Benefit Analysis (SCBA)

It is a methodology for evaluating investment projects from social

point of view.

SCBA seeks to assess the utility of a project to society as a whole. It

attempts to separate all the expected changes viz. economic, social and
environmental likely to arise as a result of implementing the project. These
can be represented as inputs and outputs of a project and a price can be put
to each of these input an output. Since both inputs and outputs are spread
over a number of years, it is necessary to combine the costs and benefits
stream that arise over the economic life of the project.

ORIGIN: Methodological guidelines of SCBA have been developed

by international agencies like OECD AND UNIDO. India, Planning
commission issued in 1975 guidelines for the preparation of feasibility
reports for industrial reports.

Socio-Economic Appraisal

Social cost benefit analysis (SCBA) is a perfect necropsy where the

identification and determinatio of the best among project alt rnatives is
made with reference to a country’s economic and social prerogatives. It is a
systematic procedure for comprehensive review of all the costs, b nef ts, and
effects of a project. Such appraisal is performed for development and
infrastructure projects usually by emphasizing the economic, technical,
operational, institutional, and financial factors to ensure that the selected
project meets all necessary requirements and is implementable.

SCBA focuses on the following objectives:

 to contribute effectively to GDP of an

economy;  to aid in economic development;
 to justify the utilisation of economy’s scarce of growth;
 to maintain and protect environment from pollution;
 to educate new lines of functioning that are simple and cost
effective;
 to benefit the rural poor and reduce regional imbalances;

177
Notes
 to justify the risks undertaken to implement and the sacrifices
made in the process.

Therefore, it is important to identify the major economic,

environmental, social and other factors a project may influence directly or
indirectly.

Few notable contributions towards social-cost-benefit approach are:

 UNIDO — Guidelines for Project Evaluations released during

early 70s
 M.D.Little, J.A.Mirrlees —Appraisal and Planning for
Developing Countries

Limitations of SCBA

1 No st ndard method or technique applicable to all types of

investment projects.
2. Quantification and measurement of social cost and benefits are
formidable.
3. However these limitations can be rectified by removing subjectivity
in it.

Summary

Thus the project has to be appraised to ensure that the project will
generate sufficient return on the resources invested in it. The viability of the
project depends on technical feasibility, marketability of the products at a
profitable price, availability of financial resources in time and proper
management of the unit. It should be also within the framework of national
priorities bases on social cost benefit analysis.

In brief, a project should satisfy the tests of technical, commercial,

financial and managerial feasibilities as given above.

****

178
 Notes

Lesson 3.5 - Ownership Structure

Choice of Organisation

Every entrepreneur has to be decide, the nature ownership of his

organization which in turn helps to determine the risk, responsibility and
control of the entrepreneur as well as the division of profits. The right form
of organsiation can help the enterprise not only through initial success but in
later growth too. There are four main forms of organization viz., Sole
Trader, Partnership, Joint Stock Company and Co-operative Organisation. A
brief description of these organsiation are given below.

Sole Properitorship

Sole Proprietorship is the simplest and oldest form of ownership

organsiation. It is a business owned and co trolled by one person. The
individual may borrow money and employ assistants. But he/she alone is
responsible for the results of the business. The individual who establishes it
is known as sole proprietor or sole trader.

It is suitable in the following cases:

 Where small amount of capital is required

 Where quick decisions are very important.
 Where limited risks are involved
 Where personal attention to invidual tastes and fashions of
customers is required.
 Where the demand is local, seasonal or temporary
 Where fashions changes quickly.
 Where the operation is simple and does not requires skilled
management.

Thus, sole trader is a comman form of organization in retail trade,

professional firms, hoursehold and personal services. This form of

179
Notes
organsiation is quite popular in our country. It accounts for the largest
number of business establishments in India, despite its limitations.

Partnership

It is relationship between person who have agreedto share the profits

of a business carried on by all or anyone of them actinag for all. It is an
agreement among two or more or more persons to carry on jointly a lawful
business and to share the profits arising therefrom. Persons who enter into
such agreement are known individually as partners and collectively firm.

A Partnership firm can be formed through an agreement among two

or more persons. The agreement may be oral or in writing. Such a written
agreement among partners is known as Partnerhip Deed. It must e signed by
all the partners and should be properly stamped. It can be altered with the
mutual consent of all the partners.

Partner hip firms may be registered or un registered. It can be

registered with the Registrar of firms appointed by the Government.
Registration is not compulsory but helps to get concessions or identity when
comparing to unregistered firm.

The partnership form of business own rship enjoys the following

advantages:

 Ease of formation
 Larger financial resources
 Flexibility of operations
 Specialisation and balanced approach
 Protection of minority interest.
 Personal incentive and
supervision  Capacity for survival
 Better human and public relations
 Business secrecy could be maintained.

This form of organisation has also certain shortcomings

 Unlimited libility

 Limited resources

180
 LESSON : 9

DEMAND ANALYSIS AND MARKET POTENTIAL

MEASUREMENT

INTRODUCTION
Demand analysis is concerned with two broad issues: What is the
likely aggregate demand for the product/service? What share of the market
will the proposed project enjoy?
Intelligent and meaningful answers to them call for an in-depth study
and assessment of various factors like patterns of consumption growth,
income and price elasticity of demand, composition of the market, nature of
competition, availability of substitutes, teach of distribution channels etc.
Given the importance of demand analysis, it should be carried out in an
orderly and systematic manner. The key steps in such analysis are as follows:
(i) Situational analysis and specification of objectives
(ii) Collection of secondary information
(iii) Conduct of market survey
(iv) Characterisation of the market
(v) Demand forecasting
(vi) Market planning
This chapter discusses these steps in detail.
(A) SITUATIONAL ANALYSIS AND SPECIFICATION OF
OBJECTIVES
In order to know the relationship between the product and its demand,
entrepreneur may informally talk to customers, competitors, middlemen, and
others in the industry. Situational analysis generates enough data to measure

(228)
the market. To get a reliable handle over projected demand and revenues, a
formal study need not be carried out, particularly’ when cost and time
considerations so suggest. To carry out such a study, it is necessary to spell
out its objectives clearly and comprehensively. Often this means that the
intuitive and informal goals that guide situational analysis need to be
expanded and articulated with greater clarity. A helpful approach to spell
out objectives is to structure them in the form of questions. In doing so,
always bear in mind how the information generated will be relevant in
forecasting the overall market demand and assessing the share of the market
the project will capture. This will ensure that questions not relevant to
market and demand analysis will not be asked unnecessarily.
To illustrate, suppose that data is to be gathered about food
processor based on a new principle that appears to offer several advantages
over the conventional mixie. The entrepreneur needs information about
where and how to market the food proce or. The objectives of market and
demand analysis in this case may be to answer the following questions:
ä Who are the buyers of mixie?
ä What is the total current demand for m xie?
ä How is the demand distributed temporally (patt rn of sales over the
year) and geographically?
ä What is the break-up of demand for mixie of different sizes?
ä What price potential customers be convinced about the superiority of
the food processor?
ä How can potential customers be convinced about the superiority of
the food processor?
ä What price and warranty will ensure its acceptance?
ä What channels of distribution are most suited for the food processor?
What trade margins will induce distributors to carry it? .
ä What are the prospects of immediate sales?
(229)
(B) COLLECTION OF SECONDARY INFORMATION
In order to answer the questions listed while delineating the
objectives of the market study, information may be obtained from
secondary and/or primary sources. Secondary information is information
that has been gathered in some other context and is already available.
Primary information, on the other hand, represents information that is
collected for the first time to meet the specific purpose on hand. Secondary
information provides the base and the starting point for demand analysis. It
indicates what is known and often provides leads and cues for gathering
primary information required for further analysis. This section looks at the
secondary information and the following at the primary information.
General Sources of Secondary Information
Census of India : A decennial publication of the Government of
India, it provides, information on population, demographic characteristics,
household size and composition.
Economic Survey : An annual publication of the Ministry of Finance,
it provides the latest data on industrial production, wholesale prices,
consumer prices, exports, agricultural production, national i come, tc.
Guidelines to Industries : An annual publication of the Central
Statistical Organisation, it contains information on various aspects of industry:
number of units and state-wise distribution, average number of worki g days,
employment, materials consumption, quantity of products, etc.
Annual Reports of the Development Wing, Ministry of Commerce and
Industry : An annual publication, it gives a detailed review of industries under
the purview of the wing. It also provides information about new items
manufactured for the first time in India and the list of protected industries.
Annual Bulletin of statistics of Exports and Imports : An annual
publication of the Ministry of Commerce, it provides data on imports and
exports for a very large number of items and as per international classification.
(230)
 Monthly Studies of Production of Selected Industries : A monthly
publication of the Central Statistical Organisation, it provides all India data
on production, number of units installed capacity, state-wise break-up,
stock level, etc., for several selected industries.
Publications of Advertising Agencies : The leading advertising
agencies like Clarion, McCann and Thompson have published test markets,
marketing rating indices of towns of India, consumer index of markets, and
other studies which throw valuable light on Indian markets.
Evaluation of Secondary Information
While secondary information is available economically and readily,
its reliability, accuracy, and relevance for the purpose under consideration
must be carefully examined. The analyst should seek to know :
ä Who gathered the information? What was the objective?
ä When was the information gathered? When was it published?
ä How representative was the period for which the information was
gathered?
ä Have the terms in the study been carefully a d unambiguously defined?
ä What was the-target population? How was the sample chosen?
ä How representative was the sample?
ä How satisfactory was the process of information gathe ng?
ä What was the degree of sampling bias and non-response bias in the
information gathered?
ä How accurately was the “information edited, tabulated, and analysed?
ä Was statistical analysis properly applied?
(C) CONDUCT OF MARKET SURVEY
Secondary information, though useful, often does not provide a
comprehensive basis for demand analysis. It needs to be supplemented with
primary information gathered through a market survey, specific to the
project being appraised.
(231)
 The market survey may be a census surveyor a sample survey. In a
census survey the entire population is covered. The word ‘population’ refers to
the totality of all units under consideration in a specific study. Census surveys
are employed principally for intermediate goods and investment goods when
such goods are used by a small number of firms. In other cases, a census
survey is very costly and may also be infeasible. For, example, it would be
inordinately expensive-may be impossible-to cover every user of Lux soap or
every person in the income bracket of Rs. 5,000-Rs. 10,000.
Due to the above mentioned limitations of the census survey, the market
survey, in practice, is typically a sample survey. In such a survey a sample of the
population is studied/observed and relevant information is gathered. On the basis
of such information, inferences about the population may be drawn.
The information sought in a market survey may relate to one or more
of the following:
ä Total demand and rate of growth of demand
ä Demand in different segments of the market
ä Income and price elasticities of demand
ä Motives for buying Purchasing plans and intentions
ä Satisfaction with existing products Unsatisfied needs
ä Attitudes toward various products
ä Distributive trade practices and preferences
ä Socio-economic characteristics of buyers
Steps in a Sample Survey
Typically, a sample survey consists of the following steps:
1. Define the Target Population : In defining the target population the
important terms should be carefully and unambiguously defined. The

(232)
 target population may be divided into various segments which may
have differing characteristics. For example, all television owners
may be divided into three to four income brackets.
2. Select the Sampling Scheme and Sample Size : There are several
sampling schemes: simple random sampling, cluster sampling,
sequential sampling, stratified sampling, systematic sampling, and
non probability sampling. Each scheme has its advantages and
limitations. The sample size has a bearing on the reliability of the
estimates-the larger the sample size, the greater the reliability.
3. Develop the Questionnaire : The questionnaire is the principal
instrument for eliciting information from the sample of the respondents.
The effectiveness of the questionnaire as a device for eliciting the
desired information depends on its length, the types of questions, and
the wording of questions. Developing the questionnaire requires a
thorough understanding of the product/service and its usage,
imagination, insights into human behaviour, and familiarity with the
tools of descriptive and inferential statistics to be used later for
analysis. It also requires knowledge of psychological scali g techn ques
if the same are employed for obtaining information relating to attitud s,
motivations, and psychological traits. Industry and trade market surv
ys, in comparison to consumer surveys, generally involve more
technical and specialised questions.
Since the quality of the questionnaire has an important bearing
on the results of market survey, the questionnaire should be tried out in
a pilot survey and modified in the light of problems/difficulties noted.
4. Recruit and Train the Field Investigators : Recruiting and training of field
investigators must be planned well. Great care must be taken for recruiting
the right kind of investigators and imparting the proper kind of training to
them. Investigators involved in industry and trade market survey need
intimate knowledge of the product and technical background particularly
for products based on sophisticated technologies.
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5. Obtain Information as per the Questionnaire : Respondents may be
interviewed personally, telephonically, or by mail for obtaining
information. Personal interviews ensure a high rate of response.
They are, however, expensive and likely to result in biased responses
because of the presence of the interviewer. Mail surveys are
economical and evoke fairly candid responses. The response rate,
however, is often low. Telephonic interviews, common in western
countries, have very limited applicability in India because telephone
tariffs are high and telephone connections are few.
6. Scrutinise the Information Gathered : Information gathered should
be thoroughly scrutinised to eliminate data which is inconsistent and
is of dubious validity. For example, a respondent with a high income
and large family may say that he lives in a one-room house. Such
information, probably inaccur te, should be deleted. Sometimes data
inconsistencies may be revealed only after some analysis.
7. Analyse and Interpret the Information : Information gathered in the
survey needs to be analysed and. i terpreted with care and imagination.
After tabulating it as per a plan of analysis, suitable statistical
investigation may be conducted, wherever possible and ec ssary. For
purposes of statistical analysis, a variety of methods are available. They
may be divided into two broad categories: parametric methods a d non-
parametric methods. Parametric methods assume that the variable or
attribute under study conforms to some known distribution. Non-
parametric methods do not presuppose any particular distribution.
Results of data based on sample survey will have to be extrapolated
to the target population. For this purpose, appropriate inflationary factors,
based on the ratio of the size of the target population to the size of the
sample studied, will have to be used.
The statistical analysis of data should be directed by a person who
has a good background in statistics as well as economics.

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It may be emphasised that the results of the market survey can be vitiated by:
(i) non-representativeness of the sample, (ii) imprecision and inadequacies
in the questions, (iii) failure of the respondents to comprehend the
questions, (iv) deliberate distortions in the answers given by the
respondents, (v) improper handling of the interviews by the investigators,
(vi) cheating on the part of the investigators, (vii) incorrect and
inappropriate analysis and interpretation of data.
(D) CHARACTERISATION OF THE MARKET
Based on the information. gathered from secondary sources and
through the market survey, the demand for the product/service may be
described in terms. of the following:
(i) Effective Demand in the Past and Present
The effective demand in the past and present, can be gauged with the
formula as given below :
Production + Imports - Exports - Changes in stock level
(ii) Breakdown of Demand
To get a deeper insight into the nature of demand, the aggregate
market demand may be broken down into demand for different s gm nts of
the market. Market segments may be defined by (i) nature of product (ii)
consumer roup, and (iii) geographical division.
Nature of Product : One generic name often subsumes many
different products: steel covers sections, rolled products, and various semi-
finished products; commercial vehicles cover trucks and buses of various
capacities and so on.
Consumer Groups : Consumers of a product may be divided into
industrial consumers and domestic consumers. Industrial consumers may be
subdivided industry wise. Domestic consumers may be further divided into
different income groups.

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 Geographical Division : A geographical breakdown of consumers,
particularly for products which have a small value-to-weight relationship
and products which require regular, efficient after-sales service is helpful.

Segmental information is helpful because the nature of demand tends

to vary from one segment to another (the demand from consumers in high
income brackets may not be sensitive to price variations whereas the
demand from consumers in low income brackets may be very sensitive to
price variations) and different marketing strategies may be appropriate to
different market segments.

(iii) Price

Price statistics must be gathered along with statistics pertaining to

physical quantities. It may be helpful to distinguish the following types of
prices : (i) manufacturer’s price quoted as FOB (free on board) price or CIF
(cost, insurance, and freight) price, (ii) landed price for imported goods,
(iii) average wholesale price, and (iv) average reta l price.
(iv) Methods of Distribution and Sales Promotion

The methods of distribution may vary with the nature of p oduct.

Capital. goods, industrial raw materials or intermediates, and consumer
products tend to have differing distribution channels. Likewise, methods
used for sales promotion (advertising, discounts, gift schemes, etc.) may
vary from product to product.

The methods of distribution and sales promotion employed presently

and their rationale must be specified. Such a study may explain certain
patterns of consumption and highlight the difficulties that may be
encountered in marketing the proposed products.

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(v) Consumers

Consumers may be characterised along two dimensions as follows:

Demographic and sociological Attitudinal

Age Preferences

Sex Intentions

Income Habits

Profession Attitudes

Social background Responses

(vi) Supply and Competition

It is necessary to know the existing sources of supply and whether

they are foreign or domestic. For domestic sources of supply, information
along the following lines may be gathered: location, present production
capacity, planned expansion, capacity utilisation level, bottlenecks in
production, and cost structure.
Competition from substitutes and near-substitut s should be specified
because almost any product may be replaced by some oth r p oduct as a result
of relative changes in price, quality, availability, promotional effort, a d so on
(vii) Government Policy

The role or government in influencing the demand for a product may

be significant. Governmental plans, policies, legislations, and fiats which
have a bearing on the demand of the product under examination should be
spelt out. These are reflected in : production targets in national plans,
import and export trade controls, import duties, export incentives, excise
duties, sales tax, industrial licensing, preferential purchases, credit controls,
financial regulations, and subsidies/penalties of various kinds.
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(E) DEMAND FORECASTING
After gathering information about various aspects of demand from
primary and secondary sources, an attempt may be made to estimate future
demand. Demand forecast is an estimate of sales in monetary or physical
units for a specified future period under a proposed business plan or
programme or under an assumed set of economic and other environmental
forces, planning premises outside the business organisation for which the
forecast or estimate is made.
An efficient demand forecast helps the management to take suitable
decisions regarding plant capacity, raw-material requirements, space and
building needs and availability of labour and capital. Production schedules
can be prepared in conformity with demand requirements minimising
inventory, production and other related costs.
Demand forec sting also helps in evaluating the performance of sales
department.
Thus demand forecasting is a necessary and effective tool in the
hands of the management of an enterprise to have finished goods of right
quality and quantity at right time with minimum cost.
Management experts have developed many forecasting tech iques to
help managers handle the increasing complexity in management dec s on
making. It is a tricky and experimental process. No one method of forecasti
g can be applied to all enterprises. In many cases the decisions are based on
a combination of several, if not all, of these approaches. Final forecast
generally include the contributions of many men of varied experience. The
use of particular-method depends upon the nature of the enterprise, the
products manufactured, information system in use etc.
Forecasts may be derived by means of sophisticated analysis .or they
may be the result of intuition. Organisations commonly use following
methods for demand forecasting :

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Qualitative Methods : These methods rely essentially on the judgement of
experts to translate qualitative information into quantitative estimates. The
important qualitative methods are as follows.
ä Jury of executive opinion method : This method calls for the Pooling
of views of a group of executives on expected future sales and
combining them into a sales estimate.
ä Delphi method : This method involves converting the views .of a
group, of experts, who do not interact face-to-face, into a forecast
through an interactive process.
Time Series Projection Methods : These methods generate forecasts on the
basis of an analysis of the historical time series. The important time series
projection methods are as follows :
ä Trend projection method : The trend projection method involves
extrapolating the pa t trend into the future. The methods under this
category are based on the assumption at future events are a
continuation of the past. In other words, historical data can be used to
predict the future. A firm accumulates data on its sales at different
points of time in the past. If this firm has been In existence for some
arrangement of this data (time-wise) gives a time series. A time s ri s is
the measurement of a variable (say, sales, production or profit) over
time. This data can then be used to forecast sales (or demand) in future
by projecting the past trend into future. Popularity of these methods
rests on the fact that these are simple, inexpensive and quick methods
of forecasting. These methods yield reasonably accurate results so long
as the trend of the data has a persistent tendency to move in the same
direction. But if the data shows significant turns then the time series
analysis may not give acceptable results.
ä Exponential smoothing method : Exponential smoothing, is a very
popular approach for short-term forecasting. This method determines
values by computing exponentially weighted system. The weights
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 assigned to each value reflect the degree of importance of that value. More
recent values being more relevant for forecasting, these are assigned
greater weight than previous period values. It may be noted that weights
(w) are so assigned that w lies between zero and unity (O<w<l).
To describe the process of exponential smoothing, let Y be the
observed value of the series at time t, and S t be the smoothened
value at time t. The smoothing scheme begins by setting smoothened
value equal to observed value for the first period (t=l) :
SI=Y1
and for any succeeding time period t, the smoothened value S t is
found ith help of the equation: St = wyt + (l-w)St

This is the basic equation of expo ential smoothing. The weight ‘w’
is also called smoothing constant. In the expo ential smoothing
scheme, the contribution of remote values to St becomes l ss at each
successive time period. However, the rate at which this contribution
decl nes depends on the value of w. If value of w is near 0 the impact
of emote values dampens slowly, while if w is near 1 it dampens out
quickly. Though the rigorous mathematical technique of selecting
the best value of ‘w’ is beyond the scope of the lesson, rule-of-the-
thumb may be prescribed for its selection:
i) When the magnitude of the random variations is large, give a lower value
to w so as to average out the effects of the random variation quickly;

ii) When the magnitude of the random variation is moderate, a large

value be assigned to die smoothing constant w.

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ä Moving average method : Moving average are smoothened values of
time series. These averages are derived by averaging the value of
series over successive time intervals. The illustration below gives the
3-yearly moving average of sales of sales of a company (col. 4). Let
St represent the actual sales during year t. The average sales of the
first years have been founded as : B(S1 + S2 + S3) = B x 132 = 44.
Year Sales (Rs. ’000) 3 – Yearly 3-yearly
Totals Moving Average
(Trend Value)
(1) (2) (3) (4)
1977 30 — —
1978 42 30+42+60=132 44
1979 60* 42+60+72+=216 58
1980 72 60+72+84=216 72
1981 84 72+84+92+=248 82.7
1982 92 84+92+100+276 92
1983 100 92+100+112=304 101.3
1984 112 =338 112.7
1985 126 =378 126
1986 140 =414 138
1987 148 =452 150.7
1988 164 =492 164
1989 180 =534 178
1990 190 =574 191.3
1991 204 =614 204.7
1992 220 — —
Since the average represents the interval of 3 years the average value is
centered at the middle of the interval (i.e., the moving total and moving average
are listed against the 2nd year in the Table and in the figure accompanying the
Table). If we call this average as S2, then S2=44. By shifting the interval

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forward by one year each time, we can compute moving average for
successive years. For example, the second interval of 3 years is.
S2 = B (S2 + S3 + S4) = B x 174 = 58

Further, the third interval, fourth interval, etc. would be

(S
S3 = B 3 + S4 + S5) = B x 216 = 72
(S
S4 = B
4 + S5 + S6) =
B x 248 = 82.7
And so forth. The moving-average formula can be written in a simplified
form (known as recursive form).

S1 = St-1+

where, St is the moving average at time point t;

M is ‘the interv l of time taken for averaging (for example 3 year in
the above illustration).
If we look carefully at the movi g average computation, we will find
that all we are doing at each step is to recompute the average by adding the
next observation and dropping the observation that occurr d M periods in
the past (i.e., the 1st observation in calculating previous S).
Odd number of time periods (i.e., 3 yearly, 5 yearly etc.) are usually
preferred for determining moving average because the averaged out value (St) can
be placed at the middle of the interval (as shown in Illustration above) If the
number of time periods is even, the middle of the interval does not lie against any
time point-rather it would lie between two time points. For example, if 4-yearly
moving average is attempted in the above case, then the middle of the first
interval would lie between 1978 and 1979. In order that comparison of moving
averages with the actual value is possible, we prefer odd number of time periods.
However, if we need to handle even number of time periods when computing
moving average, we need to add another column to the Table. For example, if in
the earlier illustration we take a 4-yearly moving average
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then the values of moving average would be respectively 51, 64.5, 75, and so
on. And, these moving average values will lie respectively between 1978 and
1979, between 1979 and 1980, between 1980 and 1981, and so forth. We will,
therefore have to construct a fresh column of centered moving averages where
we find the mean of these moving averages-and then place them against the

relevant year. For example, is now placed against 1979, =

is placed against 1980; and so on. In this manner we

overcome the disadvantage of even number of time periods.
Causal Methods : More analytical than the preceding methods, causal
methods seek to develop forecasts on the basis of specified in an explicit,
quantitative manner. The important methods under this category are as follows:
ä Chain ratio method : A simple analytical approach, this method calls
for applying a series of factors for developing a demand forecast.
ä Consumption level method : Useful for a product that is directly
consumed, this method estimates consumption level on the basis of
elasticity coefficients, the important ones being the income elasticity
of demand and the price elasticity of dema d.
ä End use method : Suitable for intermediate products, the end use
method develops demand forecasts on the basis of the consumption
coefficient of the product for various uses.
ä Leading indicator method : According to this method, observed changes
in leading indicators are used to predict the changes in lagging variables.
Demand Analysis and Managerial Decisions
The quantity demanded at a point of time is subject to many influences.
Economists treat price of the product as the single most important variable
influencing demand. However, in the highly competitive modem business world,
perhaps the other determinants have acquired equal importance, if not more.

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To keep up-to-date knowledge about the movement of prices of rival firms,
changes in tastes and fashion, etc. is essential for survival and growth of a firm.
Management of a firm may also like to find out which of the variables
in the demand function, can be subject to managerial control. It is quite
obvious that factors like population, distribution of consumer (economically,
socially, ethnically and demographically), prices of related goods as well as
consumes’ present income and their expected future incomes are beyond the
control of management of any firm. So, these factors have to be taken as given
by the management at any point of time. On the other hand, one finds that’
management has considerable control over the price of its own product as well
as the level and nature of advertisement for its product. With the help of the
latter it may influence the tastes and preferences of consumers, thereby
generating more demand for its own product.
In short, we m y say that the scope of management to influence
demand is quite restricted.
(F) MARKET PLANNING
To enable the product to reach a desired level of market penetration,
a suitable marketing plan should be developed. Broadly, it should cover
pricing, distribution, promotion, and service. The details that n d to be
hammered out are shown below:
Pricing Distribution
Ex-factory price Packaging

Taxes and duties applicable

for the domestic price Transportation arrangements
Trade margins/discounts Channel of distribution
Final price to the domestic
customer wholesalers, and retailers.
Export price

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Promotion Service
Branding Advertising” Installation

Advertising User education

Personal selling Warranties

Promotional efforts After-sales service

MARKET POTENTIAL MEASUREMENT
A market potential is an estimate of the maximum possible sales
opportunities. present in a particular market segment and open to all sellers
of a good or service during a stated future period. Thus, an estimate of the
maximum number of low-priced pocket cameras that might be sold in
Haryana, during the calendar year 2001 by all sellers is the market potential
for. low-priced “pocket camer s. A market potential indicates how much of
a particular product can be sold to particular market segment over some
future period, assuming the application of appropriate marketing methods.
The following steps are to be undertaken for measuri g -the market
potential of a particular product.
(a) Market Identification : The first step in measuring a product’s
market potential is to identify its market. Market identification equ
res finding answers to three questions:
(1) Who buys the product?
(2) Who uses it?
(3) Who are the prospective buyers and/or users?
In some companies answers to these questions are found in internal
records; but in most companies, especially those that use long marketing
channels, meaningful answers are obtained only through field research. In
consumer goods marketing, buyers, users, and prospects are identified and
classified by according to such characteristics as age, sex, education, income,

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and social class. In industrial-goods marketing, buyers, users, and prospects
are identified and classified by such characteristics as size of firm,
geographical location, and type of industry.
Market identification studies reveal the characteristics that differentiate
the market segments making up the product’s total market potential.
Frequently they uncover unexploited market segments whose patronage’ might
by obtained through redirecting personal-selling effort or changing
promotional strategy. Sometimes, market identification studies provide, as a
side result, customer data on such factors .as purchase frequency, searching
time expended, unit of purchase, and seasonal buying habits. When these data
are assembled and analyzed, they are helpful in estimating market potential.
(b) Market Motivation
The second step in measuring a product’s market potential is to detect
the reasons why customers buy it and the reasons why potential customers
might buy it. Market motivation studies aim to answer twin questions: Why do
people buy? Why don’t people buy? The answers are helpful not only in
estimating a product’s market potential but are of immense value to the sales
executive seeking to increase the effectiveness of promotional programs.
Motivation research techniques vary, but the most widely used are the
projective techniques, in which respondents project th ms lves, the r attitudes,
interests, and opinions into interpretations of special materials presented by the
researcher. Analysis of results by trained specialists seeks to lay bare what
goes on in buyers’ minds, including the real reasons for buying ‘or not buying
the product. Most motivation studies have been directed toward explaining the
buying behaviour of ultimate consumers rather than that of industrial users.
Information derived from motivation studies helps not only in estimating a
product’s market potential but assists in deciding:
(1) How best to present the product in sales talks?
(2) The relative effectiveness of different selling appeals.
(3) The relative appropriateness of various promotional methods.

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(c) Measuring of Market Potential
Having identified the potential buyers and their buying behavior, the
third step is to measure the market potential. Generally, market potential
cannot be measured directly, so analysis requires the use of market factors
(a market factor is a market feature or characteristic related to the product’s
demand). For instance, the number of males reaching shaving age each year
is one market factor influencing the demand for men’s electric shavers. But
not every male reaching shaving age is a prospective buyer of an electric
shaver some will be late in starting to shave, others will adopt other shaving
methods, some will not have the money to buy a shaver or will prefer to use
that money for something else, and. still others will use borrowed shavers
or, perhaps, simply will grow beards. Thus, using market factors in
measuring market potential is a two-step process:
1. Select the market factors most associated with the product’s demand.
2. Eliminate those market segments that for one reason or another do
not contain prospective bu ers of the product.
SELF-T ST QUESTIONS
1. Describe briefly the general sources of s condary information
available in India.
2. Discuss the key steps in a sample survey.
3. Define the term ‘Market Potential’ . How it can be measured?
4. Briefly discuss the key steps involved in demand analysis.
REFERENCES
1. Production Management by B.S, Goe1.
2. Projects-Preparation, Appraisal, Budgeting and Implementation by
Prasanna Chandra.
3. Sales Management by Cundiff & Still.
4. Production and Operations Management by Chunnawalla and Patel.
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 LESSON : 10
WORKING CAPITAL MANAGEMENT

Working capital is the lifeblood of a business. Its adequate planning and

proper management is necessary for the successful operation and continued
existence of a business. Efficient management of working capital is a basic
necessity for sound operational health of a every enterprise. Therefore, working
capital management is an integral part of business management. Working capital
management basically means management of current assets, current liabilities,
and interrelationship between the two. Working capital is of a liquid nature.
Therefore, orking capital management is also called ‘liquidity management’.

Concept of Working Capital

Working capit l is understood in the following two ways:

Net Working Capital : Net working capital is the excess of current

assets over the current liabilities. In other words, it may be defined as the
provision of long term (non-current) funds for current assets. The use of the
concept of net working capital is qualitative as provid s a m asurement of
the financial health of a firm. The higher the amount of net wo k ng capital
in relation to sales, the better the current financial health. The net worki g
capital also indicates the ‘margin of safety’ for meeting the maturing short-
term liabilities (claims).
Gross Working Capital : Gross working capital is considered to be
equal to the total current assets required by a business firm. In this context,
the concept of total current assets has a broader application. It is intended to
denote the total investment of funds in current assets for operation purposes
or the total requirement of funds for current assets regardless of the
financing sources.
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Components of Gross Working Capital

The constituent parts of gross working capital, otherwise called

current assets, are:
1. Advance given for purchases of raw materials and stores, etc.

2. Inventories:

(i) Raw materials, stores and packing material, spare parts, etc.

(ii) Work-in-process.

(iii) Finished goods.

3. Book debtors or credit to customers.

4. Marketable investment (securities) on short-term basis: .

(i) To earn something on temporary surplus cash.

(ii) To meet the requirement of offering security for some facilities
and/ or contract with government or some other agencies.
5. Cash and bank balances.
Nature of Current Assets and the Cash Operating Cycle:
All current assets (except cash) finally get converted into cash. In fact,
each current asset is heading towards conversion into cash. In a typical
business, cash is invested in materials, supplies, labour and various overhead
services, and these costs are traced through and attached to inventories.
Inventories are eventually realised by conversion into book debts
(Accounts receivable) and these are in turn collected and become once more the
available purchasing power. The average laps of time between the investment in
materials and services and the final conversion back to cash is the length of the
cash operating cycle. Such an operating cycle maybe computed as follows:

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 Computation of Cash Operating Cycle
Operating cycle Flow Computation Method
Cash (and credit)
365
Materials, labour, services -----------------------------------------------------------------------------------------------

Raw materials turnover- Average credit period

365
Production -------------------------------------------------------------------

Production in process turnover

365
Storage ----------------------------------------------------------

Finished product turnover

Sales
365
Accounts receivable -------------------------------------------------------------------

Accounts receivable turnover

Cash (and credit)

Total
Note: 1. The above format is for a manufacturi g company and is
based on the assumption that the accounti g figur s
available are for a one-year operation.
2. In a trading organisation, the production phases are
substituted by the merchandise acquisition phase.
DETERMINANTS OF WORKING CAPITAL
There are no set rules or formulae to determine the working capital
requirements of the firms. A large number of factors influence the working
capital needs of the firms. All factors are of different importance. Also, the
importance of the factors changes for a firm over time. Therefore, an analysis
of the relevant factors should be made in order to determine the total
Investment in working capital. The following is the description of the factors
which generally influence the working capital requirements of the firms.
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Nature and Size of Business :

The working capital requirements of a firm are basically influenced by

the nature of its business. Trading and financial firms have very less
investment in fixed assets, but require a large sum of money to be invested in
working capital. Retail stores, for example, must carry large stocks of a variety
of goods to satisfy the varied and continuous demand of their customers. Some
manufacturing businesses, such as tobacco manufactures and construction
firms, also have to invest substantially in working capital and a nominal
amount in the fixed assets. In contrast, public utilities have a very limited need
for working capital and have to invest abundantly in fixed assets. Their:
working capital requirements are nominal because they have cash sales only
and supply services, not product. Thus, no funds will be tied up in debtors and
stock (inventories). The working capital needs of most of the manufacturing
concerns fall between the two extreme requirements of trading firms and
public utilities. Such concerns have to make adequate investment in current
assets depending upon the total assets structure and other variables.
Manufacturing Cycle:
The manufacturing cycle starts with the purchase and use of raw materials
and completes with the production of finished goods. Long r the ma ufacturing
cycle, larger will be the firm’s working capital retirements. An extended
manufacturing time span means a larger tie-up of funds in inventories. Thus, if
there are alternative ways of manufacturing a product, the process with the
shortest manufacturing cycle should be chosen. Once a Manufacturing process
has been selected, it should be ensured that manufacturing cycle is completed
within the specified period. This needs proper planning and coordination at all
levels of activity. Any delay in manufacturing process will result in accumulation
of work in process and waste of time. In order to minimise their investment in
working capital, some firms, specifically the firms manufacturing industrial
products, have a policy of asking for advance payments from their customers.
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Business Fluctuation :
Most firms experience seasonal and cyclical fluctuations in the demand
for their products and services. These business variation affect the working
capital. requirements, specially the temporary working capital requirements of
the firm. When there is an upward swing in the economy, sales will increase;
correspondingly, the firm’s investment in inventories and book debts will also
increase. Under boom, additional investment in fixed assets may be made by
some firms to increase their production capacity. This act of the firms will
require further addition to working capital. To meet their requirements of
funds for fixed assets and current assets under boom period, the firms
generally resort to substantial borrowings.
On the other hand, when there is a decline in the economy, sales will
fall and consequently, the levels of inventories and book debts will also fall.
Under recessionary conditions, the firms try to reduce their short-term
borrowings.
Seasonal fluctuations not only affect the working capital requirement
but also create production problems for the firm. During the periods of peak
demand, increasing production may be expensive for the firm: Similarly, it
will be more expensive during slack periods when the firm has to sustain its
work force and physical facilities without adequate production and sales. A
firm may, thus, follow a policy of steady production, irrespective of the
seasonal chan es, in order to utilise its resources to the fullest extent. Such a
policy will mean accumulation of inventories during the off season and
their quick disposal during the peak season. The increasing levels of
inventories during their slack season will require increasing funds to be tied
up in the working capital for some months.
Production Policy
We just noted that a strategy of constant production may be maintained in
order to resolve the working capital problems arising due to seasonal changes in
the demand for the firm’s product. A steady production policy will cause
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inventories to accumulate during the off-season and the firm will be
exposed to greater inventory costs and risks. Thus, if the costs and risks of
maintaining a constant production schedule are high, the firm may adopt
the policy of varying its production schedules in accordance with the
changing demand. The firms, whose production capacities can be utilised
for manufacturing varied products, Can have the advantage of diversified
activities and solve their working capital problems. They will manufacture
the original product line during its increasing demand and when it has an
off-season, other products may be manufactured to utilise the physical
resources and working force. Thus, the production policies will differ from
firm to firm, depending on the circumstances of individual firm.
Firm’s Credit Policy
The credit policy of the firm affects working capital by influencing the
level of book debts. The credit terms to be granted to the customers may
depend upon the norms of the industry to which the firm belongs. But a firm
has the flexibility of shaping its credit policy within the constraint of industry
norms and practices. The firm should be discrete in granting credit terms to its
customers. Depending upon the individual case, different terms may be given
to different customers. A liberal credit policy, without rating the credit-
worthiness of the customers, will be detrimental to the firm and will create a
problem of collecting funds later on. The firm should be prompt in making
collections. A high collection period will mean tie-up of funds in book debts
Slack collection procedures can increase the chance of bad debts.
Availability of Credit
The working capital requirements of a firm are also affected by
credit terms granted by its creditors. A firm will need less working capital if
liberal credit terms are available to it. Similarly, the availability of credit
from banks also influences the working capital needs of the firm. A firm,
which can get bank credit easily on favourable conditions, will operate with
less working capital than a firm without such a facility.

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Growth and Expansion Activities
The working capital needs increase as a firm grows in terms of sales or
fixed assets. It is difficult to precisely determine the. relationship between
volume of sales and the working capital needs. The critical fact, however, is
that the need for increasing working capital funds does not follow growth in
business activities but precedes it. It is, therefore, necessary to make advance
planning of working capital for a growing firm on a continuous basis.
A growing firm may need to invest funds in fixed assets in order to
‘sustain its growing production and sales. This will, in turn, increase
investment in current assets to support enlarged scale of operations. It
should be realised that a gro ing firm needs funds continuously. It uses
external sources as well as internal sources to meet the increasing needs of
funds. Such a firm faces further financial problems when it retains
substantial portion of its profits. It would be unable to p y dividends to
shareholders. It is, therefore, imperative that proper planing m y be done by
such companies to finance their increasing needs for working capital.
Profit- Margin and Profit Appropriation
Firms differ in their capacity to generate profit from business operations.
Some firms enjoy a dominant position, due to quality product or good marketing
management or monopoly power in the market and earn a high profit margin.
Some firms may have to operate in the environment of intense competition and
may earn low margin of profits. A high net profit margin contributes towards the
working capital pool. In fact, the net profit is a source of working capital to the
extent it has been earned in cash. The cash profit can be found by adjusting non-
cash items, such as depreciation, outstanding expenses, accumulated expenses and
losses written off, in the net profit. But, in practice, the net cash inflows from
operations cannot be considered as cash available for use at the end of the period.
Even as the company’s operations are in progress, cash is used for augmenting
stocks, book debts or fixed assets. The financial manager must see whether or not
the cash generated has been used for rightful purposes. The application of cash
should be well planned.
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Price Level Changes
The increasing shifts in price levels make the functions of financial
manager difficult. He should anticipate the effect of price level changes on
working capital requirements of the firm. Generally, rising price levels will
require a firm to maintain higher amount of working capital. The same
levels of current assets will need increased investment when prices are
increasing. However, the companies which can immediately revise their
product prices with rising price levels will not face a severe working capital
problem. Further, the effects of increasing general price level will be felt
differently by the firms as individual price may move differently. It is
possible that some companies may not be affected by the rising prices while
others may be badly hit by it. Thus, the effects of rising prices will be
different for different companies. Some will face no working capital
problems, while the working capital problems of others may be aggr vated.
Operating Efficiency
The operating efficiency of the firm relates to the optimum
utilisation of resources at minimum costs. The firm will be effectively
contributing to its working capital if it is efficient in controlling the op
rating costs. The use of working capital is improved and pace of the cash
cycle is accelerated with operating efficiency. Better utilisation of resources
improv s p of tability and, thus, helps in releasing the pressure on working
capital. Although it may not be possible for a firm to control the prices of
materials or the wages of labour, but it can certainly ensure efficient and
effective use of its materials, labour and other resources.
MIMENSIONS OF WORKING CAPITAL MANAGEMENT
We have emphasized that the firm should maintain a sound working capital
poison, on and that there should be optimum investment in working capital. Thus,
there is an uavoidable need to manage working capital well. Working capital
management refers to the administration of all aspects of current assets, namely cash,
marketable securities, debtors and stock (inventories) and current
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liabilities. The financial manager must determine the levels and
composition of current assets. He must see that right sources are tapped to
finance current assets and current liabilities are paid in time.
There are many aspects of working capital management which make
it an important function of the financial manager.
1. Working capital management requires much of the financial
manager’s time.
2. Working capital represents a large portion of the total investment in
assets.
3. Working capital management has greater significance for small firms.

4. The need for working capital is directly related to sales growth.

Empirical observations show that the financial managers have to spend
much of their time to the daily internal operations, relating to current assets and
current liabilities of the firms. As the largest portion of the financial manager’s
valuable time is devoted to working eapital problems, it is necessary to manage
working capital in the best possible way to get maximum benefit.
Investment in current assets represents a very significant portion of
the total investment in assets. For example, according to an stimate of
Reserve Bank of India, in case of the 1650 large and medium public limited
companies in India, current assets constituted 62 per cent of total net assets
or total capital employed in 1975-76. This very clearly indicates that the
financial manager should pay special attention on the management of
current assets on a continuing basis. Actions should be taken to curtail
unnecessary investment in current assets.
It is particularly very important for small firms to manage their current
assets and current liabilities very carefully. A small firm may not have much
investment in fixed assets, but it has to invest in current assets, such as cash,
debtors and inventories. Further, the role of current liabilities in financing

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current assets is far more significant in case of small firms as unlike large
firms, they face difficulties in raising long-term finance.
There is a direct relationship between sales and working capital needs.
As sales grow, the firm needs to invest more in inventories and book debts.
These needs become very frequent and fast when sales grow continuously. The
financial manager should be aware of such needs and finance them quickly.
Continuous growth in sales may also require additional investment in fixed
asses, but they do not indicate same urgency as displayed by current assets.
It may, thus, be concluded that all precautions should be taken for
the effective and efficient management of working capital. The financial
manager should pay particular attention to the levels of current assets and
the financing of current assets To decide the levels and financing of current
assets, the risk return implications must be evaluated.
Estimating Working Capital Requirements:
As stated earlier both excess and shortage of working capital are
harmful for the health of an enterprise. It is, therefore, essential to correctly
assess the amount of working capital for an enterprise.
The following methods can be used to estimate the amount of
working capital.
1. Operating Cycle Method : If for instance, the operating cycle of an
enterprise is four months, it means the cycle is repeated three times in a
year The amount of working capital required would be one-third (1/3) of
the amount of annual operating expenses.
Thus,
Amount of = Total operating expenses in the year
--------------------------------------------------------------------------------------------------------
Working capital Number of operating cycles in the year.
The figure so arrived at should be adjusted in accordance with
changes in the price level.

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2. Assets and Liabilities Method : The amount of working capital can
also be estimated on the basis of current assets required for the business and
the credit facilities (current liabilities) available for the acquisition of
current assets.
Illustration 10.1 : From the following information estimate the amount of
working capital required.

Budgeted Sales (Rs. 10 per unit) Rs. 2,60,000

Cost of sales (per rupee)

Raw materials 0.30

Direct labour 0.40

Over heads 0.20

Total cost 0.90

Profit 0.10

Sales 1.00

It is estimated that :

(a) Raw materials are carried in stock for three weeks and finished oods
for two weeks

(b) Factory processing will take three weeks

(c) Suppliers will give full five weeks credit

(d) Customers will require eight weeks credit

It may be assumed that production and overheads accrue evenly

throughout the year.

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Statement of Working Capital
Current Assets (1) : Rs. Rs.
Stock

Raw materials (3weeks) = 4500

Work in progress (Note iv) = 9000
Finished goods (2 weeks) = 9000
22,500

Debtors (8weeks) = 40000

62,500
Current Liabilities (2) :
Trade creditors (5weeks) = 7500
Working capital required (1-2)
Working Notes
(i) Budgeted sals 2,60,000
Selling price per unit 10
Number of units 260000 >>10 = 26,000
(ii) Cost of sales Rs.
Raw materials 26000 × 3 = 78,000
Direct labour 26000 × 4 = 1,04,000
Overheads 260002 = 52,000
2,34,000
(iii) Number of weeks per annum have been taken as 52
(iv) Work in progress: Rs.
Raw materials = 4,500

Wages  104000  ½ = 3,000

Over-heads  52000 ½ = 1,500

9,000

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 Since, wages and overheads accrue evenly during the year, they
have been reduced to one-half.
Illustration 10.2 : A proforma cost sheet of a company provides the following particulars:
Amount per unit
(Rs.)
Elements of cost:
Raw materials 80
Direct labour 30
Overhead 60
Total cost 170
Profit 30
Selling price 200
The following further particulars are available:
Raw materials in stock, on average on month; Materials are in process,
on average half a month; Finished goods in stock, on average on month.
Credit allowed by suppliers is o e month; Credit allowed to debtors
is two months; Average time-lag in payment of wages is 1½ weeks and one
month in overhead expenses; one-fourth of the output is sold against cash;
cash in hand and at bank is expected to be Rs. 3,65,000. You are r qui ed to
prepare a statement showing the working capital needed to finance a level
of activity of 1 ,04,000 units of production.
You may assume that production is carried on evenly throughout the
year, and wages and overheads accrue similarly.
Solution:
Working notes and assumptions:
(i) 26,000 units have been sold for cash. Therefore, credit sales pertain
to 78,000 units only.
(ii) Year has 52 ,weeks.

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(iii) (a) Profits may be or may not be a source of working capital.
(b) Profits are to be adjusted for income-tax and dividend
payments. For these reasons, profits have been ignored.
(iv) All overheads are assumed to be variable. Presence of depreciation
element in overheads will lower the working capital requirement.
(v) Work-in-process at 50% completion stage.
Table No.1: Statement showing determination of net working capital
Amount (Rs.)
(a) Current assets:
(i) Stock of materials for 1 month:

6,40,000
(ii) Work-in-Progress for ½ month:

(a) Material 1,60,000

(b) Labour 60,000

(c) Overheads 1,20,000

(iii) Finished goods for 1 month:

(a) Material 6,40,000

(b) Labour 2,40,000

(c) Overheads 4,80,000

(iv) Debtors for 2 months 20,40,000

(v) Cash in hand and at bank 3,65,000
Total investment in current assets 47,45,000

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(B) Current Liabilities:
(i) Creditors .. 1 month
1 month’s purchase of raw materials, i.e. 6,40,000
(ii) Average time-lag in-payment of expenses

(a) Overheads (1 month) 4,80,000

(b) Labour (1½ weeks) 90,000

________
Total estimate of current liabilities 12,10,000
(C) Net working capital :
= Current assets – Current liabilities (A–B) 35,35,000
Reserve Bank of India has prescribed the following proforma for use
by commercial banks to ess the working capital requirements of borrowers.
Assessment of Working Capital Requirements
Month’s raw material requirements weeks’/months’ consumable
stores and spares Rs.
Weeks’ stock-in-progress at anyone time (average p riod
of processing, value of raw material content in stock-in-process
and manufacturing expenses for the period of processing to
be indicated) Rs
Months’ finished goods at cost Rs
Weeks’/months’ receivables representing credit sales Rs.
One month’s manufacturing and administrative expenses Rs.
Total working capital requirements Rs.
Less: Credit available on purchase and advance payments received Rs.
Working capital in business or liquid surplus Rs.
Net working capital requirements Rs. (A)

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 Permissible Limits
Raw materials Rs. Rs.
Less: Margin Rs. Rs.
Stock-in-process Rs.
Less : Margin Rs. Rs.
Finished goods Rs.
Less: Margin Rs. Rs.
Receivables
Representing supplies to Govt. Rs.
Less : Margin Rs. Rs.
Representing supplies to sundry
parties Rs.
Less: Margin Rs. Rs.
Total Limit Rs. Rs.
Net working capital requirements Rs. (B)
Permissible limits Rs. (A)
Deficit (if any) (A–B) Rs.
How this is to be met? Rs.

SOURCES OF FINANCE AND FORMS OF CREDIT

After determining the level of working capital, as illustrated earlier,
a firm has to decide how it is to be financed. The present part discusses the
related aspect of the sources of finance for working capital and forms of
credit. The sources of finance for working capital may be said to fall into
four categories, namely,
1. Trade Credit;
2. Bank Credit;

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3. Current provisions of non-bank short-term borrowings; and
4. Long-term sources comprising equity capital and long-term borrowings.

The relative importance of these vary from country to country and from
time to time depending on the prevailing environment. In India, the primary
sources for financing working capital are trade credit and short-term bank
credit. According to an estimate, both these sources together finance about
three- fourth of the working capital requirement of industry. Another estimate
regarding the relative contribution of various sources reveals that trade credit
constitutes the most important source accounting for approximately two-fifths
of the total while short-term bank credit finances more than one- fourth.
Thus, bank credit is the primary institutional source for working capital
finance. To obtain short-term bank credit, working capital requirements have to
be estimated by the borrowers and the banks are approached with the necessary
supporting data. The b nks determine the maximum credit based on the margin
requirements of the security. The margin represents a percentage of the value of
the asset offered as security by the borrower. For example, if the margin requiring
on a particular item is 50%, the bank will be prepared to provide credit upto Rs.
50,000 against the security of an asset worth Rs. 1,00,000. The margin is based on
the nature of goods and is laid down by the Reserve Bank of India. It is changed
from time to time to suit the requirem nt of credit policy.
Forms of Credit :
After getting the over-all credit limit sanctioned by the banker, the
borrower draws funds periodically. The following forms of credit are
available to him :
Loan Arrangement : Under this arrangement the entire amount of
loan is credited by the bank at the borrower’s account. In case the loan is
repaid in installments, interest is payable on actual balances outstanding.
Overdraft Arrangements : Under this arrangement, certain facilities are
available to the borrowers which are not available under the loan arrangement.
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With the overdraft arrangement the borrower is allowed to overdraw on his
current account with the bank upto a stipulated limit. Within this limit any
number of drawings is permitted. Repayments can be made whenever
desired during the period. The interest liability of the borrower is
determined on the basis of the actual amount utilized.
Cash Credit Arrangement : This form of credit is operated in the same
way as the overdraft arrangement. The borrower can draw upto a stipulated limit
based on the security margin. He has to pay 1% as commitment charges on the
unutilized balance during the period. Cash credit is usual1y allowed against
pledge or hypothecation of goods and the borrower can provide alternative
securities from time to time in conformity with the terms of advance.
Bills Purchased and Bills Discounted : This arrangement is of relatively
recent origin in India. With the introduction of the New Bill Market Scheme in
1970 by the Reserve Bank of India, bank credit is being made available through
discounting of usance bills by banks. In brief, under the scheme, the Reserve
Bank of India envisages the progressive use of bills as an instrument of credit as
against the current practice of us ng the widely-prevalent cash credit arrangement
for financing working cap tal. This is because the cash credit arrangement gave
rise to unhealthy practices. In the first place, as the availability of bank credit was
unrelated to production n ds, bo rowers in the organised sector of private industry
enjoyed facilities in excess of their legitimate needs. Moreover, it led to double
financing. This was possible because credit was taken from different agencies for
financing the same activity. This was done, for example, by buying goods on
credit from suppliers and raising cash credit by hypothecating the same goods.
The Bill Market Scheme is intended to link credit with the sale and purchase of
goods and, thus, eliminate the scope for misuse or diversion of credit to other
purposes.
The amount made available under this arrangement is covered by the
cash credit and overdraft limit before discounting the bill the bank satisfies
itself about the credit worthiness of the, drawer and the genuineness of the

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bill. To popularise the scheme, the discount rates are fixed at lower rates
than those of cash credit, the difference being about 1-1.5%. The
discounting banker asks the drawer of the bill (i.e. seller of goods) to have
his bill accepted by the drawees (buyers) bank before discounting it. The
latter grants acceptance against the cash credit limit, earlier fixed by it, on
the basis of the borrowing value of stocks.
Therefore, the buyer who buys goods on credit cannot use the same
goods as a source of obtaining additional bank credit.
Term Loans for Working Capital : Under this arrangement banks
advance loans for 3-7 years repayable in yearly or half-yearly installments.
Mode of Security : Banks provide credit on the basis of the
following modes of security :
Hypothecation
Under this mode of security, the banks provide credit to borrowers
against the security of movable property, usually inventory of goods. The
goods hypothecated, however continue to be in the possession of the owner
of these goods (i.e., the borrower). The rights of the lending ba k
(hypothecated) depend upon the terms of the contract between the borrower
and the lender. Although the bank does not have physical possession of the
goods, it has the legal right to sell the goods to realize the outstanding loan.
Pledge
Pledge, as a mode of security, is different from hypothecation in that in
the former, unlike in the latter, the goods which are offered as security are
transferred to the physical possession of the lender. An essential prerequisite
of pledge, therefore, is that the goods are in the custody of the bank. The
borrower who offers the security is, called a “pawner” while the banks called
the “pawner”. The lodging of the goods by the pawnor to the pawnee is a kind
of bailment. Therefore, pledge creates some liabilities for the bank. It must
take reasonable care of goods pledged with it. The term “reasonable care”
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means care which a prudent person would take to protect his property. He
would be responsible for any loss or damage if he use the pledged goods for
his own purposes. In case of non-payment of the loans, the bank enjoys the
right to sell the goods.
Lien
The term “lien” refers to the right of a party to retain goods
belonging to another party until a debt due to him is paid. Lien can be of
two types : (i) particular lien, and (ii) general lien.
Particular lien is a rights to retain goods until a claim pertaining to
these goods is fully paid. On the other hand, general lien can be applied till
all dues of the claimant are paid. Banks enjoy general lien.
Mortgage
It is the transfer of interest in specific immovable property for
securing the payment of money dvanced. The person who parts with the
interest in the property is called “mortgagor” and the person in whose
favour the transfer takes place is the mortgagee. Mortgage is, thus,
conveyance of interest in the mortgage property. The mortgage interest in
the property is terminated as soon as the debt is paid.
Charge
Where immovable property of one person is by the act of parties or
by the operation of law made security for the payment of money to another
and the transaction does not amount to mortgage, the latter person is said to
have a charge on the property and all the provisions of simple mortgage
will apply to such a charge. These are :
(i) A charge is not the transfer of interest in the property though it is
security for payment. But a mortgage is a transfer of interest in the
property.
(ii) A charge may be created by the act of parties or by the operation of
law. But a mortgage can be created only by the act of parties.
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(iii) A charge need to be made in writing but a mortgage deed must be attested.

(iv) Generally, a charge cannot be enforced against a transferee for

consideration without notice. In a mortgage the transferee of the
mortgaged property can acquire the remaining Interest in the
property, if any.
Accrual Accounts : There is a time lag between receipt of income and
making payment for the expenditure incurred in earning that income During
this time lag, the outstanding expenses help an enterprise in meeting some
of its working capital needs. For example, wages and taxes become due but
are not paid immediately. Wages and salaries are paid in the first week of
the month next to the moth in which services were rendered. Similarly, a
provision from tax is created at the end of the financial year but tax is paid
only after the assessment is finalised.
Merits
(i) Accrual accounts are a spontaneous source of finance as these are
self generating.
(ii) Financing through accruals is an interest free m thod and no charge
is created on the assets.
(iii) As the size of business increases, the amount of accruals also i crease.

Demerits
(a) An enterprise cannot indefinitely postpone the payment of wages/salaries
and taxes. Therefore, it is not a discretionary source of finance.
(b) This source should be used only as a matter of last resort.
Factoring :
Factoring is an arrangement under which a financial institution (called
factor) undertakes the task of collecting the book debts of its client in return
for a service charge in the form of discount or rebate. The factoring institution

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eliminates the client’s risk of bad debts by taking over the responsibility of
book debts due to the client. The factoring institution advances a proportion
of the value of book debts of the client immediately and the balance on
maturity of book debts.
Merits
(i) As a result of factoring services, the enterprise can concentrate on
manufacturing and selling.
(ii) The risk of bed debts is eliminated.
(iii) The factoring institution also provides advice on business trends and
other related matters.
Demerits
(i) A substantial amount of discount or rebate has to be paid to the
factoring concern.
(ii) If he factoring institution uses strong arm tactics to collect money it
will spoil the image and relatio s of the firm with its customers.
Advances from Customers :
Manufacturers and suppliers of goods which are in sho t supply
usually demand advance money from their customers at the time of accepti
g their orders. For example, a customer has to make an advance at the time
of booking a car, a telephone connection, etc. Similarly, contractors
constructing buildings, etc. requite an advance from the client. In some
businesses it has become customary to receive advance payment from the
customers. This is a very cheap source of short term finance because either
no interest is payable or the rate of interest payable on advance is nominal.
Management of Working Capital :
Working capital management refers to all aspects of the administration
of both current assets and current liabilities. The basic objective here is to

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manage the firm’s current asses and current liabilities in such a way that a
satisfactory level of working capital is maintained i.e. it is neither inadequate
nor excessive. If the current assets are not sufficient to cover current liabilities
the liquidity of business is affected and there is no safety margin. On the other
hand, if the working capital is excessive, firm’s profitability is affected. It is
also necessary that different components of working capital are properly
balanced. For instance firm’s liquidity will be low despite sufficient working
capital if the amount of obsolete/slow moving inventory is very high.
A brief description of managing different components of working
capital is given below.
1. Management of Cash : It is necessary to maintain adequate cash to
pay current liabilities and to meet unexpected contingencies. At the same time,
idle cash should be avoided as it means loss of income. Cash management
involves (a) controlling the level of cash through cash budgeting, cash flow
statement contingency rrangements with banks, etc. (b) controlling cash
inflows through decentralised collection of bank debts, etc. (c) controlling
cash outflows through centralised disbursements, etc. and (d) investing
surplus cash appropriately.
2. Management of Inventory : Inventories co stitute the principal item
in the working capital of the majority of trading and industrial companies.
In inventory we include raw materials, finished goods, work-in-p ogress,
supplies and other accessories. To maintain the continuity in the operations
of business enterprise, a minimum stock of inventory is required. Though
the physical control of inventory is the operating responsibility of store
superintendent, and financial personnel have nothing to do about it. But the
financial control of these inventories in all lines of activity in which they
comprise a substantial part of the current assets is a frequent problem in the
management of working capital. Management of inventory is designed to
regulate the volume of investment in goods in hand and the types of goods
carried in stock to meet the needs of production and sales while at the same
time, the investment in them is to be kept at a reasonable level.

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3. Management of Accounts receivable : Account receivable constitute a
significant portion of current assets. A firm sells goods on credit to increase the
volume of sales. But it involves loss of interest and risk of bad debt. The objective
of receivables management is to ensure that the cost involved in financing bank
debts does not exceed the income from investment in book debts. The size of
accounts receivable depends on the level of credit sales, credit period, terms of
credit, cash discount offered, efficiency of collection. In order to minimize
investment in accounts receivable without sacrificing the firm’s competitive
position, it is necessary to lay down specific credit standards, to adopt a sound
credit policy and to adopt efficient collection procedures.
4. Management of Accounts Payable : Need for working capital can
be reduced by obtaining liberal terms of credit from suppliers. While
managing accounts payable the saving of interest cost through delayed
payments should be offset against loss of credit standing of the firm. Thus,
effective management of working capital involves the following measures.
(i) Controlling the amount of cash in hand and cash at bank through
speedy collection of money from debtors and checking untimely
outflows of cash.
(ii) Forecasting cash needs to identify surplus cash that can safely be
invested for a temporary period to earn income.
(iii) Budgeting the raw material needs and devising a proper system of
inventory control.
(iv) Ensuring uninterrupted operations to minimise blockage of working
capita in work in progress.
(v) Expediting despatch of finished goods to realise cash fast.
(vi) Ensuring proper balance between different components of working
capital.
(vii) Blending judiciously the different sources of working capital so as to
minimise the cost of raising such capital.
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TANDON COMMITTEE :
The Report of the Study Group to Frame Guidelines for follow-up of
Bank Credit, popularly known as Tandon Committee, was an almost
revolutionary development in the sphere of distribution of bank credit in
accordance with planning priorities.
The peculiarities of the Indian banking system called for a scientific
systems of rationing of bank credit. The nationalisation of the major
commercial banks brought about a transformation in the banking system in
India. Moreover, public enterprises turned to banks for their working capital
needs. Since industries were to be developed in all parts of the country, credit
had also to be distributed on an equitable, national basis. In the context of the
growing demand from various types of borrowers, bank credit had become an
extremely scarce commodity. Another peculiar feature of the Indian banking
was the inherent weakness of the prev iling commercial credit system which
was popularly known as the cash credit y tem with its three elements of annual
credit limits, drawing accounts and drawing power based on a security-
stipulation. This has been the subject of serious criticism a d the Deheja
Committee questioned the direction and purpose of bank lending. In comment
d extensively on the shortcomings of the prevalent system of security-cum-
guarantee-oriented approach to lending that had led to over-financing of large
industry. In the context of the new approach to lending, with the emphasis
shifting from security-oriented to production-related lending, it was necessary
to strictly ration bank credit to large industry, thereby meeting genuine needs
and preventing a wasteful utilisation of credit. It was also necessary that banks
should keep in close touch with the operations of the borrowers so as to ensure
that borrowed funds are used properly and the desired objectives are achieved.
The unprecedented inflation in 1974 and the rise in demand for credit
compelled a close look at the existing system to remove all shortcomings. It
was against this background that the Tandon Committee was constituted by
the Reserve Bank of India. Its main recommendations were as follows :

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Recommendations :
The recommendations of the Group cover practically all aspects of
lending. It has suggested an integrated scheme to ensure the planned provision
of credit and supervise its use such that bank credit leads to rapid economic
development. The salient features of the package system recommended by the
Study Group are based on three rules. First, the desirability of developing
financial discipline planning and budgeting by the borrowers so as to make
banks and their customer’s partners in a joint venture, the banks providing the
wherewithal for working, and the customers using it constructively. This, in
turn, implies an appraisal system. Borrowers should, therefore, supply
information to their bankers relating to the broad features of their operating
plans for the ensuring year. This would serve as the basis for a realistic
appraisal of their needs and subsequent periodic follow-up during the ensuing
year. At present, review-cum-appraisal is not done annually in many cases and
in most cases it is based on two year-old information, not on what is intended
to be done during the ensuing year; follow-up is confined merely to a check on
security; it does not cover the operations of the borrower. The second rule on
which the recommendations of the Group are based is the need to relate
inventory and bank credit to production. Finally, the banks should know the
end-use of bank credit so as to prevent its diversion for purposes other than
those for which it is made available. Banks should, therefore, finance only a
reasonable part of the working capital gap so as to ensure a minimum cu ent
ratio. The salient features of the scheme suggested by the Tandon Comm ttee
are now outlined.
Fixation of Norms
A notable feature of the recommendations of the Tandon Panel
relates to fixation of “norms” for bank lending to industry. The “norms”
conceived by the Group fall into two categories : (i) Inventory Norms, and
(ii) Lending Norms.
Inventory Norms :
The term ‘norms’ refers to the maximum level for holding inventories and
receivables in each industry. The Study Group has envisaged that eventually

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the entire system of credit planning should be dovetailed with production
planning, both to make efficient use of bank credit and also to ensure better
management of cash, materials and receivables. As a beginning in that direction,
it has suggested inventory and receivable norms. It may, however, be noted that
this recommendation of the Tandon Group is not entirely original. Certain banks
have been following such norms in assessing credit requirements of borrowers
before the Panel came out with its proposals. However, there was not uniform
approach and banks permitted deviations on the slightest pretext, presumably
from fear of losing customers to competing banks. What the Group has really
done in this respect is that it has formalised the approach.
The criteria underlying the emphasis on such norms, according to the
Group, ere (i) bank credit is to be viewed as a tool for resource allocation in
the economy and (ii) banks must uniformly assess working capital
requirements. In this context the committee suggested inventory and
receivable norms in respect of 15 major industries which accounted for
about one-half of the industrial advances of banks.
The norms suggested by the Group pertain to (i) raw materials
including stores and other items used in the process of manufacture; (ii) stock-
in-process; (iii) finished goods; and (iv) receivables and b lls purchased and
discounted. The norms have been worked out on the basis of “time l m nt”.
Raw materials are expressed as so many month’s consumption; stock-in-
process are expressed as so many month’s cost of production; finished goods
and rece vables are expressed as so many months’ cost of sales respectively.
The norms prescribed for receivables relate only to inland sales on a short-
term basis, i.e. excluding receivables arising out of deferred payment sales and
exports. These norms have been fixed taking into account (1) company finance
studies by the Reserve Bank of India, (2) process period in different industries,
(3) discussions with experts in the industries concerned, (4) general
discussions with industry, (5) need for ensuring smooth production, depending
upon the availability of the materials, seasonality, etc., and (6) reaction and
feedback on the interim report which had laid down norms for 10 industries.

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 These norms represent the maximum levels of holding inventory and
receivables in each industry. Borrowers are not expected to hold more than
that level. If a borrower has managed with less in the past, he should
continue to do so. The fixation of these norms is, thus, intended to reduce
the dependence of industry on bank credit.
The norms, however, are not to be applied rigidly. The Group has
underscored the desirability of flexibility in fixing norms so that where
circumstances justify deviations .may be permitted. The plausible
circumstances in which temporary deviations may be permitted have been
listed by the Group in the Report and include : (1) bunched receipt of raw
materials including imports; (2) power-cuts, strikes and other unavoidable
interruptions in the process of production; (3) transport delays and bottlenecks;
(4) accumulation of finished goods due to non-availability of shipping space
for exports or other disruptions; (5) build-up of stocks of finished goods such
as machinery due to failure on the part of the purchasers, for whom these were
specifically manufactured, to take deliver ; (6) need to stock raw materials for
specific export contracts of a short duration. Moreover, deviations should be
allowed for agreed periods and there should be a return to the level of the
norm when conditions revert to normal. In other words, the flexibility in
inventory and receivable norms should work both ways.
Lending Norms
The second category of norms suggested by the Tandon Committee
relates to lending. Although the recommendation of the Group relating to
inventory norms has attracted the most attention, its recommendation
relating to “lending norms” is more basic and has far-reaching implications.
In terms of the “inventory norm” the borrowers are expected to hold
only a reasonable level of inventory and receivables. The Study Group has
visualised the banker’s main role, as a lender, to supplement the borrower’s
resources in carrying a reasonable level of current assets in relation to his
production requirements and not to meet his entire working capital heeds as

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was the earlier practice. In the light of this, the Group has suggested a new
approach to lending. According to the “lending norm” recommended by the
Group, a part of the current assets should be financed by trade credit and
other current liabilities. The remaining part of the current assets, which are
termed-by the Group as “working capital gap”, should be partly financed by
the owner’s funds and long-term borrowings and partly by short-term bank
credit. In the context of this approach to lending, the Group has suggested
three alternative methods for working out the maximum permissible level
of bank borrowings, each successive method reducing the involvement of
short-term bank credit to support current assets.
According to the first method, the short-term bank credit will finance
a maximum of 75% of the working capital gap, i.e. total current assets less
current liabilities other than bank borrowings; the remaining part of the
“gap” is to be financed out of long-term funds comprising owned funds and
term loans. This method will give a minimum current ratio of 1:1. The
second method, stipulates that the borrowers will provide for a minimum of
25% of total current assets out of long-term funds. A certain) level of credit
for purchase and other current liabilities will be available and the balance
will be provided by the banks. Total current liabilities will be ava lable and
the balance will be provided by the banks. Total current liabilities inclusive
of bank borrowings will not exceed 75 per cent of the current assets. The
curr nt at o, according to this method, will be 1.3:1 The third method
excludes core curre t assets from total current assets on the theory that core
current assets should be financed out of long-term funds. The term “core”
refers to the absolute minimum level of raw materials, stock-in-progress,
finished goods and stores which are in the pipeline, to ensure continuity of
production and constitute a fixed element. The third method would mean a
further reduction in bank credit and strengthening of the current ratio.
The quantum of permissible bank finance for working capital
according to three alternative methods suggested by Tandon Committee is
illustrated in Example.
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Example 10.3
From the following balance sheet of Sumit Limited, determine the
maximum permissible bank finance for working capital as per Tandon
Committee. Assume core current assets of Rs. 40 lakhs for the firm.
Balance sheet as at 31st December, Current Year

Liabilities Amount Assets Amount

(Rs.) (Rs.)
Equity share capital 300 Fixed assets 480
Retained earnings 100 Current assets 300
13 % Debentures 200
Creditors and other
outstanding bills 180
780 780

Also determine current ratios under each method.

Solution
(I) Maximum, permissible bank finance :
(i) 1st Method : 0.75 (CA–CL)
0.75 (Rs. 300 – Rs. 180) = Rs. 90 lakhs
(ii) 2nd Method : 0.75 CA–CL
[(0.75  Rs. 300) – Rs.180)] = Rs. 45 lakhs
(iii) 3rd Method : 0.75 (CA–CCA) – CL
[(0.75 (Rs.300 – Rs. 40) – Rs. 180] = Rs. 15 lakhs
(II) Current ratio :
Assuming the firm avails of bank credit to the maximum permissible
limit, the resultant current ratio of the firm consequent to the borrowing
under three methods would be :

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 Current Assets
Current Liabilities (including bank borrowings)
Rs. 390 lakhs
(i) 1st Method: = 1.44 : 1
Rs.-------------------------------------270lakhs

Rs. 345 lakhs

(ii) 2nd Method: = 1.53 : 1
Rs.-------------------------------------225lakhs

Rs. 315 lakhs

(iii) 3rd Method: = 1.62 : 1
Rs.-------------------------------------195lakhs

The Group expressed the view that the third method is ideal as it will
provide the largest multiplier of bank finance; the next best method from
this viewpoint is the second one. However, to avoid hardship to borrowers
it has recommended that a beginning should be made by placing all
borrowers on the first method within a year and then moving to the second
and third methods in stages in the light of the Reserve Bank’s assessment of
the prevailing circumstances. The recommendation was applicable to all
borrowers having a credit limit of Rs. 10 lakhs from the banking system.
The proposed approach to lending by the Group is virtually significant.
It takes into account all the current asset requirements of bo owers, as the
banker should actually be concerned with the borrower’s total operatio al
needs and not merely inventories or receivables; it also takes into account all
the other sources of finance at his command. Another merit of tht1 proposed
approach is that it will invariably ensure a positive current ratio and will, thus,
keep under check any tendency to “over-trade” with borrowed funds. Finally,
the concept of bank credit forming only a portion of the ‘working capital gap’
could also be used as an instrument for influencing the direction at flow of
credit, say, for aligning bank credit with priority industries. The Reserve Bank
can, for instance, lay down different scales of financing as a percentage of the
working capital gap thereby influencing economic policy, for different classes

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of industries, the relevant percentage can be comparatively high for high-
priority industries and low for low-priority industries.
Examination Questions :
1. What do you understand by the term ‘working capital’? Distinguish
between Gross working capital and Net working capital.
2. Discuss the need for and significance of adequate working capital in
the successful functioning of small scale enterprises.
3. How will you estimate the amount of working capital required for a
new small business firm?
4. Explain the factors that determine the working capital requirements
of a small scale industrial unit.
5. Discuss the sources of working capital finance for a small firm.
6. You are an entrepreneur planning to setup a small-scale unit catering
to everyday provision needs of a large housing complex. How would
you assess your working capital requirements and wherefrom such
requirements be met?
7. Explain the main elements of managing effectiv ly the working
capital of small-scale industries.
8. Define working capital. How can effective inventory management
lead to proper working capital management?
References :
Papdey, I.M. : Financial Management
Jain, P.K. and Khan, M.Y. : Financial Management
Gupta, C.B. and Khanka, S.S. : Entrepreneurship and Small Business Management.

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 LESSON : 11
GOVERNMENT SUPPORT TO ENTREPRENEURS:
Policy Initiatives for Entrepreneurial
Growth; Incentives and Subsidies.

In the post-independence era, the Government had to synchronise and

harmonise the twin considerations of rapid industrialisation and the parameters
of a welfare state. The Plan objective of economic growth with social justice
was kept in view in the overall strategy of industrial development. All
segments of the industry large, medium and small-were assigned a mutually
complimentary role ith a view to facilitate an integrated and harmonious
growth of Industrial sector as a whole. In the context of the major problems of
poverty and unemployment faced by the Indian economy, the development of
Small Scale Industries (SSI) was considered essential because of its being
labour intensive and having implications for equity, flexibility, capability to
contribute to decentralisation, to promote entrepreneurship, optimum use of
local resources and talents, etc.
Since independence, a series of six Industr al Policy Resolutions
aimed at promoting industrial growth and determining a patt rn of State
intervention and assistance have been announced by the Central Governm
nt. While spelling out the framework of the basic and strategic industries,
the Industrial Policy Resolution, 1948, realised Cottage and Small Scale
Industries to be particularly suited for better utilisation of local resources
and achievement of ‘local self-sufficiency’ in respect of certain types of
industrial goods. The policy of supporting the cottage, village and small
industries took shape in 1956 when the Government decided to initiate
measures to build the competitive strength of small and village industries.
The 1956 Resolution underlined the role that the SSI sector could play, in
providing employment opportunities, mobilising local skills and capital
resources, and in the integrating process with large industrial sector.

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The Industrial Policy Statement, 1977, stressed upon wider dispersal of
cottage and small industries in the rural areas and small towns. The concept
of District Industries Centres was also mooted so as to provide services to
small industries under one roof. While the Industrial Policy Statement of
1980 was important from the point of view of ancillarisation and creation of
nucleus plants for the growth of the sector, that of 1990 emphasised the
steps for enhancing the contribution of the SSI Sector in overall exports,
employment generation, and dispersal of industries in rural areas.
The Industrial Policy measures announced in 1991 laid special thrust on
promotion and strengthening of small, tiny and village industries. Besides
effecting changes in investment limits, equity participation, etc., a. new scheme of
Integrated Infrastructure Development for SSIs with the participation of State
Governments and Financial Institutions was initiated and a pro-active role for
NGO sector was mooted. In order to protect their interest and facilitate their rapid
development, the Government in pursuance of its policies, have initiated a
number of support measures from time to time which include policy of
reservation, revision of investme t ceilings, modernisation, technology
upgradation, marketing assistance, etc. The emerg g economic scenario in the
changed 11beralised and competitive economic e vironment, has necessitated
structural and fundamental changes in the policy fram work put into place for the
development of this vital sector of the economy. Accordingly, there has been a
shift in focus from ‘protection’ to ‘promotion’. In the post reform period, a
number of steps including partial dereservation, change in investment limits,
facilitating foreign participation, establishment of growth centres, export
promotion, marketing assistance and incentives for quality improvement, etc.
have been taken by the Government for strengthening of this sector. The
highlights of the Small Scale Industries Policy of August 1991 are as follows:
–The investment limit for the tiny sector was raised to Rs. 5 lakhs from Rs.
2 lakhs. This limit has now been raised to Rs. 25 lakhs.
–Here after irrespective of their location would be recognised as small scale
industries.
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–The small Industries Development Organisation (SIDO) has been
recognised as the nodal agency to support the small scale industries,
export promotion.
–An export development centre would be set up in SIDO to serve the small
scale units through its network of field officers to further augment
export activities of the sector.
–A technology development cel1 (TDC) will be set up in SIDO which
could provide technology inputs to improve quality and
competitiveness of product of small scale sector.
–The scheme for the handloom sector, which contributed 30% of the total
textile production in the country, would be redesigned keeping in
view the local and regional needs. It would be the policy of the
Government to promote handloom to sustain employment in rural
areas and to improve quality of life for handloom weavers.
–The National Small Industries Corporation (NSIC) would concentrate on
marketing of mass, consumption items under common brand name and
organizational links between NSIC and SSIDCs would be established.
–The scope of the national equity fund scheme will be widened to cover
projects upto Rs. 10 lakhs for Equity Support (Upto 15 per cent).
–The Single Window loan scheme has also been enlarged to cover Projects upto
Rs. 20 lakhs with working capital margin upto Rs. 10 lakhs.
–Small Scale units can have equity support to the extent of 24% of the total
investment from the medium and large scale industries, Public
Undertakings, NRIs or foreign investment.
In conformity with the socio-economic objectives of the national
development plans, the development banks have introduced a number of
promotional innovative schemes to be operated either separately or jointly.
Some of the important schemes are soft loan scheme, seed capital assistance,

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risk capital assistance, concessional schemes, etc. In addition, IFCI is
operating different subsidy schemes for new and small entrepreneurs.
Recently, it has introduced eight consultancy schemes and four interest
subsidy schemes for the benefit of the entrepreneurs.
The SSI Sector has proved its mettle even in the changed liberalised economic
environment of the country. The steps required for opening up of the economy
have affected the operations of this sector, throwing/open new opportunities
and challenges at the same time. The need of the hour undoubtedly is to
provide sustenance through suitable measures to strengthen it for converting
the challenges into opportunities for scaling new heights.
In order to enable the Government to place more focussed attention on the
problems of the, SSI Sector, a new Ministry of Small Scale Industries and
Agro and Rural Industries h been created on 14th October 1999, under the
Independent Charge of Minister of State. To give a direction -and
perspective to the development strategy, the Minister in-charge of Small
Scale Industries and Agro & Rural Industries announced an “A enda for the
Millennium” which places special emphasis on evolution of a new policy
framework, improved supply of credit, better infrastructural facilities, and
imp tus for modernisation and technology up gradation in small scale
industri s. The Agenda takes cognisance of the special role to be played by
Information Technology, sunrise industries, hi-tech industries, export
potent industries, and at the same time stipulates all possible steps to meet
the requirements of the tiny and micro-enterprises which constitute over 95
per cent of total small scale industrial units in the country.
Knowing of the crucial role of small enterprises, and the problems being
faced by them, the Planning Commission, in 1999, constituted a Study
Group under the Chairmanship of Dr. S.P. Gupta, Member, Planning
Commission, on Development of Small Enterprises. The Study Group has
submitted its report on 13th July 2000.
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INCENTIVES AND SUBSIDY
The term “incentive” includes concessions and bounties. ‘Subsidy’
denotes a single lump sum which is given by a government to industry. It is
granted to an industry which is considered essential in the national interest. The
term ‘bounty’ denotes bonus or financial benefit which is given by a government
to an industry to help it compete with other units in a nation or in a foreign
market. It is given in proportion to the output. Bounty confers benefits on a
particular industry, while a subsidy is given in the interest of the nation.
These subsidies and incentives offer the following advantages :
(a) They act as a motivational force which attract the prospective
entrepreneurs to enter into manufacturing line.
(b) They encourage the entrepreneurs to start industries in backward areas.

(c) By providing sub idies and incentives the Government can : (i) bring
industrial development uniformly in all regions, (ii) develop more
new entrepreneurs which lead to entrepreneurial development, (iii)
increase the ability of entrepreneurs to face competition successfully,
and (iv) reduce the overall problems of small scale entr preneurs.
Schemes of Incentives in Operation
Various incentive schemes offered by Central and State Governments
including Union Territories to the entrepreneurs in India are as follows :
Incentives Under The Licensing Regulations
When the controls dominate, a relaxation of the control itself is a
significant incentive. A government notification states that the Central
Government is of the opinion that directions for a further positive production
orientations are to be given to the economy to increase production by removing
all constraints to the maximum extent possible. Now, therefore, in exercise of
powers conferred by Section 29(B) (i) of the Industries (Development and
Regulation) Act, 1951, the Central Government hereby exempts all undertakings

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registered under the said Act from the operation of Section 13(i) (d). “Such
exemptions are quite many and resorted to frequently”.
Incentives For Development of Industries In Backward Areas
As a part of the measures to ensure balanced regional development,
Government of India has announced a number of concessions and facilities
for industries established in selected backward districts/areas from time to
time. The Central government has declared 247 districts (covering about
70% of the areas in the country) as backward and eligible for the subsidies.
Many State Governments have added to this list for the purpose of State
level subsidies. The programme of assistance drawn up for setting up
industries in the selected back ard area/district is briefly indicated below :
(i) Concessional finance : All India financial institutions namely,
Industrial Finance Corporation of India and Industrial Credit and Investment
Corporation of India, Industrial Development Bank of India, extend financial
assistance on concessional terms to all, new and existing industrial projects
having expansion schemes irrespective of the project costs located in the 247
districts selected by the government. The concessions given by these financial
institutions are in the form of lower interest rate viz., 9.5% p.a. against the
normal rate of 11 %, a reduced commitment charge of 0.5% (which could be
waived in exceptional cases), lower underwriting commission of 1.25% and
0.75% for shares and debentures respectively, initial moratorium period upto
five years, longer amortisations of 15 to 20 years and participation in the risk
capital on selective basis. Besides these, the IDBI follows a flexible attitude in
respect of promoter’s contribution, margin requirements, and rescheduling of
repayments during the tenure of the loan. Depending upon the merits of
specific cases in respect of reliance, the IDBI charges a special rate of 6% with
the primary lender’s rate being subjected to a ceiling of 9.5%. The normal rate
of refinance is 6% with ceiling of 12.5% by the primary lending institution.
(ii) Capital Investment Subsidy : The granting of cash subsidy on the
capital investment is called capital investment subsidy. It will be usually in the

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form of outright grant of 10% to 20% of the amount of capital invested in
the industrial units in areas specified to be backward regions/districts. It is
offered by the Central Government.
Out of the districts declared backward by the planning commission,
101 districts/areas have been selected to qualify for Central investment
subsidy. These districts/areas, have been selected on the pattern of six
districts/areas for industrially backward states and three districts/areas for
other states. The salient features of the scheme are given below :
(i) Quantum of subsidy : When the scheme was originally announced
in 1971, 10% of the investment made on fixed capital investment viz., land,
building, and plant and machinery, was to be reimbursed as an outright
grant subject to a ceiling of Rs. 15 lacs. This was raised to 15% with effect
from 1-3-1973. The maximum amount payable is, however, restricted to
Rs. 15 lacs per industrial unit.
After the division of backward districts into (A), (B) and (C) categories the
subsidy will be : (A) 25% subject to a maximum of Rs. 25 lacs; (B) 15% subject
to a maximum of Rs. 15 lacs (c) 10% subject to a maximum of Rs. 10 lacs.
(ii) Eligibility : An industrial unit other than those run departmentally
which made investments in land, building, and plant and machinery on or
after 1-3-1973 and located in the above category of districts/areas s eligible
to claim subsidies. Existing units taking into expansion, modernisation and
diversification are also eligible to claim subsidy.
(iii) Procedure for Claiming Subsidy : The State Governments/Union
Territory administrations have nominated disbursing agencies to administer
the scheme of investment subsidy. State Financial Corporation and financial
institutions such as IDBI, IFCI, and ICICI are some of the agencies selected
for disbursements of subsidy under the scheme. Each industrial unit being set
up in the specified district gets registered with the Director of Industries for
claiming investment subsidy. The units desirous of getting investment subsidy
may approach the disbursing agencies who in turn make recommendation after
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verification etc. to the State level committee which has been appointed in
each State/Union Territory.
Tax holiday to new industrial undertakings set up in backward States
and Union Territories
Under section 80-IA of the Income-tax Act 1961, deduction is allowed in
computing the taxable Income in respect of profits derived from new
industrial undertaking or a ship or the business of a hotel. The deduction
under this section is allowed in the case of companies, at 30 per cent of
profits in respect of the assessment year relevant to the previous years in
which the hotel starts functioning or the industrial undertaking starts
manufacturing or the ship is first brought to use and nine assessment years
immediately succeeding the initial assessment year. In the case of taxpayers
being a co-operative society, similar deduction is llowed for the initial
assessment year and eleven succeeding years, the deduction is allowed at
the rate of 25% in the case of non-corporate assesses. Likewise in the case
of new hotels set up in a hilly area or a rural area or a place of pilgrimage or
such other place as the Central Government may specify, the deduction is
adm ssible at the rate of 50 per cent of the profits.
With a view to giving substantial thrust for encouraging the industrialisation in
States and Union Territories which are industrially very backwa d, the Finance
Bill proposes to provide incentive for dispersal of industrialisat on in remote
and industrially backward regions. It is proposed to allow, in respect of any
new industrial undertaking, located in a State or Union Territory specified in
the new Eighth Schedule of the Income-tax Act, which starts manufacturing or
production after 1.4.1993, deduction under section 80-IA at the rate of 100 per
cent of profits in respect of the first five assessment years starting from the
assessment year relevant to the previous year in which the industrial
undertaking begins manufacture or production. For the subsequent assessment
years, deduction from the profits of such undertakings will be allowed at the
normal rate of 30 per cent in the case of companies and 25 per cent in the

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case of Non-corporate assesses. The deduction, at the enhanced rate and the
normal rate together, will be limited to twelve assessment years in the case
of co-operative societies and ten assessment years in the case of other
assesses, as in the existing provisions.
States and Union Territories which are industrially very backward have been
identified as those in which, according to the backward area Notification S.O.
No. 165 dated 19-2-1986, all the districts are industrially backward. These
States and Union Territories are Arunachal Pradesh, Assam, Goa, Himachal
Pradesh, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland,
Sikkim, and Tripura and the Union Territories of the Andaman and Nicobar
Islands, Dadra & Nagar Haveli, Daman & Diu, Lakshadweep, and
Pondicherry. The above list corresponds to the existing list of industrially
backward areas specified by the Ministry of Industry.
The proposed amendments will take effect from 1st April, 1994 and will,
accordingly, apply in relation to assessment year 1994-95 and subsequent years.
Tax holiday for the power sector
Under section 80-IA of the Income-tax Act, 1961, deduction is allowed, in
computing the taxable income, in respect of profits deriv d from a new
industrial undertaking or a ship or the business of a hotel.
With a view to substantially increasing the power generation capacity in the
country the Bill proposes to provide for a full tax holiday for five years and
there after a partial tax holiday in respect of profits and gains of industrial
undertakings set up any where in India for generation and distribution of
power. Such undertaking which begins to generate power on or after 1-4-1993
will be allowed deduction under section 80-IA, at the rate of 100 percent of
profits in respect of the first five assessment years starting from the assessment
year relevant to the previous year in which the undertaking begins generation
of power. For thy subsequent assessment years, deduction from the profits
from such undertakings will be allowed at the normal rate of 30 per cent in the
case of companies and 25 per cent in the case of non-corporate assesses. The
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deduction, at the enhanced rate and the normal rate together, will be limited
to twelve assessment years in the case of cooperative societies and ten
assessment years in the case of other assesses, as in the existing provisions.
The proposed amendments will take effect from 1st April, 1994 and will,
accordingly, apply in relation to assessment year 1994-95 and subsequent years.
SUBSIDISED CONSULTANCY SERVICES
Small entrepreneurs proposing to set up rural, cottage, tiny or small scale units, or
to expand/diversify/modernise their existing units can get consultancy services at
a low cost from the technical consultancy organ is at ions (TCO’s) sponsored by
All India and State level financial and promotional institutions and banks. They
have to pay only 20% of the fees charged by a TCO for assignments such as
preparation of feasibility studies, project reports, market studies, pre-investment
tudies, diagnostic studies and special studies and applications for seeking
financial assistance from financial institutions technical assistance, etc. The entire
balance of 18% or Rs. 5,000 whichever is lower is subsidised by IFCI in the case
of assignments relating to the use of biogas or renewable/alternative sources of
energy. For units identified or assignments covering physically handicapped or
scheduled caste/tribe entrepreneurs, 100
% of the fees of the TCO for the assignment or Rs. 6,000 whichever is
lower is subsidised. If any entrepreneur is unable to take effective steps to
set up the project within one year from the date of completion of co
sultancy assignments he will not be entitled to prevent the use of the report
in any form or manner by the TCA or other entrepreneurs. An entrepreneur
who has already set up a project at one place and wishes to setup an entirely
different project at another place may be considered eligible to subsidy for
the second project also. In any case, the subsidy will not be made available
to the same entrepreneur for more than two projects.
Subsidy For Market Studies
New entrepreneurs (locally based or non resident Indians) entering the field of
Medium and/or medium large industry for the first time in the country can
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have market studies for their products undertaken by TCA at a cheaper cost.
The fee for the preparation of a market study payable to TCA would be
subsidised by IFCI up to 75% of the cost or Rs. 15,000 whichever is lower.
The subsidy will be made available only to the TCA with which one or more
financial institutions or Development agencies at the State or All India level
are associated as shareholders(s) or member(s) of board of management. The
entrepreneur will have to bear only 25% of the cost of the study.
Adoption of Indigenous Technology
Promoters of projects involving commercial exploitation of indigenous
technology can get assistance in the form of subsidy covering the interest
payment due to IFCI during the first three years of operations of the project
subject to ceiling of Rs. 5 lakhs a year. In appropriate cases; the total subsidy
could be upto Rs. 25 l khs over a period of five years. The subsidy would be
reimbursed to the concern after it makes payments of installments of interest to
IFCI on due dates. For being eligible for concessional assistance, the project
should be set up with loan assistance from IFCI and be based on indigenous
technology. The right to use this tech olo y must have been acquired by the
agency implementing the project from the concerned i stitution, viz,
Government laboratories, public sector companies, universities, or any other
institution recognised by the Government of India. The technology should be
one which has not already been exploited on a commercial scale in the cou try,
and a certificate to this effect will have to be obtained from the concerned i
stitution The technology should be basic to the manufacture of the proposed
product and not merely peripheral and the project must be of national priority
as indicated by government from time to time.
Special Facilities for Import of Raw Materials
The Import Policy of 1978-79 has introduced special concession of import of raw
materials in the case of industrial units set up in backward areas or by graduates/
diploma holders in professional subjects or by ex-servicemen persons belonging
to scheduled castes scheduled tribes. The maximum value of the

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licence shall be Rs. 5 lakhs in respect of new or proposed small scale units
instead of Rs. 3 lakhs. They will also be eligible for preferential treatment
in the matter of canalised items.
Transport Subsidy
The transport subsidy scheme, 1971 envisages grant of a transport subsidy
to industrial units in selected areas to the extent of 50% of the transport cost
of raw materials which are brought into and finished goods which are taken
out of the selected areas.
The scheme covers the State of Jammu and Kashmir, Himachal Pradesh, hilly
areas of Uttar Pradesh and North Eastern Region comprising of States of
Assam, Meghalaya, Nagaland, Tripura and the Union Territories of Arunachal
Pradesh, Andaman and Nicobar Islands, Mizoram and Lakshadweep.
Subsidy is paid on transport costs between the selected railheads and
location of the industrial units in the above states/Union Territories.
The highlights of the scheme are :
1. Industrial units in the above-me tioned areas will be given transport
subsidy in respect of the raw materials brought into and the finished
goods which are taken out of such areas.
2. No transport subsidy will be allowed for the internal moveme t of
raw, materials and finished goods within the State of Jammu and
Kashmir and the North Eastern Region.
3. In the case of Jammu and Kashmir, the transport subsidy will be
given between the railhead at Pathankot and the location of the
industrial unit or between the location of the industrial unit and
Jammu, whichever is nearer.
4. Barring Jammu and Kashmir, the transport subsidy will be given on the
transport cost between Siliguri and the location of the industrial unit in
the North Eastern States. While calculating the transport cost, the

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 cost from Siliguri to the railway station nearest to the industrial unit
will be taken into account in respect of raw materials and finished
goods. If any other mode of transport is used the cost will be limited
to the amount which the industrial unit may have paid, if it had used
the above mode of transport.
5. Freight charges for the movement of goods by road will be
determined on the basis of the transport rates fixed by the
government of a State/ Union Territory from time to time, or the
actual freight paid, whichever is less.
6. The cost of loading or unloading and other handling charges will be
taken into account for the purpose of determining transport costs.
7. All new industrial units located in the selected areas will be eligible
for a transport sub idy equivalent to 50% of the transport cost of raw
materials and fini hed goods.
8. Existing industrial units are also eligible for a 50% subsidy in respect
of additional transport costs of raw materials and finished goods
resulting from a substantial expansion or diversif cation effected by
them after the commencement of the Transport Subsidy sch me.
9. The transport subsidy will cover 50% of the transport charges on the
movement of steel from the Gauhati Stockyard of Hindustan Steel
Limited to the site of an industrial unit in the North-Eastern Re ion
10. The Directorates of Industries in the States/Union Territories will lay
down system of pre-registration of industrial units which are eligible
for the transport subsidy.
Incentives Available to SSI Units in Backward/Rural Industries Project
Areas
Certain special facilities and incentives which have been provided to the
backward districts are enumerated below :

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1. An outright subsidy of 15% on the fixed capital investment up to a
maximum of Rs. 15 lakhs is admissible to the units being set up in
backward areas.
2. Allotment of factory or factory sheds in industrial estates/areas and
industrially developed colonies on easy terms.
3. Interest-free loans in lieu of inter-state Sales tax paid/payable by SSI
units are available up to 7 years, provided the loan in a particular
year will not exceed 8% of the capital investment.
4. The State Financial Corporations grant loans for acquisition of fixed
assets up to Rs. 30 lakhs in the case of limited companies and
registered co-operative societies and up to Rs. 15 lakhs for others at
liberalised margins and rate of interest, and this is done over a longer
span of repayment and moratorium period.
5. The Central/St te Government directly or through its subsidiary
concern, the State Industrial Development Corporation-underwrites
or participates in the preference shares of public limited companies
on a selective basis for setting up medium and large i dustrial units.
The State Government also considers cases for setti g up of joint
ventures with the private sector.
6. The SSI units in the backward areas and other industries w th a
capital investment in plant and machinery upto Rs. 1 lakh are
exempted from the following taxation in some States :
(i) New units established in the districts are completely exempted from
the payment of electricity duty up to a period of 7 years.
(ii) New units are exempted from property tax for a period of 5 years.
(iii) Industrial units set up with in the municipal limits are exempted
from octroi on capital equipment and, building materials subject to a
maximum period of 3 years from the date of regular registration.

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7. Provision of essential, controlled raw materials to the SSI units on
priority and at very liberal terms.
8. State Governments have set up independent testing laboratories on behalf
of the Indian Standards Institution, the Export Inspection Council, the
Department of Defence, Government of India and various other
government organisations for making industrial products of good quality.
9. In order to provide some important and sophisticated common facilities, a
network of industrial development centres, heat treatment centres and
common facility workshops have been set up in the States to equip the SSI
units with modem techniques and process of manufacturing.
Seed Capital Assistance
One of the constraints faced by the entrepreneurs, especially first generation or
technical entrepreneurs is the lack of resources to meet the minimum promoter’s
contribution. To help the entrepreneurs overcome the problem, IDBI has come up
with a scheme which has gained popularity as the Seed Capital Schemes. If the
project is comi g up in non-backward area, then the project would not be eligible
for subsidy. Hence, the e tire amount of promoter’s contribution would be brought
by the contributor h mself. This would be reduced to the extent of the subsidy if
the project is comi g up in backward areas like (category A, B, or C). The
maximum amount which can be sanct oned is to the extent of Rs. 5 lacs per
project on the fulfilment of certain conditions.
Objectives of-the Schedule
The objective of the scheme is to create new generation entrepreneurs who have
the requisite traits of entrepreneurship but whose financial resources are limited. It
envisages extension of assistance at a nominal service charge for meeting the risk
capital requirements of entrepreneurs. The scheme is expected to promote wider
dispersal of ownership and control of industrial undertakings.
Agencies for Operating the Scheme
The scheme is operated through the agency of notified SFCs and SFCs. Assistance

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under the scheme will also be given directly by IDBI in exceptional cases.
Projects assisted by commercial banks are also eligible for seed capital
assistance. However, the entrepreneurs will have to submit their
applications through SFC/SIDC functioning in the region.
Eligibility Criteria
To be eligible for assistance the entrepreneurs should be technically or
professionally qualified or possess relevant experience or skills either in
industry, business or trade. The following categories of entrepreneurs are
eligible for assistance under the scheme :
1. New generation entrepreneurs in small scale sector requiring seed
capital of more than Rs. 4 lacs.
2. Small scale entrepreneurs who undertake expansion/diversification
or modernisation.
3. Entrepreneurs intending to graduate from the small scale to medium
sector for the first time.
4. Entrepreneurs intending to set up a project in the medium sector for
the first time.
5. Entrepreneurs already in medium sector and int nding to undertake
diversification for achieving better viability.
6. Entrepreneurs seeking additional seed capital to meet project cost
over run caused by factors beyond the control.
7. Entrepreneurs intending to take over an existing sick or closed units
and projects constituted as public/private limited companies or
partnership/ proprietary concerns eligible for assistance.
Amounts and Mode of Assistance
The amount of seed capital assistance for project shall not exceed Rs. 15 lacs.
However, the actual amount will be determined on the basis of gap in the equity

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required for the project as also shortfall, if, any in the prescribed minimum
promoter’s contribution after taking into consideration his own contribution
and from other sources and subsidies and incentives. For deciding the
quantum of assistance, the debt equity norms of 2:1 in the case of SSI units
and 1.5:1 in the case of medium scale units would be adopted.
The assistance will be in the form of soft loans in the case of proprietary and
partnership concerns. In the case of private limited companies the assistance
will be by the way of soft loans or subscription to 1% cumulative redeemable
preference shares. In the case of public limited companies the assistance will
be normally by way of subscription to, equity capital or cumulative
redeemable preference’s shares (at 1%) or both or by way of soft loans.
The soft loan would be interest free which will carry a service charge of 1%
per annum. However, IDBI may have option to charge the interest on soft
loan at a different rate. There is no commitment charge. The repayment
period depends upon repaying capacity of the unit with an initial
moratorium period not exceeding 5 years. No security except the personal
guarantee of the promoter is stipulated.
Industrial Licensing : July 1991 Chan es
The process of liberalisation got a fillip with the a nounc ment of the new
industrial policy in July 1991. The major provisions r lating to i dustrial
licensing in this policy can be summarised as follows :
(i) Industrial licensing will be abolished for all projects except for a
short list of 18 industries related to security and strategic concerns,
social reasons, hazardous chemicals and overriding environmental
reasons, and items of elitist consumption.
(ii) In projects where imported capital goods are required, automatic
clearance will be given in case where foreign exchange available is
ensured through foreign equity or where the CIF value of imported
capital goods required is less than 25% of total value of plant and
equipment, up to maximum value of Rs. 2 crore.

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(iii) The system of phased manufacturing programmes run on an administrative
case by case basis will not be applicable to new projects. Existing projects
with such programmes will continue to be governed by them
(iv) Existing units will be provided a new broad banding facility to enable
them to produce any article without any additional investment.
(v) The exemption from licensing will apply to all substantial
expansions of existing units.
(vi) All existing registration schemes will be abolished.
(vii) Entrepreneurs will henceforth be required to file an information
memorandum on new projects and substantial expansions.
(viii) The mandatory convertibility clause will no longer be applicable for
term loans from the financial institutions for new projects.
Taxation Benefits
The taxation benefits available to small scale industries are
explained below :
1. Tax Holiday : New small scale industries are exempted from the
payment of income tax under Section 80J of the Act on their profits up to
6% (7.5% for companies) from the total income of the units in the assessme
t year in which the units began manufacturing, provided the small scale u
its have followed the procedures laid down in Section 80J. This tax holiday
is available up to 5 years from the commencement of production.
2. Depreciation Allowance : Under Section 32 of the Income Tax Act,
a small scale industry is eligible to get a deduction on depreciation account
of plant and machinery, land and buildings, at the prescribed rates. In the
case of small scale industries the deduction from the actual cost of plant and
machinery is allowed up to Rs. 20 lakhs.
The deprecation is calculated on the reducing balance system. Full depreciation is
available for a year irrespective of the actual number of days for which the
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assets have been used. Sometime, an additional allowance, called extra shift
allowance is available to the units. Any machinery or plant costing less than
Rs. 750 is allowed to be written off completely in the year in which it is
first used.
3. Development Rebate : In respect of new plant and machinery other
than office appliances or road transport vehicles of a small scale unit, which
is wholly used for the purpose of production, a sum, by way of
development rebate, as specified below, is allowed under Section 33, in
addition normal depreciation.
(i) In the case of plant and machinery, 35% of the actual cost if it were
installed before 1st April 1970, and 25% of such cost if it were
installed after 31st March 1970.
(ii) Where the plant and machinery was installed after 31st March 1967,
being an asset repre enting expenditure of a capital nature on
scientific research related to the business carried on by a unit,
development rebate is given at the specified rates.
4. Rehabilitation Allowance : This is ranted to small scale units, under
Section 33B, whose business has been disturb d by :
(a) Riot or civil disturbance.
(b) Floods, hurricanes, cyclones, earthquakes or other natural disasters
(c) Accidental fire or explosion.
(d) Action by an enemy.
The small scale unit re-established, reconstructed or revived, is allowed a
deduction of a sum, by way of rehabilitation allowance, equivalent to 60%
of the amount of the deduction allowance to the unit.
Publication of Books : A small scale industry engaged in the business of
publication of books is entitled to claim a deduction of a sum equal to 20 per
cent of the profits and gains derived from such business under section 80 of
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the Act. “Books” for the purpose of this Section do not include newspapers,
journals, Magazines, diaries, brochures, pamphlets and other publication of
similar nature.
Tax Benefits for Amalgamation of Sick Units : Sickness in an industry,
whether large or small, is quite widespread in the country and has become a
national problem which has caused a great deal of concern. It is estimated
that the aggregate amount involved in the sick units is more than Rs. 2000
crores. The policy of the government has been to encourage the
amalgamation of sick units and concessions have been announced to induce
healthy units to take over sick concerns in the public interest. Tax
concessions are available for the amalgamation of sick units.
Incentive to the small scale/ancillary units acquiring ISO 9000 certificate

Government of India l unched a Scheme in March, 1994 to give incentive to

small scale/ancillary units acquiring ISO-9000 certification or its equivalent.
According to the present norms, the Scheme provides for reimbursement of
charges for acquiring ISO-9000 (or its equivalent) certification to the extent of
75% of the cost subject to a maximum of Rs. 75,000/- in each cases.
The present procedural norms of submitting copies of various documents like
vouchers/receipts of payment made to the certification ag ncies & co sultants
etc. alongwith the application to claim reimbursement have been reviewed,
and simplification in these norms has now been introduced. According to the
revised procedural norms, a certificate from the Chartered Accountant
certifying the expenditure incurred towards Application fee, Assessment/Audit
fee, Annual feel/ Licence fee, Training, Technical Consultancy etc. (excluding
hotel & travel expenses) in acquiring 180-9000 certification shall be submitted
in place of the certified copies of various vouchers/receipts of payments.
Further the Application Form has also been simplified. The revised norms
shall reduce their documentation work by the small/ancillary units to a great
extent & would also accelerate processing of reimbursement applications.

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The revised norms are as under :
1. 75% of the cost of acquiring of ISO-9000 certification or its equivalent
subject to a maximum of Rs. 75,000 would be reimbursed in each case.
2. The scheme of reimbursement will remain in operation till end of 9th
plan i.e. upto 31st March, 2002.
3. The small scale units seeking reimbursement of cost for acquiring ISO-
9000 certification under revised norms, continue to file application (as per
revised format) with the Development Commissioner (SSI), Minister of
Small Scale Industries & Agro and Rural Industries, Nirman Bhavan, New
Delhi-110011 alongwith the, following documents :
1. i) Permanent Small Scale Ancillary Registration Certification issued by
DIC/State Directorate of Industries, Certified copy.
ii) Proof of SSI st tus of the unit as on date of application by submitting
the following documents – either (a) or (b)
a) A certificate (in original) from State DI/GM, DIC to the effect that
the unit is in SSI sector in terms of investme t limits (original
purchase value or machinery and equipment) as prescrib d by Govt.
on the date of submission of application for reimbursem nt.
or
b) An affidavit (in original) from Managing Director/Director/Proprietor/
Partner of the SSI unit to the effect that the unit still continues to be a
SSI/ancillary unit, accompanied by a CA certificate indicating the total
investment in Plant & Machinery as on date.
II. ISO-9000 Certification (or its equivalent-attested copy).
III. Chartered Accountant Certificate in support of payments made for
acquiring ISO-9000 Certification or equivalent (excluding hotel &
travel expenses).

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IV. An Undertaking/declaration (in original) giving details of the amount(s)
claimed or received by way of grant/reimbursement for acquiring ISO-
9000 (or its equivalent) from a State Govt. or any financial institution.
The declaration should also be filed stating that the unit shall disclose
the reimbursement made by the Central Government (Office of DCSS)
at the time of claiming reimbursement, if any, under any other similar
scheme run by the Central/State Government/Financial Institution etc.
The revised Application Format alongwith Formats of undertaking
and CA certificates may be had from the General Manager of the District
Industries Centre.
Credit Link Capital Subsidy Scheme for Technology Up gradation of SSIs-
Guidelines :
1. Title
The Scheme is called the “Credit linked Capital subsidy Scheme for
Technology Upgradation of the Small Scale Industries” (SSI).
2. Purpose
The scheme will provide 12 per cent back e d d Capital Subsidy on
projects of technology upgradation by SSI units in the sp cified
products/sub-sectors.
3. Scope of the Scheme
i) To begin with, the Scheme would cover the following products/sub-
sectors in the SSI :
a) Leather and Leather Products including Footwear and Garments;
b) Food Processing ;
c) Information Technology (Hardware) ;
d) Drugs and Pharmaceuticals ;
e) Auto Parts and Components ;

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f) Electronic Industry particularly relating to Design and Measuring ;
g) Glass and Ceramic items including Tiles ;
h) Dyes and Intermediates ;
i) Toys ;
j) Tyres ;
k) Hand Tools ;
l) Bicycle Parts ; and
m) Foundries-Ferrous and Cast Iron.
The above list of products/sub-sector would be expanded as the
Scheme progress ith the approval of the Technical Advisory Committee
constituted under this Scheme.
4. Type of Unit to be covered
i) Existing SSI unit registered with the State “Directorate of Industries
which upgrade with the state-of-the-art technology with or without
expansion.
ii) New SSI units which are registered w th the State, Directorate of
Industries and which set up their facilities only with the appropriate
eligible and proven technology duly approved by the T chn cal
Advisory Committee.
5. Definition of Technology Upgradation
i) Technology upgradation would ordinarily mean induction of state-
of-the-art or near state-of-the-art technology. In the case of more than 7500
products being produced in the Indian small scale sector, technology
upgradation would mean a significant step from the present technology
level to a substantially higher one involving improved productivity, or/and
improvement in the quality of products or/and improved environmental
conditions. It would include installation of improved packaging techniques
as well as anti-pollution measures and energy conservation machinery.
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ii) Replacement of existing equipment/technology with the same
equipment technology will not qualify for this Scheme, nor would the
Scheme be applicable to units upgrading with second hand machinery.
6. Duration of the Scheme
The Scheme will be in operation for a period of five years from 1.10.2000
to 30.9.2005, or till the time sanctions of capital subsidy by the Nodal
Agency reaches Rs. 600 crores, whichever is earlier.
7. Nodal Agency
Small Industries Development Bank of India (SIDBI) will act as the Nodal
Agency.
8. Cap on Amount of Subsidy
i) The financial assistance by the Banks/SIDBI for technology
upgradation will be need b sed. However, the subsidy support would
be limited to the loan amount indicated in Table I.
ii) Value of Plant & Machinery bei g acquired under the Scheme will
be determined by its purchase price.
iii) Capital Subsidy under this Scheme will not be admissible for loan
amount exceeding the limits indicated above.
9. Working capital requirement
Since the success of the technology upgradation programme, to a large
extent, depends upon the availability of adequate working capital,
commercial banks should provide adequate working capital.
10. Other Conditions for Loans
i) Promoters’ contribution, security, debt-equity ratio, up-front fee, etc.,
will be determined by the lending agency as per its existing norms.
ii) Entrepreneurs availing Credit Linked Capital Subsidy for technology
upgradation shall not avail any other benefit including Interest
Subsidy, under any other Scheme of the Central Government.
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 Table-I
S.No. Existing Investment Limit Maximum Celing of Loan eligible
for support
1. Tiny units with investment in Rs. 8 lakhs
plant and machinery less than
Rs. 10 lakhs
2. Tiny units with investment Rs. 20 lakhs
in plant & machinery between
Rs. 10 liikhs to Rs. 25 lakhs
3. SSI units with investment Rs. 40 lakhs
in plant & machinery above
Rs. 25 lakhs
iii) One of the m in requirements of sanction of assistance under the
Technology Upgradation Scheme will be availability of competent
management to the unit concerned to carry out the upgradation programme
and to manage the operation of the unit efficiently. Towards this end, the
lending agencies may stipulate conditions as may be considered necessary.
11. Procedure for Sanctions and Disbursements of Loans
The SSI unit will have to apply for financial assistance in the p escribed
form to any scheduled Commercial Bank or SIDBI or one of the declared
eli ible State Financial Corporations (SFCs). The list of eligible SFCs
would be finalised in consultation with the Banking Division, Ministry of
Finance. The bank/SFC after appraisal would refer the cases to the SIDBI,
which would convey clearance for capital subsidy. The lending institutions
would be required to lodge claims of capital subsidy from SIDBI on a
quarterly basis. SIDBI will settle the claim expeditiously.
12. Procedure for Sanction and Release of Subsidy
i) In order to get the Scheme operationalised, an interest free advance of

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Rs. 30 crores will be given to SIDBI by the Ministry of SSI&ARI, Govt. of India.
The entire subsidy amount of Rs. 600 crores would be released in suitable
instalments to SIDBI and for which necessary provison would be made in the
Annual Plan Budget of the Office of The Development Commissioner (SSI).
ii) SIDBI would prescribe the modalities for submission of subsidy
claims by Commercial banks/State Financial Corporations.
iii) The detailed methodology of the release and adjustments of subsidy
shall be worked out in consultation with the SIDIU.
iv) The SIDBI shall maintain and monitor fund utilisation under the Scheme.

13. Preferential Sanction/Disbursement for the Tiny Sector

SIDBI/all Scheduled Commercial Banks/eligible State Financial Corporations
would ensure preference to the tiny sector for loans for technology upgradation.
14. Monitoring of the Scheme-Constitution of a Governing Board
The Scheme will be monitored by a Gover ing Board. The Secretary
(SSI&ARI) will be the Chairperson of the Board and the Development
Commissioner (SSI) will be its Member Secretary. The Govern g Board shall
consist of representatives of Banking Division (Ministry of Finance), Planning
Commissioner, Department of Science and Technology, Council of Scientific
& Industrial Research. Indian Council for Agricultural Research, SIDBI,
some selected public sector banks and some selected small scale i dustries
associations as members. The governing Board will monitor and review the
functioning of the Scheme and will meet at least twice a year.
15. Review of approved technologies Constitution of a Technical
Advisory Committee
i) Identification of technology is a continuous process. Moreover, new
technologies may also come during the operation of the Scheme.
ii) The Technical Advisory Committee would be set up under the
Chairmanship of Secretary (SSI&ARI) to identify the state-of the-art technology
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and benchmark existing and new technologies which will be eligible for support
under the Scheme. It will consist of representatives of concerned Ministries
including Planning Commission, Technical Research Institutes/Organisations
such as Council of Scientific & Industrial Research, Department of Science and
Technology, National Research Development Corporation, Indian Council for
Agricultural Research and Industry Associations. The Development
Commissioner (Small Scale Industries) will be the Member-Secretary of the
Technical Advisory committee. The Committee would periodically meet and
identify the new technologies for approval under this Scheme.
16. Estimated Requirement of Funds
i) As credit linked capital subsidy is to be provided for loans of Rs. 5000
crores during the five years of its operation, total liability of Government
would be Rs. 600 crores (12% of Rs. 5000 crores) under this scheme.
ii) For the purpose of e timating the yearly financial requirements it has
been assumed that in a year about 15,000 units would be assisted under the
Scheme.
iii) Based on this, the estimated Year-wise fundi g requirements during
the operation of the Scheme is as follows :
Year Loan Amount to be covered Credit Link d Cap tal Subsidy
for subsidy (Rs. in cores) (Rs. in crore)
2000-2001 500 60
2001-2002 1000 120
2002-2003 1000 120
2003-2004 1000 120
2004-2005 1000 120
2005-2006 500 50
Total 5000 600
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Examination Questions :
1. What are the salient features of New Small Enterprise Policy, 1991 ?
2. What do you mean by incentives and subsidies? Briefly present an
account of the schemes of incentives in operation in India.
3. Explain the different incentives available to SSI units in backward areas.

4. What do you mean by seed capital assistance? Who are eligible to

avail it?
5. Write a note on Subsidised Consultancy Services.
6. What is meant by transport subsidy? List the main features of this scheme.

7. State the changes made in July 1991 in Industrial Licensing.

8. What taxation benefits are enjoyed by SSIs in our country ?
9. Discuss the scheme of Incentives to the small scale/ancillary units
acquiring ISO 9000 certificate.
10. Write a detailed note on “Credit Linked Capital Subsidy Scheme for
Technology Upgradation of SSIs”.
References :
Gupta, C.B. and Srinivasan, N.P. : Entrepreneurship Development in India.
Gupta, C.B. and Khanka, S.S. : Entrepreneurship and Small Business Management

Khan, M.A. : Entrepreneur Development Programmes in India.

John Kao and Harars Stevenson : Entrepreneurship – What it is and How to
Teach it.

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 LESSON : 12
INSTITUTIONAL SUPPORT TO
ENTREPRENEURS

Governments-both Central and State, have in the past taken a number of measures
for the development of small and medium enterprises. Government has set up a
number of development institutions to support entrepreneurs. Some of the
institutions assisting entrepreneurs include District Industries Centres (DICs) and
Industrial Estate, Small Industries Development Organisation (SIDO), Small
Industries Service Institutes (SISI), Small Industry Development Corporation
(SIDCO), Entrepreneurial Guidance Bureau (EGB), National Alliance of Young
Entrepreneurs (NAY ), National Productivity Council (NPC) and Venture capital
funds (VCF). In addition, all India financial institutions-IDBI, IFCI, ICICI-have
promoted/sponsored number of Technical Consultance Organisations (TCOs) to
assist small entrepreneurs in different ways. Recently, the Small Industries
Development Bank of India (SIDBI) has been established to help small scale
units. Besides, agencies like Khadi a d Village Industries Commission,
Commercial Banks, Cooperative Banks, EXIM Ba k and National Science and
Technology Entrepreneurship Board undertake promotional activities aiming at
support in entrepreneurship development. Now, what follows in the subsequent
pages is the various kinds of support provided by aforesaid inst tutio s to the
entrepreneurs to help them establish industries.
Small Scale Industries Board (SSIB)
The Government of India constituted a Board, namely, Small Scale Industries
Board (SSIB) in 1954 to advise on the development of small scale industries in
the country. The SSIB is also known as Central Small Industries Board. The
range of developmental work in small scale industries involves several
departments/ministries and several organs of the Central/State Governments.
Hence, to facilitate co-ordination and inter-institutional1inkages, the Small
Scale Industries Board has been constituted. If is an apex advisory body

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constituted to render advice to the Government on all issues pertaining to
the development of small-scale industries.
The Industries Minister of the Government of India is the Chairman of the
SSIB. The SSIB comprises of 50 members including State Industry
Minister, some Members of Parliament, Secretaries of various Departments
of Government of India, financial institutions, public sector undertakings,
industry associations and eminent experts in the field.
State Small Industries Corporations
Many State Governments have set up Small Industries Corporations in
order to undertake a number of commercial activities. The most important
of these activities are distribution of scarce raw materials, supply of
machinery on hire-purchase basis, constitution and management of
industrial estates, procurement of orders from Government Departments,
assistance in export marketing and in certain cases provision of financial,
technical and managerial assistance to small enterprises.
Small Industries Development Corporation (SIDCO)
In Tamilnadu SIDCO is the state small industr es corporation. It plays a
lead role in developing small scale sector. It provides the following
facilities to small scale units :
(a) It makes provision of constructed sheds/plots in industrial estates. These
are sold to entrepreneurs on hire-purchase basis or given on re tal basis
(b) Assistance in procuring some scarce key raw materials like iron and
steel, paraffin wax, potassium chlorate, Fatty Acids, etc., through its
various distribution centres.
(c) Financial assistance in the form of subsidies to industrial units in
backward areas like Central Investment subsidy, state capital subsidy.
Interest-Free sales tax loans, power tariff subsidy and margin money
assistance for the rehabilitation of the sick small scale industries.
(d) Marketing assistance to small entrepreneurs.
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Small Industries Service Institutes (SISIs)
The Small Industries Services Institutes (SISIs) are set up to provide
consultancy and training to small entrepreneurs-both existing and prospective.
The activities of SISIs are coordinated by the Industrial Management Training
division of the DCSSI’s office. There are 28 SISIs and 30 branch SISIs set up
in State capital and other places all over the country.
The main functions of SISIs include :
• To serve as interface between Central and State Governments.
• To render technical support services.
• To conduct Entrepreneurship Development Programmes.
• To initiate promotional programmes.
The SISIs also render s i tance in the following areas :
(i) Economic Consultanc /Information/EDP Consultancy.
(ii) Trade and market informations.
(iii) Project profiles.
(iv) State industrial potential survey.
(v) District industrial potential surveyes.
(vi) Modernisation and inplant studies.
(vii) Workshop facilities.
(viii) Training in various trade/activities.
District Industries Centres (DICs)
The District Industries Centres (DICs) were established in May 1978 with a
view to provide integrated administrative framework at the district level for
promotion of small-scare industries in rural areas. The DICs are envisaged as a
single window interacting agency with the entrepreneur at the district level.
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Services and support to small entrepreneurs are provided under a single
roof through the DICs. They are the implementing arm, of the Central and
State Governments for various schemes and programmes. Registration of
small industries is done at the district industries centres.
The organisational structure of DICs consists of General Manager, four
Functional Managers and three Project Managers to provide technical
service in the area relevant to the needs of district concerned. Management
of the DIC’s is done by the State Governments. The scheme has now been
transferred to the states and from the year 1993-94, funds will not be
provided by the Central Government to the States for running the DICs.
Functions : The DICs role is mainly promotional and developmental. To
attain this, they have to perform the following main functions :
• To conduct industrial potential surveys keeping in view the availability of
resources in terms of material and human skill, infrastructure, demand for
product, etc. To prepare techno-economic surveys and identify product
lines and then to provide investment advice to entrepreneurs.
• To prepare an action plan to effectively implement the schemes identified.
• To guide entrepreneurs in matters relati g to selecting the most
appropriate machinery and equipment, sourc s of its supply and
procedure for procuring imported machinery, if needed, assessing
requirements for raw materials etc.
• To appraise the worthiness of the various proposals received from
entrepreneurs.
• To assist the entrepreneurs in marketing their products and assess the
possibilities of ancillarisation and export promotion of their products.
• To undertake product development work appropriate to small industries.
• To conduct artisan training programmes.
• To function as the technical arms of DRDA in administering IRD
and TRYSEM programmes.

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INDUSTRIAL ESTATES
Developing countries require institutional arrangements for their rapid
industrialisation and balanced growth. One such institutional measure is
industrial estates. The term ‘industrial estate’ is called by different names,
e.g., industrial park, industrial zone, industrial region, industrial city,
industrial area, industrial township, etc.
An industrial estate has been defined as a method of “organising, housing
and servicing industry, a planned clustering of industrial enterprises
offering standard factory building erected in advance of demand and a
variety of services and facilities to the occupants”. In other words, an
industrial estate is a tract of land sub-divided and developed according to a
comprehensive plan for the use of a community of industrial enterprises. It
is a planned clustering of industrial units offering standard f ctory buildings
and a variety of services and facilities to entrepreneurs.
Types of Industrial Estates
Industrial estates are classified on various bases. The prominent ones are :
1. Classification on the basis of Functions : On the basis of functions
industrial estates are broadly classified into two types : (i) G n ral type
industrial estates, and (ii) Special type industrial estates.
General Type Industrial Estates: These are also called as conve tional or
composite industrial estates. These provide accommodation to a wide
variety and range of industrial concerns. The Indian industrial estates are
mainly of this type.
Special Type Industrial Estates : This type of industrial estates are constructed
for specific industrial units, which are vertically or horizontally interdependent.
2. Classification on the basis of Organisational Set-up : On this
basis, industrial estates are classified into following four types :
(i) Government Industrial Estates,

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(ii) Private Industrial Estates,
(iii) Co-operative Industrial Estates, and
(iv) Municipal Industrial Estates.
3. Other Classifications :
(i) Ancillary Industrial Estates : In such industrial estates, only those
small-scale units are housed which are ancillary to a particular large
industry. Examples of such units are like one attached to the HMT,
Bangalore.
(ii) Functional Industrial Estates : Industrial units manufacturing the same
product are usually housed in these industrial estates. These industrial
estates also serve as a base for expansion of small units into larger units.
(iii) The Workshop-bay : Such types of industrial estates are
constructed mainly for very small firms engaged in repair work.
Objectives of Industrial Estates
The main objectives of the establishme t of ndustrial estates are :
(i) To provide infrastructure and accommodation facilities to the
entrepreneurs;
(ii) To encourage the development of small-scale industries in the country;

(iii) To decentralise industries to the rural and backward areas;

(iv) To encourage ancillarisation in surrounding major industrial units; and

(v) To develop entrepreneurship by creating a congenial climate to run

the industries in these estates.
Industrial Estates in India
One of the handicaps faced by small scale industries in India has been the lack
of well-developed space with the necessary infrastructure for carrying on their
manufacturing operations. In order to overcome this problem, the Government
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of India launched the programme of setting up industrial estates in 1955.
The responsibility for planning, developing, constructing and managing
industrial estates lies with the respective State Governments. They are free
to run the estates through corporations or any other agencies of their choice.
The Central Government provides financial assistance to the State
Governments for the development of industrial estates. Such financial
assistance is provided in the form of loans, grants and subsidies.
Industrial estates as a tool of rapid and balanced economic development,
occupy a prominent place in the scheme of planned growth in India. These
estates are expected to foster the growth of small scale industries, help in
rural industrialisation, and decentralisation of industrial location. Therefore,
increasingly more funds have been allocated under successive five year
plans for the development of industrial estates. Such allocation of funds
increased from Rs. 58 lakhs under the First Five Year Plan to more than Rs.
90 crores in the Eighth Five Ye r Plan.
The programme of industrial estates in I dia is designed to achieve the
following objectives :
(i) to encourage the development of small-scale a d m dium sized
industrial units for balanced regional development;
(ii) to remove concentration or congestion of industries in b g cities by
facilitating the movement of industrial units to suburban and rural areas;
(iii) to secure decentralisation of industry by diverting new industrial
units to underdeveloped regions;
(iv) to encourage the growth of ancillary units in the townships surrounding
major industrial undertakings, both in public and private sectors. No developing
country has launched such a massive programme of industrial estates as India.
Over the years there has been a remarkable growth in industrial estates. However,
a sizeable portion of capacity in industrial estates remains unutilised.
Experience reveals that urban industrial estates have been more successful

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semi-urban and rural estates. Rural estates have not been much successful due
to lack of sound infrastructural facilities. Therefore, efforts should be made to
develop sound infrastructure in rural and suburban industrial estates.
Small industry certainly needs a boost through industrial estates. But industrial
estates should not simply become a housing colony for small units,
irrespective of their merits. Encouraging the small units that do hot fit into the
nation’s needs and the national priorities is pointless. Identification of the
product, manufacturing of which results in the promotion of labour - intensive
industry and choosing the techniques that help promote the labour - and
intensive manufacturing should be the objectives of the industrial estates.
National Small Industries Corporation Ltd. (NSIC)
The National Small Industries Corporation Ltd. (NSIC), an enterprise under
the Union Ministry of Industries, was set up in 1955 to promote, and foster
the growth of small scale indu tries in the country. NSIC provides a wide
range of services, predominantly promotional in character to small scale
industries. Its main functions are:
• To provide machinery on hire-purchase scheme to small scale industries.

• To provide equipment leasing facility.

• To help in export marketing of the products of small scale i dustries.
• To develop proto-type of machines and equipments to pass on to
small scale industries for commercial production.
• To distribute basic raw material among small scale industries
through raw material depots.
• To help in the development and upgradation of technology and
implementation of modernisation programmes of small scale industries.
• To impart training in various industrial trades.
• To undertake the construction of industrial estates.

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Small Industries Development Organisation (SIDO)
Small Industries Development Organisation (SIDO) is a subordinate office
of the Department of SSI & ARI. It is an apex body and nodal agency for
formulating, coordinating and monitoring the policies and programmes for
promotion and development of small-scale industries. Development
Commissioner is the head of the SIDO. He is assisted by various directors
and advisers in evolving and implementing various programmes of training
and management consultancy, industrial investigation, possibilities for
development of different types of smallscale industries, development of
industrial estates, etc. The main functions of SIDO
are classified into (i) co-ordination, (ii) industrial development and (iii)
extension. These functions are performed through a national network of
institutions and associated agencies. All small-scale industries except those
falling within the speci lised boards and agencies like KVIC, Coir Boards,
Central Silk Board, etc. fall under the purview of the SIDO.
Following are the main tasks performed by the SIDO in each of its three
categories of functions.
Functions Relating to Co-ordination
• To evolve a national policy for the developme t of small scale industries,

• To co-ordinate the policies and programmes of var ous State

Governments,
• To maintain a proper liasion with the related Central Ministries, Planning
commission, State Governments, Financial Institutions, etc., and
To co-ordinate the programmes for the development of industrial estates.
Functions Relating to Industrial Development
• To reserve items for production by small-scale industries,
• To collect data on consumer items imported and then, encourage the
setting of industrial units to produce these items by giving
coordinated assistance,
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• To render required support for the development of ancillary units, and

• To encourage small scale industries to actively participate in

Government Stores Purchase Programme by giving them necessary
guidance, market advice and assistance.
Functions Relating to Extension
• To make provision of technical services for improving technical
process, production planning, selecting appropriate machinery,
preparing factory layout and design.
• To provide consultancy and training services to strengthen the
competitive ability of small-scale industries.
• To render marketing assistance to small-scale industries to
effectively sell their products, and
• To provide assistance in economic investigation and information to
smallscale industries.
Entrepreneurial Guidance Bureau (EGB)
The EGB has, been set up to guide entrepreneurs in identifying investment
opportunities, assisting them in selecting locations or the projects, preparing
project profiles, assisting them to get financial assistance.
EGB has been supplying information pertaining to the products that offer
scope for manufacture, statistical details relating to demand, capacity
production, sources of raw materials, types of equipments required, investment
involved, sources of finance, etc. Information of procedures pertaining to
obtaining letters of intent, import of capital equipment, export of finished
products is also furnished. EGB also renders assistance from banks/financial
institutions or for submitting proposals for the letter of intent, etc. EGB also
establishes direct contact with engineering graduates, technically qualified
personnel and small entrepreneurs to promote entrepreneurship development.

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National Alliance of Young Entrepreneurs (NAYE)
National Alliance of Young Entrepreneurs (NAYE) sponsored an
Entrepreneurial Development Scheme with Bank of India in August 1972
on pilot basis. This scheme, known as BINEDS, is operative in the States of
Punjab, Rajasthan, Himachal Pradesh, Jammu and Kashmir and Union
Territories of Chandigarh and Delhi. NA YE entered into similar
arrangements with a few other banks as are discussed below.
1. Dena Bank - NAYE : For Promoting ancillary units and small scale
enterprises in Madras..
2. Punjab National Bank- NAYE : Entrepreneurship Assistance
Programme launched in the States of West Bengal and Bihar in
March 1973.
3. Central Bank of India - NAYE : Entrepreneurship Development
Programme being implemented in Maharashtra.
4. Union Bank of India - NA YE : Entrepreneurship Development
Programme inaugurated in June 1975 in Tamilnadu with an intention
to adopt 200 entrepreneurs.
The main objective of the scheme is to help young entrepreneurs in
identifying investment and self-employment opportuniti s; securi g proper
arrangements for their training including development of their ma ufacturing
capabilities; providing necessary financial assistance on the basis of properly
prepared reports; securing package of consultancy services on appropriate
terms and arranging for all possible assistance, facilities and incentives being
extended to young entrepreneurs by Government and other institutions.
Small Industry Extension Training Institute (SIETI)
SIET entered the field of consultancy on abhoc basis mainly to support the
activities of State Governments and development corporations. SIETI’s
consultancy services have recently become broad-based in terms of both the
types of assignments undertaken and area covered. The activities have been

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operative in Jammu and Kashmir, Karnataka, Nagaland, Meghalaya, Manipur,
Assam, Maharashtra and Andhra Pradesh. The assignments in the earlier-years
pertained to (1) identification of industrial opportunities, (2) identification of
growth centres, (3) preparation’ of regional development plans, (4) industrial
profiles, (5) feasibility studies, (6) organisational development, and (7) designing
information system. They now include entrepreneurial development; training and
counselling of the educated unemployed; management counselling for sick
industrial units; and training of trainers and consultants for entrepreneurial
development. Particular attention is given to industrialisation of backward areas.
National Productivity Council (NPC)
Recently National Productivity Council has started a Package Consultancy
Service to Small Industries. This service is in three stages.
(a) Training young nd prospective entrepreneurs;
(b) Undertake market urve s in the States. These surveys are conducted
for identifying investment opportunities and consumption patterns
for the prospective entrepreneurs; develop data bank for providing
information in respect of investment opportunities and financial
resources required, facilities available for obtaining loans; selection/
modernisation of processes and equipme t, product development,
availability of raw materials and market opportuniti s, sales
promotion and marketing and to undertake techno-economic feasib
lity studies either on behalf of prospective or existing entrepreneurs
or on behalf of financial institutions.
(c) Post-investment service consultancy and follow-up in the following
form.
To assist the entrepreneurs in repayment of loans in the minimum possible
time by helping them in improving their enterprise level productivity through
periodical visits; assist the small scale industries in training of workers in
specific trades and supervisory and managerial personnel in techno-managerial
subjects, assist the existing enterprises in improving their enterprise level

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productivity through training and consultancy services; and assisting them
in market studies and sales promotion.
National Research Development Corporation of India (NRDCI)
NRDCI makes available processes which have been developed by various
laboratories in the country: It brings out periodically a publication, entitled,
‘PRDC Processes’, which gives in brief particulars of the various processes,
uses of the products, raw materials required and capital outlays.. If an
entrepreneur is interested to adopt a process, he is expected to pay a
lumpsum premium; royalty is also payable bi-anually for specified period
after starting production. The concerned institute or laboratory releases the
process details to the license after he has executed an agreement. NRDC
also provides technical appraisals on a few projects, which are variously
priced at Rs. 25 to Rs. 750 per copy.
Khadi And Village Indu tries Commission (KVlC)
KVIC was set up in 1953. The primary objective of establishing KVIC is to
develop Khadi and Village industries and improving rural employment
opportunities. Its wide range of activities i clude trai ing of artisans, extension
of assistance for procurement of raw materials, marketing of finished products
and arrangement for manufacturing and/ distribution of improv d tools,
equipment and machinery to producers on concessional terms.
KVIC provides assistance to Khadi and Village industries which are
characterised by low capital intensity and ideally suited to manufacturing
utility goods by using locally available resources. There are about 26
specified-village industries such as processing of cereals and pulses, leather,
cottage matches, gur and khandsari, palm gur, non-edible oils and soaps,
village pottery, carpentry, gobargas, household aluminium utensils, etc.
KVIC’s policies and programmes are executed through 30 State Khadi and
Village Industries Boards, 2320 institutions registerd under the Societies
Registration Act, 1960 and about 30,600 Industrial Cooperative Societies
registered under State Cooperative Societies Act. Activities involving pioneering

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types of work, such as developing new industries in hilly, backward and
inaccessible areas are undertaken by KVIC directly.
National Institute of Entrepreneurship and Small Business
Development (NISEBUD), New Delhi
It is an apex national level institute of its kind set up at New Delhi in 1983.
Its main functions are to coordinate research and training in
entrepreneurship development and to impart specialised training to various
categories of entrepreneurs. Besides, it also serves as a forum for
interaction and exchange of views between various agencies engaged in
activities relating to entrepreneurial development
National Institute of Small Industries Extension Training (NISIET),
Hyderabad
This institute was set up in 1956 to develop the required manpower for running
small-scale industries in the country. Accordingly, its main functions are:
(a) To impart training to the perso s engaged in small-scale industries.
(b) To undertake research studies relating to development of small-scale
industries.
(c) To enter into agreements relating to consultancy s rvices both with
national and international organisations to provide consultancy
services to small industries in the country.
The institute conducts courses in business management for the benefit of
the entrepreneurs and semi-managerial personnel of small industries. It is
located at Hyderabad.
Other Institutes Supporting Entrepreneurs
Following are some of the important institutes set up by the Government
for development of small-scale industries :
(a) Electronic Training and Service Institute, Nainital.
(b) Central Machine Tools Limited, Bangalore.

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(c) Sports Goods and Leisure Time Equipment, Meerut.
(d) Central Institute of Plastics Engineering and Tools, Madras.
(e) National Institute of Foundry and Forging Technology, Ranchi.
Technical Consultancy Organisations (TCOs)
A network of Technical Consultancy Organisations (TCOs) was established
by the all India financial institutions in the seventies and the eighties in
collaboration with state level financial/development institutions and
commercial banks to cater to the consultancy needs of small industries and
new entrepreneurs. At present, there are 17 TCOs operating in various
states, some of them covering more than one state. These 17 TCOs are:
1. Andhra Pradesh Industrial and Technical Consultancy Organisation
Ltd. (APITCO).
2. Bihar Industri l nd Technical Consultancy Organisation Ltd. (BITCO).
3. Gujarat Industri l and Technical Consultancy Organisation Ltd. (GITCO).

4. Haryana-Delhi Industrial Consultants Ltd. (HARDICON).

5. Himachal Consultancy Organisation Ltd. (HIMCO).
6. Industrial and Technical Consultancy Orga isation of Tamil Nadu
Ltd. (ITCOT).
7. Jammu and Kashmir Industrial and Technical Consultancy Orga
isation Ltd. (J&KITCO).
8. Karnataka Industrial and Technical Consultancy Organisation Ltd
(KITCO).
9. Madhya Pradesh Consultancy Organisation Ltd. (MPCON).
10. Mahrashra Industrial and Technical Consultancy Organisation. Ltd.
(MITCON).
11. North-Eastern Industrial Consultants Ltd. (NECON).
12. North-Eastern Industrial and Technical Consultancy Organisation
Ltd. (NEITCO).
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13. North-India Technical Consultancy Organisation Ltd. (NITCON).
14. Orissa Industrial and Technical Consultancy Organisation Ltd.
(ORITCON).
15. Rajasthan Consultancy Organisation Ltd. (RAJCON).
16. U.P. Industrial Consultants Ltd. (UPICO).
17. West Bengal Consultancy Organisation Ltd. (WEBCON).
Functions
Initially, TCOs’ functions were focused on pre-investment studies for small
and medium scale enterprises. Over the years, they have diversified their
functions to include the following:
• To prepare project profiles and feasibility profiles.
• To undertake indu trial potential surveys.
• To identify potential entrepreneurs and provide them with technical
and management assistance.
• To undertake market research and surveys for specific products.
• To supervise the project and where necessary, r nder technical and
administrative assistance.
• To undertake export consultancy for export-oriented projects based
on modern technology.
• To conduct entrepreneurship development programmes.
• To offer merchant banking services.
• A summary view of the progress/performance of TCOs
Commercial banks and Entrepreneurial Development
In recent times commercial banks have not confined themselves to mere
extension of finance to small entrepreneurs but have shown genuine concern

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for their progress and development. They have now entered the challenging
field of promoting new small scale entrepreneurs through entrepreneurship
development programmes. In their new role as promoters of small scale
sector they have accepted yet another challenging task. They are now
holding EDPs in collaboration with specialized institutions such as DIC,
SISI, TCOs, etc. with a view to identifying entrepreneurs, especially in
backward areas, and training and monitoring them to start new ventures.
Assessment Questions
1. Describe the institutional set up for entrepreneurial development in
India.
2. Discuss the need for institutional support to small-scale industries.
3. Discuss the support provided by the National Small Industries
Corporation Ltd. (NSIC) to small-scale industries in the country.
4. What are the functions performed by the Small Industries
Development Corporation (SIDCO) to boost the growth of small-
scale industries in the country?
5. Describe the role that State Small Industr es Dev lopment Corporations
(SSIDC) play in developing small enterprises in the country.
6. What are District Industries Centres (DICs)? Explain the fu ctions of
the DICs.
References:
Gupta, C.B. and Srinivasan, N.P. : Entrepreneurship Development in India.
Gupta, C.B. and Khanka, S.S. : Entrepreneurship and Small Business Management.

Khan, M.A. : Entrepreneur Development Programmes in India.

John Kao and Harars Stevenson: Entrepreneurship- What it is and How to
Teach it.

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