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PMH1631: ENTREPRENEURSHIP IN HOSPITALITY AND TOURISM

Module One: Entrepreneur and Entrepreneurship

Evolution of the concept of entrepreneur, characteristics of an entrepreneur, distinction between an

entrepreneur and a manager; functions and types of entrepreneurs, intrapreneur, entrepreneurial traits and
motivation; entrepreneurship development programmes (EDPs); meaning of and need for rural
entrepreneurship, problems and development of rural entrepreneurship, organisations providing
mentorship for entrepreneurs in India

MEANING AND DEFINITION OF ENTREPRENEUR

An entrepreneur is ordinarily called a businessman. He is a person who combines capital and labour for the
purpose of production. He organizes and manages a business unit assuming the risk for profit. He is the artist
of the business world.

In the words of J.B. Say, “An entrepreneur is one who brings together the factors of production and
combines them into a product”. He made a clear distinction between a capitalist and an entrepreneur.
Capitalist is only a financier. Entrepreneur is the coordinator and organizer of a business enterprise. Joseph
A Schumpeter defines an entrepreneur as “ one who innovates, raises money, assembles inputs and sets the
organization going with the ability to identify them and opportunities, which others are not able to fulfil such
economic opportunities”. He further said, “An entrepreneur is an innovator playing the role of a dynamic
businessman adding material growth to economic development”.

According to George Bernard Shaw, people fall into three categories: (i) those who make things happen. (2)
Those who watch things happen, and (3) those who are left to ask what did happen. Generally, entrepreneurs
fall under the first category.

EVOLUTION OF THE CONCEPT OF ENTREPRENEUR

The word ‘entrepreneur’ is derived from the French word entreprendre. It means ‘to undertake’. Thus,
entrepreneur is the person who undertakes the risk of new enterprise. Its evolution is as follows.

 EARLY PERIOD: The earliest definition of the entrepreneur as a go-between is Marco Polo. He
tried to establish trade route to the far East. He used to sign a contract with a venture capitalist to sell
his goods. The capitalist was the risk bearer. The merchant adventurer took the role of trading. After
his successful selling of goods and completing his trips, the profits were shared by the capitalist and
the merchant.
 MIDDLE AGES: The term entrepreneur was referred to a person who was managing large projects.
He was not taking any risk but was managing the projects using the resources provided. An example
is the cleric who is in charge of great architectural works such as castles, public buildings, cathedrals
etc.
  17th CENTURY: An entrepreneur was a person who entered into a contractual arrangement with the
Govt. to perform a service or to supply some goods. The profit was taken (or loss was borne) by the
entrepreneur.
 18th CENTURY: It was Richard Cantillon, French Economist, who applied the term entrepreneur to
business for the first time. He is regarded by some as the founder of the term. He defined an
entrepreneur as a person who buys factor services at certain prices with a view to sell them at
uncertain prices in the future
 19th CENTURY: The entrepreneurs were not distinguished from managers. They were viewed
mostly from the economic perspective. He takes risk, contributes his own initiative and skills. He
plans, organizes and leads his enterprise.
 20th CENTURY: During the early 20th century Dewing equated the entrepreneur with business
promoter and viewed the promoter as one who transformed ideas into a profitable business. It was
Joseph Schumpeter who described an entrepreneur as an innovator. According to him an
entrepreneur is an innovator who develops untried technology.
 21th CENTURY: Research Scientists live De Bone pointed out that it is not always important that
an individual comes up with an entirely new idea to be called an entrepreneur, but if he is adding
incremental value to the current product or service, he can rightly be called an entrepreneur.

Entrepreneur Vs Entrepreneurship

The major differences between these two terms are as follows.

Entrepreneurship is the function of seeking investment and production opportunity organising an enterprise
to undertake a new production process, raising capital, arranging labour and raw materials, finding a site
introducing a new technique and commodities, discounting new sources for the enterprise. Entrepreneur is
one who combines capital and labour for the purpose of production.

Entrepreneur, Entrepreneurship and Enterprise

The word entrepreneur literally came from French language meaning someone who undertakes an
enterprise.

The word enterprise is attached to self-propelled, usually self-made businessman who thinks about a
venture, dreams it, starts it, works on it and grow with it.

Entrepreneurship could be defined as ability of an individual or a group of individual to introduce changes

or innovate like introduction of a new product or service, opening of a new market and carrying out a new
organization. Hence entrepreneurship can be called as a process.

Any undertaking / venture involving some economic activity which requires risk taking ability, resources
mobilization efforts, keen planning and organisation and effective decision making skill in all types of
decision situations. It has got a separate entity and perpetual successions. It consists of people who work
together mainly for production and selling of goods and services so as to make some economic gains. It may
be of private or public, small or large, domestic or international.

Thus Entrepreneur refers to a person, entrepreneurship indicates the process adopted by him and enterprise
is the work place where in he adopts his entrepreneurial skilled.

Why an entrepreneur is called a change agent?

Whenever and wherever problems occur, the individual seeks to eliminate the problems so that the world
could be a better place to live in, a life worth living. In order to make it happen, one has to think of such
processes that would yield merchandise and services that would enable and bring happiness, joy, comfort
and peace. Therefore, he seeks such ventures that would bring about this change. He looks for opportunities
for converting the challenges into comforts. So, he is called as change agents

Entrepreneurial Process:
Entrepreneurship is a process, a journey, not the destination; a means, not an end. All the successful
entrepreneurs like Bill Gates (Microsoft), Warren Buffet (Hathaway), Gordon Moore (Intel) Steve Jobs
(Apple Computers), Jack Welch (GE) GD Birla, Jamshedji Tata and others all went through this process.
To establish and run an enterprise it is divided into three parts – the entrepreneurial job, the promotion, and
the operation. Entrepreneurial job is restricted to two steps, i.e., generation of an idea and preparation of
feasibility report. In this article, we shall restrict ourselves to only these two aspects of entrepreneurial
process.

1. Idea Generation:
To generate an idea, the entrepreneurial process has to pass through three stages:
a. Germination:
This is like seeding process, not like planting seed. It is more like the natural seeding. Most creative ideas
can be linked to an individual’s interest or curiosity about a specific problem or area of study.
b. Preparation:
Once the seed of interest curiosity has taken the shape of a focused idea, creative people start a search for
answers to the problems. Inventors will go on for setting up laboratories; designers will think of engineering
new product ideas and marketers will study consumer buying habits.
c. Incubation:
This is a stage where the entrepreneurial process enters the subconscious intellectualization. The sub-
conscious mind joins the unrelated ideas so as to find a resolution.
2. Feasibility study:
Feasibility study is done to see if the idea can be commercially viable. It passes through two steps:
a. Illumination:
After the generation of idea, this is the stage when the idea is thought of as a realistic creation. The stage of
idea blossoming is critical because ideas by themselves have no meaning.
b. b. Verification:
This is the last thing to verify the idea as realistic and useful for application. Verification is concerned about
practicality to implement an idea and explore its usefulness to the society and the entrepreneur.

NATURE AND CHARACTERISTICS OF ENTREPRENEURSHIP

Features of entrepreneurship are summarized as follows:

1) It is a function of innovation.
2) It is a function of leadership.
3) It is an organization building function.
4) It is a function of high achievement.
5) It involves creation and operation of an enterprise.
6) It is concerned with unique combinations of resources that make existing methods or products
obsolete.
7) It is concerned with employing, managing, and developing the factors of production.
8) It is a process of creating value for customers by exploiting untapped opportunities.
9) It is a strong and positive orientation towards growth in sales, income, assets, and employment.

INNOVATION AND ENTREPRENEURSHIP

Innovation is one of the underlying dimensions of entrepreneurship. It is a key function in the

entrepreneurial process. Without innovation, an entrepreneur cannot survive in the modern competitive
business world. Entrepreneurship is a creative and innovative response to the environment and an ability to
recognize, initiate and exploit an economic opportunity. An entrepreneur is an innovator who introduces
who introduces something new in an economy.
As per the Schumpeter’s view, a person becomes an entrepreneur only when he or she is engaged in
innovation .further, innovation is equal to competitive advantage. The entrepreneurs today realize the need
for innovation. Innovation adds value to the product. It is only through innovation, the organizations can
survive the increasing competition in the market place.

Peter Drucker describes the businessperson in a befitting manner as “one who is involved in gathering and
using resources to opportunities to produce results”.

According to him, the following should be the qualities of a businessperson.

1. Searches for a change

2. Respond to change
3. Exploits the change as an opportunity.

Peter Drucker argues that the innovation is a specific instrument of a businessperson. Hence, an effective
businessperson converts a source into a resource.

CHARACTERISTICS OF AN ENTREPRENEUR

An entrepreneur is a highly achievement oriented, enthusiastic and energetic individual. He is a business

leader. He has the following characteristic:

1) An entrepreneur brings about change in the society. He is a catalyst of change.

2) Entrepreneur is action-oriented, highly motivated individual who takes risk to achieve goals.
3) Entrepreneur accepts responsibilities with enthusiasm and endurance.
4) Entrepreneur is thinker and doer, planner and worker.
5) Entrepreneur can foresee the future, seize market with a salesman’s persuasiveness, manipulate funds
with financial talent and smell error, frauds and deficiencies with an auditor’s precisions.
6) Entrepreneur undertakes venture not for his personal gain alone but for the benefit of consumers,
government and the society as well.
7) Entrepreneur builds new enterprises. He possesses intense level of determination and a desire to
overcome hurdles and solves the problem and completes the job.
8) Entrepreneur finds the resources required to exploit opportunities.
9) Entrepreneur does extraordinary things as a function of vision, hard work, and passion. He challenges
assumptions and breaks rules.
10) Although many people come up with great business ideas, most of them never act on their ideas.

FACTORS AFFECTING ENTREPRENEURIAL GROWTH

There are large number of varied factors which contribute to the growth of entrepreneurship. These factors
can be broadly classified into five.
  PSYCHOLOGICAL FACTORS: - Inspiration for achievement prepares an entrepreneur to set
higher goals and achieve them. The important psychological factors influencing entrepreneurial
growth may be outlined as below:
(A) Need for Achievement: - Need for achievement means the drive to achieve a goal. People having need
for achievement will be so much self – confident that they do not believe in mere luck. If an individual has
need for achievement, he will become a successful entrepreneur.
(B) Personal Motives: - These have been found to be one of the crucial factors responsible for
entrepreneurship amongst individuals. Bill Gates dreamt that one day he would become the richest person.
His dream became a reality later.

(C) Recognition: - Many people become successful entrepreneurs just for getting recognition from others.
(D) Need of Authority: - ‘Need of authority’ will inspire men to work. When they become entrepreneurs,
they can exercise authority over managers, employees etc.

 CULTURAL FACTORS: - Culture consists of (1) Tangible man – made objects like furniture,
buildings etc.., (2). Intangible concepts like Laws, morals, knowledge etc.., (3) Values and behaviour
acceptable within the society. The important cultural factors influencing entrepreneurial growth are
briefly explained as follows:
(A) Culture: - Culture is closely related with accepted values and human behaviour. For e.g. some
societies have customs of polygamy and some have not.
(B) Religious Belief: - According to Max Weber, entrepreneurism is a function of religious belief and the
impact of religion shapes the entrepreneurial culture. He emphasized that the entrepreneurial energies are
exogenous supplied by means of religious belief.
(C) Minority Groups: - Hoselitz explained that the supply of entrepreneurship is governed by cultural
factors, and culturally minority groups are the spark plugs of entrepreneurial and economic development.
Minority groups like the Jews and Greeks in Medieval Europe, the Lebanese in West Africa, the Indians in
East Africa has important roles in promoting economic development.

(D) Spirit of Capitalism: - It guides the entrepreneur to engage in activities that can bring more and more
profits. The profit motive character coupled with the attitude towards acquisition of money urges the
individual to start new venture.
 SOCIAL FACTORS: - What mould a man into an entrepreneur is the sociological and
environmental factors during childhood, and at the school, personal experience in adult life at the
college and job environments, the mobility, occupation and support from parents. The social factors
include:
 (A) Legitimacy of Entrepreneurship: - System of norms and values within a socio – cultural setting is
responsible for the emergence of entrepreneurship. The degree of approval or disapproval granted to
entrepreneurial behaviour will influence its emergence and its characteristics if it does emerge.
(B) Social Marginality: - Individuals or groups on the perimeter of a given social system or between
two social systems provide the personnel to assume the entrepreneurial roles. Social marginality is
likely to promote entrepreneurship are largely determined by two factors, namely the legitimacy of
entrepreneurship and social mobility
(C) Family, Role Models and Association with Similar Type of Individuals: - If an individual has a
supportive family, he or she is more likely to become an entrepreneur. Similarly, if an individual has
role models who have been successful in entrepreneurship, certainly, he may be motivated to start
ventures. If a person is in association with entrepreneurs, this may add to his or her desire of setting
up a new venture. Reliance, Tata, Birla etc. are the industries depend upon family based inheritance.
Roberts (1991) has developed the idea of the ‘entrepreneurial heritage’ to describe the importance of
the family background for the entrepreneur. This heritage includes factors such as the father’s
occupation, the family work ethic and religion, family size and the first born son, growing up
experience and so on.

(D) Caste System: - Certain religions and caste encourage the growth of entrepreneurial talent. Some
religious communities like the parsees, marwaris and sindhees seem to have an affinity for entrepreneurial
activity. The caste system in Hindu society has promoted to the growth of business and professional skills.
(E) Occupation :- Those born in rich families with silver spoons in their mouth have not only an
advantage of having financial resources for carrying out business but also learn the business skill by
continuous interaction and contacts with parents, customers, employees and visitors in family shops, offices
and homes.
(F) Education and Technical Qualifications: - Education is the best means of developing man’s
resourcefulness which encompasses different dimensions of entrepreneurship. It may be expected that the
high level of education may enable the entrepreneurs to exercise their entrepreneurial talent more
efficiently and effectively.
(G) Social Status: - Every human being aspires for a high social status and once he achieves a reasonable
level, his aspirations and desires for its start getting multiplied. People work hard to maintain their status as
it also contributes to their entrepreneurial growth.
(H) Social Responsibility: - It is the obligation to the society in which the business enterprise operates.
An entrepreneur generates employment for others besides helping himself.

 ECONOMIC FACTORS: - Economic factors also influence the growth of entrepreneurship. The
important economic factors are:
(A)Infrastructural Facilities: - Entrepreneurship development requires certain basic infrastructure like
power, transportation, communication, technical information etc. These provide external economies and
improve the efficiency of investments by entrepreneurs. These infrastructural facilities are scarce in less
developed countries. The entrepreneurs themselves have to procure these facilities at their own cost. They
have to obtain these facilities at higher costs. This will greatly discourage the entrepreneurship
development. In advanced countries, those who are desirous of starting an enterprise will find no difficulty
in procuring the infrastructural facilities at reasonable costs.

(B) Financial Resources: - Finance is the life blood of business activity. Capital is required to obtain
materials, machinery, equipment, etc. and to undertake innovation. Capital is regarded as lubricant to the
process of production. The lack of financial resources discourages the youth and potential entrepreneurs to
start new ventures. Hence, the need for fixed and working capital should be adequately met if new
entrepreneurs are to come forward and grow.

(C) Availability of Material and Know – How: - Entrepreneurship is encouraged only if there is an
adequate supply of materials and know-how. Easy availability of materials attracts more individuals
towards entrepreneurship. Technical know-how is essential for innovation. With technical knowledge, men
discover more and sophisticated techniques of production.

(D) Labour Conditions: - The quality rather than quantity of labour is another factor which influences the
emergence and growth of entrepreneurship. The availability of cheep labour positively affects
entrepreneurship. Labour problem can be solved not by capital intensive technologies but by increasing
their mobility, by offering them facilities, incentives and concessions in every remote corner of the country.

(E) Market: - The size and composition of market influence entrepreneurship in their own ways.
Practically, monopoly in a particular product in a market becomes more influential for entrepreneurship
than a competitive market.
(F) Support System: - Ability, initiative and support systems include financial and commercial
institutions, research, training, consultancy services, ancillary industry etc.
(G) Government Policy: - The socio- political and economic policies of the government inhibit or foster
entrepreneurial growth. Land and factory sheds at concessional rates, adequate sources of power, supply of
materials and other physical facilities should be provided by the government to facilitate the setting up of
new enterprises. The government has a dominant role to play in the industrial development of backward
regions with a view to attain a balanced regional development.

 PERSONALITY FACTORS: - The supply of entrepreneurship in a society is largely influenced by

the presence of individuals with the initiativeness, foresightedness and organizing and managerial
competence. The following personality factors contribute to the entrepreneurial development:
 (A). Personality: - The entrepreneurial personality comprises of the person, his skills, styles and motives.
Impressive personality and individual skill help to develop entrepreneurship. These qualities are required
for entrepreneurs because they have to work with officers, managers, engineers, labourers, customers,
investors, govt. officers, ministers etc.

(B). Independence:-Another personality factors which influences entrepreneurship is independence. An

entrepreneur works out plans on his own, searches and explores resources and experiences and uses inner
urge to make the enterprise a success instead of waiting for suggestions or directions from others.

(C). Compulsion: - Certain compelling reasons also force the people to become entrepreneurs. These
include: (a) unemployment or dissatisfaction with existing job or occupation, (b) to use technical or
professional knowledge and skills, (c) to put the idle funds to use. A large number of technically qualified
people after gaining initial experience and confidence and not being satisfied by their growth in the
profession have a compulsive reason to try entrepreneurship.

QUALITIES OF A SUCCESSFUL ENTREPRENEUR

In order to organize and run it successfully, the entrepreneur must possess some qualities and traits.

They are as following:

1) Willingness to Make Sacrifices and Assume Risks: - A new venture is full of difficulties and
unanticipated problems. In such an inhospitable environment entrepreneur has to be prepared to sacrifice his
time, energy and resources in order to carry out the venture and make it success.
2) Hard Work: - Willingness to work hard distinguishes a successful entrepreneur from an unsuccessful
one. For example, Assim Premji (chairman of Wipro) works in his office fourteen hours every day. He is a
successful entrepreneur. He is one of the richest persons in India.
3) Optimism: - Successful entrepreneurs are not worried by the present problems that they face. They are
optimistic about the future. This enhances their confidence and drives them towards success. Some of the
world’s greatest entrepreneurs failed before they finally succeeded.
4) Self Confidence: - This is the greatest asset of a successful entrepreneur. He must have the confidence to
make choices alone and bounce back when he fails.

5) Leadership: - Successful entrepreneur generally has strong leadership qualities. He should be a good
judge of human nature and a good leader. He must be able to select, train and develop persons who can
properly manage and control the labour force. McClelland identified two main characteristics in an
entrepreneur- (1) Doing things in a new and better manner. (2) Decision making under uncertainty. A
successful entrepreneur must be capable and well-informed, a successful leader of men, a keen judge of
things, courageous and prudent. Above all he must be gifted with a large measure of practical common
sense. There are not many Fords, Tatas, Birlas, Thapars and Ambanis in the world. Entrepreneurship is not
limited to any class, community or religion. There is no age bar, for any person who possesses certain
behavioural traits and attitudes can work to become an entrepreneur.

Entrepreneurial Motivation

Meaning

The entrepreneurial motivation is the process that activates and motivates the entrepreneur to exert higher
level of efforts for the achievement of his/her entrepreneurial goals. In other words, the entrepreneurial
motivation refers to the forces or drive within an entrepreneur that affect the direction, intensity, and
persistence of his / her voluntary behaviour as entrepreneur. So to say, a motivational entrepreneur will be
willing to exert a particular level of effort (intensity), for a certain period of time (persistence) toward a
particular goal (direction).

Definition

Motivation is regarded as “the inner state that energizes activities and directs or channels behavior towards
the goal”. Motivation is the process that arouses action, sustains the activity in progress and that regulates
the pattern of activity.

Entrepreneurial Motivating Factors

Most of the researchers have classified all the factors motivating entrepreneurs into internal and external
factors as follows:

Internal Factors

These include the following factors:

1. Desire to do something new.

2. Become independent.

3. Achieve what one wants to have in life.

4. Be recognized for one’s contribution.

5. One’s educational background.

6. One’s occupational background and experience in the relevant field.

External Factors

These include:

1. Government assistance and support.

2. Availability of labour and raw material.

3. Encouragement from big business houses.

4. Promising demand for the product.

NEED FOR ACHIEVEMENT (ACHIEVEMENT MOTIVATION)

It is the psychological need to achieve. It provides drive to the entrepreneur to set up a new venture, to
achieve targets, to sense problems and opportunity, to take much risk so as to run the business successfully.
It is nothing but a person’s desire either for excellence or to succeed in competitive situation. Thus
achievement motivation means a drive to overcome challenges in reaching higher goals. It is a strong desire
to achieve a higher goal and make dreams come true. In short it is the strong desire to win.

TYPES OF ENTREPRENEURS

Entrepreneurs may be classified in a number of ways.

A. ON THE BASIS OF TYPE OF BUSINESS.

Entrepreneurs are classified into different types. They are

1) Business Entrepreneur: He is an individual who discovers an idea to start a business and then builds a
business to give birth to his idea.
2) Trading Entrepreneur: He is an entrepreneur who undertakes trading activity i.e; buying and selling
manufactured goods.
3) Industrial Entrepreneur: He is an entrepreneur who undertakes manufacturing activities.
4) Corporate Entrepreneur: He is a person who demonstrates his innovative skill in organizing and
managing a corporate undertaking.
5) Agricultural Entrepreneur: They are entrepreneurs who undertake agricultural activities such as
raising and marketing of crops, fertilizers and other imputs of agriculture. They are called agripreneurs.

B. ON THE BASIS OF USE OF TECHNOLOGY:

Entrepreneurs are of the following types.

1) Technical Entrepreneur: They are extremely task oriented. They are of craftsman type. They develop
new and improved quality goods because of their craftsmanship. They concentrate more on production
than on marketing.
2) Non-Technical Entrepreneur: These entrepreneurs are not concerned with the technical aspects of the
product. They develop marketing techniques and distribution strategies to promote their business. Thus
they concentrate more on marketing aspects.
3) Professional Entrepreneur: He is an entrepreneur who starts a business unit but does not carry on the
business for long period. He sells out the running business and starts another venture.

C. ON THE BASIS OF MOTIVATION:

Entrepreneurs are of the following types:

1) Pure Entrepreneur: They believe in their own performance while undertaking business activities.
They undertake business ventures for their personal satisfaction, status and ego. They are guided by the
motive of profit. For example, Dhirubhai Ambani of Reliance Group.
2) Induced Entrepreneur: He is induced to take up an entrepreneurial activity with a view to avail some
benefits from the government. These benefits are in the form of assistance, incentives, subsidies,
concessions and infrastructures.
3) Motivated Entrepreneur: These entrepreneurs are motivated by the desire to make use of their
technical and professional expertise and skills. They are motivated by the desire for self-fulfillment.
4) Spontaneous Entrepreneur: They are motivated by their desire for self-employment and to achieve or
prove their excellence in job performance. They are natural entrepreneurs.

D. ON THE BASIS OF STAGES OF DEVELOPMENT: They may be classified into;

1) First Generation Entrepreneur: He is one who starts an industrial unit by means of his own
innovative ideas and skills. He is essentially an innovator. He is also called new entrepreneur.
2) Modern Entrepreneur: He is an entrepreneur who undertakes those ventures which suit the modern
marketing needs.
3) Classical Entrepreneur: He is one who develops a self supporting venture for the satisfaction of
customers’ needs. He is a stereo type or traditional entrepreneur.

E. CLASSIFICATION ON THE BASIS OF ENTREPRENEURIAL ACTIVITY:

They are classified as follows:

1) Novice: A novice is someone who has started his/her first entrepreneurial venture.
2) Serial Entrepreneur: A serial entrepreneur is someone who is devoted to one venture at a time but
ultimately starts many. He repeatedly starts businesses and grows them to a sustainable size and then sells
them off.
3) Portfolio Entrepreneurs: A portfolio entrepreneur starts and runs a number of businesses at the same
time. It may be a strategy of spreading risk or it may be that the entrepreneur is simultaneously excited by a
variety of opportunities.

F. CLASSIFICATION BY CLARENCE DANHOF:

Clarence Danhof, On the basis of American agriculture, classified entrepreneurs in the following categories:

1) Innovative Entrepreneurs: They are generally aggressive on experimentation and cleverly put
attractive possibilities into practice. An innovative entrepreneur, introduces new goods, inaugurates new
methods of production, discovers new markets and reorganizes the enterprise. Innovative entrepreneurs
bring about a transformation in lifestyle and are always interested in introducing innovations.
2) Adoptive Or Imitative Entrepreneurs: Imitative entrepreneurs do not innovate the changes
themselves, they only imitate techniques and technology innovated by others. They copy and learn from
the innovating entrepreneurs. While innovating entrepreneurs are creative, imitative entrepreneurs are
adoptive.
3) Fabian Entrepreneurs: These entrepreneurs are traditionally bounded. They would be cautious. They
neither introduce new changes nor adopt new methods innovated by others entrepreneurs. They are shy
and lazy. They try to follow the footsteps of their predecessors. They follow old customs, traditions,
sentiments etc. They take up new projects only when it is necessary to do so.
4) Drone Entrepreneurs: Drone entrepreneurs are those who refuse to adopt and use opportunities to
make changes in production. They would not change the method of production already introduced. They
follow the traditional method of production. They may even suffer losses but they are not ready to make
changes in their existing production methods.

There is another classification of entrepreneurs. According to this, entrepreneurs may be broadly classified
into commercial entrepreneurs and social entrepreneurs.

o Commercial Entrepreneurs: They are those entrepreneurs who start business enterprises for their
personal gain. They undertake business ventures for the purpose of generating sales and profits. Most
of the entrepreneurs belong to this category.
o Social Entrepreneurs: They are those who identify, evaluate and exploit opportunities that create
social values and not personal wealth. Social values refer to the basic long standing needs of society.
They focus on the disadvantaged sections of the society. They play the role of change agents in the
society. In short, social entrepreneurs are those who start ventures not for making profits but for
providing social welfare.

COPRENEURS
Copreneurs are entrepreneurial couples who work together as co-owners of their business. They are creating
a division of labour that is based on expertise as opposed to gender studies show that companies co-owned
by spouses represent one of the fastest growing business sectors. Marcia

INTRAPRENEURS

The term intrapreneur was coined in USA in the late seventies. Many senior executives of big companies in
America left their jobs and started small business of their own. They left the organisation because they did
not get any opportunity to apply their own ideas and innovative ability. These entrepreneurs become
successful in their own ventures. Some of them caused a threat to the corporations they left. This type if
entrepreneurs have come to be called Intrapreneurs. They believe strongly in their own talents. They have
desire to create something of their own. They want responsibility and have a strong drive for individual
expression and more freedom in their present organisational structure. When this freedom is not
forthcoming, they become less productive or even leave the organisation to achieve self actualisation
elsewhere.

ULTRAPRENEURS

Now-a-days, new products and services are conceived, create, tested, produced and marketed very quickly
and with great speed. Therefore, today’s entrepreneur needs to have a different mindset about establishing
and operating a business. This mindset is called ULTRAPRENEURING. An entrepreneur with this mind set
is known as Ultrapreneur. The concept of Ultrapreneuring is to identify a business opportunity, determine
its viability and form a company. It requires assembling a super competent management team, who then
develop, produce and markets the product or service in the shortest optimum time period. They create
business and then sell out, merge or combine.

ENTREPRENNEURIAL COMPETENCIES

Competency is a characteristic of a person, which results in effective and/or superior performance in a job. It
is a combination of knowledge, skills and appropriate motives or traits that an individual must possess to
perform a given task.

MEANING OF ENTREPRENEURIAL COMPETENCIES

It is defined as characteristics such as generic and special knowledge, motives, traits, self-image, social roles
and skills which result in birth of a venture, its survival and/ or growth. In short, the competencies required
by an entrepreneur for starting a business venture and carrying it on successfully are known as
entrepreneurial competencies.

TYPES OF ENTREPRENEURIAL COMPETENCIES: It may be classified into two types:

A) PERSONAL ENTREPRENEURIAL COMPETENCIES: These are required to perform the tasks
effectively and efficiently. This includes the following:

• Initiative: It is an inner urge in an individual to do or initiate something.

• Ability to See and Act on Opportunities: Entrepreneurs look for opportunities and take action on such
opportunities.
• Persistence: It means the capacity or skill to take repeated and different actions to overcome obstacles.
• Information Seeking: A successful entrepreneur always keeps his eyes and ear open. He should accept
new ideas which can help him in realizing his goals. He is ready to consult experts for getting their
expert advice.
• Concern for High Quality of Work: Entrepreneurial persons act to do things that meet or beat existing
standards of excellence.
• Commitment to Work: Successful entrepreneurs are prepared to make all sacrifices for completing the
commitments they have made.
• Commitment to Efficiency: Entrepreneurial persons have to look and find ways for or find ways to do
things faster or with fewer resources or at a lower cost. They should try new methods aimed at making
work easier, simpler, better and economical.
• Systematic Planning: Entrepreneurial persons should be able to develop and use the logical step by
step plans to reach goals.
• Problem Solving: Entrepreneurial persons are supposed to possess the skill of identifying new and
potentially unique ideas to reach goals. They should generate new ideas or innovative solutions to solve
problems.
• Assertiveness: They assert own competence, reliability or other personal or company’s qualities. They
also assert strong confidence in own company’s products or services.
• Persuasion: Entrepreneurs should have the ability to successfully persuade others to perform the
activities effectively and efficiently.
• Use of Influence Strategies: Entrepreneurs should have the competence of using a variety of strategies
to influence others. Such entrepreneurs can develop business contacts and use influential people to
accomplish his/her own objectives.

A) VENTURE INITIATION AND SUCCESS COMPETENCIES:

An entrepreneur must also posses the competencies required for launching the enterprise and for its survival
and growth. These competencies may be further divided into two categories of competencies:

1. ENTERPRISE LAUNCHING COMPETENCIES: These include the following:

 Competency to understand the nature of business.
 Competency to comply with Government regulations.
 Competency to deal with the business.
 Competency to finance the business.
 Competency to locate the business.
 Competency to plan the marketing strategy.
 Competency to choose the type of ownership.
 Competency to obtain technical assistance.
 Competency to develop a business plan.
 Competency to determine the potential as an entrepreneur.

2. ENTERPRISE MANAGEMENT COMPETENCIES: These include the following:

 Competency to protect the business.
 Competency to manage customer credit and collection.
 Competency to manage the finances.
 Competency to manage the business records.
 Competency to manage sales efforts.
 Competency to promote the products and services of the business.
 Competency to manage human resources.
 Competency to manage the business.

FUNCTIONS OF AN ENTREPRENEUR

Entrepreneur is a lead player in the drama of business. According to Kilbt, an entrepreneur has to perform
four groups of functions:

EXCHANGE RELATIONSHIP
1) Gaining command over scare resources.

2) Purchasing inputs.

3) Marketing of the products and responding to competition.

POLITICAL ADMINISTRATION

1) Dealing with public bureaucracy (concession, licences and taxes)

2) Managing the human relation within the firm.

3) Managing customer and supplier relations.

MANAGEMENT CONTROL

1) Managing finance.

2) Managing production.
TECHNOLOGY

1) Acquiring and overseeing assembly of the factory.

2) Industrial engineering.

3) Upgrading process and product quality.

4) Introducing new products.

According to Arther H. Cole, an entrepreneur performs the following functions

1) Determining the objectives of the enterprise and revising the objectives in the light of changed
circumstances.
2) Developing an organization including efficient relations with subordinates and all employees.
3) Securing adequate finance.
4) The requisition of efficient technological equipment.
5) Developing a market for the products and devising new products to meet customers demand.
6) Maintaining good relations with public authorities and with society.

Entrepreneurial traits and motivation;

Entrepreneurial traits

1. Mental ability: Mental ability consists of intelligence and creative thinking. An entrepreneur must
be reasonably intelligent, and should have creative thinking and must be able to engage in the
analysis of various problems and situations in order to deal with them.
2. Clear objectives: An entrepreneur should-have a clear objective as to the exact nature of the goods
to be produced and subsidiary activities to be undertaken. A successful entrepreneur may also have
the objective to establish the product, to make profit or to render social service.
3. Business secrecy: An entrepreneur must be able to guard business secrets. Leakage of business
secrets to trade competitors is a serious matter, which should be carefully guarded against by an
entrepreneur. An entrepreneur-should be able to make a proper selection of his assistants.
4. Human Relations Ability: The most important, personality traits contributing to the success of an
entrepreneur is emotional stability, personal relations, consideration and tactfulness. An entrepreneur
must maintain good relations with his customers if he is to establish relations that will encourage
them to continue to patronize his business. He must _also maintain good relations with his
employees if he is to motivate them to perform their jobs at a high level of efficiency.
5. Communication ability: Communication ability is the ability to communicate effectively. Good
communication also means that both the sender and the receiver understand each other and are being
understood. An entrepreneur who can effectively communicate with customers, employees, suppliers
and creditors will be more likely to succeed than the entrepreneur who does not.
 6. Technical knowledge: An entrepreneur must have a reasonable level of technical knowledge.
Technical knowledge is the one ability that most people are able to acquire if they try hard enough.
7. Motivator: An entrepreneur must build a team, keep it motivated and provide an environment for
individual growth and career development.
8. Self-confidence: Entrepreneurs must have belief in themselves and the ability to achieve their goals.
9. Long-term involvement. An entrepreneur must be committed to the project with a time horizon of
five to seven years. No ninety-day wonders are allowed.
10. High-energy level- Success of an entrepreneur demands the ability to work long hours for sustained
- periods of time.
11. Persistent problem-solver: An entrepreneur must have an intense desire to complete a task or solve
a problem. Creativity is an essential ingredient.
12. Initiative: An entrepreneur must have initiative accepting personal responsibility for actions, and
above all make good use of resources.
13. Goal setter: An entrepreneur must be able to set challenging but realistic goals.
14. Moderate risk-taker: An entrepreneur must be a moderate risk-taker and learn from any failures.
These personal traits go a long way in making an entrepreneur a successful man/woman. But however, no
entrepreneur possesses total strengths. In such cases, he associates and/or acquires and thus strengthens his
enterprise.

ENTREPRENEUR VS PROFESSIONAL MANAGERS

Entrepreneurs and professional managers are the two sides of the coin. Their individual itineraries will make
the difference between success and failure for the enterprise. An effective entrepreneurial strategy should be
an integral part of an enterprise’s competitive positioning. The progressive development in the size of
business and the separation of ownership and management in enterprises has made management a distinct
profession. Although both strive to achieve the similar goals they are said to distinguish themselves in varied
measures.

According to the Sachar Committee on Company Law “A professional manager is an individual who

i. belongs to the profession of law, accountancy, medicine, engineering or architecture, or

ii. is a member of a recognised professional body or institutional body exercising supervisory jurisdiction
over its members, or
iii. is a holder of a degree or diploma in management from any recognised university and possesses not less
than five years experience in an executive capacity in a company, corporation or in the government”; or
possesses minimum of ten years’ experience in the same capacity and in the same institutions mentioned
in the third category.
A professional manager is one who specializes in the work of planning, organizing, leading and controlling
the efforts of others by the systematic used of classified knowledge and principles. He subscribes to the
standards of practice and code of ethics established by a recognized body. To be a professional manager he
should

i. have an insight of his job requirements;

ii. carry out continuous updating of his learning to fulfill his job requirements;

iii. have a performance-oriented relationship with his subordinates, super-ordinates and colleagues based
on mutual respect to facilitate team work for collective contribution to

iv. the organization;

v. have a relationship based on long-term mutual benefit approach with customers, suppliers and other
members of the public, and

vi. have communication with colleagues to improve the standard contribution and the prestige
managerial profession.

Professional Management

The progressive development in the size of business and the separation of ownership and management in the
corporate enterprises have contributed to the emergence of management as a distinct profession. A
management can be professional not, by hiring professional managers but by adopting the style of
professional management. Professional management organizes managerial functions by setting long-term
objectives, formulating policies and strategies, developing formal communication network and evaluation
system to deal with the emergence of business problems. The characteristics of professional management are
as follows:

Body of Knowledge: Management theory has a philosophy of its own. It is based on systematic and
scientific studies. Precisely, the management of knowledge is’ the passport to enter the world of
entrepreneurship.

Management Tools: Tools of management such as accounting, business law, psychology, statistics and data
processing have been developed to enhance the practical utility of the science of management.

Specialization: There is a growing tendency to select and appoint highly qualified, trained and experienced
persons to manage the business in each functional area of management. This has created greater demand for
professionals.

Separate Discipline: Management studies in many universities and institutions of higher learning are
recognized as a separate discipline. Seminars, special courses, and training programmes have become
essential in management areas like export management, personnel management, production management,
marketing management, financial’ management, etc.

Code of Conduct: Business management is regarded as a social institution. It has social responsibilities
towards customers, employees’ and the society on the whole. Consumer-oriented marketing concept is an
important corporate code of conduct. Pressure of consumerism, trade unionism, public opinion and
legislation are definitely inducing the management to evolve a code of ethics for consumer satisfactions and.
holding a major market share.

Professional Association: In our country too, business management associations have’ been formed. They
mainly aim at spreading the ethics of business management and build up a sound public image of the
managerial profession. A professional manager is required to possess specific management knowledge
relating to (a) Technical processes, products, materials, equipment and procedures; (b) Economic knowledge
about the basic objective of the entrepreneurs and its position in the economic and social system within
which it is operating; (c) Human knowledge about employee motivation, moral and delegation of authority;
and (d) Administrative knowledge about application and analysis of data. This will facilitate him to deal
with various problems of the organisation in an effective manner.

A person can become a professional manager by the acquisition of knowledge through formal education. .
An owner-manager can achieve success due to his personal cultural traits. Many great entrepreneurs are self-
made, for they were not handicapped by their lack of formal education but came out as successful
entrepreneurs due to their skill and intelligence.

MANAGERS AND ENTREPRENEURS

Both managers and entrepreneurs are answerable for producing results. The results are, of course, different.
In their respective result areas, the buck stops with them. While they can delegate, they are finally
accountable.

Both have to produce results through people working with them though they deal with different sets of
people. They are not effective in the long run, if they are loners. Both are decision-makers but the decisions
are different as their tasks vary. Both have to operate under constraints, which are understandably different.

To be effective in their respective roles, both have to follow sound principles of management like planning,
staffing, delegation and control. The focus of these management tools may vary depending upon the ultimate
purpose.

Similarities between Managers and Entrepreneurs

• To produce results
• To produce results through people
• To take decisions
• To cooperate under constraints
 • To follow sound principles of management

A successful organisation needs both entrepreneurship and management. The entrepreneurial role may be
played by the Chief Executive and his team of top-level executives, the managerial role by the middle-level
and joint-level executives;

Comparison between Entrepreneur and Manager:

Entrepreneur Manager

Definition A person who sets up a business or A person responsible for controlling

(Oxford businesses, taking on financial risks or administering an organization or
Dictionaries) in the hope of profit. group of staff

Business Set up their own business Work in someone else’s business

Role Owner Employee

Financial Take on the financial risks of the Does not take on the financial risks
Risks business of the business

Reward Profit Salary

Manages the business and the people Manages the business and the
Management
involved, i.e. staff people involved, i.e. staff

Focus Business startup Ongoing operations

ENTREPRENEURSHIP DEVELOPMENT PROGRAMMES (EDPS)

Concept of Entrepreneurial Development

Entrepreneurial Development helps to identify, motivate and strengthen the new breed of entrepreneurs
require different programmes, policies, strategies and a sound support of the financial and non-financial
institutions. This will ultimately help them in facing the risks and uncertainties and to set-up new business
ventures. Entrepreneurial development is also meant to make contributions towards individual growth as a
part of a national drive for HRD (Human Resource Development).

A class of entrepreneurs is must for the economic and industrial development of country. To some extent
entrepreneurs are born but not totally. Those who have decided to become entrepreneurs must have basic
understanding, visionary power, sense of value, risk-taking capacity, innovative nature etc. as basic
qualities. But now-a-days one can be developed as per his/her requirement.

They can be motivated and developed to undertake the entrepreneurial activities. Someone has rightly said
that, "Selfdevelopment is the best development”. There are so many means, facilities, supportive
institutions, tools, etc. that can be used to motivate and develop entrepreneurs.

ED is an educational process and efforts in HRD. Learning is a continuous process and ED is part of it.
Human being is considered as a physical resources and therefore its development is necessary. Human being
can be developed through HRD techniques, but it requires an environment that facilitates entrepreneurs to
learn and discharge their functions effectively and efficiently. ED has now a days become extremely
important in achieving the goals of alround development in the country. Joseph E. Stepanek identifies
intelligence, motivation, knowledge and opportunity as the prerequisites for entrepreneurial development.

ED is an organised and systematic development. It is a tool of industrialization and a solution to

unemployment problem for any country. The objective of entrepreneurial development is to motivate a
person for entrepreneurial career and to make him capable of perceiving and exploiting successfully
opportunities for business enterprises. One trained entrepreneur can guide others on how to start their own
business and approach various institutions for help, assistance and counselling related to business functions.
Trained entrepreneurs become catalysts of developing industry and economic growth and progress.

The pioneering experiment on entrepreneurship known as Kakinada Experiment, has taken its shape and was
carried out by McClelland, the world famous Harvard psychologist and authority on achievement
motivation, at this institute and several subsequent studies, have paved the way in the formulation of model
of entrepreneurship development. The institute has conducted several programmes for EDP trainers, and
thus gained the reputation of being a trainer’s training institute. Our country has tried much for the working
of several institutes to develop the entrepreneurs.

As of now, we have National Institute of Entrepreneurship and Small Business Development (NIESBUD) at
New Delhi, Entrepreneurship Development Institute of India (EDII) at Ahmedabad; Uttar Pradesh Institute
of Entrepreneurship Development set up by U.P. Government at Lucknow; Centre for Entrepreneurship
Development (CED) at Gandhinagar, etc.

In addition to these, State Bank of India has its own training wing for Entrepreneurship Development.
Several State Government Corporation like Small Scale Industries Development
Corporations, Industrial Development Corporations, Technical and Consultancy Organisations are also
organising training programme in developing entrepreneurship.

4.2 NEED OF ED

In our country the need of ED arises due to the following reasons:

1. To gear and speed up the process of activating the factors of production.

2. To lead a higher rate of economic growth and development.

3. Scattering of economic activities in all the areas of the country.

4. To develop the backward and tribal areas.

5. To create more /additional employment opportunities for youth.

6. To ameliorate the living standard of weaker-section of the society.

7. To participate and involve all the sections of the society in the process of growth.

8. To utilize and explore the abundant natural resources of our country.

What is EDP?

EDP is defined as a programme designed to help an individual in strengthening his entrepreneurial motive
and in acquiring skills and capabilities necessary for playing his entrepreneurial role effectively. EDP may
be defined as “a programme designed to help an individual in strengthening his entrepreneurial motive and
in acquiring skills and capabilities necessary for playing his entrepreneurial role effectively.”

An EDP is a training-cum-counselling programme. It takes care of all the constraints and therefore it is
proved to be one of the most effective tools for developing new entrepreneurs. In a global business a layman
can’t become an effective entrepreneur and run a business.

It is Inculcation, Development and Polishing of entrepreneurial skills

Objectives

• To identify and train potential entrepreneurs.

• To develop necessary knowledge and skills amongst the participants.

• To impact basic managerial understanding.

• To provide post training assistance.

Long Term Objectives

• To augment the number of entrepreneurs for increasing the pace of industrialization.

 • To assist in the development of small and medium scale units which is essential for the generation of
employment and dispersal of ownership.

• To industrialize rural and backward areas

• To generate self employment for the educated unemployed youth.

• To improve managerial skills of entrepreneurs.

Basic Elements of EDP

• Identification and selection of entrepreneurs, for training programme.

• Inculcating entrepreneurship competencies amongst the trainees.

• Educating trainees w.r.t basic managerial qualities and strategies.

• Providing a viable industrial proposal for each potential entrepreneur.

• Assisting potential entrepreneur in mobilizing requisite resources and infrastructure facilities.

• Subsidizing training cost by charging only nominal amount.

Course Content / curriculum of EDP

• Introduction to entrepreneurship

• Motivation training

• Management skills

• Support system and procedure

• Feasibility study

• Plant visits

Phases of EDP

• Pre-training phase.

• Training phase.

• Post training or follow up phase.

1. Pre Training Phase

This stage includes the activities and the preparation required to launch the training programme. Thus, it
involves the identification and selection of potential entrepreneurs and providing initial motivation to them.
The main activities are:

• Creation of Infrastructure for training,

 • Preparation of training syllabus
• Tie up of guest faculties
• Arrangement for inauguration of the programme
• Designing tools and techniques for selecting the trainees,
• Formation of selection committee
• Publicity campaign for the programme
• Development of Application form

Selection involves:

– Analysis of application blank

– Psychological tests
• Thematic Appreciation Test
• Risk taking (ring toss)
• Personal efficacy
• Locus of control
– Group planning exercises
– Personal interview
– Final score
2. Training Phase

In this stage the training programme is implemented to develop motivation and skills among the
participants. The training of potential entrepreneurs covers special inputs such as, behavioural inputs
(achievement motivation) and business opportunity guidance, information and technical inputs and
managerial inputs. The trainers have to judge how much, and how far the trainees have moved in their
entrepreneurial pursuits.
Most of the business inputs can be given through management/ professional consultants, practitioners,
business and industrial executives, experts of state industrial agencies, bankers, technical consultancy
institutions and small-scale entrepreneurs. Inhouse care teams can also be formed from the group of
trainers or experts where resource persons from industry and trade are not locally available.
Field trips to selected industrial units can also be arranged to expose trainees to actual operating
conditions.

3. Post training and Follow-up Phase

Post-training phase is a review phase of training programme. This stage involves assessment to judge how
far the objectives of the programme have been achieved. Each group of entrepreneurs in an entrepreneurship
programme can be looked after by the entrepreneur trainer - motivator. This involves:-

 follow-up on loan application for finance,

  facilitating infrastructure such as land, factory shed, power, road, etc and finally,
 trouble shooting.
It consists of reviewing of work in the following manner:
– Review of pre-training work
– Review of actual training programme
– Review of post training programme so that cost effectiveness of the present programme can
be evaluated.

Problems in the conduct of EDPs

• No policy at the National Level.

• Problems at the pre training phase.
• Over estimation of trainees.
• Duration of EDPs.
• Non availability of infrastructure.
• Improper methodology.
• Mode of Selection.
• Non availability of competent faculty.
• Poor Response of Financial Institution.

RURAL ENTREPRENEURSHIP

“Rural Entrepreneurship can be defined as entrepreneurship emerging at village level which can take place
in a variety of fields of Endeavour such as business, industry, agriculture and acts as a potent factor for
economic development”.

Industries coming under the purview of Khadi and Village Industries Commission (KVIC) are treated as
rural industries.

Despite all the inadequacies in rural areas one should assess their strengths and build on them to make rural
areas places of opportunities. Enabling them to think positively, creatively and Entrepreneurship
purposefully is utmost for the development of rural areas.

The entrepreneur may or may not be of rural origin. The entrepreneurs may be from anywhere, but their
enterprises have to be located in a rural area, using mainly local resources both material as well as human.
Also, the enterprises have to be located in a rural area though it need not be actually using 100% local
material and human resources. Some amount of material and some people may be from urban cities. But
certainly large portion of material used has to be locally produced and an appreciable number of people
engaged in the production of finished goods should be people based or living in rural areas.

Even a unit set up by the government or a large company in a rural area could promote rural
entrepreneurship depending on how much opportunities it throws up for entrepreneurs to use local resources,
to fulfill the demands of such large units and the multiplier effect such large units create. Any large unit
coming up in rural areas more or less does have an impact in activating the surrounding economy for
entrepreneurs to take advantage of. This is precisely the reason why it is recommended to shift industries
from urban centers to neighboring rural areas.

Such shifting initially may be a difficult proposition but in the long run beneficial in many ways. Moreover,
it would throw up lots of opportunities in the rural areas and result in decongestion of the urban centers.
Urban slums would start disappearing with large number of industries getting shifted to rural areas resulting
in increasing opportunities in the rural areas. Thus, both the rural as well as urban areas get benefited by
setting up more industrial units in the rural areas, making rural areas attractive locations for investments.

Constraints of Potential Rural Entrepreneurs and Development Inputs

Need for Rural Entrepreneurship

• Labour intensive

• Generates incomes in rural areas

• Balanced regional development

• Protect and promote art and creativity (heritage)

• Economic development in rural areas

• Environment friendly

Types of Rural Entrepreneurship

1] INDIVIDUAL ENTREPRENEURSHIP/PROPRIETORSHIP In this; it is the entrepreneur who is the

only (100%) owner. The entrepreneur bears full responsibility for each and every activity and is alone the
strategic thinker and decision maker to make the unit viable as well as profitable. There is hardly any
difference between personal assets and business assets. The entrepreneur has "unlimited liability under the
law". This type of entrepreneurship is quite prevalent in rural areas where an entrepreneur has limited
resources.

2] GROUP ENTREPRENEURSHIP It is classified into mainly three types such as i) Partnership; ii)
Private Limited Company and iii) Public Limited Company.

3] CLUSTER FORMATION It is primarily a formal and non-formal group of people to achieve a common
objective. It basically covers Non-Governmental Organizations (NGOs), Voluntary Organization (VOs),
Self-Help Groups (SHGs), Community-Based Organizations (CBOs) and networking of all these.

4] COOPERATIVES According to ILO, a cooperative organization is an association of persons usually of

limited means, who have voluntarily joined together to achieve a common economic end, through formation
of a democratically controlled business organisation making equitable contributions to the capital required
and accepting a fair share of risks and benefits of the undertaking. According to International Cooperative
Alliance (ICA) "A cooperative is an autonomous association of persons united voluntarily to meet their
common economic, social and cultural needs and aspirations through a jointly-owned and democratically
controlled enterprise".

DOMAINS OF RURAL ENTREPRENEURSHIP

• Food Processing

• Poultry Industry

• Cottage and Handicrafts Industry

• Oil Industry

• Pottery

• Repair of Phone/Mobile Phone, Electronic and Electrical goods

• Rural Tourism

• Entertainment

Advantages of Rural Industrialization :

 Small & Cottage industries can be started with low capital investment
 The rural industries can take advantage of local resources-local raw material, skill & experience
 Catering to the local demand thereby avoiding transaction cost.
 Rural enterprise create jobs in the rural areas of developing countries.
  Specialized components of large industries can be manufactured at a less cost in small units in rural
areas by means of subcontract system.
 Rural industries can produce the best type of products where skilled labour of specific nature is
required.
 Slow down urban migration.
 Reduce unemployment
 Meet demand arising from local consumption needs.
 The role of rural industries is of paramount importance in our country due to above-mentioned
advantages.

Major challenges in the way of development of Rural Industries

 Captive market for rural industrial products.

 Safeguard micro-enterprises and micro-rural Industries.
 Better Allocation of resources and control for products.
 Make regulatory policies.
 Promote more modern types of processing industries.
 To find solution from problem of sickness.
 Access to information, credits and technology.
 Exemption from Excise and Sales Tax.
 To Cope with rural Infrastructure.
 To motivate professionals in the field of finance.
 To impart need-based entrepreneurship development programme for entrepreneurs of rural areas.

Recommendations To Boost Up Rural Entrepreneurship

 Modernization of Rural Industrial Sector and Upgradation of Rural Skills.

 Supply of Raw Material at Reasonable rate.
 Specific action to link the production centers to market in the urban areas.
 Training in Government Schemes.
 Training Institution needs to be Strengthened.
 Eliminate Middle Men in Marketing Business.
 Exemption from Excise and Sales Tax.
 Micro Finance Organization should be set up
 Common Marketing Complex should be Developed.
 Growth of Entrepreneurship, Managerial Skills can be made possible through training Programmes
Entrepreneurship through Poverty Alleviation Programmes :

 Government of India and State Government have Sponsored Several Self-Employment generation
and poverty alleviation programmes.

 IRDP

 TRYSEM

 DWCRA

 JGSY

 SGSY

 PMRY

 REGP etc.

INSTITUTIONS IN AID OF ENTREPRENEURS

EDII: ENTREPRENEURSHIP DEVELOPMENT INSTITUTE OF INDIA.

 Set up in the year 1982,at Ahmedabad

 One of the resource organisation at national level.
 Established by central government.

NIESBUD: national institute for entrepeneurship and small business development.

 located at New Delhi.

 co-ordinates activities related to entrepreneurship and small business development.
RED :RURAL ENTREPRENEUR DEVELOPMENT INSTITUTE.

 set up at ranchi in the year 1983.

 aims at setting up new ventures in rural areas.

MDI: MANAGEMENT DEVELOPMENT INSTITUTE OF INDIA.

 set up at gurgaon (haryana).

 acts as management training , research and consultancy.
 prime goal is to improve managerial effectiveness.
 conducts for executives a number of developmental programmes.
 objectives of the institution is to accelerate the process of entrepreneurship development.
 to evolve standardised process of selection,training to run the enterprise.
 to provide vital information to trainers.

STEPS: SCIENCE AND TECHNOLOGY ENTREPRENEURSHIP PARKS.

 BITS
 NECP
 TREC
 MAULANA AZAD COLLEGE OF TECHNOLOGY.

XAVIERS INSTITUTE OF SOCIAL SERVICE,RANCHI.

 involved with tribals.

 group of young tribal youths formed local organisation for promotion of socio economic and health
schemes.
Module Two: Micro and Small Enterprises
Meaning and definition; features and characteristics of MSME; scope and rationale behind micro and small
enterprises; setting up a MSME unit; role of MSME in economic development; problems of micro and small
enterprises; sickness in small enterprises and its remedy

Small Business

A small business can be defined as one that is independently owned and operated, is indominant in its field
and meets a variety of size standards. This is mostly a localized business so as to satisfy the felt needs of the
community.

Small business offers an opportunity to the youth to excel in their field. “Small is beautiful” goes a saying.
The objective of small business is to utilize the available resources for balanced regional and local
development. This requires interest and risk taking abilities. The raw materials are plenty and investment is
negligible in a small business concern. The only hurdle is the lack of proper management.

Small industry is the nation’s leading employer and forms the backbone of the economy. There is, therefore,
an urgent need to highlight the advantages of small industries and a need to develop the concept of
entrepreneurship through education.

The small size of a business provides some unique competitive advantages over large size business. Small
firms are often the ones to offer innovations, new concepts and new products in the market place. Innovative
behaviour is also found in the marketing strategies of these firms. The provision of product or service at
cheaper cost due to less overhead costs is another advantage. Due to small size of some of the economies
economic and organizational factors dictate that an industry consists essentially of small firms.

Defining MSME in India

In accordance with the provision of Micro, Small & Medium Enterprises Development (MSMED) Act, 2006
the Micro, Small and Medium Enterprises (MSME) are classified in two Classes:

a. Manufacturing Enterprises- The enterprises engaged in manufacture or production of goods

pertaining to any industry specified in the first schedule to the industries (Development and regulation) Act,
1951). The manufacturing enterprise is defined in terms of investment in Plant & Machinery.
b. Service Enterprises- The enterprises engaged in providing or rendering of services and
are defined in terms of investment in equipment.

Definition of MSMEs in India

The limit for investment in plant and machinery / equipment for manufacturing / service
enterprises, as notified, vide S.O. 1642(E) dtd.29-09-2006 are

Manufacturing enterprises Services enterprises

(Investment in plant and machinery) (Only investment in equipment)

Micro Up to Rs 25 lakhs Up to Rs 10 lakhs

From Rs 25 lakhs to Rs 5 From Rs 10 lakhs to Rs 2

Small
Crores Crores
From Rs 5 Crores to Rs 10 From Rs 2 Crores to Rs 5
Medium
Crores Crores

Meaning of Ancillary Units:

Ancillary units are a part of MSMEs. MSMED Act 2006 gave them a separate identity because
of their nature of work of being providers of materials to large/parent enterprises. Promotion of
ancillary units provides good scope for the development of MSME sector as it facilitates off-
loading of the products from the large sector, thus providing assured market. An ancillary unit
can be a micro, small or a medium sized enterprise. Though the earlier SSI policy gave it a
separate identity, now under MSMED Act, it is considered as a part of MSMEs. Efforts have
been made to define ancillary type of enterprises also. The following requirements are to be
complied with by an industrial undertaking for being regarded as ancillary industrial
undertaking: -
An industrial undertaking which is engaged or is proposed to be engaged in the manufacture or
production of parts, components, sub-assemblies, tooling or intermediates, or the rendering of
services and the undertaking supplies or renders or proposes to supply or render not less than
50 per cent of its production or services, as the case may be, to one or more other industrial
undertakings and whose investment in fixed assets in plant and machinery whether held on
ownership terms or on lease or on hire-purchase, does not exceed Rs 10 million.
Tiny Enterprises
Investment limit in plant and machinery in respect of tiny enterprises is Rs 2.5 million
irrespective of location of the unit.
Women Entrepreneurs
A Small Scale Industrial Unit/ Industry related service or business enterprise, managed by one
or more women entrepreneurs in proprietary concerns, or in which she/ they individually or
jointly have a share capital of not less than 51% as Partners/ Shareholders/ Directors of Private
Limits Company/ Members of Cooperative Society.

FEATURES & CHARACTERISTICS OF MSME:

Ownership: Ownership of small scale unit is with one individual in sole proprietorship or it
can be with a few individuals in partnership.
Management and Control: A small scale unit is normally a one man show and even in care
of partnership the activities are mainly carried out by the active partner and the rest are
generally sleeping partners. These units are managed in a personalized fashion. The owner is
actively involved in all the decision concerning business.
Gestation Period: Gestation period is that period after which problems are over and return on
investment starts. Gestation period of small scale unit is less as compared to large scale unit.
Area of Operation: The area of operation of small scale unit is generally localized catering to
the local or regional demand. The overall resources at the disposal of small scale units are
limited and as a result of this, it is forced to confine its activities to the local level.
Technology: Small industries are fairly labour intensive with comparatively smaller capital
investment than the larger units. Therefore these units are more suited for economies where
capital is scarce and there is abundant supply of labour.
Resources: Small scale units use local or indigenous resources and as such can be located
anywhere subject to the availability of these resources like labour and raw materials.
Dispersal of units: Small scale units use local resources and can be dispersed over a wide
territory. The development of small scale units in rural and backward areas promotes more
balanced regional development and can prevent the influx of job seekers from rural areas to
cities.
Flexibility: Small scale units as compared to large scale units are more change susceptible and
highly reactive and responsive to socio economic conditions. They are more flexible to adopt
hanges like new method of production, introduction of new products etc.

Advantage and disadvantages of MSME

Advantages
 Close customer contacts
 Continuing innovation
  Niche strategies, specialization on certain limited market segments – often market
leader
 Motivated, high engaged and flexible employees
 Flat business structure, not formalized, manager or entrepreneur is in the midst of the
company activities
 High flexibility, fast reaction times – ability to adopt to new situations
 Long-term perspective – no shareholder value
 Special corporate culture
 Stability
 Regional embedness
Disadvantages
 Difficulties to get capital
 Nepotism
 Concentration on owner or manager, problem if business acumen/foresight is missed
 Disadvantage in measures of economies of scales
 R&D is limited because of costs
 High fix costs
 Missing resources
 Difficulties to hire good personal

RATIONALE BEHIND MSME DEVELOPMENT

Emphasizing the very rationale of Small-scale industry in the Indian economy, the Industrial
Policy Resolution (IPR) 1956 stated: “They provide immediate large scale employment, they
offer a method of ensuring a more equitable distribution of the national income and they
facilitate an effective mobilization of resources of capital and skill which might otherwise
unutilized. Some of the problems that unplanned urbanization tends to create will be avoided
by the establishment of small centers of industrial production all over the country”. The
rationale of small scale industries so established can broadly be classified into four arguments
as discussed below.
1. Employment Argument: In view of abundant labour and scarce capital resources, the
most important argument in favor of the SSI’s that have a potential to create immediate
large scale employment opportunities. There are many research findings available which
will establish that smallscale units are more labour intensive than large units. Small units
use more of labour per unit than investment. Studies have shown that the output-
employment ratio is the lowest in small sector, employment generating capacity of small
sector is eight to ten times that of large scale sectors. Some scholars oppose this argument.
 They are of the opinion that employment should not be created for the sake of
employment. According to them it is not how to Management and Entrepreneurship absorb
surplus resources but how to make the best use of scarce resources. Then employment
argument becomes output argument.
2. Equality Argument: An important argument in favor of small-scale industries is that they
ensure a more equitable distribution of national income and wealth. This is based on two
major considerations: (i) Compared to ownership of large scale units, the ownership of
small-scale units is wide spread. (ii) Their more labour-intensive nature and
decentralization and dispersal to rural and backward areas provide more employment
opportunities to the unemployed. Most of these small-scale units are proprietary or
partnership concerns, the relations between workers and employers are more harmonious
in small-scale units than in large-scale units. In an underdeveloped country like India, even
if small-scale units provide low paid jobs, they would be of virtual importance in our
economy where millions are already in search employment to eke-out their livelihood.
3. Decentralization Argument: Big industries are concentrated everywhere in urban areas,
but small industries can be located in rural or semi-urban areas to use local resources and
to cater to the local demands. Hence it promotes balanced regional development in the
country. Though it is not possible to start small-scale industry in every village, but it is
quite possible to start small units in a group of villages. Decentralization will help tap local
resources, idle savings, and local talents and improves the standard of living even in
erstwhile backward areas. The good example of this phenomenon is the economy of
Punjab which has more small-scale units than even the industrially developed state of
Maharashtra.
4. Latent Resource Argument: According to this argument, small enterprises are capable of
mapping up latent and unutilized resources like hoarded wealth and ideal entrepreneurial
ability etc. Dhar and Lydall feel that the real source of latent resources argument lies in the
existence of entrepreneurial skill.

ROLE OF SMALL SCALE INDUSTRIES IN ECONOMIC DEVELOPMENT:

The promotion of small scale industries as an important element of the development strategy
underlying in our five year plans is the basic part. The rationale behind such an approach is
that small industries provide substantial scope for increasing employment because of its labour
intensive techniques and less capital. They have lesser gestation period and can easily be set
up in rural areas or in backward areas. They need relatively smaller markets to be economical
and hence they have advantage in set up as an ancillary units. They stimulate growth of
entrepreneurship and promote a more decentralized pattern in terms of ownership and location.
The following are some of the important role played by small- scale industries in India.
1. Employment generation: The basic problem that is confronting the Indian economy is
increasing pressure of population on the land and the need to create massive
employment opportunities. This problem is solved to larger extent by small-scale
industries because small- scale industries are labour intensive in character. They
generate huge number of employment opportunities. Employment generation by this
sector has shown a phenomenal growth. It is a powerful tool of job creation.
2. Mobilisation of resources and entrepreneurial skill: Small-scale industries can
mobilize a good amount of savings and entrepreneurial skill from rural and semi-urban
areas remain untouched from the clutches of large industries and put them into
productive use by investing in small-scale units. Small entrepreneurs also improve
social welfare of a country by harnessing dormant, previously overlooked [Link],
a huge amount of latent resources ;re being mobilised by the small-scale sector for the
development of the economy.
3. Equitable distribution of income: Small entrepreneurs stimulate a redistribution of
wealth, income and political power within societies in ways that are economically
positive and without being politically disruptive. Thus small-scale industries ensures
equitable distribution of income and wealth in the Indian society which is largely
characterised by more concentration of income and wealth in the organised section
keeping unorganised sector undeveloped. This is mainly due to the fact that small
industries are widespread as compared to large industries and are having large
employment potential.
4. Regional dispersal of industries: There has been massive concentration of industries
m a few large cities of different states of Indian union. People migrate from rural and
semi urban areas to these highly developed centres in search of employment and
sometimes to earn a better living which ultimately leads to many evil consequences of
over-crowding, pollution, creation of slums, etc. This problem of Indian economy is
better solved by small- scale industries which utilise local resources and brings about
dispersion of industries in the various parts of the country thus promotes balanced
regional development.
5. Provides opportunities for development of technology: Small-scale industries have
tremendous capacity to generate or absorb innovations. They provide ample
opportunities for the development of technology and technology in return, creates an
environment conducive to the development of small units. The entrepreneurs of small
 units play a strategic role in commercialising new inventions and products. It also
facilitates the transfer of technology from one to the other. As a result, the economy
reaps the benefit of improved technology.
6. Indigenization: Small-scale industries make better use of indigenous organisational
and management capabilities by drawing on a pool of entrepreneurial talent that is
limited in the early stages of economic development. They provide productive outlets
for the enterprising independent people. They also provide a seed bed for
entrepreneurial talent and a testing round for new ventures.
7. Promotes exports: Small-scale industries have registered a phenomenal growth in
export over the years. The value of exports of products of small-scale industries has
increased to Rs. 393 crores in 1973-74 to Rs. 71, 244 crores in 2002-03. This
contributes about 35% India's total export. Thus they help in increasing the country's
foreign exchange reserves thereby reduces the pressure on country's balance of
payment.
8. Supports the growth of large industries: The small-scale industries play an important
role in assisting bigger industries and projects so that the planned activity of
development work is timely attended. They support the growth of large industries by
providing, components, accessories and semi finished goods required by them. In fact,
small industries can breath vitality into the life of large industries.
9. Better industrial relations: Better industrial relations between the employer and
employees helps in increasing the efficiency of employees and reducing the frequency
of industrial disputes. The loss of production and man-days are comparatively less in
small- scale industries. There is hardly any strikes and lock out in these industries due
to good employee-employer relationship. Of course, increase in number of units,
production, employment and exports of small- scale industries over the years are
considered essential for the economic growth and development of the country. It is
encouraging to mention that the small-scale enterprises accounts for 35% of the gross
value of the output in the manufacturing sector, about 80% of the total industrial
employment and about 40% of total export of the country.

Challenges of MSME sector

 Access to adequate credit
Despite several measures adopted by GoI and RBI, availability of credit continues to
remain the key hurdle in the growth and investment of the MSME sector. Though there
are several sources available for financing, few problems related to each of the sources
make it difficult to get credit on affordable terms. The main reason for bank credit is its
 risk perception about the MSME sector owing to lack of collateral and high transaction
cost involved in loan proposal. Absence of equity capital is also hindering the growth.
Though private equity is most suitable for MSME, fiscal and regulatory barrier as well
as global financial turmoil has dried up the finances from this source. According to
stastical data released by 4th census of MSME only 5.16% of total MSMEs both
registered and unregistered have availed of the finance through institutional sources.
Further, 2.05% of the enterprises have taken finance via non-institutional sources,
majority of them i.e. 92.73% belong to no finance or self-finance category. Hence,
proactive measures are required to be taken to enhance credit from banks, especially to
unbanked population, to divest traditional ownership of family business and
methodological infusion of equity to achieve the broad based growth.

 Inadequate Infrastructure
The availability of quality infrastructure is essential for increasing production, bringing
down the cost, achieving economies of scale and resultant synergy. MSME sector can
be divided into clusters consisting of old artisans at one end and industrialised
enterprises at the other. These are either situated in rural areas of the country or older
industrial estates. The state of basic infrastructure in rural areas such as roads, power,
water etc is inadequate to support the growth of the sector. In addition, inadequate
market infrastructure retail shops, e- commerce, and technological infrastructure in the
form of R&D center testing lab, tool room etc act as a barrier for them to become a
globally competitive firm. Hence, there is need of infrastructure development in the
MSME sector, inclusive of all sorts of basic and supporting infrastructure facilities as
well as upgrading the existing infrastructure.

 Skilled labour
MSMEs’ role in terms of employment creation is eminent yet, entrepreneurs in the
sector complain of having labour shortage. There is insufficient number of vocational
training institutes. The available network of Industrial Development Institutes and
Information & Communication Technologies (ICT) not only lack adequate amenities
but also fail to provide placements. There is a need to have training programmes to
train the people in order to combat shortage of skilled labour. In case of enterprises
operating on a small scale, certain numbers of people are involved in performing
critical role. These organizations, to sustain in future, have to pass on the work
systematically to the successors through proper training. The National Policy on Skill
Development has set a target of skilling 500 million people by 2022.
  Technology constraint
In India, the MSME sector is mainly labour intensive and there is also availability of
cheap labour. However, technology has its role to play in achieving economies of
scale, improving quality, and prevailing over labour shortage. Use of appropriate
technology in the manufacturing process, will bring down the cost of production and
improve productivity. The current state of globalization, which is characterized by
innovation and competition, makes it inevitable for MSMEs to equip themselves with
new technology and modernization. The working group on Prime Minister’s task force
has also recommended total allocation of ` 95 bn for various schemes under the
technology vertical during 12th Five Year Plan.

 Marketing
Marketing is one of the weak areas in the MSME sector, having major issues mainly
due to unavailability of finance and lack of awareness. The sector still needs to learn
the best of global marketing practices. This is evident from the fact that mere 1% of the
total MSMEs are exporting units. There are a few MSME owners who are using web
and social media tools to promote brands, create related communities, and conducting
surveys, however, the result of such a campaign is largely focused on enhancing sales
rather than improving customer loyalty or gaining market insights. Hence, the major
challenge for the MSME sector today is to update and act upon the changes in
marketing dynamics arising out of globalisation and technological upgradation in every
sphere of marketing, brand building, after sale service, and building clientele.
Outlook
The MSME sector in India has performed remarkably well and contributed to the nation’s
growth. With less capital and high absorption of manpower, the sector has contributed to rural
industrialization and employment generation. With the government support and constant
endeavor to resolve challenges faced by the sector predominantly marketing, capital as well as
technology, the sector will continue to play a substantial role in Indian economy.

SICKNESS IN MEDIUM AND SMALL ENTERPRISES

A Small Enterprise should be considered 'Sick' on account of the following:

 a) Any of the borrower accounts of the unit remains substandard for more than six months
i.e. principal or interest, in respect of any of its borrowed accounts has remained
overdue for a period exceeding one year. The requirement of overdue period exceeding
one year will remain unchanged even if the present period for classification of an
account as sub-standard, is reduced in due course; or

b) there is erosion in the net worth due to accumulated cash losses to the extent of 50 per
cent of its net worth during the previous accounting year; and

c) decline in output in last three years.

Combining the three yardsticks used to measure sickness, viz., (a) delay in repayment of loan
over one year, (b) decline in net worth by 50%, and (c) decline in output in last three years,
about 14.47% of the units in the registered MSMEs were identified to be either sick or
incipient sick.

REASONS FOR SICKNESS IN MSMES

The different types of industrial sickness in Small Scale Industry (SSI) fall under two
important categories. They are as follows:
Internal causes for sickness
We can say pertaining to the factors which are within the control of management. This
sickness arises due to internal disorder in the areas justified as following:
a) Lack of Finance: This including weak equity base, poor utilization of assets,
inefficient working capital management, absence of costing & pricing, absence of
planning and budgeting and inappropriate utilization or diversion of funds.
b) Bad Production Policies : The another very important reason for sickness is wrong
selection of site which is related to production, inappropriate plant & machinery, bad
maintenance of Plant & Machinery, lack of quality control, lack of standard research &
development and so on.
c) Marketing and Sickness : This is another part which always affects the health of any
sector as well as SSI. This including wrong demand forecasting, selection of
inappropriate product mix, absence of product planning, wrong market
research methods, and bad sales promotions.
d) Inappropriate Personnel Management: The another internal reason for the sickness of
SSIs is inappropriate personnel management policies which includes bad wages and
 salary administration, bad labour relations, lack of behavioural approach causes
dissatisfaction among the employees and workers.
e) Ineffective Corporate Management: Another reason for the sickness of SSIs is
ineffective or bad corporate management which includes improper corporate planning,
lack of integrity in top management, lack of coordination and control etc.
External causes for sickness
a) Personnel Constraint: The first for most important reason for the sickness of small
scale industries are non-availability of skilled labour or manpower wages disparity in
similar industry and general labour invested in the area.
b) Marketing Constraints: The second cause for the sickness is related to marketing. The
sickness arrives due to liberal licensing policies, restrain of purchase by bulk
purchasers, changes in global marketing scenario, excessive tax policies by govt. and
market recession.
c) Production Constraints: This is another reason for the sickness which comes under
external cause of sickness. This arises due to shortage of raw material, shortage of
power, fuel and high prices, import-export restrictions.
d) Finance Constraints: The another external cause for the sickness of SSIs is lack of
finance. This arises due to credit restrains policy, delay in disbursement of loan by
govt., unfavorable investments, fear of nationalization.
e) credit squeeze initiated by the government policies.

Sickness in MSMEs can also be prevented by diversifying to emerging opportunities in

knowledge based sectors like fashion technology, Information technology, Design
Technology, Health Technology, Bio Technology. Hospitality Industry., media &
entertainment, animation, games and gaming.

REMEDIES / CORRECTIVE MEASURES:

After analyzing the industry type, sickness, causes of sickness and stage of sickness held, the
corrective actions that can be recommended to prevent sickness and to provide the treatment of
sickness are as follows:

At Planning Stage:
Keeping the causes of sickness in the planning of any project makes the project born sick. So,
preventive measures can be taken to remove the causes of sickness in the project planning. The
preventive measures include scientific and systematic selection of project, proper evaluation
and implementation by taking the help of experts in every stage. Specifically the location
selection, layout and material handing plan should be given proper importance,

At The Operation Stages of Normal Units:

To prevent the ‘sickness’ of industrial units it is important to routine check up the operation of
units by various technical methods like implementing inventory and supply chain
management, implementing TQM and quality circle in significant stages of production,
reengineering when necessary and routine checkup of financial reports and keep it at standard
level.

For Units Tending to Be Sick:

Regular check up of the managerial practices and removing the deficiency in finance,
marketing, human relation, operation & infrastructure are important to prevent the sickness for
the units that tend to be sick.

For Units of Incipient Sick:

Identification and detection of sickness at the incipient stage of sickness are most important for
effective decision making. In order to do that, banks and other financial institutions should
periodically review the accounts of borrowers to arrest the sickness in incipient stage and
cooperate the entrepreneurs to provide effective treatment to remove sickness. It needs
integration of diverse viewpoints of management, financial institutions and labor union to
come on the unified decision to treat the sickness.

For Sick Units:

To make effective decision regarding the sick units there must be effective division in
authority to treat those units. Not only financial measures can treat sick units, other measures
must need to rehabilitate those units.
Establishment of BIFR:
The Central Government has set up a Board for Industrial and Financial Re-construction
(BIFR) with effect from 12 January 1987 in pursuance of enactment of the Sick Industrial
Companies (Special Provision) Act, 1985. This is a major step for intervening at an early stage
and detecting, preventing, as well as taking ameliorative, remedial and such other measures
which to be taken with respect to sick and potentially viable companies.
The role of the Board for Industrial and Financial Reconstruction (BIFR) needs a re-look in the
face of a steep rise in the number of industries turning sick. BIFR was constituted to facilitate
the revival of industries deemed sick. When an industry turns sick, BIFR acts as an operating
agency (generally the lead financial institution having the largest loan exposure among the
creditors) to devise a revival strategy proposal.
Progress in the right disposal of sick company cases registered with BIFR has been slow on
account of the conflicting interests between the companies and the creditors (banks and
financial institutions, government bodies/agencies) and certain lacunae in the SIC A Act. The
rehabilitation schemes met with 40-45% failure, as a result of which many of the cases had to
be reopened.
Module Three: Project Feasibility Analysis

Generation and screening of ideas; project identification and selection, project appraisal and
appraisal criteria, market and demand analysis, technical feasibility, financial feasibility,
competitor analysis; sustainability analysis; Selection and analysis of a project – social cost
benefit analysis, capital budgeting; NPV and IRR methods, decision tree analysis; network
techniques, Gnatt Chart, PERT, CPM, Work Breakdown Structures, hotel pre-opening
management

PROJECT SELECTION PROCESS

Identification of a new project is a complex problem. Project selection process starts with the
generation of project ideas. In order to select the most promising project, the entrepreneur
needs to generate a few ideas about the possible project one can undertake. The project ideas
as a process of identification of a project begins with an analytical survey of the economy (also
known as pre-investment surveys). The surveys and studies will give us ideas. The process of
project selection consists of following stages :

 Idea generation
 Environment appraisal.
 Corporate appraisal
 Scouting for project ideas.
 Preliminary screening.
 Project rating index
 Sources of positive Net Present Value.
 Entrepreneur qualities.

IDEA GENERATION
The foremost task of a dynamic entrepreneur is the generation of an idea that is new and
appears to be worthwhile for further use. This involves a lot of creativity on the part of the
entrepreneur. The business idea arises from an opportunity in the market. It originates from
real demand for any product or service that an entrepreneur should have a keen and open mind
to look for opportunities and generate business ideas.

While selecting a business idea, the following points need adequate consideration:

i. The business idea should enable the entrepreneur to utilise his technical and
professional skills. If an entrepreneur has knowledge of some special manufacturing
techniques, because of previous experience or otherwise, it would be easier for the
entrepreneur to manage such techniques effectively.
ii. It should enable the use of locally available raw materials for product or service. As
compared to imported materials/ local materials are easy to procure.
iii. It should ensure making products that have a demand, but are not freely available in the
market. It is potentially a good idea to start with a product that could be sold.
iv. It should enable the entrepreneur to solve a current problem existing in the market.
Products may be available in the market but they do not meet the demand fully or in a
satisfactory manner. Sometimes, an existing product is used in combination with
another, which is not available. Attempts to solve such market problems do give rise to
business ideas.

Sources of Information for Business Ideas

As said earlier, generation of project idea is the starting point in product development. For this,
an entrepreneur can refer to potential studies prepared by different organisations. There are a
number of potential studies conducted by several organisations like the National Council of
Applied Economic Research (NCAER), financial institutions and other promotional
organisations such as Confederation of Indian Industries (CII), etc. These may include the
following:

a) Area studies which identify development potential of particular areas like a backward
area or a district.
b) Subsectoral studies which identify opportunities in specified subsectors (such as food
processing).
 c) Resource-based studies which identify opportunities based on utilisation of natural or
industrial resources such as forest-based industries, marine-based industries, industries
using rubber as the main raw material, etc.
d) Studies of the product consumption pattern of the country.
e) Surveys of existing industrial establishments.
f) Import and export possibilities.

Demand forecasts made by Industrial Chambers such as CII, FICC1, ASSOCHAM, etc.

Approaches to Generating Ideas

While exploring different sources of business ideas, an entrepreneur can use the following
approaches to generate ideas:

i. Brainstorming. It helps in generating a large number of product ideas. It should be

conducted by an expert and none of the ideas mentioned should be evaluated or judged.
At this stage one should not worry if the ideas are suitable or not.
ii. New ways of doing old things. A large number of products are being made and
provided in the market using traditional methods and practices. One approaches can be
to examine if these could be made by a different and newer method that would give the
entrepreneur an advantage over the older methods.
iii. Converting hobby into business. Some people are adept at doing something or the other
as a hobby or for use in the house only. It is possible to use such skills to set up an
enterprise. Hobbies like photography, interior decoration, fashion designing etc. are
often developed as business ventures.
iv. Improving an existing product. An existing product can be improved by using old
techniques with more care or using newly developed technology.
v. Utilising waste material. Conservation and environment protections are presently
getting a lot of attention. Recycling waste or turning them into useful products are good
product ideas. Presently, energy conservation products also have good potential.

Selection of Project Idea

At this stage, all the project ideas are screened on the basis of well defined criteria to eliminate
ideas which are not promising and select the best idea. While selecting the idea, the following
facts should be considered:
 i. The project should be compatible with the objectives and resources of the entrepreneur.
It should also match his capabilities and skills.
ii. The resources required for the project such as capital requirements, technical know-
how, raw materials, power supply etc. must be reasonably assured.
iii. The cost structure of the proposed project must enable it to realise reasonable returns
on investment.
iv. The effect of external environmental factors such as technological changes, state of
economy, competition, etc. should be considered.
The project idea should be consistent with the government policies, licensing requirements,
environmental regulations, foreign exchange regulations, etc.

Environment appraisal :- An entrepreneur or a firm systematically appraise the environment

and assess its competitive abilities. For the purposes of monitoring, the business environment
may be divided into six broad sectors as shown in fig. no. 1.3. The key elements of the
environment are as follow :
Economic Sector
• State of the economy
• Overall rate of growth
• Cyclical fluctuations
• Inflation rate
• Growth rate of primary, secondary and territory sector
• Growth rate of world economy
• Trade surplus and deficits
• Balance of Payment
Government Sector
• Industrial policy
• Government programmes and projects
• Tax structure
• EXIM policy
• Financing norms
• Subsidies incentives and concessions
• Monetary policy
Technological Sector
• Emergence of new technologies
• Access to technical know-how, foreign as well as indigenous
Socio-demographic Sector
• Population trends
• Age shifts in population
• Income distribution
• Educational profile
• Employment of women
• Attitudes toward consumption and investment
Competition Sector

• Number of firms in the industry and the market share of the top few
• Degree of homogeneity and differentiation among the products
• Entry barrier
• Comparison with substitutes in term of quality and price
• Marketing polices and practices

Supplier Sector

• Availability and cost of raw material

• Availability and cost of energy
• Availability and cost of capital

Corporate Appraisal :- A realistic appraisal of corporate strengths and weaknesses is

essential for identifying investment opportunities which can be profitably exploited. The broad
areas of corporate appraisal and the important aspects to be considered under them are as
follow :

Marketing and Distribution

• Market Image
• Product Line
• Product Mix
• Distribution Channels
• Customer loyalty
• Marketing & distribution costs
Production and Operations
• Condition and capacity of plant and machinery
• Availability of raw material and power
• Degree of vertical integration
• Locational advantage
• Cost structure
Research and Development
• Research capabilities of the firm
• Track record of new product developments
• Laboratories and testing facilities
• Coordination between research and operations
Corporate Resources and Personnel
• Corporate image
• Dynamism of top management
• Relation with government and regulatory agencies
• State of industry relations
Finance and Accounting
• Financial leverage and borrowing capacity
• Cost of capital
• Tax structure
• Relation with shareholders and creditors
• Accounting & control system
• Cash flow and liquidity

PROJECT LIFE CYCLE

A project is not a one shot activity. Even a shooting star has a time and life span. Project
lifecycle is spread over a period of time. There is an unavoidable gestation period for the
complex of activities involved to attain the objectives in view. This gestation period, however,
varies from project to project but it is possible to describe, in general term, the time phasing of
project planning activities common to most projects. The principal stages in the life of a
project are :
• Identification
• Initial formulation
• Evaluation (selection or rejection)
• Final formulation (or selection)
• Implementation
• Completion and operation

Development projects are expressly designed to solve the varied problems of the economics
whether in the short or long run. The surveys or in depth studies would locate the problems
and the project planner will have to identify the projects that would solve the problems most
effectively. At this stage, we are concerned with the kind of action and type of project that
would be required in rather broad term. In other words the surveys and studies will give us
ideas and throw up suggestions which would be worked out in detail later and then evaluated
objectively before being accepted for implementation.

What types of surveys and studies are to be undertaken? The current socio-political economic
situation has to be critically assessed. It will also be necessary to review it in its historical
perspective necessitating the undertaking of a survey of the behaviour and growth of the
economy during the preceding decades. On the basis of past trends, extrapolation may be made
of future possible trends and tendencies, short and long term. There are scientific techniques
for doing so which can be broadly grouped as forecasting methodology. It is however not
sufficient to view the socio-economic panorama on the historical canvas. More detailed
investigations from an operational point of view would be called for in respect of each
economic sector.

Initial Formulation:- Identification is only the beginning in the lifecycle of a project. Having
identified the prospective projects, the details of each project will have to be worked out and
analysed in order to determine which of them could be reckoned as suitable for inclusion in the
plan, allocate funds and put into execution. As a follow up to the finding of techno-economic
surveys, and number of feasibility study group are set up, as the name implies to examine the
possibility of formulating suitable projects and to put concrete proposals in sufficient detail to
enable authorities concerned to consider the feasibility of the proposal submitted.

Evaluation or Project Appraisal :- After the socio-economic problems of an economy have

been determined and developments objectives and strategies agreed, concrete steps have to be
taken. The main form this takes is that of formulating appropriate development projects to
achieve plan objectives and meet the development needs of the economy. Proposals relating to
them are then put to the plan authorities for consideration and inclusion in the plan. These
proposals as pointed out above take the following forms of feasibility studies :

• Commercial viability
• Economic feasibility
• Financial feasibility
• Technical feasibility
• Management

The scope for scrutiny under each of these five heads would necessarily render their careful
assessment and the examination of all possible alternative approaches. The process almost
invariably involves making decision relating to technology, scale, location, costs and benefits,
time of completion (gestation period), degree of risk and uncertainty, financial viability,
organisation and management, availability of inputs, know-how, labour etc. The detailed
analysis is set down in what is called a feasibility report.

Formulation :- Once a project has been appraised and approved, next step would logically,
appear to that of implementation. This is, however, not necessarily true, if the approval is
conditional to certain modifications being affected or for other reasons, such as availability of
funds, etc. The implementation stage will be reached only after these pre-conditions have been
fulfilled. Project formulation divides the process of project development into eight distinct and
sequential stages. These stages are

• General information
• Project description
• Market potential
• Capital costs and sources of finance
• Assessment of working capital requirement
• Other financial aspect
• Economic and social variables.

Project Implementation:- Last but not the least, every entrepreneur should draw an
implementation time table for his project. The network having been prepared, the project
authorities are now ready to embark on the main task of implementation the project. To begin
with successful implementation will depend on how well the network has been designed.
However, during the course of implementation, many factors arise which cannot be anticipated
or adequately taken note of in advance and built into the initial network. A number of network
techniques have been developed for project implementation. Some of them are PERT, CPM,
Graphical Evaluation and Review Technique (GERT), Workshop Analysis Scheduling
Programme (WRSP) and Line of Balance (LOB).

Project Completion :- It is often debated as to the point at which the project life cycle is
completed. The cycle is completed only when the development objectives are realized.

PROJECT FEASIBILITY ANALYSIS

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 determining the
viability 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-term profitability.

Appraisal of term loan proposals (projects) is an important 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:

i. ECONOMIC ANALYSIS
ii. MARKET ANALYSIS
iii. TECHNICAL ANALYSIS
iv. MANAGERIAL COMPETENCE
v. FINANCIAL ANALYSIS
vi. ECOLOGICAL ANALYSIS

I. ECONOMIC ANALYSIS :
Under economic analysis the aspects highlighted include
• Requirements for raw material
• Level of capacity utilization
• Anticipated sales
• Anticipated expenses
• Proposed profits
• Estimated demand

It is said that a business should have always a volume of profit clearly in view which will
govern other economic variable like sales, purchase, expenses and alike.

II. 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 unit.

Before the production actually starts, the entrepreneur needs to anticipate the possible market
for the product. He has to anticipate who will be the possible customer for his product and
where his product will be sold. This is because production has no value for the producer unless
it is sold. In fact, the potential of the market constitutes the determinant of possible reward
from entrepreneurial career.
Thus knowing the anticipated market for the product to be produced become an important
element in business plan. The commonly used methods to estimate the demand for a product
are as follows. :
1 Opinion polling method

In this method, the opinion of the ultimate users. This may be attempted with the help of either
a complete survey of all customers or by selecting a few consuming units out of the relevant
population.

2. Life Cycle Segmentation Analysis

It is well established that like a man, every product has its own life span. In practice, a product
sells slowly in the beginning. Barked by sales promotion strategies over period its sales pick
up. In the due course of time the peak sale is reached. After that point the sales begins to
decline. After sometime, the product loses its demand and dies. This is natural death of a
product. Thus, every product passes through its life cycle. The product life cycle has been
divided into the following five stage : Introduction, Growth, Maturity, Saturation and Decline.

The sales of the product varies from stage to stage as shown in figure below

Time Period

Product Life Cycle

Considering the above five stages of a product life cycle, the sale at different stages can be
anticipated.
 III. 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;

 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;

IV. 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 subjectivity
in the decision of the banks/financial institutions. In appraisal parlance, 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.
 V. 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:

1. The cost of the project i.e., the amount required to complete the project and bring it to
normal operation
2. The means of financing the cost i.e. the sources from which the required funds are to
be raised.

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 determining, profitability of the project
generally projections are obtained over the entire repayment 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
 Expected selling price
 Provisions made for depreciation
 Provisions for various taxation liabilities

Profitability Analysis

The financial projection such as profitability estimates, 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.

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 are stocked 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 lending 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

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 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
BEP = ----------------------
Contribution per unit

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 changed in the same proportion in which
the level of production changes.

Discounted Cash Flow Techniques

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.

a. Pay back method

b. Average Rate of Return Method
c. Net present value method
d. 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.

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 predetermined 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 investment 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.
Estimation of working results could be done in the following manner:

A. Cost of production of goods / services

B. Total admin expenses
C. Total sales expenses
D. Royalty etc payable
E. Total cost of production (A+B+C+D)
F. Depreciation
G. Expected sales
H. Operating profit (G-E-F)
I. Total financial expenses
J. Gross profit before interest (H-I)
K. Other income
L. Preliminary expenses written off
M. Profit / Loss (J+K-L)
N. Provision for tax
O. Profit after tax (M-N)

VI. ECOLOGICAL ANALYSIS

In recent years, environmental concerns have assumed great deal of significance. Ecological
analysis should also be done particularly for major projects which have significant implication
like power plant and irrigation schemes, and environmental pollution industries like bulk-
drugs, chemical and leather processing. The key factors considered for ecological analysis are :
 Environmental damage
 Restoration measure

MARKET AND DEMAND ANALYSIS

INTRODUCTION

The exercise of project appraisal often begins with an estimation of the size of the market.
Before a detailed study of a project is undertaken, it is necessary to know, at least roughly, the
size of the market because the viability of the project depends critically on whether the
anticipated level of sales exceeds a certain volume. Many a project has been abandoned
because preliminary appraisal revealed a market of inadequate size.

INFORMATION REQUIRED FOR MARKET AND DEMAND ANALYSIS

The principal types of information required for market and demand analysis relate to

(i) Effective demand in the past and present

To guage the effective demand in the past and present, the starting point typically is apparent
consumption which is defined as-

Production + Imports – exports – changes in stock level

In a competitive market, effective demand and apparent consumption are equal. However, in
most of the developing countries, where competitive markets do not exist for a variety of
products due to exchange restrictions and controls on production and distribution, the figure of
apparent consumption may have to be adjusted for market imperfections. Admittedly, this is
often a difficult task.

(ii) Breakdown of demand

To get a deeper insight into the nature of demand, the aggregate (total) market demand may be
broken down into demand for different segments of the market. Market segments may be
defined by (i) nature of product, (ii) consumer group, 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 etc.

Consumer groups— Consumers of a product may be divided into industrial consumers and
domestic consumers. Industrial consumers may be sub-divided industry-wise. Domestic
consumers may be further divided into different income groups.

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.

(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, average wholesale price, and (iv) average retail price.

(iii) Methods of distribution and sales promotion

The method of distribution may vary with the nature of product. Capital goods, industrial raw
materials or intermediates, and consumer products tend to have differing distribution channels.
Further, for a given product, distribution methods may vary. 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 studied carefully. Such a study may explain certain patterns of consumption and highlight
the difficulties that may be encountered in marketing the proposed products.

(v) Consumers

Two categories of information about the consumers may be required: demographic and
sociological information, and attitudinal information. Under the first category, information on
the following is required: age, sex, income, avocation, residence, religion, customs, beliefs,
and social background. Under the second category, information on the following is required-
preferences, intentions, attitudes, habits, and responses.

(vi) Governmental policy

The role of government in influencing the demand and market for a product may be
significant. Governmental plans, policies, legislations, and fiats which have a bearing on the
market and demand of the product under examination should be studied. 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.

(vii) 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 utilization level,
bottlenecks in production, and cost structure.
Competition from substitutes and near-substitutes should be examined because almost any
good may be replaced by some other good as a result of changes in relative prices, quality,
availability, promotional strategies, consumer taste, and other factors.

SECONDARY SOURCES OF INFORMATION

The information required for demand and market analysis is usually obtained partly from
secondary sources and partly through a market survey. In marketing research, a distinction is
usually made between primary information and secondary information. Primary information
refers to information which is collected for the first time to meet the specific purpose on hand;
secondary information, in contrast, is information which is in existence and which has been
gathered in some other context. Secondary information provides the base and the starting point
for market and demand analysis. It indicates what is known and often provides leads and cues
for further investigation.

General secondary sources of information

The important sources of secondary information useful for market and demand analysis in
India are mentioned below-

Census of India— A decennial publication of the Government of India, it provides information

on population, demographic characteristics, household size and composition, and maps.

National sample survey reports— Issued from time to time by the Cabinet Secretariat,
Government of India, these reports present information on various economic and social aspects
like patterns of consumption, distribution of households by the size of consumer expenditure,
distribution of industries, and characteristics of the economically active population. The
information presented in these reports is obtained from a nationally representative sample by
the interview method.

Plan reports— Issued by the Planning Commission usually at the beginning, middle, and end
of the five-year plans, these reports and documents provide a wealth of information on plan
proposals, physical and financial targets, actual outlays, accomplishments, etc.
Statistical abstract of the Indian Union— An annual publication of the Central Statistical
Organisation, it provides, inter alia, demographic information, estimates of national income,
and agricultural and industrial statistics.

India Year Book— An annual publication of the Ministry of Information and Broadcasting, it
provides wide ranging information on economic and other aspects.

Other publications— Among other publications mention may be made of the following: (i)
Weekly Bulletin of Industrial Licences, Import Licences and Export Licences (published by
the Government of India); (ii) studies of the economic division of the State Trading
Corporation; (iii) commodity reports and other studies of the Indian institute of Foreign Trade;
(iv) studies and reports of export promotion councils and commodity boards; and (v) Annual
report on Currency and Finance (issued by Reserve Bank of India).

Evaluation of secondary information

While secondary information is available economically and readily (provided the market
analyst is able to locate it) its reliability, accuracy, and relevance for the purpose under
consideration must be carefully examined. The market analyst should seek to know (i) Who
gathered the information? What was the objective? (ii) When was information gathered? When
was it published? (iii) How representative was the period for which information was gathered?
(iv) Have the terms in the study been carefully and unambiguously gathered? (v) What was the
target population? (vi) How was the sample chosen? (vii) How representative was the sample?
(viii) How satisfactory was the process of information gathering? (ix) What was the degree of
sampling bias and non-response bias in the information gathered? (x) What was the degree of
misrepresentation by respondents? (xi) How properly was the information by respondents?
(xii) Was statistical analysis properly applied?

MARKET SURVEY

Secondary information, though useful, often does not provide a comprehensive basis for
demand and market analysis. It needs to be supplemented with primary information gathered
through a market survey, specific for the project being appraised.

The market survey may be a census survey or a sample survey. In a census survey the entire
population is covered. (The word ‘population’ is used here in a particular sense. It refers to the
totality of all units under consideration in a specific study. Examples are- all industries using
milling machines, all readers of the Economic Times). 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 prohibitively costly and may also be
infeasible. For example, it would be inordinately expensive to cover every user of Lifebuoy or
every person in the income bracket Rs. 10,000-Rs. 15,000.

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 contacted/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 (i) Total
demand and rate of growth of demand; (ii) Demand in different segments of the market; (iii)
Income and price elasticity of demand; (iv) Motives for buying; (v) Purchasing plans and
intentions; (vi) Satisfaction with existing products; (vii) Unsatisfied needs; (viii) Attitudes
toward various products (ix) Distributive trade practices and preferences; (x) Socio-economic
characteristics of buyers.

Steps in a sample survey

Typically, a sample survey consists of the following steps:

1. Definition of the target population— In defining the target population the important
terms should be carefully and unambiguously defined. The 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. Selection of 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, other things being equal, has a bearing on the reliability of the
estimates— the larger the sample size, the greater the reliability.

3. Preparation of 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 thorough
understanding of the product/service and its usage, imagination, insights into human
behaviour, appreciation of subtle linguistic nuances, and familiarity with the tools of
descriptive and inferential statistics to be used later for analysis. It also requires knowledge of
psychological scaling techniques if the same are employed for obtaining information relating
to attitudes, motivations, and psychological traits. Industry and trade market surveys, in
comparison to consumer surveys, generally involve more technical and specialized 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. Recruiting and training of field investigators must be planned well since it can be time-
consuming. Great care must be taken for recruiting the right kinds 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.

5. Obtaining information as per the questionnaire from the sample of respondents—

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 few.

6. Scrutiny of information gathered— Information gathered should be thoroughly

scrutinized to eliminate data which is internally inconsistent and which is of dubious validity.
For example, a respondent with a high income and large family may say that he lives in a one-
room tenement. Such information, probably inaccurate, should be deleted. Sometimes data
inconsistencies may be revealed only after some analysis.

7. Analysis and interpretation of data— Data gathered in the survey needs to be analysed
and interpreted with care and imagination. After tabulating it as per a plan of analysis, suitable
statistical investigation may be conducted, wherever possible and necessary. For purposes of
statistical analysis, a variety of methods are available. They may be divided into two broad
categories: parametric methods and 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 for the target population. For this purpose, appropriate inflatory
factors, based on the ratio of the size of the target population and the size of the sample
studied, will have be to be used.

DEMAND FORECASTING

After gathering information about various aspects of the market and demand from primary and
secondary sources, an attempt may be made to estimate future demand. Several methods are
available for demand forecasting. The important ones are—

(i) Trend projection method

It consists of (i) determining the trend of consumption by analyzing past consumption

statistics, and (ii) projecting future consumption by extrapolating the trend.

Out of the above relationships the most commonly used relationship is-

Yt = a + bt

In the above equations Yt represents demand for year t, t is the time variable, a, b and aj’s are
constants. This relationship may be estimated by using one of the following methods: (i) visual
curve fitting method, and (ii) least squares method.

Evaluation— The basic assumption underlying the trend projection method is that the factors
which influenced the behaviour of consumption in the past would continue to influence the
behaviour of consumption in the future. This hypothesis is sometimes referred to as the
hypothesis of “mutually compensating effects”. Clearly, this is a deterministic hypothesis of
questionable validity. Notwithstanding this weakness, the trend projection method is used
popularly in practice. Often a starting point in the forecasting exercise, it is likely to be relied
upon heavily when no other viable method seems available. The ease with which it can be
applied may induce a sense of complacency.

(ii) Consumption level method

Useful for a product which 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 demand.
Income elasticity of demand— The income elasticity of demand reflects the responsiveness of
demand to variations in income. It is measured as follows:

Q2 – Q1 I1 + I2

E1 = ———— × ———

I2 – I1 Q2 + Q1

Where E1 = income elasticity of demand

Q1 = quantity demanded in the base year

Q2 = quantity demanded in the following year l1 = income level in the base year

l2 = income level in the following year

The income elasticity of demand differs from one product to another. Further, for a given
product, it tends to vary from one income group to another and from one region to another.
Hence, wherever possible, disaggregative analysis should be attempted.

Price elasticity of demand— The price elasticity of demand measures the responsiveness of
demand to variations in price. It is defined as—

Q2 – Q1 P1 + P2

Ep = ———— × ———

P2 – P1 Q2 + Q1

Where, Ep = price elasticity of demand

Q1 = quantity demanded in the base year

Q2 quantity demanded in the following year

P1 = price per unit in the base year

P2 = price per unit in the following year

The price elasticity of demand is a useful tool in demand analysis. The future volume of
demand may be estimated on the basis of the price elasticity coefficient and expected price
change. The price elasticity coefficient may also be used to study the impact of variable price
that may obtain in future on the economic viability of the project. In using the price elasticity
measure, however, the following considerations should be borne in mind: (i) the price
elasticity coefficient is applicable to only small variations. (ii) The price elasticity measure is
based on the assumption that the structure and behaviour remain constant.

(iii) End use method

Suitable for estimating the demand for intermediate products, the end use method, also
referred to as the consumption coefficient method involves the following steps:

1. Identify the possible uses of the product.

2. Define the consumption coefficient of the product for various uses.

3. Project the output levels for the consuming industries.

4. Derive the demand for the product.

(iv) Leading Indicator Method

Leading indicators are variables which change ahead of other variables, the lagging variables.
Hence, observed changes in leading indicators may be used to predict the changes in lagging
variables. For example, the change in the level of urbanization a leading indicator may be used
to predict the change in the demand for air conditioners a lagging variable.

Two basic steps are involved in using the leading indicator method: (i) First, identify the
appropriate leading indicator(s). (ii) Second, establish the relationship between the leading
indicator(s) and the variable to be forecast.

The principal merit of this method is that it does not require a forecast of an explanatory
variable. It, however, is characterized by certain problems.

i. It may be difficult to find an appropriate leading indicator(s).

ii. The lead-lag relationship may not remain stable over time. In view of these problems
this method has limited use.
(v) Econometric method

An econometric model is a mathematical representation of economic relationship/s derived

from economic theory. The primary objective of econometric analysis is to forecast the future
behaviour of the economic variables incorporated in the model.

Two types of econometric models are employed: the single equation model and the
simultaneous equation model. The single equation model assumes that one variable, the
dependent variable (also referred to as the explained variable), is influenced by one or more
independent variables (also referred to as the explanatory variables). In other words, one-way
causality is postulated.

MARKET PENETRATION FOR THE PRODUCT

Once a reasonably good handle over the aggregate demand is obtained, the next logical
question is: What will be the likely demand for the product of the project under examination?
The answer to this question depends on—

1. Aggregate potential supply

2. Nature of competition

3. Consumer preferences

4. Sales promotion efforts

If the aggregate potential domestic supply is likely to be significantly less than the aggregate
potential domestic demand, the demand for the product of the project under examination is
likely to be very strong, provided liberal imports which may hurt domestic manufacturers are
not allowed. The nature of competition and market-sharing arrangement (if any) has a bearing
on the demand for the product of the project under examination. Consumer preferences for
competing products and the sales promotional efforts of various competitors obviously
influence the relative market shares enjoyed by them.

UNCERTAINTIES IN DEMAND FORECASTING

Demand forecasts are subject to error and uncertainty which arise from three principal sources:

(i) Data about past and present market

The analysis of past and present market, which serves as the springboard for the projection
exercise, may be vitiated by the following inadequacies of data:

Lack of standardization— Data pertaining to market features like product, price, quantity, cost,
income etc. may not reflect uniform concepts and measures.

Few observations— Not enough observations may be available to conduct meaningful

analysis.

Influence of abnormal factors— Some of the observations may be influenced by abnormal

factors like war or natural calamity.

(ii) Methods of forecasting

Methods used for demand forecasting are characterized by limitations.

Inability to handle unquantifiable factors— Most of the forecasting methods, quantitative in

nature, cannot handle unquantifiable factors which sometimes can be of immense significance.

Unrealistic assumptions— Each forecasting method is based on certain assumptions. For

example, the trend projection method is based on the ‘mutually compensation effects’ premise
and the end-use method is based on the constancy of technical coefficients. Uncertainty arises
when the assumptions underlying the chosen method tend to be unrealistic and erroneous.

Excessive data requirement— In general, the more advanced a method, the greater the data
requirement. For example, to use an econometric model one has to forecast the future values of
explanatory variables in order to project the explained variable. Clearly, predicting the future
value of explanatory variables is a difficult and uncertain exercise.

(iii) Environmental changes

The environment in which a business functions is characterized by numerous uncertainties.

The important sources of uncertainty are mentioned below:

Technological change— This is a very important but hard-to-predict factor which influences
business prospects. A technological advancement may create a new product which performs
the same function more efficiently and economically, thereby cutting into the market for the
existing product. For example, electronic watches have encroached on the market for
mechanical watches.
Shift in governmental policy— In India, governmental regulation of business is extensive.
Changes in governmental policy, which may be difficult to anticipate, may have a telling
effect on business environment, e.g. granting of licenses to new companies, particularly
foreign companies, may alter the market situation significantly.; banning the import of a
certain product may create a sheltered market for the existing producers; liberalizing the
import of some product may lead to stiff competition in the market place; relaxation of price
and distribution controls may widen the market considerably.

Developments on the international scene— Developments on the international scene may have
a profound effect on industries. The most classic example of recent times is the OPEC price
hike, which led to near-stagnation in the Indian automobile industry.

Discovery of new sources of raw material— Discovery of new sources of raw materials,
particularly hydrocarbons, can have a significant impact on the market situation of several
products.

Vagaries of monsoon— Monsoon, which plays an important role in the Indian economy, is
somewhat unpredictable. The behaviour of monsoon influences, directly or indirectly, the
demand for a wise range of products.

COPING WITH UNCERTAINTIES

Given the uncertainties in demand forecasting, adequate efforts, along the following lines may
be made to cope with uncertainties.

1. Conduct analysis with data based on uniform and standard definitions.

2. In identifying trends, coefficients, and relationships, ignore the abnormal or out-of-the-
ordinary observations.
3. Critically evaluate the assumptions of the forecasting methods and choose a method
which is appropriate to the situation.
4. Adjust the projections derived from quantitative analysis in the light of a due
consideration of unquantifiable, but significant influences.
5. Monitor the environment imaginatively to identify important changes.
6. Consider likely alternative scenarios and their impact on market and competition.
7. Conduct sensitivity analysis to assess the impact on the size of demand for
unfavourable and favourable variations of the determining factors from their most
likely levels.
 SOCIAL COST BENEFIT ANALYSIS

Cost-benefit analysis (CBA) is a tool used to determine the worth of a project, programme or
policy. It is used to assist in making judgments and appraising available options. The main
reason for undertaking a CBA is to determine whether a project, programme or policy will
make the wider community better or worse off. In other words, whether the net impact of the
project is positive or negative.

Social Cost Benefits Analysis means to analyze the social cost and total social benefits if we
accept any project. We all know that for completing the big project, we need big investment.
In social cost benefit analysis (SCBA), we see whether return or benefits on this investment
are more than its cost from point of view of society in which we are living. In public
investment, we analyze and compare government expenditure with total benefits to society
through SCBA. It is also a good technique of financial evaluation of a project because we
reject those projects whose benefits to society are less than their total cost because all the
resources are drawn from the society.

Broadly, CBA has two main purposes:

1. To determine if an investment/decision is sound (justification/feasibility) – verifying

whether its benefits outweigh the costs, and by how much;

2. To provide a basis for comparing projects – which involves comparing the total
expected cost of each option against its total expected benefits.

CBA is a quantitative analytical tool to aid decision-makers in the efficient allocation of

resources. It identifies and attempts to quantify the costs and benefits of a programme or
activity and converts available data into manageable information. The strength of the method
is that it provides a framework for analysing data in a logical and consistent way. CBA helps
managers answer questions such as:

 Does the proposal provide a net benefit to the community as a whole?

 Should the proposed project, programme or policy be under taken?

 Should the project or programme be continued?

 Which of various alternative projects or programmes should be undertaken?

In principle, CBAs enable agencies to compare the relative merit of different (or alternative)
programmes or projects in terms of their returns on the use of public resources. CBA may also
be used to evaluate the social returns on the use of privately owned resources as in regulation
reviews.

In practice, it is often difficult to provide a clear ranking of alternative demands on public

funds. Another important stumbling block faced by economists in all evaluations is that the
assessment depends on what would have happened without the project or programme, which
has to be forecast. What is foregone when we undertake a project is known as the ‘opportunity
cost’.

Social Cost

The cost of goods when transported from one place to other, private firm is said to incur
transportation cost. Besides this transportation cost, there are certain costs which though
ignored by a firm does have a serious impact on the society. These costs are related to the wear
n tear of roads and pollution etc .These costs which has to be borne by the society, comes
under the head of Social cost.

The following are some of the examples of social costs for which business firm is responsible:

 Air pollution
 Water pollution
 Depletion and destruction of animal resource
 Soil Erosion
 Deforestation
 Impairment of human resources
 Deterioration in the law and order conditions

Social Benefits

The term social benefits refer to an increase in the overall welfare of the community or society
which is being derived from a particular course of action by a business firm or government
other than the person who is receiving the benefit. For example Society gets benefitted from
public parks developed and maintained by government. Under SCBA, it is social benefit. The
term social benefits, in economics, refer to the total benefit to society from producing or
consuming a good / service. Social benefit includes all the private benefits plus any external
benefits (external benefit is cost or benefit that affects a party who did not choose to incur that
cost or benefit) of production / consumption. If a good has significant external benefits, then
the social benefit will be greater than the private benefit.
The social benefits may be in the form of products and services provided, payment of taxes
and rates, additional employee’s benefits, donations to the community, ancillary benefits,
environmental improvements, etc.

In nutshell, the terms social costs and benefits are concerned with measurement of impact of
the project on society, which may be positive or negative. The positive impact is social benefit
and negative impact is social cost. Infact when we evaluate a project from the point of view of
the society (or economy) as a whole, it is called Social Cost Benefit Analysis.

Rationale for SCBA

a) Market imperfection: The following factors are to be considered to understand the market
imperfection.

Rationing factor: It means some of raw material prices are controlled by Government and
hence, project cost may increase but its social benefits will go to poor community.

Regulation for providing minimum wage factor: It also affects social cost and benefits of any
project.

Foreign Exchange Regulations factor: Sometime, projects involve foreign currency

transactions. Hence, we should analyze this point also.

b) Externalities: Externalities are non-cash or benefits which an organization suffer or get if it

starts the project. For example, if government lays road near your project plant, you can get
this facility without any payment. On the other side, if any other organization is polluting and
spreading diseases, it will create adverse impact due to absence of employee because they go
to hospitals.

c) Tax and Subsidies: Tax is levied on the earning of the project and it will reduce the overall
benefits. On the other hand, if government gives us subsidy for operating any project, it will
count for our cost benefit analysis.

Arriving Net Benefit of Project to Society

With United Nations Development Organization (UNIDO) approach, we can evaluate net
benefit from any project. Formula is given below:
WHEN IS A COST-BENEFIT ANALYSIS USED?

CBAs can be used to guide a wide range of decisions. Some of these are briefly discussed
below.

Analysing capital expenditure

Many projects involve capital expenditure for a new or replacement capital project. Capital
projects, including buildings and equipment but also other forms of infrastructure and
productive investment, should be subjected to an analysis of their costs and benefits over their
lifetime. Key questions are whether or not to undertake the investment, whether to undertake it
now or later, and which option to choose.

Analysing a policy option

In principle, any proposal or policy option can be subjected to CBA. Policies almost always
confer benefits on some parties and impose costs on others. Thus benefits and costs can be
valued in the same way as benefits and costs arising from capital expenditures. However, the
qualification ‘in principle’ is important because benefits and costs may be difficult to quantify.

Those proposals that involve minimal or no external costs and/or external benefits present little
difficulty. As previously noted, in such cases w ere there are minimal non-market effects,
financial analysis can also be used to evaluate policies.

Using or disposing of an existing asset

A CBA can be undertaken when an agency is considering the retention or disposal of an
existing asset. CBAs an address issues such as whether or not to sell land, whether to relocate
facilities, and whether to repair an asset or to replace it.

Post evaluation of a project or programme

CBA provides a valuable means of determining whether or not a particular programme or

project has generated a net benefit for the community. Used retrospectively instead of
prospectively, the known outcome from the activity, in terms of both costs and benefits, can be
compared with what would have happened in the absence of the project, which is often
described as ‘the counterfactual’. This provides transparency and accountability in reporting
on how well public funds have been spent. It is also useful for technical reasons as it provides
evidence on the validity and appropriateness of assumptions, forecasts and analyses used in
future decision-making.

STEPS IN CONDUCTING SCBA

 The Methodologies used for SCBA
The most favoured among the methods of Social Cost-Benefit Analysis (SCBA) are:
I. Little and Mirrlees (L-M) method;
II. UNIDO method.

PROJECT APPRAISAL - CAPITAL BUDGETING

A number of capital budgeting techniques are used in practice to perform project appraisal.
They may be grouped in the following two categories: -
I. Capital budgeting techniques under certainty; and
II. Capital budgeting techniques under uncertainty

Capital budgeting techniques under certainty:

Capital budgeting techniques (Investment appraisal criteria) under certainty can also be
divided into following two groups:

Non-Discounted Cash Flow Criteria: -

(a) Pay Back Period (PBP)
(b) Accounting Rate Of Return (ARR)

Discounted Cash Flow Criteria: -

(a) Net Present Value (NPV)
(b) Internal Rate of Return (IRR)
(c) Profitability Index (PI)

Non-Discounted Cash Flow Criteria: These are also known as traditional techniques:

(a) Pay Back Period (PBP) :

It is the number of years required to recover the original cash outlay invested in a project. The payback
period (PBP) is the traditional method of capital budgeting. It is the simplest and perhaps, the most
widely used quantitative method for appraising capital expenditure decision.

Methods to compute PBP: There are two methods of calculating the PBP.

(a) The first method can be applied when the CFAT is uniform. In such a
situation the initial cost of the investment is divided by the constant annual
 cash flow: For example, if an investment of Rs. 100000 in a machine is
expected to generate cash inflow of Rs. 20,000 p.a. for 10 years. Its PBP
will be calculated using following formula:

PBP = InitialInvestment = 100000 = 5years

Cons tan tAnnualCash inf low 20000

(b) The second method is used when a project’s CFAT are not equal. In such a
situation PBP is calculated by the process of cumulating CFAT till the
time when cumulative cash flow becomes equal to the original investment
outlays.

For example, A firm requires an initial cash outflow of Rs. 20,000 and the annual cash
inflows for 5 years are Rs. 6000, Rs. 8000, Rs. 5000, Rs. 4000 and Rs. 4000 respectively.
Calculate PBP. Here, When we cumulate the cash flows for the first three years, Rs. 19,000 is
recovered. In the fourth year Rs. 4000 cash flow is generated by the project but we need to
recover only Rs. 1000 so the time required recovering Rs. 1000 will be (Rs.1000/Rs.4000) ×
12 months = 3 months. Thus, the PBP is 3 years and 3 months (3.25 years).

Decision Rule:
 The PBP can be used as a decision criterion to select investment proposal.
 If the PBP is less than the maximum acceptable payback period, accept the project.
 If the PBP is greater than the maximum acceptable payback period, reject the project.

This technique can be used to compare actual pay back with a standard pay back set up by the
management in terms of the maximum period during which the initial investment must be
recovered. The standard PBP is determined by management subjectively on the basis of a
number of factors such as the type of project, the perceived risk of the project etc. PBP can be
even used for ranking mutually exclusive projects. The projects may be ranked according to
the length of PBP and the project with the shortest PBP will be selected.

Merits:

1. It is simple both in concept and application and easy to calculate.

2. It is a cost effective method which does not require much of the time of finance
executives as well as the use of computers.
3. It is a method for dealing with risk. It favours projects which generates substantial cash
inflows in earlier years and discriminates against projects which brings substantial inflows
in later years . Thus PBP method is useful in weeding out risky projects.
4. This is a method of liquidity. It emphasizes selecting a project with the early recovery of
the investment.

Demerits:
1. It fails to consider the time value of money. Cash inflows, in pay back calculations,
are simply added without discounting. This violates the most basic principles of
financial analysis that stipulates the cash flows occurring at different points of time
can be added or subtracted only after suitable compounding/ discounting.
2. It ignores cash flows beyond PBP. This leads to reject projects that generate
substantial inflows in later years. To illustrate, consider the cash flows of two
projects, “A” & “B”:

Year Project “A” Project “B”

0 Rs. 2,00,000 Rs. 2,00,000

1 100,000 40,000

2 60,000 40,000

3 40,000 40,000

4 20,000 80,000

5 60,000

6 70,000

The PB criterion prefers A, which has PBP of 3 years in comparison to B, which has PBP of 4
years, even though B has very substantial cash flows in 5&6 years also. Thus, it does not consider
all cash flows generated by the projects.

3. It is a measure of projects capital recovery, not profitability so this can not be used as
the only method of accepting or rejecting a project. The organization need to use some
other method also which takes into account profitability of the project.

4. The projects are not getting preference as per their cash flow pattern. It gives equal
weightage to the projects if their PBP is same but their pattern is different. For example,
each of the following projects requires a cash outlay of Rs. 20,000. If we calculate its PBP
 it is same for all projects i.e. 4 years so all will be treated equally. But the cash flow pattern
is different so in fact, project Y should be preferable as it gives higher cash inflow in the
initial years.

(b) Accounting/Average Rate of Return (ARR):

The ARR is the ratio of the average after tax profit divided by the average investment. This
method is also known as the return on investment (ROI), return on capital employed (ROCE) and
is using accounting information rather than cash flow.

Method to compute ARR:

There are a number of alternative methods for calculating ARR. The most common method of
computing ARR is using the following formula:

ARR = AverageAnnual Profit After Tax ×100

Average Investment
The average profits after tax are determined by adding up the PAT for each year and dividing
the result by the number of years. The average investment is calculated by dividing the net
investment by two.
For example, A project requires an investment of Rs. 10,00,000. The plant & machinery
required under the project will have a scrap value of Rs. 80,000 at the end of its useful life of
5 years. The profits after tax and depreciation are estimated to be as follows:

Year 1 2 3 4 5

PAT (Rs) 50000 75000 125000 130000 80000

We shall calculate ARR using above formula.

(50000 + 75000 + 125000 + 130000 + 80000)÷ 5

ARR = = 17.04%
(1000000 + 80000)÷ 2

Decision Rule:

 The ARR can be used as a decision criterion to select investment proposal.

  If the ARR is higher than the minimum rate established by the management, accept
the project.
 If the ARR is less than the minimum rate established by the management, reject the
project.

The ranking method can also be used to select or reject the proposal using ARR. It will rank a
project number one if it has highest ARR and lowest rank would be given to the project with
lowest ARR.

Merits:
1. It is simple to calculate.
2. It is based on accounting information which is readily available and familiar to
businessman.
3. It considers benefit over entire life of the project.

Demerits:

1. It is based upon accounting profit, not cash flow in evaluating projects.

2. It does not take into consideration time value of money so benefits in the earlier years or
later years cannot be valued at par.
3. This method does not take into consideration any benefits which can accrue to the firm
from the sale or abandonment of equipment which is replaced by a new investment. ARR
does not make any adjustment in this regard to determine the level of average
investments.
4. Though it takes into account all years income but it is averaging out the profit.
5. The firm compares any project’s ARR with the one which is arbitrarily decided by
management generally based on the firm’s current return on assets. Due to this yardstick
sometimes super normal growth firm’s reject profitable projects if it’s ARR is less than
the firm’s current earnings.

Use: The ARR can better be used as performance evaluation measure and control devise but it is
not advisable to use as a decision making criterion for capital expenditures of the firm as it is not
using cash flow information.

Discounted Cash Flow Criteria:

These are also known as modern or time adjusted techniques because all these techniques take
into consideration time value of money.
 (a) Net Present Value (NPV):

The net present value is one of the discounted cash flow or time-adjusted technique. It
recognizes that cash flow streams at different time period differs in value and can be
computed only when they are expressed in terms of common denominator i.e. present value.

Meaning:

The NPV is the difference between the present value of future cash inflows and the present
value of the initial outlay, discounted at the firm’s cost of capital.

The procedure for determining the present values consists of two stages. The first stage involves
determination of an appropriate discount rate. With the discount rate so selected, the cash flow
streams are converted into present values in the second stage.

Method to compute NPV:

The important steps for calculating NPV are given below

1. Cash flows of the investment project should be forecasted based on realistic
assumptions. These cash flows are the incremental cash inflow after taxes and are
inclusive of depreciation (CFAT) which is assumed to be received at the end of each
year. CFAT should take into account salvage value and working capital released at the
end.
2. Appropriate discount rate should be identified to discount the forecasted cash flows. The
appropriate discount rate is the firm’s opportunity cost of capital which is equal to the
required rate of return expected by investors on investments of equivalent risk.

3. Present value (PV) of cash flows should be calculated using opportunity cost of capital
as the discount rate.
4. NPV should be found out by subtracting present value of cash outflows from present
value of cash inflows. The project should be accepted if NPV is positive (i.e. NPV >0)

The NPV can be calculated with the help of equation.

NPV = Present value of cash inflows – Initial investment

A1 A2 An

W = (1 + K ) + (1 + K ) + ....... + (1 + K ) − C
1 2 n
 n At N

NPV = ∑ −C OR NPV = ∑(CFt × PVIFk ,t )− CF0

t =1 (1 + K ) t t =1

Where,

 A1, A2 … represent the stream of benefits expected to occur if a course of action is

adopted,
 C is the cost of that action &
 K is the appropriate discount rate to measure the quality of A’s.
 W is the NPV or, wealth which is the difference between the present worth of the stream
of benefits and the initial cost.

 CFt is the cash flow for t period

 PVIF is the present value interest factor

Decision Rule:
The present value method can be used as an accept-reject criterion. The present value of the
future cash streams or inflows would be compared with present value of outlays. The present
value outlays are the same as the initial investment.
 If the NPV is greater than 0, accept the project.
 If the NPV is less than 0, reject the project.
This method can be used to select between mutually exclusive projects also. Using NPV the
project with the highest positive NPV would be ranked first and that project would be
selected. The market value of the firm’s share would increase if projects with positive NPVs
are accepted.

For example,

Calculate NPV for a Project X initially costing Rs. 250000. It has 10% cost of capital. It generates
following cash flows:

PV @
Year Cash flows PV
10%

1 90000 0.909 81810

 2 80000 0.826 66080

3 70000 0.751 52570

4 60000 0.683 40980

5 50000 0.621 31050

ΣPV 272490

Less: NCO 250000

NPV( Rs.) 22490

As the project has positive NPV, i.e. present value of cash inflows is greater than the cash
outlays, it should be accepted.

Merits:

This method is considered as the most appropriate measure of profitability due to following
virtues.
1. It explicitly recognizes the time value of money.
2. It takes into account all the years cash flows arising out of the project over its useful life.
3. It is an absolute measure of profitability.
4. A changing discount rate can be built into NPV calculation. This feature becomes
important as this rate normally changes because the longer the time span, the lower
the value of money & higher the discount rate
5. It is always consistent with the firm’s goal of shareholders wealth maximization.

Demerits:
1. This method requires estimation of cash flows which is very difficult due to uncertainties
existing in business world due to so many uncontrollable environmental factors.

2. It requires the calculation of the required rate of return to discount the cash flows. The discount
rate is the most important element used in the calculation of the present values because different
 discount rates will give different present values. The relative desirability of the proposal will
change with a change in the discount rate.
3. When projects under consideration are mutually exclusive, it may not give dependable
results if the projects are having unequal lives, different cash flow pattern, different cash
outlay etc.
4. It does not explicitly deal with uncertainty when valuing the project and the extent of
management’s flexibility to respond to uncertainty over the life of the project.
5. It ignores the value of creating options. Sometimes an investment that appears
uneconomical when viewed in isolation may, in fact, create options that enable the firm
to undertake other investments in the future should market conditions turn favourable. By
not accounting properly for the options that investments in emerging technology may
yield, naive NPV analysis can lead firms to invest too little.

Use: NPV is very much in use capital budgeting practice being a true profitability measure.

(b) Profitability Index (PI):

Profitability Index (PI) or Benefit-cost ratio (B/C) is similar to the NPV approach. PI
approach measures the present value of returns per rupee invested. It is observed in
shortcoming of NPV that, being an absolute measure, it is not a reliable method to evaluate
projects requiring different initial investments. The PI method provides solution to this kind of
problem.

Meaning:

It is a relative measure and can be defined as the ratio which is obtained by dividing the present value
of future cash inflows by the present value of cash outlays. This method is also known as B/C ratio
because numerator measures benefits & denominator cost.

Decision Rule: Using the PI ratio,

 Accept the project when PI>1
 Reject the project when PI<1
 May or may not accept when PI = 1, the firm is indifferent to the project.

The selection of the project with the PI method can also be done on the basis of ranking. The
highest rank will be given to the project with the highest PI, followed by the others in the
same order.
Merits:
1. PI considers the time value of money as well as all the cash flows generated by the
project.
2. At times it is a better evaluation technique than NPV in a situation of capital rationing
especially. For instance, two projects may have the same NPV of Rs. 20,000 but project
A requires an initial investment of Rs. 1, 00,000 whereas B requires only Rs. 50,000.
The NPV method will give identical ranking to both projects, whereas PI will suggest
project B should be preferred. Thus PI is better than NPV method as former evaluate the
worth of projects in terms of their relative rather than absolute magnitude.
3. It is consistent with the shareholders’ wealth maximization.

Demerits:

Though PI is a sound method of project appraisal and it is just a variation of the NPV, it has
all those limitation of NPV method too.

1. When cash outflow occurs beyond the current period, the PI is unsuitable as a selection
criterion.
2. It requires estimation of cash flows with accuracy which is very difficult under ever
changing world.
3. It also requires correct estimation of cost of capital for getting correct result.
4. When the projects are mutually exclusive and it has different cash outlays, different cash
flow pattern or unequal lives, it may not give unambiguous results.

Use: It is useful in evaluating capital expenditures projects being a relative measure.

(c) Internal Rate of Return (IRR):

This technique is also known as yield on investment, marginal productivity of capital, marginal
efficiency of capital, rate of return, and time-adjusted rate of return and so on. It also considers the
time value of money by discounting the cash flow streams, like NPV. While computing the
required rate of return and finding out present value of cash flows-inflows as well as outflows- are
not considered. But the IRR depends entirely on the initial outlay and the cash proceeds of the
projects which are being evaluated for acceptance or rejection. It is, therefore, appropriately
11
referred to as internal rate of return. The IRR is usually the rate of return that a project earns.

Meaning:
The internal rate of return (IRR) is the discount rate that equates the NPV of an investment
opportunity with Rs.0 (because the present value of cash inflows equals the initial
investment). It is the compound annual rate of return that the firm will earn if it invests in the
project and receives the given cash inflows.
Methods to compute IRR:

When any project generates uneven cash flow, the IRR can be found out by trial and error. If
the calculated present value of the expected cash inflow is lower than the present value of
cash outflows a lower rate should be tried and vice versa. This process can be repeated unless
the NPV becomes zero.
For example, A project costs Rs. 32,000 and is expected to generate cash inflows of Rs.
16,000, Rs.14,000 and Rs. 12,000 at the end of each year for next 3 years. Calculate IRR. Let
us take first trial by taking 10% discount rate randomly. A positive NPV at 10% indicates that
the project’s true rate of return is higher than 10%. So another trial is taken randomly at 18%.
At 18% NPV is negative. So the project’s IRR is between 10% and 18%.

When any project generates equal cash flows every year, we can calculate IRR as follows. For
example, An investment requires an initial investment of Rs. 6,000. The annual cash flow is
estimated at Rs. 2000 for 5 years. Calculate the IRR.

The rate which gives a PVAIF of 3 for 5 years is the project’s IRR approximately. While
referring PVAIF table across the 5 years row, we find it approximately under 20% (2.991)
column. Thus 20% (approximately) is the project’s IRR which equates the present value of
the initial cash outlay (Rs. 6000) with the constant annual cash flows (Rs. 2000 p.a.) for 5
years.

Decision Rule for IRR:

 When IRR is used to make accept-reject decisions, the decision criteria are as follows:
 If the IRR is greater than the cost of capital, accept the project. (r >k)
 If the IRR is less than the cost of capital, reject the project. (r<k)

NPV Profile

Cash Flow(Rs) Discount Rate NPV (Rs)

(6000) 0% 4000
2000 5% 2659
 2000 10% 1582
2000 19% 115
2000 19.86% 0
2000 35% (1560)

5000

4000

3000

2000

1000

-1000 0% 5% 10% 15% 19.86% 35%

-2000
DISCOUNT RATE

One can observe in the above table and figure that NPV of a project declines as the discount rate
increases and NPV will be negative when discount rate is higher than the project’s IRR. NPV
profile of the project at various discount rates is shown above. When the discount rate is less than
19.86% IRR, then the project has positive NPV; if it is equal to IRR, NPV is zero; and when it
greater than IRR, NPV is negative (at 35%). Thus, IRR can be compared with the required rate of
return. When projects are independent and cash flows are conventional, IRR and NPV will give
the same results if there is no funds constraint but when the projects are mutually exclusive both
these methods may give conflicting results if the projects under consideration are having unequal
lives, different cash outlays, and different cash inflow pattern.

Merits:
1. It considers the time value of money and it also takes into account the total cash flows
generated by any project over the life of the project.
2. IRR is a very much acceptable capital budgeting method in real life as it measures
profitability of the projects in percentage and can be easily compared with the
opportunity cost of capital.
3. It is consistent with the overall objective of maximizing shareholders wealth.
Demerits:
1. It requires lengthy and complicated calculations.
2. When projects under consideration are mutually exclusive, IRR may give conflicting
results.
3. We may get multiple IRRs for the same project when there are non-conventional cash
flows especially.
4. It does not satisfy the value additivity principle which is the unique virtue of NPV. For
example,

NPV @ IRR
Project Co (Rs) C1 (Rs) 10% (Rs) (%)

X (200) 240 18.18 20.0%

Y (300) 336 5.45 12.0%

X+Y (500) 576 23.64 15.2%

Comparison of NPV and IRR:

Both NPV and IRR will give the same results (i.e. acceptance or rejections) regarding an
investment proposal in following two situations.

1. When the project under consideration involve conventional cash flow. i.e. when an
initial cash outlays is followed by a series of cash inflows.
2. When the projects are independent of one another i.e., proposals the acceptance of
which does not preclude the acceptance of others and if the firm is not facing a
problem of funds constraint.
The reasons for similarity in results in the above cases are simple. In NPV method a proposal is
accepted if NPV is positive. NPV will be positive only when the actual rate of return on
investment is more than the cut off rate. In case of IRR method a proposal is accepted only when
the IRR is higher than the cut off rate. Thus, both methods will give consistent results since the
acceptance or rejection of the proposal under both of them is based on the actual return being
higher than the required rate i.e.
 NPV will be positive only if r > k,
 NPV will be negative only if r < k,
 NPV would be zero only if r = k

Problems with IRR:

Non-conventional Cash Flows:

When IRR is used to appraise non-conventional cash flow, it may give multiple IRR.

For example, A project has following cash flow stream attached with it:

Project C0 C1 C2 NPV @25% NPV @400%

A (Rs) (80000) 500000 (500000) Rs.0 Rs.0

Dual Internal rate of

return

NPV (Rs.) Discount rate (%)

(80,000.00) 0

(38,677.69) 10

0.00 25

31,111.11 50

45,000.00 100

40,000.00 150

31,111.11 200

22,040.82 250

13,750.00 300

6,419.75 350
 0.00 400

60,000.00

30,000.00

0.00
NPV
25% 400

(30,000.00)

(60,000.00) Discount Rate

(90,000.00)

Dual Internal Rate of Return

We can see in the above table and figure that NPV is zero at two discount rates 25% as well as
400%. Which of the two is appropriate? In fact, NPV is positive in between the two rates i.e. 25%
and 400%. The number of rates of return depends on the number of times the sign of cash flow
changes. In the above project, there are two reversals of sign (-+-) and we have two rates of return.
So it is better to use NPV method for evaluating the projects instead of making modification in
IRR and using it.

(d) Modified Internal Rate of Returns (MIRR):

Despite NPV's conceptual superiority, managers seem to prefer IRR over NPV because IRR is
intuitively more appealing as it is a percentage measure. The modified IRR or MIRR
overcomes the shortcomings of the regular IRR. MIRR is superior to the regular IRR in two
ways.
1. MIRR assumes that project cash flows are reinvested at the cost of capital whereas the
regular IRR assumes that project cash flows are reinvested at the project's own IRR.
Since reinvestment at cost of capital (or some other explicit rate) is more realistic than
reinvestment at IRR, MIRR reflects better the true profitability of a project.
2. The problem of multiple rates does not exist with MIRR.
 WORK BREAKDOWN STRUCTURE (WBS)

To ensure that the scope definition of a project is complete, the following project scope
checklist may be used:

a) Project Objectives: The first step of project definition is to define the overall objective to
meet the customers’ needs. The project objective answers the questions of what, when and
how much.

b) Deliverables: The next step is to define major deliverables – the expected outputs over the
life of the project. For example, deliverables in the early design phase of a project might be a
list of specifications.

c) Milestones: A milestone is a significant event in a project that occurs at a point in time. The
milestone schedule show only major segment of work. It represents first, rough estimates of
time, cost and resources for the project. The milestone schedule is built using the deliverables
as a platform to identify major segments of work and an end date. IT should ne natural,
important control points in the project and should be easy for all the project participants to
recognize.

d) Technical Requirements: Technical requirements to complete the project successfully

should be clearly spelt out.

e) Limits and exclusions: The limits of scope should be defined. Failure to define limits can
lead to false expectations and to expending resources and time on the wrong problem.
Exclusions further define the boundary of the project by starting what is not included.

f) Reviews with customer: Completion of the scope checklist ends with a review with the
customer – internal and external. The main concern here is the understanding and agreement of
expectations. The main concern is the understanding and agreement of expectations.

The above checklist is generic and different industries and companies will develop unique
checklists and templates to fit their needs and specific kinds of projects. Many projects suffer
from scope creep, which is the tendency for the project scope to expand over time – usually by
changing requirements, specifications, and priorities.

Creating the Work Breakdown Structure

The Work Breakdown Structure (WBS) is a tree structure, which shows a subdivision of effort
required to achieve an objective; for example a program, project, and contract. The WBS may
be hardware, product, service, or process oriented. A WBS can be developed by starting with
the end objective and successively subdividing it into manageable components in terms of
size, duration, and responsibility (e.g., systems, subsystems, components, tasks, subtasks, and
work packages), which include all steps necessary to achieve the objective. The WBS provides
a common framework for the natural development of the overall planning and control of a
contract and is the basis for dividing work into definable increments from which the statement
of work can be developed and technical, schedule, cost, and labor hour reporting can be
established. Work Breakdown Structure (WBS) is defined by PMBOK Guide as: “A
deliverable-oriented hierarchical decomposition of the work to be executed by the project team
to accomplish the project objectives and create the required deliverables.” The following
figure shows the hierarchical breakdown of the WBS.

Purpose for Creating a WBS for Projects

There are three reasons to use a WBS in your projects.

a) The first is that is helps more accurately and specifically define and organize the scope of
the total project. The most common way this is done is by using a hierarchical tree structure.
Each level of this structure breaks the project deliverables or objectives down to more specific
and measurable chunks.

b) The second reason for using a WBS in your projects is to help with assigning
responsibilities, resource allocation, monitoring the project, and controlling the project. The
WBS makes the deliverables more precise and concrete so that the project team knows exactly
what has to be accomplished within each deliverable. This also allows for better estimating of
cost, risk, and time because you can work from the smaller tasks back up to the level of the
entire project.

c) Finally, it allows you double check all the deliverables’ specifics with the stakeholders and
make sure there is nothing missing or overlapping.

CREATING A WBS

The first step to creating your WBS is to get all your team, and possibly key stakeholders,
together in one room. Although your team is not listed as an input or tool in the above
sections, they are probably your most vital asset to this process. Your team possesses all the
expertise, experience, and creative thinking that will be needed to get down to the specifics of
each deliverable. Next, we have to get the first two levels setup. The first level is the project
title, and the second level is made up of all the deliverables for the project. At this stage it is
important to function under the 100% Rule. This rule basically states that the WBS
(specifically the first two levels) includes 100% of all the work defined in the project scope
statement and management plan. Also, it must capture 100% of all the deliverables for the
project including internal, external, and interim. In reality the WBS usually only captures
between 90-95%, and 100% is our goal. The following diagram shows the WBS.

Work Packages

Once we have completed the first two levels set, it is time to launch into our decomposition.
Decomposition is the act of breaking down deliverables in to successively smaller chunks of
work to be completed in order to achieve a level of work that can be both realistically managed
by the project manager and completed within a given time frame by one or more team
members. This level of breakdown and detail is called the work package. Work packages are
the lowest level of the WBS and are pieces of work that are specifically assigned to one person
or one team of people to be completed. This is also the level at which the project manager has
to monitor all project work. Most project managers concur that the work package can usually
be measured using the 8/80 Rule. The 8/80 Rule says that no work package should be less than
8 hours or greater than 80 hours.

Most Project Management Offices (PMOs) have basic WBS templates that can be used for
starting. Another great technique to make project easier is the Post-It Note Technique. It
actually works very well. In this technique you simply write each deliverable on a post-it note
and stick them at the top of a wall. Then you and your team start to break down each
deliverable into components and write each component on its own post-it note. This way, as
you place them on the wall and start to create your tree structure, everyone can easily see what
has been accomplished and where you are headed. Also this technique allows for easy
movement of components around within the WBS.

Many projects will also find it necessary to create a WBS Dictionary to accompany their
WBS. The WBS Dictionary is simply a document that describes each component in the WBS.
This helps clarify any specifics later on when team members completing the work or
stakeholders viewing the deliverables have questions. Also, when creating the WBS for very
large, lengthy, or complex projects, all the deliverables’ specifics might not be known up front
and, therefore, it is difficult to create a full WBS. In cases such as these many people use what
is called Rolling Wave Planning. This is when you plan down to the level of detail currently
known and go back to plan deeper once more information is acquired. Usually rolling wave
planning needs to stay as least 2-3 months ahead of the actual work being done, but of course
this varies slightly by industry.

Integrating the WBS with the organization

An integral part of WBS is to define the organizational units responsible for performing the
work. In practice, the outcome of the process is the organization breakdown structure
(OBS). The OBS depicts how the firm has organized to discharge work responsibility. The
purpose of the OBS are to provide a framework to summarize organization unit work
performance, identify organization units responsible for work packages and tie the
organizational unit to cost control accounts. Cost accounts group similar work packages. The
OBS defines the organization sub-deliverables in a hierarchical pattern in successively smaller
and smaller units.

As in the WBS, the OBS assigns the lowest organizational unit the responsibility for work
packages within a cost account. The intersection of work packages and the organizational unit
creates a project control point (cost account) that integrates work and responsibility. Control
can be checked from two directions – outcomes and responsibility. In the execution phase of
the project, progress can be tracked vertically on deliverables (client’s interest) and tracked
horizontally by organizational responsibility (management’s interest).

Responsibility Matrix

A Responsibility Matrix (RM) describes the participation by various roles in completing tasks
or deliverables for a project or business process. It is especially useful in clarifying roles and
responsibilities in cross-functional/departmental projects and processes.

Role Distinction: There is a distinction between a role and individually identified people: a
role is a descriptor of an associated set of tasks; may be performed by many people; and one
person can perform many roles. For example, an organization may have 10 people who can
perform the role of project manager, although traditionally each project only has one project
manager at any one time; and a person who is able to perform the role of project manager may
also be able to perform the role of business analyst.

Description of the Responsibility Matrix

Setting up a Responsibility Matrix is about establishing “what”, “who”, and level of
participation. The following Figure, activities are listed on the rows and resources are in the
columns and note that resources may be persons, roles, groups, or vendors.

Resource 1 Resource 2 Resource 3 Resource 4

Activity 1

Activity 2

Activity 3

Activity 4

R=Responsible, A=Approve, I=Inform, S=Support/Assist

As shown in the figure, resources might not have a participation type code for every activity.
Every activity should have one resource designated as the one responsible for the activity.

RACI

There are a number of ways to create a Responsibility Matrix using different participation
types. One common version is called the RACI matrix. RACI is an acronym derived from the
four key responsibilities most typically used: Responsible, Accountable, Consulted and
Informed. It is used to show the connections between work that needs to be done and project
team members. This is a highly versatile tool that can be easily modified to suit multiple
project needs. RMs can be developed at various levels of detail, from high to low. It can be
used during any project phase, including the post-implementation support phase, and is
especially useful when activities require coordination between several different groups,
agencies, or vendors. Following Figure is a sample RACI chart.

Activity Person 1 Person 2 Person 3 Person 4 Person Person 6

5

Investigate R A I C C

Design Software I A C R

Develop UAT Plan R A I C

Obtain Signoff R A I C C C
R=Responsible, A=Accountable, C=Consulted, I=Informed

Here is a detailed explanation of the participation types used in the RACI matrix:

Responsible - The person or role who is assigned to achieve the task. There is only one
resource given this category type. Others may be required to assist in the work but they are
either given another participation code, such as Assist, or are not included as the RM may only
list the key people for the activities.

Accountable – This person or role must sign off on work that Responsible provides. They are
ultimately accountable for the correct and thorough completion of the deliverable or task, and
the one to whom Responsible is accountable. There must be only one Accountable specified
for each task or deliverable.

Consulted - Those whose opinions are sought and with whom there is two-way
communication.

Informed - Those who are kept up-to-date on progress, often only on completion of the task or
deliverable, and with whom there is just one-way communication (informational only).

NETWORK TECHNIQUES

Decision Tree Analysis

Decision Tree Analysis is another technique which is helpful in tackling risky capital
investment proposals. Decision tree is a graphic display of relationship between a present
decision and possible future events, future decisions and their consequences.

The sequence of event is mapped out over time in a format resembling branches of a tree. In
other words, it is pictorial representation in tree form which indicates the magnitude,
probability and interrelationship of all possible outcomes.

An outstanding feature of decision tree analysis technique is that it links events

chronologically with forecasted probabilities and thus gives systematic appearance of
decisions and their forecasted results.

Constructing a Decision Tree

The following steps are taken for constructing a decision tree:

Definition of the proposal: The proposal is defined, i.e., what is exactly required under the
proposal, e.g., entering a new market, introducing a new product line, etc.

Identification of Alternatives: Every proposal will have at least two alternatives – accept or
reject. However, there may be more than two alternatives also.

Graphing the Decision Tree: The decision tree is then laid down showing decision point (i.e.,
the cash outlay), decision branches (i.e., alternatives available and other data).

Forecasting Cash Flows: The forecasted cash flows regarding each decision branch are also
shown along with the branch. Probabilities are also assigned to each cash flow. Expected
values of future returns are calculated and the total expected value for the decision is
determined.

Evaluating Results: Having determined the expected value for each decision, the results are
analysed. Some alternatives may look to be acceptable while others may be weak or
unacceptable. The firm may proceed with the profitable alternative or alternatives or may decide to
reconsider them because of incomplete data or other reasons.

The technique of decision tree analysis has the advantages of giving an overall view of all the
possibilities associated with a project. The management can take a decision keeping the entire
picture in mind. However, it has one big disadvantage. Its format may become unwieldy and
complex if the project has a long life with different possibilities of cash flows. In such a situation,
it becomes almost impossible to understand and derive a proper conclusion from the decision tree
analysis.

Illustration:
 NETWORK ANALYSIS (PERT & CPM)

(The students should also go through the PowerPoint presentation)

What is a network?

A network is a set of symbols connected with each other with a sequential relationship with
each step making the completion of a project/event. As discussed earlier, a business plan or
project involves various activities to be undertaken to convert it into an enterprise. Delays in
the completion of activities cause, among other things, cost overruns. Hence, there is a need
for deciding the sequential order' of all activities of the project so as to accomplish the project
economically in the minimum available time with the limited resources. A number of network
techniques have been developed for project scheduling. Some of them are:
1: Programme Evaluation and Review Technique (PERT).

2. Critical Path Method (CPM).

3. Graphical Evaluation and Review Technique (GERT).

4. Workshop Analysis Scheduling Programme (WASP).

5. Line of Balance (LOB).

Programme Evaluation and Review Technique (PERT)

PERT was first developed as a Management Aid for completing Polaris Ballistic Missile
Project in USA in October 1958. It worked well in expediting the completion of the project
from 7 years to 5 years. Since then, PERT has become very popular technique used for project
planning and control. In nutshell, it schedules the sequence of activities to be completed in
order to accomplish the project within a short period of time. It helps reduce both the time and
cost of the project.

Steps Involved in PERT: The following steps are involved in PERT technique:

1. The activities involved in the project are drawn up in a sequential relationship to show what
activity follows what. '

2. The time required for completing each activity of the project is estimated and noted on
network.

3. The critical activities of the project are determined. ,

4. The variability of the project duration and probability of the project completion in a given
time period are calculated.

Advantages of PERT:

PERT technique bears the following advantages:

1. It determines the expected time required for completing activity.

2. It helps complete the project within a given period of time.

 3. It helps management handle uncertainties involved in the project and thus, reduce the
'risk element in the project.

4. It enables management to make optimum allocation of limited resources. 5. It presses for the
right action, at the right point and at the right time in the organization.

Limitations of PERT:

PERT suffers from the following limitations:

1. PERT network is mainly based on time estimates required for each activity. On account of
wrong time estimates, the network is bound to become highly unrealistic.

2. This technique also does not consider the resources required at different stages of the
project.

3. For effective control of a project by using PERT technique requires frequent

updating and revising the PERT calculations. But, this proves quite a costly affair for the
organization.

Critical Path Method (CPM)

The Critical Path Method (CPM) was first developed in USA by the [Link] Nemours &
Co. in 1956 for doing periodic overhauling and maintenance of a chemical plant. It resulted in
reducing the shutdown period from 130 hours to 90 hours and saving the company $ 1 million.
The CPM differentiates between planning and scheduling of the project. While planning refers
to determination of activities to be accomplished, scheduling refers to the introduction of time
schedule for each activity of the project. The duration of different activities in CPM are
deterministic. There is a precise known time that each activity in the project will take.

Advantages of CPM:

The important advantages of CPM technique are:

1. It helps in ascertaining the time schedule of activities having sequential relationship.

2. It makes control easier for the management.

3. It identifies the most critical elements in the project. Thus, the management is kept alert and
prepared to pay due attention to the critical activities of the project.
4. It makes better and detailed planning possible.

Limitations of CPM:

The main limitations of the CPM are:

1. CPM operates on the assumption that there is a precise known time that each activity in the
project will take. But, it may not be true in real practice.

2. CPM time estimates are not based on statistical analysis.

[Link] cannot be used, as a controlling device for the simple reason that any change introduced
will change the entire structure of network. In other words, CPM cannot be used as a dynamic
controlling device.

1. Notation and construction

To construct and analyse networks you need to be familiar with the notation and language.

An activity is a task or job that requires time and resources, such as counting the number of
defective items, constructing a sampling frame or writing a report. An activity is represented
by an unbroken arrow. It should be noted that the method of network construction presented in
this book is `activity on the arrow' (the alternative is referred to as `activity on the node').

An event or node is a point in time when an activity starts or finishes, for example, start
counting the number of defective items or complete writing the report. An event or node is
represented by a circle.

A dummy activity is used to maintain the logic of the network and does not require time or
resources. A dummy activity is represented by a broken line with an arrow:
A network is a combination of activities and nodes which together show how the overall
project can be managed.

CASESTUDY
The Ressembler Group is looking at the possible test launch of a new type of picture frame
called `Dale'. The main activities have been identified and times estimated as shown in Table
1.

The speedy construction of a network is a matter of practice and experience. A number of

computer packages will construct the network diagram, but activities and precedence need to
be fully specified. Network construction is an iterative process and several attempts may be
needed to achieve a correct representation. Every network starts and finishes with a node; for
good practice, you should avoid arrows that cross and arrows that point backwards.
In Figure 1, we see the beginnings of the network for the project outlined in Table 1. Activities
A, B and C can all begin immediately, since none have prerequisites. Once activity B is
complete then activity D can begin. Each arrow is labelled, indicating that the method of
construction is activity on the arrow.

The completed network is shown as Figure 2. The use of the dummy variable to maintain the
logic should be noted; activity G follows only activity D whereas activity J follows both
activity D and F.

Two situations when a dummy variable is likely to be required are shown in Figure 3.
EXERCISE
Check that you can use the information given in Table 2 to draw the network shown in Figure
4
2. The critical path
The critical path is defined by those activities that must be completed on time for the project
to be completed on time. To find the critical path we need to determine the earliest and latest
times that an activity can begin and end. Each node is divided into three, as shown in Figure 5.

The earliest start time

The earliest start time (EST) is the earliest time that an activity could begin assuming all the
preceding activities are completed as soon as possible. The convention is always to start with
0. As a rule of thumb the earliest start times are found by moving forward (from left to right)
through the network adding activity times. If there are two or more routes leading to a node,
the largest value is used.
The latest start times
The latest start time (LST) is the latest time an activity can begin without causing a delay in
the overall duration of the project. It is necessary to use the overall duration given in the finish
node and work backwards. As a rule of thumb the latest start times are found by moving
backwards (from right to left) from the finish node, subtracting activity times. If two or more
activities lead backwards to a node then the smallest value is used.

The critical path

In general, the critical path will pass through all those nodes where the EST is equal to the
LST and this provides an easy way of scanning the network for the critical path. However, in
some circumstances (see section 3, fig 8) this approach may suggest that a non-critical activity
is critical.. To be sure, you need to check that a measure called total float is equal to 0 (no
spare time).

Total float
The total float for an activity is the difference between the maximum time available for that
activity and the duration of that activity. The total float for an activity with a start node of i and
a finish node of j is given as:

total float = LST for j - EST for i - duration of activity

The earliest and latest start times for the project described in Table 1 are given in Figure 6.
The calculation of time begins with a 0 EST in node 1. We would then add a 1, 2 and 3 to 0 to
get the EST at nodes 2, 3 and 4. The activity times for E and D, 2 and 1, are then added to get
the EST at nodes 5 and 6. At node 7, we need to consider the cumulative times from activity F
and through the dummy. To ensure the inclusion of a route using a dummy, the dummy can be
given the value 0. In this case, from node 5 to 7 we have 3 + 3 and from node 6 to 7 we have 3
+ 0; the largest value is 6 and therefore becomes the EST at node 7. At node 8 we need to
consider 3 + 2 (node 6 to 8) and 3 + 5 (node 4 to 8); the largest value is 8 and becomes the
EST at node 8. Finally the largest sum at node 9 is 8 +10 and 18 becomes the EST. It should
be noted that even at this stage we can identify 18 days as the duration of the project. To find
the LST’s we work backwards using the’duration of the project, 18, as the LST at the finish
node.

Subtraction of activity times J and I gives the LST of 15 at node 7, and 8 at node 8. At node 6
we need to consider moving backwards from node 7 (15 - 0) and from node 8 (8 - 2); the
smallest value is 6 and this becomes the LST. The process continues until all the time
measures are calculated. The critical path is formed by the activities C, H and I and is shown
by the // symbol. In this case, the nodes where the EST = LST define the critical path. (It is
clear by observation that activities C, H and I have 0 total float and all other activities have
some total float.)

EXAMPLE
Using the information given in Table 2 and the network given as Figure 4 check the times and
critical path shown in Figure 7.
The EST’s and LST’s again make the critical path obvious: A, D, H, K. However, suppose that
activities C and G were combined into a new activity L taking six days. This part of the
network is shown in Figure 8.

The EST’s and LST’s are equal on nodes 2 and 8 but activity L is not a critical activity. The
total float for activity L is

= LST for j (node 8) – EST for i (node 2) – duration of activity L

= 17 – 10 – 6

= 1 day

The total float is 0 on activities D and H and they remain critical.

3. Measures of float
We have seen that if the difference between the maximum time available and the duration of
the activity, the total float, is 0 then the activity is critical. There are two other important
measures of float, free float and independent float.

Free float
Free float is the time that an activity could be delayed without affecting any of the activities
that follow.

Free float = EST for j - EST for i - duration of activity

However, free float does assume that previous activities run to time.

Independent float
The independent float gives the time that an activity could be delayed if all the previous
activities are completed as late as possible and all the following activities are to start as early
as possible.

Independent float = EST for j - LST for i - duration of activity

The determination of total, free and independent float is illustrated in Figure 20.10.
 GNATT CHART

 A GANTT chart is a type of bar chart that illustrates a project schedule.

 After the PERT/CPM analysis is completed, the following phase is to construct the
GANTT chart and then to re-allocate resources and re-schedule if necessary.

 GANTT charts have become a common technique for representing the phases and
activities of a project work breakdown structure.

 It was introduced by Henry Gantt around 1910 – 1915.

Characteristics:
  The bar in each row identifies the corresponding task
 The horizontal position of the bar identifies start and end times of the task
 Bar length represents the duration of the task
 Task durations can be compared easily
 Good for allocating resources and re-scheduling
 Precedence relationships can be represented using arrows
 Critical activities are usually highlighted
 Slack times are represented using bars with doted lines
 The bar of each activity begins at the activity earliest start time (ES)
 The bar of each activity ends at the activity latest finish time (LF).

Advantages
 Simple
 Good visual communication to others
 Task durations can be compared easily
 Good for scheduling resources
Disadvantages
 Dependencies are more difficult to visualise
 Minor changes in data can cause major changes in the chart
The steps to construct a GANTT chart from the information obtained by PERT/CPM are:
1. Schedule the critical tasks in the correct position.
2. Place the time windows in which the non-critical tasks can be scheduled.
3. Schedule the non-critical tasks according to their earliest starting times.
4. Indicate precedence relationships between tasks
Module Four: Project Financing
Sources of finance, national and state level financial institutions, Tourism Finance Corporation
of India (TFCI); Venture capital; venture capital financing concept and features, need,
relevance and development of venture capital funds; structure and regulatory framework of
venture capital financing in India, investment process and evaluation.

Types and Sources of Financing (capital) for Start-up Businesses

Financing is needed to start a business and ramp it up to profitability. There are several sources
to consider when looking for start-up financing. But first you need to consider how much
money you need and when you will need it. The financial needs of a business will vary
according to the type and size of the business. For example, processing businesses are usually
capital intensive, requiring large amounts of capital. Retail businesses usually require less
capital. Debt and equity are the two major sources of financing. Government grants to finance
certain aspects of a business may be an option. Also, incentives may be available to locate in
certain communities and/or encourage activities in particular industries.

Equity Financing

Equity financing means exchanging a portion of the ownership of the business for a financial
investment in the business. The ownership stake resulting from an equity investment allows
the investor to share in the company’s profits. Equity involves a permanent investment in a
company and is not repaid by the company at a later date. The investment should be properly
defined in a formally created business entity. An equity stake in a company can be in the form
of membership units, as in the case of a limited liability company or in the form of common or
preferred stock as in a corporation. Companies may establish different classes of stock to
control voting rights among shareholders. Similarly, companies may use different types of
preferred stock. For example, common stockholders can vote while preferred stockholders
generally cannot. But common stockholders are last in line for the company’s assets in case of
default or bankruptcy. Preferred stockholders receive a predetermined dividend before
common stockholders receive a dividend.

Savings

The first place to look for money is your own savings or equity. Personal resources can include
profit sharing or early retirement funds, real estate equity loans, or cash value insurance
policies.
Life insurance policies - A standard feature of many life insurance policies is the owner’s
ability to borrow against the cash value of the policy. This does not include term insurance
because it has no cash value. The money can be used for business needs. It takes about two
years for a policy to accumulate sufficient cash value for borrowing. You may borrow most of
the cash value of the policy. The loan will reduce the face value of the policy and, in the case
of death, the loan has to be repaid before the beneficiaries of the policy receive any payment.

Home equity loans - A home equity loan is a loan backed by the value of the equity in your
home. If your home is paid for, it can be used to generate funds from the entire value of your
home. If your home has an existing mortgage, it can provide funds on the difference between
the value of the house and the unpaid mortgage amount. For example, if your house is worth
Rs.1,50,00,000 with an outstanding mortgage of 60,00,000, you have 90,00,000 in equity you
can use as collateral for a home equity loan or line of credit. Some home equity loans are set
up as a revolving credit line from which you can draw the amount needed at any time. The
interest on a home equity loan is tax deductible.

Friends and Relatives

Founders of a start-up business may look to private financing sources such as parents or
friends. It may be in the form of equity financing in which the friend or relative receives an
ownership interest in the business. However, these investments should be made with the same
formality that would be used with outside investors.

Venture Capital

Venture capital refers to financing that comes from companies or individuals in the business of
investing in young, privately held businesses. They provide capital to young businesses in
exchange for an ownership share of the business. Venture capital firms usually don’t want to
participate in the initial financing of a business unless the company has management with a
proven track record. Generally, they prefer to invest in companies that have received
significant equity investments from the founders and are already profitable.

They also prefer businesses that have a competitive advantage or a strong value proposition in
the form of a patent, a proven demand for the product, or a very special (and protectable) idea.
Venture capital investors often take a hands-on approach to their investments, requiring
representation on the board of directors and sometimes the hiring of managers. Venture capital
investors can provide valuable guidance and business advice. However, they are looking for
substantial returns on their investments and their objectives may be at cross purposes with
those of the founders. They are often focused on short-term gain. Venture capital firms are
usually focused on creating an investment portfolio of businesses with high growth potential
resulting in high rates of returns. These businesses are often high-risk investments. They may
look for annual returns of 25 to 30 percent on their overall investment portfolio.

Because these are usually high-risk business investments, they want investments with expected
returns of 50 percent or more. Assuming that some business investments will return 50 percent
or more while others will fail, it is hoped that the overall portfolio will return 25 to 30 percent.

More specifically, many venture capitalists subscribe to the 2-6-2 rule of thumb. This means
that typically two investments will yield high returns, six will yield moderate returns (or just
return their original investment), and two will fail.

Angel Investors

Angel investors are individuals and businesses that are interested in helping small businesses
survive and grow. So their objective may be more than just focusing on economic returns.
Although angel investors often have somewhat of a mission focus, they are still interested in
profitability and security for their investment. So they may still make many of the same
demands as a venture capitalist. Angel investors may be interested in the economic
development of a specific geographic area in which they are located. Angel investors may
focus on earlier

stage financing and smaller financing amounts than venture capitalists.

Government Grants

Federal and state governments often have financial assistance in the form of grants and/or tax
credits for start-up or expanding businesses.

Equity Offerings

In this situation, the business sells stock directly to the public. Depending on the
circumstances, equity offerings can raise substantial amounts of funds. The structure of the
offering can take many forms and requires careful oversight by the company’s legal
representative.

Initial Public Offerings

Initial Public Offerings (IPOs) are used when companies have profitable operations,
management stability, and strong demand for their products or services. This generally doesn’t
happen until companies have been in business for several years. To get to this point, they
usually will raise funds privately one or more times.
Warrants

Warrants are a special type of instrument used for long-term financing. They are useful for
start-up companies to encourage investment by minimizing downside risk while providing
upside potential. For example, warrants can be issued to management in a start-up company as
part of the reimbursement package.

A warrant is a security that grants the owner of the warrant the right to buy stock in the issuing
company at a pre-determined (exercise) price at a future date (before a specified expiration
date). Its value is the relationship of the market price of the stock to the purchase price
(warrant price) of the stock. If the market price of the stock rises above the warrant price, the
holder can exercise the warrant. This involves purchasing the stock at the warrant price. So, in
this situation, the warrant provides the opportunity to purchase the stock at a price below
current market price.

If the current market price of the stock is below the warrant price, the warrant is worthless
because exercising the warrant would be the same as buying the stock at a price higher than
the current market price. So, the warrant is left to expire. Generally warrants contain a specific
date at which they expire if not exercised by that date.

Debt Financing

Debt financing involves borrowing funds from creditors with the stipulation of repaying the
borrowed funds plus interest at a specified future time. For the creditors (those lending the
funds to the business), the reward for providing the debt financing is the interest on the amount
lent to the borrower. Debt financing may be secured or unsecured. Secured debt has collateral
(a valuable asset which the lender can attach to satisfy the loan in case of default by the
borrower). Conversely, unsecured debt does not have collateral and places the lender in a less
secure position relative to repayment in case of default.

Debt financing (loans) may be short term or long term in their repayment schedules.
Generally, short term debt is used to finance current activities such as operations while long-
term debt is used to finance assets such as buildings and equipment.

Friends and Relatives

Founders of start-up businesses may look to private sources such as family and friends when
starting a business. This may be in the form of debt capital at a low interest rate. However, if
you borrow from relatives or friends, it should be done with the same formality as if it were
borrowed from a commercial lender. This means creating and executing a formal loan
document that includes the amount borrowed, the interest rate, specific repayment terms
(based on

the projected cash flow of the start-up business), and collateral in case of default.

Banks and Other Commercial Lenders

Banks and other commercial lenders are popular sources of business financing. Most lenders
require a solid business plan, positive track record, and plenty of collateral. These are usually
hard to come by for a start- up business. Once the business is underway and profit and loss
statements, cash flows budgets, and net worth statements are provided, the company may be
able to borrow additional funds.

Commercial Finance Companies

Commercial finance companies may be considered when the business is unable to secure
financing from other commercial sources. These companies may be more willing to rely on the
quality of the collateral to repay the loan than the track record or profit projections of your
business. If the business does not have substantial personal assets or collateral, a commercial
finance company may not be the best place to secure financing. Also, the cost of finance
company money is usually higher than other commercial lenders.

Government Programs

Federal, state, and local governments have programs designed to assist the financing of new
ventures and small businesses. The assistance is often in the form of a government guarantee
of the repayment of a loan from a conventional lender. The guarantee provides the lender
repayment assurance for a loan to a business that may have limited assets available for
collateral.

Bonds

Bonds may be used to raise financing for a specific activity. They are a special type of debt
financing because the debt instrument is issued by the company. Bonds are different from
other debt financing instruments because the company specifies the interest rate and when the
company will pay back the principal (maturity date). Also, the company does not have to make
any payments on the principal (and may not make any interest payments) until the specified
maturity date. The price paid for the bond at the time it is issued is called its face value. When
a company issues a bond it guarantees to pay back the principal (face value) plus interest.
From a financing perspective, issuing a bond offers the company the opportunity to access
financing without having to pay it back until it has successfully applied the funds. The risk for
the investor is that the company will default or go bankrupt before the maturity date. However,
because bonds are a debt instrument, they are ahead of equity holders for company assets.

Lease

A lease is a method of obtaining the use of assets for the business without using debt or equity
financing. It is a legal agreement between two parties that specifies the terms and conditions
for the rental use of a tangible resource such as a building and equipment. Lease payments are
often due annually. The agreement is usually between the company and a leasing or financing
organization and not directly between the company and the organization providing the assets.
When the lease ends, the asset is returned to the owner, the lease is renewed, or the asset is
purchased. A lease may have an advantage because it does not tie up funds from purchasing an
asset. It is often compared to purchasing an asset with debt financing where the debt
repayment is spread over a period of years. However, lease payments often come at the
beginning of the year where debt payments come at the end of the year. So, the business may
have more time to generate funds for debt payments, although a down payment is usually
required at the beginning of the loan period.

The sources of finance can be broadly classified into the following

A business might have access to various sources of financing its needs. These sources of
finance can be classified as:
INTERNAL AND EXTERNAL

Internal: this is money raised from inside the business. It includes

 Sales of assets: Business might sell off old, obsolete assets which are no longer used
by the business to raise additional cash for the business.

Advantage Disadvantage

Better use of capital A new business might not have any old or
obsolete assets

 Retained profits: Businesses (especially limited companies) usually keep some part of
the profit every year for future use. This is also known as ploughed back profit. Over a
period of time it can total up to a huge amount which can be used for financing the
business.

Advantage Disadvantage

Does not increase liabilities Not available to new businesses

No need to pay interest

 Reduction in working capital: Cutting the stock levels can also help the business to
raise additional cash.

Advantage Disadvantage

Costs related to storage of stock is May lead to shortage of stock and loss
reduced of sales

External: This is the money raised from outside the business. It includes

SHORT TERM

Bank overdraft: Bank overdraft is a facility given by banks to its business customers, people
having current accounts. Through this facility the customers can overdraw their accounts to a
greater value than the balance in the account. To overdrawn amount is agreed in advance with
the bank manager. The bank assigns a limit to overdraw from the account and the business can
meet its short term liabilities by writing cheques to the extent of limit allowed.
 Advantage Disadvantage

 No need for collaterals or  Interest rates are usually

security. variable and higher than
 More flexible and the bank loans.
overdraft amount can be  Cash flow problems can
adjusted every month arise if the bank asks for the
according to needs. overdraft to be repaid at a
short notice.

Trade Credit: Usually in business dealing supplier give a grace period to their customers to
pay for the purchases. This can range from 1 week to 90 days depending upon the type of
business and industry.

Advantage Disadvantage

No interest has to be paid. The business may not get cash

discounts.

By delaying the payment of bills for goods or services received, a business is, in effect,
obtaining finance which can be used for more important expenditures.

Factoring of debts: It involves the business selling its bills receivable to a debt factoring
company at a discounted price. In this way the business get access to instant cash.

MEDIUM TERM

Hire purchase: It involves purchasing an asset paying for it over a period of time. Usually a
percentage of the price is paid as down payment and the rest is paid in installments for the
period of time agreed upon. The business has to pay an interest on these installments.

Leasing: Leasing involves using an asset, but the ownership does not pass to the user.
Business can lease a building or machinery and a periodic payment is made as rent, till the
time the business uses the assets. The business does not need to purchase the asset.

Advantage Disadvantage

 The business can benefit from  The total cost of leasing may
 the asset without purchasing end up higher than the
it. purchasing of asset
 Usually the maintenance of
the asset is done by the leasing
firm.

Medium term bank loan: A bank loan for 1 year to 5 years.

LONG TERM

A business requires funds to purchase fixed assets like land and building, plant and machinery,
furniture etc. These assets may be regarded as the foundation of a business. The capital
required for these assets is called fixed capital. A part of the working capital is also of a
permanent nature.

Funds required for this part of the working capital and for fixed capital is called long term
finance. Long term finance is required for the following purposes:

1. To Finance fixed assets:

Business requires fixed assets like machines, Building, furniture etc. Finance required to buy
these assets is for a long period, because such assets can be used for a long period and are not
for resale.

2. To finance the permanent part of working capital:

Business is a continuing activity. It must have a certain amount of working capital which
would be needed again and again. This part of working capital is of a fixed or permanent
nature. This requirement is also met from long term funds.

3. To finance growth and expansion of business:

Expansion of business requires investment of a huge amount of capital permanently or for a

long period.

The main sources of long term finance are as follows:

1. Shares:

These are issued to the general public. These may be of two types: (i) Equity and (ii)
Preference. The holders of shares are the owners of the business.
2. Debentures:

These are also issued to the general public. The holders of debentures are the creditors of the
company.

3. Public Deposits :

General public also like to deposit their savings with a popular and well established company
which can pay interest periodically and pay-back the deposit when due.

4. Retained earnings:

The company may not distribute the whole of its profits among its shareholders. It may retain a
part of the profits and utilize it as capital.

5. Term loans from banks:

Many industrial development banks, cooperative banks and commercial banks grant medium
term loans for a period of three to five years.

6. Loan from financial institutions:

There are many specialised financial institutions established by the Central and State
governments which give long term loans at reasonable rate of interest. Some of these
institutions are: Industrial Finance Corporation of India ( IFCI), Industrial Development Bank
of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Unit Trust of
India ( UTI ), State Finance Corporations etc.

NATIONAL AND STATE LEVEL FINANCIAL INSTITUTIONS

INSTITUTIONS SUPPORTING ENTREPRENEURS

Institutions to assist
SSI

Central Level
State Level
Institutions Institutions

 Department of Small Scale  State Directorate of Industries

 Industries  State Small Scale Industries
 Small Scale Industries Board Development Corporation
 Small Industries development  District Industries Centers
Organisation  Industrial Estates
 National Small Industries  Technical Consultancy Organisation
Corporation
 Specialised Institutions

CENTRAL LEVEL INSTITUTIONS SUPPORTING ENTREPRENEURS

SMALL SCALE INDUSTRIES BOARD (SSIB)

The government of India constituted a board, namely, Small Scale Industries Board(SSIB) in
1954 to advice on development of small scale industries in the country. The SSIB is also
known as central small industries board. The range of development working small scale
industries involves several departments / ministries and several organs of the central/state
governments. Hence, to facilitate co-ordination and inter-institutional linkages, the small scale
industries board has been constituted. It is an apex advisory body 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 [Link] SSIB
comprises of 50 members including state industry minister, some members of parliament, and
secretaries of various departments of government of India, financial institutions, public sector
undertakings, industry associations and eminent experts in the field.

NATIONAL SMALL INDUSTRIES CORPORATION (NSIC)

The National Small Industries Corporation (NSIC), an enterprise under the union ministry of
industries was set up in 1955 in New Delhi to promote aid and facilitate the growth of small
scale industries in the country. NSIC offers a package of assistance for the benefit of small–
scale enterprises.

1. Single point registration: Registration under this scheme for participating in government and
public sector undertaking tenders.

2. Information service: NSIC continuously gets updated with the latest specific information on
business leads, technology and policy issues.
3. Raw material assistance: NSIC fulfils raw material requirements of small-scale industries
and provides raw material on convenient and flexible terms.

4. Meeting credit needs of SSI: NSIC facilitate sanctions of term loan and working capital
credit limit of small enterprise from banks.

5. Performance and credit rating: NSIC gives credit rating by international agencies subsidized
for small enterprises up to 75% to get better credit terms from banksand export orders from
foreign buyers.

SMALL INDUSTRIES DEVELOPMENT ORGANIZATION (SIDO)

SIDO is created for development of various small scale units in different areas. SIDO is a
subordinate office of department of SSI and ARI. It is a nodal agency for identifying the needs
of SSI units coordinating and monitoring the policies and programmes for promotion of the
small industries. It undertakes various programmes of training, consultancy, evaluation for
needs of SSI and development of industrial estates. All these functions are taken care with 27
offices, 31 SISI (Small Industries Service Institute) 31 extension centres of SISI and 7
centres related to production and process development.

The activities of SIDO are divided into three categories as follows:

 Coordination activities of SIDO:

 To coordinate various programmes and policies of various state governments
pertaining to small industries.
 To maintain relation with central industry ministry, planning commission, state level
industries ministry and financial institutions.
 Implement and coordinate in the development of industrial estates.
 Industrial development activities of SIDO:
 Develop import substitutions for components and products based on the data available
for various volumes-wise and value-wise imports.
 To give essential support and guidance for the development of ancillary units.
 To provide guidance to SSI units in terms of costing market competition and to
encourage them to participate in the government stores and purchase tenders.
 To recommend the central government for reserving certain items to
 produce at SSI level only.
 Management activities of SIDO:
 To provide training, development and consultancy services to SSI to develop their
competitive strength.
  To provide marketing assistance to various SSI units. To assist SSI units in selection of
plant and machinery, location, layout design and appropriate process.
 To help them get updated in various information related to the small-scale industries
activities.

Khadi and Village Industries Commission (KVIC)

 Statutory body created by an act of Parliament

 It is charged with planning, promotion, organization and implementation of the

program for the development of Khadi and other village industries in the rural areas in
coordination with other agencies engaged in rural development

 KVIC’s functions also comprise building up a reserve of raw materials and implements
for supply to producers, creation of common service facilities for processing of raw
materials and provision of marketing of KVIC products

 KVIC is entrusted with the task of providing financial assistance to institutions or

persons engaged in the development and operation of Khadi and village industries and
guide them through supply of designs, prototypes and other technical information

National Small Industries Corporation Ltd. (NSIC)

 Established in 1955 by GOI with the main objectives to promote, aid and foster the
growth of SSIs in the country

 Over four decades of transition and growth in the SSI sector, NSIC has provided
strength through a progressive attitude of modernization, up gradation of technology,
quality consciousness, strengthening linkages with large and medium-scale enterprise
and boosting exports of products from small enterprises

• Main services provided by NSIC are:

 Machinery and Equipment (Hire Purchase / Lease scheme)

 Financial Assistance Scheme
 Assistance for Procurement of Raw Material
 Government Store Purchase Program
 Technology Transfer Centre (TTC)
 Marketing Assistance

National Science and Technology Entrepreneurship Development Board (NSTEDB)

 • Established in 1982 by GOI, is an institutional mechanism to help promote knowledge-
driven and technology-intensive enterprises

• Major objectives are: -

 promote and develop high-end entrepreneurship for S&T manpower as well as self-
employment by utilizing S&T infrastructure and by using S&T methods
facilitate and conduct various informational services relating to promotion of
entrepreneurship -

 network agencies of support system, academic institutions and R&D organizations to

foster self-employment using S&T with special focus on backward areas
- act as a policy advisory body with regard to entrepreneurship

National Productivity Council (NPC)

 Autonomous institution functioning under the overall supervision of the Ministry of

Industry, GOI

 Primary objective is to act as a catalyst in enhancing the productivity of all sectors of

the economy, including industry and agriculture

 Administered by a tripartite Governing Council (GC) which has equal representation

from the government, industry and trade unions

 Active in the field of consultancy and training and has a number of specialized
divisions to provide tailor-made solutions to agriculture and industry. These divisions,
manned by trained consultants, deal with issues related to industrial engineering, plant
engineering, energy management, HRD, informal sector, agriculture and so on

 NPC is a member of the Asian Productivity Organization (APO), Tokyo, an umbrella

body of all productivity councils in Asian region

 To channelize expertise of NPC to small-scale and informal sector, SIDBI has tied-up
with NPC for enhancing technology in small units

National Institute for Small Industry Extension and Training (NISIET)

 Set up in early 1950s, NISIET acts an important resource and information centre for
small units and undertakes research and consultancy for small industry development
  An autonomous arm of the Ministry of Small Scale Industries, the institute achieves its
objectives through training, consultancy, research and education, to extension and
information services

 In 1984, UNIDO has recognized NISIET as an institute of meritorious performance

under its Centre of Excellence Scheme to extend aid.

National Institute for Entrepreneurship and Small Business Development (NIESBUD)

 NIESBUD is an autonomous body under the administrative control of the Office of the
DC(SSI)

 NIESBUD established in 1983 by the Ministry of Industry, GOI, as an apex body for
coordinating and overseeing the activities of various institutions/agencies engaged in
Entrepreneurship Development particularly in the area of small industry and business

 The policy, direction and guidance to the institute is provided by its Governing Council
whose chairman is the Minister of SSI.

 Besides conducting national and international training programs, the institute

undertakes research studies, consultancy assignments, development of training aids,
etc.

Entrepreneurship development institute of India

The Entrepreneurship Development Institute of India (EDI), an autonomous and not-for-profit Institute,
set up in 1983, is sponsored by apex financial institutions - the IDBI Bank Ltd., IFCI Ltd., ICICI Bank
Ltd. and State Bank of India (SBI). The Government of Gujarat pledged twenty-three acres of land on
which stands the majestic and sprawling EDI campus.

To pursue its mission further, EDI has helped set up twelve state-level exclusive entrepreneurship
development centres and institutes. One of the most satisfying achievements, however, was taking
entrepreneurship to a large number of schools, colleges, science and technology institutions and
management schools in several states by including entrepreneurship inputs in their curricula. In view of
EDI’s expertise in Entrepreneurship, the University Grants Commission appointed the EDI as an expert
agency to develop curriculum on Entrepreneurship.

Objectives:

 Augment the supply of trained entrepreneurs through training

 Generate multiplier effect on opportunities for self employment
 Improve managerial capabilities of small scale industries
  Contribute to dispersal of business ownership and thus expand social base of the Indian
entrepreneurial class
 Contribute to the creation and dissemination of new knowledge and insight into entrepreneurial
theory and practice through research.
 The Augment supply of trainers motivators for entrepreneurship and development
 Participate in institutional
 Promote micro enterprise at rural level
 Inculcate the spirit of entrepreneurship among youth.

Indian institute of entrepreneurship

The erstwhile Ministry of Industry set up the Indian Institute of Entrepreneurship in the year 1994 in
the city of Guwahati in the north eastern state of Assam. The national institute is an autonomous body
functioning on its own in developing the skills in entrepreneurship. The institute operates under the
management committee, which is headed by the chairman who is also the secretary to the Ministry of
Small Scale Industries of the government of India The objective of the institute is to develop the skills and
train the entrepreneur. The institute also designs strategies that are propitious to the various target groups.
Documentation for formulation of policy is also a part of the activity of the institute. The research-based
institute organizes seminars and conducts discussions to promote and exchange the views of the different
groups that lead to improvement through interaction. The institute also publishes literature for development
of the entrepreneur and his industry. The small-scale industries sector has benefited from the research and
training programs undertaken by the Indian Institute of Entrepreneurship in Guwahati. The institute
helps in planning and organizing the promotion of this sector of the economy.

STATE LEVEL INSTITUTIONS

Directorate of Industries (DIs) : At the State level, the Commissioner/ Director of Industries
implements policies for the promotion and development of small-scale, cottage, medium and
large scale industries. The Central policies for the SSI sector serve as guidelines but each State
evolves its own policy and package of incentives. The Commissioner/ Director of Industries in
all the States/UTs, oversee the activities of field offices, that is, the District Industries Centers
(DICs) at the district level.
District Industries Centers (DICs) : In order to extend promotion of small-scale and cottage
industries beyond big cities and state capitals to district headquarters, DIC program was
initiated in May, 1978, as a centrally sponsored scheme. DIC was established with the aim of
generating greater employment opportunities especially in rural and backward areas in the
country. At present DICs operate under respective Sate budgetary provisions. DICs extend
services of the following nature – (i) economic investigation of local resources (ii) supply of
machinery and equipment (iii) provision of raw materials (iv) arrangement of credit facilities
(v) marketing (vi) quality inputs (vii) consultancy.

State Financial Corporation’s (SFCs) : Main objectives are to finance and promote small
and medium enterprises in their respective states for achieving balanced regional growth,
catalyze investment, generate employment and widen ownership base of industry. Financial
assistance is provided by way of term loans, direct subscription to equity/debentures,
guarantees, discounting of bills of exchange and seed capital assistance. SFCs operate a
number of schemes of refinance of IDBI and SIDBI and also extend equity type assistance.
SFCs have tailor-made schemes for artisans and special target groups such as SC/ST, women,
ex-servicemen, physically challenged and also provide financial assistance for small road
transport operators, hotels, tourism-related activities, hospitals and so on. Under Single
Window Scheme of SIDBI, SFCs have also been extending working capital along with term
loans to mitigate the difficulties faced by SSIs in obtaining working capital limits on time.

State Industrial Development / Investment Corporation (SIDC/SIIC) : Set up under the

Companies Act, 1956, as wholly owned undertakings of the State governments, act as catalysts
in respective states. SIDC helps in developing land providing developed plots together with
facilities like roads, power, water supply, drainage and other amenities. They also extend
assistance to small-scale sector by way of term loans, subscription to equity and promotional
services. 11 out of 28 SIDCs in the country also function as SFCs and are termed as Twin-
function IDCs.

State Small Industrial Development Corporations (SSIDC) : Established under Companies

Act, 1956, as State government undertaking, caters to small, tiny and village industries in
respective states. Being operationally flexible undertakes the activities like (i) procure and
distribution of scarce raw materials, (ii) supply of machinery to SSI units on hire-purchase
basis, (iii) product marketing assistance, (iv) construction of industrial estates, allied
infrastructure facilities and their maintenance (v) extending seed capital assistance on behalf of
State government and (vi) providing management assistance to production units.
Small scale industries development of India: The SIDBI was established in 1990 as the apex
refinance bank. The SIDBI is operating different programmes and schemes through 5 Regional
Offices and 33 Branch Offices. The financial assistance of SIDBI to the small scale sector is
channelized through the two routes – direct and indirect.

1. Indirect assistance

a) SIDBI’s financial assistance to small sector is primarily channelized through the existing
credit delivery system, which consists of state level institutions, rural and commercial banks.

b) SIDBI provides refinance to and discounts bills of Primarily Lending Institutions (PLI).

c) The assistance is available for

 Marketing of SSI product

 Setting up of new ventures
 Availability of working capital
 Expansion
 Modernisation
 Human resource development
 Diversification of existing units for all activities

2. Direct assistance

a) The loans are available for new ventures, diversification technology up gradation,
modernization and expansion of well run small scale enterprises. Assistance is also available
for private sector.

b) Small scale sector is eligible for maximum debt-equity ratio of 3:1

c) Foreign currency loan for import of equipment are also available to export oriented small
scale enterprises.

d) SIDBI also provide venture capital assistance to the entrepreneurs for their innovative
ventures if they have a sound management team, long term competitive advantage and a
potential for above average profitability leading to attractive return on investment.

New Initiatives of SIDBI

a) Two Subsidiaries viz. SIDBI Venture Capital Limited and SIDBI Trustee Company Limited
formed to oversee Venture Capital.

b) Technology Bureau for Small Enterprise formed to oversee Technology Transfer, Match
making Services, Finance Syndication and facilitating Joint Ventures.
c) SIDBI Foundation for Micro Credit has been launched to provide financial assistance to the
poor and to meet emerging needs of the micro finance sector especially in rural areas.

National Bank for Agriculture and Rural Development (NABARD) is an apex development
bank in India having headquarters based in Mumbai (Maharashtra) and other branches are all over
the country. It was established on 12 July 1982 by a special act by the parliament and its main
focus was to uplift rural India by increasing the credit flow for elevation of agriculture & rural non
farm sector and completed its 25 years on 12 July 2007 It has been accredited with "matters
concerning policy, planning and operations in the field of credit for agriculture and other economic
activities in rural areas in India". RBI sold its stake in NABARD to the Government of India,
which now holds 99% stake.

Role

NABARD is the apex institution in the country which looks after the development of the cottage
industry, small industry and village industry, and other rural industries. NABARD also reaches out
to allied economies and supports and promotes integrated development. And to help NABARD
discharge its duty, it has been given certain roles as follows:

1. Serves as an apex financing agency for the institutions providing investment and
production credit for promoting the various developmental activities in rural areas
2. Takes measures towards institution building for improving absorptive capacity of the credit
delivery system, including monitoring.
3. Co-ordinates the rural financing activities of all institutions engaged in developmental
work at the field level and maintains liaison with Government of India, State
Governments, Reserve Bank of India (RBI) and other national level institutions concerned
with policy formulation
4. Undertakes monitoring and evaluation of projects refinanced by it.
5. NABARD refinances the financial institutions which finances the rural sector.
6. The institutions which help the rural economy, NABARD helps develop.
7. NABARD also keeps a check on its client institutes.
8. It regulates the institution which provides financial help to the rural economy.
9. It provides training facilities to the institutions working the field of rural upliftment.
10. It regulates the cooperative banks and the RRB’s.

NABARD's refinance is available to State Co-operative Agriculture and Rural Development Banks
(SCARDBs), State Co-operative Banks (SCBs), Regional Rural Banks (RRBs), Commercial
Banks (CBs) and other financial institutions approved by RBI. While the ultimate beneficiaries of
investment credit can be individuals, partnership concerns, companies, State-owned corporations
or co-operative societies, production credit is generally given to individuals. NABARD has its
head office at Mumbai, India.

NABARD operates throughout the country through its 28 Regional Offices and one Sub-office,
located in the capitals of all the states/union territories. Each Regional Office [RO] has a Chief
General Manager [CGMs] as its head, and the Head office has several Top executives like the
Executive Directors[ED], Managing Directors[MD], and the Chairperson. It has 336 District
Offices across the country, one Sub-office at Port Blair and one special cell at Srinagar. It also has
6 training establishments.

NABARD is also known for its 'SHG Bank Linkage Programme' which encourages India's banks
to lend to self-help groups (SHGs). Because SHGs are composed mainly of poor women, this has
evolved into an important Indian tool for microfinance. As of March 2006 2.2 million SHGs
representing 33 million members had to been linked to credit through this programme.

Industrial development bank of India : is an Indian financial service company headquartered

Mumbai, India. RBI categorised IDBI as an "other public sector bank". It was established in 1964
by an Act of Parliament to provide credit and other facilities for the development of the fledgling
Indian [Link] is currently 10th largest development bank in the world in terms of reach with
1514 ATMs, 923 branches including one overseas branch at DIFC, Dubai and 621 centers
including two overseas centres at Singapore & Beijing Some of the institutions built by IDBI are
the Securities and Exchange Board of India (SEBI), National Stock Exchange of India (NSE),
the National Securities Depository Limited (NSDL), the Stock Holding Corporation of India
Limited (SHCIL), the Credit Analysis & Research Ltd, the Exim Bank (India)(Exim Bank),
the Small Industries Development Bank of India(SIDBI), the Entrepreneurship Development
Institute of India, and IDBI BANK, which is owned by the Indian [Link] Bank is on a
par with nationalized banks and the SBI Group as far as government ownership is [Link] is
one among the 26 commercial banks owned by the Government of [Link] Bank has an
aggregate balance sheet size of Rs. 2,53,378 crore as on March 31, 2011. IDBI Bank's operations
during the financial year ended March 31.

Role of IDBI

In order to increase its customer base, the Industrial Development Bank of India offers a
number of customized and innovative banking services. The services are meant to offer cent
percent satisfaction to the customers. Some of the well known services offered by the bank
are:
Wholesale Banking services: The wholesale banking services form a major part of the
banking services of the bank. The services that are offered under the wholesale division are:
Cash Management

 Transactional services
 Finance of working capital
 Agro based business transactions
 Trade services

The wholesale banking services are an important source of income in a number of

infrastructure projects such as power, transport, telecom, railways, roadways, and logistics and
so on.

Retail Banking Services: The Industrial Development Bank of India is also a leader in the
retail banking services. The Net Interest Income amounted to around ` 2166 Crores while the
Net Profit amounted to around ` 187 Crores. The main objective of the retail services is to
provide high quality financial products to the target market to give that one-stop-solution to
the banking needs. The retail products offered by the bank include:

Housing loans

 Personal loans
 Securities loans
 Mortgage loans
 Educational loans
 Merchant establishment overdrafts
 Holiday travel plans
 Commercial property loans

Single window scheme:

Purpose : To provide both term loan for fixed assets and loan for working capital through a single agency.
The total working capital requirement of such units inclusive of all fund based facilities are to be taken into
account for determining the working capital facility eligible for refinance.

Eligible Borrowers
Entrepreneurs setting up new projects in MSE / tiny sector, new promoters acquiring unencumbered fixed
assets of existing MSE concerns from PLIs and also existing well run units undertaking modernisation /
technology up gradation and potentially viable sick units undertaking rehabilitation scheme

Norms
Scheme operated through SFCs / twin function IDCs / scheduled commercial banks / eligible state co-
operative banks / scheduled urban co-operative banks
Loan Limit - Not to exceed Rs.200.00 lakh.

TOURISM FINANCE CORPORATION OF INDIA (TFCI)

As decided by the Government of India, IFCI along with other all Indian institutions and
Banks has sponsored the Tourism Finance Corporation of India Limited (TFCI) as a separate
all India Institution to cater to the specialized needs of the tourism and related projects. TFCI
was incorporated as a public limited company on the 27th January, 1989 and became
operational effective from the 1st February, 1989, pursuant to the receipt of certificate of
commencement of business form the Registrar of Companies, New Delhi.

Resources

The authorized share capital of TFCI is ` 100 crores out of which the initial paid-up share
capital is ` 50 crores, subscribed by IFCI,IDBI,ICICI, UTI, LIC, GIC, SBI, Canara Bank and
Bank of India and employees/

Directors. TFCI will also issue bonds, which will be guaranteed by government pf India for
mobilizing resources. The TFCI has been declared a public financial institutions by the
Ministry, Department of Company Affairs. In 1994 TFCI collected ` 5,11,32,300 by issuing
170,44,100 shares of ` 10 each at a premium of ` 20 each.

Objectives

TFCI provides financial assistance to enterprises for setting up and /or developed of tourism,
tourism related activities and services, which inter-alia include hotels, restaurants, holidays
resorts, amusement parks and complex for entertainment, education and sports, safari, parks,
rope-ways, cultural centres, convention halls, transport, travel and tour operating agencies,
tourists emporia, sports facilities etc. Besides, TFCI would also be coordinating and
formulating guidelines and policies related to the financing of such projects. TFCI would also
have a development role within the overall policies of Government.
Forms of Assistance

TFCI provides all forms of financial assistance for new, expansion, diversification,
modernization projects in tourism industry and related activities, facilities and services, such
as:

1. Rupee loans
2. Underwriting of public issues of shares/debentures and direct subscription of such
securities
3. Guarantee for deferred payments and credits raised in India and /or abroad
4. Equipment finance
5. Equipment leasing
6. Assistance under supplier’s credit
7. Merchant banking and advisory services
8. Refinance assistance to state level institutions /banks

Eligibility for Assistance

TFCI provides financial assistance to projects with capital cost of rupees one crores and above
however, unique project which are important from the tourism point of view and for which
assistance from state level institutions/banks is not available may be considered on exceptional
basis even though their capital cost is below rupees one crore.

Norms of Assistance
A flexible view would be taken in regard to the norms for financial assistance regarding
promoter’s contribution, debt-equity ratio, moratorium period and repayment period,
depending upon the merits and circumstances of each case.

VENTURE CAPITAL

Small businesses never seem to have enough money. Bankers and Suppliers, naturally, are
important in financing small business growth through loans and credit, but an equally
important source of long term. Growth Capital is the venture capital firm.

Venture capital is capital typically provided by outside investors for financing of new, growing
or struggling businesses. Venture capital investments generally are high risk investments but
offer the potential for above average returns and/or a percentage of ownership of the company.
A venture capitalist (VC) is a person who makes such investments. A venture capital fund is a
pooled investment vehicle (often a partnership) that primarily invests the financial capital of
third-party investors in enterprises that are too risky for the standard capital markets or bank
loans.

As defined in Regulation 2(m)of SEBI (Venture Capital Funds) Regulation , 1996 "venture
capital fund means a fund established in the form of a company or trust which raises monies
through loans, donations issue of securities or units as the case may be, and makes or proposes
to make investments in accordance with these regulations.

Meaning of Venture Capital

Venture capital is long-term risk capital to finance high technology projects which involve
risk but at the same time has strong potential for growth. Venture capitalist pools their
resources including managerial abilities to assist new entrepreneur in the early years of the
project. Once the project reaches the stage of profitability, they sell their equity holdings at
high premium.

Characteristics of Venture Capital

The three primary characteristics of venture capital funds which may them eminently
suitable as a source of risk finance are:

(1) that it is equity or quasi equity investments;

(2) it is long-term investment; and

(3) it is an active from of investment.

First, venture capital is equity or quasi equity because the investor assumes risk. There is no
security for his investment. Venture capital funds by participating in the equity capital
institutionalize the process of risk taking which promotes successful domestic technology
development.

Investors of venture capital have no liquidity for a period of time. Venture capitalist or funds
hope that the company they are backing will thrive and after five to seven years from making
the investment it will be large and profitable enough to sell its shares in the stock market. But a
reward is thee for liquidity and waiting. The venture capitalists hope to sell their share for
many times what they paid for. If the unit fails the venture capitalists losses everything. The
probability distribution of expected returns for most venture capital investment is highly
skewed to the right. The success rate is 10-20 percent.

Secondly, venture capital is long-term investment involving both money and time.
Finally, venture capital investment involves participation in the management of the company.
Venture capitalist participates in the Board and guides the firm on strategic and policy
matters. The features of venture capital generally are, financing new and rapidly growing
companies; purchase of equity shares; assist in transformation of innovative technology based
ideas into products and services; and value to company by active participation; assume risks in
the expectation of large rewards; and possess a long-term perspective. These features of
venture capital render it eminently suitable as a source of risk capital for domestically
developed technologies.

Thus venture capital is the capital invested in young, rapidly growing or changing companies
that have the potential for high growth. The VC may also invest in a firm that is unable to raise
finance through the conventional means.

Venture capitalists generally:

 Finance new and rapidly growing companies;

 Purchase equity securities;

 Assist in the development of new products or services;

 Add value to the company through active participation;

 Take higher risks with the expectation of higher rewards;

 Have a long-term orientation

Venture capitalists mitigate the risk of venture investing by developing a portfolio of young
companies in a single venture fund. For decades, venture capitalists have nurtured the growth
of America's high technology and entrepreneurial communities resulting in significant job
creation, economic growth and international competitiveness. Companies such as Digital
Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel,
Microsoft, Yahoo, Airtel and Genentech are famous examples of companies that received
venture capital early in their development.

The Origin of Venture Capital

In the 1920's & 30's, the wealthy families of and individuals investors provided the start up
money for companies that would later become famous. Eastern Airlines and Xerox are the
more famous ventures they financed. Among the early VC funds set up was the one by the
Rockfeller Family which started a special fund called VENROCK in 1950, to finance new
technology companies.
USA is the birth place of Venture Capital Industry as we know it today. During most its
historical evolution, the market for arranging such financing was fairly informal, relying
primarily on the resources of wealthy families.

The number of such specialized investment firms, eventually to be called venture capital firms,
began to boom in the late [Link] growth was aided in large part by the creation in 1958 of
the federal Small Business Investment Company program. Hundreds of SBICs were formed in
the 1960s, and many remain in operation today.

Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978

During the 1960s and 1970s, venture capital firms focused their investment activity primarily
on starting and expanding companies. More often than not, these companies were exploiting
breakthroughs in electronic, medical or data-processing technology. As a result, venture
capital came to be almost synonymous with technology finance.

Highs & Lows of the 1980s

In 1980, legislation made it possible for pension funds to invest in alternative assets classes
such as venture capital firms. 1983 was the boom year - the stock market went through the
roof and there were over 100 initial public offerings for the first time in U.S. history. That year
was also the year that many of today's largest and most prominent firms were founded.

Due to the excess of IPOs and the inexperience of many venture capital fund managers, VC
returns were very low through the 1980s. VC firms retrenched, working hard to make their
portfolio companies successful. The work paid off and returns began climbing back up.

Boom Times in the 1990s

The 1990s have been, by far the best years for the Venture Capital Industry. The engine for
growth has been the favourable economic climate in the US coupled with the advent of the
Internet boom. During this decade, the interest rates were low and the P/Es were very high
compared to historical averages. Finally, the rate of M&A activity has increased dramatically
in the 1990s, creating more opportunities for small, venture-backed companies to exit (cash
out) at high prices.

The advent of the Internet as a new medium for both personal and business communications
and commerce created an avalanche of opportunities for venture capitalists in the mid and late
1990s. As a result, the industry has experienced extraordinary growth in the past few years,
both in the number of firms, and in the amount of capital they have raised.
FEATURES OF VENTURE CAPITAL

The main features of venture capital are:

Long-time horizon: In general, venture capital undertakings take a longer time — say, 5-10
years at a minimum — to come out commercially successful; one should, thus, be able to wait
patiently for the outcome of the venture.

Lack of liquidity: Since the project is expected to run at start-up stage for several years,
liquidity may be a greater problem.

High risk: The risk of the project is associated with management, product and operations.

Unlike other projects, the ones that run under the venture finance may be subject to a higher
degree of risk, as their result is uncertain or, at best, probable in nature.

High-tech: Venture capital finance caters largely to the needs of first-generation entrepreneurs
who are technocrats, with innovative technological business ideas that have not so far been
tapped in the industrial field.

However, a venture capitalist looks not only for high-technology but the innovativeness
through which the project can succeed.

Equity participation and capital gains: A venture capitalist invests his money in terms of
equity or quasi-equity. He does not look for any dividend or other benefits, but when the
project commercially succeeds, then he can enjoy the capital gain which is his main benefit.
Otherwise, he will be losing his entire investment.

Participation in management: Unlike the traditional financier or banker, the venture

capitalist can provide managerial expertise to entrepreneurs besides money.

Since many innovations and inventions cannot be commercialized due to lack of finance,
venture capital finance acts as a strong impetus for entrepreneurs to develop products
involving newer technologies and to commercialize them.

Venture capital has also gained in importance as a mechanism for the rehabilitation of sick
companies. Moreover, venture capitalists also assist smaller units in upgrading their
technology.

Types of Venture Capital Firms

Venture Capital can be divided into many different types according to the characteristics of the
shareholders and sources of investment -- such as private equity firms, banks, financial
institutions, private corporations, the government or insurance companies.
Generally there are three types of organized or institutional venture capital funds: venture
capital funds set up by angel investors, that is, high net worth individual investors; venture
capital subsidiaries of corporations and private venture capital firms/ funds. Venture capital
subsidiaries are established by major corporations, commercial bank holding companies and
other financial institutions.

Venture funds in India can be classified on the basis of the type of promoters.

 Financial institutions led by ICICI ventures, ILFS, etc. Private venture funds like
Indus, etc.
 Regional funds: Warburg Pincus, JF Electra (mostly operating out of Hong Kong).
 Regional funds dedicated to India: Draper, Walden, etc.
 Offshore funds: Barings, TCW, HSBC, etc.
 Corporate ventures: venture capital subsidiaries of corporations.
 Angels: high net worth individual investors.
 Merchant bankers and NBFCs who specialize in "bought out" deals also fund
companies.
On the basis of geographical focus
 Regional
 Global
On the basis of industry specialty
 IT and IT-enabled services
 Software Products (Mainly Enterprise-focused)
 Wireless/Telecom/Semiconductor
 Banking
 Media/Entertainment
 Bio Technology/Bio Informatics
 Pharmaceuticals
 Contract Manufacturing
 Retail

On the basis of funding stage:

 Seed/early
 Late/mbo
 Pipe
The Venture Capital firms in India can be categorized into the following four groups:
1. All-India DFI-sponsored VCFs such as
 o Technology Development and Information Company of India Ltd. (TDICI) by
ICICI,
o Risk Capital and Technology Finance Corporation Ltd. (RCTFC) by IFCI and
o Risk Capital Fund by IDBI
2. SFC-sponsored VCFs such as
o Gujarat Venture Capital Ltd. (GVCL) by GIIC and
o Andhra Pradesh Venture Capital Ltd. (APVCL) by APSFC
3. Bank-sponsored VCFs such as Canfina and SBI Caps
4. Private VCFs supported by private sector companies such as
o Indus Venture Capital Fund,
o Credit Capital Venture Fund.
ADVANTAGES OF VENTURE CAPITAL

Venture capital has made significant contribution to technological innovations and promotion
of entrepreneurism. Many of the companies like Apple, Lotus, Intel, Micro etc. have emerged
from small business set up by people with ideas but no financial resources and supported by
venture capital. There are abundant benefits to economy, investors and entrepreneurs provided
by venture capital.

Economy Oriented-

 Helps in industrialization of the country

 Helps in the technological development of the country

 Generates employment

 Helps in developing entrepreneurial skills

Investor oriented-

 Benefit to the investor is that they are invited to invest only after company starts earning
profit, so the risk is less and healthy growth of capital market is entrusted.
 Profit to venture capital companies.
 Helps them to employ their idle funds into productive avenues.

Entrepreneur oriented:

 Finance - The venture capitalist injects long-term equity finance, which provides a solid
capital base for future growth. The venture capitalist may also be capable of providing
additional rounds of funding should it be required to finance growth.
 Business Partner - The venture capitalist is a business partner, sharing the risks and
rewards. Venture capitalists are rewarded by business success and the capital gain.

 Mentoring - The venture capitalist is able to provide strategic, operational and financial
advice to the company based on past experience with other companies in similar situations.

 Alliances - The venture capitalist also has a network of contacts in many areas that can add
value to the company, such as in recruiting key personnel, providing contacts in
international markets, introductions to strategic partners and, if needed, co-investments
with other venture capital firms when additional rounds of financing are required.

 Facilitation of Exit - The venture capitalist is experienced in the process of preparing a

company for an initial public offering (IPO) and facilitating in trade sales.

VENTURE CAPITAL IN INDIA

This activity in the past was possibly done by the developmental financial institutions like
IDBI, ICICI and State Financial Corporations. These institutions promoted entities in the
private sector with debt as an instrument of funding.
For a long time funds raised from public were used as a source of VC. This source however
depended a lot on the market vagaries. And with the minimum paid up capital requirements
being raised for listing at the stock exchanges, it became difficult for smaller firms with viable
projects to raise funds from public.

In India, the need for VC was recognised in the 7th five year plan and long term fiscal policy
of GOI. In 1973 a committee on Development of small and medium enterprises highlighted the
need to foster VC as a source of funding new entrepreneurs and technology. VC financing
really started in India in 1988 with the formation of Technology Development and Information
Company of India Ltd. (TDICI) - promoted by ICICI and UTI.

The first private VC fund was sponsored by Credit Capital Finance Corporation (CFC) and
promoted by Bank of India, Asian Development Bank and the Commonwealth Development
Corporation viz. Credit Capital Venture Fund. At the same time Gujarat Venture Finance Ltd.
and APIDC Venture Capital Ltd. were started by state level financial institutions. Sources of
these funds were the financial institutions, foreign institutional investors or pension funds and
high net-worth individuals. Though an attempt was also made to raise funds from the public
and fund new ventures, the venture capitalists had hardly any impact on the economic scenario
for the next eight years.

GROWTH OF FIRMS IN INDIA

Year No. of Funds Year No. of Funds

1995 4 2001 12

1996 7 2002 6

1997 10 2003 2

1998 6 2004 3

1999 5 2005 1

2000 47 2006 2

India is prime target for venture capital and private equity today, owing to various factors such
as fast growing knowledge based industries, favourable investment opportunities, cost
competitive workforce, booming stock markets and supportive regulatory environment among
others. The sectors where the country attracts venture capital are IT and ITES, software
products, banking, PSU disinvestments, entertainment and media, biotechnology,
pharmaceuticals, contract manufacturing and retail. An offshore venture capital company may
contribute upto 100 percent of the capital of a domestic venture capital fund and may also set
up a domestic asset management company to manage the fund. Venture capital funds (VCFs)
and venture capital companies (VCC) are permitted upto 40 percent of the paid up corpus of
the domestic unlisted companies. This ceiling would be subject to relevant equity investment
limit in force in relation to areas reserved for SSI. Investment in a single company by a
VCF/VCC shall not exceed 5 percent of the paid up corpus of a domestic VCF/VCC. The
automatic route is not available.

Future of Venture Capital in India

Rapidly changing economic environment accelerated by the high technology explosion,

emerging needs of new generation of entrepreneurs in the process and inadequacy of the
existing venture capital funds/schemes are indicative of the tremendous scope for venture
capital in India and pointers to the need for the creation of a sound and broad-based venture
capital movement India.

There are many entrepreneurs in India with a good project idea but no previous
entrepreneurial track record to leverage their firms, handle customers and bankers. Venture
capital can open a new window for such entrepreneurs and help them to launch their projects
successfully.

Differences Venture Finance and Debt Finance

Points Venture Finance Debt Finance

Objective Maximize return Interest payment

Holding period 3-10 years Short/long term

Instruments Common shares, convertible bonds, Loan, factoring,

options, warrants leasing
Pricing Price earnings ratio, net tangible Interest spread
assets
Collateral Very rare Yes

Ownership Yes No

Control Minority shareholders, rights Covenants

protection, board members
 Impact on Balance sheet Reduced leverage Increased leverage
of financed
Exit Mechanism Public offering, sale to third party, Loan repayment
sale to entrepreneur
VENTURE CAPITAL SCENARIO IN INDIA

1972: The Committee on Development of Small and Medium Entrepreneurs, under the
chairmanship of Mr. R. S. Bhatt, first highlighted venture capital financing in India.

1975: venture capital financing was introduced in India by the financial institutions with
the inauguration of Risk Capital Foundation (RCF), sponsored by IFCI with a view to
encouraging technologists and professionals to promote new industries.

1976: The seed capital scheme was introduced by IDBI.

1983: The Technology Policy statement of the Government set the guidelines for
technological self-reliance by encouraging the commercialization and exploitation of
technologies developed in the country. Till 1984 venture capital took the form of risk capital
and seed capital.

1986: ICICI launched a venture capital scheme to encourage new technocrats in the private
sector in emerging fields of high-risk technology.

1986-87: the Government levied a 5 per cent cess on all know-how payments to create a
venture capital fund by IDBI. ICICI also became a partner of the venture capital industry in the
same year.

1988-89: The first attempt to frame comprehensive guidelines governing venture capital funds
was. Even under these guidelines, only all India financial institutions, all scheduled banks
including foreign banks operating in India, and the subsidiaries of the above were eligible to
set up venture capital funds/companies.

 IFCI sponsored RCF was converted into the Risk Capital and Technology Finance Corporation of
India Ltd.

 Unit Trust of India sponsored venture capital unit schemes. State Bank of India has a venture capital
scheme operated through its subsidiary SBI Caps.

 ICICI flagged off a new venture capital company called Technology Development and Information
Company of India with the objective of encouraging new technocrats in the private sector in high-risk
areas.
 The first scheme floated by Canara Bank had participation by World Bank. About the same time, two
State level corporations, viz., Andhra Pradesh and Gujarat also took initiatives to promote venture
capital funds and could obtain World Bank assistance. A foreign bank set up a Venture Capital Fund
in 1987. In addition, other public sector banks have participated in the equity share capital of venture
capital companies or invested in schemes of venture capital funds.

Several venture capital firms are incorporated in India and they are promoted either by financial
institutions, such as IDBI, ICICI, IFCI, State-level financial institutions and public sector banks, or
promoted by foreign banks/private sector financial institutions such as Indus Venture Capital Fund,
Credit Capital Venture Fund, and so on. Hence, the total pool of Indian venture capital today stands
over Rs 5,000 crore.

VENTURE capital, the new-age finance, is gaining importance in the Indian economy as
traditional financial institutions and commercial banks are hamstrung by inadequacy of equity
capital, focus on low-risk ventures, conservative approach, and delays in project evaluation.

Venture capital is also often described as "the early stage financing of new and young
enterprises seeking to grow rapidly".

From the above table we can see that venture capital is continuously growing in INDIA.

The venture capital sector in India is still at the crossroads and striving hard to take off. In the
recent past, many changes have been occurred in the industry. They are:

 Capital is pouring into private equity funds;

 Average ticket size of VC investment is increasing;
  First-generation entrepreneurs are finding it easier to raise funds;
 Investors are demanding non-financial value addition;
 Most States are setting up regional VC funds;
 VC firms are getting professionalised;
 Incubation of entrepreneurs is increasing;
 VC firms are acquiring specific industry focus; and
 Competition is stretching valuations.
The industry can well leap into the high growth trajectory if it is given the necessary boost and
the Government and the venture capitalists take the proper measures.

Unless the challenges facing the sector are rightly addressed, VC funding cannot meet with the
kind of success it has in the developed countries.

PROCESS OF VENTURE CAPITAL

Venture capital investment activity is a sequential process involving five steps:

1. Deal origination
2. Screening
3. Evaluation or due diligence
4. Deal structuring
5. Post-investment activities and exit
 POST INVESTMENT ACTIVIES/ EXIT

DEAL STRUCTURING

DUE DILIGENCE

SCREENING

DEAL ORIGINATION

1. Deal origination A continuous flow of deals is essential for the venture capital business.
Deals may originate in various ways. Referral system is an important source of deals. Deals
may be referred to the VCs through their parent organizations, trade partners, industry
associations, friends etc.

The venture capital industry in India has become quite proactive in its approach to
generating the deal flow by encouraging individuals to come up with their business plans.
Consultancy firms like Mckinsey and Arthur Anderson have come up with business plan
competitions on an all India basis through the popular press as well as direct interaction with
premier educational and research institutions to source new and innovative ideas. The short
listed plans are provided with necessary expertise through people who have experience in the
industry.

2. Screening: VCFs carry out initial screening of all projects on the basis of some broad
criteria. For example the screening process may limit projects to areas in which the venture
capitalist is familiar in terms of technology, or product, or market scope. The size of
investment, geographical location and stage of financing could also be used as the broad
screening criteria.

3. Evaluation or due diligence Once a proposal has passed through initial screening, it is
subjected to a detailed evaluation or due diligence process. Most ventures are new and the
entrepreneurs may lack operating experience. Hence a sophisticated, formal evaluation is
neither possible nor desirable.

The VCs thus rely on a subjective but comprehensive, evaluation. VCFs evaluate the quality of
the entrepreneur before appraising the characteristics of the product, market or technology.
Most venture capitalists ask for a business plan to make an assessment of the possible risk and
expected return on the venture. Following points are taken into consideration while performing
due diligence. These include-

 BACKGROUND
 MARKET AND COMPETITORS
 TECHNOLOGY AND MANUFACTURING
 MARKETING AND SALES STRATEGY
 ORGANIZATION AND MANAGEMENT
 FINANCE AND LEGAL ASPECT
Investment Valuation The investment valuation process is aimed at ascertaining an
acceptable price for the deal. The valuation process goes through the following steps:

 Projections on future revenue and profitability

 Expected market capitalization
 Deciding on the ownership stake based on the return expected on the proposed
investment

The pricing thus calculated is rationalized after taking in to consideration various economic
scenarios, demand and supply of capital, founder's/management team's track record,
innovation/ unique selling propositions (USPs), the product/service size of the potential
market, etc.

4. Deal Structuring: Once the venture has been evaluated as viable, the venture capitalist and
the investment company negotiate the terms of the deal, i.e. the amount, form and price of the
investment. This process is termed as deal structuring. The agreement also includes the
protective covenants and earn-out arrangements. Covenants include the venture capitalists
right to control the investee company and to change its management if needed, buy back
arrangements, acquisition, making initial public offerings (IPOs) etc, Earn-out arrangements
specify the entrepreneur's equity share and the objectives to be achieved.

Venture capitalists generally negotiate deals to ensure protection of their interests. They
would like a deal to provide for:

 A return commensurate with the risk

  Influence over the firm through board membership

 Minimizing taxes

 Assuring investment liquidity

 The right to replace management in case of consistent poor managerial performance.

The investee companies would like the deal to be structured in such a way that their
interests are protected. They would like to earn reasonable return, minimize taxes, have
enough liquidity to operate their business and remain in commanding position of their
business.

There are a number of common concerns shared by both the venture capitalists and the
investee companies. They should be flexible, and have a structure, which protects their mutual
interests and provides enough incentives to both to cooperate with each other.

The instruments to be used in structuring deals are many and varied. The objective in
selecting the instrument would be to maximize (or optimize) venture capital's
returns/protection and yet satisfy the entrepreneur's requirements. The different instruments
through which a Venture Capitalist could invest a company include: Equity shares, preference
shares, loans, warrants and options.

5. Post-investment Activities and Exit: Once the deal has been structured and agreement
finalized, the venture capitalist generally assumes the role of a partner and collaborator. He
also gets involved in shaping of the direction of the venture. This may be done via a formal
representation of the board of directors, or informal influence in improving the quality of
marketing, finance and other managerial functions.

The degree of the venture capitalists involvement depends on his policy. It may not,
however, be desirable for a venture capitalist to get involved in the day-to-day operation of the
venture. If a financial or managerial crisis occurs, the venture capitalist may intervene, and
even install a new management team.

Venture capitalists typically aim at making medium-to long-term capital gains. They
generally want to cash-out their gains in five to ten years after the initial investment. They play
a positive role in directing the company towards particular exit routes. A venture capitalist can
exit in four ways:

 Initial Public Offerings (IPOs)

 Acquisition by another company
 Repurchase of the venture capitalist share by the investee company
 VENTURE CAPITAL SCENARIO IN INDIA

1972: The Committee on Development of Small and Medium Entrepreneurs, under the
chairmanship of Mr. R. S. Bhatt, first highlighted venture capital financing in India.

1975: venture capital financing was introduced in India by the financial institutions with
the inauguration of Risk Capital Foundation (RCF), sponsored by IFCI with a view to
encouraging technologists and professionals to promote new industries.

1976: The seed capital scheme was introduced by IDBI.

1983: The Technology Policy statement of the Government set the guidelines for
technological self-reliance by encouraging the commercialization and exploitation of
technologies developed in the country. Till 1984 venture capital took the form of risk capital
and seed capital.

1986: ICICI launched a venture capital scheme to encourage new technocrats in the private
sector in emerging fields of high-risk technology.

1986-87: the Government levied a 5 per cent cess on all know-how payments to create a
venture capital fund by IDBI. ICICI also became a partner of the venture capital industry in the
same year.

1988-89:

 The first attempt to frame comprehensive guidelines governing venture capital funds was. Even under
these guidelines, only all India financial institutions, all scheduled banks including foreign banks
operating in India, and the subsidiaries of the above were eligible to set up venture capital
funds/companies.

 IFCI sponsored RCF was converted into the Risk Capital and Technology Finance Corporation of
India Ltd.

 Unit Trust of India sponsored venture capital unit schemes. State Bank of India has a venture capital
scheme operated through its subsidiary SBI Caps.

 ICICI flagged off a new venture capital company called Technology Development and Information
Company of India with the objective of encouraging new technocrats in the private sector in high-risk
areas.

 The first scheme floated by Canara Bank had participation by World Bank. About the same time, two
State level corporations, viz., Andhra Pradesh and Gujarat also took initiatives to promote venture
capital funds and could obtain World Bank assistance. A foreign bank set up a Venture Capital Fund
in 1987. In addition, other public sector banks have participated in the equity share capital of venture
capital companies or invested in schemes of venture capital funds.

Several venture capital firms are incorporated in India and they are promoted either by financial
institutions, such as IDBI, ICICI, IFCI, State-level financial institutions and public sector banks, or
promoted by foreign banks/private sector financial institutions such as Indus Venture Capital Fund,
Credit Capital Venture Fund, and so on. Hence, the total pool of Indian venture capital today stands
over Rs 5,000 crore.

VENTURE capital, the new-age finance, is gaining importance in the Indian economy as traditional
financial institutions and commercial banks are hamstrung by inadequacy of equity capital, focus on
low-risk ventures, conservative approach, and delays in project evaluation.

Venture capital is also often described as "the early stage financing of new and young enterprises
seeking to grow rapidly".

From the above table we can see that venture capital is continuously growing in INDIA. The
venture capital sector in India is still at the crossroads and striving hard to take off. In the
recent past, many changes have been occurred in the industry. They are:
 Capital is pouring into private equity funds;
 Average ticket size of VC investment is increasing;
 First-generation entrepreneurs are finding it easier to raise funds;
 Investors are demanding non-financial value addition;
 Most States are setting up regional VC funds;
 VC firms are getting professionalised;
 Incubation of entrepreneurs is increasing;
 VC firms are acquiring specific industry focus; and
 Competition is stretching valuations.
The industry can well leap into the high growth trajectory if it is given the necessary boost and
the Government and the venture capitalists take the proper measures.

Unless the challenges facing the sector are rightly addressed, VC funding cannot meet with the
kind of success it has in the developed countries.

ISSUES FACED BY VENTURE CAPITALISTS IN INDIA

1. As it presently stands, the Act requires that investments are made by Venture Capital
Funds only in equity instruments, which imposes avoidable constraints. SEBI, which
regulates venture capital funds permits investment in equity and equity like
instruments. All over the world, instruments such as convertible preference shares,
fully and partly convertible debentures are used for financing by venture capital
companies.
2. According to the Indian Venture Capital Association, there is no regulatory framework
for structuring the funds. Most of the domestic funds have been set up under the Indian
Trust Act 1882. While domestic funds are required to follow SEBI guidelines, offshore
funds are required to follow RBI guidelines.
3. There is an anomaly in the tax treatment between domestic and offshore funds.
Offshore funds are generally registered in Mauritius and do not pay any tax whereas
domestic funds have to pay maximum marginal tax.
4. Even among domestic funds, funds settled by Unit Trust of India are totally exempt
from tax. The contention is that offshore funds which invest only in large industries are
exempt from tax whereas domestic funds that invest in small and medium industry are
taxed.
5. Again, the provisions of Section 10 (23) F restrict venture capital companies from
investing in the services sector barring computer.
6. There is a strong opinion that telecommunication and related services, computer
hardware related services, project consultancy, design and testing services, tourism
related services and health related services should qualify for exemption under the Act
for venture capital investment.
7. There is also a view that greater flexibility should be made available to venture capital
investments in unlisted securities. Interestingly, even foreign institutional investors are
permitted to invest in unlisted debt instruments.
Module Five: Feasibility reports

Unit One: Project reports, contents of a project report, development of project reports for
hospitality undertaking and travel and tour company

CONTENTS OF A BUSINESS PLAN

A good business plan should include all of the following information:

Front Cover

The cover gives the reader an instant impression of the business so it needs to look
professional. It should show the business name and logo, if you have one, and your name. A
well laid out cover page will present a professional image to funders and will attract their
attention and interest. You should make every effort to have your plan word-processed. It will
make the document easier to read.

Executive Summary

Although the summary is the first section that people will read, it should probably be written
last. However, since it is the first bit you will read, we will describe it first.

The summary should briefly describe the business and highlight its purpose. It should explain
how the purpose will be achieved and why the proprietor is the person to make it happen.

If one of the uses for your business plan is to raise finance, then a clear simple outline will
catch the attention of prospective funders and make them interested enough to read on.
Remember that the people assessing your business are likely to be very busy. Highlight the
strengths of the business and why you should be supported. Indicate the expected turnover and
profitability for the following year. If you are already in business, briefly describe your history
to date and, in particular, provide details of turnover and profitability for the previous one or
two years. How does the business’s performance compare with its competitors? What have
been its major achievements?

Lastly, indicate how much money you need to raise and the proposed sources.

The Business

This section should briefly describe the purpose and goals of the business. Whether or not the
business has started, explain who owns it. What was the trigger to launch the business?

Explain the legal structure of the business (company, sole trader or partnership). State if there
are any distinguishing features, such as a unique feature of the product. Describe the purpose
and goals of your business.

Product or Service

Describe your product or service. In particular, explain its features and its benefits. Describe
what you are selling, or intend selling, in language which any reader will understand. Avoid
jargon wherever possible; a reader wanting more detailed information on technical aspects of
your product will ask for it. Or else include such information in an appendix.

Explain why customers will want to buy the product or services. What needs does it fulfil?
Describe not only the features but also the benefits. Benefits might include, for example, ease
of use, comfort, safety, economy, flexibility, taste, etc. Remember that the customer buys the
benefits but you pay for the features.

Are any of the features unique? Give details of patent, design registration or copyright if
appropriate. Outline plans for future development over, say, the next two years. Will you
phase in additional products or services as you start to make more money? Will you pilot an
initial product to test the market? Will you add to the product range later?

The Market

Define carefully who you perceive to be your customer groups or niche markets. Your market
research may have suggested that you aim your sales at a precisely defined target market or
segment.

Outline the research that you have undertaken – both primary and secondary research are
important - including summary information in tables or graphs. Detailed supporting
information can be included in the appendices.
You need to show that a market exists. What is the overall size of the market? Estimate likely
demand for your product or service in the short and long-term and justify this estimate. It is on
the basis of such information that you will estimate your sales turnover.

You need to explain to the reader the extent of the competition. What competition is there?
How many competitors will you have? Is there likely to be further competition in the future?
Explain why your product is going to be preferable to those of your competitors. What is your
product’s unique selling point?

Are there any barriers to entry to this particular market - and, if so, what are they and how will
you overcome them?

Marketing Plan

You described the purpose of your business in the summary or in the business section. That
purpose should be translated into marketing objectives and goals which will support its
realisation.

Objectives should be quantifiable, measurable, challenging and achievable. Typical objectives

might be profitability, sales growth, diversification and improvement in market share.

Objectives might include, for example:

 to sell 220 units and generate £100,000 over the next 12 months
 to achieve a gross profit margin of 45%; or,
 to capture 18% of the defined market.
The marketing plan to achieve these objectives should be described using the 4Ps. Your
chosen “positioning” will also affect how you implement the 4Ps.

Explain how you propose to position the business (and the product) in the market place. Is the
product a quality product targeted at a quality market (and therefore able to command a
premium price)? This is known as differentiation. Is the product a commodity - with nothing to
choose between competitors except price? This is called cost leadership.

Place

The location of your business and the way you will distribute your product to your clients are
both important. How will the product or service be sold to customers - directly or via dealers
or agents (such as wholesalers or retailers)? How will the product be transported to its point of
sale?
If customers come to the business, can it be reached conveniently? Does it give the right
image? Explain why you have chosen the site or premises from which you intend to operate.

Price

The price must cover all your costs and provide a profit. You will need to explain how you
reached your decision on price. If you choose a differentiation strategy, quality and service is,
within reason, more important than price. If you choose a cost leadership strategy you will
need to set the price by reference to the market - and then control your costs to enable you to
sell at that price whilst still making a profit. The latter is often a difficult strategy for small
businesses so most, either consciously or unconsciously, choose the differentiation route.

Promotion

Finally, you need to explain your promotional strategy - how you intend to break into the
market and let the customer know you exist.

Explain how you will promote what you have to offer, for example, through advertising, direct
mail, door-to-door leaflets, social media campaigns, etc.

Management and Organisation

It is important to demonstrate that you have the ability to carry out the tasks to make the
business work. Focus only on the key points.

People

Describe the people involved highlighting the particular strengths and skills they bring to the
business. This may include technical skills (such as joinery or sales experience), personal
attitudes (such as enthusiasm or ability to work under pressure), education and specialist
training. If you wish, provide curricula vitae for the key staff in the appendices. If there are
apparent weaknesses, explain how these will be overcome (for example, by sub-contracting a
particular aspect of the production process).

Production

Describe the production process (if any) and highlight any competitive advantages.
Break-Even Analysis

Once you have worked out your likely costs, and determined the price at which you will sell
your product or service, you can work out exactly how much you need to sell in order to cover
costs - either in terms of units sold or productive hours worked. The level of sales at which you
start to exceed your costs is known as the break-even point. Beyond this you start to go into
profit.

Explain how you have derived the price for your product or service and show the expected
break-even point. Mention the margin of safety.

Financial Forecasts

The two key financial requirements are to generate a profit and to generate sufficient cash to
be able to make payments to suppliers, staff and others as they fall due. The objective of this
section of the plan is to demonstrate that the business will achieve both of these requirements.
Forecast for at least one year ahead. If a substantial investment is sought or if the business is
unlikely to show profitability within the year, then forecasts for two or even three years may
be required.

This section will normally include a cashflow forecast, a forecast profit and loss account and a
forecast balance sheet. Let’s look at each in turn:

A forecast of the profit and loss account: The sales turnover is derived from the market
research section. What are the direct costs, the gross profit, the overhead costs, and the likely
net profit? How will the profit be distributed? It may also help to explain how the price has
been derived. Remember to include drawings and interest when adding the total overhead cost
to the direct costs.

A cash flow forecast: Explain likely delays in receipt of income and in paying for expenditure.
Provide a cashflow forecast to show receipts and payments on a month by month basis and,
therefore, the required level of external finance.

Ideally, you should also include a forecast of the balance sheet - otherwise the prospective
funder will attempt to derive one from the other information you have provided. This might
not, however, show the business exactly as you would like; you might, for example, be
introducing fixed assets or stock which will not appear on the cash flow forecasts.
Sensitivity or Risk Analysis

Prospective funders are interested in risks - the risk that you may not achieve your forecast, the
risk that you may default on the loan and even the risk that your business might cease to trade.
It will help them considerably - and demonstrate that you too have thought about risk - if you
include a break-even analysis (explained earlier) and a sensitivity analysis.

Sensitivity analysis looks at “what if...?” questions. What will be the effect, say, of a 10% fall
in sales or a 20% increase in raw material prices? You can help the business plan appraiser by
briefly considering such questions yourself and assessing the likely risks particularly of falling
sales or rising prices.

Financial Requirements

Indicate how much money or other assets will be invested by yourself (and any partners). Give
details of how much is sought from other sources and explain whether it is wanted as overdraft
(for working capital), as term loans (for equipment for example), as equity, or as a
combination of these.

If any security, for example, in the form of a house, is available, then say so. Most banks look
for at least some security, particularly if they are being asked to provide the bulk of the
finance. The offer of security is a demonstration of your commitment to, and confidence in,
the business. It is also a demonstration of your willingness to take risks, especially if you have
little cash of your own to invest.

Explain your total financial requirements and the way in which, ideally, you would like these
to be met; explain how much you will be introducing to the business and whether you have
any security.

Appendices

Keep any additional material to a minimum. You may find there are some aspects of your
business where more background information might be helpful, but don’t regard this as an
excuse to include everything.

In addition to the items mentioned above, you might include:

 photographs
 quotations for equipment and necessary insurance
 legal information - partnership agreement, leases etc
 a copy of your primary research questionnaires; and
  relevant secondary research information.

Conclusion

In describing your business, in highlighting the features and benefits of your product or
service, in demonstrating your knowledge of the market, in providing details of actual
performance or forecasts of potential and in demonstrating your willingness to take risk, you
have prepared a business plan. You can now think about writing the summary.

Now write your summary.

Earlier, we suggested that the quality of the information you gather for your plan will
determine the quality of your business plan. Equally, the quality of the business plan will
determine the success or otherwise of any application for funding. No less importantly, the
quality of your business planning will determine the success or otherwise of your business.

Remember that your plan is neither a static document nor simply a tool with which to get
funding; it is an evolving statement of all the ideas, research and actions which you are
employing to ensure the survival and growth of your business.

Your business will require frequent changes of direction as new opportunities present
themselves. How you meet those opportunities will be a function of the quality of your
planning, of your flexibility of approach, and of how you develop and use your plan.

Unit Two: Business Plan Preparation – The students shall work outline of a business
planbased on academic inputs and training and finally develop a business plan. The students
must undertake the necessary research, survey and field work to develop a viable business plan
in a format acceptable to financial institutions. This will be evaluated by faculty in charge.