Finance for it and Service Sector Finance Essay

The objective of this project is to have a detail study about the start-up IT companies and the different problems faced by them, the various source of fund available to start a company and the advantages enjoyed by the established companies. Also compare between the companies using various tools of financial statements, ratio analysis and following the market trends.

PART 1A

ANALSING THE MAJOR SOURCE OF FUNDS FOR START-UP I.T. COMPANIES

Own contribution-People start companies at different points in their lives. Some entrepreneurs start companies during the early stages of their career. A majority of entrepreneurs start companies at later stages in their lives and these entrepreneurs often have personal assets that they could use to finance their ideas. It is important for entrepreneurs to invest their personal savings in their business ideas as it indicates that the entrepreneur is confident about his or her own idea, thereby encouraging other investors to look at the idea more seriously. After all, who would want to invest in a company wherein the founder does not want to bet on the idea? Additionally, entrepreneurs who do not put their personal savings into the venture can find it hard to raise money from friends and family. Entrepreneurs should think thoroughly before investing their personal finances. If the business idea is not feasible, the entrepreneur loses everything.

Angel investors-Angel investors are wealthy individuals who will give an entrepreneur financing in exchange for a share of equity in the company. Investment sizes range, but usually are less than $1 Million. A small but increasing number of angel investors organize themselves into angel groups or angel networks to share research and pool their investment capital, as well as to provide advice to their portfolio companies. Angels typically invest their own funds, unlike venture capitalists, who manage the pooled money of others in a professionally-managed fund. A Harvard report by William R. Kerr, Josh Lerner, and Antoinette Schoar provides evidence that angel-funded start-up companies have historically been less likely to fail than companies that rely on other forms of initial financing. Angel investments bear extremely high risk and are usually subject to dilution from future investment rounds. As such, they require a very high return on investment. Because a large percentage of angel investments are lost completely when early stage companies fail, professional angel investors seek investments that have the potential to return at least 10 or more times their original investment within 5 years, through a defined exit strategy, such as plans for an initial public offering or an acquisition .Angel investors are more serious than the type of investor you would find in a Friends and Family Round, but they are usually less serious than a VC Firm.

Pros and cons of angel investors

Pros:

Angels normally have experience in the industry and can offer helpful guidance and introductions to their network.

Because angels are less rigid than VC Firms, flexible business agreements are common.

Cons:

You can be forced to give up some degree of control over your company. Due to the high-risk nature of angel investing, angels rarely make follow-on investments.

Venture capitalist-A venture capitalist is a person that makes venture investments, and these venture capitalists are expected to bring managerial and technical expertise as well as capital to their investments. A venture capital fund refers to a pooled investment vehicle (in the United States, often an LP or LLC) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans. These funds are typically managed by a venture capital firm, which often employs individuals with technology backgrounds (scientists, researchers), business training and/or deep industry experience. Most venture capital funds have a fixed life of 10 years, with the possibility of a few years of extensions to allow for private companies still seeking liquidity. The investing cycle for most funds is generally three to five years, after which the focus is managing and making follow-on investments in an existing portfolio. This model was pioneered by successful funds in Silicon Valley through the 1980s to invest in technological trends broadly but only during their period of ascendance, and to cut exposure to management and marketing risks of any individual firm or its product.

Pros and cons of venture capital

Pros:

VCs can invest large sums at once and they can provide expertise and other assistance that is helpful in growing and exiting your business.

Being VC funded brings instant credibility to your company.

VCs open up doors to a vast network of individuals including partners and future investors.

Cons:

The term "Vulture Capitalist" exists for a reason. VCs are about the money and will take necessary steps to see a return on their investment, including ousting you from your own company.

VCs may steer the business in a direction that you don't agree with. However, they are very experienced and may know something that you don't.

Family & Friends-As an entrepreneur, you can lobby friends, family, and associates for funding that is usually invested more because of your personal relationship rather than an accurate assessment of the business plan. The Friends and Family Round often acts as a seed investment to get the business to a point where it will be able to obtain larger funding from an Angels or VCs.

Pros and cons of family funding

Pros:

Funding is usually obtainable quickly due to your existing relationship.

Potential exists for the mutual vested interest in the business to bring you closer with loved ones.

The investment terms are usually more flexible and potential exists for numerous equity or pay back methods.

Cons:

Immense pressure to succeed can strain personal relationships.

Friends and family frequently have an extremely limited ability to evaluate the potential of your business, though they tend to give advice because of their monetary stake in the company.

Friends and family usually bring nothing more to the table as an investor besides the initial capital.

IPO (Equity) - As opposed to debt financing, equity financing transfers the risk from the entrepreneur to the investors, but has its own set of drawbacks. Equity financing is when entrepreneurs can raise money only through selling common or preferred stock to investors. This implies that an entrepreneur gives up some of his or her voting rights to investors. Although most angels offer equity financing, institutional venture capitals make the biggest equity financing investments. Institutional venture capital firms usually manage large funds - anywhere from $25 million to $1 billion - and invest in high growth companies.

Debt-

Bank loan-Entrepreneurs can also raise capital from banks through the debt financing route. Although some angels provide debt capital, commercial banks are the primary providers of debt capital to small companies. Bankers tend to make business loans through lines of credit, term loans and mortgages. A line of credit loan is the largest amount of money that the borrower can obtain from the bank at any one time. In addition to the line-of-credit load, banks issue five to ten year term loans that are generally used to finance equipment. Since the economic benefits of investing in equipment extend beyond a single year, banks are generally open to lending money to buy equipment that generate revenues, which match the interest to be received from such a loan. Finally, entrepreneurs can also obtain a mortgage to provide funding.

Debenture is a type of debt instrument issued by corporations to raise capital. The debenture holders have a right to receive regular interest payments and a fixed sum called the principal on maturity. Debentures are not secured by any asset but are backed by the general credit worthiness and integrity of the issuing.

Bonds are debt instrument issued by a business which obligates it to make periodic interest payments to the holder of the bond, as well as to repay the principal of the bond at the maturity day;

The issuer obtains funds by placement of bonds in the capital market, i.e. they are sold to the economic subjects that invest their funds to purchase these securities. The process of the issue is similar to that one of the shares.

Pros and cons of debt financing

Pros:

Debt financing increases the potential for higher rates of return on investment (ROI)

Allows entrepreneurs to retain much of the board control, also.

Cons:

Irrespective of the start-up's outcome, banks make sure that they will get their investment back along with interests. To accomplish this, banks structure their agreements accordingly

Govt. sponsored program-Several government programs provide financing to small businesses. The federal government has a long history of helping new businesses get started, primarily through the following federal programs:

Small Business Administration (SBA)

Small Business Investment Companies (SBIC)

Small Business innovative Research (SBIR)

Small Business Technology Transfer (STTR)

Apart from the federally sponsored programs, state and local government are also becoming increasingly active in financing new businesses. The nature of financing varies, but each program is generally geared to augment other sources of funding.

Pros and cons of govt.funding

Pros:

Helps to raise money with low interest rates and equity

Cons:

Entrepreneurs must have the patience to go through the time-consuming government bureaucratic processes.

PART 1B

SOURCE OF FINANCE FOR EXISTING I.T. COMPANIES

Rights issues-A rights issue provides a way of raising new share capital by means of an offer to existing shareholders, inviting them to subscribe cash for new shares in proportion to their existing holdings. A company making a rights issue must set a price which is low enough to secure the acceptance of shareholders, who are being asked to provide extra funds, but not too low, so as to avoid excessive dilution of the earnings per share.

Preference shares- are a special kind of shares, the holders of such shares enjoy priority, both as regards to the payment of a fixed amount of dividend and repayment of capital on winding up of the company. Long-term funds from preference shares can be raised through a public issue of shares. Preference share capital is a hybrid form of financing which partakes some characteristics of equity capital and some attributes of debt capital.

Retained earnings- For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Profit re-invested as retained earnings is profit that could have been paid as a dividend. The major reasons for using retained earnings to finance new investments, rather than to pay higher dividends and then raise new equity for the new investments areA (a)The use of retained earnings as opposed to new shares or debentures avoids issue costs. (b) The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares.

Bank lending- Borrowings from banks are an important source of finance to both start-up and existing companies. Bank lending is still mainly short term, although medium-term lending is quite common these days. Medium-term loans are loans for a period of from three to ten years. The rate of interest charged on medium-term bank lending to large companies will be a set margin, with the size of the margin depending on the credit standing and riskiness of the borrower. A loan may have a fixed rate of interest or a variable interest rate, so that the rate of interest charged will be adjusted every three, six, nine or twelve months in line with recent movements in the Base Lending Rate.

Leasing- A lease is an agreement between two parties, the "lessor" and the "lessee". The lessor owns a capital asset, but allows the lessee to use it. The lessee makes payments under the terms of the lease to the lessor, for a specified period of time.

Leasing is, therefore, a form of rental. Leased assets have usually been plant and machinery, cars and commercial vehicles, but might also be computers and office equipment. There are two basic forms of lease: (a) Operating leases- Operating leases are rental agreements between the lessor and the lessee whereby the lessor supplies the equipment to the lessee. (b) Finance leases- Finance leases are lease agreements between the user of the leased asset (the lessee) and a provider of finance (the lessor) for most, or all, of the asset's expected useful life.

Hire purchase- An industrial or commercial business can use hire purchase as a source of finance. Hire purchase is a form of instalment credit. Hire purchase is similar to leasing, with the exception that ownership of the goods passes to the hire purchase customer on payment of the final credit instalment, whereas a lessee never becomes the owner of the goods. Hire purchase agreements usually involve a finance house.

PART 2

Looking at the advantages of existing IT companies over start-up companies.

Existing IT major's always have an added advantage over the start-up companies. We shall now analyse the advantages of an existing companies by look at some specific area of superiority over new IT companies:-

Brand Popularity-Being recognized all over the world as a respected brand is a sustained competitive advantage that companies such as TCS, Wipro and Infosys etc. have used as leverage to hold the market sway for years. Effective brand names build a connection between the brand personalities as it is perceived by the target audience and the actual product/service. Brand identity is fundamental to consumer recognition and symbolizes the brand's differentiation from competitors. This companies has uses its brand name as leverage to break into new markets in completely new territories. Unfortunately new IT companies have a long way to go before they become a household name.

Corporate reputation-Corporate reputation is a form of sustained competitive advantage that companies such as Infosys, Wipro and others major IT companies-which were/are mentored by people like N. R. Narayana Murthy, Azim Hashim Premji have leveraged to become world class entities. New companies often do not have right people for guidance.

Strong research and Innovation - The technology industry is one of the leading industries with respect to strong research and innovation. And when it comes to setting the pace using innovation as leverage existing companies always have an added advantage. Existing companies earn huge profit and spend a considerably part of their expenses in R&D sector.

Strategic assets-Holding strategic assets such as patents, intellectual property right is a strong source of sustained competitive advantage and big IT compnies have seen to it because of the several patents held. For example-Infosys was granted patents by the U.S. Patent and Trademark Office for

System and Method for Managing Playout Time in Packet Communication Network and Methods and System for Configurable Domain Specific Abstract Core (DSAC).

Access to working Capital-Generally, public liability companies (quoted companies) have a sustained competitive advantage over private companies because of their infinite capacity to raise capital from the public. Start-up companies are mostly funded by angel investors or venture capitalists hence they have a limited scope of raising more and more capital.

High volume production-High volume of production reduces cost per unit of a product to a great extent. Old IT companies have a large workforce and they are able to produce in a large volume, reducing cost and selling at a lower rate.

Now let us look at some of the problems faced by the start-up companies:-

Not Enough Start-up Money-In a 2004 survey of new business closures, 79 percent of respondents cited starting out with too little money as one of the chief causes of their failure. Most start-up companies are financed by venture capitalists or through debt (term loan or debenture) who always have/give a limited amount of money which acts as a deterrent in the path of growth.

Charging Too Little-One of the most common problems of new businesses is trying to beat the competition by offering lower prices. Start-up companies in order to capture the markets price their product as low as possible often resulting in losses and as a results they have zero reserve to finance their growth. The better strategy is to price your goods or services at a fair market value and try to beat the competition on high quality, customer service and your "unique selling proposition,"

Poor Marketing Strategy-One of the most important elements of a successful business plan is a well-researched marketing plan. It starts with the market data you produced from census reports, feedback and competitive analysis. Once you have a clearly defined target customer, you need to design a marketing campaign that turns him or her into a paying customer. A common problem for new businesses is to rush into newspaper ads, glossy brochures and billboards. The first consideration should be the budget. Start-ups need to figure out how much each type of advertising costs and how many of your potential customers it will reach.

Bad Business Plan-A common problem for new businesses is that they rush a product or service to market without a clear focus. The result is that the business owner ends up chasing too many potential markets and new products. At the beginning, it's much more important to have a single focus with a proven client base. Existing IT companies always have a definite focus plan and they stay focus to it.

PART 3

ANALYSING THE PERFORMANCE OF I.T. SECTOR IN INDIA

From a nascent start, India has made rapid progress in the IT domain. The opening of the economy in the early 1990s gave it a tremendous boost. India's prowess in the software field is now recognized the world over, with its software consultancy firms having a truly global presence and with nearly all the top Fortune 500 Companies as

its clients. The existence of a separate Department of Information Technology under the Central Government is a reminder to the importance attached to IT and the impact it is having on various fronts including governance. Information Technology has come to be recognized as a key-leveraging factor in the National Development. It

has had a profound effect on other industries in increasing productivity and changing cost structure.

The Indian IT success story has also highlighted India's attractiveness as an investment destination far beyond the IT sector. Another key impact of the global sourcing model popularised by the growth of IT and IT Enabled Services (ITES) has been the reversal of the brain drain - as people of Indian origin (who went to pursue careers abroad), as well as young expatriates, are now attracted to work in India. The rapid growth of ITES-BPO and the IT industry as a whole has made a deep impact on the socioeconomic dynamics of the country, having a significant multiplier effect on the Indian economy. Apart from the direct impact on national income, the sector has risen to become the biggest employment generator with the number of jobs added almost doubling each year, has spawned a number of

Ancillary businesses such as transportation, real estate and catering; played a key role in the rise in direct-tax collection and has contributed to a rising class of young consumers with high disposable incomes. The industry's contribution to the national economic output is estimated to account for 4.1 per cent of the national

GDP in the year 2004-05. The IT services and software sector is expected to add 109,000 jobs in the current fiscal, ITES-BPO another 94,500. The number of professionals employed in India by the IT and ITES sector is estimated at 1,045, 000 by March 2005. Of these, 345,000 were in the IT software and services export industry; nearly 348,000 were in the ITES-BPO sector; 30,000 in the domestic

Software market and over 322,000 in user organizations.

The Indian software and services export was to the tune of Rs. 78,230 crore (US$ 17.2 billion) in 2004-05, as compared to Rs. 58,240 crore (US $12.8 billion) in 2003-04, an increase of 34 per cent both in rupee terms and dollar terms. The Indian ITES-BPO (Business Process Outsourcing) sector industry also continues to grow from strength to strength, witnessing high levels of activity - both onshore as well as

Offshore. Export revenues from ITES-BPO exports from India have exceeded the US $ 5 billion mark in the year 2004-05.

The economic survey 2011-2012 gives the following interesting information regarding the IT sector:-

The IT and IT enabled services (ITeS) sector are giving India the image of a young and resilient global knowledge power. The IT-ITeS industry has four major sub-components: IT services, business

Process outsourcing (BPO), engineering services and research and development (R&D), and software products. As per the estimates of NASSCOM, India's IT and BPO sector (excluding hardware) revenues

were US$ 87.6 billion in 2011-12, generating direct employment for nearly 2.8 million persons and indirect employment of around 8.9 million. As a proportion of national GDP, IT and ITeS sector revenues have grown from 1.2 per cent in 1997-8 to an estimated 7.5 per cent in 2011-1210.45 Software exports in 2011-12 are estimated at US$69 billion compared to US$59 billion in 2010-11. While exports continue to dominate the IT-ITeS industry and constitute about 78.4 per cent of total industry revenue, the CAGR of the domestic sector has also been high at 12.8 per cent compared to the14.2 per cent for exports during the Eleventh Five Year Plan period. The growth rate of the domestic sector in 2010-11 was 20.6 per cent as compared to

18.8 per cent for the export sector; in 2011-12 it was9.7 per cent for domestic sector and 16.4 per cent for export sector.

In 2012-13, as per NASSCOM estimates, export revenues are expected to grow by11-14 per cent and domestic revenues by 13-16 per cent. These estimates are a pointer to the possibilities of making further forays into the untapped domestic sector for IT and ITeS.

Consistent demand from the US, which increased its share in total exports of India's IT and ITeS services from 61.5 per cent to 62 per cent, characterized 2011-12. Emerging markets of Asia Pacific and the rest of the world also contributed to overall growth. While the industry's vertical market mix is well balanced across several mature and emerging sectors, there was broad-based demand not only across traditional segments such as banking, financial services, and insurance (BFSI), but also new emerging verticals of retail, health care, media, and utilities. Sub-sector-wise in 2011-12, as per the provisional estimates of NASSCOM, in the export sector, IT services were the major component with a 58 per cent share and CAGR of 15.7 per cent for the Eleventh Plan period; followed by BPO with

a 23.1 per cent share and 12.5 per cent CAGR; and software products / engineering with a 18.9 per cent share and 11.8 per cent CAGR. Indian IT service offerings have evolved from application development and maintenance to emerge as full service players

providing testing and infrastructure services, consulting, and system integration. The year also witnessed the next phase of BPO-sector evolution, characterized by greater breadth and depth of services, process re-engineering across the value chain, increased delivery of analytics and knowledge-based services through platforms, strong domestic market focus, and Small and Medium-sized Business (SMB) centric delivery models. In the engineering design and products development segments, there was increasing use of electronics,

adoption of fuel efficiency norms, convergence of local markets, and use of localized products. Increasing confidence between customers and service providers successfully executing a variety of activities across low-medium-high complexity projects has led to increasingly larger sizes of projects being sourced from India. In the domestic

sector, the major component is IT services with 64.2 per cent share, followed by software products/ engineering with 19.6 per cent share and BPO with16.2 per cent share. The CAGRs of these sectors were 11.5 per cent, 13.6 per cent, and 18.1 % respectively. Strong economic growth, rapid advancement in technology infrastructure,

Increasingly competitive Indian organizations enhanced focus by the government and emergence of business models that help provide IT to new customer segments are the key drivers for increased technology adoption in India. The IT and ITeS sector is also a generator of skilled employment with direct employment expected to reach 2.8 million in 2011-12 compared to 2.5 million in 2010-11.

Challenges faced by IT companies in today's environment and role of Govt.

Some of the challenges faced by the IT and ITeS sector include increasing competition from other countries with incentivized low costs, rising costs in India with wage-push inflation, increasing

costs of relevant talent and skilled personnel, infrastructure constraints with over 90 per cent of total revenue generated from seven Tier-1 locations, risks like currency fluctuations and security, both physical and data related, and rising protectionist sentiments in key markets. Government has taken various initiatives to promote the growth of the IT-ITeS industry and has been a key catalyst for

increased IT adoption--through sectors reforms that encourage IT acceptance, National e-Governance Plan (NeGP), and the Unique Identification Development Authority of India (UIDAI) programme

that creates large-scale IT infrastructure and promotes corporate participation. The Draft National Policy on Information Technology 2011 focuses on deployment of information communication

technology (ICT) in all sectors of the economy and providing IT solutions to the world. The Policy emphasizes adoption of technology-enabled approaches to overcome developmental challenges in education, health, skill development, financial

inclusion, employment generation, and governance so as to enhance efficiency across the board in the economy. It seeks to bring ICT within the reach of the whole of India while at the same time

harnessing the immense human resource potential in the country to

enable it to emerge as the global hub and destination for IT-ITeS Services by 2020. The NeGP was approved by the Government of India in May 2006 to make all government services accessible to the common man in his locality, through common service delivery outlets at affordable costs. The NeGP comprises mission mode projects (MMPs) and core e-infrastructure. Significant progress has been made in laying down core e-infrastructure and in most of the MMPs. More than 97,000 common service centres (CSCs) have

been established across the country as web enabled service access points for making public services available to citizens on anytime, anywhere basis. Initiatives under the NeGP also include online

services related to income tax, Ministry of Corporate

Affairs (MCA) 21, passports, and central excise.

The government has also initiated new e-Governance projects for education, health, public distribution system and postal services. This will ensure the common man access to quality education, cost efficient and quality health care and postal services at affordable costs. The number of public services available to citizens in electronic mode will be expanded through the Electronic Delivery of Services

(EDS) Bill, approved by the union cabinet on 20 December 2011.

PART 4

COMPARISION BETWEEN EXISTING AND START-UP IT COMPANIES WITH RESPECT TO VARIOUS FINANCIAL INSTRUMENTS

Cost of capital- The cost of capital is a term used in the field of financial investment to refer to the cost of a company's funds (both debt and equity), or, from an investor's point of view "the shareholder's required return on a portfolio company's existing securities". It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet.

Debt Equity ratio-The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. Closely related to leveraging, the ratio is also known as Risk, Gearing or Leverage. The two components are often taken from the firm's balance sheet or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company's debt and equity are publicly traded, or using a combination of book value for debt and market value for equity financially.

Now let us analyze the financial statement of some established IT companies-

TATA CONSULTACNY SERVICE(TCS)

Tata Consultancy Services Limited (TCS) is an Indian multinational information technology (IT) services, business solutions and outsourcing Services Company headquartered in Mumbai, Maharashtra. TCS is a subsidiary of the Tata Group and is listed on the Bombay Stock Exchange and the National Stock Exchange of India. It is one of India's most valuable companies and is the largest India-based IT services company by 2012 revenues.

Let us look at the important financial position of the company:-

The revenue of TCS has steadily increased since its inception. The company earned a revenue of INR 48894crores as of 31/3/12 an increase of 23.66% form the FY ending 31/3/11 where it clocked a revenue of INR 37325 crores. In March '10 the same stood at INR 30029 crores.

The operating profit of the company was INR 13517 crores in March '12 vs. INR 10443 crores in March '11 vs. INR 8034 crores in March '10.

Adjusted EPS for March '12 stood at INR 53.07 and the total dividend (equity) paid for the same time period was INR 4839.04 crores.

Total debt (both long term & short term) of the company as of 31/3/12 stood at INR 116.26 crores, while the total equity as of 31/3/12 stood at INR 195.72 crores (195.72 crores equity shares of Re. 1 each).

EBITDA for the company stood at INR 14435.31 crores and EBT stood at INR 13923.31 crores as on 31/3/12.

INFOSYS

Infosys Limited (formerly Infosys Technologies Limited) is an Indian multinational provider of business consulting, technology, engineering, and outsourcing services. It is headquartered in Bangalore, Karnataka. Infosys ranked among the most innovative companies in a Forbes survey, leading technology companies in a report by The Boston Consulting Group and top ten green companies in Newsweek's Green Rankings.

Infosys was voted India's most admired company in The Wall Street Journal Asia 200[8] every year since 2000. The corporate governance practices were recognized by The Asset Platinum award and the IR Global Rankings.

Infosys was also ranked as the 15th most trusted brand in India by The Brand Trust Report.

Let us look at the important financial position of the company:-

The company earned a revenue of INR 31235crores as of 31/3/12 an increase of 18.73% form the FY ending 31/3/11 where it clocked a revenue of INR 25385 crores.

The operating profit of the company was INR 9267crores in March '12 vs. INR 8414 crores in March '11.

Adjusted EPS for March '12 stood at INR 145.83 and the total dividend (equity) paid for the same time period was INR 2001 crores.

The total equity as of 31/3/12 stood at INR 286 crores same as March '11 and total shareholder's fund was INR 31332 crores (March '12). The debt-equity ratio of the company is 0 (zero)

EBIT for the company stood at INR 9267 crores and EBT stood at INR 11699 crores as on 31/3/12.

[NOTE: all figures as per consolidated financial statements]

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