How would you estimate the capital requirement of a new company?

(A) ESTIMATION OF CAPITAL REQUIREMENTS:

Before approaching the capital market to collect finance, it is essential to determine or estimate the capital requirements of the company. This problem arises either at the time of promotion of a company  or at the time of launching an expansion programme. It is an attempt towards proper capitalization which is necessary for the smooth running of the business. If company is over-capitalized or under-capitalized, it will be harmful to the business and businessmen both. While determining the total capital requirements of a company, the following points should be considered well :-

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I. Cost of Fixed Assets: Fixed assets like building, plant and machinery, furniture etc. form a major proportion of total capital requirements, mainly in capital incisive industries. These assets are permanent assets.

II. Cost of Current Assets: Current assets include stock in trade, debtors and bills receivable, cash and bank balance etc. Sufficient amount of current assets is required for the smooth functioning of the business.

III. Promotional Expenses: Promotional expenses are incurred in formation and incorporation of a company. These expenses include expenses on preliminary investigations, legal and technical advice, drafting and printing of several documents and statements like Memorandum and Articles of Association, etc., registration fee, office expenses, remuneration paid to promoters etc. Promotional expenses are not fixed and therefore, are not easy to be estimated.

IV. Cost of Financing: Cost of financing include expenses on the procurement of capital font the ma nut/pub lie. These expenses include expenses of drafting and printing of prospectus and application forms, expenses on adverting, underwriting commission, brokerage and other expenses on the marketing securities.

V. Cost of Intangible Assets: A new company sometimes has to acquire goodwill patent rights from an existing company. These expenses should also be taken into account while estimating the capital requirement of a new company.

VI. Cost of Developing Business: Often a large company takes some time before it starts generating profits. The operating losses likely to be incurred in the initial stage of its operation or before it reaches break-even point (no profit no loss line) are the cost of developing the business. A good financial plan should also include this cost also in estimating the capital requirement of a new company.

(B) FIXED CAPITAL AND ITS DETERMINANTS:

Fixed capital is that portion of the capital which is represented by the fixed assets such as building, plant and machinery, furniture etc. These assets are used in the business for meeting the permanent needs of the company. These assets are not for sale and are meant again and again for generating revenue. These assets are not convertible into cash within a year. Fixed assets are also known as ‘block capital’ because it is blocked up in  fixed assets for a fairly long time.

DETERMINANTS OF FIXED CAPITAL:

The amount of fixed  capital required in a business concern can be determined on the basis of the following considerations –

I. Nature of Business: An industrial or a public utility concern require a large amount of fixed capital as compared to a trading concern.

II. Type of Manufacturing Process: Processing (analytical and synthetically) industries require a larger/amount of fixed capital than assembly and service industries. If an industry is highly mechanized, its investment in fixed capital is higher as compared to industries having less degree of mechanization.

III. Scale of Operation: A large scale manufacturing unit requires a larger amount of fixed capital than an industrial unit carrying on its operation on small scale. For instance, a large steel plant like Tata Iron and Steel Company, requires huge investment in fixed assets in comparison with a mini steel plant.

IV. Mode of Acquiring Fixed Assets: Mode of acquiring a fixed assets determines the need of fixed capital. A firm may acquire asset on cash down basis (outright purchase for cash) or on hire purchase or installment basis. In former case, the amount of investment in fixed assets will be very high. In the latter case, the need will be very low as the asset can be acquired under this mode only at the time of making initial down payment. Acquiring land and building and other assets or on lease on hire (instead of outright purchase) and the other facility of sub-contracting work to outside firm tend to reduce the fixed capital requirements.

V. Technique of Production: The technique of production also affects the total requirements of fixed capital. If a manufacturing concern using capital intensive technique requires larger amount of fixed capital than the concern of the same size using labour intensive technique. Thus, shifts technology lead to changes in the amount of fixed capital.