Finance Roll

Introduction: Every business needs money to run. The nature of expenses incurred by the business, decides the type of financing required by it. As an example, payroll expenditure, common to all businesses, is a recurring expenditure, required fortnightly, or monthly, to remunerate the workforce. On the other hand, funds to buy an office building for the business, is required, once in probably several decades. Whereas the former is a short term expenditure requiring short term financing, the latter is a long term one, requiring correspondingly long term financing.
 
There are various sources of finance available to a firm, depending on its needs, as also its eligibility to source such finance. Banks and Financial Institutions are, of course, the major and most widely accessed source of funds.
 
But there are situations, when a firm is either not in a position to access Bank funds on account of various constraints, or it is in such a strong financial position, as to raise funds on more favorable terms by taking the unconventional route of issuing Commercial Paper.
 
Commercial Paper (CP): Commercial Paper is an unsecured, short-term, debt instrument, in the form of a usance promissory note, issued at a discount to face value, to meet short term financing requirements.

Rules regarding the issue and conduct of the Commercial Paper business differ from country to country. However, some of the common features of the CP are that it is unsecured. It is a short-term debt instrument, not over one year in maturity. It is issued at a discount on its face value, i.e., its maturity value is equal to its face value. Higher the creditworthiness of the issuer, lower the discount allowed.

It is meant to raise funds to meet the short term expenses of the firm, like those related to payroll, inventories and the like. It is not meant to be invested in long term asset like land, buildings, plant and machinery etc. However, some firms do use the funds from CP for long term requirements, which is called "bridge-financing", as a stop gap arrangement to long term financing.
 
Who can issue: From the definition of Commercial Paper, as given above, it may be inferred that only highly rated companies and financial institutions can issue CP, as it is unsecured. The investors can only depend upon the creditworthiness of the issuer, and have no other support, like collateral, to fall back on, in case of the issuer's default.
 
Normally, two types of firms may issue CP. One, a firm that does not find the traditional financing methods convenient and or economical. Second, a firm, which, by virtue of its financial standing, and rating, is able to command the most favorable terms for its borrowings. Such firms, instead of approaching financiers, issue their own debt instruments, in the form of CP, as and when required.
 
However, it is also observed that firms, not enjoying the best ratings are also in the fray with this product (CP), with the help of a tie-up with their better rated peers.
 
Benefits of CP to the issuer:

• In many countries, rules regarding the issue and conduct of the Commercial Paper business are quite liberal, and do not attract the normally comprehensive set of regulations, applicable to other debt instruments, like bonds.
• The cost of funds obtained through the CP route is generally less than that from the Banking sector.
• The issuers, being top rated, and with good standing, do not have to provide any collateral to the investors.
• The issuers have the freedom to fix the discount on the face value of the CP, depending on their creditworthiness.
• Issuers can avoid brokers and dealers, by going directly to the investors, and saving on administrative and other costs.
• Issuers have the option to "roll over" their debt, i.e. issue fresh CP to pay off the maturing one.

Summary: To sum up, Commercial Paper is a niche financing option, available to financially sound firms, that has more advantages than disadvantages for the issuing firms.