Working Capital Finance
Introduction
• In India, short term funds are used to finance working capital.
• The significant sources include– Trade credit– Bank borrowing
• Others are– Factoring of receivables– Commercial papers
Slide Title
Trade credit• Credit terms• Benefits • Accrued income• Deffered income
Bank borrowing• Forms of bank finance• Security required
Trade Credit
Trade credit
• Refers to credit that a customer gets from suppliers
• It is an informal agreement, granted on an open account basis
Credit terms• Credit terms refers to conditions under
which the supplier sells on credit to the buyer, and the buyer is required to repay the credit
• Conditions– Due date– Cash discount
Benefits of trade credit
• Spontaneous source of financing• Easy availability• Flexibility• Informality• Stretching accounts payable
Accrued expenses• Accrued expenses represent a liability that a
firm has to pay for the services which it has already received
• Accrued wages & salaries represent obligations payable by the firm to its employees
• Accrued taxes & interests constitute taxes paid after the firm has earned profits
Deferred income• It represents funds received by the firm for
goods & services which it has agreed to supply in future
• In other words, advance payments
Bank borrowing
Bank finance for working capital
Banks are main institutional sources of working capital finance
• Credit limit – amount approved by the bank for the firm’s working capital
• Margin money – it is based on principle of conservatism and is meant to ensure security
Forms of bank finance
• Overdraft• Cash credit• Purchase or discounting of bills• Letter of credit• Working capital loan
• Overdraft– The borrower is allowed to withdraw funds in
excess of the balance in his current account up to a certain limit
• Cash credit – Similar to overdraft. Her the borrower is allowed
to withdraw funds from the bank up to a sanctioned limit
• Purchase or discounting of bills– The borrower can obtain a credit from a bank
against his bills. The bank purchases or discounts the borrower’s bills.
• Letter of credit– Suppliers, particularly the foreign suppliers, insist
that the buyer should ensure that his bank will make the payment if he fails to honor his obligations.
• Working capital loan– Banks provide demand loan account or separate
non operable cash credit account if a borrower requires temporary accommodations in excess of sanctioned credit limit to meet unforeseen contingencies.
Security required in bank finance
• Hypothecation– Borrower is provided with working capital finance
against the security of movable property.– Neither ownership nor possession is passed to the
creditor.
Security required in bank finance
• Pledge – Borrower transfers physical possession of the
property.– Bank has the right to lien and can retain
possession of goods.
Security required in bank finance
• Mortgage – Borrower transfers a legal or equitable interest in
a specific immovable property.• Lien – The bank has the right to retain property
belonging to the borrower.