2801

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.