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Chapter - 31: Working Capital Finance

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67 views

Chapter - 31: Working Capital Finance

Uploaded by

palak bansal
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter - 31

Working Capital Finance


Short-term Sources of Finance
 Trade Credit
 Accrued Expenses and Deferred Income
 Bank Borrowings
 Factoring of receivables
 Commercial Paper

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Trade Credit
 Customer gets from supplier of goods in
normal course of business.
 An informal arrangement, granted on an open
account basis, not formally acknowledge as a
debt.
 Trade credit may also take the form of bills
payable.
 Credit Terms refers to the conditions of due
date and cash discount.

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Pros and Cons
 Advantages
1. Easy Availability.
2. Flexibility.
3. Informality.
 Disadvantages
1. Implicit Cost.
2. Stretching A/P can prove to be very costly.

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Accrued Expenses and Differed Income
 Accrued Expenses
1. Accrued Wages and Salaries.
2. Accrued taxes and Interest.
 Deferred Income
1. Advance Payments.

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Bank Finance for Working Capital
 Overdraft
 Cash Credit
 Purchase or Discounting of Bills
 Letter of Credit
 Working Capital Loan

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Security for Bank Finance
 Hypothecation
 Pledge
 Mortgage
 Lien

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Regulation of Bank Finance
 Dehejia Committee (1968)
 Tandon Committee (1974)
 Chore Committee (1979)
In the deregulated economic environment in
India recently, banks have considerably
relaxed their criteria of lending. In fact, each
bank can develop its own criteria for the
working capital finance.

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Dehejia Committee–Existing
Deficiencies
 It is the borrower who decides how much he would
borrow; the banker does not decide how much he
would lend and is, therefore not in a position to do
credit planning.
 The bank credit is treated as first source of finance
and not as supplementary to other source of finance.
 The amount of credit extended is based on the
amount of security available, not on the level of
operations of borrower.
 Security does not by itself ensure safety of bank
funds since all bad and sticky advances are secured
advances; safety essentially lies in the efficient
follow-up of the industrial operations of the borrower.

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The Tandon Committee
Recommendations
 Operating Plan
 Production Based Financing
 Partial Bank Financing
 Maximum Permissible Bank Finance
1. First Method
2. Second Method
3. Third Method

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The Chore Committee
Recommendations
 Reduced Dependence on Bank Credit.
 Credit limit to be separated into “peak level”
and “normal peak level” limits.
 Existing Lending System to Continue.
 Information System.

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Commercial Paper
 Unsecured promissory notes issued by firms to
raise short-term funds.
 In India introduced in 1989 on recommendation
of the “Vaghul Working Group”.
 Commercial papers sell at a discount from face
value.
 FaceValue – Sale Price   360 
Implied Yield    
 Sale Price   Days of Maturity 

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Merits and Demerits
 Merits
1. Alternative Source of Finance.
2. High Liquidity in Money Market.
3. Low Cost of C.P.
4. Investors – Investment of Surplus funds.
 Demerits
1. Impersonal Method of financing.
2. Only available to financially sound companies.
3. Can not be redeemed until maturity.
4. Limited to the amount of excess liquidity of
purchasers.

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