Chapter - 31

Working Capital Finance

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

Financial Management, Ninth 2

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.

Financial Management, Ninth 3

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.

Financial Management, Ninth 4

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

Financial Management, Ninth 5

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

Financial Management, Ninth 6

Security for Bank Finance
Hypothecation
Pledge
Mortgage
Lien

Financial Management, Ninth 7

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.

Financial Management, Ninth 8

Dehejia CommitteeExisting
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.

Financial Management, Ninth 9

 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

Financial Management, Ninth 10

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.

Financial Management, Ninth 11

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

Financial Management, Ninth 12

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.

Financial Management, Ninth 13