Ch_031

Chapter - 31

Working Capital Finance

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

BY Akash Saxena

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.

BY Akash Saxena

Pros and Cons 

Advantages
1. 2. 3.

Easy Availability. Flexibility. Informality. Implicit Cost. Stretching A/P can prove to be very costly. 

Disadvantages
1. 2.

BY Akash Saxena

Accrued Expenses and Differed Income 

Accrued Expenses
1. 2.

Accrued Wages and Salaries. Accrued taxes and Interest. Advance Payments. 

Deferred Income
1.

BY Akash Saxena

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

BY Akash Saxena

Security for Bank Finance 
Hypothecation  Pledge  Mortgage  Lien

BY Akash Saxena

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.

BY Akash Saxena

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.

BY Akash Saxena

The Tandon Committee Recommendations 
  

Operating Plan Production Based Financing Partial Bank Financing Maximum Permissible Bank Finance
1. 2. 3.

First Method Second Method Third Method

BY Akash Saxena

The Chore Committee Recommendations 
Reduced Dependence on Bank Credit.  Credit limit to be separated into ³peak level´

and ³normal peak level´ limits.  Existing Lending System to Continue.  Information System.

BY Akash Saxena

Commercial Paper 
Unsecured promissory notes issued by firms to

raise short-term funds.  In India introduced in 1989 on recommendation of the ³Vaghul Working Group´.  Commercial papers sell at a discount from face value.
¸ 360 ¨ FaceValue ± Sale Price ¸ ¨ Implied Yield ! © ¹© ¹ Sale Price ays o Maturity º ª ºª

BY Akash Saxena

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.
BY Akash Saxena

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