Sources of working capital finance

Accruals Trade credit Advances by banks Public deposits Inter corporate deposits Short term loans form financial institutions and NBFCs Rights debentures for working capital Commercial paper Factoring International factoring Forfaiting

Trade Credit and Credit Terms

Refers to the credit that the 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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Benefits and Costs of Trade Credit

Benefits
1. Easy Availability. 2. Flexibility. 3. Informality.
Suppliers sometimes offer cash discount to buyers for making prompt payment. Buyer should calculate the cost of foregoing cash discount to decide whether or not cash discount should be availed. The following formula can be used:

Costs
1. Implicit Cost. 2. Stretching A/P can prove to be very costly.

ACCRUED EXPENSES AND DEFERRED INCOME

Accrued Expenses
Accrued expenses represent a liability that a firm has to pay for the services which it has already received. 1. Accrued Wages and Salaries. 2. Accrued taxes and Interest.

Deferred Income

Deferred income represents funds received by the firm for goods and services which it has agreed to supply in future. 1. Advance Payments.

A commercial paper is an unsecured money market instrument issued n the form of a promissory note. Since the CP represents an unsecured borrowing in the money market, the regulation of CP comes under the purview of the Reserve Bank of India which issued guidelines in 1990 on the basis of the recommendations of the Vaghul Working Group. These guidelines were aimed at: (i) Enabling the highly rated corporate borrowers to diversify their sources of short term borrowings, and (ii) To provide an additional instrument to the short term investors. It can be issued for maturities between 7 days and a maximum upto one year from the date of issue. These can be issued in denominations of Rs. 5 lakh or multiples therefore. Accruals : spontaneous source of wc. An accrual expense is an expense that has been incurred but has not yet been paid.

Merits
1. It is an alternative source of raising shortterm finance. 2. It is a cheaper source of finance in comparison to the bank credit. 3. From an investors point of view, it provides an opportunity to make a safe, short-term investment of surplus funds.

Demerits
1. It is an impersonal method of financing. 2. A firm facing temporary liquidity problems may not be able to raise funds by issuing new paper. 3. The amount of loanable funds available in the commercial paper market is limited to the amount of excess liquidity of the various purchasers of commercial paper. 4. It cannot be redeemed until maturity.

Factoring involves provision of specialised services relating to credit investigation, sales ledger management, purchase and collection of debts, credit protection as well as provisions of finance against receivables and risk bearing. In factoring, accounts receivables are generally sold to a financial institution that charges commission and bears the credit risks associated with it.

Public deposits - Public deposit is the source of fund for private and non-banking companies. It means to accept fund from public in the form of deposit. The interest on these deposits is more than interest which is given by banks and post offices. Company law 1956s section 58A provides the power to central govt. to make rules and regulation for controlling public deposits.
The maximum maturity period for a public deposit is 3 years The minimum maturity period for public deposits is 6 months The maximum maturity period for a public deposit for Non-Banking Financial Corporation is 5 years The public deposits of a company cannot go past 25% of free reserves and share capitals The companies asking for public deposits need to publish information regarding the position and financial performance of the firm The companies having public deposits need to keep aside the 10% of the deposits by 30th April every year that will mature by 31st March next year.

 Inter-corporate deposits are deposits made by one company with another company, and usually carry a term of six months. The three types of intercorporate deposits are: three month deposits, six month deposits, and call deposits. Rights debenture for Wc Public limited companies can issue rights to share holders. Factoring is a financial transaction whereby a business sells its accounts receivable
(i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset) not the firms credit worthiness. Secondly, factoring is not a loan it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

Forfaiting is the purchase of receivables alongwith avalised negotiable instruments like promissory note or bills of exchange (without recourse to any previous holder of the instruments) due on a specific date to be matured in future and arising from the exports of goods on credit.

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

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What should be the mix of short-term & long-term sources of finance?

1. Matching/ Hedging approach 2. Conservative approach
3. Aggressive approach