c




  

  
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‡ c
 





 refers to
current assets and current liabilities
‡ There are two concepts of working capital:
‡ 

 
 i.e. current assets
‡ 

 
 i.e. current assets ± current
liabilities
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: it is a continuous
process of making decisions relating to short term
financing it deals with current assets and current
liabilities.
‡ Management of working capital refers to the
management of current assets as well as current
liabilities
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‡ ¦ : under this policy the investment in
current asset is high. This means that a firm has huge
balance of cash and marketable securities, large
amount of inventories, and high level of debtors.
‡ 


 : under this policy the investment
in current asset is low. This means that firm has small
balance of cash and marketable securities, small
amount of inventories, and low level of debtors.
 ?

‡ Determining the optimal level of current assets
involves a tradeoff between costs that rise with
current assets (carrying costs) and costs that fall with
current assets (shortage costs)
‡ ?

 

are mainly in nature of
the cost of financing a higher level of current assets.
‡ 

 

 are mainly in the form of
disruption in production schedule, loss of sale, and
loss of customer goodwill.
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‡ Expenses incurred but not paid. The major accruals items are
wages and taxes. Since no interest is paid by the firms on its
accruals they are often regarded as free source of finance they
are a good source of finance but they are not under the control
of management
 
  

‡ Refers to the credit that a customer gets from suppliers of
goods in the normal course of business. In practice the buying
firm do not have to pay cash immediately for the purchases
made. This delay of payment is a short term financing called
trade credits it contributes to about one third of the short term
financing .
‡ 


 
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‡ Earnings record over a period of time

‡ Liquidity position
‡ Record of payment
‡ Cultivating good supplier relationship
 

‡ Benefits
‡ Easy availability
‡ Flexibility
‡ Informality
  





  



‡ Bank finance are the main institutional sources of working
capital finance in India.
‡ Bank considers firms sales and production plans and the
desirable level of current assets in determining the working
capital requirements. The amount approved is called credit
limit.
‡ In practice banks do not lend 100% of the credit limit they
deduct margin money. Margin requirement is meant to ensure
security
  


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‡ Many firms have solicited unsecured deposits from the public
in recent years, mainly to finance their working capital
requirements.
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‡ The procedure for obtaining public deposits is fairly simple
‡ No restrictive covenant (agreement or contract) are involved
‡ No security is offered against public deposit
‡ The post-tax cost is fairly reasonable
 ?

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‡ Rate of interest is higher than other alternatives
‡ The maturity period is fairly short- one to three years
‡ "

‡ ! 
  
‡ The quantum of funds that can be raised by way of public
deposit is limited.
‡ The maturity period is relatively short
‡ ! 
 
‡ No security offered by the company
‡ Interest on public deposits is not exempt from taxation
 O


  

‡ A deposit made by one company with another, normally for
a period up to six months, is referred to as inter corporate
deposit.
‡ These are of three types
‡ Call deposits: in theory, a call deposit is withdrawable by
the lender on giving a day¶s notice. In practice, however, the
lender has to wait for at least three days. The interest rate on
these deposits may be around 10% per annum
‡ Three months deposit : most popular in practice the interest
rate on such deposits is around 12% per annum
‡ Six month deposit : normally lending companies do not
exceed deposits beyond this time they carry interest rate of
around 15% per annum.
 ?

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‡ The Life Insurance Corporation of India and the General

Insurance Corporation of India provide short-term loans to
manufacturing companies with an excellent track record.
‡ ¦


‡ They are totally unsecured and are given on the strength of a
demand promissory note.
‡ The loan is given for a period of 1 year and can be renewed for
two consecutive years
‡ After a loan is repaid, the company will have to wait for at
least 6 months before availing of a fresh loans
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‡ Public limited companies can issue rights debentures to their
shareholders with the object of augmenting the long term resources
of the company for working capital requirements.
‡  
 


‡ The amount of debenture issue should not exceed (a) 20 percent of
the gross current assets , loans and advances minus the long term
funds presently available for financing working capital, or (b) 20
percent of the paid up share capital, including preference capital and
free reserves, whichever is lower of the two
‡ The debt : equity ratio , including the proposed debenture issue,
should not exceed 1:1
‡ The debenture shall first be offered to the existing Indian resident
shareholders of the company on a pro rata basis
 ? 

 
‡ Commercial paper represents short-term unsecured promissory
notes issued by the firms which enjoy a fairly high credit rating.
Generally, large firms with considerable financial strength are
able to issue commercial paper.
‡ ¦


‡ The maturity period of commercial paper usually range from 90
days to 360 days.
‡ Commercial paper is sold at a discount from its face value and
redeemed at its face value. Hence the implicit interest rate is a
function of the size of discount and the period of maturity.
‡ Commercial paper is either directly placed with investors who
intend holdings it till its maturity hence there is no well
developed secondary market for commercial paper
 

 
‡ A factor is a financial institution which offers services
relating to management and financing of debts arising from
credit sales.
‡ While factoring is well established in developed countries
like USA and UK. It has extended to number of other
countries in recent past including India. Subsidiaries of four
Indian banks provide factoring services.
‡ Factoring is a unique financial innovation. It is both a
financial as well as management support to a client.
‡ It is a method of converting a non productive, inactive
asset(receivables) into a productive asset (cash) by selling
receivables to a company that specializes in their collection
and administration
 ?

‡ Features
‡ The factor selects the account of the client that would be
handled by it and establishes, along with the client, the credit
limits applicable to the selected accounts.
‡ The factor assumes responsibility for collecting the debt of
accounts handled by it. For each account, the factor pays to the
client at the end of the credit period or when the amount is
received whichever is earlier.
‡ The factor advances money to the client against not yet
collected or not yet due debts. Typically the amount advanced
may be 70 to 80% of the face value of the debt .
 ?

‡ It carries an interest rate which may be equal to or marginally
higher then the lending rate of commercial banks.
‡ Factoring may be on a recourse basis (that means the credit
risk is borne by the client ) or on a non recourse basis (
means credit risk is borne by the factor)
‡ Besides the interest on advances against debt the factor
charges a commission which may be 1 to 2 percent of the face
value of the debt factored


  



 ¦
 
 ? 


 


:Under such arrangement a
predetermined limit for borrowing is specified by the bank, the
borrower can draw as often as required provided it should be in
cash credit or overdraft limit.
 Interest is charged on the amount actually withdrawn.
 There is no requirement to borrow the entire sanctioned credit
at once, rather he can draw periodically to the extent of his
requirement.
 Overdraft have some minimum charges but in cash credit there
is no such charge. Cash credit limits are sanctioned against the
securities of current assets.
 

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‡ These are advances of fixed amount which are credited to the
current account of the borrower or released to him in cash.
‡ The borrower is charged with interest on the entire amount
irrespective of how much he withdraws.
‡ Loans are payable either on demand or in periodical
installments. When payable on demand, loans are supported by
a demand promissory note executed by the borrower. There is
often a possibility of renewing the loan.
 ?

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‡ Under the purchase or discounting of bill a borrower can
obtain credit from a bank against its bills.
‡ The bank purchases or discounts the borrowers bills. The bill
may be either clean or documentary.
‡ Though the term bill purchased implies that the bank become
owner of the bills, in practice bank holds bills as security for
the credit.
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‡ Suppliers particularly the foreign suppliers insist that the buyer

should ensure that his bank will make the payments if he fails
to honour its obligations.
‡ This is ensured through a letter of credit arrangement. Bank
opens a letter of credit in favor of a customer to facilitate his
purchase of goods, if the customer does not pay to the supplier
within the credit period the bank makes the payment under the
letter of credit arrangement.
‡ This arrangement passes the risk of suppliers to the bank.
‡ Bank charges the customer for opening the letter of credit. It
is an indirect financing.
 ?

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 Under hypothecation, the borrower is provided with working capital
finance by the bank against the security of moveable property,
generally inventories. The borrower does not transfer the property to
the bank and the possession remains with the owner itself.
 u 
 Under this arrangement, the borrower is required to transfer the
physical possession of the property offered as a security to the bank
to obtain credit the banker has a right of lien and can retain
possession of the goods pledged unless payment of interest ,
principal and any other expenses is made.
 ?

‡ à

 : is the transfer of legal or equitable interest in a
specific immovable property for the payment of debt. In this
case the possession of the asset will remain with the borrower
and the lender getting full legal title. Borrower is called as
mortgagor, the bank is called the mortgagee, and the
instrument of transfer is called the mortgage deed.
‡ $ : means right of the lender to retain property belonging to
the borrower until he repays credit. There are two types of lien
particular lien and general lien. Banks usually enjoy general
lien.
 ?

 À   


  
 
 The recommendations of Tondon committee are based on
the following notions:
 

 
 The borrower should indicate the likely demand for credit.
For this purpose he should draw the operating plans for the
ensuing year and supply them to the banker.
 This procedure will facilitate credit planning at the bank
level.
 It will also help the banker in evaluating the borrower¶s
credit needs in a realistic manner and in the periodic follow
up during the ensuing year
 ?

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‡ The banker should finance only the genuine production
needs of the borrower.
‡ The borrower should maintain responsible level of
inventory and receivable.
‡ He should hold just enough to carry on his target
production. Efficient management of resources should,
therefore, be ensured to eliminated slow moving and flabby
inventories.
 ?

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‡ The working capital needs of the borrower cannot be
entirely financed by the banker.
‡ The banker will finance only a reasonable part of it for the
remaining the borrower should depend upon his own funds,
generated internally or externally.
  



  

 
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 In view of the above approach to bank lending, the
committee suggested the following three methods of
determining permissible level of bank borrowing:
 ¦

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 In the first method, the borrower will contribute 25 percent
of the working capital gap; the remaining 75 percent can be
financed from bank borrowings. This method will give a
minimum current ratio of 1:1
 MPBF = 0.75 (CA-CL)
 CA = current assets as per the norms
 CL = non bank current liabilities like trade credit and
provisions
 ?

‡  à

‡ In the second method, the borrower contribute 25 percent of
the total current assets. The remaining of the working capital
gap (i.e. the working capital gap less the borrower¶s
contribution) can be bridged from the bank borrowings. This
method will give a current ratio of 1.3:1
‡ MPBF= 0.75(CA)-CL
 ?

‡ ! 
à

‡ In the third method, the borrower will contribute 100 percent
of 

&as defined and 25 percent of the balance of
current assets. The remaining of the working capital gap can
be met from the borrowings. This method will further
strengthen the current ratio.
‡ MPBF= 0.75(CA-CCA)-CL
‡ CCA= core current assets : this represents the permanent
component of working capital.
  



 
‡ $ 

: the sources of long term financing
include ordinary shares capital, preference share capital,
debentures, long term borrowings and reserves and surplus.
‡ 



short term financing is obtained for a
period less then 1 year. It includes loans from banks, public
deposits, commercial papers, factoring of receivables etc.
 

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‡ The term working capital leverage, refers to the impact of level
of working capital on company¶s profitability.
‡ Higher level of investment in current assets than is actually
required means increase in the cost of interest charges on the
short term loans and working capital finance raised from banks
etc. and will result in lower return on capital employed and
vice versa. Working capital leverage measures the
Responsiveness of ROCE ( return on capital employed) for
changes in current assets.
‡ It is calculated by using the following formula:
‡ Working capital leverage = C.A
T.A ± D.C.A
‡ C.A= Current Assets
‡ T.A= total assets (i.e., net fixed assets +current assets)
‡ D.C.A = change in current assets.


 
 
  



‡ Nature of business
‡ Seasonality of operations
‡ Production policy
‡ Market conditions
‡ Conditions of supply