Various Sources of Working Capital

Various Sources of Working Capital
Financial Management Notes
B.Com Notes (CBCS and Non-CBCS Pattern)

Various Sources of Working Capital

Sources of working capital are many. There are both external and internal sources. The external sources are both short-term and long-term. Trade credit, commercial banks, finance companies, indigenous bankers, public deposits, advances from customers, accrual accounts, loans and advances from directors and group companies etc. are external short-term sources. Companies can also issue debentures and invite public deposits for working capital which are external long term sources. Equity funds may also be used for working capital. A brief discussion of each source is attempted below:

1) Trade Credit

Trade credit is a short term credit facility extended by suppliers of raw materials and other suppliers. It is a common source. It is an important source. Trade credit is an informal and readily available credit facility. It is unsecured. It is flexible too; that is advance retirement or extension of credit period can be negotiated. Trade credit might be costlier as the supplier may inflate the price to account for the loss of interest for delayed payment.

2) Commercial Banks

Commercial banks are the next important source of working capital finance commercial banking system in the country is broad based and fairly developed. Straight loans, cash credits, hypothecation loans, pledge loans, overdrafts and bill purchase and discounting are the principal forms of working capital finance provided by commercial banks.  They provide loan in the following form:

a)      Straight loans are given with or without security. A onetime lump-sum payment is made, while repayments may be periodical or one time.

b)      Cash credit is an arrangement by which the customers (business concerns) are given borrowing facility upto certain limit, the limit being subjected to examination and revision year after year. Interest is charged on actual borrowings, though a commitment charge for utilization may be charged.

c)       Hypothecation advance is granted on the hypothecation of stock or other asset. It is a secured loan. The borrower can deal with the goods.

d)      Pledge loans are made against physical deposit of security in the bank's custody. Here the borrower cannot deal with the goods until the loan is settled.

e)      Overdraft facility is given to current account holding customers t^ overdraw the account upto certain limit. It is a very common form of extending working capital assistance.

f)       Bill financing by purchasing or discounting bills of exchange is another common form of financing. Here, the seller of goods on credit draws a bill on the buyer and the latter accepts the same. The bill is discounted per cash will the banker. This is a popular form.

3) Finance Companies

Finance companies abound in the country. About 50000 companies exist at present. They provide services almost similar to banks, though not they are banks. They provide need based loans and sometimes arrange loans from others for customers. Interest rate is higher. But timely assistance may be obtained.

4) Indigenous Bankers

Indigenous bankers also abound and provide financial assistance to small business and trades. They change exorbitant rates of interest by very much understanding.

5) Public Deposits

Public deposits are unsecured deposits raised by businesses for periods exceeding a year but not more than 3 years by manufacturing concerns and not more than 5 years by non-banking finance companies. The RBI is regulating deposit taking by these companies in order to protect the depositors. Quantity restriction is placed at 25% of paid up capital + free services for deposits solicited from public is prescribed for non-banking manufacturing concerns. The rate of interest ceiling is also fixed. This form of working capital financing is resorted to by well established companies.

6) Advances from Customers

Advances from customers are normally demanded by producers of costly goods at the time of accepting orders for supply of goods. Contractors might also demand advance from customers. Where sellers* market prevail advances from customers may be insisted. In certain cases to ensure performance of contract in advance may be insisted.

7) Accrual Accounts

Accrual accounts are simply outstanding dues to workers, suppliers of overhead service requirements and the like. Outstanding wages, taxes due, dividend provision, etc. are accrual accounts providing working capital finance for short period on a regular basis.

8) Loans

Loans from directors, loans from group companies etc. constitute another source of working capital. Cash rich companies lend to liquidity crunch companies of the group.

9) Commercial Papers

Commercial papers can be used to raise funds. It is a promissory note carrying the undertaking to repay the amount on or after a particular date. Normally it is an unsecured means of borrowing and the companies are allowed to issue commercial papers as per the regulations issued by SEBI and Company’s Act.

10) Debentures and Equity Fund

Debentures and equity fund can be issued to finance working capital so that the permanent working capital can be matchingly financed through long term funds.