2. Working Capital Finance
Working capital financing is done by various
modes such as trade credit, cash credit / bank
overdraft, working capital loan, purchase of bills /
discount of bills, bank guarantee, letter of credit,
factoring, commercial paper, inter corporate
deposits etc.
Types of Working Capital Finance:
Trade Credit: This is simply the credit period which
is extended by the creditor of the business. Trade
credit is extended based on the creditworthiness of
the firm which is reflected by its earning records,
liquidity position and records of payment.
3. Cash Credit / Bank Overdraft: Cash credit or bank
overdraft is the most useful and appropriate type of
working capital financing extensively used by all
small and big businesses. It is a facility offered by
commercial banks whereby the borrower is
sanctioned a particular amount which can be utilized
for making his business payments.
Working Capital Loans: Working capital loans are
as good as term loan for a short period. These loans
may be repaid in instalments or a lump sum at the
end.
Discount of Bills: For a business, it is another good
service provided by commercial banks for working
capital financing. Every firm generates bills in the
normal course of business while selling goods to
debtors. Ultimately, that bill acts as a document to
receive payment from the debtor.
4. Bank Guarantee: It is primarily known as non fund based
working capital financing. Bank guarantee is acquired by
a buyer or seller to reduce the risk of loss to the opposite
party due to non performance of agreed task which may
be repaying of money or providing of some services etc.
Letter of Credit: It is also known as non fund based
working capital financing. Letter of credit and bank
guarantee has a very thin line of difference. Bank
guarantee is revoked and bank makes payment to the
holder in case of non performance of the opposite party
whereas in case of letter of credit, the bank will pay the
opposite party as soon as the party performs as per
agreed terms.
Factoring: Factoring is an arrangement whereby a
business sells all or selected accounts payables to a third
party at a price lower than the realizable value of those
accounts.
5. Sources of working capital:
Sources of working capital can be spontaneous,
short term and long term.
Spontaneous working capital includes mainly
trade credit such as sundry creditor, bills payable,
and notes payable.
Short term sources are tax provisions, dividend
provisions, bank overdraft, cash credit, public
deposits, bills discounting, short term loans and
commercial paper.
Long term sources are retained profits, provision
for depreciation, share capital, long-term loans,
and debentures.
6. Spontaneous Sources Short Term Sources Long Term Sources
Internal Sources External Sources Internal Sources External Sources
Trade Credit Tax Provisions Bank Overdraft Retained Profits Share Capital
Sundry Creditors Dividend Provisions Trade Deposits
Depreciation Provisio
n Long Term Loans
Bills Payable Public Deposits Debentures
Notes Payable Bills Discounting
Accrued Expenses Short Term Loans
7. Spontaneous Sources of
Working Capital Finance
The word ‘spontaneous’ itself explains that this
source of working capital is readily or easily available
to the business in the normal course of business
affairs.
The quantum and terms of this credit depends on the
industry norms and relationship between buyer and
seller. These sources include trade credit allowed by
the sundry creditors, credit from employees, and
other trade related credits.
The biggest benefit of spontaneous sources as
working capital is its effortless raising and
insignificant cost compared to traditional ways of
financing
8. Short Term Sources of Working
Capital Finance
Short term sources can be further divided
into internal and external sources of working
capital finance. Short term internal sources
include tax provisions, dividend provisions
etc.
Short term external sources include short
term working capital financing from banks
such as bank overdrafts, cash credits, bills
discounting, short-term loans, commercial
paper, etc.
9. Long Term Sources of
Working Capital Financing
Long term sources can also be divided into internal
and external sources. Long term internal sources of
finance are retained profits and provision for
depreciation whereas external sources are share
capital, long term loan, and debentures.
Retained profits and accumulated depreciation are
as good as funds available to the business without
any explicit cost. These are the funds completely
earned and owned by the business itself. They are
utilized for expansion as well as working capital
finance.