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Chapter 30 WORKING CAPITAL FINANCING. Centre for Financial Management , Bangalore. OUTLINE Accruals Trade credit Working capital advance by commercial banks Regulation of bank finance Public deposits Inter-corporate deposits Short-term loans from financial institutions
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Chapter 30 WORKING CAPITAL FINANCING Centre for Financial Management , Bangalore
OUTLINE • Accruals • Trade credit • Working capital advance by commercial banks • Regulation of bank finance • Public deposits • Inter-corporate deposits • Short-term loans from financial institutions • Rights debentures for working capital • Commercial paper • Factoring Centre for Financial Management , Bangalore
ACCRUALS • The major accrual items are wages and provisions. • Accruals vary with the level of activity of the firm. • While accruals are a welcome source of financing, they • are typically not amenable to control by management. Centre for Financial Management , Bangalore
TRADE CREDIT • Trade credit represents the credit extended by the • suppliers of goods and services. It is a spontaneous • source of finance. • The confidence of suppliers is the key to securing trade • credit. • The cost of trade credit is: • Discount % 360 • x • 100 – Discount % Credit period – Discount period Centre for Financial Management , Bangalore
WORKING CAPITAL ADVANCE BY COMMERCIAL BANKS • Application and processing • Sanction, terms and conditions • Forms of bank finance • Cash credits/Overdrafts • Loans • Purchase/Discount of Bills • Letter of credit • Security • Hypothecation • Pledge • Margin amount Centre for Financial Management , Bangalore
MAXIMUM PERMISSIBLE BANK FINANCE (MPBF) • Tandon Committee had suggested three methods for determining the MPBF • Method 1 : MPBF = 0.75 (CA – CL) • Method 2 : MPBF = 0.75 (CA) – CL • Method 3 : MPBF = 0.75 (CA – CCA) – CL • CA = current assets • CL = non-banking current liabilities • CCA = core current assets Centre for Financial Management , Bangalore
PUBLIC DEPOSITS • These are unsecured deposits from the public. • Public deposits cannot exceed 25 percent of share capital • and free reserves. • The maximum maturity period allowed for public • deposits is 3 years. However, for NBFCs it is 5 years. Centre for Financial Management , Bangalore
INTER-CORPORATE DEPOSITS • A deposit made by one company with another, normally • for a period up to six months is referred to as an inter- • corporate deposit. • Inter-corporate deposits are typically unsecured. • Inter-corporate deposits are usually of three types: call • deposits, three-month deposits, and six-month deposits. Centre for Financial Management , Bangalore
SHORT-TERM LOANS FROM FINANCIAL INSTITUTIONS • Insurance companies provide short-term loans to • manufacturing companies with an excellent track record. • Such loans are unsecured and given for a period of 1 • year, renewable for two consecutive years. • A company, to be eligible for such loans, should satisfy • certain conditions relating to dividend payment, debt- • equity ratio, current ratio, and interest cover ratio. Centre for Financial Management , Bangalore
RIGHTS DEBENTURES FOR WORKING CAPITAL • A company can issue “rights” debentures to its shareholders • to augment the long-term source for working capital • requirements • The key guidelines applicable to “rights” debentures relate to • the quantum of such issues and the debt : equity ratio Centre for Financial Management , Bangalore
COMMERCIAL PAPER • Commercial paper represents short-term unsecured • promissory notes issued by firms which enjoy a fairly • high credit rating. • Commercial paper is either directly placed with • investors or sold through dealers • The effective pre-tax cost of commercial paper is: • Face value – Net amount realised 360 • Net amount realised Maturity period Centre for Financial Management , Bangalore
FACTORING A factor is a financial institution which offers services relating to management and financing of debt arising from credit sales. customer Centre for Financial Management , Bangalore
SUMMING UP • Typically, the current assets of the firm are supported by • a combination of long-term and short-term sources of • financing. • The following sources of finance more or less exclusively • support current assets: accruals, trade credit, working • capital advance by commercial banks, public deposits, • inter-corporate deposits, shot-term loans from financial • institutions, rights debentures for working capital, • commercial paper, and factoring. Centre for Financial Management , Bangalore