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Working Capital Finance

Chapter 4 : Asset-Based Corporate Financial Services. Working Capital Finance. Working Capital. Capital required to meet the recurring expenses. Also known as circulating capital Classified as Gross Working Capital and Net Working Capital

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Working Capital Finance

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  1. Chapter 4 : Asset-Based Corporate Financial Services Working Capital Finance

  2. Working Capital • Capital required to meet the recurring expenses. • Also known as circulating capital • Classified as Gross Working Capital and Net Working Capital • Total of Current Assets is known as Gross working capital • When the Total of Current Liabilities is deducted from Gross Current Asset we get Net Working Capital

  3. Working Capital Finance • Banks finance the working capital gap • Working capital gap is calculated by deducting the current liabilities excluding short-term bank borrowings and current surplus or owners’ contribution from the gross current assets • Working capital is a short-term finance

  4. Forms of Working Capital Finance • Working Capital Finance can be classified as: • Fund-based; and • Non-fund-based • Working capital can be financed by internal accruals also • Trade Creditors extend finance for working capital • Commercial papers are the latest addition to the working capital finance.

  5. Fund-based Working Capital Finance • Cash Credit- Hypothecation • Cash Credit- Pledge • Demand Loan • Bill Finance • Issue of Commercial Paper • Internal Accruals • Trade Creditors

  6. Non-fund Based Working Capital Finance • Letter of Credit • Deferred payment guarantee • Bills co-acceptance • Line of Credit

  7. Cash Credit • Cash Credit- Hypothecation • Running account • Limit is sanctioned based on the lending norms • Security- stock purchased by the loan • Borrower has the custody of the stock and use it for production. The sales proceeds are to be remitted to the account • Periodical inspection is conducted by the bank • Borrower has to submit periodical stock statements based on which drawing limits are decided by the bank. • Usually sanctioned for a period of one year and bank considers renewal based on utilization, financial performance and compliance with the terms of sanction • Interest is charged periodically for the balance outstanding

  8. Cash Credit • Cash Credit- Pledge • Running account • Limit is sanctioned based on the lending norms • Security- stock purchased by the loan • Bank keeps the stock under lock and key and is released only on remitting the corresponding value • In a continuous production process, the borrower will have a pledge and hypothecation limits and the bank debits the hypothecation account for the value of stock released from the pledge account. • Periodical inspection is conducted by the bank • Borrower has to submit periodical stock statements based on which drawing limits are decided by the bank. • Usually sanctioned for a period of one year and bank considers renewal based on utilization, financial performance and compliance with the terms of sanction • Interest is charged periodically for the balance outstanding

  9. Cash Credit • Common Features • Bank collects inspection charges • Penalty is levied for overdrawing as well as default in payment of periodical interest • Limit is fixed based on the Maximum Permissible Bank Finance required to meet the working capital gap • Working capital gap can be calculated using traditional method and as per the norms recommended by Tandon Committee. • Large borrowers have to comply with the norms fixed as per Tandon Committee Norms • The borrower has to submit periodical review statements to the bank

  10. Bill Finance • As per Tandon Committee norms, 75 per cent of the working capital finance should be by way of bill finance • Bills can be Demand Bills or Usance Bills • Demand bills are payable on demand • Usance bills are payable only after the date mentioned in the bill plus the grace period wherever applicable.

  11. Bill Finance Contd… • Demand bills should be paid on presentation whereas the usance bills should be accepted by the buyer of the goods as and when presented • Only trade bills representing genuine trade transactions shall be discounted. • Banks give only discounted value which is calculated by deducting the interest for the period starting from the date of discounting till the estimated date of realization. If the period exceeds, banks will collect the difference interest.

  12. Bill Market Scheme • Reserve Bank of India introduced the Bill Market Scheme in 1952 under Section 17 (4) (c ) of RBI Act 1934 to promote bill culture • The Bill Market Scheme enable RBI to extend credit to scheduled commercial banks against the security of bills provided the following conditions are fulfilled with: • The instruments should be usance promissory notes or bills drawn on and payable in India • The bills should represent bonafide commercial or trade transactions • The instrument should bear two good signatures one of which should be that of a scheduled commercial bank • The bills should mature within 90 days from the date of advance

  13. Bill Market Scheme • In 1958, RBI extended the Bill Market Scheme to export bills also to promote exports • In 1963, a new Export Bill Credit Scheme was introduced • In 1970, the New Bill Market Scheme (NBMS) was introduced • The NBMS made four types of bills eligible under the scheme: • Bills drawn on and accepted by the purchaser’s bank • Bills drawn on the purchaser and the purchaser’s bank jointly and accepted by them jointly • Bills drawn and accepted by the buyer under an irrevocable letter of credit • Bills drawn on and accepted by the buyer and endorsed by the seller in favour of his bank

  14. Bill Market Scheme • RBI also introduced the following measures to promote bills as a form of trade finance: • Lodgment of bills below the face value of Rs.10 lakhs was replaced with derivative bills • Minimum amount of bills stipulated under the scheme was cancelled • Banks were advised to insist 25% of the cash credit limit in the form of bill finance • Government of India permitted remission of stamp duty on bills with tenor of not more than 3 months after the date of sight • Banks were permitted to rediscount with a few financial institutions like LIC, GIC, UTI with approval of RBI • All India Financial Institutions and Mutual Funds were included in the bill market • Discount and Finance House of India (DFHI) was established • Revised procedure was introduced enabling the discounting of derivative bills under the scheme • Banks were permitted to charge the market determined interest rate.

  15. Bill Market Scheme • In 1999 a Working Group on Discounting of Bills by banks was constituted which made the following prominent recommendations: • Introduction of invoice financing • Obtaining post-dated cheques from clients • Introduction of banker’s acceptance • Digital presentation of documents using internet

  16. Working Capital Finance to Exporters • Pre-shipment Finance: • Rupee Packing Credit • Foreign Currency Packing Credit • Advance against Cash Incentives and Duty Drawback • Post-shipment Finance • Purchase/Discounting of Export Bills • Negotiation of Export Bills under LC • Export Bills Re-discounting (Foreign Currency Bills) • Rupee Advance against Export Bills Sent on Collection Basis • Advance against Duty Drawback/Cash Incentives • Advance against Undrawn Balance

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