WORKING CAPITAL MANAGEMENT PART 5

Financing of Working Capital

After determining the amount of working capital required, the next step is to arrange funds. Broadly speaking, the working capital finance may be classified between the two categories:

• Spontaneous sources
• Negotiable sources

The Spontaneous sources of finance are those which naturally arise in the course of business operation.

For example: Trade credit, credit from employees, credit from suppliers, accrued expenses etc.

Negotiable sources of finance are those which have to be specifically negotiated with lenders

For example: Loan from commercial banks, financial institutions, general public etc. 

Sources of Finance

Inter-corporate Loans and Deposits: organizations having surplus funds invest for short-term period with other organizations. The rate of interest will be higher than the bank rate of interest and depending on financial soundness of the borrower company.

Commercial Paper (CP): This is an instrument that enables highly rated corporate borrowers for a short-term borrowings and provides an additional financial instrument to investors with a freely negotiable interest rate. The maturity period ranges from minimum 7 days to less than 1 year. However this source of borrowing is not available for small businesses.

Funds Generated from Operation: Funds generated from operation increase the working capital amount by equivalent amount. The two main components of funds generated from operation are profit and depreciation.

Public Deposit: Deposit from the public is one of the important source of finance particularly for well established big companies with huge capital base for short and medium term.

Bill Discounting: In the process of bill discounting, the supplier of goods draws a bill of exchange with direction to the buyer to pay a certain amount of money after a certain period, and gets its acceptance from the buyer or drawee of bill. This bill may be further endorsed to bank or other party.

Factoring:  The concept of factoring has already been discussed in part 4.

Working Capital Finance from Banks: Banks in India today constitute the major suppliers of working capital credit to any business activity. Recently, some term lending financial institutions have also announced schemes for working capital financing. The two committees viz., Tandon Committee and Chore Committee have evolved definite guidelines and parameters in working capital financing.

With this we come to conclusion of this series of Working Capital Management. In the five parts I have tried to cover as much as possible about working capital management, but the concept is very large as it is one of the major contributor for profitability and growth of business.