WORKING CAPITAL MANAGEMENT CHAPTER – 1 INTRODUCTION OF WORKING CAPITAL Working capital is the employment of current assets and current liabilities in such a way as to increase short-term liquidity. Working capital management is a significant fact of financial management due to the fact that it plays a crucial role in keeping the wheels of business enterprise running. Working capital management is concerned with the short-term financial decisions, which have been comparatively neglected in the literature of finance. Shortage of funds for working capital has caused many businesses to fail. Lack of efficient and effective utilization of working capital leads to low rate of returns on capital employed or even compels to sustain loses. The need for skilled working capital has become greater in recent years. A firm usually invests a part of its permanent capital in fixed assets and keeps a part of it for working capital, for example meeting day-to-day requirements. The requirement of working capital varies from firm to firm, depending on the nature of business, production policy, market conditions, seasonality of operation, condition of supply etc. Working capital to a company is like a blood of human body. It is the most vital ingredient of business. Working capital if carried out effectively and efficiently and consistently, will assure the health of an organization. 1
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WORKING CAPITAL MANAGEMENT
CHAPTER – 1
INTRODUCTION OF WORKING CAPITAL
Working capital is the employment of current assets and current liabilities in
such a way as to increase short-term liquidity. Working capital management is a
significant fact of financial management due to the fact that it plays a crucial role in
keeping the wheels of business enterprise running. Working capital management is
concerned with the short-term financial decisions, which have been comparatively
neglected in the literature of finance. Shortage of funds for working capital has
caused many businesses to fail. Lack of efficient and effective utilization of working
capital leads to low rate of returns on capital employed or even compels to sustain
loses. The need for skilled working capital has become greater in recent years.
A firm usually invests a part of its permanent capital in fixed assets and keeps
a part of it for working capital, for example meeting day-to-day requirements. The
requirement of working capital varies from firm to firm, depending on the nature of
business, production policy, market conditions, seasonality of operation, condition of
supply etc. Working capital to a company is like a blood of human body. It is the
most vital ingredient of business. Working capital if carried out effectively and
efficiently and consistently, will assure the health of an organization.
Every organization has to arrange for adequate funds for meeting day-to-day
expenditure, apart from investment from fixed assets. Working capital is the flow of
ready funds necessary for the working of the enterprise. It consists of funds invested
in current asset of that asset, which in the ordinary course of business, can be turned
into cash within a brief period without undergoing reduction in value and without
disruption of organization. Current liabilities are those indented to be paid in ordinary
course of business within a short period of time. Working capital serves the fallowing
purposes: -
1. To meet the cost of inventories, raw materials purchases, work in progress,
finished goods etc.
2. To pay wages and salaries.
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3. To meet overhead cost, factory cost, office and administration cost, taxes,
selling distribution expense, packing, advertisements etc.
FIG 1.1 CIRCULATION OF CURRENT ASSET
CHAPTER – 2
DEFINITION OF WORKING CAPITAL
2
INVENTORIES
CASH
RECEIVABLES
WORKING CAPITAL MANAGEMENT
In case of gross working capital, it is the concept that focus attention of two
aspects of current asset management:
1. Optimum investment in current asset.
2. Financing of current assets.
Following definitions of working capital place emphasis on gross working
capital.
1. According to Mead, Mallot & Field. “Working capital means current assets”.
2. According to Bonneville. “Working capital is any acquisition of funds which
increase the current asset, increases working capital, for they are one and the
same.”
3. According to J.S Mills. “The sum of current asset is the working capital of
the firm”.
Now let us look at the definitions of net working capital. It reflects the modern
concept of working capital, which is also most commonly used. According to the new
concept of working capital it refers to the difference between current asset and
current liability. It is the excess of current asset over current liability. Current liabilities
refer to the claims of outsiders, which are expected to mature for payment within an
accounting year. It includes creditors for goods, bills payable, bank overdraft etc. The
concept may be better understood in the fallowing equation: -
WORKING CAPITAL = CURRENT ASSET – CURRENT LIABILITY.
The net working capital (a) indicate the liquidity position of the firm and (b)
suggest the extend to which working capital needs to be financed by permanent
sources of fund. Both the net and gross concept of working capital is the two facets
of working capital management.
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Net working capital may be of the fallowing type:
Positive and quantitive net working capital: - It arises when current asset
exceeds current liability.
Negative or quantities net working capital: - It occurs when current
liabilities are in excess of current asset.
CHAPTER – 3
CLASSIFICATION OF WORKING CAPITAL
Working capital may be classified on the fallowing basis:
1. On the basis of concept:
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I. Gross working capital (represented by the total current asset).
II. Net working capital (excess of current asset over current liabilities).
2. On the basis of periodicity of requirements:
I. Fixed or permanent working capital: It represents that part of capital
permanently locked up in the current asset to carry out the business smoothly.
This investment in current asset increase as the size of business expands.
Examples of such investment are those required to maintain the minimum stock
of raw material, work in progress, finished products, loose tools and
equipments. This arrangement requires minimum cash balance to be kept in
reserve for payment of wages salaries and all other current expenditure
throughout the year. The permanent fixed working capital may again be
subdivided into fallowing:
(A) Regular working capital: It is the minimum amount of liquid capital
required to keep up the circulation of the capital from cash to inventories; to
receivables and again to cash. This includes sufficient minimum cash balance
to discount all bills and to maintain adequate supply of raw material etc.
(B) Reserve margin or cushion working capital: It is the excess capital over
the needs of regular working capital, that should be kept in reserve for
contingencies, that may arise at any time. These contingencies include rising
price, strikes, business decompressions, special operation such as
experiment with new product etc.
II. Variable working capital: Variable working capital changes with the increase or
decrease in the volume of business. It may be subdivided into fallowing: -
{A} Seasonal variable working capital: The working capital required to meet
the seasonal liquidity of business is seasonal variable working capital.
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{B} Special variable working capital: It is that part of variable working capital,
which is required for financing special operation such as extensive marketing
campaigns, experiment with product or methods of production, carrying of
special jobs etc.
CHAPTER – 4
ADEQUACY OF WORKING CAPITAL
Working capital or investment in current asset is a must for meeting the day-
to-day expenditure on salaries, wages rent, advertising etc and for maintaining the
fixed asset. Large-scale capital in fixed asset is often determined by relatively small
amount of current asset. The heart of industry, working capital, if weak the business
cannot prosper and survive, although there may be a large investment of fixed
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assets. Inadequate as well as superfluous working capital is dangerous for the health
of the industry.”Inedequate working capital is disastrous, whereas superfluous
working capital is a criminal waste”. Both situations are unwarranted in a sound
business organization. Adequacy of working capital is the lifeblood and controlling
nerve center of a business.
Some of the uses of adequate working capital are:
1) CASH DISCOUNT: By adequate working capital the business can avail the
advantage of cash discount by paying cash for the purpose of raw material
and merchandise. If proper cash balance is maintained, this will reduce the
cost of production.
2) SENSE OF SECURITY AND CONFIDENCE: Adequate working capital create
a sense of security, confidence and loyalty throughout the business and also
among its consumers, creditors and business associates .The proprietor,
official or manager of a concern are carefree, if they have proper capital
arrangements because they need not worry for the payment of business
expenditure or creditors.
3) SOLVENCY AND CONTINUOUS PRODUCTION: In order to maintain the
solvency of business, it is essential that sufficient amount of funds are
available to make all the payments in time as and when they are due. In the
absence of working capital, production will suffer in the era of cutthroat
competition and business can never flourish in the absence of adequate
working capital.
4) SOUND GOODWILL AND INCREASED DEBT CAPACITY: Promptness of
payment in business creates goodwill and increases the debt capacity of the
firm. If the investors and borrowers are confident that they will get their due
interest and payment of principle in time, a firm can raise funds from market,
purchase goods on credit and borrow short term loans from bank etc.
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WORKING CAPITAL MANAGEMENT
5) EASY LOANS FROM THE BANK: An adequate working capital helps the
company to borrow unsecured loans from the bank, because the excess
provides a good security to the unsecured loans. If the business has a good
credit standing and trade reputation, bank favors in granting seasonal loans.
6) DISTRIBUTION OF DIVIDEND: Short of working capital, a company cannot
distribute dividend to its shareholders in spite of sufficient profits. To make up
for the deficiency of working capital, profits are to be retained in business. On
the other hand ample dividend can be declared and distributed to the market
value of share and increase by sufficient working capital.
7) EXPLOITATION OF GOOD OPPORTUNITIES: Good opportunity can be
exploited through adequacy of capital in a concern. For example – A company
may make off seasons purchase, resulting in substantial saving or it can fetch
big supply orders resulting in good profits.
8) MEETING UNSEEN CONTINGENCY: As stock piling of finished goods
becomes necessary, depression shoots up the working demand of capital. If a
company maintain adequate working capital, unseen contingencies such as
financial crisis due to heavy loses, business oscillation etc can easily be
overcome.
9) INCREASE IN EFFICIENCY OF FIXED ASSETS: Proper maintainces and
adequate working capital increase the efficiency of fixed asset of business. It
has been rightly said,” the fate of large scale investment in fixed capital is
often determined by a relatively small amount of current asset.”
10)HIGH MORALE: The provision of adequate working capital improves the
morale of the executive as they get an environment of security, certainty and
confidence, which is a great psychological factor in improving the overall
efficiency of business and of the person who is at the helm of affair in the
company.
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WORKING CAPITAL MANAGEMENT
11)INCREASE PRODUCTION EFFICIENCY: A continuous supply of raw
material, research programs, innovation and technical development and
expansion programs are successfully carried out if adequate capital is
maintained in the business. It increases production capacity, which increase
the efficiency and morale of the employees.
CHAPTER – 5
EVILS OF INADEQUATE WORKING CAPITAL
Some of the evils of not having adequate working capital in a business firm or
a company are as fallows:
1) LOSS OF CREDIT WORTHINESS AND GOODWILL: A firm losses its credit
worthiness and goodwill if it fails to honors its current liability. It finds it difficult
to procure the required funds for its business operation on easy terms. This
leads to reduced profitability and production interruption.
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WORKING CAPITAL MANAGEMENT
2) NO BENEFIT FROM FAVORABLE OPPORTUNITY: With inadequate working
capital a firm fails to undertake profitable projects. It prevents the firm from
availing the benefit of available opportunity and stagnate its growth.
3) FAILURE TO AVAIL CREDIT OPPORTUNITY: Due to inadequate working
capital a firm fail to avail attractive credit opportunities.
4) OPERATING INEFFICIENCIES: Inadequate working capital leads to
operating inefficiencies, as day-to-day commitment cannot be met.
5) LOW RATE OF RETURN ON FIXED ASSET: Inadequate working capital
leads to a lowering down of rate of returns of fixed asset, as it cannot be
efficiently utilized or maintained due to inadequacy of working capital.
6) INCREASE IN BUSINESS RISKS: Inadequate working capital increases the
business risk of the firm. Unable to discharge its current liability it is liable to
be declared as insolvent. Thus inadequate working capital posses a serious
threat to the working and survival of the firm.
7) CANNOT ACHIEVE PROFIT TARGET: Due to inadequate working capital the
firm cannot achieve its profit target, as it cannot put into operation, its
operating plans due to shortage of working capital.
8) LOW MORALE OF BUSINESS EXECUTIVES: Inadequate working capital
adversely lowers the morale of the firm’s executive, as they do not have an
environment of certainty safety and confidence, which is necessary
psychological factor in improving the overall efficiency of a business firm.
9) WEAKENING OF FINANCIAL CAPACITY: Inadequate working capital
weakens the shock absorbing capacity of the firm, as it cannot meet the
contingencies arising from business fluctuation, financial loses etc.
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WORKING CAPITAL MANAGEMENT
CHAPTER – 6
EVILS OF EXCESSIVE WORKING CAPITAL
Now let us look at some of the evils of having excessive or redundant working
capital:
1. IDLE FUNDS: Excessive and redundant working capital implies the presence
of idle funds, which earn no profits for the firm. A firm with excessive working
capital cannot earn proper rate of return on its total investments, as profits are
distributed on the whole of its capital. This brings down the rate of return to
the shareholders. Lower dividend reduce the market value of shares and
causes capital losses to the shareholders.
2. DECLINE IN OPERATING EFFICIENCY: Companies often adopt some
objectionable devices to inflate profits to maintain or increase the rate of
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WORKING CAPITAL MANAGEMENT
dividend. Sometimes unearned dividends are paid out of company’s capital to
keep the show of prosperity by window dressing of accounts. In order to make
up the deficiency of reduced earnings, certain provision, such as the provision
for depreciation, repairs and renewals are not made. This leads to decline in
operating efficiency and fall in profits.
3. LOSS OF CONFIDENCE AND GOODWILL: Excessive working capital leads
to lower rate of returns on company’s total investments. Lower dividend leads
to reduction of market value of companies share much less than the book
value. The shareholders losses confidence in the company and the goodwill
or the credit of the company suffers a serious setback. Thus the financial
stability of the company is jeopoderzied.
4. MISAPPLICATION OF FUNDS: Companies with excessive working capital do
not utilize the resources prudently. The company purchases excessive
inventories and fixed assets, which do not add to the profitability and increase
its maintaince cost and losses due to theft, waste and mishandling.
5. EVILS OF OVERCAPITALIZATION: Excessive working capital leads to over
capitalization, which is disastrous to the smooth working and survival of the
company and effect the interest of those associated with the company.
6. INEFFICIENT MANAGEMENT: Excessive working capital indicates that the
management is not interested in expanding the business; otherwise the
excessive capital might have been utilized for this purpose.
7. DESTRUCTION IN TURNOVER RATIO: Superfluous working capital destroys
the control of turnover ratio, which is commonly used in conduct of an efficient
business. It eradicates all other guide and signpost commonly used and
employed in conducting and operating a business.
Thus a company must have working capital adequate to its requirements. It
must neither be excessive or inadequate. While inadequate working capital
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adversely affects the business operation and profitability, excessive working capital
keep it idle and earn no profits.
CHAPTER – 7
WORKING CAPITAL MANAGEMENT
Working capital is the money used to make goods and attract sales. The less
working capital is used to attract sale, the higher is it likely to be the return of
investment. Working capital management is about the commercial and financial
aspect of inventory, credit, marketing, royalty and investment policy. The higher the
profit margin, lower is it likely to be the level of working capital tied up in creating and
selling titles. The faster that we create and sell the books the higher is it likely to be
the return on investment.
Now let us look at some of the definitions of working capital management:
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PROF K V SMITH: “Working capital management is concerned with problems
that arise in attempting to manage the current asset, the current liability and
the interrelation that exist between them”.
WESTON AND BRIGHAM: “Working capital management refer to all aspect
of administration of both current asset and current liability”.
JAMES C VAN HORNE: “Current asset, by definition are asset normally
converted into cash within one year. Working capital management is
concerned with the administration of these asset-namely cash and marketable
securities”.
Now let us look at some of the main and important objective of working capital
management:
1. To decide upon the optimum level of investment in various current asset I.e.
determining the size of working capital.
2. By optimizing the investment in current asset and by reducing the level of
current liability, the company can reduce the locking up of funds in working
capital and thereby it can improve the return on capital employed in the
business.
3. To decide upon the optimum mix of short-term funds in relation to long-term
capital.
4. The company should always be in a position to meet its current obligation,
which should be properly supported by current assets available with the firm.
Maintaining excess fund in working capital means locking of funds without any
returns.
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WORKING CAPITAL MANAGEMENT
5. To locate appropriate source of short term financing.
6. Maintaining working capital at appropriate levels.
7. Availability of sufficient funds at time of need.
8. The Firm should manage its current asset in such a way that marginal returns
on investment in current asset is not less than the cost of capital employed to
finance the current assets.
CHAPTER – 8
IMPORTANCE OF WORKING CAPITAL MANAGEMENT
According to Husband and Hockery,”the prime object of management is to
make a profit, either or not this is accomplished, depend on the manner in which
working capital is accomplished”. The primary object of working capital is
management is to manage the firm’s current asset and current liability in such a
manner that a satisfactory level of working capital is maintained. The firm may
become insolvent if it cannot maintain a satisfactory level of working capital. Working
capital assist in increasing the profitability of the concern. The working capital
position decide the various policies in the business with receipt to general operation
viz importance of working capital.
Positive correlation between sale and current assets: There is a positive
correlation between the sale of the product of the firm and its current assets.
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Increase in the sale of the product requires a corresponding increase in current
assets. Therefore, the current asset must be managed properly.
Investment in current asset: Generally more than half of the total capacity of
the firm is invested in current assets. Thus less than half of the capital is blocked in
fixed asset. Therefore management of working capital attracts the attention of the
management.
No alternative for current asset: While fixed capital can be acquired on
lease in emergency, there is no alternative for current asset. Investment in current
asset cannot be avoided without substantial losses.
Important for small unit: The management of working capital is more
important for small unit because they do not relay on long term capital market and
have easy access to short term finance source such as trade credit, short term bank
loans etc.
CHAPTER – 9
FACTORS DETERMINING WORKING CAPITAL REQUIREMENTS
Now let us look at the various factors determining the working capital
requirement in a business firm:
(A) Nature of businesses: The amount of working capital is related to the nature of
business. It concerns, where the cost of raw material used in manufacture of a
product is very large in production to its total cost of manufacture, the requirement of
working capital will be very large. For instance a cotton or sugar mills require a large
amount of working capital. On the other hand firms requiring large amount of
investment in fixed asset require less working capital. Public utility concern like
Indian Railways, require a lesser amount of working capital as compared to trading
or manufacturing concern, partly because of cash nature of their business and partly
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WORKING CAPITAL MANAGEMENT
because, they are selling service instead of a commodity and there is no need of
maintaining inventories.
(B) Size of business unit: The general principle in this regard is that the bigger the
size of business, the larger will be the amount of working capital required, because
the larger business unit are required to maintain big inventories for the flow of the
business and to spend more in carrying out the business operation smoothly.
(C) Seasonal variation: Strong seasonal variation create special problem of working
capital in controlling the internal financial swings in many companies such as sugar
mills, oil mills, woolen mills etc. These require larger amount of working capital in the
season to purchase the raw material in large quantity and utilize them throughout the
year. They adjust their production schedule and maintain a steady rate of production
in off seasons. Thus they require larger amount of working capital during season.
(D) Time consumed in manufacture: The average time taken in the process of
manufacture is also an important factor in determining the amount of working capital.
The larger the period of manufacture the larger will be the working capital required.
Capital goods industries managed to minimize their investment in working capital by
asking advances from consumers as work proceeds in their orders.
(E) Turnover of circulating capital: Turnover means ratio of annual gross sales to
average working asset. It means the speed with which circulating capital complete its
round, or number of times the amount invested in working asset has been converted
into cash by sale of finished goods and reinvested in working asset during the year.
The faster the sales the larger the turnover. Conversely greater the turnover, larger
the volume of business to be done with given working capital. It require lesser
amount of working capital in spite of larger sale because of great turnover.
(F) Labor intensive versus capital intensive industries: In labor intensive
industries, larger working capital is required because of regular payment of heavy
wage bills and more time taken in completing the manufacturing process. On the
other hand the capital intensive industry requires require lesser amount of working
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capital because of heavy investment in fixed asset and shorter period in many
acquiring processes.
(G) Need to stockpile raw material and finished goods: The industry, where it is
necessary to stockpile the raw material and finished goods increase the amount of
working capital, which is tied up in stock and stores. In some line of business where
the materials are bulky and best purchased in large quantity such as cements,
stockpiling of raw material is very usual and used. In companies where labor strike is
very frequent like public utility concern, stockpiling of raw material is advisable. In
certain industries which are seasonal in nature, finished goods stock have to be in
large quantity which require large working capital.
(H) Terms of purchase and sale: Cash or credit terms of purchase and sale also
affect the amount of working capital .If a company purchase all goods in cash and
sells its finished product on credit, it will require a large amount of working
capital .On the other hand a concern having credit facility and allows no credit to its
customers will require less amount of working capital. Terms and conditions of
purchase and sale are generally governed by prevailing trade practice and by
changing economic conditions.
(I) Conversion of current asset into cash: The need of having cash in hand to
meet the day to day requirement like payment of wage and salary, rent etc has an
important bearing in deciding the adequate amount of working capital. The greater
the cash requirement, higher will be the need of working capital. A company has
ample stock of liquid current asset will require lesser amount of working capital
because it can encash its assets immediately in open market.
(J) Growth and extension of business: Growing concern requires more working
capital than that which is static. It is logical to except larger amount of working capital
in a going concern to meet its growing need of funds and for its expansion programs
through it varies with economic condition and corporate practice.
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(K) Business cycle fluctuation: Business cycle affect the requirement of working
capital At times, when the prices are going up and boom condition prevail, the
management seek to pile up big stock of raw material to have an advantage of lower
price and maintain a big stock of finished goods with an expectation to earn more
profit by selling it at higher price in future. The expansion of business unit caused by
the inflationary condition creates demand for more and more working capital.
Depression involves the locking up of big amount in working capital as the
inventories remain unsolved and book debts uncollected. The reduction in the
volume of business may result in increasing the cash position because of reduction
in inventories and receivable that usually accompanies decline in sale and
shortening in capital expenditure. In such case shortage of working capital develops.
(L) Profit margin and profit appropriation: Some firms enjoy a leading position in
the market due to quality product and good marketing management or monopoly
power in the market and thereby earn huge profits. It contributes towards working
capital, provided it is earned in cash. Cash profit can be found by adjusting the non-
cash item like depreciation, outstanding expense, accumulated losses and expense
written off in net profit. But in practice the whole cash inflows are not considered as
cash available for use as cash is used up to increase the other asset like, book
debts and fixed asset stock etc. In a growing concern working capital requirement
will be estimated on how the cash available is rightfully used. Even if the net profit is
earned in cash, whole of it is not available for working capital purpose. The
contribution towards working capital is effected by the way in which profit are
appropriated and affected by tax action, dividend, depreciation and reserve policy.
(M) Price level changes: The financial manager should predict the effect of price
level changes on working capital requirement of the firm. Rising price level will
require a higher level of working capital to maintain the same level of current asset,
as it will require higher investments. However if companies reverse their product
prices, they will not face a severe working capital problem. Thus the effect of rising
price will be different for different firm depending upon their price policy and its
nature.
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(N) Dividend policies: There is a well-established relationship between dividend
and working capital in companies where successive dividend policy is followed. The
changes in working capital position bring about an adjustment in dividend policy. In
order to maintain an established dividend policy, the management gives due
consideration to its effect on cash requirements. Storage of cash may induce the
management to reduce cash dividend. Strong cash position may justify the cash
dividend, even if earnings are not sufficient to cover the payments. Shortage of cash
is one of the reasons for issue of stock dividend. On the other hand if the company
follow the policy of retention of profit in business, the working capital position will be
quite adequate, alternatively, if the whole of the profit are distributed among the
shareholders, companies working capital position will suffer.
(O) Close coordination between production and distribution policy: This will
reduce the demand of working capital.
(P) An absence of specialization in the distribution of products: This will require
more working capital as such concerns will have to maintain its own marketing
organization.
(Q) If the means of transporting and communication are less developed: More
working capital is required in such areas to store the material and finished goods.
(R) Hazards in a particular business also decide the magnitude of working
capital required.
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CHAPTER – 10
WORKING CAPITAL FINANCING
The main source of working capital financing, namely, trade credit, bank
credit, RBI framework/regulation of bank credit/finance/advances, factoring and
commercial papers will be discussed in this chapter.
1. TRADE CREDIT: Trade credit refers to the credit extended by the suppliers of
goods and service in normal course of transaction/business/sale of the firm.
According to trade practice, cash is not paid immediately for purchase but
after an agreed period of time. There is however, no formal/specific
negotiation of trade credit It is an informal arrangement between buyer and
seller. There is no legal instrument of acknowledgement of debt, which is
granted on an open account basis.
(a) ADVANTAGES: - Trade credit as a source of short-term working
capital finance has certain advantages. It is easily available. Moreover
it is flexible and spontaneous source of finance. The availability and
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magnitude of trade credits is related to the size of operation of a firm in
relation to sales/purchase. If the credit purchase of goods decline,
availability of credit will also decline. Trade credit is also an informal,
spoteganous source of finance. Not requiring negotiation and formal
agreement, trade credit is free from the restriction associated with
formal/negotiated source of finance/credit.
(b) COST: Trade credit does not involve any explicit interest charged.
However there is an implicit cost of trade credit. It depends on trade
credit offered by suppliers of goods. The smaller the difference
between the payment day and the end of the discount period, the
larger is the annual interest/cost of trade credit.
2. BANK CREDITS: It is the primary institutional source of working capital
finance in India. In fact it represent the most important source of financing of
credit asset. It can be provided by banks in five ways
(a) Cash/credit overdrafts: Under cash credits, the bank specifies a
predetermined borrowing/credit limit. The borrowers can draw/borrow
up to the stipulated credit/overdraft limit. Similarly repayment can be
made wherever desired during the period. The interest is determined
on the basis of the running balance/amount actually utilized by
borrower and not on the sanctioned amount.
(b) Loans: Under the arrangement the entire amount of borrowing is
credited to the current account of the borrower .The borrower has to
pay interest on the total amount.
(c) Bills purchased/discounted: -The amount made available under this
arrangement is covered by the cash credit and the overdraft limit.
Before discounting the bill the bank satisfies itself with the credit
worthiness of the drawer and the genuineness of the bill. To
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popularize the scheme, the discounting banker asks the drawer of the
bill (i.e. the seller of the goods) to have his bills accepted by the
drawee bank.
(d) Term loans for working capital: Under this arrangement, banks
advance loans for three to seven years repayable in yearly and half
yearly installments.
(e) Letter of credit: While the other forms of bank credit are direct forms
of financing in which banks provide funds as well as bears risk, letter
of credit is an indirect form of working capital financing and bank
assume only the risk, the credit being provided by the supplier.
MODES OF SECURITY
Banks provide credit on the fallowing modes of security:
1. Hypothecation: Under this mode of security the bank provide credit to
borrowers against the security of movable property, usually inventory of
goods.
2. Pledge: Pledge, as a mode of security is different from hypocatation in
that in the former unlike the later goods, which are offered as security
is transferred to the physical possession of the lender.
3. Lien: The term lien refers to the right of the party to retain goods
belonging to other party until a debt due to him is paid.
4. Mortgage: It is the transfer of legal stock equitable interest in specific
immovable property for securing the payment of debt.
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CHAPTER – 11
RESERVE BANK OF INDIA FRAMEWORK FOR REGULATION OF BANK
CREDIT
Till the mid sixties, the notable feature of bank financing of working capital of
corporate industrial borrowers were (a) easy access/over-reliance, i.e. in excess of
legimate requirement and (b) pre ponderance of cash credit arrangement/device
through which his finance was provided. In order to secure arrangement of a bank
credit with planning priorities and ensures equitable distribution to various sectors of
Indian economy, the RBI initiated several policy measures measure to direct bank
credit to priority sectors and enforce a measure of financial discipline among
industrial borrowers. However the basic character of bank financing and industry
namely, over borrowing and domination of cash credit system did not materially alter.
To reorient bank lending to industry to the two emerging reality of the Indian
economy in terms of the crucial factors of regulating controlling it, the RBI constitute
from time to time a number of expert groups to examine the various aspect of
banking policy relating to industrial financing, the notable being Dehejia committee of
1969,Marathe committee of 1974,Chore committee of 1980 and Marathe committee
of 1984.The recommendation of these groups ( refer to annexure) shaped the
framework/regulation of industrial finance by banks after mid 1970s.After mid 1990
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WORKING CAPITAL MANAGEMENT
the framework have been relaxed permitting banks greater flexibility in tune with the
emergence of new banking in the country, focusing on viability and profitability in
contrast with earlier trust on social/development banking .The main element of the
framework and the subsequent relaxation are discussed.
CHAPTER – 12
FIXATION OF NORMS
A notable feature of the framework /regulation to the fixation of norms for bank
lending to industry fall under two category:
1. Inventory and receivable norms: The norms refer to the maximum level
for holding inventory and receivable in each industry. Initially, the
inventory and receivable norms were applied in respect to 15 major
industries accounting for about one half of the industrial advance of the
bank. The norms pertained to (a) raw material including stores and
other item used in the process of manufacture: (b) stocks in process (c)
finished goods and receivables and bills purchased and discounted.
The norms were based on time elements
2. Lending norms: The lending norms are the basic element of the
framework of bank lending to have far-reaching implications. According
to lending norms a part of the current asset should be financed by
trade credit and other current liabilities. The remaining part of the
current asset, termed, as working capital gap should be partly financed
by owner’s funds and long-term borrowing and partly by short-term
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WORKING CAPITAL MANAGEMENT
credit. There are three alternative methods for working out the
maximum permissible level of bank borrowing/finance, each
successive method reducing the involvement of short-term bank credit
to support current assets.
CHAPTER –13
HOW “PUBLISHERS” CAN MAKING MORE EFFICIENT USE OF WORKING
CAPITAL
The table below lists items, which influence working capital levels favorably
and adversely for Publishers
Items that reduce working capital
levels
Items that increase working capital levels
-- Customers who pay promptly
-- Advance payment by customers
-- Long print runs expect where all the books are required on publication e.g. schools and university textbooks.