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Capital required for a business can be classified under two main categories viz.,
Working Capital.
Every business needs funds for two purposes-for its establishment and to carry out its day-to-
day operations. Long-term funds are required to create production facilities through purchase of fixed
assets such as plant and machinery, land, building, furniture, etc. Investments in these assets represent
that part of firms capital which is blocked on a permanent or fixed bass and is called fixed capital.
Funds are also needed for short-term purposes for the purchase of raw materials, payment of wages
and other day-to-day expenses, etc. These funds are known as working capital. In simple words,
working capital refers to that part of the firms capital which is required for financing short term or
current assets such as cash, marketable securities, debtors and inventories. Funds, thus, invested in
current assets keep revolving fast and are being constantly converted into cash and this cash flows out
again in exchange for other current assets. Hence, it is also known as revolving or circulating capital or
short-term capital.
In the words of Shubin, Working capital is the amount of funds necessary to cover the cost of
operating the enterprise.
According to Genestenberg, Circulating capital means current assets of a company that are
changed in the ordinary course of business from one form to another, as for example, from cash to
inventories, inventories to receivables, receivables into cash.
(a)
Balance Sheet Concept:- There are two interpretations of working capital under the balance
sheet concept.
In the broad sense, the term working capital refers to the gross workings capital and represents
the amount of funds invested in current assets. Thus, the gross working capital is the capital
invested in total current assets of the enterprise. Current assets are those assets which in the
ordinary course of business can be converted into cash within a short period of normally one accounting
year. Example of current assets are:
2.
Bills Receivables.
3.
4.
5.
6.
7.
Prepaid Expenses
8.
Accrued Incomes.
In narrow sense, the term working capital refers to the net working capital. Net working capital
is the excess of current assets over current liabilities, or say: Net Working Capital = Current
Assets-Current liabilities.
Net working capital may be positive or negative. When the current assets exceed the current
liability the working capital is positive and the negative working capital results when the current liabilities
are more than the current assets. Current Liabilities are those liabilities which are intended to be paid in
the ordinary course of business within a short period of normally one accounting year out of the current
assets or the income of the business. Examples of current liabilities are:
CONSTITUENTS OF CURRENT LIABILITIES
1.
Bills Payable
2.
3.
4.
5.
Dividends Payable.
6.
Bank Overdraft
7.
capital is an accounting concept of working capital. These two concepts of working capital are not
exclusive; rather both have their own merits. The gross concept is sometimes preferred to the net
concept of working capital for the following reasons:
It enables the enterprise to provide correct amount of working capital at the right time.
Every management is more interested in the total current assets with which it has to operate
than the sources from where it is made available.
The gross concept takes into consideration the fact that every increase in the funds of the
enterprise would increase its working capital.
The gross concept of working capital is more useful in determining the rate of return on
investments in working capital.
The net working capital concept, however, is also important for the following reasons:
It is a qualitative concept which indicates the firms ability to meet its operating
expenses and short term liabilities.
It indicates the margin of protection available to the short-term creditors, i.e., the
excess of current assets over current liabilities.
I suggest the need for financing a part of the working capital requirements out of
permanent sources of funds.
To conclude, it may be said that, both, gross and net, concepts of working capital are important
aspects of the working capital management. The net concept of working capital may be suitable only for
proprietary form of organisations such as sole-trader or partnership firms. But the gross concept is very
suitable to the company form of organisation where there is a divorce between ownership, management
and control.
However, it may be made clear that as per the general practice, net working capital is
referred to simply as working capital, In the words of Hoagland, Working Capital is descriptive of
that capital which is not fixed. But the more common use of the working capital is to consider it as the
difference between the book value of the current assets and current liabilities.
The following example explains both the concepts of working capital:
Rs.
Assets
Rs.
Equity Shares
2,00,000
Goodwill
8% Debentures
1,00,000
1,50,000
1,00,000
50,000
1,50,000
20,000
Inventories:
Bills Payable
30,000
Finished Goods
60,000
Outstanding Expenses
20,000
Work-in-process
40,000
Bank Overdraft
50,000
Prepaid Expenses
20,000
20,000
Marketable securities
60,000
Proposed Dividend
30,000
Sundry debtors
90,000
Bills Receivables
20,000
90,000
6,50,000
6,50,000
Raw Materials
Debtors
Work in Process
Sales
Finished goods
The gross operating cycle of a firm is equal to the length of the inventories and receivables conversion
periods. Thus,
Where,
for certain period. In that case, net operating cycle period can be calculated as below:
Average AccountsReceivables
Net Credit Sales Per Day
AveragePayables
Net Credit Purhases Per Day
On the basis of concept, working capital is classified as gross working capital and net working
capital as discussed earlier. This classification is important from the point of view of the financial
manager. On the basis of time, working capital may be classified as:
Permanent or fixed
working capital
Temporary or variable
working capital
Permanent or Fixed Working Capital:- Permanent or fixed working capital is the minimum
amount which is required to ensure effective utilisation of fixed facilities and for maintaining the
circulation of current assets. Theres is always a minimum level of current assets which is
continuously required by the enterprise to carry out its normal business operations. For example,
every firm has to maintain a minimum level of raw materials, work-in-process, finished goods and
cash balance. This minimum level of current assets is called permanent or fixed working capitals
as this part of capital is permanently blocked in current assets. As the business grows, the
requirements of permanent working capital also increase due to the increase in current assets.
The permanent working capital can further be classified as regular working capital and reserve
working capital required to ensure circulation of current assets from cash to inventories, from
inventories to receivable and from receivables to cash and so on. Reserve working capital is the
excess amount over the requirement for regular working capital which may be provided for
contingencies that may arise at unstated periods such as strikes, rise in prices, depression, etc.
given below Illustrate the difference between permanent and temporary working capital.
Amount of Working Capital
Temporary of Variable
In Fig. 1, permanent working capital is stable or fixed over time while the temporary or variable
working capital fluctuates. In Fig. 2, permanent working capital is also increasing with the passage of
time due to expansion of business but even then it does not fluctuate as variable working capital which
sometimes increases and sometimes decreases.
essential in the human body for maintaining life, working capital is very essential to maintain the smooth
running of a business. No business can run successfully without an adequate amount of working
capital. The main advantages of maintaining adequate amount of working capital are as follows:
Easy Loans:- A concern having adequate working capital, high solvency and good
credit standing can arrange loans from banks and others on easy and favourable terms.
Cash discounts:- Adequate working capital also enables a concern to avail cash
discounts on the purchases and hence it reduces costs.
Regular supply of raw Materials:- Sufficient working capital ensures regular supply
of raw materials and continuous production.
Regular payment of salaries, wages and other day- to- day commitments:A company which has ample working capital can make regular payment of salaries,
wages and other day-to-day commitments which raises the moral of its employees,
increases their efficiency, reduces wastages and costs and enhances production and
profits.
Ability to face crisis:- Adequate working capital enables a concern to face business
crisis in emergencies such as depression because during such period, generally, there is
much pressure on working capital.
Quick and regular return on investments:- Every Investor wants a quick and
regular return on his investments. Sufficiency of working capital enables a concern to pay
quick and regular dividends to its investors as there may not be much pressure to plough
back profits. This gains the confidence of its investors and creates a favourable market to
raise additional funds in the future.
operation. It should have neither redundant or excess working capital nor inadequate or shortage of
working capital. Both excess as well as short working capital positions are bad for any business.
However, out of the two, it is the inadequacy of working capital which is more dangerous from the point
of view of the firm.
Excessive Working Capital means idle funds which earn no profits for the business and
hence the business cannot earn a proper rate of return on its investments.
When there is a redundant working capital, it may lead to unnecessary purchasing and
accumulation of inventories causing more chances of theft, waste and losses.
Excessive working capital implies excessive debtors and defective credit policy which
may cause higher incidence of bad debts.
When there is excessive working capital, relations with banks and other financial
institutions may not be maintained.
Due to low rate of return on investments, the value of shares may also fall.
A concern which has inadequate working capital cannot pay its short-term liabilities in
time. Thus, it will lose its reputation and shall not be able to get good credit facilities.
It cannot buy its requirements in bulk and cannot avail of discounts, etc.
It becomes difficult for the firm to exploit favourable market conditions and undertake
profitable projects due to lack of working capital.
The firm cannot pay day-to-day expenses of its operations and it creates inefficiencies,
increases costs and reduces the profits of the business.
It becomes impossible to utilise efficiently the fixed assets due to non-availability of liquid
funds.
The rate of return on investments also falls with the shortage of working capital.
amount of working capital. The need for working capital arises due to the time gap between production
and realisation of cash from sales. There is an operating cycle involved in the sales and realisation of
cash. There are time gaps in purchase of raw materials and production; production and sales; and sales
and realisation of cash. Thus, working capital is needed for the following purposes:
To incur day-to-day expenses and overhead costs such as fuel, power and office
expenses, etc.
To maintain the inventories of raw material, work-in-progress, stores and spares and
finished stock.
For studying the need of working capital in a business, one has to study the business
under varying circumstances such as a new concern, as a growing concern and as one which has
attained maturity. A new concern requires a lot of liquid funds to meet initial expenses like promotion,
formation, etc. These expenses are called preliminary expenses and are capitalised. The amount
needed as working capital in a new concern depends primarily upon its size and the ambitions of its
promoters. Greater the size of the business unit, generally, larger will be the requirements of working
capital. The amount of working capital needed goes on increasing with the growth and expansion of
business till it attains maturity. At maturity the amount of working capital needed is called normal
working capital. There are many other factors which influence the need of working capital in a business
and these are discussed in the next pages.
such as nature and size of business, the character of their operations, the length of production cycles,
the rate of stock turnover and the state of economic situation. It is not possible to rank them because all
such factors are of different importance and the influence of individual factors changes for a firm over
time. However, the following are important factors generally influencing the working capital
requirements.
capital along with fixed investments. Generally speaking it may be said that public utility
undertaking require small amount of working capital, trading and financial firms required
relatively very large amount, whereas manufacturing undertakings require sizable working
capital between these two extremes.
capital due to high overhead charges, inefficient use of available resources and other economic
disadvantages of small size.
Production Policy:- In certain industries the demand is subject to wide fluctuations due to
seasonal variations. The requirements of working capital, in such cases, depend upon the
production policy. The production could be kept either steady by accumulating inventories
during slack periods with a view to meet high demand during the peak season or the production
could be curtailed during the slack season and increased during the peak season. If the policy
is to keep production steady by accumulating inventories it will required higher working capital.
Seasonal Variations:- In certain industries raw material is no available throughout the year.
They have to buy raw materials in bulk during the seasons to ensure and uninterrupted flow and
process them during the entire year. A huge amount is, thus, blocked in the form of material
inventories during such season, which gives rise to more working capital requirements.
Generally, during the busy season, a firm requires larger working capital than in the slack
season.
Working Capital Cycle:- In a manufacturing concern, the working capital cycle starts with
the purchase of raw material and ends with the realisation of cash from the sale of finished
products. This cycle involves purchase of raw materials and stores, its conversion into stocks of
finished goods through work-in-progress with progressive increment of labour and service
costs, conversion of finished stock into sales, debtors and receivables and ultimately realisation
of cash and this cycle continues again from cash to purchase of raw material and so on.
Debtors (Receivables)
Finished Goods
Cash
Raw Materials
Work-in-Process
firm having a low rat of turnover. For example, in case of precious stone dealers, the turnover is
very slow. They have to a maintain a large variety of stocks and the movement of stocks is very
slow. Thus, the working capital requirements of such a dealer shall be higher than that of a
provision store.
Credit Policy:- The credit policy of a concern in its dealings with debtors and creditors
influence considerably the requirements of working capital. A concern that purchases its
requirements on credit and sells its products/services on cash requires lesser amount of
working capital. On the other hand a concern buying its requirements for cash and allowing
credit to its customers, shall need larger amount of working capital as very huge amount of
funds are bound to be tied up in debtors or bills receivables.
Business Cycles:- Business cycle refers to alternate expansion and contraction in general
business activity. In a period of book i.e., when the business is prosperous, there is a need for
larger amount of working capital due t increase in sales, rise in prices, optimistic expansion of
business, etc. On the contrary in the times of depression i.e., when there is a down swing of the
cycle, the business contracts, sales decline, difficulties are faced in collections from debtors and
firms may have a large amount of working capital lying idle.
FACTORS DETERMINING WORKING CAPITAL REQUIRMENTS
1.
2.
3.
Production policy
4.
5.
Seasonal Variations
6.
7.
8.
Credit Policy
9.
Business Cycles
10.
11.
12.
13.
Other Factors
Rate of Growth of Business:- The working capital requirements of a concern increase with
the growth and expansion of its business activities. Although, it is difficult to determine the
relationship between the growth in the volume of business and the growth in the working capital
of a business, yet it may be concluded that for normal rate of expansion in the volume of
business, we may have retained profits to provide for more working capital but in fast growing
concerns, we shall require larger amount of working capital.
Earning Capacity and Dividend Policy:- Some firms have more earning capacity than
others due to quality of their products, monopoly conditions, etc. Such firms with high earning
capacity may generate cash profits from operations and contribute to their working capital. The
dividend policy of a concern also influences the requirements of its working capital. A firm that
maintains a steady high rate of cash dividend irrespective of its generation of profits needs
more working capital then the firm that retains larger part of its profits and does not pay so high
rate of cash dividend.
Price Level Changes:- Changes in the price level also affect the working capital
requirements Generally, the rising prices will require the firm to maintain larger amount of
working capital as more funds will be required to maintain the same current assets. The effect
of rising prices may be different for different firms. Some firms may be affected much while
some others may not be affected at all by the rise in prices.
Other Factors:- Certain other factors such as operating efficiency, management ability,
irregularities of supply, import policy, asset structure, importance of labour, banking facilities,
etc., also influence the requirements of working capital.
liabilities. Management of working capital therefore, is concerned with the problems that arise in
attempting to manage the current assets, the current liabilities and the inter-relationship that exists
between them. In other words it refers to all aspects of administration of both current assets and current
liabilities.
The basic goal of working capital management is to manage the current assets and current
liabilities of a firm in such a way that a satisfactory level of working capital is maintained, i.e., it is neither
inadequate nor excessive. This is so because both inadequate as well as excessive working capital
positions are bad for any business. Inadequacy of working capital may lead the firm to insolvency and
excessive working capital implies idle funds which earn no profits for the business. Working capital
management policies of a firm have a great effect on its profitability, liquidity and structural health of the
organisation. In this context, working capital management is three dimensional in nature:
Dimension I is concerned with the formulation of policies with regard to profitability, risk
and liquidity.
Dimension II is concerned with the decisions about the composition and level of
current assets.
Dimension III is concerned with the decisions about the composition and level of
current liabilities.
Dim. I
Dim. II
Dim. III
The following are the general principles of a sound working capital management policy:
Principle of Risk
Variation
Principle of Cost
of Capital
Principle of
Equity Position
Principle of Maturity
of payment
Principle of Risk Variation:- Risk here refers to the inability of a firm to meet its obligations
as and when they become due for payment. Larger investment in current assets with less
dependence on short- term borrowings increases liquidity, reduces dependence on short-term
borrowings increases liquidity, reduces risk and thereby decreases the opportunity for gain or
loss. On the other hand less investment in current assets with greater dependence on shortterm borrowings increases risk, reduces liquidity and increases profitability. In other words,
there is a definite inverse relationship between the degree of risk and profitability. A
conservative management prefers to minimise risk by maintaining a higher level of current
assets or working capital while a liberal management assumes greater risk by reducing working
capital. However, the goal of the management should be to establish a suitable trade off
between profitability and risk.
C
o
s
t
o
f
A
s
s
e
t
s
Conservative
Policy
Moderate
Policy
Aggressive Policy
Sales
(Various Working Capital Policies)
The effect of working capital policies on the profitability of a firm is illustrated below:
Conservative Policy
Aggressive policy
Sales
Rs. 20,00,000
Rs. 20,00,000
Earnings (EBIT)
Rs. 5,00,000
Rs. 5,00,000
Fixed Assets
Rs. 10,00,000
Rs. 10,00,000
Current Assets
Rs. 15,00,000
Rs. 10,00,000
Total Assets
Rs. 25,00,000
Rs. 20,00,000
Profitability
5,00,000
5,00,000
Retrun on TotalInvestments
Total Assets
100
100
25,00,000
25,00,000
=20%
=25%
Principle of Cost of Capital:- The various sources of raising working capital finance have
different cost of capital and the degree of risk involved. Generally, higher the risk lower is the
cost and lower the risk higher is the cost. A sound working capital management should always
try to achieve a proper balance between these two.
Principle of Equity Position:- This principle is concerned with planning the total
investments in current assets. According to this principle, the amount of working capital
invested in each component should be adequately justified by a firms equity position. Every
rupee invested in the current assets should contribute to the net worth of the firm. The level of
current assets may be measured with the help of two ratios: (a) current assets as a percentage
of total assets and (b) current assets as a percentage of total sales. While deciding about the
composition of current assets, the financial manager may consider the relevant industrial
averages.
Principle of Maturity of Payment:- This principle is concerned with planning the sources of
finance for working capital. According to this principle, a firm should make every effort to relate
maturities of payment to its flow of internally generated funds. Maturity pattern of various
current obligations is an important factor in risk assumptions and risk assessments. Generally,
shorter the maturity schedule of current liabilities in relation to expected cash inflows, the
greater the inability to meet its obligations in time.
To sum up, working capital management should be considered as an integral part of
overall corporate management. In the words of Louis Brand, We need to know when to look for
working capital funds, how to use them and how t measure, plan and control them. To achieve
the above mentioned objectives of working capital management, the financial manager has to
perform the following basic functions:
successfully run without an adequate amount of working capital. To avoid the shortage of working
capital at once, an estimate of working capital requirements should be made in advance so that
arrangements can be made to procure adequate working capital. But estimation of working capital
requirements is not an easy task and a large number of factors have to be considered before starting
this exercise. For a manufacturing organisation, the following factors have to be taken into
consideration while making an estimate of working capital requirements:
2.
The length of time for which raw materials are to remain in stores before they are issued
for production.
3.
The length of the production cycle or work-in-process, i.e., the time taken for conversion
of raw material into finished goods.
4.
The length of sales cycle during which finished goods are to be kept waiting for sales.
5.
6.
7.
8.
9.
given above, the total of the current liabilities, i.e., the last two items, is deducted to find out the
requirements of working capital. In case of purely trading concerns, points 1, 2, and 3 would not arise
but all other factors from points 4 to 9 are to be taken in to consideration.
In order to provide for contingencies, some extra amount generally calculated as a fixed
percentage of the working capital may be added as a margin of safely. Suggested Proformas for
estimation of working capital requirements are given on the following pages:
Cash
.............
(ii)
(iii)
..........
(iv)
Other
..........
..........
(ii)
..........
...........
..........
________
________
.........
_______
...........
________
Note: (i) Profit should be ignored while calculating working capital requirements as funds provided by
profits may or may not be used as working capital.
(ii) Stock and debtors should be taken at cost unless otherwise required in a given question.
2.
(ii)
Work-in-process (For...months)
(iii)
(iv)
...........
Raw Materials
..........
Direct Labour
..........
Overheads
..........
Raw Materials
Labour
...........
Overheads
............
...........
..........
(v)
...........
............
.............
............
(vi)
(vii)
(ii)
(iii)
..............
............
............
............
...........
.............
...............
Notes: (i) Profits should be ignored while calculating working capital requirements for the following
reasons:
(a) Profits may or may not be used as working capital.
(b) Even if profits are to be used for working capital it has to be reduced by the amount of income
tax, drawings, and dividend paid etc.
(ii)
But some authors have assumed in such a case 100% consumption of raw material and
50% (one half on an average) in case of labour and overheads.
(iii)
Calculation for stocks of finished goods and debtors should be made at cost unless
otherwise asked in the question.
3. Columnar Form
An alternative Performa for estimation of working capital requirements in columnar form is
given below:
Statement of working capital requirements
Period
Week
Total
Rs.
1.
(a)
(b)
(c)
(d)
2.
(a)
(b)
(c)
3.
(a)
(b)
(c)
4.
(A)
Raw materials:
In stock
In work in- process
In finished goods
Credit to debtors
Direct labour:
In work-in-process
In finished Goods
Credit to debtors
Overhead:
In Work-in-Process
In finished goods
Credit to Debtors
Cash and Bank
Total Current Assets
Raw
Material
Rs.
Rs.
Finished
Goods
Rs.
Debtors
Cash and
Bank
Rs.
Rs.
.........
..........
.......
-------------
.......
.......
----------
.......
.......
------------.........
Period
..........
Total
.........
..........
For Raw
For Wages
Materials
Week
5. 5. Credit By suppliers
Work-in
Process
.......
.......
.......
.......
.......
.......
.......
.......
For
overheads
.........
.......
........
........
...........
Working Capital
Requirements = (A-B)
Fixed overheads will remain the same and thus fixed overheads cost per unit will decrease.
Variable overheads will increase proportionately. However, there may be some savings in purchase
cost of materials because of large orders. Similarly, the wage rate may also be higher for second or
third shift workers.
There may be change in the amount of work-in process because of higher wage rates, etc.
The overall requirements of working capital will increase under extra shift working.
Temporary of Variable
1. Shares
1.
Commercial banks
2. Debentures
2.
Indigenous Bankers
3. Public deposits
3.
Trade Creditors
4.
Instalment Credit
5.
Advances
6.
Accounts Receivable-Credit/factoring
7.
Accured Expenses
8.
Commercial Paper
uninterrupted use for a sufficiently long period. There are five important sources of permanent or longterm working capital.
1. Shares:- Issue of shares is the most important source for raising the permanent or long-term
capital. A company can issue various types of shares as equity shares, preference shares
and deffered shares. According to the companies Act, 1956, however, a public company
cannot issue deffered shares. Preference shares carry preferential rights in respect of
dividend at a fixed rate and in regard to the repayment of capital at the time of winding up the
company. Equity shares do not have any fixed commitment charge and the dividend on these
shares is to be paid subject to the availability of sufficient profits. As for as possible, a
company should raise the maximum amount of permanent capital by the issue of shares.
2. Debentures:-A debenture is an instrument issued by the company acknowledging its debt to
its holder. It is also an important method of raising long-term or permanent working capital.
The debenture-holder are the creditors of the company. A fixed rate of interest is paid on
debentures. The interest on debentures is a charge against profit and loss account. The
debentures are generally given floating charge on the assets of the company. When the
debentures are secured they are paid on priority to other creditors. The debentures may be of
various kinds such as simple, naked or unsecured debentures, scoured or mortgaged
debentures, redeemable debentures. Irredeemable debentures, convertible debentures and
non-convertible debentures. The debentures as a source of finance have a number of
advantages both to the investors and the company. Since interest on debentures have to be
paid on certain predetermined intervals at a fixed rate and also debentures get priority on
repayment at the time of liquidation, they are very well suited to cautious investors. The firm
issuing debentures also enjoys a number of benefits such as trading on equity, retention of
control, tax benefits, etc.
3. Public Deposits:- Public deposits are the fixed deposits accepted by a business enterprise
directly from the public. This source of raising short term and medium-term finance was very
popular in the absence of banking facilities. In the past, generally, public deposits were
accepted by textile industries in Ahmedabad and Bombay for periods of 6 months to 1 year.
But now a-days even long-term deposits for 5 to 7 years are accepted by the business
houses. Public deposits as a source of financial have a large number of advantages such as
very simple and convenient source of finance, taxation bene3fits, trading on equity, no need
of securities and an inexpensive source of finance. But it is not free from certain dangers
such as, it is uncertain. Unreliable. Unsound and inelastic source of finance. The reserve
bank of Indian has also laid down certain limits on public deposits. Non-banking concerns
cannot borrow by way of the public deposits more than 25% of its paid up capital and free
reserves.
4. Ploughing back of Profits:-ploughing back of profits means the reinvestments by concern
of its surplus earnings in its business. It is an internal source of finance and is most suitable
for an established firm for its expansion, modernisation and replacement etc. This method of
finance has a number of advantages as it sit he cheapest rather cost-free source of finance;
there is no need to keep securities; there is no dilution of control; it ensures stable dividend
policy and gains confidence of the public. But excessive resort to ploughing back of profits
may lead to monopolies, misuse of funds, over capitalisation and speculation, etc.
5. Loans from financial Institutions:- Financial institutions such as commercial banks, Life
Insurance Corporation, Industrial finance Corporation of India, State Financial Corporations,
State Industrial Development corporation, Industrial Development bank of India, etc. Also
provide short-term, medium-term and long-term loans. This source of finance is more suitable
to meet the medium-term demands of working capital. Interest is charged on such loans at a
fixed rate and the amount of the loan is to be repaid by way of instalments in a number of
years.
Instalment Credit
d. Advances
e. Accounts Receivable Credit or Factoring
f.
Accrued Expenses
g. Deferred incomes
h. Commercial paper
i.
a.
Commercial banks
Indigenous Bankers:- Private money-lenders and other country bankers used to be the only
source of finance prior to the establishment of commercial banks. They used to charge very high
rates of interest and exploited the customers to the largest extent possible. Now-a-days with the
development of commercial banks they have lost their monopoly. But even today some business
houses have to depend upon indigenous bankers for obtaining loans to meet their working capital
requirements.
b.
Trade Credit:- Trade credit refers to the credit extended by the suppliers, of goods in the normal
course of business. As present day commerce is built upon credit, the trade credit arrangement
of a firm with its suppliers is an important source of short-term finance. The credit-worthiness of a
firm and the confidence of its suppliers are the main basis of securing trade credit. It is mostly
granted on an open account basis whereby supplier sends goods to the buyer for the payment to
be received in future as per terms of the sales invoice. It may also take the form of bills payable
whereby the buyer signs a bill of exchange payable on a specified future date.
When a firm delays the payment beyond the due date as per the terms of sales invoice, it
is called stretching accounts payable. A firm may generate additional short-term finances by
stretching accounts payable, but it may have to pay penal interest charges as well as to forgo
cash discount. If a firm delays the payment frequently, it adversely affects the credit worthiness of
the firm and it may not be allowed such credit facilities in future.