FINANCIAL MANAGEMENT

COST OF CAPITAL The items on the financing side of the Balance Sheet are called capital components. The major capital components are equity, preference and debt. Capital, like any other factor of production, has a cost. A companys cost of capital is the average cost of the various capital components (securities) employed by it. In other words, it is the average rate of return (ARR) required by the investors who provide capital to the company. Thus, the cost of capital of the firm relates to the cost that a firm incurs in retaining the funds obtained from various sources. In operational terms, cost of capital refers to the discount rate that is used in determining the present value of the estimated future cash proceeds and eventually deciding whether the project is worth undertaking or not. In this sense it is defined as the minimum rate of return that a firm must earn on its investments to maintain its market value and attract funds. The cost of capital is visualized as being composed of several elements. These elements are the cost of each component of capital (equity, preference, debt etc.) The cost of each source or component is called Specific Cost of Capital. When these specific costs are combined to arrive at Overall Cost of Capital, it is referred to as the Weighted Cost of Capital.

Components of Cost of Capital: The overall cost of capital of a firm consists of the costs of various segments of the total funds which may be identified as: 1. Cost of Debt i.e. Debentures and loans from various institutions 2. Cost of Preference Capital 3. Cost of Equity Capital 4. Cost of Retained Earnings. Relevance of cost of capital in Decision Making: Since the business should atleast be capable of earning so much revenue as to be able to meet its cost of capital and to finance its growth, cost of capital of a firm constitutes a crucial factor in most financial decisions.

It is relevant both to capital budgeting and capital structure planning, the main areas in financial management. In capital budgeting decisions, cost of capital may be taken as the discounting rate. Obviously, if a particular project gives an internal rate of return higher than its cost of capital, it should be an attractive opportunity.

In capital structuring decisions, the cost of capital is an important consideration along with the risk factor. For example loan may be cheaper but it entails higher risk of cash insolvency as also of variation in the earnings per share due to the financial leverage effect. It is therefore essential that the cost of each source of funds is carefully

considered and compared with the risk involved in it. Determination of Cost of Capital: The term Cost of Capital, as a decision criterion is the Overall Cost. This is the combined Cost of the specific costs associated with specific sources of financing. The computation of the cost of Capital, therefore, involves two steps: I. The computation of the different elements of cost in terms of the cost of the different sources of finance (Specific Costs) and II. The Calculation of the overall cost by combining the specific costs into a composite cost.

I.

Measurement of Specific Costs: The specific costs have to be calculated for : -

1. 2. 3. 4.

Long term Debt (including Debentures) Preference Shares Equity Shares Retained Earnings.

1. Cost of Debt: The Debt instruments promise a stated rate of return and a maturity period. The stated rate of return is called coupon rate. The interest paid on debt is computed at the coupon rate on the face value of the debt instruments. Factors affecting the cost of Debt: Fixed Interest Rate.

Issue Expenses like Brokerage, Underwriting Commission etc. Discount/Premium on Issue / Redemption. Income Tax Rate. The debt can be either perpetual/irredeemable or redeemable 2. Cost of Preference Shares: Preference Capital Carries a fixed rate of dividend and is generally redeemable in nature. The dividend on preference shares is paid out of profits only, therefore the payment of preference dividend is not as firm as interest to debenture holders. Unlike interest payments on debt, dividend payable on preference shares is not tax deductible because preference dividend is not a charge on profits but an appropriation of profits. They are paid out of after tax earnings of the company. Therefore, no adjustment is required for taxes while computing the cost of capital. Factors affecting cost of Preference Shares The Considerable factors while calculating cost of Preference Shares are: (a) Fixed Dividend Rate (b) Issue expenses like underwriting commission, Brokerage etc. (c) Discount/Premium on Issue /Redemption. (d) Dividend Distribution Tax. The preference shares may be irredeemable or redeemable. The first category is a kind of perpetual security. The redeemable preference shares are issued with a maturity date so that the principal will be repaid at source future date. Accordingly the cost of Preference shares is to be calculated. 3. Cost of Equity: Equity Capital, like other sources of funds, does involve a cost to the firm. When equity holders invest their funds they also expect returns in the form of dividend. Conceptually, the cost of equity capital may be defined as the minimum rate of return that a firm must earn on the equity financed portion of an investment project in order to leave unchanged the market price of the shares. Equity finance may be obtained in two ways: (1) Issue of additional equity and (2) Retention of earnings.

The cost of equity is same in both the cases. The only difference is in floatation costs. There is no floatation cost for retained earnings whereas there is a floatation cost of 2-10% or even more for additional equity. Factors affecting Cost of Equity: The computation of the Cost of Equity requires an understanding of factors concerning the behavior of the investors and their expectations. The considerable factors while calculating the Cost of Equity include: (1) Price of an Equity Share in the beginning of the year. (2) Expected Equity Dividend at the end of the year. (3) Growth Rate. Two commonly adopted approaches to calculate Cost of equity Capital are: (1) Dividend Approach and (2) Capital Asset Pricing Model approach. Both the Dividend and CAPM approaches are theoretically sound. Some major problems are encountered in the practical application of the CAPM approach in collecting data, so the use of the Dividend approach appears to be more appropriate to measure the cost of Equity Capital. 4. Cost of Retained Earnings: Some people hold the view that retained earnings do not involve any cost on the assumption that the company has a separate identity distinct from its shareholders and it has not to pay anything for withholding the earnings in the company. The contention that retained earnings are free of cost, however, is not correct. On the contrary, and it has not to pay anything for withholding the earnings in the company. The contention that retained earnings are free of cost, however, is not correct. On the contrary, they do involve cost like any other source. It is true that a firm is not obliged to pay a return on retained earnings but retention of earnings does have implications for the shareholders of the firm. If earnings were not retained, they would have been paid out to the ordinary shareholders as dividends. When earnings are retained, shareholders are forced to forego dividends. The dividends foregone by the equity holders are an opportunity cost. The firm is implicitly required to earn on the retained earnings at least equal to the rate that would have been earned by the shareholders if they were distributed to them. This is said to be the cost of retained earnings. Therefore, the

cost of retained earnings may be defined as opportunity cost in terms of dividends foregone by/withheld from the equity shareholders. The alternative use of retained earnings is based on external-yield criterion. As per this, the alternative to retained earnings is external investment of funds by the firm itself. The opportunity cost of retained earnings is the rate of return that could be earned by investing the funds elsewhere instead of what would be earned by the shareholders. The firm should estimate the yield it can earn from external investment opportunities by investing its retained earnings there. The external yield criterion, therefore, represents and economically

justifiable opportunity cost. Since retained earnings do not involve any explicit cost (say floatation cost) the cost of retained earnings shall be less than the cost of new equity capital. Weighted Average Cost of Capital: The term cost of capital means the overall composite cost of capital defined as weighted average of the cost of each specific type of fund. The use of weighted average and not the simple average is warranted by the fact that the proportions of various sources of funds in the capital structure of the firm are different. To be representative, therefore, the overall cost of capital should take into account the relative proportions of different sources and hence the weighted average. The computation of the overall cost of capital (represented symbolically by ko) involves the following steps: 1. Assigning weights to specific costs. 2. Multiplying the cost of each of the sources by the appropriate weights. 3. Dividing the total weighted cost by the total weights. The crucial part of the exercise is the decision regarding appropriate weights and the related aspects. Assignment of Weights The aspects relevant to the selection of appropriate weights are (i) Historical weights versus Marginal weights; (ii) Historical weights can be (a) Book value weights or (b) Market value weights. Thus, the simple average cost of capital is not appropriate to use since firms need not necessarily use various sources of funds in equal proportion in the capital structure. It facilitates the

computation of Equity Financial Break Even Point i.e. that level of EBIT at which firm is just able to recover the fixed interest cost of Debt, Fixed Preference Dividend and the Cost of Equity. LEVERAGE OPERATING & FINANCIAL LEVERAGE: A firm can make use of different sources of financing whose costs are different. These sources may be classified into those which carry a fixed rate of return and those on which the return vary. Since debt involves the payment of a stated rate of interest, the return to the ordinary

shareholders is affected by the magnitude of debt in the capital structure of the firm. Leverage arises from the presence of fixed costs in a firms cost structure. The employment of an asset or source of funds for which the firm has to pay a fixed cost or fixed return may be termed as leverage. Consequently, the earnings available to the shareholders and the risk, are also affected. If earnings less the variable costs exceed the fixed cost, or earnings before interest and taxes exceed the fixed return requirement, the leverage is called favourable. When they do not, the result is unfavourable leverage. There are two types of leverage: 1. Operating Leverage 2. Financial Leverage Operating leverage arises form fixed operating costs (fixed costs (fixed costs other than

financing costs) such as salaries, depreciation, advertising expenditures, property taxes etc. Financial leverage arises from the presence of fixed financing costs such as interest on debentures/ loans. 1. Operating Leverage: - Operating leverage is determined by the relationship between the firms Sales revenues and its earnings before interest & taxes (EBIT). The earnings before interest and taxes are also generally called as operating Profits. Operating leverage results from the existence of fixed operating expenses in the firms income stream. It may be defined as the firms ability to use fixed operating costs to magnify the effects of changes in sales on its earnings before interest & taxes. Operating leverage occurs anytime a firm has fixed costs that must be met regardless of volume. With fixed costs, the percentage change in profits accompanying a change in volume is greater than the percentage change in volume. This occurrence is known as operating leverage.

2. Financial Leverage: It represents the relationship between the firms earnings before interest and taxes and the earnings available for ordinary shareholders. Financial leverage results from the presence of fixed financial charges in the firms income stream. These fixed charges do not vary with the EBIT (or operating Profits). They are to be paid regardless of the amount of EBIT available to pay them. After paying them, the operating profits belong to the ordinary shareholders. Financial leverage is concerned with the effects of changes in EBIT on the earnings available to equity holders. It is defined as the ability of the firm to use fixed financial charges to magnify the effects of changes in EBIT on the earnings per share (EPS). It is based on the assumption that the firm is to earn more on the assets that are acquired by the use of funds on which a fixed rate of interest/dividend is to be paid. The difference between the earnings from the assets and the fixed cost on the use of the funds goes to the equity holders. Financial leverage is also called trading on equity. The operating profits (EBIT) are used as the pivotal point in defining operating and financial leverage. In a way, the two leverages represent tow stages in the process of determining the earnings available to equity shareholders. EBIT-EPS ANALYSIS: EBIT-EPS Analysis illustrates the sensitivity of the EPS to changes in EBIT under different financial options in the capital of the firm. As a method to study the effect of leverage, EBIT-EPS analysis essentially involves the comparison of alternative methods of financing under various assumptions of EBIT. A firm has the choice to raise funds for financing its investment proposals from different sources (debt, equity or preference) in different proportions. The choice of the combination of various sources would be one which, given the level of earnings before interest and taxes (EBIT), would ensure the largest EPS. Example: Suppose a firm has a capital structure exclusively comprising of ordinary shares amounting to Rs.10,00,000. The firm mow wishes to raise additional Rs.10,00,000 for expansion. The firm has four alternative financial plans. A. It can raise the entire amount in the form of equity capital. B. It can raise 50 per cent as equity capital and 50 percent as 5% debentures. C. It can raise the entire amount as 6% debentures.

D. It can raise 50 per cent as equity capital and 50 percent as 5% preference capital. Further assume that the existing EBIT are Rs.1,20,000, the tax rate is 35 per cent, outstanding ordinary shares 10,000 and the market price per share is Rs.100 under all the fur alternatives. Which financing plan should the firm select? Solution: EPS Under Various Financial Plans Particulars A EBIT Less: Interest Earnings before taxes Taxes Earnings after taxes Less: Preference dividend Earnings shareholders Number of Shares Earnings per share (EPS) 20,000 3.9 15,000 4.1 10,000 3.9 15,000 3.5 available to ordinary Financing plans B C D

Rs.1,20,000 Rs.1,20,000 Rs.1,20,000 Rs.1,20,000 _ 1,20,000 42,000 78,000 78,000 25,000 95,000 33,250 61,750 61,750 60,000 60,000 21,000 39,000 39,000 1,20,000 42,000 79,000 25,000 56,000

The above reveals that given a level of EBIT of Rs.1,20,000/-, the financing alternative B is the most favourable with respect to EPS. The level of EBIT which is equal to firms fixed financial costs is called financial Break Even Point (BEP). It can be determined by: Financial BEP = I + DP 1-t Where I- Annual Interest Charges, Dp = Preference dividend and T = Tax rate. The EBIT level at which the EPS is the same for two alternative financial plans is referred to as the indifference point/level. The indifference point may be defined as the level of EBIT beyond which the benefits of financial leverage begin to operate with respect to earnings per share (EPS).

Debt + Equity 13 . alternative Debt advantage

Equity alternative

Indifference Point 6.5 EPS (Rs.) Equity advantage

. 0 1

. 2

. 3

. 4

. 5

. 6

. 7

EBIT (Rs. in lakhs)

Working Capital Management

Working Capital refers to funds required to be invested in the business for a short period usually upto one year. There are two concepts of working capital, also referred to as working capital, means the total current assets. The term net working capital can be defined in two ways (1) The common definition of net working capital (NWC) (2) The alternative definition of NWC. (1) The Common Definition of NWC NWC is commonly defined as the difference between current assets and current liabilities. The theoretical justification for the use of NWC to measure liquidity is based on the premise that the greater the margin by which current assets cover the short term obligations, the more is the ability to pay obligations when they become due for payment. The NWC is necessary because the cash outflows and inflows do not coincide. The non-synchronous nature of cash flows makes NWC necessary. (2) The alternative definition of NWC NWC can alternatively be defined as that part of current assets which are financed with long term funds. Since current liabilities represent

sources of short term funds, as long as current assets exceed the current liabilities, the excess must be financed with long term funds.

Purpose of Working Capital: Working capital is required to meet day to day operating expenses and for holding stocks of rawmaterials, spare parts, consumables, work in progress and finished goods and book debts (i.e. debtors balances and bills receivable). More specifically, working capital is needed: 1. to hold the stock of raw materials for such a period so as to facilitate an uninterrupted supply of raw material to production process; 2. to hold the stock of work-in-progress for process period (i.e., the time duration needed to convert the raw materials into finished products); 3. to hold the stock of finished goods for such a period so as to meet the demands of customers on continuous basis and sudden demand from some customers; 4. to grant credit to its customers for marketing and competitive reasons; 5. to hold cash balances to meet the manufacturing, office and administrative, selling and distribution expenses, taxes etc.

Working Capital Management 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. The goal of working capital management is to manage the firms current assets & liabilities in such a way that a satisfactory level of working capital is maintained. The current assets should be large enough to cover its current liabilities in order ensure reasonable margin of safety. The current assets must also be managed efficiently in order to maintain liquidity while not maintaining too high a level of any of them. Each of the short term sources of financing must be continuously managed to ensure that they are obtained and used in the best possible way. The interaction between current assets and current liabilities is, therefore, the main theme of the theory of working capital management. Thus, working capital management is concerned with planning, organizing, directing and controlling the working capital. The major issues in working capital Management are : (1) Determining the need of working capital. (2) Determining the optimum levels of investment in various current assets.

(3) Determining the optimum sources for financing current assets. (4) Ensuring the payment of current liabilities as and when due.

Whenever the situation of excessive or inadequate working capital arises, prompt and timely action should be taken by the management to correct the imbalances.

Working capital Management Policies and their impact on Profitability and liquidity (outline): Profitability & liquidity are inversely related. When one increases, the other decreases.
Policy 1. Effect on Profitability results in Effect on Liquidity results in and high hence threaten Conservative Policy (i.e. Excessive It investment in current assets low It

profitability excess

because liquidity in does

investment

not

current assets remains solvency of the firm. idle and earns nothing 2. Aggressive Policy (i.e. Inadequate It investment in current assets results in high It results in hence low can

profitability since there liquidity are no idle funds

threaten solvency of the firm if it fails to meet its current

obligations as & when due.

Factors affecting Working Capital Requirements: The working capital requirements of a firm depends on a variety of factors. These factors affect different enterprises differently and vary from time to time. These can be highlighted as: (1) Nature of Business The working capital needs are influenced by the nature & conduct of business. Small trading concerns or retail shops need small amount of working capital as their operating cycle period is small. They mostly have cash sales and carry small quantities of goods in stock. They normally buy on credit but sell for cash. On the other hand Large Trading firms & Manufacturing Firms require large amount of working capital as their operating cycle period is large. They carry large amount of goods in stock and large debtors balances. They also carry large amount of cash.

(2) Manufacturing cycleManufacturing cycle refers to the time gap between the purchase of raw-materials and the production of finished goods. Funds have to be tied up during the process of manufacture necessitating enhanced working capital. Larger the manufacturing cycle, larger will be the working capital requirements of the firm. Shorter the manufacturing cycle, smaller will be the firm working capital requirements. (3) Business CycleBusiness fluctuations lead to cyclical and seasonal changes which in turn, cause a shift in the working capital position. During Boom conditions, there is increase in demand and sales. This requires increase in investment in inventory and receivables leading to larger retirement of working capital. The need of working capital in recessionary conditions is bound to decline as there is decrease in demand and sales. (4) Production Policy In certain lines of business, the demand for products is seasonal. There are two options open to such enterprises (a) Seasonal Production Policy (i.e. Production during peak period only) Increasing This results in low investment in inventory and

receivables leading to small requirement of working capital.

production during peak period may be expensive due to increased costs of material, labour and other expenses. The firm will also have to sustain its work force and physical facilities without production and sale. The working capital requirement will be large during peak period and small during slack period. (B) Steady Production Policy (i.e. production throughout the year) This certainly involves large accumulation of finished goods ( inventories) during the off-season and their quick disposal during the peak season. The working capital requirements will follow a steady pattern. Some firms may follow a Diversified Production Policy. This involves manufacturing of

original product during the peak period and other product(s) during slack period to utilize the work force and physical resources. The working Capital requirements will vary according to the nature of the product.

(5) Credit Policy The credit Policy of a firm depends upon industry practice, current economic conditions and the managements attitude. The credit policy relating to sales and purchases affects the working capital requirements in two ways (a) Through credit terms granted by the firm to its customers/buyers of goods If the firm follows a liberal credit policy, it results in higher credit sales, higher book debts therefore higher working capital requirement and vice versa in case of tight or conservative credit policy (b) Through credit terms available to the firm A firm will need less working capital if liberal credit terms are available to it and will need more working capital if no credit / tight credit terms are available to it. If credit period received from suppliers is greater than the credit period allowed to customers, the working capital requirements will reduce and will increase if the credit period received from suppliers is less than credit period allowed to customers. (6) Growth & Expansion Growing firms require more working capital than those that are static. As a company grows, logically larger amount of working capital will be needed. The need for working capital arises before growth takes place, that is why an advance planning of working capital is to be made for a growing firm on a regular basis. (7) Price level changes Changes in price levels also affect the working capital requirements. Rising price level requires a higher investment in working capital because increased investment is required to maintain the same level of current assets. However, companies which can proportionately increase the prices of products, may not face severe working capital problem in period of rising price levels. Moreover the price rise doesnt have a uniform effect on all commodities. Thus increase in price level may have different implications on working capital requirements of different companies. (8) Profit Margin & Profit appropriation A high net profit margin contributes towards the working capital pool. The net profit is a source of working capital to the extent it has been earned in cash. Cash from operations can be found out by adjusting non-cash items such as depreciation, losses written off etc. High rate of margin leads to higher profits resulting in higher contribution towards working capital.

(9) Availability of raw materialIf the raw materials and other required materials are available freely and continuously, lower stock levels may suffice. Thus working capital requirements may be low. If however, raw materials do not have a record of un-interrupted availability, higher stock levels may be required leading to large working capital requirement. Also, larger the lead time, larger shall be the amount of working capital required. (10) Operating efficiency Firms manage their operations with varied degree of efficiency. A firm managing its raw materials efficiently may be able to manage with a smaller balance. Similarly a better debtors turnover ratio may be achieved reducing the amount tied up in receivables. Such efficiencies may reduce the level of raw-materials, finished goods & debtors resulting in lower requirement of working capital.

To conclude, the level of working capital is determined by a wide variety of factors. Efficient working capital management requires efficient planning and a constant review of the needs for an appropriate working capital strategy. Working Capital Financing Sources of working capital : After determining the level of working capital, a firm has to decide how it is to be raised i.e. the sources of obtaining working capital. The various sources of financing working capital are: (1) Trade Credit It refers to an arrangement whereby the suppliers allow the customers to pay the outstanding balances within a credit period allowed by them. Generally suppliers grant credit for a period of three to six months, thus provide short term funds to finance current assets. It is an informal arrangement between the buyer and seller. There may not be legal

instruments/acknowledgements of debt. (2) Advances from Customers Advances from customers against orders also act as source of short term finance. It is a cheap source of finance and in order to minimize the investment in working capital, some firms having

long production cycle, specially the firms manufacturing industrial products prefer to take advances from their customers. (3) Discounting Bills of ExchangeWhen goods are sold on credit, the suppliers generally draw bills of exchange upon customers who are required to accept the same. The term of such bills may be three to six months. Instead of holding the bill till maturity, the companies may get them discounted with the bank. The bank charges discount in terms of interest for the unexpired term of the bill. On the due date the bank presents the bill to the drawee/acceptor and receives the full amount. In case the bill is

dishonoured, the bank debits to the account of the company and returns it the dishonoured bill. (4) Bank OverdraftIt refers to an arrangement whereby the bank allows the customers to overdraw from its current deposit account within a specified limit. The interest is charged on the amount overdrawn for the actual period of use. It may be granted against the security of assets or personal security. (5) Cash Credit Under cash credit the bank specifies a pre-determined borrowing/credit limit. The borrower can draw money from time-to-time within the specified cash-credit limit. Any number of drawals are possible and re-payments can be made during the period. Interest is charged only on the amount actually withdrawn for the actual period of use. The cost of raising finance through this method is the interest charged by the bank. (6) Letter of credit It is an indirect form of working capital financing and banks assume the risk, the credit being provided by the supplier himself. L/C is the guarantee provided by the buyers bankers to the seller that in case of default or failure of the buyer to pay, the bank shall make the payment to the seller. Thus, the supplier sells goods on credit/extends credit (finance) to the buyer, the bank gives a guarantee and bears risk only in case of default by the purchaser. (7) Commercial PapersCommercial paper is a short term unsecured promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is issued by large and creditworthy companies to raise short term funds at lower rates of interest than market rates. It usually has a maturity period of 15 days to one year. It is sold at a discount and redeemed at par. The liquidity and earning power of the issuer are the only guarantee.

(8) FactoringFactor is a financial institution that specializes in purchasing accounts receivables from business firms. It provides resources to finance receivables as well as facilitates collection of receivables. Factoring can broadly be defined as an agreement in which receivables arising out of sale of goods or services are sold by a firm(client)to the factor (a financial intermediary) as a result of which the title of goods/services represented by the said receivables passes on to the factor. Henceforth the factor becomes responsible for all credit control, sales accounting and debt collection from the buyer(s). Realization of credit sales is the main function of factoring services. Once a sale transaction is completed, the factor steps in to realise the sales. Thus the factor works between the seller and the buyer. Depending on the type/form of factoring, the main functions of a factor, in general can be classified into five categories: (i) (ii) (iii) (iv) (v) Financing facility/trade debts. Maintenance/administration of sales ledger. Collection facility/of accounts receivables. Assumption of credit risk/credit control and credit restriction. Provision of advisory services.

The two main methods of factoring are: (a) Recourse and (b) Non-recourse.

Under Recourse factoring the client is not protected against the risk of bad-debts. On the other hand, the factor assumes the entire credit risk under Non-recourse factoring ie. full amount of invoice is paid to the client in the event of the debt becoming bad. The factoring firms are professionally competent with skilled persons to handle credit sales realizations for different clients in different trades for better credit management. Thus, need for factor services is felt by traders to concentrate on sales and realization of credit sales be left in specialized hands to minimize the risk of bad-debts. If sales are realized

within reasonable time, the firms need not depend much for bank finance for scorching capital. (9) AccrualsAccrued expenses are the expenses which have been incurred but not yet due hence not yet paid. These are simply what the firm owes to its employees & to the govt. Most important items of accruals are wages & salaries, interest & taxes. Payment for these is made much after the benefit in relation to these has been enjoyed. In the intervening period they serve as a good source of finance. The amount of accruals varies with the level of activity of the firm. As they respond more or less automatically to changes in the level of activity they are treated as part of spontaneous financing. Moreover, as no interest is payable on them they represent a free source of financing. However, it must be noted that it may not be desirable/possible to postpone these expenses for a long period as the delay may result in penalties. Thus the frequency and magnitude of accruals is beyond the control of management, so even though they serve as spontaneous interest free funds, their use as a source of financing is much restricted.

(10)

Inter-corporate Deposits-

A deposit made by one company with another, normally for a period upto six months is referred to as inter-corporate deposit. Such deposits are usually of three types(i) Call Deposit- Theoretically, it is a deposit withdrawable by the lender by giving a days notice. In practice, however the lender has to wait for atleast three days. (ii) Three months deposit- these deposits are popular and are taken by borrowers to tide over a short term cash inadequacy. (iii) Six-months deposit- made for a period of six months, however lending companies do not generally exceed deposits beyond this time frame. Thus, working capital requirements are typically financed by a combination of sources. The finance department has to exercise caution and select the optimum mix of the available sources for the purpose.

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