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WORKING CAPITAL FINANCING

(10 % CREDIT)

B.K.M.I.B.A./Prof. S. Agrawal/2010

TOPICS TO BE COVERED

TRADE CREDIT BANK CREDIT COMMERCIAL PAPERS FACTORING FORFAITING NUMERICALS

B.K.M.I.B.A./Prof. S. Agrawal/2010

1. TRADE CREDIT

Credit extended by supplier of goods and services in the normal course of business Informal arrangement between the buyer and seller No legal instrument

Advantages: Easily available Flexible


B.K.M.I.B.A./Prof. S. Agrawal/2010

COST OF TRADE CREDIT

No explicit cost Example:

45 days net

Implicit cost Example:

2/15 net 45

B.K.M.I.B.A./Prof. S. Agrawal/2010

IMPLICIT COST
D 1D * 360 DAYS CP DP

D- Discount rate CP Credit Period DP Discount Period

B.K.M.I.B.A./Prof. S. Agrawal/2010

The smaller the difference between the payment day and the end of discount period, the larger is the annual interest cost of trade credit. 2/15 net 45 = 24.5% 2/10 net 30 = 36.4%

B.K.M.I.B.A./Prof. S. Agrawal/2010

2. BANK CREDIT

Forms of bank credit:

Cash Credit (OD) Loans Bills Discounting Letter of Credit (L/C) WK Term Loans

B.K.M.I.B.A./Prof. S. Agrawal/2010

2a. CASH CREDIT

Arrangement b/w a bank and a firm specifying the amount of short term borrowing the bank would make available to the firm over a given period of time. Interest charged on the amount withdrawn and not on the sanctioned limit Minimum commitment charge payable for the facility

B.K.M.I.B.A./Prof. S. Agrawal/2010

2b. Loans

The entire amount of borrowing is credited to the account of the borrower Interest payable on total amount

B.K.M.I.B.A./Prof. S. Agrawal/2010

2c. BILLS DISCOUNTING

Cash credit involved double financing:

Buying goods on credit from suppliers and raising cash credit by hypothecating the same goods

Seller - Drawer of Bill Buyer Drawee of Bill Bank Payee (pays bills on maturity or at discount)
B.K.M.I.B.A./Prof. S. Agrawal/2010

2d. WK TERM LOANS

Loans for 3 to 7 years Payable in annual or half yearly installments

B.K.M.I.B.A./Prof. S. Agrawal/2010

2e. LETTER OF CREDIT

Letter written by bank stating that the bank guarantees the payment of an invoiced amount if all the underlying agreements are met or the buyer fails to make the payment Bank assumes the risk of credit

B.K.M.I.B.A./Prof. S. Agrawal/2010

MODES OF SECURITY

Hypothecation Pledge Lien Mortgage

B.K.M.I.B.A./Prof. S. Agrawal/2010

HYPOTHECATION

Use of movable property (inventory) as a collateral to obtain a short term loan Possession of goods lies with the borrower Bank has legal right to sell the goods in case of default

B.K.M.I.B.A./Prof. S. Agrawal/2010

PLEDGE

Use of movable property (inventory) as a collateral to obtain a short term loan Possession of goods lies with the BANK Bank takes reasonable care of the goods Borrower Pawnor / Pledgor Bank Pawnee / Pledgee

B.K.M.I.B.A./Prof. S. Agrawal/2010

LIEN

Right of a party to retain the goods belonging to another party until a debt due to her is paid.

B.K.M.I.B.A./Prof. S. Agrawal/2010

MORTGAGE

Transfer of a legal/equitable interest in specific immovable property as a security Borrower Mortgagor Bank Mortgagee Instrument Mortgage Deed

B.K.M.I.B.A./Prof. S. Agrawal/2010

3. COMMERCIAL PAPERS

Short term unsecured promissory note issued by firms with a high credit standing Issued at discount on face value Investors can choose from a variety of CPs having different maturity

B.K.M.I.B.A./Prof. S. Agrawal/2010

4. FACTORING

An arrangement b/w a factor and his client which includes atleast 2 of the following services:

Finance Maintenance of accounts Collection of debts Protection against credit risk

B.K.M.I.B.A./Prof. S. Agrawal/2010

An arrangement in which receivables arising out of sale of goods or services are sold by a firm (client) to the factor ( a financial intermediary) 80% to 85% of the sale is paid by the factor, balance when collected after deducting the factor charges.

B.K.M.I.B.A./Prof. S. Agrawal/2010

FUNCTIONS OF FACTOR

Maintenance of Sales Ledger Collection of Accounts Receivable Financing of Trade debts Assume credit risk Advisory services

B.K.M.I.B.A./Prof. S. Agrawal/2010

TYPES OF FACTORING

Recourse and Non-Recourse Factoring Advance and Maturity Factoring Full Factoring Disclosed and undisclosed Factoring Domestic and Cross Border/Export Factoring

Exporter (client) Export Factor Importer (customer) Import Factor


B.K.M.I.B.A./Prof. S. Agrawal/2010

ADVANTAGES

Off balance sheet finance Reduction in current liabilities Improves current ratio Higher credit standing Improved efficiency More time for planning, production and other business activity Reduction in cost
B.K.M.I.B.A./Prof. S. Agrawal/2010

5. FORFAITING

Purchase of trade bills/PNs by a bank or FI without recourse to the seller Bank pays cash to the seller after discounting the bills and assumes all the risk All responsibilities of collection are that of bank

B.K.M.I.B.A./Prof. S. Agrawal/2010