Working Capital Financing

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
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

COST OF TRADE CREDIT
No explicit cost Example:
45 days net
Implicit cost Example:
2/15 net 45
IMPLICIT COST
D 1D * 360 DAYS CP DP
D- Discount rate CP Credit Period DP Discount Period
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%
2. BANK CREDIT
Forms of bank credit:
Cash Credit (OD) Loans Bills Discounting Letter of Credit (L/C) WK Term Loans
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 Interest charged on the amount withdrawn and not on the sanctioned limit Minimum commitment charge payable for the facility
2b. Loans
The entire amount of borrowing is credited to the account of the borrower Interest payable on total amount
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)
2d. WK TERM LOANS
Loans for 3 to 7 years Payable in annual or half yearly installments
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
MODES OF SECURITY
Hypothecation Pledge Lien Mortgage
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
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
LIEN
Right of a party to retain the goods belonging to another party until a debt due to her is paid.
MORTGAGE
Transfer of a legal/equitable interest in specific immovable property as a security Borrower Mortgagor Bank Mortgagee Instrument Mortgage Deed
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
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
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.
FUNCTIONS OF FACTOR
Maintenance of Sales Ledger Collection of Accounts Receivable Financing of Trade debts Assume credit risk Advisory services
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

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
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

Working Capital Financing

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Working Capital Financing

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WORKING CAPITAL FINANCING

TRADE CREDIT BANK CREDIT COMMERCIAL PAPERS FACTORING FORFAITING NUMERICALS

Advantages: Easily available Flexible

COST OF TRADE CREDIT

No explicit cost Example:

Implicit cost Example:

D- Discount rate CP Credit Period DP Discount Period

Forms of bank credit:

2a. CASH CREDIT

2c. BILLS DISCOUNTING

Cash credit involved double financing:

2d. WK TERM LOANS

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

2e. LETTER OF CREDIT

Hypothecation Pledge Lien Mortgage

Finance Maintenance of accounts Collection of debts Protection against credit risk

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

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