Page 233 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes of banks is to finance working capital requirement of firms. Working capital advances forms
major part of advance portfolio of banks. In determining working capital requirements of a
firm, the bank takes into account its sales and production plans and desirable level of current
assets. The amount approved by the bank for the firm’s working capital requirement is called
credit limit. Thus, it is maximum fund which a firm can obtain from the bank. In the case of firms
with seasonal businesses, the bank may approve separate limits for ‘peak season’ and ‘non-peak
season’. These advances were usually given against the security of the current assets of the
borrowing firm usually; the bank credit is available in the following forms:

Cash Credit: Under this facility, the bank specifies a predetermined limit and the borrower
is allowed to withdraw funds from the bank up to that sanctioned credit limit against a
bond or other security. However, the borrower can not borrow the entire sanctioned
credit in lump sum; he can draw it periodically to the extent of his requirements. Similarly,
repayment can be made whenever desired during the period. There is no commitment
charge involved and interest is payable on the amount actually utilized by the borrower
and not on the sanctioned limit.

Overdraft: Under this arrangement, the borrower is allowed to withdraw funds in excess
of the actual credit balance in his current account up to a certain specified limit during a
stipulated period against a security. Within the stipulated limits any number of withdrawals
is permitted by the bank. Overdraft facility is generally available against the securities of
life insurance policies, fixed deposits receipts, Government securities, shares and
debentures, etc. of the corporate sector. Interest is charged on the amount actually withdrawn
by the borrower, subject to some minimum (commitment) charges.
Loans: Under this system, the total amount of borrowing is credited to the current account
of the borrower or released to him in cash. The borrower has to pay interest on the total
amount of loan, irrespective of how much he draws.

Notes Loans are payable either on demand or in periodical installments. They can also be
renewed from time to time. As a form of financing, loans imply a financial discipline on
the part of the borrowers.

Bills Financing: This facility enables a borrower to obtain credit from a bank against its
bills. The bank purchases or discounts the bills of exchange and promissory notes of the
borrower and credits the amount in his account after deducting discount. Under this
facility, the amount provided is covered by cash credit and overdraft limit. Before
purchasing or discounting the bills, the bank satisfies itself about the creditworthiness of
the drawer and genuineness of the bill.
Letter of Credit: While the other forms of credit are direct forms of financing in which the
banks provide funds as well as bears the risk, letter of credit is an indirect form of working
capital financing in which banks assumes only the risk and the supplier himself provide
the funds.

Did u know? What is letter of credit?

A letter of credit is the guarantee provided by the buyer’s banker to the seller that in the case
of default or failure of the buyer, the bank shall make the payment to the seller. The bank
opens letter of credit in favour of a customer to facilitate his purchase of goods. This
arrangement passes the risk of the supplier to the bank. The customer pays bank charges for
this facility to the bank.

228 LOVELY PROFESSIONAL UNIVERSITY