Page 44 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 3: Financing of Working Capital Needs

3.1.1 Commercial Banks Notes

Commercial banks are the major source of working capital finance to industries and commerce.
Granting loan to business is one of their primary functions. Getting bank loan is not an easy task
since the lending bank office may ask number of questions about the prospective borrower’s
financial position and its plans for the future. At the same time bank will want to monitor of the
borrower’s business progress. But there is a good side to this that is borrower’s share price tends
to rise, because investor know that convince banks is very difficult.

Forms of Bank Finance

Banks provide different types of tailored made loans that are suitable for specific needs of a firm.
The different types of forms of loans are:
1. Loans
2. Overdrafts
3. Cash credits

4. Purchase or discounting of bills and
5. Letter of Credit
6. Bank Guarantee.

1. Loans: Loan is an advance – a sum given to borrower against some security. Loan amount
is paid to the applicant in the form of cash or by credit to his/her account. In practice the
loan amount is paid to the customer by crediting his/her account. Interest will be charged
on the entire loan amount from the date the loan is sanctioned. Borrower can repay the
loan either in lump sum or in installments depending on conditions.

Notes If the loan is repayable in installment basis, interest will be calculated on quarterly
and on reduced balances. Generally, working capital loans will be granted for one-year
period.
2. Overdrafts: Overdraft facility is an agreement between the borrower and the banker, where
the borrower is allowed to withdraw funds in excess of the balance in his/her current
accounts up to a certain limit during a specified period. It is flexible from the borrower’s
point of view because the borrower can withdraw and repay the cash whenever he/she
wants within the given stipulations. Interest is charged on daily drawn balances and not on
the overdraft limit given by the bank. But bank charges some minimum charges.

3. Cash Credit: It is the most popular source of working capital finance in India. A cash credit
facility is an arrangement where a bank permits a borrower to withdraw money up to a
sanctioned credit limit against tangible security or guarantees. Borrower does not require
withdrawing the total sanctioned credit at a time, rather, he can withdraw according to
his/her requirements and he can also repay the surplus cash in his cash credit account.
Interest is chargeable on actually used amount and there is no commitment charge. Cash
credit is a flexible source of working capital from borrower’s point of view.
4. Purchasing or Discounting of Bills: Bills receivable arises out of sales transaction, where
the seller of goods draws the bill on the purchaser. The bill may be documentary or clean
bill. Once the bill is accepted by the purchaser, then the drawer (seller) of the bill can go to
bank for discount or sale. The credit worthiness of the drawer (seller) is satisfactory, then

LOVELY PROFESSIONAL UNIVERSITY 39