Page 47 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Banks provide working capital finance through financing receivables. A “Factor” is a financial
institution, which renders services relating to the management and financing of sundry debtors
that arises from credit sales. Factoring is a popular mechanism of managing, financing and
collecting receivables in developed countries like USA and UK, and it has spread over to a
number of countries in recent past including India. In India, factoring service started in April
1994, after setting up of subsidiaries. It is yet at the formative stage. In India, there are only four
public sector banks that offer factoring related service in the respective regions of the country
(authorized by RBI) viz., State Bank of India {subsidiary State Bank of India Factoring and
Commercial Services Limited), Canara Bank (Canara Bank Factoring Limited), Allahabad Bank
and Punjab National Bank to cater to the needs of the Western, Southern, Eastern and Northern
regions, respectively.

Self Assessment

Fill in the blanks:
5. By reducing the size of its .......................... , more money is made available for investment
in the firm’s growth.

6. A .......................... is a financial institution, which renders services relating to the
management and financing of sundry debtors that arises from credit sales.
7. Commercial Paper is an unsecured ..........................

3.1.4 Trade Credit

Trade credit refers to the credit extended by the supplier of goods or services to his/her customer
in the normal course of business. Trade credit occupies very important position in short-term
financing due to the competition. Almost all the traders and manufacturers are required to
extend credit facility (a portion), without which there is no possibility of staying back in the
business. Trade credit is a spontaneous source of finance that arises in the normal business
transactions of the firm without specific negotiations (automatic source of finance). In order to
get this source of finance, the buyer should have acceptable and dependable credit worthiness
and reputation in the market. Trade credit generally extended in the format open account or
bills of exchange. Open account is the form of trade credit, where supplier sends goods to the
buyer for the payment to be received in future as per terms of the sales invoice. As such trade
credit constitutes a very important source of finance; it represents 25 per cent to 50 per cent of the
total short-term sources for financing working capital requirements.

Getting trade credit may be easy to the well-established or well-reputed firm, but for a new or the
firm with financial problems will generally face problem in getting trade credit. Generally suppliers
look for earning record, liquidity position and payment record which is extending credit. Building
confidence in suppliers is possible only when the buyer discussing his/her financial condition
future plans and payment record. Trade credit involves some benefits and costs.
Advantages of Trade Credit

The main advantages are:
1. Easy availability when compared to other sources of finance (except financially weak
companies).

2. Flexibility is another benefit, as the credit increases with the growth of the firm’s sales.
3. Informality as we have already seen that it is an automatic finance.

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