Page 50 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 3: Financing of Working Capital Needs

3.2 Summary Notes

Estimation of working capital required is completed, then the next step is financing of
working capital.

Statement of working capital gives clear picture about the components and required
investment in these components of working capital.

Working capital should be financed by suitable and optimal mix of short-term source of
funds and long-term source of funds.
Main sources of financing funds are trade credit, accruals, differed incomes, commercial
papers and commercial banks.
Trade credit refers to the credit extended by the supplier of goods or services to his
customer in the normal course of business.
Trade credit is a spontaneous source of finance that it arises in the normal business
transactions of the firm without specific negotiations (automatic source of finance).

Accrued expenses are those expenses which the company owes to the other persons or
organisations, but not yet due to pay the amount.

Deferred Incomes are income received in advance by the firm for supply of goods or
services in future period.
Commercial Papers represents a short-term unsecured promissory notes issued by firms
that have a fairly high credit (standing) rating.

Commercial Paper is an alternative source of finance and proves to be helpful during the
period of tight bank credit, it is a cheaper source of short-term finance when compared to
the bank credit.
Commercial banks are the major source of working capital finance and loaning of funds to
business is one of their primary functions.
Forms of bank finance are loans, overdrafts, cash credits, purchase or discounting of bills
and letter of credit.

Factoring service may be offered to the client in two ways: (a) with recourse to the drawer(s)
and (b) without recourse to the drawer(s).

3.3 Keywords

Accounts Receivable: Money owed to a firm by its suppliers.

Acid Test Ratio: A liquidity measure which is defined as current liabilities.
Commercial Papers (CPs): Commercial paper represents a short-term unsecured promissory
note issued by firms that have a fairly high credit (standing) rating.

Loans: Loan is an advance – a sum given to borrower against some security.
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.
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.

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