Page 32 - DMGT409Basic Financial Management

Unit 2: Source of Finance

Notes

Note Distinction between Cash Credit and Bank Overdraft

1. Cash credit is an arrangement of credit granted by a bank to a fi rm. The firm may or

may not have an account with the bank. Overdraft is granted to an accountholder
purely on the basis of his credit-worthiness. Credit worthiness is decided by the
financial soundness of past dealings of the customer with the bank.

2. In case of cash credit, the amount of credit is placed in a separate account of the
borrower. Overdraft limit is generally granted to an existing account of the
customer.
3. The amount of credit in case of cash credit depends upon the value of securities offered.
But overdraft limit is decided on the average balance in the customers account.
4. Overdraft is granted without the security of any assets. But for cash credit, security of
tangible assets is an essential requirement.

4. Discounting of Bill: Banks also give advance money by discounting bill of exchange. When
a bill of exchange is presented before the bank for encashment, bank credits the amount
to customer’s account after deducting some discount. The amount of discount is charged
on the basis of the interest for the period of bill. On maturity of the bill, the payment is
received by the bank from the drawee.
2.3.8 Accruals

Accrued expenses are those expenses which the company owes to the other persons or
organisations, but not yet due and not yet paid the amount. In other words, accruals represent

a liability that a firm has to pay for the services or goods, which it has already received. It is
spontaneous and interest-free sources of financing. Salaries, wages, interest and taxes are the

major constituents of accruals. Salaries and wages are usually paid on monthly and weekly basis
respectively. The amounts of salaries and wages have owed but not yet paid and shown them

as accrued salaries and wages on the balance sheet at the end of financial year. Longer the time
lag in payment of these expenses, the greater is the amount of funds provided by the employees.
Similarly, interest and tax are other accruals, as source of short-term fi nance.
2.3.9 Factoring

Factoring is a method of raising short-term finance for the business in which the business can
take advance money from the bank against the amount to be realised from the debtors. By this

method, the firm shifts the responsibility of collecting the outstanding amount from the debtors
on payment of a specified charge. Here the business gets the money in advance without waiting

for due date. Also it saves the effort of collecting the debts.

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