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TOPICS TO BE COVERED
Determination of level of current assets. Bank finance for working capital. Working capital financing: Short term financing of working capital, long term financing of working capital. Working capital leverages Sources for financing working capital.
CURRENT ASSETS
Current assets are reasonably expected to be realized in cash, or sold or consumed, during the longer of one year or the companys operating cycle Current assets include: Cash -- ultimate liquid asset Cash equivalents -- temporary investments of excess cash Marketable securities -- debt or equity securities held as ST investments Accounts receivable -- Amounts due from credit sales Inventories -- items held for sale in the normal course of business Prepaid expenses -- advance payments for services and supplies
CURRENT LIABILITIES
Current liabilities are obligations expected to be satisfied within a relatively short period of time, usually one year Current liabilities include:
Definition of WCM
Working Capital Mgt is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the interrelationship that exists between them. The goal of working capital management is to manage the firms current assets and liabilities in such a way that a satisfactory level of WC is maintained.
Permanent WC
Time
Cont
Operating Cycle
The continuing flow from cash to suppliers, to inventory, to accounts receivable and back into cash is called Operating cycle. In other words, the term cash cycle refers to the length of time necessary to complete the following cycle of events.
Conversion of cash into inventory Conversion of Inventory into receivables Conversion of receivables into cash Receivables Phase 3
CASH vg
Phase 2
Inventory
Phase 1
CONSERVATIVE POLICY
Conservative current assets policy indicates constant level of fixed assets, and a higher CA/FA ratio It involves greater liquidity & lower risk The high level of current assets involves high cost and in turn high liquidity PWC or TWC Financed from LTS Low risk offers low profit
AGGRESSIVE POLICY
Aggressive current assets policy indicates constant level of fixed assets, and a lower CA/FA ratio It involves higher risk & poor liquidity The low level of current assets involves low cost and in turn poor liquidity PWC or TWC Financed from the STS High risk offers high profit
COMPARISION
Approach Conservative Trade off Aggressive Degree of Risk Lowest Moderate Highest Degree of Liquidity Highest Moderate Lowest
C.A. = Current Assets T.A. = Total Assets (Net Fixed Assets + Current Assets) CA = Change in Current Assets
SPONTANEOUS FINANCING
Types of spontaneous financing are Trade Credit and Accrued expenses Stretching Accounts payable is also known as a type of spontaneous financing
TRADE CREDIT
Customer gets credit from supplier of goods in normal course of business. An informal arrangement, granted on an open account basis, not formally acknowledge as a debt. Trade credit may also take the form of bills payable. Credit Terms refers to the conditions of due date and cash discount.
TRADE CREDIT
Advantages Easy Availability. Flexibility. Informality. Disadvantages Implicit Cost. Stretching A/P can prove to be very costly.
365 days X
(payment date discount period)
ACCRUED EXPENSES
Accrued expenses means the expenses incurred but not paid Examples Accrued Wages and Salaries. Accrued taxes and Interest. It is regarded as short term finance because some services are enjoyed by the concern without making any payment for a short period
Functions
1. Collection of A/R 2. Administration of A/R 3. Credit protection against bad debts 4. Credit control. Advantage of Factoring
It provides credit protection for the receivables. It helps the business to meet increasing sales demand and expand. Factoring helps in saving time as the invoice financing company collects the money itself. especially if factor engages in aggressive or unprofessional practices when collecting accounts. Cost is another disadvantage cost involved in factoring agreement may be more than the cost of other methods of financing available in the business.
BANK FINANCE
Overdraft Invoice Discounting Term Loans Advances of fixed amount which are credited to the current Account of the borrower or released to him in cash. Charged with interest on the entire amount irrespective of how much he withdraws.
Overdraft
it is an agreement by a bank to allow a company to borrow up to a certain limit without the need for further discussion. An Overdraft is a flexible source of finance in that a company only uses it when the need arises. The bank will charge daily interest at a variable rate on the debt outstanding. The bank may also require security or collateral as protection against the risk of non payment by the company.
Invoice Discounting
It is a form of short term borrowing often used to improve a companys working capital and cash flow position. Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid. A borrower can obtain credit from a bank against its bills. The bank become owner of the bills, in practice bank holds bills as security for the credit.
Secured loan
In a secured loan, the borrower pledges assets as collateral for the loan. For short-term loans, the most commonly pledged assets are receivables and inventories. Securities are great collateral, but generally not available
Unsecured Loan
It is a loan obtained without collateral. A person obtaining an unsecured loan agrees to pay back the loan within a set term and signs documents attesting to such. Another common type of unsecured loan is a purchase made on a credit card. Each time a person makes a credit card purchase, he or she signs a form which authorizes the payment and stands as an agreement to pay the money borrowed.
Pledge Under this arrangement, the borrower is required to transfer the physical possession of the property offered as a security to the bank to obtain credit the banker has a right of lien and can retain possession of the goods pledged unless payment of interest, principal and any other expenses is made.
Mortgage
It is the transfer of legal or equitable interest in a specific immovable property for the payment of debt. In this case, the possession of the asset will remain with the borrower and the lender getting full legal title. The borrower is called as mortgagor, the bank is called the mortgagee, and the instrument of transfer is called the mortgage deed.
Public Deposits
The term public deposit implies any money received by a company through the deposits or loans collected from the public. The Public includes the general public, employees and shareholders of the company but excludes the money received in the form of shares and debenture. The public deposits are generally solicited by the firms in order to finance the working capital requirement of the firm. Public deposits are an important source of financing the medium term and long term requirements of a company. The Max maturity period is 3 years and Min is 6 months.
Lien Means right of the lender to retain property belonging to the borrower until he repays credit.
Commercial Paper
It refers to short term unsecued promisory note sold by large business firms to raise cash. It can be sold either directly or through dealers.
Intercorporate deposits
It is also one type of short term deposits with other companies is a fairly attractive form of investment of short term funds in terms of rate of return which currently ranges between 12 to 15 percent.
Retained earnings The co may not distribute the whole of its profits among its shareholders. It may retain a part of the profits and utilize it as capital. Term loans from banks. Many industrial dvt banks, cooperative banks and commercial banks grant loans for a period of 3 to 5 years.
MPBF
Maximum Permissible Bank Finance Recommended by Tandon committee The group (headed by Sh. Prakash Tandon) was appointed in July 1974 which was to frame guidelines for follow-up of bank credit and submitted its final report during 1975
MPBF
According to Tandon committee Method I : 0.75 (Current Assets Current Liabilities) Method II : (0.75 *Current Assets) Current Liabilities Method III: 0.75 (Current Assets CCA) Current Liabilities
Method I
Total Current Assets Less: Total Current Liabilities (#) Working Capital Gap Less: 25% from Long Term Sources MPBF xxx xx xxx xx xxx
# Note: Total Current Liabilities means Liabilities excluding Bank Borrowings to be taken into account for Calculation
Method II
Total Current Assets Less: 25% from Long Term Sources xxx xx
xxx
xx xxx
# Note: Total Current Liabilities means Liabilities excluding Bank Borrowings to be taken into account for Calculation
Method III
Total Current Assets xxx
xx
xxx xx xxx xx xxx
# Note: Total Current Liabilities means Liabilities excluding Bank Borrowings to be taken into account for Calculation