|
Introduction
What is Working Capital?
Apart from financing for investing
in fixed assets, every business also requires funds on a continual basis
for carrying on its operations. These include amounts expenses incurred
for purchase of raw material, manufacturing, selling, and administration
until such goods are sold and the monies realized. Business transactions
are generally carried on credit with a number of days elapsing subsequent
to the sale being effected for realization of proceeds1.
While part of the raw material maybe purchased by credit, the business
would still need to pay its employees, meet manufacturing & selling
expenses (wages, power, supplies, transportation and communication) and
the balance of its raw material purchases. Working capital refers to the
source of financing required to by businesses on a continual basis for
meeting these needs.
Thus the need for working
capital arises from the prevalence of credit in business transactions,
need to fund manufacturing and support and to account for the variations
in the supply of raw material and demand for finished goods.
Characteristics of working
capital
-
It is continually required for
a going concern
-
However, the quantum of working
capital fluctuates depending on the level of activity
-
Working Capital is impacted by
numerous transactions on a continual basis
The above characteristics render
limit based financing from banks ideal for working capital financing.
This is because the client is charged interest only on the average outstanding
utilized and is saved with the bother of reinvesting short term surpluses
arising out of low working capital utilization at a point in time.
Further since the transactions of the business are generally routed through
a current account with a bank, availing a credit limit from the same bank
is really convenient. Thus, working capital requirements are generally
financed through limit based financing from banks.
Bank Financing for Working
Capital
The financing limits are granted
based on assessment of the working capital requirement. The assessment
factors include various characteristics such as the nature of industry,
industry norms, actual level of activity for the previous year and the
projected level of activity for the subsequent year to arrive at the working
capital requirement. The bank financing limit is thereafter decided after
factoring in margins on the different types of current assets forming part
of the working capital. (Detailed example provided
in the section on Estimation of Working Capital requirements)
The Bank Financing Limit is
fixed on an annual basis. However, since such limit is provided to meet
specific
requirements, utilizing the limits is subjected to the Drawing
Power, which is decided on a monthly/ quarterly basis.
The effective bank financing
is therefore to the extent of the lower of:
-
Bank Financing Limit: Determined
on an annual basis based on an assessment of the current year’s projections
and the actuals for the previous year.
-
Drawing Power: Linked to
the quantum of current assets (and current liabilities) owned by the business
with appropriate margins. Fixed on a monthly/ quarterly basis depending
on the submission of Monthly/Quarterly Information System returns indicating
the position of the stock statement, receivables, Work in Progress, payables,
etc.
Bank Financing (max.
permissible) = Bank Financing Limit OR Drawing Power whichever is less
1The pace
at which a business realizes its proceeds depends on the terms it is able
to dictate. Thus a large corporate like Hindustan Lever maybe able to insist
on advance payment. In case of exports the proceeds are generally realized
through 180 day usance L/Cs.
Close window
Types of Working Capital Financing
Procedures to avail working capital
from banks
Estimation of Working Capital Requirement
Working Capital – The Status Today
We would look forward to receiving
your feedback and suggestions on this module at services@indiamarkets.com
|