Virtually, all firms invest in working capital and therefore, must finance such investments. As already discussed, the working capital need of a concern can be classified in to two parts. First, permanent or fixed working capital requirements and Second, temporary or variable working capital requirements. Hence, for need based funding, one must recognize the fixed need for working capital, which is more or less long-term in nature and the fluctuating or seasonal need for working capital, which is short-term in nature. The funding should also be so done that long term uses or needs of the working capital are financed from long-term sources and short-term uses of the working capital are financed from short-term sources of capital. The details regarding these two sources are given below:
1. Long-Term Sources of Working Capital:
The long-term working capital requirements include the initial and the regular working capital. Along with it, the minimum level of investment in various current assets also determines the requirement of long-term working capital. This capital can be conveniently financed by the following sources:
A. Share Capital A part of long-term working capital can be financed with the share capital. Generally the company issues both preference and equity shares for raising the long-term capital. Preference shares carry preferential rights in respect of dividend at a fixed rate and in regard to the repayment of capital at the time of winding up of the company. Whereas, equity shares do not have any fixed commitment chargers and dividend on these shares is to be paid subject to the availability of sufficient profit.
B. Debentures A debenture is an instrument issued by the company acknowledging its debt to its holder. The debenture holders are the creditors of the company. A fixed rate of interest is paid on debentures. These are also an important source of long-term working capital because, they are fixed cost sources. The debentures may be of various kinds such as Simple, Naked or Unsecured Debentures, Secured or Mortgage Debentures, Redeemable and Irredeemable Debentures, Convertible and Non-Convertible Debentures, etc.
C. Ploughing Back of Profits A part of the earned profits may be ploughed back by the firm in meeting their working capital requirements. It is a regular and cheapest source of working capital as it does not involve any explicit cost of capital.
D. Sale of Fixed Assets The idle fixed assets of the concern, if any, can be sold out and sale proceeds can be utilized for financing the working capital requirements.
E. Term Loans The loans rose for a period varying from 3 to 5 or 7 years are also important source of working capital. This type of finance is ordinarily repayable in installments. Such loans usually increase the working capital of the enterprise.
2. Short-Term Sources of Working Capital:
This category of funds covers the need of working capital for financing day-today business requirement. Normally, the duration of such requirements does not exceed beyond a year. The short-term sources of working capital may be internal as well as external.
A. Internal Sources
I. Depreciation Funds The Depreciation funds constitute important source of short-term working capital.
II. Provision for Taxation The provision for taxation can also be used by the companies as a source of working capital during the intermittent period.
III. Accrued Expenses The firm can postpone the payment of expenses for short periods; hence more accrued expenses also constitute an important source of working capital.
B. External Sources
I. Trade Credit One of the most important sources of short-term finance is the trade credit extended by one business enterprise. The use of trade credit has increased in recent years due to mainly perhaps to the credit squeeze. The trade credit may also assume three forms; purchase an open account, purchasing of furnishing a prorate for specified period and purchase a trade acceptance.
II. Bank Credit Commercial banks are also principal source of working capital. They provide working capital in a number of ways such as overdrafts, cash credit, line of credit, short-term loans etc., Compared with other methods of borrowing, this is the most flexible source, because when the debt is no longer required it can be quickly and easily reduced. It is also comparatively cheap.
III. Credit Papers In the category of credit papers, bills of exchange and promissory notes of shorter duration between a month and six months are used. These papers are discounted with a bank, and varying capital can be arranged. Accommodation bills are an important method of such finance.
IV. Public Deposits Public deposits are also an important source of short-term and mediumterm finance. Due to shortage of bank credit in recent past, the importance of public deposits has increased.
V. Customer’s Credit Advances may also be obtained on contract entered into by enterprise. The customers are often asked to make some advance payments in cash in lieu of the contract purchase. Such advance can be utilized in purchasing raw materials, paying wages and so on.
VI. Govt. Assistance Some time central and state Govt. also provide short-term finance on easy terms.
VII. Loans from Directors An enterprise can also obtain loans from its officers, directors, etc. These loans are often obtained at almost negligible rates of interest. Sometimes no interest is charged on them. Loans can also be obtained from other fellow companies working within the same group.
VIII. Security of Employees If employees are required to make deposits with their employer’s companies, such companies utilize those amounts on meeting their working capital needs.
IX. Factoring It involves raising funds on the security of the company debts so that cash is received earlier than if the company waited for the debtors to pay. Thus the factors help in improving the company’s liquidity position. But this finance is not cheap in comparison to bank credits, etc.
For citing this article use:
- Somanchi, H. K. (2013). A comparative study on working capital management in pharmaceutical industry.