Working Capital Financing - India

Sources of Working Capital Finance

 

Accruals

Trade credit

Advances by banks

Public deposits

Inter corporate deposits

Short term loans form financial institutions and NBFCs

Rights debentures for working capital

Commercial paper

Factoring

International factoring

Forfaiting

 

 

 

commercial paper

 

 

The eligibility criteria for issue of commercial paper

 

 

Eligibility criteria for issuer of commercial paper

The companies satisfying the following conditions are eligible to issue commercial paper.

¨         The tangible net worth of the company is Rs. 5 crores or more as per audited balance sheet of the company.

¨         The fund base working capital limit is not less than Rs. 5 crores.

¨         The company is required to obtain the necessary credit rating from the rating agencies such as CRISIL, ICRA etc.

¨         The issuers should ensure that the credit rating at the time of applying to RBI should not be more than two moths old.

¨         The minimum current ratio should be 1.33:1 based on classification of current assets and liabilities.

¨         For public sector companies there are no listing requirement but for companies other than public sector, the same should be listed on one or more stock exchanges.

¨         All issue expenses shall be borne by the company issuing commercial paper.

Features of Commercial Paper (CP)

A commercial paper is an unsecured money market instrument issued in the form of a

promissory note. Since the CP represents an unsecured borrowing in the money market, the regulation of CP comes under the purview of the Reserve Bank of India which issued guidelines in 1990 on the basis of the recommendations of the Vaghul Working Group.

These guidelines were aimed at:

(i) Enabling the highly rated corporate borrowers to diversify their sources of short term

borrowings, and

(ii) To provide an additional instrument to the short term investors.

It can be issued for maturities between 7 days and a maximum upto one year from the

date of issue. These can be issued in denominations of Rs. 5 lakh or multiples therefore.

All eligible issuers are required to get the credit rating from credit rating agencies.

 

 

Factoring

 

Factoring involves provision of specialised services relating to credit investigation, sales ledger management, purchase and collection of debts, credit protection as well as provisions of finance against receivables and risk bearing. In factoring, accounts receivables are generally sold to a financial institution that charges commission and bears the credit risks associated with it.

Thus, factoring is not just a single service, rather a portfolio of complimentary financial services available to clients i.e. sellers. The sellers are free to avail of any combination of services offered by the factoring organisations according to their individual requirements.

 

Factoring allows the seller to outsource the activities related to giving credit and collection.

 

Benefits of Factoring

(i) The firm can convert accounts receivables into cash without bothering about repayment.

(ii) Factoring ensures a definite pattern of cash inflows.

(iii) Continuous factoring virtually eliminates the need for credit department.

(iv) Unlike an unsecured loan, compensating balances are not required in this case.

Another advantage consists of relieving the borrowing firm of substantial credit and collection costs and to a degree from a considerable part of cash management.

 

 

 

 

References

 

Prasanna Chandra, Financial Management, 5^th Ed.,  Tata McGraw Hill, 2001

Brealey and Myers, Corporate Finance, Fifth Edition, Prentice Hall India, 2001

 

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