This document discusses sources of working capital finance in India, focusing on trade credit and bank borrowing. It provides details on trade credit terms, benefits, and factors to consider in deciding whether to take a discount or pay later. For bank borrowing, it outlines forms of financing like overdrafts and cash credits, as well as security requirements and regulations on financing based on recommendations from the Tandon and Chore Committees to the Reserve Bank of India.

1. WORKING CAPITAL FINANCE
Funds available for a period of one year or
less are called short term finance.
In India short term funds are used to finance
working capital.
The two most significant ways of working
capital financing are TRADE CREDIT & BANK
BORROWING.

2. WORKING CAPITAL FINANCE
Two other sources have come up in the
recent years and they are : FACTORING &
COMMERCIAL PAPER.
TRADE CREDIT : It refers to the credit that a
customer gets from suppliers in normal
course of trade. This deferral of payments is
a short term financing which is called trade
credit.

3. WORKING CAPITAL FINANCE
It is a major source of finance for firms. In
India, it contributes to about 1/3rd of the
total short term financing.
Particularly, small firms are heavily
dependant on trade credit as a source of
finance since they find it difficult to raise
funds from banks or other sources.
TRADE CREDIT is also called SPONTANEOUS
SOUCRE OF FINANCING.

4. WORKING CAPITAL FINANCE
CREDIT TERMS : This refers to the conditions
under which the supplier sells on credit to the
buyer, and the buyer is required to repay the
credit.
A typical way of expressing credit terms is for
example : 3/15 net 45. This means 3% discount
is available if payment is made within 15 days
and if this discount is not availed payment is to
be made on or before 45 days.

5. WORKING CAPITAL FINANCE
BENEFITS OF TRADE CREDIT :
Easy availability : Unlike other sources of
finance, trade credit is relatively easy to
obtain.(Except in cases of financially very
unsound parties).
Flexibility : Trade credit grows with the growth
is the firm’s sales. The growth in sales causes
growth in the purchases of goods and
services, which is automatically financed by
trade credit.

6. WORKING CAPITAL FINANCE
BENEFITS OF TRADE CREDIT :
Informality : Trade credit is an
informal, spontaneous source of finance. It
does not require any special negotiations or
formal agreements. It does not have the
restrictions which are usually part of negotiated
sources of finance.
At the same time there is something called the
cost of trade credit. It is nothing but the cost of
foregoing the discount offered.

7. DECISION MAKING ON TRADE CREDIT
Suppose Co. “A” has to purchase raw
materials worth one lakh and is extended
trade credit in the terms of 2/15 net 45.
Option A – Pay Rs.98,000/- on the 15th day
and save Rs.2000/-.
Option B – Pay 100000/- on the 45th day and
thereby use the amount of Rs.98,000/- for
extra 30 days. This use of funds for 30 days
may generate returns more than 2000/-.

8. OTHER SOURCES OF SPONTANEOUS
FINANCE OF WORKING CAPITAL
ACCRUED EXPENSES : Is a liability that a firm
has to pay for the services which it has already
received. Thus, they represent a
spontaneous, interest free source of financing.
(Eg. Wages, Salaries, Taxes, Interest etc.)
Deffered Income : It represents funds received
by the firm for goods or services which it has
agreed to supply in the future.(Eg. Advance
Payments).

9. BANK FINANCE OF WORKING CAPITAL
Banks are the main institutional source of
working capital finance in India.
The amount approved by the bank for the
firm’s working capital is called the CREDIT
LIMIT.
Credit limit is the maximum funds which a firms
can obtain from the bank for use as working
capital.

10. BANK FINANCE OF WORKING CAPITAL
The bank considers the firm’s sales, production
plans and desirable level of current assets in
determining its working capital requirement or
the credit limit.
Actually, the banks do not lend 100% of the
credit limit. They deduct the Margin money
from the loan to keep as security.

11. FORMS OF BANK FINANCE
OVERDRAFT : The borrower is allowed to
withdraw funds in excess of his balance in his
current account up to a certain specified limit.
The extra amount borrowed is
repayable on demand. (???)
The borrower can withdraw and
repay funds whenever he desires within the overall
stipulations.
Interest is charged on daily
balances – on the amount actually withdrawn –
subject to minimum charges.

12. FORMS OF BANK FINANCE
CASH CREDIT (CC A/C) : Same as overdraft except for
differences given below :
Borrower is not allowed to withdraw the full
amount of the limit at once, rather he should borrow
periodically as per his requirement and also repay
periodically.
There is no commitment charge therefore interest
is payable on the amount actually used by the borrower.
Cash credit limits are sanctioned against security
of current assets ( Debtors, Stock etc.)

13. FORMS OF BANK FINANCE
PURCHASE OR DISCOUNTING OF BILLS :
A borrower can obtain credit from banks
against its bills.
The bank purchases and discounts the
bills of the borrower.
The borrower is paid the discounted
amount immediately.
The bank collects the full amount on
maturity of the bill.

14. FORMS OF BANK FINANCE
LETTER OF CREDIT (LOC) :
Mostly used in case of import transaction.
The bank gives assurance of payment to foreign
suppliers in event of non payment by the
domestic party.
Generally, provided by banks to financially
sound and creditworthy parties.
It is an indirect way of financing.

15. FORMS OF BANK FINANCE
WORKING CAPITAL LOAN :
A borrower may sometimes require funds in
excess of the sanctioned credit limits to meet
unforeseen contingencies.
Banks provide such accomodation through a
“demand loan account” . The borrower is expected
to pay high rates of interest in such exceptional
cases.

16. SECURITY REQUIRED IN BANK FINANCE
HYPOTHECATION : Under this the borrower is provided working
capital finance against the security of movable property
(stock, debtors).
The borrower does not transfer the property to the bank
physically.
Thus hypothecation is a charge against property where
neither ownership nor the possession is passed on to the
creditor.
Banks generally grant credit against hypothecation only to first
class customers with high integrity.

17. SECURITY REQUIRED IN BANK FINANCE
PLEDGE : Under this arrangement the
borrower, is required to physically transfer the
possession of the property offered as security
to the bank.
(eg. Share certificates, FD certificates, Insurance
policy documents etc.)

18. REGULATIONS OF BANK FINANCE
• Banks follow certain norms in granting
working capital finance to firms. These norms
are greatly influenced by the
recommendations of various committees
appointed by the RBI.
• Banks followed the norms suggested by the
“Tandon Committee”.
• Further recommendations were made by the
“Chore Committee” to strengthen the
procedures and norms.

19. THE TANDON COMMITTEE
RECOMMENDATIONS
1.Operating Plan : The borrowers should
prepare operating plans and on that
basis indicate the amount of working
capital finance requirement.
2.Production based financing : The banks should
finance only the production based
genuine needs of financing.
3.Partial bank financing : The bank should not
finance the total requirement of the
borrower. Only a reasonable part of it
should be financed by the bank.

20. THE TANDON COMMITTEE
RECOMMENDATIONS
4.Reasonable level of Current Assets : The
committee further recommends that
the borrower should be allowed to
maintain current assets specifically
debtors and inventories only up to a
reasonable level. Flabby, profit making
or excessive inventory should not be
permitted under any circumstance.
However, the bank also visualized the
abnormal circumstances such as
strikes, power cuts etc. and allowed
flexibility to the bankers.

21. THE TANDON COMMITTEE
RECOMMENDATIONS
5.Maximum permissible bank finance (MBFC) :
The committee suggested the following
three methods of determining the MBFC.
1. The borrower will contribute 25% of the
working capital gap, the remaining 75%
will be financed from bank borrowings.
W.C.Gap = CA-CL excluding bank
borowings.(Some analysts define the net
working capital in the same manner)

22. THE TANDON COMMITTEE
RECOMMENDATIONS
Maximum permissible bank finance (MBFC) :
2. The borrower will contribute 25% of the
total current assets. The remaining of
the working capital gap will be financed
by the bank.
3. The borrower will contribute 100% of
the core assets and 25% of the balance
of current assets. The remaining of the
working capital gap will be financed.

23. THE TANDON COMMITTEE
RECOMMENDATIONS
Maximum permissible bank finance (MBFC) :
The first two methods were
immediately accepted for
implementation but the third method
was not.
Illustrationmbfc.xlsx

24. THE TANDON COMMITTEE
RECOMMENDATIONS
6. Information System :
The committee recommened for
greater flow of information both for
operational purposes and for the
purpose of supervision and follow up
of credit.
The statement / information required
by the banks are :

25. THE TANDON COMMITTEE
RECOMMENDATIONS
QUARTERLY REQUIREMENTS( ONLY FIRMS
HAVING CREDIT LIMIT ON MORE THAN ONE
CRORE.)
1. Operating Statement.
2. Quarterly Budget.
3. Fund flow statement.
(Actuals and Projections)

26. THE TANDON COMMITTEE
RECOMMENDATIONS
MONTHLY REQUIREMENTS
1. Stock Statement.
2. Debtors List.
The Banks were supposed to strictly ensure
that the funds lent by the banks were used
only for the purposes, for which it was lent.

27. THE TANDON COMMITTEE
RECOMMENDATIONS
CONCLUSION : The Tandon Committee Report
was widely debated and criticised both by the
borrowers and the banks.
The Bankers found a lot of difficulties in
implementation of the recommendations.
However, it should be admitted that the report
has brought about a perceptible change in the
outlook of both borrowers and bankers. The
report has helped in bringing a financial
discipline in the scheme of bank lending.

28. THE CHORE COMMITTEE
RECOMMENDATIONS
In the year 1979 the RBI constituted a
working group to review the system of cash
credit under the Chairmanship of
Mr.K.B.Chore.
This was basically a follow up of the Tandon
Committee.

29. Major recommendations
1. Reduced dependence on Bank Credit : The borrowers
should contribute more funds to finance their working
capital requirements. The idea was to place all
borrowers in the 2nd method suggested by the Tandon
Committee. In case of difficulties the resort could be
taken to WCTL.
2. Credit limits to be separated in to “Peak level” and “Non
Peak Level” limits : Credit limits should be assessed and
separated in to “Peak level” and “Normal level” for
borrowers with credit limits more than 10 lacs.
Borrowers should, in advance, inform the requirement of
peak level limits. Moreover, any deviation in utilisation
beyond 10% tolerance, should be treated as an
irregularity. Additional interest of 1% should be charged
on adhoc borrowings.

30. Major recommendations
3. Existing lending system to continue : The
existing system had three types of lending.
(a) Cash credit
(b) WCTL,
(C) Bill discounting.
Cash credit system should be replaced by
the other two wherever possible.
Cash credit accounts of large borrowers to
be scrutinized, at least once a year.

31. Major recommendations
4. Information System : The discipline
regarding submission of quarterly
statements should be strictly adhered to, in
respect of all borrowers having limits of 50
lacs and above.

32. COMMERCIAL PAPER
A money market instrument in the advanced
countries, to raise short term funds.
Introduced in India in 1989 by the RBI on the
recommendation of Vaghul Working Group.
In USA , only the highest rated and
financially sound companies can issue
Commercial papers.

33. COMMERCIAL PAPER
The buyers of C.P’s are Banks, Insurance
Companies, Unit trusts and Firms with surplus
funds to invest for a short period.
In India, the issue of CP’s is regulated by the
RBI.
Only those Companies, which have (a) Net
Worth of 10 Crore, (b) MPBF of not less than 25
Crore © Listed in Stock Exchange can issue CP’s.
Size of a single issue should be atleast One
Crore and size of each CP should be atleast 25
Lacs. (5 lacs suggested by Vaghul).

34. COMMERCIAL PAPER
Maturity of the CP’s in India runs between 91 to 180
days. In the USA it is 1 to 270 days.
Though the issue of CP’s is regulated by the RBI, still
the interest rate is determined by the market.
The interest rate depends on (a) PLR, (b) Maturity, ©
Credit worthiness (d) and the rating of the CP
provided by agencies.
In USA the two main rating agencies are STANDARD
& POOR and MOODY.
In India this is done by ICRA ( an agency set up by
ICICI & UTI).