Working capital is the difference between the organization current asset and its current liability. there are various types of working capital loans in India and in the international market available like trade credit, cash credit/bank overdraft, working capital loan, purchase of bills/discount of bills, bank guarantee, letter of credit, factoring, commercial paper, inter-corporate deposits etc.
The arrangement of working capital is playing the vital role in any organization. It is the very important activity which requires much attention of the finance managers or an Entrepreneur.
why small business owner need working capital finance
The reason behind all this, working capital is the money which is important need of the business in order to run its daily operational activities appropriately. Without sufficient sources of capital it is difficult of the survival of the organization.
Because when there is no money, there is no concept of any business. When you have no cash on your hand, you are unable to pay your dues tou your creditors or supplier. So your source of financing should be appropriate.
An inappropriate source of funding lead toward the uncertainty and loss to the organization.
What are different types of Working Capital financing?
Types of Working Capital Financing / Loans
Enlist below there are some working capital source of financing / Loan
Trade credit (TC) is the first source of financing in which business form an agreement with the supplier for the purchasing of goods. Or in other word it is an extension of credit period time by the creditor to its creditworthiness business customer on the basis of its earning records, liquidity position, and records of payments.
Types of Trade Credit
There different types of Trade credit like as under:
it is the written agreement between borrower and lender whereby the borrower received assets (normally Inventory) on credit and make promises to repay the purchase price (may be with some extra) in full or on installment at or before the specified period of time( or within one accounting period).
This is a short time peiod agreement between business and supplier whereby the supplier offers a specific amount of linit of credit purchase to the business, and the business can transact multiple time on credit basis but within the available time.
- parties are not bound to singed any note for each single transaction
- life of the agreement varies from 1 month to 12 month and the maturity life is 3 months..
Cash Credit / Bank Overdraft
The second one and the most important source of funding is Cash Credit or Bank Overdraft used by the most of the small, medium and big business organizations. In this source of financing the Borrower approaches a commercial Banks and the borrower sanctioned a specific amount of cash for the sack of injecting in the business. In this way business make will be in the position to smoothly run its routine operations.
The amount offered by the banks is sanctioned and the borrower is bound that he will not cross the sanctioned limits. The most interesting thing in this source of financing is that the interest will be charged only on the amount that you had used in your business, and not on all the sanctioned amount. There is no doubt that this is most effective source of Working capital financing.
Working Capital Loans
Working capital loans also known as the term Loan for short Period. Businesses borrowed these types of loan to make its financing permanent working capital needs. At the end of period working capital loan will be in lump sum or in rapid installment.
Pledging of account Receivable / Purchase / Discount of Bills /
This is another good source of short-term secures working capital financing. In this type of financing the business organization uses the account receivable as a collateral/security for the sack of working capital finance by commercial banks
This is the 3rd step process as under:
- Quality of Receivable is evaluated: it means the degree or possibility with which receivable will eb converted into cash. if the receivable with 100% of quality will be able to make 90% amount of loan for business. For example 400,000 will be provided out of 500,000 on this criteria. The credit worthiness of the business client can be evaluated on the basis of 5Cs. At the maturity business will notify its account receivable to make payment to the bank on his behalf. Or collect the cash from account receivable and make payment to the bank itself.
This is the non-fund based working capital source of financing. In such source of financing the Buyer or seller approaches to the bank and acquire bank guarantee in order to reduce the risk / uncertainity or reducing the risk of loss from the opposite party which may be in the form of repaying money or some services. In case of non performance of the agreement Banks revoke the agreement.
Letter of Credit (LC)
This is also non-fund based WC source of financing. There is very little difference in between LC and Bank Guarantee. In case of Bank Guarantee on nonperformance of the agreement Banks revoke the agreement. But in case of Letter of Credit the buyer purchased the LC from the bank and send it to the seller and received the good as per agreement. The banks will pay the amount to the seller on behalf of buyer to the seller and collect then collect this amount from the buyer.
The last one source of financing is “Factoring”. In this source of funding the business sell all of its or selected account receivable to the third party on discount or at lower price. The party who are providing factoring services is called Factor. The Factor is third party organization whose responsibility would not only to provide the services of financing through selling the account receivable but also to collect the amount from the debtor as well.
There are two types of factoring:
- factoring with recourse: if the credit risk of non-payment by the debtor is because of business it would be factoring with recourse.
- Without recourse: if the credit risk of non-payment by the factor then it would be considered as without recourse.