Sources of Working Capital or Short Term Finance

1652056964 Sources Of Working Capital Or Short Term Finance.png
1652056964 Sources Of Working Capital Or Short Term Finance.png

Working capital, also known as net working capital (NWC), is the difference between a company’s current assets—such as cash, accounts receivable/customers’ unpaid bills, and inventories of raw materials and finished goods—and its current liabilities, such as accounts payable and debts.

NWC is a measure of a company’s liquidity, operational efficiency, and short-term financial health. If a company has substantial positive NWC, then it should have the potential to invest and grow. If a company’s current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors. It might even go bankrupt.

Following are various sources of working capital or short-term finance:

  1. Public Deposit is a significant source of working capital. It is an unsecured loan. It is taken by the company from the depositor for a short period. The maximum duration is three years. It has a high rate of interest. It is very popular in India. All types of companies widely use it because it gives many benefits. The procedure for taking it is simple. It is very economical. Here, the company can trade on equity, the capital becomes flexible, and so on. However, it is not suitable for all firms and is only suitable for reputed ones.
  2. Bank Credit is also called Bank Loan. It is a well-known source of working capital. Manufacturing and trading companies use it. It is a secured loan. That is, the company first has to give some security to the bank only then the bank approves the loan. Once approved, later the company has to pay interest on the loan. Commercial and Co-operative Banks give bank credit. It is given for short and long periods. It is very lengthy and time-consuming. It involves many formalities. Therefore, many companies take private loans instead of bank loans. Banks give credit through the following ways:
    1. Demand Loans,
    2. Advances,
    3. Overdrafts,
    4. Cash Credit,
    5. Letter of Credit,
    6. Discounting of Bills, etc.
  3. Trade Credit: Dealers purchase goods from the company and sometimes give an advance payment. This advance payment is called Advance from Dealers or Trade Credit. The company uses this money as a working capital. So, trade credit is an another source of working capital. It is readily available. It is given for 60 to 90 days. Here, the rate of interest is low. Companies that have a monopoly in the market gets this credit. It is given for the Consumer Durable Goods like scooters, motorbikes, cars, televisions, refrigerators, etc.
  4. Advance from Customers: Sometimes, customers also make an advance payment to the company. The company uses this money paid in advance as a working capital. Hence, the advance from customers is a source of working capital for it. For example, a luxury automobile manufacturer gets an advance from customers who have booked a car. Today, it is difficult to such an advance from customers because of rising competition in the market.
  5. Income from Sales: The company sells its goods and earns income. This income later gets used as a working capital. Income earned from sales is the largest source of working capital for most companies.
  6. Self Financing: The company does not distribute its all profits to the shareholders. It saves a part of profits. This saving gets used as a working capital. So, the company uses own savings as working capital. Such behaviour is called Self Financing or Ploughing Back of Profits. Self-financing is very economical because there is no need to pay any interests.
  7. Issue of Shares: The company issues shares to the public. It gets equity share capital. This equity share capital gets used as a long-term working capital. Equity share capital is the best source of working capital because there is no interest payment on it. Also, the company need not repay the equity share capital.
  8. Issue of Debentures:
    1. The company issues different types of debentures to get debenture capital. The company uses debenture capital as a working capital. So, the issue of debentures is a significant source of working capital.
    2. In India, debentures are very popular. It receives a good response from the public. Therefore, most companies use debenture capital as working capital. However, debenture capital is a borrowed capital. Therefore, the company has to repay it at a high rate of interest.
  9. Cash Credit is also an important source of working capital. It is a secured loan. It is similar to Overdraft. The company is allowed to withdraw money from the bank up to a certain limit. Bank charges interest on the amount that is withdrawn.
  10. Discounting of Bills is another important source of working capital. The company sells goods on credit. It gets Bills Receivable from the debtors. Bank discount these bills. Here, it is not necessary to wait for the maturity of the bills. So, the company receives money very quickly from the bank. This money is also a working capital.
  11. Packing Credit is a loan facility given to the exporters by commercial banks. It is also called Pre-Shipment Finance. This loan is offered to the exporters only if they have a Letter of Credit. This money gets used as a working capital.
  12. Commercial Paper is a short-term promissory note. It is unsecured. Only well-established companies can issue it. Banks and financial institutions purchase it. It is purchased, at a discount. This discount is just like interest. The banks provide short-term finance to established companies in exchange for commercial paper. It is given for a short period of 90 to 180 days.

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