Sources of Working Capital Finance — Spontaneous and Negotiated

## Financing of Working Capital

### Permanent vs Temporary Working Capital

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### Types of Financing Sources

### Factors Affecting Choice of Financing Source

1. Cost — which source is cheapest?

2. Impact on credit rating

3. Feasibility — can the firm access this source?

4. Reliability — will funds be available when needed?

5. Restrictions — any covenants or conditions attached?

6. Hedging/Matching Approach — finance assets with sources of matching maturity (short assets → short funding)

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## Spontaneous Sources — Details

### (a) Trade Credit

• Largest spontaneous source — contributes ~1/3 of total short-term finance
• Lower cost than most alternatives
• Open Account Trade Credit: Extended without formal instruments (just an invoice)

### (b) Bills Payable

• Purchaser gives a written promise to pay at demand or fixed future date
• Simple, easily available, lower explicit cost
• More common among small and medium enterprises
• Amount depends on purchase volume and payment timing

### (c) Accrued Expenses

• Outstanding wages, salaries, taxes, duties — services received but not yet paid
• Interest-free, automatic, built-in source of finance
• Firm effectively uses employee/government funds temporarily
• Helps maintain liquidity without any borrowing cost

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## Negotiated Sources — Details

### (a) Inter-Corporate Loans and Deposits

• One company invests surplus funds in another company for short-term
• Interest rate is higher than bank deposit rate (compensates for higher risk)
• Reduces borrowing company's dependency on bank finance

### (b) Commercial Papers (CP)

• Unsecured promissory note issued for short-term funding
• Only available to highly rated corporates
• Maturity: 7 days to less than 1 year
• Minimum denomination: ₹5 lakh

CP — Advantages:

• No restrictive conditions (unsecured)
• Continuous rollover (new CP repays maturing CP)
• Maturity tailored to firm's specific needs
• Usable even in tight money markets
• Lower cost than bank loans

CP — Limitations:

• Restricted to highly rated firms only (credit barrier)
• Cannot be redeemed early or extended post-maturity (inflexible)

### (c) Funds from Operations

• Profit + Depreciation retained in the business increases net working capital
• Depreciation is a non-cash charge — cash stays in the firm

### (d) Public Deposits

• Short to medium-term source for large, well-established companies

### (e) Bills Discounting

• Supplier draws a bill of exchange on the buyer; buyer accepts it
• Supplier discounts the accepted bill with a bank for immediate cash
• Bank collects full face value from buyer on maturity

### (f) Bill Rediscounting Scheme

• Introduced by RBI on 1st November 1970
• Promotes use of bills of exchange in trade finance
• Scheduled banks can rediscount eligible bills with the Reserve Bank of India

### (g) Factoring

• Sale of trade debts at a discount to a financial institution (factor)
• Continuous arrangement: client → factor → debtor
• Factor may or may not take recourse
• Factor also administers the sales ledger (unlike pure discounting)

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## Factoring vs Bills Discounting