UNIT – VI FINANCING OF WORKING CAPITAL

A set of QUESTION_AND_ANSWER flashcards covering key concepts from UNIT – VI: Financing of Working Capital, including permanent vs. temporary financing, spontaneous vs. negotiated sources, instruments like trade credit, bills payable, accrued expenses, inter-corporate loans, commercial papers, funds generated from operations, public deposits, bills discounting, rediscounting, factoring, and regulatory guidelines.

What are the two main categories of working capital sources based on the duration and how should each be financed?

Permanent working capital is financed by long-term sources (debt and equity), while temporary working capital is financed by short-term sources.

What are the two broad categories of working capital finance sources?

Spontaneous sources and Negotiated sources.

Name three spontaneous sources of finance for working capital.

Trade credit, Bills payable, and Accrued expenses.

What is the hedging or matching approach in working capital financing?

Financing of assets with the same maturity as the assets.

What is trade credit and why is it important in working capital management?

Trade credit is financing extended by suppliers; it contributes about one-third of short-term requirements and is often open account when formalities are minimal.

Define Bills Payable and its significance for small and medium enterprises.

A written promise to pay the amount on demand or at a fixed future date; simple to use and widely accessible, with dependence on volume and timing.

What are accrued expenses in the context of spontaneous financing?

Outstanding expenses for services availed but not yet paid; automatic and interest-free, providing liquidity by accruing these expenses.

What are inter-corporate loans and deposits?

Short-term loans where one corporation lends to another; typically offer a higher rate than bank rates and reduce dependence on banks.

What are Commercial Papers (CP) and their basic features?

Unsecured promissory notes issued by a firm for short-term borrowing; maturity from a minimum of 7 days to less than 1 year; denominations often ₹5 lakhs or multiples.

List two advantages of issuing Commercial Papers.

Unsecured and allows rollover by issuing new CP; maturity can be tailored; usable when money markets are tight; generally lower cost than bank loans.

What are the limitations or drawbacks of Commercial Papers?

Only highly credit-rated firms can use them; they cannot be redeemed before maturity or extended beyond maturity.

What are funds generated from operations and its main components?

Funds that increase working capital during an accounting period; primarily profits and depreciation.

What are public deposits in working capital financing?

Deposits from the public used as a source of short- to medium-term financing, especially for well-established large companies.

Explain Bills Discounting and its role in short-term financing.

Discounting a bill of exchange with a bank; the seller receives immediate funds and the buyer/acceptor pays the bank at maturity.

What is the Bill Rediscounting Scheme?

A Reserve Bank of India program since 1 November 1970 allowing banks to rediscount eligible bills with RBI to promote a bill market.

What is factoring and how does it differ from bills discounting?

Factoring involves selling trade debts to a factor who collects the dues; it is a continuous arrangement (client, factor, debtor) and manages book debts, unlike bills discounting which is a borrowing transaction (drawer, drawee, payee) and falls under the Negotiable Instrument Act.

Who are the typical parties in a factoring arrangement?

Client (seller of goods), Factor (finance institution), Debtor (customer).

Which two committees influenced working capital financing guidelines in banks, as mentioned in the notes?

Tandon Committee and Chore Committee.

What change did the RBI implement in 1997 regarding Maximum Permissible Bank Finance (MPBF)?

The RBI withdrew the prescription of MPBF; banks are now free to evolve their own assessment methods for working capital needs.