BA7024 CORPORATE FINANCE

Unit II
-Working capital requirements
-Approach adopted by commercial banks
-Public deposits
-Inter corporate investments

What is a Working Capital ?

Refers to the cash a business requires.
Cash required for day to day operations.
Financing for the conversion of raw materials
into finished goods.
Important items of working capital are
inventory, debtors and creditors.
Sign of companys efficiency and financial
strength.

Needs of working capital

Types of working capital

On the basis of concept
Gross working capital
Net working capital

On the basis of time

Permanent or fixed working capital
Temporary or variable working capital

Factors determining the working capital

Nature of business first determinant of the
working capital
Production policy absolutely affecting the
needs of working capital
Dividend policy company can distribute the
part of net profit.
Manufacturing cycle process of converting raw
material into finished goods
Price level changes impacting the amount of
working capital we need.

Factors determining the working capital

Nature of demand pattern of customer
expectations influence working capital
Credit policy purchasing and selling of goods on
credit basis.
Working capital cycle cash purchasing of raw
material and then converting into finished good.
Business cycles boom and recession periods.
Effect of external business environment fiscal
policy, monetary policy and other bank policies.

Advantages of adequate working capital

Cash discount
Creates a feeling of security and confidence
Must for maintaining solvency and continuing
production
Sound goodwill and debt capacity
Easy loans from the banks
Distribution of dividend
Exploitation of good opportunity
Meeting unseen contingency
High morale
Increased production efficiency

Estimating working capital requirements

Working capital as a percentage of net sales
Working capital as a percentage of total assets
or fixed assets
Projected balance sheet method
Adjusted profit and loss method

Computing a Working capital

Sources of short term working capital

financing
Indigenous bankers private money lenders and other
country bankers.
Installment credit purchase and possession of assets
taken immediately.
Outstanding expenses incurred but not due
Account payable individual purchases on credit terms
or other funding transactions.
Trade credit credit extended by the suppliers of goods
Bills discounting short term, negotiable, self liquidating
money market instrument
Certificates of deposit essence tradable bank deposits.

Sources of short term working capital

financing
Letter of credit bank helps its customer to obtain credit
from its suppliers
Factoring lending money to producers and dealers.
Commercial banks main institutional sources of
working capital financing.
Commercial paper those are unsecured promissory
notes.
Public deposits fixed deposits accepted by a business
enterprise.
Inter corporate investments deposits made by one
company in another company.

Sources of Long term working capital

financing
Shares - a part or portion of a larger amount which is divided
among a number of people, or to which a number of people
contribute.
Debentures - a long-term security yielding a fixed rate of
interest, issued by a company and secured against assets
Retained Earnings - the percentage of net earnings not paid
out as dividends, but retained by the company to be reinvested
Term Loans - a thing that is borrowed, especially a sum of
money that is expected to be paid back with interest.

Commercial bank Financing

Forms of Bank Finance
Term loans granted by a bank for a fixed
deposit
Cash credit loan given against the current
asset such as stock, debtors etc.
Overdrafts instant extension of credit.
Bills discounting short term negotiable and
self liquidating money market instrument.

Procedures to avail Working capital

financing from banks
Application for the working capital
List of documents accompanying the
application
In principle sanction for working capital
Appraisal and final sanction
Post sanction requirements
Monitoring and follow up

Approaches adopted by commercial banks

Hedging/matching policy simultaneous
activities which are opposite to each other.
Conservative policy holding excess cash
balances mid escess inventory levels.
Aggressive policy major part of the current
asset requirements should be financed from
short term sources.
Zero working capital policy at all times
current assets shall equal the current liabilities.

Advantages of Commercial Banks

Financial assistance
Agency services
Attractive rates of interest
General utility services
Smooth functioning of foreign trade

Disadvantages of commercial banks

Insufficient growth
Increasing over dues
Lower efficiency
Declining trends in profitability
Lack of expert

Features of Commercial Papers

Nature these are unsecured debts of corporate

Market comprise of issues made by public sector.
Rating required to be graded by the organization.
Interest rates they are subject to varied interest rates.
Marketability rates prevailed in the call money market.
Maturity minimum maturity is brought down from 3
months to 30 days.
Credit policy in lieu of Working Capital automatic
restoration of working capital limits.

Types of Commercial Paper

Finance paper
Banks borrow money through the sale of
short term commercial paper.
Finance companies selling CP and lending
the same money to customers.
Industrial paper to finance working capital on
both permanent and seasonal basis.
Asset backed paper pledged with some
companys assets.

Requirements of commercial paper

Should have a tangible net worth of not less
than 4 crores.
Should have working capital limit of not less
than 4 crores.
Should have p2/a2 rating from CRISIL.
Should be listed in one of the recognized stock
exchange.
Borrowed account should be classified as
standard.

Advantages of Commercial
Paper
It proves to be handy during periods of tight
bank.
Cheaper source of finance in comparison to
the bank credit.
Opportunity to make a safe, short term
investment.

Disadvantages of Commercial paper

Impersonal method of financing
Available always to financially sound and
highest rated companies.
Amount of loanable funds is limited.
Cannot be redeemed until maturity.

Public Deposits
Features
Deposits are not secured
Available for a period ranging between 6
months and three years
They carry fixed rate of interest
Do not require complicated legal formalities.

Government regulation on public deposits

Ceiling on deposits
Maturity of deposits
Form and particulars of advertisement
Form of application for deposits
Furnishing of receipts to depositors
Register of deposits
Interest on deposits
Ceiling on brokerage
Repayment of deposits
Maintenance of liquid assets
Return of deposits

Advantages of Public Deposits

Simple and easy

No charge on assets
Highly economical
Flexibility

Disadvantages of Public Deposits

Uncertainty
Insecurity
Lack of attraction for professional investor
Uneconomical
Hindrance to growth of capital market
Over capitalization.

Inter corporate Investments

Features
Unsecured in nature no collaterals needed
Risk and return not much risky as it is an investment
made on other company
Period equipped with short term, medium term
investment.
Liquidity liquidity is considered to be very low.
Rate of interest depends primarily upon the demand
and supply.
Highly sensitive highly sensitive to default.

Corporate Investment Categories

Minority Passive Investments
Investor has no significant influence or control

Minority Active Investments

Investor exert significant influence

Controlling interest
Greater than 50 percent ownership in an investee.

Joint ventures
Relates to shared control by two or more entities.

Advantages of Inter-corporate Investments

Transaction is free from bureaucratic rules and
regulations.
Huge volume of cash volume is involved as it
is a corporate based investment.

Disadvantages of Inter-corporate Investments

Unsecured in nature
Liquidity is relatively highly low.
An investment of this sort is found to be
highly sensitive.