The excess of the amount of working capital over permanent working capital is known as variable or short-term working capital. The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. It may again be sub-divided into seasonal and special working capital. Seasonal working capital is required to meet the seasonal demands of busy periods occurring at stated intervals. On the other hand, special working capital is required to meet extra-ordinary needs for contingencies.
The main sources of short-term working capital are as follows:
1. Indigenous Bankers
Private moneylenders and other country bankers used to be the only source of finance prior to the establishment of commercial banks. They used to charge very high rates of interest and exploited the customers to the largest extent possible. Now a day with the development of commercial banks they have lost their monopoly. But even today some business houses have to depend upon indigenous bankers for obtaining loans to meet their working capital requirements.… Read More »
Working capital refers to that part of the total capital employed which has been invested for the financing of current assets e.g. inventories, debtors, cash and bank balances, bills receivable, prepaid expenses etc. That is, total of all current assets is working capital.
Permanent working capital refers to the minimum amount of investment, which should always be there in the fixed or minimum current assets like inventory, accounts receivable, or cash balance etc., in order to carry out business smoothly. This investment is of a regular or permanent type and as the size of the firm expands, the requirement of permanent working capital also increases.
Permanent working capital should be financed in such a manner that the enterprise may have its uninterrupted use for a sufficiently long period. There are five important sources of permanent or long-term working capital.
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- Shares. Issue of shares is the most important-source for raising the permanent or long-term capital. A company can issue various types of shares as equity shares, preference shares and deferred shares.
Dividend is the amount paid out to the shareholders out of the earnings for equity shareholders. That part of the total earnings, which is not paid out as dividend, is the retained earnings (RE), which is ploughed back or reinvested in the business. The higher the amount of dividend, the lower the retained earnings and vice versa. Retained profit increases the long-term capital base of the company and thus increases the potential of future earning capacity. On the other hand, the higher the dividend, the higher the earnings of the equity shareholders at present. The question is what is the trade-off between present earnings and higher future earnings; what is the optimum dividend policy. As in other matters, that dividend policy is optimum, which maximizes the net wealth of equity shareholders. The issue before dividend policy is to determine the best distribution of profit between dividend per share (DPS) and retained earnings per share (RES).
There are some aspects which may affect dividend policy of a firm.… Read More »
The primary task of a lending institutions before granting a term loan is to assure itself that the anticipated rise in the income of the borrowing unit would materialize, thus providing the necessary funds for repaying the loans according to the terms of amortization. The liquidity of term loans depends not so much on the short-run sale ability of the goods and commodities as on the increased term loan income of borrowing units resulting from a higher level of utilization of existing installed capacity. For assessing the risks involved in term lending, the normal criteria used for judging the soundness of short-term loans are often unreliable and inadequate. The methods of analysis and the standard to be adopted for appraisal of term loans are more similar to investment decisions than to short-term lending. Appraisal of term-loans requires a dynamic approach involving, inter alia, a projection of future trends of output, sales, and estimates of costs, returns and flow of funds. Appraisal of term loans depends to a large extent on estimates of forecasts.… Read More »
Considerations of security form an important basis of lending. In fact, they constitute necessary adjunct to financial appraisal. Lending institutions have to examine the loan proposals from the point of view of nature and extent of security offered. Sometimes, there is a greater reliance on security due to inadequate financial appraisal, which in its turn may be due to non-availability of the necessary data. The security cover of the loan should, however, not be regarded as a substitute for an adequate financial assessment.
Security considerations are of particular importance in less developed countries like India where information on the character, integrity and credit-worthiness of the borrowers is not readily available and much ground work has yet to be done in the establishment of credit information bureaus. A prudent term lending institution, therefore, secures its loan by adequate collateral and, where necessary, guarantees. It also embodies in the loan agreement suitable protective and restrictive covenants such as maintenance of certain minimum financial standards, supplying to the lender adequate financial information, earlier repayment of loans under certain conditions, restriction on the payment of dividend and any other payments like managing agency or selling agency commission.… Read More »
The concept of leasing can be understood by comparing the lease to the purchase of a specific asset. If a firm wishes to obtain the service of a specific asset, it has two alternatives: Purchase or Lease. To purchase the asset, the firm must payout a lump sum or agrees to some type of installment plan that involves incurring a long term liability. Leasing the assets, on the other hand, provides the firm with asset’s services without necessarily incurring any capital liability. Leasing is a source of financing as it enables the firm to obtain the use of assets in exchange for agreeing to pay lease rentals.
In case of leasing, the asset is handed over by the lessor to the lessee in return for a lease rental. The ownership and the title to the assets remain with the lessor. The lessor, however, recovers the cost of the assets as well as a reasonable return in form of rental income.… Read More »