10 Main Sources of Working Capital

Sources of working capital are many. There are both external and internal sources. The external sources are both short-term and long-term.

Trade credit, commercial banks, finance companies, indigenous bankers, public deposits, advances from customers, accrual accounts, loans and advances from directors and group companies, etc., are external short-term sources.

Companies can also issue debentures and invite public deposits for working capital which is the external long-term source. Equity funds may also be used for working capital.

Sources of Working Capital

These are the sources of working capital explained below:

  1. Trade Credit
  2. Commercial Banks
  3. Straight Loans
  4. Cash Credit
  5. Hypothecation Advance
  6. Pledge Loans
  7. Overdraft Facility
  8. Bill Financing
  9. Finance Companies
  10. Indigenous Bankers
  11. Public Deposits
  12. Advances From Customers
  13. Accrual Accounts
  14. Loans From Directors
  15. Commercial Papers
  16. Debentures and Equity Fund
Sources of Working Capital
Sources of Working Capital

Trade Credit

Trade credit is a short-term credit facility extended by suppliers of raw materials and other suppliers. It is a common source. It is an important source. Either open account credit or acceptance credit may be adopted.

In the former as per business custom credit is extended to the buyer, the buyer is not signing any debt instrument as such. The invoices are the basic document.

In the acceptance credit system, a bill of exchange is drawn on the buyer who accepts and returns the same. The bill of exchange evidences the debt. Trade credit is an informal and readily available credit facility.

It is unsecured. It is flexible too, that is, advance retirement or extension of credit period can be negotiated. Trade credit might be costlier as the supplier may inflate the price to account for the loss of interest for delayed payment.

Commercial Banks

Commercial banks are the next important source of working capital finance. The commercial banking system in the country is broad based and fairly developed. Straight loans, cash credits, hypothecation loans, pledge loans, overdrafts, and bill purchase and discounting are the principal forms of working capital finance provided by commercial banks.

Straight Loans

Straight loans are given with or without security. A one-time lump-sum payment is made, while repayments may be periodical or one-time.

Cash Credit

Cash credit is an arrangement by which the customers (business concerns) are given borrowing facilities up to a certain limit, the limit is subjected to examination and revision year after year. Interest is charged on actual borrowings, though a commitment charge for utilization may be charged.

Hypothecation Advance

Hypothecation advance is granted on the hypothecation of stock or other assets. It is a secured loan. The borrower can deal with the goods.

Pledge Loans

Pledge loans are made against a physical deposit of security in the bank‘s custody. Here the borrower cannot deal with the goods until the loan is settled.

Overdraft Facility

An overdraft facility is given to current accounts holding customers to overdraw the account up to a certain limit. It is a very common form of extending working capital assistance.

Bill Financing

Bill financing by purchasing or discounting bills of exchange is another common form of financing. Here, the seller of goods on credit draws a bill on the buyer and the latter accepts the same. The bill is discounted per cash with the banker. This is a popular form.

Finance Companies

Finance companies abound in the country. About 50,000 companies exist at present. They provide services almost similar to banks, though they are not banks. They provide need-based loans and sometimes arrange loans from others for customers. The interest rate is higher, but timely assistance may be obtained.

Indigenous Bankers

Indigenous bankers also abound and provide financial assistance to small businesses and trades. They charge exorbitant rates of interest by understanding.

Public Deposits

Public deposits are unsecured deposits raised by businesses for periods exceeding a year but not more than three years by manufacturing concerns and not more than five years by non-banking finance companies.

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The RBI is regulating deposit-taking by these companies in order to protect the depositors. Quantity restriction is placed at 25 percent of paid-up capital + free services for deposits solicited from the public are prescribed for non-banking manufacturing concerns. The rate of interest ceiling is also fixed. This form of working capital financing is restored by well-established companies.

Advances From Customers

Advances from customers are normally demanded by producers of costly goods. At the time of accepting orders for supply of goods. Contractors might also demand advance from customers.

Where the sellers‘ market prevails, advances from customers may be insisted on. In certain cases to ensure performance, a contract in advance may be insisted on.

Accrual Accounts

Accrual accounts are simply outstanding dues to workers, suppliers of overhead service requirements, and the like. Outstanding wages, taxes due, dividend provision, etc., are accrual accounts providing working capital finance for a short period on a regular basis.

Loans From Directors

Loans from directors, loans from group companies, etc., constitute another source of working capital. Cash-rich companies lend to liquidity crunch companies of the group.

Commercial Papers

Commercial papers are used as promissory notes negotiable by endorsement and delivery. Since 1990, CPs came to be introduced. There are restrictive conditions as to the issue of commercial papers.

CPs are privately placed after RBI‘s approval with any firm, incorporated or not, any bank or financial institution. Big and sound companies generally float CPs.

Debentures and Equity Fund

Debentures and equity funds can be issued to finance working capital so that the permanent working capital can be matching financed through long-term funds.

FAQs About the Sources of Working Capital

What are the sources of working capital?

The following are the sources of working capital:
1. Trade Credit
2. Commercial Banks
3. Straight Loans
4. Cash Credit
5. Hypothecation Advance
6. Pledge Loans
7. Overdraft Facility
8. Bill Financing
9. Finance Companies
10. Indigenous Bankers.