TO IDENTIFY THE VARIOUS SOURCES

OF FINANCE AND MANAGEMENT OF

WORKING CAPITAL

PRESENTED BY::
ANUJ PANDEY
ARBAB KALAM
ATHUL RAG G K
 Sources of Finance
Objectives:
❏ Meaning and importance of business finance

❏ Classification of the various sources of business finance

❏ Evaluation of merits and limitations of various sources of finance

❏ Examine the factors that affect the choice of an appropriate

source of finance
Business Finance
Business is concerned with the production and distribution of goods
and services for the satisfaction of needsof society.Forcarrying out
various activities, businessrequires money. Finance, therefore, is
called the life blood of any business. The requirements of funds by
businessto carry out its various activities iscalledbusinessfinance.

The need for funds arises from the stage when an entrepreneur makes
a decision to start a business. Some funds are needed immediately say
for the purchase of plant and machinery, furniture, andother fixed
assets.Similarly,somefundsarerequired for day-to-day operations, say
to purchase raw materials, pay salaries to employees, etc. Also when the
business expands, itneeds funds.
Various sources of finance
A business can raise funds from various sources. Each of the
source has unique characteristics, which must be properly
understood so that the best available source of raising funds
can be identified. There is not a single best source of funds for
all organisations. Depending on the situation, purpose, cost and
associated risk, a choice may be made about the source to be used.
The sources of funds can be categorised using different basis viz.,
on the basis of the period, source of generation and the
ownership.
 I
SOURCE OF FINANCE TO START
I
UP A BUSINESS
*
*PERSONAL I
INVESTMENT
*
*LOVE MONEY
*
*VENTURE I
CAPITAL
*
*ANGELS
* I
*BUSINESS I
INCUBATORS
*
*GOVERNMENT I I
GRANT S AND SUBSIDIES
*
*BANK LOANS
 I
PERSONAL INVESTMENT

An amount of money that is invested in a startup by a person,

rather than by a company or organization.
 LOVE MONEY

It iis a capital
it l extended
t by ffamily
il and
fri
friends tto an entrepreneur
tr r r tto start
t rt a
business.
i .
 I
VENTURE CAPITAL

It iis a fform
r off fi
financing
i tthatt iis provided
r i by fir
firms
orr ffunds tto small,ll, early
rl stage,
t , emerging
r i fir
firms tthatt
are
r deemed tto have high i growth
r t potential.
t ti l.
 ANGELS

Angell iinvestor
t r iis a high
i nett worth
rt iindividual
i i l who
provides
r i fi
financial
i l backings
i fforr small
ll
entrepreneurs.
tr r r .
 I
BUSINESS I
INCUBATORS

IIs a company that helps new start up companies i

tto develop
l by providing
r i i services
r i such as
managementt tr
training
i i 0rr office
ffi space..
 GOVERNMENT GRANT S AND
SUBSIDIES
I I

Eg . Mudra r loan
l
National
ti l smallll industry
i tr corporation
r r ti subsidy
i
 BANK LOANS

IIn IIndia
i banks are r giving
i i various
ri lloan schemes
t ri tto tthis
catering i emerging
r i startup
t rt culture
lt r ..
 ON THE BASIS OF PERIOD

❖ Retained Earnings
➢ A company generally does not distribute all its
earnings amongst the shareholders as dividends. A
portion of the net earnings may be retained in the
business for use in the future. This is known as retained
earnings.
➢ Merits:
Retained earnings is a permanent source of funds available to an
organisation.
It does not involve any explicit cost in the form of interest, dividend
or floatation cost.
As the funds are generated internally, there is a greater degree of
operational freedom and flexibility.
It enhances the capacity of the business to absorb unexpected losses.
It may lead to increase in the market price of the equity shares of a
company.
Limitations:
Excessive ploughing back may cause dissatisfaction amongst the
shareholders as they would get lower dividends.
It is an uncertain source of funds as the profits of business are
fluctuating.
The opportunity cost associated with these funds is not recognised by
many firms. This may lead to suboptimal use of the funds.
❖ Debentures

Debentures are an important instrument for

raising long term debt capital. A company
can raise funds through issue of debentures,
which bear a fixed rate of interest. The
debenture issued by a company is an
acknowledgment that the company has
borrowed a certain amount of money, which
it promises to repay at a future date.
Debenture holders are, therefore, termed as
creditors of the company.
➢ Merits:
It is preferred by investors who want fixed income at lesser risk;
Debentures are fixed charge funds and do not participate in profits of the
company;
The issue of debentures is suitable in the situation when the sales and earnings are
relatively stable;
As debentures do not carry voting rights, financing through debentures does not
dilute control of equity shareholders on management;
Financing through debentures is less costly as compared to cost of preference or
equity capital as the interest payment on debentures is tax deductible.
Limitations:
As fixed charge instruments, debentures put a permanent burden on the earnings
of a company. There is a greater risk when earnings of the company fluctuate;
In case of redeemable debentures, the company has to make provisions for
repayment on the specified date, even during periods of financial difficulty;
Each company has certain borrowing capacity. With the issue of debentures, the
capacity of a company to further borrow funds reduces.
Trade Credit

Trade credit is the credit extended by one trader to

another for the purchase of goods and services. Trade
credit facilitates the purchase of supplies without
immediate payment. Such credit appears in the records
of the buyer of goods as ‘sundry creditors’ or ‘accounts
payable’.
➢ Merits:
■Trade credit is a convenient and continuous source of funds.
■Trade credit may be readily available in case the credit worthiness of the
customers is known to the seller.
■Trade credit needs to promote the sales of an organisation.
■ If an organisation wants to increase its inventory level in order to
meet expected rise in the sales volume in the near future, it may use
trade credit to, finance the same.
■ It does not create any charge on the assets of the firm while providing
funds.
➢ Limitations:
■Availability of easy and flexible trade credit facilities may induce a firm
to indulge in overtrading, which may add to the risks of the firm.
■Only limited amount of funds can be generated through trade credit.
■ It is generally a costly source of funds as compared to most other sources
of raisingmoney.
Lease Financing

A lease is a contractual agreement whereby one

party i.e., the owner of an asset grants the
other party the right to use the asset in
return for a periodic payment. In other
words it is a renting of an asset for some
specified period.
➢ Merits:
It enables the lessee to acquire the asset with a lower investment.
Simple documentation makes it easier to finance assets.
Lease rentals paid by the lessee are deductible for computing taxable profits.
It provides finance without diluting the ownership or control of business.
The lease agreement does not affect the debt raising capacity of an enterprise.
The risk of obsolescence is borne by the lesser. This allows greater flexibility to
the lessee to replace the asset.
Limitations:
A lease arrangement may impose certain restrictions on the use of assets. For
example, it may not allow the lessee to make any alteration or modification in
the asset.
The normal business operations may be affected in case the lease is not renewed.
It may result in higher payout obligation in case the equipment is not found
useful and the lessee opts for premature termination of the lease agreement.
The lessee never becomes the owner of the asset. It deprives him of the residual
value of the asset.
Public Deposits

The deposits that are raised by organisations

directly from the public are known as
public deposits. Rates of interest offered on
public deposits are usually higher than that
offered on bank deposits. The acceptance of
public deposits is regulated by the Reserve
Bank of India.
➢ Merits:
The procedure of obtaining deposits is simple and does not contain restrictive
conditions as are generally there in a loan agreement.
Cost of public deposits is generally lower than the cost of borrowings from
banks and financial institutions.
Public deposits do not usually create any charge on the assets of the company.
The assets can be used as security for raising loans from other sources.
As the depositors do not have voting rights, the control of the company is not
diluted.
Limitations:
New companies generally find it difficult to raise funds through public
deposits.
It is an unreliable source of finance as the public may not respond when the
company needsmoney.
Collection of public deposits may prove difficult, particularly when the size
of deposits required is large.
❖ Commercial Banks

Commercial banks occupy a vital position as they

provide funds for different purposes as well as for
different time periods. Banks extend loans to firms
of all sizes and in many ways, like, cash credits,
overdrafts, term loans, purchase/discounting of bills,
and issue of letter of credit. The rate of interest
charged by banks depends on various factors such as
the characteristics of the firm and the level of interest
rates in the economy. The loan is repaid either in lump
sum or in installments.
➢ Merits:
Banks provide timely assistance to business by providing funds as and when needed
by it.
Secrecy of business can be maintained as the information supplied to the bank by the
borrowers is kept confidential;
Formalities such as issue of prospectus and underwriting are not required for
raising loans from a bank. This, therefore, is an easier source of funds;
Loan from a bank is a flexible source of finance as the loan amount can be increased
according to business needs and can be repaid in advance when funds are not needed.
Limitations:
Funds are generally available for short periods and its extension or renewal is
uncertain and difficult;
Banks make detailed investigation of the company’s affairs, financial structure etc.,
and may also ask for security of assets and personal sureties. This makes the
procedure of obtaining funds slightly difficult;
In some cases, difficult terms and conditions are imposed by banks. for the grant of
loan. For example, restrictions may be imposed on the sale of mortgaged goods, thus
making normal business working difficult.
 Factors affecting the choice of an
appropriate source of finance.
An effective appraisal of various sources must be instituted by the business to achieve
its main objectives. As no source of funds is devoid of limitations, it is advisable to use a
combination of sources, instead of relying only on a single source. A number of factors
affect the choice of this combination, making it a very complex decision for the
business. The selection of a source of business finance depends on factors such as:

● Cost
● financial strength
● risk profile
● tax benefits
● flexibility of obtaining funds
These factors should be analysed together while making the decision for the choice of an
appropriate source of funds.
Management of Working Capital
Objectives:
❏ Meaning and concept of working capital
❏ Significance of Working Capital Management
❏ Working capitalcycle
❏ Components of working capitalmanagement
❏ Principles of Working Capital Management
❏ Factors influencing Working Capital
Management
Working Capital Management
Working capital management refers to a company's managerial
accounting strategy designed to monitor and utilize the two
components of working capital, current assets and current
liabilities, to ensure the most financially efficient operation of the
company.
The primary purpose of working capital management is to make
sure the company always maintains sufficient cash flow to meet its
short-term operating costs and short-term debt obligations.
Significance of Working Capital Management
Working capital has acquired a great significance and sound position
in the recent past for the twin objects of profitability and liquidity. In period
of rising capital costs and scare funds, the working capital is one of the
most important areas requiring management review. It consumes a
great deal of time to increase profitability as well as to maintain proper
liquidity at minimum risk. There are many aspects of working capital
management which make it an important function of the finance manager.
In fact we need to know when to look for working capital funds, how to use
them and how measure, plan and control them.
Importance of working capital management
stems from two reasons, viz.,

A substantial portion of total investment is

invested in current assets, and
level of current assets and current liabilities
will change quickly with the variation in sales.
Though fixed assets investment and long-term
borrowing will also response to the changes in
sales, but its response will be weak.
Working Capital Cycle
The duration of time required to complete the following sequence of events,
in case of manufacturing firm, is called the Working Capital Cycle or
Cash Cycle or Operating Cycle :

Conversion of cash into raw materials.

Conversion of raw materials into work-in- progress.

Conversion of work in process(WIP) into finished goods.

Conversion of finished goods into debtors and bills receivables through

sales.

Conversion of debtors and bills receivables into cash.

The length of cycle will depend on the nature of business. Non
manufacturing concerns, service concerns and financial concerns will not
have raw material and work-in-process so their cycle will be shorter.
Financial Concerns have a shortest operating cycle.
Calculation of working capital cycle
Average
Finished stock of Finished
Goodsholding PeriodGoodsAverage stock of Raw Materials
= -R
--a
--w---m
--a--t-e-r-i-a-l--h-o--ld
--i-n-g--p
--e--r-io
--d---=
-------------- --------------------------------------
-
Average Cost of Finished Goods pAevredraagye Cost of Consumption per day

Average WIP
WIP holding period. = --------------------------------------------------
Average Cost of Production per day
Receivable andDebtors Collection period. = Average Book Credit
-------------------------------------
Average credit sale per day

Credit period allowed by Sundry Creditors. = Average TradeCreditors

------------------------------------------
Average credit purchase per day
In the form of a simple equation,
working capital cycle can be represented asbelow:

WWC = R+ W + F + D + B– C

Where; WWC= Working Capital Cycle

R= RawMaterials
W= Work in progress
F= Finished Stock
B=Cash at Bank
D= Debtors and Receivable collection period
C= Credit period available
Components of working capital management
1. Cash Management:
Cash is one of the important components of current
assets. It is needed for performing all the activities of a
firm, i.e. from acquisition of raw materials to marketing
of finished goods.
Therefore it is essential for a firm to maintain an
adequate cash balance. One of the important functions of
a finance manager is to match the inflows and outflows of
cash so as to maintain adequate cash.
 2. Receivables Management:
The term receivable is defined as any claim for money owed to
the firm from customers arising from sale of goods or services in
normal course of business. The term account receivable
represents sundry debtors of a firm. It is one of the significant
components of working capital next to cash and inventories.
The total volume of accounts receivable depends on its credit sale
and debt collection policy—these two significantly influence the
requirement of working capital. Liberal credit policy increases
the vol ume of sales but at the same time it also increases the
investment in receivables. Therefore, examination of costs and
benefits associated with credit policy is one of the important
tasks of a finance manager.
 3. Inventory Management:
Inventory constitutes a major part of total working capital.
Efficient management of inventory results in
maximization of earnings of the shareholders. Efficient
inventory management consists of managing two
conflicting objectives: Minimization of investment in
inventory on the one hand; and maintenance of the smooth
flow of raw materials for production and sales on the
other.
Therefore the objective of a finance manager is to
calculate the level of inventory where these conflicting
interests are reconciled. Like cash, a firm holds inventory
for transaction, precautionary and speculative motives.
 4. Accounts Payable Management:
Payables or creditors are one of the important
components of working capital. Payables provide a
spontaneous source of financing of working capital.
Payable management is very closely related with the
cash management. Effective payable management leads
to steady supply of materials to a firm as well as
enhances its reputation.
It is generally considered as a relatively cheap source of
finance as suppliers rarely charge any interest on the
amount owed.
However, trade creditors will have a cost as a result of
loss of enjoying cash discount on cash purchases.
 Principles of Working Capital Management
1.Principle of Risk Variation:
Risk refers to inability of firm to meet its obligation as and when they
become due for payment. Larger investment in current assets with less
dependence on short-term borrowings increases liquidity, reduces risk and
thereby decreases opportunity for gain or loss. On other hand less
investment in current assets with greater dependence on short-term
borrowings increases risk, reduces liquidity and increases profitability.
There is definite direct relationship between degree of risk and profitability.
A conservative management prefers to minimize risk by maintaining
higher level of current assets while liberal management assumes greater
risk by reducing working capital. However, the goal of management should
be to establish suitable trade off between profitability and risk.
2. Principle of Cost of Capital:

The various sources of raising working capital finance have different cost of
capital and degree of risk involved. Generally, higher the risk lower is cost
and lower the risk higher is the cost. A sound working capital management
should always try to achieve proper balance between these two.

3. Principle of Maturity of Payment:

This principle is concerned with planning the sources of finance for working
capital. According to this principle, a firm should make every effort to relate
maturities of payment to its flow of internally generated funds. Generally,
shorter the maturity schedule of current liabilities in relation to expected
cash inflows, the greater inability to meet its obligations in time.
3. Principle of Equity Position:

This principle is concerned with planning the total investment in

current assets. According to this principle, the amount of working
capital invested in each component should be adequately justified by
firm’s equity position. Every rupee invested in current assets should
contribute to the net worth of firm. The level of current assets may be
measured with help of two ratios:
(i) Current assets as a percentage of total assets and
(ii) Current assets as a percentage of total sales.
Factors influencing Working Capital Management

1. Nature of business:
The nature of business is of two types: Manufacturing Business and
Trading Business. Manufacturing businesses take longer to turn raw
material into finished goods. Capital remains invested for a long time
in raw material, so more working capital needed.

2. Conditions of availability:
If the raw material available throughout year, small working capital can
be invested in inventory. But if supply conditions aren’t available
always good stock of inventory will need bigger working capital.
Factors influencing Working Capital Management

3. Production Policy:

If the policy is to keep production steady by accumulating inventories it will

require higher working capital; also depends on length of production cycle.

4. Seasonality of Operations:
Some goods are demanded throughout the year while others have seasonal
demand. If demand is uniform, such enterprises need little working capital.
Factors influencing Working Capital Management
5. Credit availability:
If raw material and other inputs are easily available on credit, less
working capital is needed.

6. Credit policy of enterprises:

Enterprises providing credit facilities to the customers need more working
capital.
Factors influencing Working Capital Management

7. Price level change:

When there is a rise in prices, more capital is required than before in
order to maintain the previous scale of production and sales.

8. Volume of sale:
When the business is prosperous, more needs to be produced. To keep
things up, we need an increase in working capital.
Factors influencing Working Capital Management
9. Management Ability:
Working capital should be managed in such a way that it is available in
a moderate level: neither inadequate, nor excess.
10. Liquidity and Profitability:
Liquidity: Degree to which a product can be bought/sold in market at
a price reflecting its intrinsic value.
Profitability: Ability of a company to generate profit from its’
operations.
Optimum amount of working capital should be determined to keep
profitability of business intact, without fall in liquidity.
Factors influencing Working Capital Management

11. Circulation of Working capital:

If the circulation of working capital is comple ted in an efficient
manner, (ie. the processes from raw material conversion, till final
d
,
12.External Environment:
● Interest rates
● Economy
● New Technology
● Level of competition
Thank you!