CHAPTER 31

WORKING CAPITAL FINANCE

Q.1.
A.1.

Explain the importance of trade credit and accruals as sources of working

capital. What is the cost of these sources?
Trade credit refers to the credit that a customer gets from suppliers of goods in
normal course of business. This deferral of payments is a short-term financing
and a major source of finance. It is mostly granted on an open account basis. It
may also take the form of bills payable. It is a spontaneous source of
financing. It appears to be cost free since it does not involve explicit interest
charges. But, in practice, it involves implicit costs, i.e., via the increased price
of goods supplied to customer.
Accrued expenses represent a liability that a firm has to pay for the
services which it has already received. They represent spontaneous, interest
free sources of financing. The most important components of accruals are
wages and salaries, taxes and interest. Accrued taxes and interest also
constitute another source of financing.

Q.2.
A.2.

Explain the rationale of the Tandon Committees recommendations.

The Tandon Committee was appointed by the Reserve Bank of India in July
1974 to suggest guidelines for the rational allocation and optimum use of bank
credit.
Bank credit is a scarce resource; hence it should be optimally used
under all circumstances. The bank credit should also be available, in addition
to industrial units, to agriculture, small-scale industry, farmers, common man
and many others. The bank funds should be utilized in most efficient way by
all sectors of the economy. The Tandon Committee, have given due weightage
on above rationale, while recommending the three methods for financing.

Q.3.
A.3.

Describe the important features of the Tandon Committees recommendations.

The important features of Tandon Committees recommendations are
enumerated hereunder in brief:
1) The borrower should indicate the likely demand of credit in a realistic
manner.
2) The banker should finance only the genuine production needs of the
borrower.
3) The borrower should maintain reasonable levels of inventory and
receivables; just enough to carry on his target production.
4) The working capital needs of the borrower will be partly financed by
bank; for the remaining, the borrower should depend upon his own
funds, generated internally or externally.
5) The committee has pointed out that borrower should be allowed to
hold a reasonable level of current assets, particularly inventory and
receivables. The committee has suggested norms separately for heavy
engineering, heavy seasonal, small-scale industries, etc.
6) The committee admitted that norms cannot be followed rigidly. It
allowed flexibility in the application of norms when a major change in
the environment justifies.

7) The committee also recommended the bifurcation of total credit into

fixed and fluctuating parts.
8) They also recommended methods for calculation of maximum
permissible bank finance.
9) The committee also recommended the flow of information from
borrower to the bank on regular basis, comparing estimates and
actuals, etc.
Q.4.
A.4.

Q.5.
A.5.

What are the implications of the recommendations suggested by the Tandon

Committee?
Bankers found difficulties in implementing the committees recommendations.
The Tandon Committee report has brought about a perspective change in the
outlook and attitude of both the bankers and their customers. The report has
also helped in bringing a financial discipline through a balanced and integrated
scheme for bank lending.
Define commercial paper. Explain its pros and cons.
Commercial paper (CP) is a form of unsecured promissory note issued by
firms to raise short-term funds. The CP are issued by companies having net
worth of Rs 10 crore or more, are financially sound and are highest rated
companies. In addition to this, companies should have maximum permissible
bank finance of not less than Rs 25 crore, and must be listed on the stock
exchange. The RBI provided that size of issue should be at least Rs 1 crore
and the size of the each CP should not be less than Rs 25 lakh. In India, the
maturity of CP runs between 91 to 180 days. It is expected that CP is used for
short-term financing only, as an alternative to bank credit and other short-term
sources. The interest rate of CP will be determined by market.
Advantages:
1) The CP is an alternative source of raising short-term finance.
2) It is a cheaper source of finance in comparison to bank credit.
Disadvantages or limitations:
1) As it is an impersonal method, so it may not be possible to get the
maturity of CP extended.
2) It cannot be redeemed until maturity, and will have to incur interest
costs.
3) A firm facing temporary liquidity problems may not be able to raise
funds by issuing new CP, etc.