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Need and Objectives of Financing of Working Capital, Short Term Credit

The primary objective of working capital management is to ensure smooth operating cycle of the business. Secondary objectives are to optimize the level of working capital and minimize the cost of such funds.

The superior objective of financial management is wealth maximization and that can be gained by profit maximization accompanied with sustainable growth and development. For sustainable growth and development, the objectives of all the stakeholders including customers, suppliers, employees, etc should be aligned to the growth of the organization.

This implies that the operating cycle i.e. the cycle starting from the acquisition of raw material to its conversion to cash should be smooth. It is Objectives of Working Capital Management not easy; it is as good as circulating 5 balls with two hands without dropping a single one. If following 6 points can be managed, this operating cycle can be management well.

  • It means raw material should be present on the requirement and it should not be a cause to stoppages of production.
  • All other requirements of production should be in place before time.
  • The finished goods should be sold as early as possible once they are produced and inventoried.
  • The accounts receivable should be collected on time.
  • Accounts payable should be paid when due without any delay.
  • Cash should be available as and when required along with some cushion.

LOWEST WORKING CAPITAL

Working capital here refers to the current assets less current liabilities (net working capital). It should be optimized because higher working capital means higher interest cost and lower working capital means a risk of disturbance of operating cycle.

MINIMIZE RATE OF INTEREST OR COST OF CAPITAL

The cost of capital utilized on working capital should be minimized so as to achieve higher profitability. If the investment in working capital involves bank finance, interest rates should be negotiated with the bank.

Cost can be minimized by utilizing long-term funds but in a proper mix. While deciding the mix of working capital, the fundamental principle of financial management should be kept in mind that fixed assets and permanent assets should be financed by long term sources of finance of approximately same maturity and short-term or temporary assets should be financed by short-term sources of finance.

OPTIMAL RETURN ON CURRENT ASSET INVESTMENT

The return on the investment made in current assets should be more than the weighted average cost of capital so as to ensure wealth maximization of the owners. In other words, the rate of return earned due to investment in current assets should be more than the rate of interest or cost of capital used for financing the current assets.

SHORT TERM CREDIT

Short-term loans are usually extended by financial institutions generally for a period of 1-2 years. These are mostly unsecured, which means you don’t have to pledge a collateral as security to avail them. Though funds can be extended quickly, the reason why they are labeled “short-term” is the associated repayment tenor (to be paid off in full within 6-18 months) rather than the speed of funding.

What differentiates such a loan from the other conventional ones in the market is the ease of availing one. However, there are many short terms loan in India offering you the funds you need to meet any short-term financial need. Here, we try to cover the ins and outs of the 5 most popular sources of short-term loans, to help you make an informed decision when it comes to availing short-term finance.

  1. Trade Credit

Possibly one of the most affordable sources of obtaining interest-free funds, you can avail a trade credit where the lender would give you the time to pay for a purchase without incurring any additional cost. A trade credit is usually extended for a period of 30 days.

However, you can consider asking for a longer tenor that would easily fit into your plan.

A flexible repayment tenor will allow you to leverage the additional time and funds to finance other initiatives.

  1. Bridge Loans

A bridge loan will help to tide you over till the time you get another loan, usually of a bigger value, approved. In India, such a loan assumes importance in case of transactions relating to property. For example, if you want to buy a new house but don’t have sufficient funds because the old one hasn’t been sold off yet. You might want to wait for the funds to come through once you get a potential buyer for the old property, but this will have its own downsides, including the price of the new property shooting up. 

It is during this waiting time that you can avail a bridge loan, that offers two-pronged benefits- it helps you with the funds to buy the property while giving you ample time to wait and get a good deal on the old one.

  1. Demand Loans

A demand loan can help you meet any urgent financial obligation. You can pledge your insurance policies and other savings instruments such as NSCs in lieu of the loan. A certain percentage of the maturity value on such savings instruments will determine the extent to which you will be eligible to borrow as the loan amount.

4. Bank overdraft

This is a facility that you can avail on your current account. With an overdraft facility at your disposal, you will be able to withdraw money despite your account not having sufficient cash to cover such withdrawals. Essentially, it helps you to borrow money within a sanctioned overdraft limit.

Much like any other loan, an interest rate (often lower than that on credit cards) is levied on the outstanding overdraft balance. Having said that be wary of certain additional costs that might be attached with such a facility, including fees per withdrawal.

5. Personal loans

You can avail a personal loan to meet a variety of needs like home renovation, wedding, higher education or travel costs. You could also use a personal loan to meet a medical emergency or consolidate all your existing into one.

Many lenders offer a personal loan on the basis of your income level, employment and credit history, and perceived capacity to repay. Unlike a home or car loan, a personal loan isn’t a secured one. This simply means that the lender will not have anything to auction in case you default on repaying the loan amount. What differentiates a personal loan from all the above loans is that it gives you a substantial loan amount with flexible tenor to facilitate repayment.

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