Working Capital Financing^355
A business firm may have diverse credit needs and may require either (1) a revolving
credit arrangement, (2) a seasonal line of credit, (3) funding on a transaction basis, or
(4) get its bills discounted. Banks will take care that it meets the kind of requirements
that the company has and not push their own systems of financing. Banks do participate
even in financing some of the money market instruments (like CPs) but the basic funding
remains through the working capital loans only.
A line of credit is simply a formal or informal agreement between a commercial bank
and a borrowing customer regarding the maximum amount of credit the bank is willing
to extend to that customer over a given number of months usually a quarter. These
limits are usually rollable from year to year after reassessment of the requirements.
Seasonal business borrowers commonly request seasonal lines of credit. By preparing
and analysing cash budget reflecting his firmís operations over some period, the financial
administrator estimates the patterns of his seasonal financing needs and arranges a line
of credit with the firmís bank, the upper limit of which equals the firmís forecasted
peak requirements, as shown in his cash budget.
The seasonal build up of inventories, accounts receivable, or both create needs for
funds, the firm simply signs promissory notes for the amounts required at the times they
are required, and the bank credits the firmís account in the proper amounts. Subsequently,
the post seasonal shrinkage in working capital needs permits the firm to repay the
advances with funds generated from the sale of inventories and the collection of accounts
receivable. (for example in sugar industry where demand for WC builds up for six
months and comes down in the rest six months).
Banks usually access the peak seasonal demand and off-season demand separately
and sanction credit on this basis.
Revolving Credit Agreements
Earlier the whole working capital loan was revolving credit in the sense that the company
could repay whatever part of the loan it wanted to.
Revolving lines typically were continuous and were negotiated as formal commitments
to lend by the bank, and a commitment fee was charged on any portion of the line that
lied unused. The main problem was that the bank had to keep aside a huge portion of
funds, which, in the case of corporates not utilising them, were not earning any return
except the return from the call money markets (which were very low as compared to
the returns from the loans).
To rectify this problem the banks divided the working capital loans into two parts,
demand loan and cash credit in a ratio of 80:20. Demand loan became the fixed portion
of the bank working capital financing and only the cash credit was allowed to be kept
fluctuating.