FINANCING OF WORKING CAPITAL

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CHAPTER - III

FINANCING OF WORKING CAPITAL

This chapter is divided into three parts. The first part deals wth the concept of financing of working capital followed by the responses of executives of six companies i.e. Bajaj Auto, Eicher Motors, Eicher Tractors, Hero Honda, Bajaj Tempo and Escorts. In the last part financing of working capital has been evaluated in thirteen companies through annual reports for the last five years.

The first part explains the concept of working capital financing, forecasting, then operating cycle and finally the sources of working capital finance.

3.1 CONCEPT OF FINANCING OF WORKING CAPITAL -

A firm has to judiciously use funds to generate profits. "For without proper finance there will be no efficient planning, nor purchase of raw material, nor production, nor marketing, nor arfyCfafr profit the latter in its turn forming the foundation of finance itself'.^

There are conflicting views regarding the nature of financing v^rking capital. One view is that working capital needs are short term in nature as they

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are self liquidating^ in nature. Another view is that since a firm is a going concern, so >A/orking capital needs are continuous as well as long term in nature.

The third view is that financing Is need based. According to this view the working capital requirement is not consistent throughout the year. Its need will fluctuate taking into account the nature of business, seasonality etc. There will be a fixed requirement of working capital throughout the year to pay for rent, salary etc. and variable requirement which will increase or decrease with the level of production. The fixed part should be financed by long term sources and the fluctuating part from short term sources.^

A bank will prefer to finance only that part of working capital which can be realized even in worst conditions, while, the balance however as margin money^, be arranged by the owner.

3.1.1 FORECASTING OF WORKING CAPITAL REQUIREMENT -

To determine financial needs of a company sales forecasting is done generally for two different time frames i.e. long term (3-5 years) and short term (six months, three months or one month). The short term sales forecasting helps in forecasting working capital requirement.^

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"Forecasting becomes the basis of co-ordinated thinking about the future and reduces emergency decisions and surprises. It can be used to set standards of performance to measure and control the separate and collective decisions in various parts of the company. It can be used to anticipate financial needs and the financial effects of new and changing policies. It also forms a good basis for discussing the fund needs with prospecting creditors."^

There are two methods of forecasting : conventional and statistical. Conventional forecasting is a purely human judgement analysis where the projections are based upon the intuition and logic of individuals or group of persons. Statistical method brings in more accuracy to projections although the element of uncertainty is not eliminated by this method also.^

3.1.2 CONCEPT OF OPERATING CYCLE -

The concept of operating cycle was developed by Park Gladston* it begins with the acquisition of raw materials and ends up with the collection of receivables.? The fundamental function of working capital is to meet cash demand on a continuous basis^?. The need of working capital at a given time will be determined by the operating cycle.

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An operating cycle is a summation of raw material and stores stocking period, work-in-process period, debtors collection period, finished goods storage period less the creditors payment period.

3.1.3 SOURCES OF WORKING CAPITAL FINANCE -

The sources of finance can broadly be divided into short and long term sources. The long term finance includes external sources like ordinary shares,

preference shares, debentures and loans from financial institutions and internal sources like retained earning, provisions for depreciation etc. The short term finance includes external sources like goods on credit, bank borrowings, discounting of bills, overdraft, advances and deposits from friends and employees etc., and internal sources like gratuity, dividend, contingencies, pension, provision for taxation and other miscellaneous liabilities like unclaimed dividend, outstanding salaries and wages, etc.

3.2 COMPANY WISE FINANCING OF WORKING CAPITAL PRACTICES-

The second part of this chapter deals with the responses received from the excutives of Hero Honda, Eicher Motors, Eicher Tractors, Bajaj Auto, Bajaj Tempo

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and Escorts. First it explains the approacties to financing, followeci by forecasting, sources and forms of financing and finally the policy of the companies regarding financing of working capital.

3.2.1 APPROACHES TO FINANCING -

Hero Honda Eicher Motors, Eicher Tractors and Escorts use hedging approach in financing of working capital. Bajaj Auto and Bajaj Tempo have a conservative approach of financing working capital.

3.2.2 FORECASTING -

In all the companies working capital forecasting is done by formal/statistical methods. Hero Honda, Escorts and Bajaj Auto use panel of experts, moving averages, exponential smoothing, trend adjusted exponential smoothing and trend projection tools for forecasting working capital. In Bajaj Tempo, Eicher Motors and Eicher Tractors working capital forecasting is done by informal method.

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All the companies have experienced situations when forecasted values deviated from actual requirements of working capital. However, all the companies emphasized uncontrollable factors being responsible for such occurrence.

The duration of operating cycle in Hero Honda and Escorts is approximately fortyfive days. In Escorts it is about forty days and in Eicher Motors and Eicher Tractors it has being varying between forty to fifty five days . Bajaj Auto did not respond. In Bajaj Tempo the duration of operating cycle is thirty days.

Operating cycle remains constant in Hero Honda while it fluctuates in Escorts, Eicher Motors and Eicher Tractors. Bajaj Auto did not respond. The operating cycle remains constant in Bajaj Tempo.

In Hero Honda and Escorts operating cycle period is considered in forecasting. Eicher Motors, Eicher Tractors and Bajaj Auto did not respond. In Bajaj Tempo operating cycle is incorporated in forecasting working capital requirement through constant study of market and mobilization of funds.

Operating cycle is kept constant while determining demand on the basis of advance booking, followed by supply schedules and finally with the help of

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dedicated ancillaries in Hero Honda. Eicher Motors, Eicher Tractors and Bajaj Auto did not respond.

3.2.3 SOURCES AND FORMS OF FINANCING WORKING CAPITAL -

The main sources of working capital finance in Hero Honda are long term external sources such as debentures and loans from financial institutions; long term internal sources like retained earnings; short term external sources like bank borrowings, discounting of bills and overdraft and short term internal sources when provision of funds made for future payments are used for working capital requirements. In Escorts the major sources of financing working capital are long term external sources like ordinary shares, preference shares, debentures and loans from financial institutions; long term internal sources like retained earnings; short term external sources like goods on credit, bank borrowings, discounting of bills, and overdraft. In Eicher Motors and Eicher Tractors the main sources of financing of working capital are short term external sources like borrowings. In Bajaj Auto the major sources of financing are long term external sources like ordinary shares and short term external sources like bank borrowing and goods on credit earning. In Bajaj Tempo the major sources of working capital finance are long term external sources like loan from financial institution; long term internal sources like

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retained earning; short term external sources like goods on credit and bank borrowing; and short term internal sources like provision for taxation.

The major forms of financing in Hero Honda are current liability, cash credit, working capital loan from central government and equity/long term loans. In Escorts the major forms include all the above specified in case of Hero Honda except working capital loan from central government; it also includes deferred credit. In Eicher Motors and Eicher Tractors the major form of financing is cash credit. Current liability is the major form of financing in Bajaj Auto. In Bajaj Tempo the major forms of financing working capital are current liability, cash credit, deferred credit and equity/long term loans.

3.2.4 POLICY -

The overall policy of Hero Honda regarding financing of working capital is to satisfy all variable needs with short term sources and only for the periods needed, and financing inventory only from long term sources and one half of the current assets by long term sources. The overall policy of Escorts in this regard is to finance a portion of variable need with long term sources and a portion of the permanent needs from short term sources. The overall policy of Eicher Motors, Eicher Tractors and Bajaj Auto is to satisfy all variable needs with short term sources and only for the period needed. The overall policy of

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