Working capital financing is done by various modes such as trade credit, cash credit/bank overdraft, working capital loan, purchase of bills/discount of bills, bank guarantee, letter of credit, factoring, commercial paper, inter-corporate deposits, etc.
The arrangement of working capital financing forms a major part of the day-to-day activities of a finance manager. It is a very crucial activity and requires continuous attention because working capital is the money that keeps the day-to-day business operations smooth. A firm may get into trouble without appropriate and sufficient working capital financing. Insufficient working capital may result in the non-payment of certain dues on time. An inappropriate mode of financing would result in a loss of interest, which directly hits the profits of the firm
This is simply the credit period that is extended by the creditor of the business. Trade credit is extended based on the creditworthiness of the firm, which is reflected by its earning records, liquidity position, and records of payment. Just like other sources of working capital financing, trade credit also comes with a cost after the free credit period. Normally, it is a costly source as a means of financing business working capital.
Cash Credit / Bank Overdraft
Cash credit or bank overdraft is the most useful and appropriate type of working capital financing extensively used by all small and big businesses. It is a facility offered by commercial banks whereby the borrower is sanctioned a particular amount that can be utilized for making his business payments. The borrower has to make sure that he does not cross the sanctioned limit. The best part is that the interest is charged to the extent the money is used and not on the sanctioned amount, which motivates him to keep depositing the amount as soon as possible to save on interest costs. Without a doubt, this is a cost-effective working capital financing.