So I run a business since 15 years, and would hands down say that the sources of working capital in financial management have boomed. If you just go and check online, the many fintech start ups which primarily deal with working capital loans for business’s. In my observation post the market crisis in 2008 and the strict implementation of banking rules. Which led to banks becoming very lethargic, and that’s how these new age sources have cropped up.
Various Sources of Working Capital in Finance- Old & New
If you asked any senior business man over 50’s especially in India, different source of working capital. Then he is guaranteed to name the first source as;
Bank Over Draft
OD as you popularly call it. I was approached by own bank ICICI with several emails, and calls to apply for Overdraft facility. And I generally don’t really like discussing such important things on the phone without getting details. In fact I had also asked the relationship manager, to just send me the details of the overdraft.
Now please, look at the offer I got. So they are ready to give me a working capital source of INR 18 Lacs at 9.5% interest rate+ 0.5% process fee which makes it 10%. But here is the catch I Need to provide a collateral of 125%. Which comes around to INR 22.5 Lacs.
I am sure you understand and can infer my decision. I didn’t go for it.
Payment Gateways – New Products
Now from the start of our business we believed in keeping things very digital and efficient. And since most of my customers pay digitally online, we were hunting for a good payment gateway. First I was in discussion with a number of them. The first meeting was with Bill desk, which at that time was dominating the market share in India.
Fast forward we shortlisted razor pay as the best option and went for it. Now over the years, this company was supposed to just provide payment gateway solutions. But look at this offer of regular working capital offered by them. This is my own official portal.
However also notice the name of collaboration for this, which is Aditya Birla capital.
Line of Credit
Now when you saw my first experience with short term sources of working capital given by ICICI Bank. It was related to my current account with ICICI Bank. However, what if I now want something similar to working capital, from another NBFC or bank? If I go by the usual process, then I would have to open another bank account.
So line of credit is just an extension of overdraft, where the bank account is not necessary. Another important difference is that line of credit has a pre- sanctioned limit. Whereas if you took the ICICI overdraft facility, the bank would still permit you to cross the limit But charge accordingly.
Customer Direct Financing
If you ask me over the years, which long term sources of working capital has really made a difference. Then I would say customer financing. I remember in 2016 when I was working with an education company, and Bajaj finance executives approached me to finance courses for our students. I was perplexed at that time because, I had hear of education loans but this? It is also marketed as zero interest loan.
Now here is how it works.
- I the owner of business have to tie up with the financing company like Bajaj finance.
- Now, lets say my customer wants to enrol for my course which will cost INR 30K.
- So, If the customer were to take a loan by himself then he would have to pay a cumulative interest of 2700 for a year at 9%.
- So now instead of the customer paying the interest of INR 2700, I pay to the financing company. Making the loan to the customer interest free.
- Now, where if I were to offer instalments to my customer, then I would have to wait for 6 months to collect the receivables./
- But now this has been cut shot and my net working capital days have reduced by 6 months.
This is also called as subvention charges.
Trade Credit as short term working capital
Now, in my business Domain the major suppliers are suppliers of service like Facebook and google ads. When I first started this business in 2020, I use to pre pay for Facebook ads. Which means, that I would have to either use my own cash to first fill the ads account and then my ads would run.
After about 4 years advertising, Facebook offered me a new type of working capital which is meta credit. Look at the credit facility image below. So I basically have INR 8.32 Lacs worth of credit available to be used for marketing.
What this has done for me is that my gross working capital needs of lets say 2 lacs monthly has been reduced.
In fact you could get the same facility of credit from google, but you need a larger and consistent spend for 1 year.
Credit Card
Yes, whether you agree or not but for my business this classification of working capital has been a saviour. Let me explain this to you. Firstly when I started the business and formed the limited liability partnership, by itself it didn’t have a credit history.
So, there was no question of getting a credit card for the company account. Although I tried it but was denied. But since I had a long credit history and a good credit score hence I had access to almost INR 8-9 Lacs of free credit Available.
In my opinion credit cards are a great source of managing digital payments and hence helps in sources of working capital management.
Central Bank Regulations for Different Source of Working Capital
So when it comes to formal banking, then the amount of working capital has to follow strict guidelines. Also there are categories of working capital as per the RBI guidelines
Working Capital Requirements Upto Rs 1 Crore
- So as per Reserve bank of India guidelines, for working capital loans upto 1 cr needs to be assessed basis the annual turnover.
- 25% of total turnover is usually considered as a part of working capital requirements. However 5% needs to be contributed by the business owner.
- However the assessment of eligibility and need of working capital including reliability of assessments is discretionary for the banks.
Working Capital Requirements Upto Rs 5 Cr.
- This is where the assessment of assets and current liabilities comes into picture. Where the current ratio should be at least 1.33: 1 as per Rbi. This was also called as the maximum permissible bank finance (MPBF) but this method has now been removed.
- The amount of loan again can be calculated basis the annual turnover method.
The Market Of Working Capital Loan Providers
Currently as per introspective market research report, the working capital loan market globally is around $1.38 Trillion. Of which 48% is dominated by banks. Now this market has been and is expected to grow in my opinion at around 10%-11% CAGR. Also I think the major reason for this boom in short term debt financing is due to the following factors;
- Surge in the SME business globally.
- In india alone there are 75 million SME’s and 90 million more SME’s are expected to be born in the next two to three years. Which would boost the requirement for short term loans.
Expert opinions on Working Capital Requirements Management
As I had the opportunity to discuss working capital management with a CFO of a renowned company. Who requested not to named said this about working capital management.
“Working capital, to me, is very essential in the operation of small businesses and yet seems neglected. I found that in trying to come up with a simple daily routine in treasury management—which includes cash reconciliations and the management of credit lines—it was necessary.
Even though it is usually wrong, forecasting is very helpful for predicting cash flow, especially for paying payrolls. Regular account receivable and inventory reviews will reveal inefficiencies and assist in preventing unnecessary tying up of cash.
Finally, the annual macro review of earnings, capital expenditures, and other significant cash uses provides a quick alert mechanism regarding potential financial challenges and maintains a high-level strategic view of the business’s health. These relationships can also be supported by building strong supplier relationships such that payment terms align with inventory turnover.”
