Sources of Working Capitals

Retained earnings refer to the accumulated profits of a company that are not distributed to shareholders as dividends but kept within the business. These funds act as an internal source of working capital and help finance day-to-day operations such as purchasing raw materials, payment of wages, and meeting administrative expenses. It is the most economical source because no interest or repayment obligation exists. It increases financial independence and improves creditworthiness. However, excessive retention of profits may cause dissatisfaction among shareholders who expect regular dividends and returns on their investments.

• Trade Credit

Trade credit is a facility provided by suppliers allowing the business to purchase goods and pay later after a specified credit period, such as 30 to 90 days. It is one of the most common and convenient sources of working capital because it requires no formal agreement or collateral security. It helps firms maintain production even when cash is limited. Trade credit also strengthens business relationships between buyers and suppliers. However, delay in payment can damage goodwill, and suppliers may charge higher prices or reduce credit limits to compensate for risk.

• Bank Overdraft

Bank overdraft is an arrangement under which a bank permits the business to withdraw more money than the balance available in its current account, up to a predetermined limit. The firm pays interest only on the amount actually used and only for the period of use. This makes it a flexible and convenient source of short-term finance. It helps businesses meet urgent expenses such as wages, utility bills, and small purchases. However, banks may demand security and reserve the right to cancel the facility at any time if terms are violated.

• Cash Credit

Cash credit is a widely used method of bank financing for working capital. The bank sanctions a credit limit against the security of stock or receivables. The firm can withdraw funds as needed within the approved limit and repay whenever surplus funds are available. Interest is charged only on the utilized amount, not on the entire sanctioned limit. This facility is especially useful for firms with fluctuating working capital requirements. However, banks impose strict margin requirements and periodic inspections, which may restrict business flexibility.

• Short-Term Bank Loans

Short-term bank loans are borrowings obtained from commercial banks for a period usually less than one year. These loans may be secured or unsecured and are used to finance purchase of inventory, payment of suppliers, and other operational needs. The interest rate and repayment schedule are predetermined, enabling financial planning. Such loans provide immediate funds and are suitable for seasonal businesses. However, regular interest payments increase financial burden and failure to repay on time negatively affects the firm’s credit rating and borrowing capacity.

• Commercial Paper

Commercial paper is an unsecured promissory note issued by financially sound companies to raise short-term funds directly from investors. It is generally issued for a period ranging from a few days to one year. Large and reputed corporations prefer this source because it is cheaper than bank borrowing and involves fewer formalities. It helps meet temporary working capital requirements efficiently. However, only companies with high credit ratings can issue commercial paper, and unfavorable market conditions may limit investor interest.

• Factoring (Receivables Financing)

Factoring is a financial arrangement in which a firm sells its accounts receivable to a specialized financial institution known as a factor. The factor immediately advances a large portion of the receivable amount and later collects payment from customers. This improves liquidity and reduces the risk of bad debts. It also saves administrative cost of debt collection. Factoring is especially useful for firms facing delayed payments. However, the factor charges commission and service fees, making it a comparatively expensive source of working capital.

• Public Deposits

Public deposits are funds collected by companies directly from the public, shareholders, or employees for a short period, usually six months to three years. Companies offer attractive interest rates to encourage deposits. This source is simple and less expensive compared to bank loans. It helps meet short-term financial needs and strengthens working capital position. However, excessive dependence on public deposits may affect financial stability if many depositors demand repayment simultaneously.

• Advances from Customers

Advances from customers represent payments received before delivery of goods or services. These advances provide immediate funds to the firm without any interest cost. They are common in industries such as construction, customized manufacturing, and service contracts. Customer advances reduce the need for external borrowing and support working capital management. However, the firm must deliver goods on time and maintain quality standards. Failure to fulfill obligations may result in cancellation of orders and damage to business reputation.

• Accrued Expenses and Outstanding Liabilities

Accrued expenses are expenses incurred but not yet paid, such as wages, salaries, rent, taxes, and utility bills. These unpaid obligations act as a temporary and spontaneous source of working capital because the business can use available cash until payment becomes due. It requires no formal agreement or interest payment. However, it is available only for a short period, and excessive delay in payment may harm goodwill, reduce employee morale, and create legal complications.