Need for credit and its nature, Financial Management

Assignment Help:

Need for Credit and its nature

On the demand side of the economy are the consumers of goods and services who require funds basically for acquiring certain consumer durables. The credit facility offered to the households will generally be in the form of auto-finance, educational loans, credit card loans, housing loans and for the purchase of other consumer durable items. Loans will also be provided to individuals against other financial and real assets. Except for the housing loans all the other types of individual loans range from short- to medium-term.

Similarly, on the supply side also, the credit market provides funds to the corporates, though for entirely different purposes. Corporates basically require funds for project finance while initiating an investment plan and working capital finance for their day-to-day operations.

Credit extended for project finance would enable the corporates to acquire real assets, plant and machinery, technological expertise, etc., required for expansion/ modernization/diversification purposes. It can be observed that the funds required for these purposes will be large in amount and for periods ranging from medium- to long-term.

In certain cases, where the project is very large and the funds cannot be provided by a single institution, consortium lending will be resorted to. In this facility, two or more intermediaries will join together to finance large project proposals. Such funding requirements will generally arise while financing large infrastructure projects, petroleum projects, etc.

In addition to the long-term requirements, firms would also require short-term funds for meeting their working capital requirements. Firms require these funds to meet their day-to-day operational requirements and for maintaining adequate levels of current assets. Since these funds support the daily operations of the firms, they are required on a continuous basis. The financial assistance for the working capital requirements is generally provided by banks in the form of Cash Credit (CC), Overdraft Facility (OD) and bill finance.Under the cash credit facility, limits are set based on the requirements of the firm and the CC is sanctioned for one year. The CC limits sanctioned for a year, in practice, will generally be renewed after assessing the working capital requirements for the following year. Thus, the cash credit has a permanent feature, though, technically the funds are repayable on demand. The CC limit sanctioned based on the working capital estimates will have the combined features of a loan and a current account. Funds will be made available through an account of the firm from which the firm can withdraw (within the sanctioned CC limits) when funds are required and deposit when funds are in excess. The interest charged will be on the daily outstanding (net debit balances) in this account and will generally be paid on a quarterly basis.

In the overdraft facility, the bank will allow the firm to overdraw from its current account to a predetermined level of credit. This credit limit will be set based on the security offered by the firm. Such type of credit facility will generally be short-term in nature, not exceeding a year.

The other type of short-term credit will be in the form of bill financing. Here, the intermediary will finance the trade bills of the firm for a period ranging up to
6 months. The overdraft facility is either clean or against some security such as real estate whereas cash credit account is invariably secured by inventory.

While the short-term and the long-term credit facilities mentioned above appear on the balance sheet of the firm, there are a few contingent credit facilities which do not appear on the balance sheet. These off balance sheet activities are generally in the form of letter of credit or a standby facility or guarantees. The contingent claim is transformed into a credit claim when the contractual obligation is activated. The returns on such off balance sheet transactions are high, but so are the risks.

Apart from the above, the credit market in a few economies also facilitates priority sector lending. As per the regulations of these economies, a prescribed percentage of the total loanable funds of the intermediaries will have to be utilized to fund the priority sector. In India, banks are required to allocate 40 percent of the total funds provided as loans in that year towards the priority sector lending. For a developing economy such selective credit control becomes essential to ensure the proper use of institutional credit since a major portion of the savings lie with these intermediaries as loanable funds.

 


Related Discussions:- Need for credit and its nature

Explain capital investment project appraisal, Question: (a) The future ...

Question: (a) The future value (F) of a sum invested now can be calculated using the formula: F = P(1 + r) n Required: (i) Describe each of the other constituents in the

Explain intuition behind the npv capital budgeting framework, What is the i...

What is the intuition behind the NPV capital budgeting framework? The NPV framework is a discounted cash flow method. The method compares the present value of all cash inflows

Source documents of an accounting system, Source documents of an accounting...

Source documents of an accounting system: Source documents are those documents that identify the particular transaction that is being recorded.  They act as an internal control

Definition of budgetary control, DEFINITION OF BUDGETARY CONTROL As pe...

DEFINITION OF BUDGETARY CONTROL As per the ICMA, BUDGETARY CONTROL is the establishment of budgets, relating the tasks of executives to the requirements of a policy, and the c

Types of financial incentive schemes, Types of financial incentive schemes ...

Types of financial incentive schemes Performance associated pay (PRP) systems e.g. piecework or sales commission Bonuses e.g. supplementary payments for targets or ai

Profit maximization-objectives of a business entity, Profit maximization ...

Profit maximization Traditionally, this was considered to be the major goal of the firm. Profit maximization refers to attaining the maximum possible profits throughout the yea

Weighted average cost of capital or composite, Q. What is denoted by weight...

Q. What is denoted by weighted average cost of capital OR Composite? How is it calculated? Exemplify with an example. Ans. Weighted Average Cost of Capital: - Capital formation

Consistency in accounting, Consistency - ACCOUNTING postulate that stipulat...

Consistency - ACCOUNTING postulate that stipulates, except as otherwise noted in FINANCIAL STATEMENT, same accounting procedures and policies have been followed from period to peri

Evaluation of credit policy, Q. What is Evaluation of Credit Policy? Ev...

Q. What is Evaluation of Credit Policy? Evaluation of Credit Policy: - A credit policy is prepared to maintain the investment in receivables at optimum level. Receivable Turnov

What is monopoly, MONOPOLY Several governments consider it necessary to...

MONOPOLY Several governments consider it necessary to prevent or control monopolies. A untainted monopoly exists when one organisation controls the production or supply of a go

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd