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A Perspective Study on Financial Innovation in Working Capital Management

Essay by   •  August 19, 2011  •  Essay  •  300 Words (2 Pages)  •  1,399 Views

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Financial Innovation helps in sustainable growth of the financial institutions that delivers prompt financial services to corporate, capital market and the public in large. Basically there are three types of innovations namely

(i) Financial system / institutional innovations: These innovations have a direct impact on the changes in business structures, new types of financial intermediaries and hence changes in the legal and supervisory framework is required.

(ii) Process innovation: These include introduction of new business processes, modified processes to achieve competitive edge.

(iii) Product innovation: These are required to address market demand due to the changes in political, legal, social, technological and economic environment.

The financial institutions acts a supporting pillar to corporate, by extending various financial services namely issue management, short term lending, leasing, hire purchase, factoring etc. A firm's objective is to increase shareholders wealth, expressed as 'Economic Value Added (EVA)'. EVA offers various benefits to different entities. The investors and financial analysts use EVA to judge the performance of the firm in making investment decisions. The financial institutions are keen about firm's EVA to determine the credibility of the firm for making financing decisions. EVA is calculated as net operating after taxes profit minus a charge for the capital invested.

The capital consists of two main components namely fixed capital having equity, debt and working capital. Working capital has greater impact on EVA and some of the leading firms are experimenting on zero working capital. The major ingredients of working capital namely inventories, accounts receivables and accounts payables if managed properly, reduce working capital and hence capital charge will be lower. This is the area where the financial institutions can introduce a new financial service to the corporate. This paper focus on institutional and process innovation namely, inventory management using the commodity future contracts and options to reduce working capital of a firm.

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