Assecessment of Working Capital For Borrowers Account

THIS REPORT IS ONLY
FOR STUDY PURPOSE IT

CONTAINS INFORMATION
FROM SEVERAL BOOKS
AND POLICY GUIDELINES.
A Report on Assessment of Working Capital for Borrowers Account 2009
A Project Report
On
Assessment of Working
Capital for Borrowers
Account
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3
Report
On
Assessment of Working Capital for Borrowers Account
This Report examines the ways in which assessment of working capital can be done
and while assessing a borrowers account for working capital limits, certain features
that need to be looked at and how actually assessment of working capital is been done
in a bank.
ACKNOWLEDGEMENTS
TABLE OF CONTENTS
Introduction to Working Capital

2.1 Working capital in terms of five components
3. Two Different Concepts of Working Capital

3.1 Balance sheet or Traditional concept
3.2 Operating cycle concept
4. Working Capital Finance

4.1 Sources of Working Capital.
4.2 Types of Working Capital Finance
5. Common Guidelines / Instructions for Lending to SME Sector in Bank of

Baroda.
5.1 Application Forms for Financial Assistance:
5.2. Receipt of applications and acknowledgment
5.3. Register of Credit Applications Received
5.4. Time norms for disposal of loan applications:
6. Financial Ratios for Credit Appraisal
7. Methods for calculating Working Capital Limits

7.1 Turnover Method
7.1.1 Information on Nayak Committee for SSIs
7.2 Cash Budget System
7.3 Committee Recommendations
7.3.1 Tandon Committee on Follow-up of Bank Credit
8. Information/Data Required for Assessment of Working Capital.
9. Check-List for verification of the information/Data.

9.1 Utilization of Existing Limits
9.2 Operating Statement
9.3 Analysis of Balance Sheet
9.4 Computation of maximum Permissible Bank Finance
9.5 Funds-Flow Statement
10 Fixation of Find-based and Non-fund based Limits

10.1 Bank Finance for Payment of Bonus
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11 Case Study on Assessment of Working Capital
11.1 Background of company:
11.2 Working Capital Assessment
11.2.1Utilization of Existing Limits
11.2.2Working Result of The company
11.2.3Financial position of the company
11.2.4Current Assets and Current Liabilities
11.2.5Assessment of working Capital
1. INTRODUCTION TO WORKING CAPITAL

 “Working capital means the part of the total assets of the business that change
from one form to another form in the ordinary course of business operations.”
 The word working capital is made of two words

1. Working and
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2. Capital
 The word working means day to day operation of the business, whereas the word
capital means monetary value of all assets of the business.
 Working capital may be regarded as the life blood of business. Working capital is
of major importance to internal and external analysis because of its close relationship
with the current day-to-day operations of a business. Every business needs funds for
two purposes. Long term funds are required to create production facilities through
purchase of fixed assets such as plants, machineries, lands, buildings etc and Short
term funds are required for the purchase of raw materials, payment of wages, and
other day-to-day expenses.. It is otherwise known as revolving or circulating capital It
is nothing but the difference between current assets and current liabilities.
Working Capital = Current Asset – Current Liability.
2.1 Working capital in terms of five components:

(i) Cash and equivalents: -
This most liquid form of working capital requires constant supervision. A good cash
budgeting and forecasting system provides answers to key questions such as: Is the
cash level adequate to meet current expenses as they come due? What is the timing
relationship between cash inflow and outflow? When will peak cash needs occur?
When and how much bank borrowing will be needed to meet any cash shortfalls?
When will repayment be expected and will the cash flow cover it?
(ii) Accounts receivable: -
Many businesses extend credit to their customers. If you do, is the amount of accounts
receivable reasonable relative to sales? How rapidly are receivables being collected?
Which customers are slow to pay and what should be done about them?
(iii) Inventory: -
Inventory is often as much as 50 percent of a firm's current assets, so naturally it
requires continual scrutiny. Is the inventory level reasonable compared with sales and
the nature of your business? What's the rate of inventory turnover compared with
other companies in your type of business?
(iv) Accounts payable:-
Financing by suppliers is common in small business; it is one of the major sources of
funds for entrepreneurs. Is the amount of money owed suppliers reasonable relative to
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what you purchase? What is your firm's payment policy doing to enhance or detract
from your credit rating?
(v) Accrued expenses and taxes payable: -
These are obligations of your company at any given time and represent a future
outflow of cash
3. TWO DIFFERENT CONCEPTS OF WORKING CAPITAL ARE:-
 Balance sheet or Traditional concept
 Operating cycle concept.
3.1 Balance sheet or Traditional concept
It shows the position of the firm at certain point of time. It is calculated in the basis of
balance sheet prepared at a specific date. In this method there are two type of working
capital (i) Gross working capital and (ii) Net working capital
(i) Gross working capital:- It refers to the firm’s investment in current assets. The sum
of the current assets is the working capital of the business. The sum of the current
assets is a quantitative aspect of working capital. Which emphasizes more on quantity
than its quality, but it fails to reveal the true financial position of the firm because
every increase in current liabilities will decrease the gross working capital.
Gross Working Capital = Total of Current Asset
(ii) Net working capital:- It is the difference between current assets and current
liabilities or the excess of total current assets over total current liabilities.
Working capital= current assets - current liabilities.
Net working capital: - It is also can defined as that part of a firm’s current assets
which is financed with long term funds. It may be either positive or negative.
When the current assets exceed the current liability, the working capital is positive
and vice versa.
3.2 Operating cycle concept:-
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The duration or time required to complete the sequence of events right from purchase
of raw material for cash to the realization of sales in cash is called the operating cycle
or working capital cycle.
The day to day business operations of a concern of any nature and, size involves many
successive steps and final working results would depend on the effective combination
of all these steps. The steps in general may include.
 Acquisition and storage of raw material and other stores and spares required for
manufacture of any product.
 Actual production process when the raw material is subjected to different

processes to bring it to final shape of finished goods.
 Storage of finished goods awaiting sales.
 Sales of finished goods and realisations of sale proceeds.
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We start from cash to buy raw material etc. and after completing all the steps end up
with the cash. The intervening period required for completion of this entire process is
the 'Operating Cycle'. The operating cycle may thus be defined as the intervening
period from the time the goods or services enter the business till their realisation in
cash. The study of this operating cycle is obviously very important as the actual
requirement of the unit may be limited to the funds required to complete an operating
cycle and the simplest formula for the working capital requirement may be
represented as under:
Total working capital requirement = Total operating expenses expecting during the year
No. of operating cycles in a year
This system of calculation of working capital requirement is not in vogue as it only

helps to assess the total requirement of a unit whereas the banks granting working
capital limits would be interested in proper classification of its various components.
The concept of operating cycle, however, throws light on various components of
working capital required for the unit and these components may be classified as
under:
 Raw material stores and spares consumed in the production process. The unit
must have some stocks of these items for uninterrupted production.
 Manufacturing expenses such as wages, power and fuel etc. to be incurred during
the process of manufacture.
 Stocks of work-in-process/semi finished goods maintained by the unit to complete

an operating cycle.
 Stocks of finished goods awaiting sale. All the finished goods may not be
immediately sold.
 Administrative and selling expenses during this process.
 Bills receivable/debtors for credit sales.
4. Working Capital Finance

4.1 Sources of Working Capital.
Working Capital is financed by following sources:
 Owned Fund:- A portion of long term funds, equity share capital and reserves &
surplus is utilized to fund working capital
 Bank Borrowing :- Various bank products like cash credit, packing credit, bills
discounting etc.
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 Creditors :- Creditors of raw materials , suppliers etc.
4.2 Types of Working Capital Finance
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 Cash Credit :- A cash-credit is an arrangement to extend short term working capital

facility . Under the system, bank sanctions a limit called the cash-credit limit to each
borrower upto which he is allowed to borrow against the security of stipulated
tangible assets i.e. stocks, book debts etc.
 Drawing against Un-Cleared effects (DAUE) :- When a customer wishes to draw

cheques against unclear balance i.e. against the cheques deposited in his current
account, sent for clearing but not yet realised, then the bank may allow payment of
such cheques. It is allowed only to first class parties who maintain satisfactory and
well conducted current accounts at the branch.
 Working Capital loan :- This refers to the working capital limit of a borrower
extended to him in the form of a loan. The loan component covers the permanent part
of the working capital need while cash credit component caters to the fluctuating part
of the limit.
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 Bills Financing :- Bills are negotiable instruments that the buyer (drawee) agrees to
pay the drawer/ payee the value of the goods after a specified period of time.
A seller of goods draws a bill of exchange (drawer) on buyer (drawee). Such bills can
be routed through the banker of the seller to the banker of the buyer for effective
control.
 Letter of credit :- A binding document that a buyer can request from

his bank in order to guarantee that the payment for goods will be transferred to
the seller. Basically, a letter of credit gives the seller reassurance that he will receive
the payment for the goods.
 Bank Guarantee :- It is a contract to perform the promise or discharge the liability of

a third person in case of his default.
It is of three types 1) Financial 2) Performance 3) DPG
 Export Financing :- The Export Financing for the working capital is designed to
provide short-term working capital to exporters.
 Factoring :- The selling of a company's accounts receivable , at a discount, to

a factor, who then assumes the credit risk of the account debtors and receives cash as
the debtors settle their accounts.
 Inter-corporate Deposits :- It involves movement of funds from funds-surplus

companies to credit worthy corporate borrowers. The critical factor here is the rapid
response time. The period of deposit varies from purely on call and to 180 days.
As the cost of funds for a corporate in much higher than a bank, the rates in this
market are higher than those in the other markets.
 Commercial Papers :- These are short term unsecured promissory notes issued by
firms with a high credit rating at a discount to the face value. The maturity varies
from 15 days to a year.
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These are issued mainly by the corporate businessmen to fund their working capital
needs.
5. COMMON GUIDELINES/INSTRUCTIONS FOR

LENDING TO SME SECTOR IN BANK OF BARODA:
5.1 Application Forms for Financial Assistance:
Application forms in use to grant credit facilities are detailed as under :
I. Application form for credit facilities upto Rs.10/- lacs.

II. Application form for credit facilities of over Rs. 10/- lacs and upto Rs.50/-
lacs.
III. Application form for credit facilities of over Rs. 50/- lacs and upto Rs. 2/-
crore.
IV. Application form for credit facilities over Rs. 2/- crore.
Application forms as aforesaid are devised for assistance by way of either term loans
or working capital or both and are applicable to new projects, expansion,
diversification and modernisation of existing projects.
Bank is in process of devising application forms for ME units and will be provided to
the branches on its approval by the competent authorities. In the meantime, above
forms may be used for ME units also.
5.2. Receipt of applications and acknowledgment
With a view to facilitate timely sanction of adequate credit facilities, the following
guidelines have been issued to the branches:
 An acknowledgment with the date of receipt for credit application received to be

given. A definite date to be intimated to the applicant for discussions, clarifications
etc. if considered necessary.
 The bank’s decision regarding credit assistance to be communicated to the

applicant within the prescribed period.
5.3. Register of Credit Applications Received
All applications received should be entered in a “Register of Loan Applications

Received” for recording therein the complete particulars such as date of sanction,
rejection, reasons for rejection etc.
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5.4. Time norms for disposal of loan applications:
In order to provide better customer service and to ensure that applications for loans
for all categories of borrowers are dealt with and disposed off expeditiously, the
following norms shall be adhered to, provided the loan applications received are
complete in all respects and duly accompanied by a check list.
 In respect of loans upto Rs.25,000/- within a maximum period of one week of

receipt of loan applications complete in all the respects and duly accompanied by a
check list.
 In respect of other cases for loans above Rs.25,000/- and upto Rs.5.00 lacs, within
a maximum period of two weeks on receipt of duly completed loan applications in all
the respects and accompanied by a checklist.
 In respect of loans over Rs. 5.00 lacs, within a maximum period of 4 weeks on
receipt of duly completed loan applications in all respects and accompanied by a
check list.
 In respect of credit applications processed at SME loan Factories, it should be

disposed off within 14 working days on receipt of full information if no TEV study is
required and within 21 working days on receipt of full information if TEV study is
required.
6 . FINANCIAL RATIOS FOR CREDIT APPRAISAL
Following ratios can be accepted for granting credit facilities to SME units falling as
per regulatory guidelines or SMEs as per expanded coverage.
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The above ratios are indicative and deviations can be considered by the sanctioning
authority / competent authority on case-to-case basis, depending on industry
specific problems of unit, etc.
7.Methods for calculating Working Capital Limits:

Presently, the following guidelines are in place for financing Working capital
facilities of SME units:
7.1 Turnover Method
The credit requirements of village industries, Micro Enterprises, Small Enterprises

and Medium Enterprises having aggregate fund based working capital limits upto
Rs.5.00 crores from the banking system, will be computed on the basis of a minimum
of 20 % of their acceptable projected annual turnover for new as well as existing units
as per Nayak Committee recommendations.
 Working Capital Requirement = 25% of Turnover
 Promoter Contribution (Margin) = 5% of Turnover
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 Bank Finance = 20% of Turnover
 Proposed by The Nayak Committee
 Used for assessment of working capital needs of small trading companies
 Not appropriate for manufacturing and big trading companies
7.1.1 Information on Nayak Committee for SSIs

Considering the contribution of the SSI sector to the overall industrial production,
exports and employment and also recognising the need to give fillip to this sector, a
special package of measures was devised by RBI (during April 1993) to ensure
adequate and timely credit to this sector. While doing so the recommendations of the
PR Nayak committee were taken into account. Examination of bank finance profile of
working capital to the small scale sector by the committee has revealed that this sector
as a whole received a level of working capital which was only 8.1% of the its output.
The village industries and the smaller tiny industries among them could get working
capital finance to the extent of only about 2.7% of their output.
The salient features :
 Banks have been advised to give preference to village industries, tiny industries
and other small scale units in that order, while meeting the credit requirements of
small scale sector.
 The banks should step up the credit flow to meet the legitimate requirements of
the SSI sector in full during the 8th 5-year plan. For this purpose the banks should
draw up annual credit budget for the SSI sector on a bottom-up basis. Each branch of
the banks should prepare an annual budget in respect of working capital requirements
of all SSIs before the commencement of the year. Such budgeting should cover (a)
functioning units which already have borrowing limits with the branch (b) new units
and units whose proposals are under appraisal and (c) sick units under nursing and
also sick units found viable after discussion/ feedback received from the borrowing
units. The budget should take into account, among other relevant aspects, normal sale
growth, price rise during the past year, anticipated spurt in business etc.
 It is desirable that a single financing agency meets both the requirement of the
working capital and term credit for small scale units. The Single Window Scheme of
SIDBI enables the same agency SFC or commercial bank, as the case may be, to
provide term loans and working capital to SSI units having a project outlay upto Rs.
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20 lac and working capital requirement upto Rs. 10 lac. The banks have been advised
to adopt this approach.
 At present norms for inventory and receivable are applicable to all units enjoying
aggregate fund based working capital credit limits of Rs. 10 lac and above from the
banking system. Units enjoying limit of Rs. 10 lac and above but upto Rs. 50 lac are
subject to the 1st method of lending. Henceforth for the credit requirements of village
industries, tiny industries and other SSI units having aggregate fund-based working
capital credit limits upto Rs. 50 lac (subsequently raised to Rs. 1 crore and Rs. 200 lac
during April 1997, to Rs.400 lac during August 1998 and further to Rs.500 lac during
May 1999) from the banking system, the norms for inventory and receivables and also
the 1st method of lending will not apply. Instead such units may be provided working
capital limits computed on the basis of a minimum of 20% of their projected annual
turnover for new as well as existing units.
 The banks may satisfy themselves about the reasonableness of the projected
annual turnover of the applicant on the basis of annual statements of account or any
other documents such as returns filed with sales-tax/revenue authorities and also
ensure that the estimated growth during the year is realistic. These SSI units would be
required to bring in 5% of their annual turnover as margin money. In cases where
output exceeds the projections or where the initial assessment of working capital is
found inadequate, suitable enhancement in the working capital limits should be
considered by the competent authority as and when this is deemed necessary. Drawals
against the limits should be allowed against the usual safeguards so as to ensure that
the same are used for the purpose intended. Banks will have to ensure regular and
timely submission of monthly statements of stocks, receivables etc. and also
periodical verification of such statements vis-a-vis physical stocks.
 The banks can lend on the basis of 1st method of lending to those units
(companies/ organisations) which are engaged in marketing/trading of products of
SSI, village and cottage and tiny sector units. This would be subject to the condition
that 100% dealing is with the above mentioned products. If there are dealings with
other products also, then the relaxation of application of 1st method of lending will be
only to that portion of the marketing business relating to products manufactured by
above category of units. It is also a condition that dues of such units are settled by
such borrowers within a maximum period of 30 days from date of supply and it is to
be certified by the statutory auditors of the borrowing units on a quarterly basis.
Action on Nayak Committee recommendations by RBI:

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 Banks should take immediate steps to ensure full adherence in letter and spirit by
all their branches and controlling offices to the RBI guidelines. With a view to
ascertaining the position regarding implementation of these guidelines by the
branches, banks themselves should carry out special studies on an annual basis on as
large a sample or branches, as possible. The findings of the these studies should be
reported to RBI periodically indicating among others, the steps taken for rectifying
the deficiencies, if any, observed in the process.
 The procedure and time frame laid down for disposal of loan application received
from SSI borrowers should be strictly enforced. Whenever application for fresh
limits/enhancement of existing limits was not considered favourably by the
sanctioning official or where the limits applied for are proposed to be curtailed, the
same should be referred to the next higher authority with all relevant particulars, to
ensure scrutiny by any independent authority and the latter should confirm the
decision of the sanctioning official or otherwise dispose of the same, within a time
bound manner. Another alternative which would also help eliminate delays inherent in
the consideration of the proposal by the successive tiers in the hierarchy and facilitate
timely decisions on credit proposals it would be for banks to adopt a system of
Committee approach, in which decisions are taken by the competent authority after a
structured discussions with the branch managers and also the authorities at the
intervening levels.
 Problems faced by the SSI sector in regard to bank finance, to a large extent could
be solved if the branch level officials have the right aptitude, skills and orientation. In
understanding their role, the branch managers/officials at the branches should be
made aware of the importance of small scale sector from the point of view of creation
of additional employment opportunities, exports etc. A healthy growth of the sector
will facilitate smooth loan recovery in the SSI borrowal accounts. Further, timely
assistance will prevent these accounts from becoming sticky. The aforesaid aspects
should therefore, form part of the inputs in the training imparted to the banks’ staff.
There should an interaction between the banks’ staff and the SSI borrowers as part of
the training programmes. Banks may also consider awarding trophies to branches for
the outstanding performance in financing SSI units as a mark of public recognition.
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 One of the complaints frequently voiced by the SSI units pertains to insistence by
some banks on compulsory deposit mobilisation as a quid pro quo for the sanction of
credit facilities to the units. While enlisting the cooperation of banks’ customers for
deposit mobilisation cannot be faulted, insisting on deposit mobilisation of stipulated
amounts as a precondition to the sanction of credit or otherwise, has no justification.
 The 2nd All India Census of SSI (1988) carried out by the Development
Commissioner(SSI), Govt. of India, has revealed that there were 85 district in the
county each with more than 2000 registered SSI units with Industries Deptt. of the
State Govt. and another 110 districts each having between 1000 to 2000 registered
SSI units. RBI decided during July 1993 that while SFCs would act as the principal
financing agency for SSIs in 40 out of the 85 districts referred to above to take care of
both the term loan and working capital requirements of all new SSI units which can
be financed under Single Window Scheme (SWS) of SIDBI, the commercial banks
should act as the principal financing agency under the SWS in the remaining 45
districts, as well as in rest of the country. Banks should also consider converting such
of the branches as having a fairly large number of SSI borrowal accounts, into
specialised branches.
Important banking operational clarification on Nayak Committee-

Recommendations
The implementation of recommendations of Nayak Committee, relating particularly to

the assessment of working capital, gave rise to certain operational problems. Reserve
Bank has clarified these issues on the following lines:
 The assessment of credit limits for all borrowers enjoying aggregate fund based
working capital limits of less than Rs. 1 crore from the banking system, is to be done
both as per the traditional method and on the turnover basis and the higher of the two
limits is to be fixed as the permissible bank finance. However, the neither the
inventory norms stipulated under Tandon Committee apply nor the PBF is subject to
ceiling as per the first method of lending. In cases where the limits determined by the
traditional method are less than 20% of the turnover, the assessment will have to be
re-examined. Nayak Committee has stated that the working capital below the
minimum level of 20% may be justified under special circumstances in which the
requirement is demonstratively lower than the minimum level as in the case of
ancillary units.
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 Where the working capital cycle is shorter than 3 months, the working capital
required would be less than 25% of the projected turnover. In such case it is not
required to still give PBF at 20% of the turnover.
 If the liquid surplus available with the borrower is higher than 5% of the turnover,
as stipulated under the recommendations, the limits can be fixed at a lower level than
20% of the turnover keeping in view that the genuine requirements of the unit are met
adequately. If a unit has been managing its working capital efficiently, the limits can
be set at a lower level.
 The units having longer operating cycle for working capital than three months,
should be provided proper limits to operate at a viable level taking into account the
recommendation that 20% of the turnover is the minimum stipulation and not the
maximum.
 In case of seasonal industries the distinction between the peak and non-peak level
of turnover has to be considered instead of annual turnover.
 The creditors and other current liabilities are among the sources of funds required
for building up the current assets and will be treated in the same manner as in the
traditional method.
 The borrower’s contribution (margin) will be 5% of the turnover in all cases

except where the working capital cycle is not taken at three months. The margin will
proportionately increase with the increase in the period of operating cycle. Care is to
be taken that the proportion of margin to bank finance should be maintained in the
ratio of 1:4 or even higher in case of availability of higher liquid surplus. If the
borrower is not able to bring in minimum contribution of 5%, as a general rule, no
dilution should be allowed except in special circumstance like sick units or when
permitted being desirable due to peculiar circumstances in the sanction.
 The sub-limits against the various components of stocks and receivables should be
fixed taking into account the existing norms of inventory and receivables as bench
mark and bankers should adopt flexible approach on case to case basis in a realistic
manner while assessing the credit needs. While allowing deviations, the sanctioning
authority must ensure that proper justification is available and given.
 With regard to the aspects like allowing drawing power on the basis of stocks and
receivables’ statements or calling data on actual turnover on a monthly basis or
calling of certificate from auditor’s every 6 months in respect of actual sales, it has
been clarified that calling for sales data on monthly basis and comparing with the
drawings in the account would be helpful particularly in the matter of arriving at
effective operational limits as also in the monitoring the borrowal accounts. The
drawing power in any case is to be allowed on the basis of monthly stock statement.
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 In order to check the validity of projections for turnover, in case of existing units
sales data pertaining to actuals of last five years, estimates for the current year and
projections for the next year together with the true analysis of the industry to which
the borrowing unit belongs would also be useful. Other relevant information i.e
modernisation or expansion of the existing manufacturing capacity, Govt. policy on
taxation and other relevant internal and external factors also need to be taken into
account.
Seven Point Action plan
Govt. of India in budget for 1995-96 announced a 7 point action plan as under:
 Time bound action for setting up specialised SSI branches in 85 identified districts
of high small industry density.
 Adequate delegation of powers at the branch and regional level.
 Banks to conduct sample surveys of their performing SSI accounts to find out
whether they are getting adequate credit.
 Steps to be taken to see that as far as possible composite loans (covering both term
loans and working capital) are sanctioned to SSI entrepreneurs.
 Regular meetings by banks at Zonal and Regional levels with SSI entrepreneurs.
 Need to sensitize bank managers and reorient them regarding working of the SSI
sector.
 Simplification of procedural formalities by banks for SSI entrepreneurs.
7.2 CASH BUDGET SYSTEM
Cash budget Approach:

RBI has appointed Mr.K.K.Kannan, the chairmen of the Bank of Baroda in 1996. the
committee has recommended that the borrowers may be assessed based on cash
Budget approach.
The recommendations of the Kannan committees are
 For all big companies enjoying money central limits of Rs.5 crores and above, a
cash budget may be adopted to appraise their limits. The companies may be asked to
submit quarterly cash budget.
 The cash budgets will only contain pure cash transaction and will not reflect the
movement of funds other then cash
 The cash budgets may have 4 components.

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(i) Cash flow from business operations

(ii) Cash flow from non- business operations
(iii) Cash flow from capital accounts.
(iv)Cash flow from sundry items.
 Banks were expected to grant working capital limits up to the gap in cash flow
from business operations.
Cash Inflow –Cash Outflow = Bank Finance in the form of Working Capital
 Cash budget system is mainly used for service sector companies
 Eliminates traditional requirement of Stock and Debtors for assessment
7.3 Committee Recommendations
Limits above Rs. 5.00 crores:

For assessment of Working Capital requirements beyond Rs.5 crores of Small Scale
Industrial Units / Medium Enterprises, the guidelines on PBF method of lending will
be followed.
7.3.1Tandon Committee on Follow-up of Bank Credit
The group (headed by Sh. Prakash Tandon) was appointed in July

1974 which was to frame guidelines for follow-up of bank credit and
submitted its final report during 1975 and gave following
recommendations, applicable to borrowers availing fund based
working capital limits of Rs. 10 lac or more:
Norms for inventory and receivables
If the bank credit is to be linked with production requirements, it is necessary to

fix curtained norms for inventory &receivables. The ” Study Group to frame
guidelines for follow – up of bank credit ” (Tondon Study Group) appointed by
Reserve Bank Of India had superseded norms for 15 major industries on the basis
of company finance studies made by Reserve Bank , Process period in the
different industries discussion with the industry experts & feed – back received on
the interim report. The norms suggested by Tondon study Group are being
reviewed from time to time by the Committee of Direction constituted by Reserve
Bank to keep a constant review of working capital requirement. The committee of
director has suggested norms for certain other industries also. A comprehensive &
updated list of the norms of inventories & receivables as applicable to certain
industries is given in the following table. The norms for raw materials, stocks in
process, finished goods & receivables should not be normally interchanged.
However, in the case of certain industries, combined norms have been suggested
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for finished goods & receivables. Similarly, combined norms have been suggested
for raw materials & stock – in –process for a few industries.
Broad Indicators
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22
23
24
25
26
27
28
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 The norms given in the above table are applicable to all industrial borrowers enjoying
aggregate fund based working capital limits of Rs. 10 lacs & above from entire banking
system. The spirit of norms has to be kept in view while giving finance to the unit requiring
less than Rs. 10 lacs.
 The norms indicate the maximum level for holding inventory & receivables in each
industry & they should not be taken as entitlement to hold inventory or receivables up to the
prescribed levels. If a borrower has maintained lower level in past, he should continue to do
so.
 Norms are also not absolute or rigid .Deviations from norms may be permitted under
certain circumstances ,however relaxations from the norms should not be given as a matter of
routine but must be fully justified and allowed only for a short period. Efforts should be made
to revert back to the norms when conditions turn to normal. Further flexibility in the level of
inventory and receivables may bhave be viewed both ways.
 In the case of industries where no norms have been fixed, level of inventory and
receivables should be computed on the basis of the process/lead time, trade practices, past
trends etc.
Approach to lending
The committee suggested three methods of lending out of which RBI accepted two
methods for implementation.
30
Method I :- According to the First Method the borrower can be allowed maximum bank
finance upto 75% of the working capital gap (working capital gap denotes difference
between total current assets required and amount of finance available in the shape of
current liabilities other than short term bank borrowings). The balance 25% to be
brought by the borrower as surplus of long term funds over the long term outlay.
Method II :- As per Second Method of lending, the contribution of the borrower has to
be 25% of the total current assets build-up instead of working capital gap. (Method of
lending as per Vaz Committee will now apply to borrowers availing working capital
fund based limits of Rs. 100 lac or more only)
Method III :- Same as 2 above, but excluding core current assets from total current assets
on the theory that core current assets should be financed out of long term funds, i.e.
owned funds plus term borrowings. Under this method, long term funds are required
to finance the entire core current assets and another 25 per cent of the remaining
current assets. However, this method has not been accepted for implementation by the
Reserve Bank.
Other major recommendations
No slip back in current ratio, normally.
 Classification guidelines for Current assets and current liabilities.

 Identification of excess borrowing.
 Information system, which was modified by Chore Committee Recommendations.
 Bifurcation of limits into loan and demand component.
All instructions relating to maximum permissible bank finance withdrawn by RBI as per
Credit Policy announced on 15.04.1997)
Computation of Maximum Permissible Bank Finance by Method I and Method II
 A part of the total current assets can be financed by credit for purchases and other
current liabilities. Funds required to carry the remaining current assets may be called
the working capital gap which can be bridged partly from the borrower’s owned funds
and long term borrowings and partly by bank borrowings.
 In the context of the above approach, the Tandon Study Group had suggested the
following three alternatives for working out the maximum permissible level of bank
finance:-
31
 It may be observed from the above that borrower’s contribution from long-term
funds would be 25 per cent of working capital gap (total current assets – current
liabilities other than bank borrowings) under the First Method of Lending and 25 per
cent of total current assets under the second method of lending. The above minimum
contribution of long-term funds is called minimum stipulated Net Working Capital
(NWC) which comes from owned funds and term borrowings. It may be mentioned
that a borrower is export receivables. Therefore, export receivables should be
excluded from the total current assets while calculating maximum contribution
required from long term funds.
 The above two methods of lending may be illustrated by taking the following
example of a borrower’s financial position, projected as the end of next year.
Current liabilities Amt. Current Assets Amt.

Creditors for purchases 200 Raw materials 380
Other current liabilities 100 Stock-in-process 40
300
Bank borrowings, 400 Finished goods 180
including bills discounted
with bnkers
Receivables, including bills 110
discounted
with bankers
Other current assets 30
700 740
 As per suggested norms or past practice, whichever is lower, in relation to

projected sales/ production for the next year.
First Method Amt. Second Method Amt.

Total current assets 740 Total current assets 740
Less: Current liabilities 300 25% of above from long 185
other term sources
than bank borrowings
Working Capital Gap 440 Working Capital Gap 555
32
Less: 25% of above from 110 Less: current liabilities 300

long-term sources other than bank borrowings
Maximum permissible 330 Maximum permissible 255

bank bank finance
Finance
Excess bank borrowings 70 Excess bank borrowings 145
Current ratio 1.17:1 Current Ratio 1.33:1
It may be observed from the above that in the First Method, the borrower has to
provide a minimum of 25 per cent of working capital gap from long-term funds
(owned funds and term borrowings) and it gives a minimum current ratio of 1:1. In
the Second Method, the borrower has to provide a minimum current ratio 1:1. In the
Second Method, the borrower has to provide a minimum of 25 per cent of total
current assets from long term funds (owned funds and term borrowings) and it gives a
minimum current ratio 1.33:1.
 If the existing net working capital (excess of current assets over current liabilities
including bank borrowings) of a unit exceed 25 per cent of the working capital gap (in
First Method) or 25 per cent of total current assets (in Second Method), the
contribution from long term funds may be kept to the extent of the already existing
net working capital. In other words, if a unit is already having more long-term funds
than the minimum stipulated requirement, it should continue to maintain such long-
term funds instead of reducing them to the minimum stipulated requirement.
 All borrowers having aggregate fund based working capital limits of Rs. 50 lakhs
and above from the banking system are expected to follow the Second Method of
lending. Steps have taken to enforce this discipline in stages on borrowers enjoying
credit limits of less than Rs. 50 lakhs also. In the case of sick/ weak units, maximum
permissible bank finance may be computed under the first method of lending.
 The Second Method of lending was implemented in December 1980 and a

provision was made at that time to provide working capital term loan to finance the
excess borrowings over the maximum permissible bank finance as per the Second
Method of lending. It was also decided that the working capital term loan thus
provided should be made repayable in half yearly installments within a definite period
not exceeding five years. As many years are now over, working capital term loan
should not be provided in the normal circumstances.
 Estimating the total requirement of long term funds for new projects, financial
institutions/ banks should calculate margin for working capital on the basis of norms
33
prescribed for inventory and receivables and by applying the Second Method of
lending. A project may suffer from shortage of working capital funds if sufficient
margin for working capital is not provided as per the Second Method of lending while
funding new projects. Proper co-ordination between banks and financial institutions is
necessary to ensure availability of sufficient working capital finance to meet the
production requirements.
8 Information/Data Required for Assessment of

Working Capital.
In order to assess the requirement of working capital on the basis of production needs,
it is necessary to get the data from the borrower regarding their past/projected
production, sales, cost of production, cost of sales, operating profit, etc. In order to
ascertain the financial position of the borrower and the amount of working capital
needs to be financed by banks, it is necessary to call for the data from the borrower
regarding their net worth, long term liabilities, current liabilities, fixed assets, current
assets, etc. The reserve Bank prescribed he forms in 1975 to submit the necessary
details regarding the assessment of the working capital requirements under its Credit
Authorization Scheme. The Scheme of Credit Authorization was changed in to Credit
monitoring Scheme in 1988. The forms used under Credit Authorization Scheme for
submitting necessary information have also been simplified in 1991 for reporting the
credit sanctioned by banks above the cut-off point of Reserve Bank under its scheme
of Credit Monitoring Arrangement.
As the traders and merchant, exporters who do not have manufacturing activities are
not required to submit the data regarding raw materials, consumable stores, goods-in-
process, power and fuel, etc., a separate set of forms has been designed for traders and
merchant exporters. In view of the peculiar nature of leasing and hire purchase
concerns, a separate set of forms has been designed for them. Similarly, a separate set
of forms has been prescribed for diamond exporters also. In case of certain agro-based
seasonal industries like tea and sugar, requirements of finance for production may be
at the peak during the season, while sale proceeds are realized throughout the year. In
Such cases, limits are decided on the basis of projected monthly cash budgets to be
submitted by the borrowers before the beginning of the season.
In order to assess the working capital requirements of Rs. 50 lakhs and over, banks
obtain the basic information from the borrowers in the above mentioned forms
prescribed by Reserve Bank for reporting under its scheme of Credit Monitoring
Arrangement (Formerly Credit Authorization Scheme). In addition to the
information/data in the prescribed forms banks may call for additional information
required by them depending on the nature of the borrowers activities and their
financial position. The information/ data is collected from he borrowers in he
following six forms:-
34
I. Particulars of the existing/proposed limits from the banking

system (Form I)
Particulars of the existing credit from the entire banking system as also the term loan
facilities availed of from the term lending institution/bank are furnished in this form.
Maximum and minimum utilization of the limits during the last 12 months and
outstanding balance as on a recent date are also given so that a comparison can be
made with the limits now requested and the limits actually utilized during the last 12
months.
II. Operating Statement (Form II)
The data relating to gross sales, net sales, cost of raw materials, power and fuel, direct
labour, depreciation, selling, general and administrative expenses, interest, etc. are
furnished in this from. It also covers information on operating profit and net profit
after deducting total expenditure from total sale proceeds.
III. Analysis of balance Sheet (form III)

A complete analysis of various items of the last year’s balance sheet, current year’s
estimating and following year’s projections is given in this form. The details of
current liabilities, term liabilities, net worth, current assets, fixed assets, other non-
current assets, etc. are given in this form a per the classification accepted by the
banks.
IV. Comparative statement of Current Assets and Current Liabilities

(Form IV)
This forms gives the details of various items of current assets and current liabilities as
per the classification accepted by the banks. The figures given in this form should
tally with figures given in the Form III where details of all the liabilities & assets are
given. This form is used to indicate all the current assets & current liabilities at one
place. In case of inventory (raw material , consumable spares, stock-in-process &
finished goods), receivables & sundry creditors; the holdings/levels are given not only
in absolute amount but also in terms of number of months so that a comparative study
may be done with the prescribed norms/past trends. They are indicated in terms of
number of months in brackets below their amounts.
V. Computation of Maximum Permissible Bank Finance (Form V)
35
On the basis of the details of the current assets & current liabilities given in Form IV,
Maximum Permissible Bank Finance is calculated in this form to find out the credit
limits to be allowed to the borrowers.
VI. Fund Flow Statement (Form VI)

In this form, Fund flow to long term sources & uses is given whether long term funds
are sufficient for meeting the long term requirements. In addition to long term sources
and uses, increase/decrease in current assets is also indicated in this form.
9 Check-List for verification of the information / Data.

Banks should verify not only the arithmetical accuracy of the data furnished by the
borrowers but also the logic behind various assumptions based on which the
projections have been made. For this purpose, bank officials should hold discussions
with the borrowers on projected sales, level of operations, level of inventory,
receivables etc. If necessary, a visit to the factory may also be made to have a clear
idea of the products and processes. An illustrative check-list is given below to indicate
the various points to be examined by banks while finalizing the credit requirements of
the borrowers.
9.1Utilization of Existing Limits :-
 It may be examined whether the limits have been adequately utilized during the
last 12 months. If not, the justification for further enhancement may be ascertained. It
may so happen that the past profits which were employed in working capital might be
intended to be withdrawn for investment in fixed assets on account of modernization,
expansion, diversification, etc., thereby creating need for recouping working capital
funds. In such cases, additional limit might be sought although the existing limits
were not utilized adequately during the year. The sanction of additional limits was not
utilized adequately during the last year. The sanction of additional limits in such
cases may lead to a slip-back in the current ratio, but slip-back should not be allowed
to a level below 1.33.
 If the Limits have been overdrawn ,its reasons may be ascertained. If the financial
position of the unit is weak, steps for its improvement may be decided.
36
 Tin case of borrowers coming under the purview of credit Monitoring

Arrangement (i.e. Those borrowers who enjoy aggregate working capital facilities
exceeding Rs. 5 crores),it is necessary that limits sanctioned to such borrowers against
book-debts should not be more than 75percent of the aggregate limits sanctioned to
them for financing their inland credit sales. In other words, at Least 25% of the
aggregate limit for financing inland credit sales should be provided by the way of
bills. If bill finance is lower than 25% , reasons for it may be as curtained and
necessary steps may be taken to develop bill culture in case of such borrowers.
9.2Operating Statement
 As the entire working capital assessment is directly linked to the sales figure, it
may be ensured that the annual projection of sales is reasonable in relation to the
installed/licensed capacities, availability of input, environmental conditions,
marketing prospects, etc
.
 In case of existing units, projected sales should be in accordance with the past
trend. If the projected sales are not in tune with the past trend and appear to be over
ambitious, the reasons should be ascertained to ensure that the sales projections are
realistic.
 If the unit is likely to implement a modernization/expansion/diversification

project, its impact on sales may be assessed.
 It may be ascertained whether the previous year’s projection of sales, on the basis
of which limits were fixed last year, has been realized. If not , the reasons for the short
fall may be examined. If a borrower approaches for additional limits on the basis of
the projection higher than that given in the previous year which was not realized, the
matter should be carefully examined.
 If there is a declining trend in net sales, reasons therefore may be studied. A

detailed study should be done if an increase in limits is sought in such case.
 The valuation of sales projection should be based on the current running prices.
37
 Similarly, the valuation of various input constituting cost of sales in the projection
should also be based on current prices. It should be ensured that the price escalation
are not built into the projection of sales as well as cost of various input.
 It may be ascertained whether the raw materials consumption as a percentage of

cost of production is in keeping with the past trend. If it shows any undue increase,
the reasons for it may be examined.
 It may be ensured that consumable stores and other items used in the process of
manufacture are included in raw materials. The norms for raw materials included
consumable stores and other materials. The norms for raw materials included
consumable stores and other materials used in process of manufacture.
 It may be ascertained whether adequate depreciation has been provided. If the

method of providing depreciation is charged, its impact on cost of production may be
analyzed.
 It may be ascertained whether selling, general and administrative expenses are in

keeping with the past trend. If they show an increase in terms of percentage of sales,
the reasons for it may be examined.
 It may be examined whether the operating profit/profit before tax is increasing in

line with the sales. If not, its reason may be ascertained and analyzed.
 In the case of new units, the estimated production may be assumed at 40 to 80

percent of the installed capacity in the first year during on the nature of products,
availability of input, marketing prospect , etc. The utilization of the capacity may
gradually increase in subsequent years. In the case of new units financed by terms
Lending Institutions. Projection accepted by them regarding sales, requirement of raw
materials, cost of production, etc. may be taken as the basis for providing working
capital. Bank and terms lending institutions should have joint/simultaneous appraisal
of the projects.
9.3Analysis of Balance Sheet
38
 The classification of current assets & current Liabilities should be made as per the
usual accepted approach of bank and guidelines indicatives in this regard by reserve
bank.
 It may be ascertained whether the level of raw materials, stock in process, finished
goods, and receivables are in conformity with the stipulated norms.
 If a unit which has been maintaining in the past inventory and receivables at level
lower than the norms wants to raise the level up to the norms, the reasons for it may
be examined.
 If he norms for finished goods & receivables is a combined one, monthly average
for the purpose of arriving at the combined norms may be worked out by combining
the level of finished goods & receivables on the one hand and cost of sales and gross
sales on other hand.
 In the case of industries where the norms have not been stipulated, the levels of
inventory and receivables should be in tune with the past trends.
 The level of stock of spares may be estimated on the basis of past experience. The
project stock of spares maybe estimated on basis of past experience. The projected
stock of spares not exceeding 12 months’ consumption for imported items and
9months’ consumption for indigenous items may be treated as current assets. In case
of fertilizer industry. Spares up to 12 months’ consumption even for indigenous item
may be treated as current assets. Spares held beyond these levels may be treated as
current assets. Spares held beyond this level may be treated as noncurrent assets.
 If the levels of inventories and receivables are above the norms, a detailsed
analysis may be done to find out the reasons. A time – bound programme may be
prepared to bring them down in tune with the norms.
 Some of te borrowers may have the tlndency to show the requirement of imported
raw materials at an inflated level. The higher build-up of imported raw materials
should be justified on basis of economic quantity for placing purchase order, lead time
in getting replenishment, etc.
39
 Normally, level of stock-in-process in terms of number of months related to the

cost of product should not charge. Its change may be justified only on account of
change in production process/technology or as a result of production bottlenecks.
 If the level of inventories is very high, the details of age of inventory may be
obtained to find out whether some of the item have become obsolete.
 If the level of receivables is very high. The names of main buyers and the priod of
credit offered may be ascertained. It may be examined whether a portion of the
receivables is likely to be irrecoverable and if so , sufficient provision should be made
for bad debts.
 The details of inter-corporate investments and advances should be obtained and

the reason for not liquidating them may be examined.
 Some of the borrower may have a tendency to show the sundry creditors and other
current liabilities in the projected figure at a reduced level. Although no norms have
been fixed for sundry creditors, it is expected that the level of sundry creditors should
be in terms of months, purchase may be verified with the past trend.
 It may be ensured that intangible assets like patents, goodwill, etc. are written-off
over a period of years.
 It may be ascertained whether the net worth shows an increasing trend. If the
trends shows a decline in net worth, its reasons may be ascertained.
 Net working capital should show an increasing rend from yea to year. If not
reasons thereof should be ascertained.
 If the data of balance sheet has been changed, the reasons for it should be
ascertained to find out whether it has been done only for the purpose of showing a
rosy picture.
40
 Information may be obtained about contingent liabilities to know their impact on

the working of the unit.
9.4Computation of maximum Permissible Bank Finance
 Generally, Maximum Permissible Bank Finance (MPBF) should be calculated on

the basis of the Second Method of Lending. If the Second Method of lending has been
followed, reasons for it may be ascertained.
 The second method of lending was implemented in December 1980 and three
years were allowed to provide working capital term loan to finance the excess
borrowing over the MPBF as per the Second Method o lending. As many years are
now over, working capital term loan should not be given in the normal circumstances.
In the case of sick/weak units, MPBF may be calculated on the basis of the First
Method of Lending.
 If export bills limit is to be allowed over and above the permissible bank finance,
the export bills should be excluded from the total sales and export receivable should
also be excluded from the build-up of current assets. Separate limits may be given for
export receivable even without keeping the 25 per cent margin from long term
sources.
 The third party outstation cheques /drafts purchase limits should be within the
MPBF. However, at the request of the borrowers, such limits may be allowed to a
small extent over the above the MPBF.
 It may be ascertained whether there is any co-relation between projected increase

in production of sales and increase in limits. If not, the reasons for it may be studied.
41
9.5Funds-Flow Statement
 The long-term sources should be adequate to cover the long term used and leave a
reasonable surplus for being employed in working capital. If long term sources are
less than the long term uses, it may be inferred that short term funds are being
diverted for purpose other then working capital needs. Such cases should be properly
examined.
 Increase is carry of various items of inventory which is disproportionate to

percentage rise in sales should be examined in detail.
 The increase in short-term bank borrowings should be in line with the additional
limits sought by the company over the previous year’s level of availment.
 The increase in short term bank borrowings should be matched suitable by the
increase in current asses, particularly inventory and receivables. If it is not so, short
term funds might be utilized for repayment of other current liabilities or be diverted
for fixed asset or for inter-corporate investments / advances. Such matters should be
examined in detail.
It may be noted that the above check-list is not an end in itself. It only indicates broad
aspects to be examined by banks and helps in analysis and interpretation of the data
furnished by the borrowers for taking judicious decisions.
10.Fixation of Find-based and Non-fund based Limits

After arriving at the maximum permissible bank finance on the basis of the inventory
and receivables norms and the appropriate method of lending, banks may decide
about the various fund-based and non fund based limits and sub-limits. The bulk of
the inventory limits is generally released by way of open cash credit based on the
projected level of the borrower’s operations. Within the sanctioned credit limits,
drawing power is fixed on the basis of monthly stock statements indicating actual
holding of inventory. The receivables limit may be either by way of cash credit or
overdraft against book debts or by way of bills limit. Efforts should be made to
develop the bill culture for financing receivables. In case of the borrowers enjoying
aggregate fund-based working limits of Rs. 5 crores and over, the limits sanctioned
against book debt should not be more then 75 percent of the aggregate limits
sanctioned to them for financing their inland credit sales. In other words, at least 25
per cent of the aggregate limits for financing inland credit sales should be provided by
way of bills. In order to enforce the above discipline on large borrowers enjoying
aggregate fund-based working capital limits of Rs.5 crores and above, it as been
decided that with effect from January 1, 1991, interest at 2 percentage point above the
relevant cash credit interest rate should be levied on that portion of the book debt
42
finance which is in excess of the prescribed norm of 75 per cent of limits sanctioned
to borrowers for financing inland credit sales.
Many borrowers do not utilize to a great extent the credit limits sanctioned to them.
Such large unutilized credit limits may creates several problems in efficient
management of funds and also implementing macro-credit policy. With a view to
bringing about discipline in the availment of bank finance by borrowers and to
facilitate better funds management, it has been decided to levy a commitment fees on
the unutilized portion of the working capital limis with effect from January 1, 1991. In
the case of borrowers with working capital limits of Rs. 1 crore and over, scheduled
commercial banks are required to levy a minimum commitment charge of 1 % p.a. on
the unutilized portion of the quarterly operating limit subject to a toleration level of 15
per cent of the quarterly operating limit.
In addition to the fund based limits, non-fund based limits like Inland Letter of
Credit/Foreign Letter of credit, guarantees and acceptances are given keeping in view
the genuine needs and the capacity of the borrowers. While considering foreign letter
of credit, the requirement of imports, quantum of import license on hand/expected,
sources of funds to retire the important bills when received, availability of funds to
pay import duty, ect. Should be kept in view. In the case of financial/performance
guarantees, it may be ensured that the borrower has the necessary experience, capacity
and means to perform the required obligation under the contract without any default
and that he will be in a position to reimburse the bank if default occurs due o
unforeseen circumstances and the bank is required to make the payment under the
guarantees.
Banks should not issue guarantee favoring financial institution fir the term loans
extended by them, as the institutions are expected to appraise each proposal and bear
the risk themselves. Similarly, banks should not issue guarantees/co-acceptances
favoring risk themselves. Similarly, banks should not issue guarantees/co-acceptances
favoring financial institutions for the assistance provided by them under buyer’s Line
of credit Scheme (BLCS). Under the BLCS, the financial institutions assume the role
of a primary lender by directly providing credit to the buyer to facilitate purchase of
machinery, equipments, etc., covered by the transaction. As the primary lender is
required to make a proper assessment of the proposal and secure a charge by
hypothecation of the assets financed, it would not be in order for the financial
institution of shift the risk of repayment by obtaining a bank guarantee. It may be
clarified that BLCS is different from the bills rediscounting scheme operated by
financial institutions for sale of machinery, where the primary credit is provided by
the seller’s bank to the seller through bills drawn on the buyer and co-accepted by the
buyer’s bank. As the seller’s bank has no access to the security covered by the
transaction which remains with the buyer, the buyer’ bank can give co-acceptance in
such cases. Similarly, buyer’s bank can give co-acceptance/guarantee for deferred
payments after proper appraisal of the proposal.
43
Banks should examine the proposals made by borrowers for non-fund based limits
keeping in view their genuine needs, financial position and capacity to meet the
commitments. In the case of existing borrowers, bank’s past experience about
retirement of bills under letters of credit and reimbursement to the bank when any
guarantee was invoked may also be borne in mind. Non-fund based limits should not
be out of proportion of the borrower’s genuine needs and his financial position.
10.1 Bank Finance for Payment of Bonus

Bonus and other statutory liabilities are normal items of expenditure which may be
financed from within the permitted working capital limits sanctioned to a borrower.
However, if any borrower has liquidity problems and approaches a bank for
temporary additional accommodation for the purpose, such applications may be
considered by the banking in to account the special circumstances and merits of each
case. While sanctioning accommodation for payment of bonus, banks should ensure
the following points:-
 The previous bonus loans should have been fully repaid on the due dates.
 If not repaid, there should be valid grounds for the loans still remaining
outstanding.
 The proposed loan should be for payment of statutory bonus at the minimum level
of 8.33 per cent only.
 The loan should be repayable in not more than six monthly installments.
 The repayment of the proposed loan is not likely to cause an irregularity in the
cash credit account.
Cases of sanction of such bank finance for payment of bonus to borrowers enjoying
working capital
Limits above Rs. 5 crores should be reported to Reserve Bank for post-sanction security.
44
11. Case Study on Assessment of Working Capital

The procedure followed by banks for assessment of working capital requirement has
been explained in this case study.In order to illustrate the information/data being
submitted by the borrower and procedure being followed the banks.
The case study may help in understanding the procedure followed by bank for
determining the maximum permissible bank finance for a borrower.
11.1 Background of company:
ABC Ltd., a public limited company, is engaged in manufactureing buk drugs and
formulations in the form of tablets, granules, powders, syrups, ointments, creams,
lotions etc. The drugs manufactured by he company inclide antibiotics, surlphas,
analgesics, anti-diabetics, anti – T.B. drugs , anti dysentery drugs and vitamins. The
products of the company have good reputation in the market. It has approached the
bank to increase its working capital limits from the existing level of Rs. 235.00 lakhs
in the current year to Rs. 350 for the following year.
11.2 Working Capital Assessment
ABC Ltd. has submitted the necessary data in prescribed forms which are given as
Annexures I to VI as under.
Form I : Particulars of existing/proposed limits from the banking system
Form II : Operating Statement
Form III : Analysis of Balance Sheet
45
Form IV : Comparative Statement of Current Assets & Current Liabilities
Form V : Computation of Maximum Permissible Bank Finance
Form VI : Fund Flow Statement
The information in Form I is compiled on the basis of various credit facilities enjoyed
by the company from banks and financial institutes. The data in Form II and Form III
are furnished on the basis of Proofit and loss account and balance sheet of company,
respectively. Analysis of balance sheet in Form III should be done as per the
classification of various assets and liabilities accepted by banks. The Form IV gives
comparative position of current assets and current liabilities which is taken from
analysis of balance sheet given in Form III. The norms prescribed for the industry are
also mentioned in the Form. After completing the Form IV, maximum permissible
bank finance can be calculated in Form V. The Form VI indicates sources and uses on
the basis of the movements of various assets and liabilities indicated in Form III.
Bank should verified not only the arithmetical accuracy of the data furnished in these
forms but also the various assumptions on the basis of which the projection have been
made for the following years. An illustrative check list indicating the various points
to be examined by banks while finalizing working capital. If necessary additional
information may be called for from the borrowers.
After scrutinizing the data given by the company as per Annexure I to VI , the bank
has made following observations for assessment of working capital requirements of
this company.
11.2.1 Utilization of Existing Limits
It is observed from the data given in Form I that the company is at present having
working capital limits of Rs. 321lakhs .The company has now approach the bank to
increase the limit for the existing level of Rs. 321 lakhs to Rs. 381 lakhs to meet the
requirement of increase in level of operations. The company has been paying
installments of the term loans in time and does not have any over dues.
11.2.2 Working Result of The company
46
Working Result of Company can be studied from the operating Statement (Form I )
submitted by the company. It may be observed that sales of the company are likely to
increase from last year Rs. 1951 lakhs to Rs. 2444 lakhs during current year and
further to Rs. 2755 lakhs during the following year. The estimated increase in net
sales during next year at 12.26 percent as compare to increase of 22.76 percent
during current year is quite reasonable. It is hoped that the company will be able to
achieve the expected increase in sales. The company has assumed sale prices of its
products as well as costs of various inputs required for production at current
prices/costs. The company’s profit before tax is likely to increase from Rs. 60 lakhs
during last year to Rs. 82 lakhs during current year and further to Rs. 10 lakhs during
next year. The working results of the company can be considered satisfactory.
11.2.3 Financial position of the company
It may be observed from the analysis of balance sheet (From III) that the net worth of
the company has increased from Rs. 410 lakhs at the end of last year to Rs. 435 lakhs
at the end of current year. I is expected that the net worth will increase to Rs. 490
lakhs at the end of next year. As equity capital remains at the existing level of Rs. 163
lakhs, the increase in net worth is due to plough back of the profit earned by company.
Its total reserves at the end of current year ratio has improved from 1.27 at the end of
year before last to 1.40 at the end of last year. It is likely to be 1.37 at the end of
current year. As per the project made by the company, the current ratio is likely to
improve to 1.44 at the end of next year. As the company is having a good equity and
maintaining current ratio above 1.33, its financial position can be considered
satisfactory.
11.2.4 Current Assets and Current liabilities
The company has estimated total current assets at Rs. 1401 lakhs for the next year
against Rs. 1086 lakhs for last year and Rs. 1241 lakhs for current year. Total current
liabilities (other than bank brrowing) have been estimated at Rs. 595 lakhs for the
next year against Rs. 550 lakhs for last year and Rs. 583 lakhs for current year.
Comparative statement of current assets and current liabilities has been given in form
IV. It is necessary to study this statement to know the level of current assets and
current liabilities. Following observations can be made from this statement on the
important items of current assets and current liabilities.
(i) Raw Materials
The projected level of raw materials at 3.04 months is very high as

compared to prescribed norm of 2.75 months for the industry. The break-up of
raw material between imported and indigenous items indicates that the
47
projected level of imported raw materials at 3.37 months is higher than the
indigenous raw materials’ level of 2.67 months. However, no distinction has
been made between imported and indigenous raw materials while fixing the
norms for the industry and combined norm of 2.75 months has been fixed for
raw materials. It can be observed that while the projected level of indigenous
raw material is lower than the norm, stock of imported ram aerials is very high
as compared to the norm. The company has stated that it is necessary for it to
import raw materials in economic order quantity. Fr manufacturing bulk drugs,
it has to keep the necessary raw materials to satisfy the requirement s of at
least one batch. Further, the requirement of raw material holding has increased
due o location of its factories at two places having a distance of 180 Kms. If a
comparative study of raw materials (including imported raw materials) at 3.04
months for the next year will be quite low as compare to 3.47 months for the
last year. It will be almost equal to current year’s level of 3.02 months. In view
of the heavy requirements of imported raw materials and a declining company
may be asked to gradually bring down the level of raw materials to the
stipulated level of 2.75 months in future.
(ii) Consumable spares.
The company projected the stock of imported spares at 7.30 months and
indigenous spares at 6.95 months against the current year’s level of 7.43
months for the imported spares and 7.06 months for indigenous spares. As per
the norms prescribed by Reserve Bank, the stock of spares not exceeding 12
months consumption for imported items and 9 months consumption for
indigenous items may be treated as current assets. As the projected levels of
both the spares, imported as well as indigenous, are lower than the norms and
are in tune with the past trend, imported as well as indigenous, are lower than
the norms and are in tune with past trend, we may take them as quite
reasonable.
(iii) Stocks-in-process
Stocks-in-process have been projected that the level of 1.08 months

against the norm of 0.75 months stipulated for the industry. It has been stated
by the company that more than 75 percent of its production is for such bulk
48
drugs where the production cycle is very long. Further, its foreign
collaborations undertake strict quality control which alone needs sox to eight
weeks item for certain products. If a comparative study for the previous years
is made, it is observed that the level of stock-in-process has come down from
1.25 months during last year to 1.09 months during current year. It has been
projected at 1.08 months for the next year. As manufacturing process of the
products of the company is very long, we may have to accept the level of 1.08
months for stock-in-process. However, the bank may emphasis the need to
reduce the level of stocks-in-process to the extent possible.
(iv)Finished goods
The company has projected the level of finished goods at 1.70 months
against the stipulated norm of 1.50 months for the industry. If a comparative
study is made with the past it may be observed that the level of finished goods
has been reduced from 1.99 months during last year to 1.74 months during
current year. It is likely to be further reduced to 1.70 months in the next year.
The company has stated that it is distributing some f its products
(pharmaceutical formulations) through its 9 branches scattered throughout the
country which requires high level finished goods. However, the reason given
by the company is not satisfactory. About 75 per cent of the company’s total
production is in bulk drugs where high level of finished goods stock is not
required. In fact, higher level of raw materials and stock-in-process have been
considered reasonable in view of the requirement of imported raw materials
and the long production cycle for bulk for bulk drugs. Higher level of the
stock of pharmaceutical formulations should be compensated by the low level
of the stock of bulk drugs. Therefore, the level of finished goods is projected
at norm of 1.5 months stipulated for the industry. If the level of finished goods
is projected at 1.5 months of cost of sales, it comes to Rs. 207 lakhs against
Rs. 235 lakhs projected by the company.
(v) Receivables
49
The company has projected domestic receivables at the level of 1.60 months
as compared to norms of 1.50 months. The company has mentioned that about
30 % of its sales are made to central/state governments which results in
payment being received 3-4 months after sales of goods. If the payment is
received from the government in time, the receivables can be managed within
the norms without any difficulty. If a comparative study with the past is done,
level of receivables has come down from 1.74 months during last year to 1.60
months during current year and it is likely to be maintained at the same level
during the next year. If export receivables are also added to the domestic
receivables, the level of total receivables come to 1.59 months of total sales,
i.e. domestic sales plus export sales. As the level of receivables is only
marginally higher than the norm and it has shown a declining trend, we may
accept it for this year. However emphasis should be made to reduce the level
of receivables to 1.50 months by next year.
(vi) Sundry Creditors
The company has projected the sundry creditors at the level of 1.75
months as compared to 1.73 months for the current year and 1.72 months for
the previous year. The level of sundry creditors may be considered reasonable.
11.2.5 Assessment of working Capital
The company has requested to increase the working capital limit from Rs. 321 lakhs
for current year to Rs. 381 lakhs for next year on the basis of an expected increase of
12.26 percent in sales over the current year. It has projected total current assets at Rs.
1401 lakhs and total current Liabilities (other than bank borrowing ) at Rs. 595 lakhs.
While analyzing the level of current assets in the above paragraphs, it has been
observed that the company has been maintaining higher level of raw materials ,stock
in process, finished goods and receivables than the prescribed norms for the industry.
However, the levels have shown a declining trend as compred to the previous years.
The company has also given justifiable reason for higher levels except for finished
goods. If thee finished goods are projected at 1.5v months off the cost of sales, it
comes to Rs. 207 lakhs against Rs. 235 lakhs projected by the company. If the
finished goods are projected at Rs. 207 lakhs, instated of Rs. 235 lakhs., the total
current assets will also come down by Rs. 28 lakhs from Rs. 1401 lakhs to Rs. 1373
lakhs. Maximum permissible bank finance for working capital will be Rs. 253 lakhs
as under.
Particulars Amount (Rs. In

50
lakhs)
1 Total Current assets 1373
2 Total Current Liabilities 595
3 Working Capital Gap (1-2) 778
4 Minimum stipulated net working capital as per the 341
second method of lending (25% of total current assets
after excluding export receivables of Rs. 10 lakhs)
5 Actual / Projected net working capital available with the 425
company (Item No. 45 of Form III – Analysis of
Balance Sheet)
6 Item 3 minus Item 4 above 437
7 Item 3 minus Item 5 above 353
8 Maximum Permissable bank Finance (Item 6 or 7 353
whichever is lower – As the net working Capital
available with the company at Rs. 437 lakhs is more
than the minised stipulated net working capital at Rs.
341 lakhs, the MPBF will be Rs. 353 lakhs instead fo
Rs. 437 lakhs)
It may be observed from the above calculation that the company can be
given working capital limit s of Rs. 353 lakhs against its request for Rs.
381 lakhs. The reduction has been done due to lower level of finished
goods at Rs. 207 lakhs (1.50 months) accepted by the bank against the
projection of Rs. 235 lakhs (1.70 months) made by the company. Higher
levels of raw materials, stock in process and receivables have been
accepted due to the various justifiable reasons given by the company.
Further, declining trend has been observed as compared to previous year
and they are now projected only marginally higher than the stipulated
norms for the industry. The bank may stipulate a condition that the
company should gradually reduce the level of inventory and receivables to
conform to the norms. In view of the good working results, sound financial
position and good current ratio maintained by the company, working
capital limits of Rs. 353 lakhs for the following year may be considered
quite reasonable and safe.
51
Annexure – I
Form – I Assessment of Working Capital Requirement
Outstandi
Propos ng as on Excess/
Sr. Existin ed 31 Over
No. Nature of facilities g Limit Limit january dues
1 Fund Based
Term Loan 190 - 120 -
2 Working Capital:
Cash credit / Over draft /
Packing Credit / Bills
Discount 160 190 158 -
Discount 81 96 78 -
Discount 80 95 78 -
Total Working Capital 321 381 314 -
3 Total Fund Based 235 355.75 149.88 -
52
Annexure II
Form II : Operating Statement
Year Ended 31st March Last Curren Followi

year t year ng year
2008 2009 2010
Act. Rs. Est. Projecti
Rs. ons
(I) (2) (3)
1 Gross Sales
1. Domestic Sales 1903 2344 2655
2. Domestic Sales 48 100 100
Total 1951 2444 2755
53
2 Less : Excise Duty & Sales Tax 224 324 375

3 Net Sales (1-2) 1727 2120 2380
4 % Rise of Fall +10.56 +22.76 +12.26
% % %
5 Cost of Sales
1. Raw Materials
A. Imported 429 575 612
B. Indigenous 362 479 540
2. Other Soares 18 21 23
A. Imported 15 17 19
B. Indigenous
3. Power & Fuel 42 58 69
4. Direct Labour 179 197 220
5. Other Mfg. Exp. 36 48 53
6. Depreciation 53 52 50
7. Sub - Total (1 To 6) 1134 1447 1586
8. Add : Opening Stock in process. 106 117 130
Sub Total 1240 1564 1716
9. Less : Closing Stock in process 117 130 142
10.Cost of Prod. 1123 1434 1574
11. Add : Op.Stk. Of Finished Goods 216 204 220
12. Add : Purchase of finished 94 95 96
goods
Sub Total 1433 1733 1890
13. Less : Cl. Stk. Of Finished Goods 204 220 235
114. Sub Total (Total Cost of 1229 1513 1655
Sales)
6 Selling General And Adm. Exp. 348 414 460
7 Sub Total (5+6) 1577 1927 2115
8 Operating Profit Before Interest (3- 150 193 265
7)
9 Interest 121 130 155
10 Operating Profit after Interest (8-9) 29 63 110
11 (i) Add : Non Operating Income
a. Duty draw back, etc. 26 21 24
b. Others 7 1 1
Sub-Total (income) 33 22 25
(ii) Deduct other non- operating
expenses
a. Transfer to Export Business 2 3 5
Reserve
b. Others - - -
Sub Total(Expenses) 2 3 5
(iii) Net of Other non-operating 31 19 20
54
income / expenses[net of 11(i) &

11(ii)]
12 Profit Before Tax / loss [10 + 60 82 130
11(iii)]
13 Prov. For Taxs 10 36 55
14 Net Profit / Loss (12-13) 50 46 75
15 a. Equity dividend 16 24 24
b. Dividend Rate 10% 15% 15%
16 Retained Profit (14-15) 34 22 51
17 Retained Profit / Net profit (%) 68.0% 47.83 68.00%
%
55
Annexure III
Form III : Analysis of Balance Sheet
56
Curre Following
Last two year nt year’s
Actuals as per year projections
A Report on Assessment of Working audited balance
Capital for Borrowersestim
Account 2009
Year Ended 31st March sheet ates
(i) (ii) (iii) (iv)
LIABILITIES
Current Liabilities
Short term Bank
1 Borrowing
(i) From applicant bank 112 114 160 190
(ii) From other banks 110 112 161 191
(iii)(of which BP and (20)
BD ) (17) (18) (20)
Sub Total (A) 222 226 321 381
Short Term Borr. From 37
2 Others 35 37 37
Sundry Creditors 174
3 (Trade) Local 129 118 157
4 Adv. From Customers 26 4 5 5
5 Prov. For Taxes 236 142 178 233
6 dividend Payable - 16 24 24
Stat. Lia.( due with in -
7 one year) - - -
Deposit/Insalmens of 10
term
loan/BPG/Debentures
etc.( due with in one
8 year) 25 12 84
9 Other Cur. Lia.
(i)Inter cooperate 43
deposits 145 114 20
(ii)others 106 107 78 69
Sub total (B) 702 550 583 595
Total curr liab. (Total of 976
10 1 to 9) 924 776 904
Term liab.
Debentures (not 225
maturing with in one
11 year) 175 175 175
Pref. shares (Redimable -
12 after one year) - - -
Term loan (Excluding 256
instalment payable
13 within one year) 68 56 92
Defered payable credits 25
( Excluding instalment
14 due within one year) 11 14 25
Term Deposits 93
(Repayable after one
15 year) 71 73 86
16 other term liabilities - - - -
Total Term Liabilities 599
17 (Total of 11 to 16) 325 318 378
Total outside liabilities57( 1575
18 total 10 + 17) 1249 1094 1282
Net worth
19 Share capital 163 163 163 163
58
Annexure IV
Form IV : Comparative Statement of Current Assets & Current Liabilities
Norms LastYearCur.Yr. FollowingYr.
Act. Est. Proj.
CURRENTASSET
Raw material
a. Imported - 126 155 172
Months Cons. 2.75m 3.52m 3.23m 3.37m
b. Indegenous - 103 110 120
Months Cons. 2.75m 3.41m 2.76m 2.67m
Consumables
a. Imported - 11 13 14
Months Cons. 12.0m 7.33m 7.43 m 7.30m
b. Indegenous - 9 10 11
Months Cons. 9.0m 7.20m 7.06m 7.95m
Stockin Process - 117 130 142
months cost of product 0.75m 1.25m 1.09m 1.08m
Finish Goods - 204 220 235
months cost of product 1.5m 1.99m 1.74m 1.7
Receivables- Local - - 312 354
Months Local sales 1.5m 1.74m 1.6m 1.6m
Export receivables - 13 10 10
Months Export Sale 1.5m 3.25m 1.2m 1.2m
Advance to Sup. Of RM - 7 8 10
Other Current Asset Cash &Bank Balance - 220 273 333
Total CurrentAsset - 1086 1241 1401
Item34- Form3
CURRENTLIABILITIES
Creditors for purchase 118 157 174
months purchase 1.72m 1.73m 1.75m
Advance fromcustomers 4 5 5
Statutoryliabilities 142 178 233
Other current Liabilities
Dividend Payable 16 24 24
Inst. Of Termloan / debenture 12 84 10
Inter corporate deposits 114 20 43
Other Liabilities 144 115 106
Total 550 583 595
(To Agree with Sub - Total Bof item2to 9- FormIII)
59
Annexure V
Form V : Computation of Maximum Permissible Bank Finance
Last Year Cur. Year Following Yr.

Act.Rs Prov.Rs Est. Rs
1 Total current assets 1086 1241 1401
2 Other Current Liabilites 550 583 595
3 WorkingCapital Gap. 536 658 806
4 Min. Stipulated Margin 268 308 348
25%of gross C.A excludingexport debtors
5 Actual/projected net workngcapital 310 337 425
6 Item3-4 268 350 458
7 Item3-5 226 321 381
8 Maximumpermissible bank finance(lower of 6and 7) 226 321 381
60
Annexure VI
Form VI : Fund Flow Statement
As At 31st March Last Year Cur. Year FollowingYr.

Act.Rs Prov.Rs Est. Rs
1 Sources
a) Net Profit 50 46 75
b) Depreciation 62 60 60
c) Increase inshare Capital
d) Increase inTermLiabilities 60 221
e) Dectrease In
1. FixedAsses
2. NonCurrent Assets
f) Others 4
g) Total
2 Uses
a) Net Loss
b) Decrease in TermLia. 7
c) Increase In
1. FixedAssets 28 120 245
2. NonCurr. Assets 1 3 3
d) dividendPayment 16 16 24
e) Others
f) Total 52 139 272

3 LongtermSurplus/ Def. (1-2) 60 27 88
4 Inc/ Decin cur. Asset. -88 155 160
5 Inc./Dec. in Curr Lia. -152 33 12
6 Inc./Dec. in WorkingCapital Gap 64 122 148
7 Net Surplus/Def. (item3- 6) -4 -95 -60
8 Inc/ Dec. In bankBor. 4 95 60
Incrise / Decrise in Net Sales 165 393 260
Bibliography
61
Books
 Handbook on Working Capital Finance By D. P. Sarda

 Introduction To Management Accounting By L. N. Chopde , D. H. Choudhari
 How to Read a Balance Sheet (Indian adaptation) By Prof. H. Bhattacharya.
Web Sites
 http://www.caalley.com/
 http://www.e-books.com
 http://www.googlebooks.com
 http://www.rushabhinfosoft.com/Webpages/BHTML/CH-16.HTM
 http://exim.indiamart.com/ssi-finance/credit-flow.html
 http://toostep.com/insight/approach-to-lending-working-capital
 http://www.ladderup.com/WORKING%20CAPITAL%20FINANCE
%204%20final%20mailed%20corrected.pdf
62

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THIS REPORT IS ONLY

FOR STUDY PURPOSE IT

Introduction to Working Capital

3. Two Different Concepts of Working Capital

3.2 Operating cycle concept

4. Working Capital Finance

5. Common Guidelines / Instructions for Lending to SME Sector in Bank of

6. Financial Ratios for Credit Appraisal

7. Methods for calculating Working Capital Limits

8. Information/Data Required for Assessment of Working Capital.

9. Check-List for verification of the information/Data.

10 Fixation of Find-based and Non-fund based Limits

11 Case Study on Assessment of Working Capital

11.1 Background of company:

11.2 Working Capital Assessment

11.2.1Utilization of Existing Limits

11.2.2Working Result of The company

11.2.3Financial position of the company

11.2.4Current Assets and Current Liabilities

11.2.5Assessment of working Capital

1. INTRODUCTION TO WORKING CAPITAL

 The word working capital is made of two words

2.1 Working capital in terms of five components:

3. TWO DIFFERENT CONCEPTS OF WORKING CAPITAL ARE:-

 Balance sheet or Traditional concept

 Operating cycle concept.

3.1 Balance sheet or Traditional concept

3.2 Operating cycle concept:-

 Actual production process when the raw material is subjected to different

 Storage of finished goods awaiting sales.

 Sales of finished goods and realisations of sale proceeds.

This system of calculation of working capital requirement is not in vogue as it only

 Stocks of work-in-process/semi finished goods maintained by the unit to complete

 Administrative and selling expenses during this process.

 Bills receivable/debtors for credit sales.

4. Working Capital Finance

 Creditors :- Creditors of raw materials , suppliers etc.

4.2 Types of Working Capital Finance

 Cash Credit :- A cash-credit is an arrangement to extend short term working capital

 Drawing against Un-Cleared effects (DAUE) :- When a customer wishes to draw

 Letter of credit :- A binding document that a buyer can request from

 Bank Guarantee :- It is a contract to perform the promise or discharge the liability of

It is of three types 1) Financial 2) Performance 3) DPG

 Factoring :- The selling of a company's accounts receivable , at a discount, to

 Inter-corporate Deposits :- It involves movement of funds from funds-surplus

5. COMMON GUIDELINES/INSTRUCTIONS FOR

Application forms in use to grant credit facilities are detailed as under :

I. Application form for credit facilities upto Rs.10/- lacs.

5.2. Receipt of applications and acknowledgment

 An acknowledgment with the date of receipt for credit application received to be

 The bank’s decision regarding credit assistance to be communicated to the

5.3. Register of Credit Applications Received

All applications received should be entered in a “Register of Loan Applications

5.4. Time norms for disposal of loan applications:

 In respect of loans upto Rs.25,000/- within a maximum period of one week of

 In respect of credit applications processed at SME loan Factories, it should be

6 . FINANCIAL RATIOS FOR CREDIT APPRAISAL

7.Methods for calculating Working Capital Limits:

7.1 Turnover Method

The credit requirements of village industries, Micro Enterprises, Small Enterprises

 Working Capital Requirement = 25% of Turnover

 Promoter Contribution (Margin) = 5% of Turnover

 Bank Finance = 20% of Turnover