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EXECUTIVE SUMMERY
It gives me great pleasure to present this project report on working capital Iinance
at bank oI Maharashtra, credit department, head oIIice, Pune. The project was carried out
Irom 1st June 2007 to 31st July 2007.
The main objective oI the project was to study various types oI working capital
Iinance provided by banks. To know details the procedure oI assessment oI working
capital Iinance extended by banks.
Wheels oI business cannot move without money. Availability oI money is being
limited and wants being unlimited. So procurement oI Iund is one oI the important
Iunctions in commercial & non-commercial enterprises and utilizes it Ior maximization
oI business proIits.
Business enterprises need Iunds to meet their diIIerent types oI requirements,
i. Long-term requirement
ii. Medium-term requirement
iii. Short-term requirement
Working capital requirement is the short-term requirement. Working capital is the
investment needed Ior carrying out day-to-day operations oI the business smoothly. Bank
is one oI the important sources oI working capital requirement. Bank gives various
Iacilities to the borrowers.
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In this project I have considered various banking Iacilities Ior the working capital
Iinance to the industries. It covers almost important aspect relating to assessment &
Iollow up oI working capital Iinance. AIter discussing the procedure Iollowed by bank,
For assessing working capital requirement case studies have been given with necessary
data in the prescribed Iorms demonstrate the calculable done by bank to arrive at
maximum permissible bank Iinance. An inventory & receivables constitute the major
portion oI the total working capital requirement.
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Company Profile
The Birth
Registered on 16th Sept 1935 with an authorized capital oI Rs 10.00 lakh and
commenced business on 8th Feb 1936.
The Childhood
Known as a common man's bank since inception, its initial help to small units has given
birth too many oI today's industrial houses. AIter nationalization in 1969, the bank
expanded rapldly lL now has 1292 branches (as of 30Lh SepLember 2003) all over lndla
The Bank has the largest network oI branches by any Public sector bank in the state oI
Maharashtra.
The Adult
The bank has Iine tuned its services to cater to the needs oI the common man and
incorporated the latest technology in banking oIIering a variety oI services.
Our Philosophy
4Technology with personal touch.
Our Emblem
The Deepmal
4With its many lights rising to greater heights.
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The Pillar
4ur institution- Symbolizing strength.
The 3 M's
Symbolising
OMobilisation oI Money
OModernisation oI Methods and
OMotivation oI StaII.
Our Aims
The bank wishes to cater to all types oI needs oI the entire Iamily, in the whole country.
Its dream is "ne Family, ne Bank, Maharashtra Bank".
The Autonomy
The Bank attained autonomous status in 1998. It helps in giving more and more services
with simpliIied procedures without intervention oI Government.
Our Social Aspect
The bank excels in Social Banking, overlooking the proIit aspect; it has a good share oI
Priority sector lending having 46 oI its branches in rural areas.
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Other Attributes
Bank is the convener oI State level Bankers committee
Bank has signed a MoU with EXIM bank Ior co-Iinancing oI project exports
Bank oIIers Depository services and Demat Iacilities in Mumbai.
Bank has captured 97.68 oI its total business through computerization.
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OB1ECTIVES
To know the various types oI working capital Iinance provided by banks.
To analyze in detail the procedure oI assessment oI working capital Iinance
extended by bank.
To apply these procedure at a practical level with the help oI case studies.
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RESEARCH METHODOLOGY
This is analytical research area where we analyses inIormation with cause and its
eIIects relationship. This analysis leads to the simple conclusions oI whether to lend
money to the institution Ior business.
Also iI the money is lend then there is reality the norms are not always perIect and
hence it is essential to priorities stringent parameters and secondary parameters.
Research Type Analytical
Source oI Data Primary and Secondary
Sample Unit Industries applying Ior loan
Sample Case studies
Sample Technique Allocation oI Case
Analysis Tool used Financial Analysis
Primary Data:
bservation, Discussion with the manager.
The company proIile, annual reports have been obtained Irom BM.
Secondary Data:
Secondary data relating to the procedure oI assessment oI working capital Iinance, old
sanction proposals, RBI guidelines etc. have been sourced Irom reIerence books.
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INTRODUCTION TO WORKING CAPITAL
In accounting, Working capital is the diIIerence between the inIlow and outIlow oI
Iunds. In other words, it is the net cash inIlow. It is deIined as the excess oI current assets
over current liabilities and provisions. In other words, it is net current assets or net
working capital.
A study oI working capital is oI major importance to internal and external analysis
because oI its close relationship with the day-to-day operations oI a business. Working
Capital is the portion oI the assets oI a business which are used on or related to current
operations, and represented at any one time by the operating cycle oI such items as
against receivables, inventories oI raw materials, stores, work in process and Iinished
goods, merchandise, notes or bill receivables and cash.
Working capital comprises current assets which are distinct Irom other assets. In the Iirst
instance, current assets consist oI these assets which are oI short duration.
Working capital may be regarded as the liIe blood oI a business. Its eIIective provision
can do much to ensure the success oI a business while its ineIIicient management can
lead not only to loss oI proIits but also to the ultimate downIall oI what otherwise might
be considered as a promising concern.
The Iunds required and acquired by a business may be invested to two types oI assets:
1. Fixed Assets.
2. Current Assets
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Fixed assets are those which yield the returns in the due course oI time. The various
decisions like in which Iixed assets Iunds should be invested and how much should be
invested in the Iixed assets etc. are in the Iorm oI capital budgeting decisions. This can be
said to be Iixed capital management.
ther types oI assets are equally important i.e. Current Assets.
These types oI assets are required to ensure smooth and Iluent business operations and
can be said to be liIe blood oI the business. There are two concepts oI working capital
Gross and Net. Gross working capital reIers to gross current assets. Net working capital
reIers to the diIIerence between current assets and current liabilities. The term current
assets reIers to those assets held by the business which can be converted into cash within
a short period oI time oI say one year, without reduction in value. The main types oI
current assets are stock, receivables and cash. The term current liabilities reIer to those
liabilities, which are to be paid oII during the course oI business, within a short period oI
time say one year. They are expected to be paid out oI current assets or earnings oI the
business. The current liabilities mainly consist oI sundry creditors, bill payable, bank
overdraIt or cash credit, outstanding expenses etc.
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NEED FOR WORKING CAPITAL
The need oI gross working capital or current assets cannot be overemphasized. The object
oI any business is to earn proIits. The main Iactor aIIecting the proIits is the magnitude oI
sales oI the business. But the sales cannot be converted into cash immediately. There is a
time lag between the sale oI goods and realization oI cash. There is a need oI working
capital in the Iorm oI current assets to Iill up this time lag. Technically, this is called as
operating cycle or working capital cycle, which is the heart oI need Ior working capital.
This working capital cycle can be described in the Iollowing words.
II the company has a certain amount oI cash, it will be required Ior purchasing the raw
material though some raw material may be available on credit basis. Then the company
has to spend some amount Ior labour and Iactory overheads to convert the raw material in
work in progress, and ultimately Iinished goods. These Iinished goods when sold on
credit basis get converted in the Iorm oI sundry debtors. Sundry debtors are converted in
cash only aIter the expiry oI credit period. Thus, there is a cycle in which the originally
available cash is converted in the Iorm oI cash again but only aIter Iollowing the stages oI
raw material, work in progress, Iinished goods and sundry debtors. Thus, there is a time
gap Ior the original cash to get converted in Iorm oI cash again. Working Capital needs oI
company arise to cover the requirement oI Iunds during this time gap, and the quantum oI
working capital needs varies as per the length oI this time gap.
Thus, some amount oI Iunds is blocked in raw materials, work in progress, Iinished
goods, sundry debtors and day-to-day requirements. However some part oI these current
assets may be Iinanced by the current liabilities also. E.g. some raw material may be
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available on credit basis, all the expenses need not be paid immediately, workers are also
to be paid periodically etc. But still the amounts required to be invested in these current
assets is always higher than the Iunds available Irom current liabilities. This is precise
reason why the needs Ior working capital arise. From the Financial management point oI
view, the nature oI Iixed assets and current assets diIIer Irom each other
1. The Iixed assets are required to be retained in the business over a period oI time and
they yield the returns over their liIe, whereas the current assets loose their identity over a
short period oI time, say one year.
2. In the case oI current assets, it is always necessary to strike a proper balance between
the liquidity and proIitability principles, which is not the case with Iixed assets. E.g. II
the size oI current assets is large, it is always beneIicial Irom the liquidity point oI view
as it ensures smooth and Iluent business operations. SuIIicient raw material is always
available to cater to the production needs, suIIicient Iinished goods are available to cater
to any kind oI demand oI customers, liberal credit period can be oIIered to the customers
to improve the sales and suIIicient cash is available to pay oII the creditors and so on.
However, iI the investment in current assets is more than what is ideally required, it
aIIects the proIitability, as it may not be able to yield suIIicient rate oI return on
investment. n the other hand, iI the size oI current assets is too small, it always involves
the risk oI Irequent stock out, inability oI the company to pay its dues in time etc. As
such, the investment in current assets should be optimum. Hence, it is necessary to
manage the individual components oI current assets in a proper way. Thus, working
capital management reIers to proper administration oI all aspects oI current assets and
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current liabilities. Working Capital Management is concerned with the problems arising
out oI the attempts to manage current assets, current liabilities and inter-relationship
between them. The intention is not to maximize the investment in working capital nor is
it to minimize the same. The intention is to have optimum investment in working capital.
In other words, it can be said that the aim oI working capital management is to have
minimum investment in working capital without aIIecting the regular and smooth Ilow oI
operations. The level oI current assets to be maintained should be suIIicient enough to
cover its current liabilities with a reasonable margin oI saIety. Moreover, the various
sources available Ior Iinancing working capital requirements should be properly managed
to ensure that they are obtained and utilized in the best possible manner.
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FACTORS AFFECTING WORKING CAPITAL MANAGEMENT
The amount oI working capital required depends upon a number oI Iactors which can be
stated as below
Nature of Business:
Some businesses are such, due to their very nature, that their requirement oI Iixed capital
is more rather than working capital. These businesses sell services and not the
commodities and not the commodities and that too on cash basis. As such, no Iunds are
blocked in piling inventories and also no Iunds are blocked in receivables. E.g. Public
utility services like railways, electricity boards, inIrastructure oriented projects etc. Their
requirement oI working capital is less. n the other hand, there are some business like
trading activity, where the requirement oI Iixed capital is less but more money is blocked
in inventories and debtors. Their requirement oI the working capital is more.
Length of Production Cycle:
In some business like machine tool industry, the time gap between the acquisitions oI
raw material till the end oI Iinal production oI Iinished product itselI is quite high. As
such more amounts may be blocked either in raw materials, or work in progress or
Iinished goods or even in debtors. Naturally, their needs oI working capital are higher.
n the other hand, iI the production cycle is shorter, the requirement oI working capital is
also less.
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Size and Growth of Business:
In very small companies the working capital requirements are quite high overheads,
higher buying and selling costs etc. As such, the medium sized companies positively have
an edge over the small companies. But iI the business starts growing aIter a certain limit,
the working capital requirements may be adversely aIIected by the increasing size.
Business Trade Cycles:
II the company is operating in the period oI boom, the working capital requirements may
be more as the company may like to buy more raw material, may increase the production
and sales to take the beneIits oI Iavourable markets, due to the increased sales, there may
be more and more amount oI Iunds blocked in stock and debtors etc. Similarly, in case oI
depression also, the working capital requirements may be high as the sales in terms oI
value and quantity may be reducing, there may be unnecessary piling up oI stocks
without getting sold, the receivables may not be recovered in time etc.
Terms of Purchase and Sales:
Sometimes, due to competition or custom, it may be necessary Ior the company to extend
more and more credit to the customers, as a result oI which more and more amounts is
locked up in debtors or bills receivables which increase working capital requirements. n
the other hand, in case oI purchases, iI credit is oIIered by the suppliers oI goods and
services, a part oI working capital requirement may be Iinanced by them, but iI it is
necessary to purchase these goods or services on cash basis, the working capital
requirement will be higher.
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Profitability:
The proIitability oI the business may vary in each and every individual case, which in its
turn may depend upon numerous Iactors. But high proIitability will positively reduce the
strain on working capital requirements oI the company, because the proIits to the extent
that they are earned in cash may be used to meet the working capital requirements oI the
company. However, proIitability has to be considered Irom one more angles so that it can
be considered as one oI the ways in which strain on working capital requirements oI the
company may be relieved. And these angles are:
Taxation Policy:
How much is required to be paid by the company towards its tax liability?
Dividend Policy:
How much oI the proIits earned by the company are distributed by way oI dividend?
Effect of Inflation on Working Capital Requirement:
The phase oI inIlation can be identiIied with the situation oI increasing price levels,
increasing demand and increasing supply. As such, the working capital requirements
multiply during the phase oI inIlation due to increasing cost oI production and increasing
level oI sales turnover. However, in order to control the increasing demand Ior working
capital during the period oI inIlation, the Iollowing measures may be applied.
Possibility oI using cheaper substitute raw material, without aIIecting the quality, should
be explored. For this purpose, research activities may be conducted. Attempts should be
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made to reduce the production costs to maximum possible extent. For this purpose, the
techniques like time and motion study, incentive schemes, cost reduction programmes
etc. may be implemented. Attempts should be made to reduce the operating cycle to the
maximum possible extent. Aiming at greater turnover at short intervals will go a long
way to reduce the stress on working capital requirements. Attempts should be made to
reduce the locked up working capital in non-moving or obsolete inventories. A clear-cut
policy should be Iormulated and Iollowed Ior timely disposal oI non- moving and
obsolete inventories. Similarly, eIIicient management inIormation system should be
developed to reIlect the position oI inventory Irom the various angles. Attempts should be
made to reduce the amount looked up in receivables. Quicker realization oI debts will go
a long way to reduce the stress on working capital requirements. Attempts should be
made to make the payments oI to creditors in time. This helps the business to build up
good reputation and increases its bargaining power with respect to period oI credit oI
credit Ior payment and other conditions.
Attempts should be made to match the projected cash inIlows and projected cash
outIlows. II they do not match, some oI the payments should be postponed or purchases
oI certain avoidable items should be deIerred. Estimation oI Working Capital
Requirements: First oI all estimates oI all current assets should be made. These current
assets may include stock, debtors. Cash/Bank balance prepaid expenses etc.
DiIIerence between the estimated current assets and current liabilities will represent the
working capital requirements. To this sometime a standard percentage may be added to
take care oI the contingencies. This technique is known as Cash Cost technique oI
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estimating oI working capital requirements. There is another technique available Ior
estimating working capital requirements also and that is in the Iorm oI Balance Sheet
Method. In this the Iorecast is made oI various assets and liabilities, the diIIerence
between assets and liabilities indicating either the surplus or deIiciency oI cash. There are
various methods available Ior Iinancing the working capital requirements:
Flied or Permanent or Core Working Capital:
This indicates the amount oI minimum working capital, which is required to be
maintained by every business at any point oI time, in order to carry on the business on
permanent and uninterrupted basis.
Variable or Temporary Working Capital:
This indicates that amount oI working capital required by the business which is over and
above Iixed or permanent or core working capital. This need oI the working capital may
vary depending upon the Iluctuations in demand as a result oI changes in production or
sales.
As Iar as Iinancing oI the Iixed or permanent needs oI working capital are concerned,
these needs should be met out oI the long term sources oI Iunds, wn generation oI
Iunds, out oI the proIits earned, shares or debentures.
As Iar as Iinancing oI the variable or temporary needs oI working capital are concerned,
these needs can be met Irom the various sources:
1. A part oI these needs may be Iinanced by way oI the credits available Irom the
suppliers oI material or services and oI delayed payment oI expenses.
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2. A part oI these needs may be Iinanced by way oI long term sources oI Iunds in the
Iorm oI own generation oI Iunds, out oI proIits earned shares, debentures and other long
term borrowings, public deposits etc.
3. A part oI these needs may be Iinanced by way oI long term sources oI Iunds in the
Iorm oI own generation oI Iunds, out oI proIits earned, shares, debentures and other long
term borrowing.
4. A major portion oI these working capital needs are Iinanced by the Banks. In
Iinancing the working capital needs oI the business, the credit obtained Irom Banks plays
a very important role.
Bank Credit as a Source of Meeting Working Capital Requirements:
While bank credit is considered as a major source oI meeting the working capital
requirement oI the industry, the banks have to consider the Iollowing Iactors beIore
meeting their requirements.
A|.What should be the amount oI working capital assistance?
B|.What should be the Iorm in which working capital assistance may be extended?
C|.What should be the security that should be obtained Ior extending the working capital
assistance?
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Amount of Assistance:
To obtain the bank credit Ior meeting the working capital requirements, the company will
be required to estimate the working capital requirements and will be required to approach
the banks along with the necessary supporting data. n the basis oI the estimates
submitted by the company, the bank may decide the amount oI assistance which may be
extended, aIter considering the margin requirements. This margin is to provide the
cushion against the reduction in the value oI security. II the company Iails to IulIill its
obligations, the bank may be required to realize the security Ior recovering the dues.
Margin money is meant to take care oI the possible reduction in the value oI security. The
percentage oI margin money may depend upon the credit standing oI the company,
Iluctuations in the price oI security or the directives oI Reserve Bank oI India Irom time
to time.
Form of Assistance:
AIter deciding the amount oI overall assistance to be extended to the company, the bank
can disburse the amount in any oI the Iollowing Iorms
Non-Fund Based Lending
Fund Based Lending
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Non-Fund Based Lending
In case oI Non-Fund Based Lending, the lending bank does not commit any physical
outIlow oI Iunds. As such, the Iunds position oI the lending bank remains intact. The
Non-Fund Based Lending can be made by the banks in two Iormsa.
Bank Guarantee:
Suppose Company A is the selling company and Company B is the purchasing company.
Company A does not know Company B and as such is concerned whether Company B
will make the payment or not. In such circumstances, D who is the Bank oI Company B,
opens the Bank Guarantee in Iavour oI Company A in which it undertakes to make the
payment to Company A iI Company B Iails to honour its commitment to make the
payment in Iuture. As such, interests oI Company A are protected as it is assured to get
the payment, either Irom Company B or Irom its Bank D. As such, Bank Guarantee is the
mode which will be Iound typically in the seller`s market. As Iar as Bank D is concerned,
while issuing the guarantee in Iavour oI Company A, it does not commit any outIlow oI
Iunds. As such, it is a Non-Fund Based Lending Ior Bank D. II on due date, Bank D is
required to make the payment to Company A due to Iailure on account oI Company B to
make the payment, this Non-Fund Based Lending becomes the Fund Based Lending Ior
Bank D which can be recovered by Bank D Irom Company B. For issuing the Bank
Guarantee, Bank D charges the Bank Guarantee Commission Irom Company B which
gets decided on the basis oI two Iactors-what is the amount oI Bank Guarantee and what
is the period oI validity oI Bank Guarantee. In case oI this conventional Ior oI Bank
Guarantee, both company A as well as Company B get beneIited as it is able to make the
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credit purchases Irom Company A without knowing Company A. As such, Bank
Guarantee transactions will be applicable in case oI credit transactions.
In some cases, interests oI purchasing company are also to be protected. Suppose that
Company A which manuIactures capital goods takes some advance Irom the purchasing
Company B. II Company A Iails to IulIill its part oI contract to supply the capital goods
to Company B, their needs to be to be some protection available to Company B. In such
circumstances, Bank C which is the banker oI Company A opens a Bank Guarantee in
Favour oI Company B in which it undertakes that iI Company A Iails to IulIill its part oI
the contract, it will reimburse any losses incurred by Company B due to this non
IulIillment oI contractual obligations. Such Bank Guarantee is technically reIerred to as
perIormance Bank Guarantee and it ideally Iound in the buyer`s market.
b. Letter of Credit:
The non-Iund based lending in the Iorm oI letter oI credit is very regularly Iound in the
international trade. In case the exporter and the importer are unknown to each other.
Under these circumstances, exporter is worried about getting the payment Irom the
importer and importer is worried as to whether he will get the goods or not. In this case,
the importer applies to his bank in his country to open a letter oI credit in Iavour oI the
exporter whereby the importer`s bank undertakes to pay the exporter or accept the bills or
draIts drawn by the exporter on the exporter IulIilling the terms and conditions speciIied
in the letter oI credit.
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Fund Based Lending
In case oI Fund Based Lending, the lending bank commits the physical outIlow oI Iunds.
As such, the Iunds position oI the lending bank gets aIIected. The Fund Based Lending
can be made by the banks in the Iollowing Iorms-
Loan: -
In this case, the entire amount oI assistance is disbursed at one time only, either in cash or
by transIer to the company`s account. It is a single advance. The loan may be repaid in
instalments, the interests will be charged on outstanding balance.
verdraIt: - In this case, the company is allowed to withdraw in excess oI the balance
standing in its Bank account. However, a Iixed limit is stipulated by the Bank beyond
which the company will not be able to overdraw the account. Legally, overdraIt is a
demand assistance given by the bank i.e. bank can ask Ior the repayment at any point oI
time. However in practice, it is in the Iorm oI continuous types oI assistance due to
annual renewal oI the limit. Interest is payable on the actual amount drawn and is
calculated on daily product basis.
Cash Credit: -
In practice, the operations in cash credit Iacility are similar to those oI overdraIt Iacility
except the Iact that the company need not have a Iormal current account. Here also a
Iixed limit is stipulated beyond which the company is not able to withdraw the amount.
Legally, cash credit is a demand Iacility, but in practice, it is on continuous basis. The
interests is payable on actual amount drawn and is calculated on daily product basis.
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Bills purchased or discounted: -
This Iorm oI assistance is comparatively oI recent origin. This Iacility enables the
company to get the immediate payment against the credit bills raised by the company.
The bank holds the bill as a security till the payment is made by the customer. The entire
amount oI bill is not paid to the company. The Company gets only the present worth oI
the amount oI bill, the diIIerence between the Iace value oI the bill and the amount oI
assistance being in the Iorm oI discount charges. n maturity, bank collects the Iull
amount oI bill Irom the customer. While granting this Iacility to the company, the bank
inevitably satisIies itselI about the credit worthiness oI the customer. A Iixed limit is
stipulated in case oI the company, beyond which the bills are not purchased or discounted
by the bank.
Working Capital Term Loans: -
To meet the working capital needs oI the company, banks may grant the working capital
term loans Ior a period oI 3 to 7 years, payable in yearly or halI yearly installments.
Packing Credit: -
This type oI assistance may be considered by the bank to take care oI speciIic needs oI
the company when it receives some export order. Packing credit is a Iacility given by the
bank to enable the company to buy the goods to be exported. II the company holds a
conIirmed export order placed by the overseas buyer or a letter oI credit in its Iavour, it
can approach the bank Ior packing credit Iacility.
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Operating cycle:
The time between purchase oI inventory items (raw material or merchandise) and
their conversion into cash is known as operating cycle or working capital cycle. The
longer the period oI conversion the longer will be the period oI operating cycle. A
standard operating cycle may be Ior any time period but does not generally exceed a
Iinancial year. bviously, the shorter the operating cycle larger will be the turnover oI the
Iund invested Ior various purposes. The channels oI investment are called current assets.
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OPERATING CYCLE
Cash
Receipt Irom
debtors
Creation oI
receivables
(Debtors)
Sales oI
Finished
Goods
Creation oI
A/c payable
(Creditors)
Purchase oI
raw material,
components
Warehousing
oI Finished
Goods
ManuIacturing
operation: wages &
salaries, Iuel,
power, etc
IIice, selling,
distribution and
other expenses
Payments to
creditors
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WORKING CAPITAL FINANCE
A manuIacturing concern needs Iinance not only Ior acquisition oI Iixed assets
but also Ior its day-to-day operations. It has to obtain raw materials Ior processing, pay
wage bills & other manuIacturing expenses, store Iinished goods Ior marketing & grant
credit to the customers. It may have to pass through the Iollowing stages to complete its
operating cyclei.
Conversion oI cash into raw materials raw material procured on credit, cash
may have to be paid aIter a certain period.
ii. Conversion oI raw materials into stock in process.
iii. Conversion oI stock in process into Iinished goods.
iv. Conversion oI Iinished goods into receivables/debtors or cash.
v. Conversion oI receivables/debtors into cash.
A non-manuIacturing trading concern may not require raw material Ior their
processing, but it also needs Iinance Ior storing goods & providing credit to its customers.
Similarly a concern engaged in providing services, it may not have to keep inventories
but it may have to provide credit Iacility to its customers. Thus all enterprises engaged in
manuIacturing or trading or providing services require Iinance Ior their day-to-day
operations, the amount required to Iinance day-to-day operation is called working capital
& the assets & liabilities are created during the operating cycle are called current assets &
current liabilities. The total oI all the current assets is called gross working capital & the
excess oI current assets over current liabilities is called net working capital.
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When entrepreneurs Ior Iinancing working capital requirements approach the
banks, the bank has to examine the viability oI the project beIore agreeing to provide
working capital Ior it. Financial institutions & bank while providing term loan Iinance to
unit Ior acquisition oI Iixed assets does a detailed viability study. They have to ensure
that the project will generate suIIicient return on the resources invested in it. The viability
oI a project depends on technical Ieasibility, marketability oI the products, at a proIitable
price, availability oI Iinancial resources in time & proper management oI the unit. In brieI
the project should satisIy the tests oI technical, commercial, Iinancial & managerial
Ieasibility.
Proper co-ordination amongst banks & Iinancial institution is necessary to judge
the viability oI a project & to provide working capital at appropriate time without any
delay. II a unit approaches banks only Ior working capital requirement & no viability
study has been done earlier which is done at the time oI providing term loans, a detailed
viability study is necessary beIore agreeing to provide working capital Iinance.
In the view oI scarcity oI bank credit, its increasing demand Irom various sectors
oI economy & its importance in the development oI economy, bank should provide
working capital Iinance according to production requirements. ThereIore it is necessary
to make a proper assessment oI total requirement oI the working capital, which depends
on the nature oI the activities oI an enterprise & the duration oI its operating cycle. It has
to be ensured that the unit will have regular supply oI raw material to Iacilitate
uninterrupted production. The unit should be able to maintain adequate stock oI Iinished
goods Ior smooth sales operation. The requirement oI trade credit, Iacilities to be given
by the unit to its customers should also be assessed on the basis oI practice prevailing in
29
the particular industry/trade which assessing above requirements, it should also be
ensured that carrying cost oI inventories & duration oI credit to customers are minimized.
AIter assessing the total requirement oI working capital, a part oI working capital
requirement should be Iinanced Ior the long term & partly by determining maximum
permissible bank Iinance.
30
ASSESSMENT OF WORKING CAPITAL
A unit needs working capital Iunds mainly to carry current assets required Ior its
operations. Proper assessment oI Iunds required Ior working capital is essential not only
in the interest oI the concerned unit but also in the national interest to use the scare credit
according to production requirements. Inadequate levels oI working capital may result in
under-utilization oI capacity and serious Iinancial diIIiculties. Similarly excessive levels
may lead to unproductive use oI credit and unnecessary interest Burdon on the unit.
Proper assessment oI working capital requirement may be done as under-
I. Norms for inventory and receivables:
II the bank credit is to be linked with production requirements, it is necessary to assess
the requirements on the basis oI certain norms. The study group to Irame guidelines to
Iollow-up oI bank credit` (Tandon Study Group) appointed by Reserve Bank oI India
had suggested the norms Ior inventory and receivables regarding 1: major industries on
the basis oI company Iinance studies made by Reserve Bank process periods in the
diIIerent industries, discussions with the industry experts and Ieed-back received on the
interim report. The norms suggested by Tandon Study Group are being reviewed Irom
time to time by the Committee oI Direction constituted by the Reserve Bank to keep a
constant view on working capital requirements. The committee has representatives
Irom a Iew banks and it generally once in a quarter. It also consults the representatives
Irom industry and trade. It keeps a watch on the various issues relating to working
31
capital requirements and gives various suggestions to suit the changing requirements oI
the industry and trade.
Banks make their own assessment oI credit requirements oI borrowers based on a total
study oI borrowers` business operations and they can also decide the levels oI holding
each item oI inventory as also oI receivables which in their view would represent a
reasonable built up oI current assets Ior being supported by banks` Iinance. Banks may
also consider suitable internal guidelines Ior accepting the projections made by the
borrowers regarding sundry creditors as sundry creditors are taken as a source oI
Iinancing current assets (inventories, receivables, etc.), it is necessary to project them
correctly while calculating need oI bank Iinance Ior working capital requirements.
II. Computation of Maximum Permissible Bank Finance (MPBF):
The Tandon Study group had suggested the Iollowing alternatives Ior working out the
maximum permissible bank Iinance:-
a. Bank can work out the working capital gap. i. e. total current assets less current
liabilities other than bank borrowings and Iinance a maximum oI 75 per cent oI
the gap; the balance to come out oI long-term Iunds, i.e. owned Iunds and term
borrowings
b. Borrower should provide Ior a minimum oI 25 per cent oI total current assets
out oI long-term Iunds, i.e. owned Iunds and long term borrowings. A certain
level oI credit Ior purchases and other current liabilities inclusive oI bank
borrowings will not exceed 75 per cent oI current assets.
32
It may be observed Irom the above that borrower`s contribution Irom long term
Iunds would be 25 per cent oI the working capital gap under the Iirst method oI lending
and 25 per cent oI total current assets under the second method oI lending. The above
minimum contribution oI long-term Iunds is called minimum stipulated Net Working
Capital (NWC) which comes Irom owned Iunds and term borrowings.
Above two method oI lending may be illustrated by taking the Iollowing example oI
a borrower`s Iinancial position, projected as at the end oI next year.
Current Liabilities Amt Current Assets Amt
Creditors Ior purchase 200 Raw materials 380
ther current liabilities 100 Stock in process 40
300 Finished goods 180
Bank borrowing, including bills
discounted with bankers
400 Receivables, including bills
discounted with bankers
110
ther current assets 30
700 740
33
First method Second method
Total current assets 740 total current assets 740
Less: current liabilities 25 oI above Irom long term
ther than bank borrowings 300 sources 185
Working capital gap 440 555
25 oI above Irom long term less: current liabilities
Sources 110 ther than bank borrowings 300
Maximum permissible bank 330 Maximum permissible bank 255
Finance Iinance
Excess Bank borrowings 70 Excess Bank borrowings 145
Current ratio 1.17:1 Current ratio 1.33:1
It may be observed Irom the above that in the Iirst method, the borrower has to
provide a minimum oI 25 per cent oI working capital gap Irom ling-term Iunds and it
gives a minimum current ratio 1.17:1. In the second method, the borrower has to provide
a minimum oI 25 per cent oI total current assets Irom long-term Iunds and gives a
minimum current ratio oI 1.33:1.
While estimating the total requirement oI long-term Iunds Ior new projects,
Iinancial institutions/banks should calculate Ior working capital on the basis oI norms
prescribed Ior inventory and receivables and by applying the second method oI lending.
A project may suIIer Irom shortage oI working capital Iunds iI suIIicient margin Ior
working capital is not provided as per the second method oI lending while Iunding new
projects. Proper co-ordination between banks & Iinancial institutions is necessary to
ensure availability oI suIIicient working capital Iinance to meet the production
requirement.
34
III. Classification of current assets & Current liabilities:
In order to calculate net working capital & maximum permissible bank Iinance, it is
necessary to have proper classiIication oI various items oI current assets & current
liabilities. All illustrative lists oI current assets & current liabilities Ior the purpose oI
assessment oI working capital are Iurnished below;
Current assets: -
a. Cash and bank balances
b. Investments
c. Receivables arising out oI sales other than deIerred receivables (including bills
purchased & discounted by bankers)
d. Installments by deIerred receivables due within one year
e. Raw materials & components used in the process oI manuIactured including
those in transit
I. Stock in process including semi Iinished goods
g. Finished goods including goods in transit
h. ther consumable spares
i. Advance payment Ior tax
j. Prepaid expenses
k. Advances Ior purchases oI raw materials, components & consumable stores
l. Payment to be received Irom contracted sale oI Iixed assets during the next 12
months
35
Current Liabilities:
a. Short-term borrowings (including bills purchased & discounted) Irom
Banks and ii. thers
b. Unsecured loans
c. Public deposits maturing within one year
d. Sundry creditors (trade) Ior raw material & consumer stores & spares
e. Interest & other charges accrued but no due Ior payments
I. Advances/progress payments Irom customers
g. Deposits Irom dealers selling agents, etc.
h. Statutory liabilities
Provident Iund dues
Provision Ior taxation
Sales-tax, excise, etc.
bligation towards workers considered as statutory
i. Miscellaneous current liabilities
Dividends
Liabilities Ior expenses
Gratuity payable within one year
Any other payments due within one year
36
Notes on classification of Current Assets & Current Liabilities:
1. Investment in shares, debenture, etc. and advances to other Iirms/companies, not
connected with the business oI the borrowing Iirm, should be excluded Irom
current assets. Similarly investment made in units oI Unit Trust oI India & other
mutual Iunds & in associate companies/subsidiaries, as well as investment made
and/or loans extended as inter-corporate deposits should not be included in the
build-up oI current assets while assessing maximum permissible bank Iinance.
2. The borrowers are not expected to make the required contribution oI 25 per cent
Irom long-term sources in respect oI export receivables. ThereIore, export
receivables may be included in the total current assets Ior arriving at the
maximum permissible bank Iinance but the minimum stipulated net working
capital may be reckoned aIter excluding the quantum oI export receivables Irom
the total current assets.
3. Dead inventory` i.e. slow moving or obsolete items should not be classiIied as
current assets.
4. Security deposits/tender deposits given by borrower should be classiIied as noncurrent
assets irrespective oI whether they mature within the normal operating
cycle oI one year or not.
5. Advances/progress payments Irom customer should be classiIied as current
liabilities. However, where a part oI advances received is required by government
regulations to be invested in certain approved securities, the beneIit oI netting
may be allowed to the extent oI such investment and the balance may be classiIied
as current liability.
37
6. Deposits Irom dealers, selling agents, etc. received by the borrower may treated as
term liabilities irrespective oI their tenure iI such deposits are accepted to be
repayable only when the dealership/agency is terminated. The deposits, which do
not IulIill the above condition, should be classiIied as current liabilities.
7. Disputed liabilities in respect oI income tax, excise, custom duty and electricity
charges need not be treated as current liabilities except to the extent oI provided
Ior in the books oI the borrower. Where such disputed liabilities are treated as
contingent liabilities Ior period beyond one year, the borrower should be advised
to make adequate provision so that he may be in a position to meet the liabilities
as & when they accrue.
8. II disputed excise liability has been shown as contingent liability or by way oI
notes to the balance sheet, it need not be treated as current liability Ior calculating
the permissible bank Iinance unless it has been collected or provided Ior in the
accounts oI borrowers. A certiIicate Irom the Statutory Auditors oI the borrowers
may be obtained regarding the amount collected Irom the customers in respect oI
disputed excise liability or provision made in the borrowers` accounts. The
amount oI excise duty payable should be treated as current liability Ior the
purpose oI working out the permissible limit oI the bank Iinance strictly on the
basis oI the certiIicate Irom the borrowers` Statutory Auditors. The same principle
may also be applied Ior disputed sales tax dues.
9. In case oI other statutory dues, dividends, etc., estimated amount payable within
one year should be shown as current liabilities even iI speciIic provisions have not
been made Ior their payment.
38
10. As per the instructions issued by the Reserve Bank in ctober, 1993, the entire
term loan investment Ialling due Ior payment in the next twelve months need not
be treated as an item oI current liabilities Ior the purpose oI arriving at MPBF.
However all overdue term loan should be treated as current liabilities unless the
loan has been rescheduled by the Iinancial institutions/banks. It may be added that
the entire amount oI term loan installments payable within the next twelve months
which is kept outside the current liabilities while calculating MPBF. Need not be
taken into account while computing net working capital (NWC). However the
entire amount oI term loan installments due within the next twelve months should
continue to be treated as current liability Ior the purpose oI calculating the current
ratio.
IV. Information/Data required for assessment of working capital:
In order to assess the requirements oI working capital on the basis oI production needs,
it is necessary to get the data Irom the borrowers regarding their past/projected
production, sales, cost oI production, cost oI sales, operating proIit, etc. in order to
ascertain the Iinancial position oI the borrowers & the amount oI working capital needs
to be Iinanced by banks, it is necessary to call Ior the data Irom the borrowers regarding
their net worth, long term liabilities, current liabilities, Iixed assets, current assets, etc.
the Reserve Bank prescribed the Iorms in 1975 to submit the necessary details
regarding the assessment oI working capital under its credit authorization scheme. The
scheme oI credit authorization was changed into credit monitoring arrangement in
39
1988. The Iorms used under the credit authorization scheme Ior submitting necessary
inIormation have also been simpliIied in 1991 Ior reporting the credit sanctioned by
banks above the cut-oII point to reserve bank under its scheme oI credit monitoring
arrangement.
As the traders and merchant exporters who do not have manuIacturing activities
are not required to submit the data regarding raw materials, consumable stores, goodsin-
process, power and Iuel, etc., a separate set oI Iorms has been designed Ior traders
and merchant exporters. In view oI the peculiar nature oI leasing and the hire purchase
concerns, a separate set oI Iorms has also designed Ior them.
In addition to the inIormation/data in the prescribed Iorms, bank may also call Ior
additional inIormation required by them depending on the nature oI the borrowers`
activities & their Iinancial position. The data is collected Irom the borrowers in the
Iollowing six Iorms: -
1. Particulars of the existing/proposed limits from the banking system (form I)
Particulars oI the existing credit Irom the entire banking system as also the term
loan Iacilities availed oI Irom the term lending institutions/banks are Iurnished in this
Iorm. Maximum & minimum utilization oI the limits during the last 12 months
outstanding balances as on a recent date are also given so that a comparison can be
made with the limits now requested & the limits actually utilized during the last 12
months.
40
2. Operating Statement (Form II)
The data relating to last sales, net sales, cost oI raw material, power & Iuel, direct
labour, depreciation, selling, general expenses, interest, etc. are Iurnished in this Iorm.
It also covers inIormation on operating proIit & net proIit aIter deducting total
expenditure Irom total sale proceeds.
3. Analysis of Balance Sheet (Form III)
A complete analysis various items oI last year`s balance sheet, current year`s
estimate & Iollowing year`s projections is given, in this Iorm. The details oI current
liabilities, term liabilities, net worth, current assets, other non-current assets, etc. are
given in this Iorm as per the classiIication accepted by banks.
4. Comparative statement of current assets & current liabilities (Form IV)
This Iorm gives the details oI various items oI current assets and current liabilities
as per classiIication accepted by banks. The Iigures given in this Iorm should tally
with the Iigures given in the Iorm III where details oI all the liabilities & assets are
given. In case oI inventory, receivables and sundry creditors; the holding/levels are
given not only in absolute amount but also in terms oI number oI month so that a
comparative study may be done with prescribed norms/past trends. They are indicated
in terms oI numbers oI months in bracket below their amounts.
41
5. Computation of Maximum Permissible Bank Finance (Form V)
n the basis oI details oI current assets & liabilities given in Iorm IV, Maximum
Permissible Bank Finance is calculated in this Iorm to Iind out credit limits to be
allowed to the borrowers.
6. Fund Flow Statement (Form VI)
In this Iorm, Iund Ilow oI long term sources & uses is given to indicate whether
long term Iunds are suIIicient Ior meeting the long term requirements. In addition to
long term sources and uses, increase/decrease in current assets is also indicated in this
Iorm.
V. Check list for verification of the information/data:
Bank should veriIy not only the arithmetical accuracy oI the data Iurnished by the
borrowers but also the logic behind various assumptions based on which the projections
have been made. For this purpose, bank oIIicials should hold discussions with the
borrowers on projected sales, level oI operations, level oI inventory, receivables, etc. iI
necessary, a visit to the Iactory may also be made to have a clear idea oI products and
processes.
42
ASSESSEMENT OF OTHER LIMITS
LETTER OF CREDIT
The banker examines the proposal oI the letter oI credit Irom two angles:
4The cases where letter oI credit is required once only
4The cases where letter oI credit is required once regularly.
In the second category it is convenient Ior the banker to Iix the separate limit oI the letter
oI credit.
43
ASSESSEMENT OF THE LIMITS UNDER LETTER OF CREDIT-WITH LEAD
TIME
The buyer does not receive the goods immediately on the placement oI the order on the
seller. There is always long time log between the order placement and the receipt oI the
material. This period is also reIerred to as the lead-time.
Example: -
II it is assumed that the total raw material requirement is Rs.240lacs per annum and the
normal lead time is 2 months, the buyer will be required to place order so that he has at
least 2 months stock (ignoring saIely level). Thus, the total number oI order placed would
be 6 per year and the value oI per order would be Rs.40 Lacs. This is shown below
Assessment of the limits under LC- with lead-time
Annual requirement oI raw material 240 Lacs
Normal lead time 2 months
Value per order (A) 240/6Rs.40 Lacs
Margin Ior customer 20(B) Rs 8 Lacs
Limits under letter oI credit (A-B) Rs 32 Lacs
44
Assessment of the limits under letter of credit-without lead-time
Annual requirement oI raw material 240 lacs
Monthly requirement oI raw material 240/12 months 20 lacs
Normal inventory level (1 month) Rs 20 lacs
Value per order (A) Rs 20 lacs
Margin Ior customer 20 (B) Rs 4 lacs
Limits under letter oI credit (A-B) Rs 16 lacs
BANK GUARANTEES
There is no standard Iormula Ior assessment oI bank guarantee limit. The details
pertaining to nature oI guarantees, particulars oI the contract, period Ior which the
guarantee is sought and the amount oI guarantee to be obtained, this inIormation along
with the view on the creditworthiness oI the borrower and relationship with the bank
comprise the major input towards deciding the sanction oI limits required by borrower.
Appropriate conditions regarding cash margin and securities have to be laid down to
protect the interest oI the bank..
45
PROCEDURE FOR WORKING CAPITAL FINANCE
CREDIT SANCTION PROCESS
The revised credit process is introduced with a view oI reducing the time lag in the
sanction oI credit besides clearly delineating the areas oI responsibilities oI various
Iunctionaries. As per this the revised process is divide into two components that is Pre
sanctioning and Post sanctioning
In the pre sanctioning it is the only time that the bank can take due assessment and
precautions to make sure that the investments are done Ior the beneIit oI the bank. The
post sanctioning is the Iollow oI the payment. Incase the payment deIaults then the
account will go into NPA in stages and the bank is then said to scrutinize the said
account.
PRE SANCTION PROCESS: -
Obtain loan application
When a customer required loan he is required to complete application Iorm and submit
the same to the bank also the borrower has to be submit the required inIormation along
with the application Iorm.
46
The inIormation, which is generally required to be submitted by the borrower along with
the loan application, is under: -
OAudited balance sheets and proIit and loss accounts Ior the previous three year(in
case borrower already in the business)
OEstimated balance sheet Ior current year.
OProjected balance sheet Ior next year.
OProIile Ior promoters/directors, senior management personnel oI the company.
OIn case the amount oI loan required by borrower is 50 lacs and above he should be
submit the CMA Report
PRE SANCTION
PROCESS
APPRAISAL &
RECMMANDATIN
ASSESSMENT
SANCTINING
47
Examine Ior preliminary appraisal
RBI guidelines. Policies
Prudential exposure norms and bank lending policy
Industry exposure restriction and related risk Iactors.
Compliance regarding transIer oI borrowers accounts Irom one bank to
another bank
Government regulation / legislation impact on the industry
Acceptability oI the promoter and applicant status with regards to other
unit to industries.
Arrive at the preliminary decision.
Examine/analysis /assessment
Financial statement (in the prescribed Iorms) reIers Iigure WC cycle & BS
assessment thumb rules.
Financial ratio & Dividend policy.
Depreciation method
Revaluation oI Iixed assets.
Records oI deIaults (Tax, dues etc.)
Pending suits having Iinancial implication (Customs, excise etc.)
QualiIications to balance sheet auditors remarks etc.
Trend in sales and proIitability and estimates /projection oI sales.
Production capacities and utilization: past & projected production
eIIiciency and cost.
48
Estimated working capital gap W.R.T acceptable buildup oI
inventory/receivables/other current assets and bank borrowing patterns.
Assess MPBF determine Iacilities required
Assess requirement oI oII balance sheet Iacilities viz.L/cs,B/gs etc.
Management quality, competence, track records
Company`s structure and system
Market shares oI the units under comparison.
Unique Ieature
ProIitability Iactors
Inventory/Receivable level
Capacity utilization
Capital market perception.
POST SANCTION PROCESS
Supervision and follow up: -
Sanction credit limit oI working capital requirement aIter proper assessment oI proposal
is alone not suIIicient. Close supervision and Iollow up are equally essential Ior saIety oI
bank credit and to ensure utilization oI Iund lend. A timely action is possible only close
supervision and Iollowed up by using Iollowing techniques.
4Monthly stock statement
4Inspection oI stock
4Scrutiny oI operation in the account
49
4Quarterly/halI quarterly statements.
4Under inIormation system
4Annual audited report
POST SANCTION
PROCESS
FLLW UP
SUPERVISIN
MNITRING &
CNTRL
50
CREDIT MONITORING ARRANGEMENT
Consequent upon the withdrawal oI requirement oI prior authorization under the
erstwhile credit authorization scheme (CAS) and introduction oI a system oI post
sanction scrutiny under credit monitoring arrangement (CMA) the database Iorms have
been recognized as CMA database. The revised Iorms Ior CMA database as drawn up by
the sub-committee oI committee oI directions have come into use Irom 1st April 1991.
The existing Iorms prescribed Ior speciIied industries continue to remain in Iorce. With a
view to imparting uniIormity to the appraisal system, database Irom all borrowers
including SSI units enjoying working capital limits oI Rs. 50 lacs and more Irom the
banking system should be obtained.
The revised sets oI Iorms have been separately prescribed Ior industrial borrowers and
traders/merchant exporters. The details oI Iorms are as under: -
Form 1: - particulars oI the existing/proposed limit from the banking system.
Form 2: -Operating statement.
It contains data relating to gross sales, net sales, cost oI raw material, power and Iuel, etc.
It gives the operating proIit and the net proIit Iigures.
Form 3 : - Analysis of balance sheet.
It is complete analysis oI various items oI last years balance sheet; current years estimate
and Iollowing years projection are given in this Iorm.
51
Form 4 : - Comparative statement of current asset and liabilities.
Details oI various items oI current asset and current liabilities are given.
The Iigures in this Iorm must tally with those in Iorm III.
Form 5: - Computation of maximum permissible bank finance for working capital.
The calculation oI MPBF is done in this Iorm to obtain the Iund based credit limits to be
granted to the borrower.
Form 6: - Fund flow statement
It provides the details oI Iund Ilow Irom long term sources and uses to indicate weather
they are suIIicient to meet the borrowers long term requirements.
CREDIT RATING MODEL
The various risk Iaced by any company may be broadly classiIied as Iollows:
Industry Risk: It covers the industry characteristic, compensation, Iinancial data etc.
Company/ business risk: It considers the market position, operating eIIiciency oI the
company etc.
Project risk: It includes the project cost, project implementation risk, post project
implementation etc.
52
Management risk: It covers the track record oI the company, their attitude towards risk,
propensity Ior group transaction, corporate governance etc.
Financial risk: Iinancial risk includes the quality oI Iinancial statements, ability oI the
company to raise capital, cash Ilow adequacy etc.
DRAWING POWER OF THE BORROWER
The drawing power that a borrower enjoys at any one point depends on each components
oI working capital. The bank Ior each component, which the borrower must hold as his
contribution to Iinance working capital, prescribes margins. The drawing power oI the
borrower can be best explained with the Iollowing illustration
Illustration:
Suppose a borrower has Rs 100.00 lacs as working capital limit sanctioned to him by a
bank.
The security provided by the borrower to the bank is the hypothecation oI inventory.
Suppose, the borrower needs to hold an inventory level oI say 130 lacs in order to enjoy
Rs 100 lacs as his working capital limit.
The actual level oI inventory with the borrower at a point is say 110 lacs.
The inventory margin prescribed by the bank is say 25
ThereIore with this inventory level, the borrower enjoys only Rs 82.5 lacs as his working
capital limit as against Rs 100 lacs.
53
Inventory level (Required) Rs 130 lacs
Drawing power of borrower Rs 100 lacs
Inventory level (Actual) Rs 110 lacs
Margin prescribed by bank 25
Drawing power of borrower 110-(0.25 110) Rs 82.5 lacs
Suppose, the borrower holds Rs 150 lacs oI inventory,
Inventory level (required) Rs 150 lacs
Drawing power of borrower Rs 100 lacs
Inventory level (actual) Rs 150 lacs
Margin prescribed by bank 25
Drawing power of borrower 150 (0.25 150) Rs. 112.2 lacs
ThereIore, in this case the borrower would still enjoy Rs 100 lacs as his working capital
limits as against Rs 112.5 lacs.
ThereIore, the lower oI the two is always considered as the working capital limit or the
drawing power oI the borrower sanctioned by the bank.
54
SECURITY
Banks need some security Irom the borrowers against the credit Iacilities extended to
them to avoid any kind oI losses. securities can be created in various ways. Banks
provide credit on the basis oI the Iollowing modes oI security Irom the borrowers.
Hypothecation: under this mode oI security, the banks provide credit to borrowers
against the security oI movable property, usually inventory oI goods. The goods
hypothecated, however, continue to be in possession oI the owner oI the goods i.e. the
borrower. The rights oI the banks depend upon the terms oI the contract between
borrowers and the lender. Although the bank does not have the physical possession oI the
goods, it has the legal right to sell the goods to realize the outstanding loans.
Hypothecation Iacility is normally not available to new borrowers.
Mortgage: It is the transIer I a legal / equitable interest in speciIic immovable property
Ior securing the payment oI debt. It is the conveyance oI interest in the mortgaged
property. This interest terminated as soon as the debt is paid. Mortgages are taken as an
additional security Ior working capital credit by banks.
55
Pledge: The goods which are oIIered as security, are transIerred to the physical
possession oI the lender. An essential prerequisite oI pledge is that the goods are in the
custody oI the bank. Pledge creates some kind oI liability Ior the bank in the sense that
Reasonable care` means care, which a prudent person would take to protect his property.
In case oI non-payment by the borrower, the bank has the right to sell the goods.
Lien: The term lien reIers to the right oI a party to retained goods belonging to other
party until a debt due to him is paid. Lien can be oI two types viz. Particular lien i.e. A
right to retain goods until a claim pertaining to these goods are Iully paid, and General
lien, Which is applied till all dues oI the claimant are paid. Banks usually enjoyed general
lien.
56
BANKING ARRANGEMENTS
Working capital is made available to the borrower under the Iollowing arrangements;
CONSORTIUM BANKING ARRANGEMENT:
RBI till 1997 made it obligatory Ior availing working capital Iacilities beyond a limit (Rs
500 million in 1997), through the consortium arrangement. The objective oI the
arrangement was to jointly meet the Iinancial requirement oI big projects by banks and
also share the risks involved in it.
While it consortium arrangement is no longer obligatory, some borrowers continue to
avail working capital Iinance under this arrangement. The main Ieatures oI this
arrangement are as Iollows;
Bank with maximum share oI the working capital limits usually takes the role oI lead
bank`.
Lead bank, independently or in consultation with other banks, appraise the working
capital requirements oI the company.
Banks at the consortium meeting agree on the ratio oI sharing the assessed limits.
Lead bank undertakes the joint documentation on behalI oI all member banks.
Lead bank organizes collection and dissemination oI inIormation regarding conduct oI
account by borrower.
57
MULTIPLE BANKING ARRANGEMENT
Multiple banking is an open arrangement in which no banks will take the lead role.
Most borrowers are shiIting their banking arrangement to multiple banking arrangements.
The major Ieatures are
Borrower needs to approach multiple banks to tie up entire requirement oI working
capital.
Banks independently assessed the working capital requirements oI the borrower.
Banks, independent oI each other, do documentation, monitoring and conduct oI the
account
Borrowers deals with all Iinancing banks individually.
SYNDICATION
A syndicated credit is an agreement between two or more lenders to provide a borrower
credit Iacility using common loan agreement. It is internationally practiced model Ior
Iinancing credit requirements, wherein banks are Iree to syndicate the credit limit
irrespective oI quantum involved. It is similar to a consortium arrangement in terms oI
dispersal oI risk but consist oI a Iixed repayment period.
58
REGULATION OF BANK FINANCE
INTRODUCTION
Bank Iollows certain norms in granting working capital Iinance to companies.
These norms have been greatly inIluenced by the reconditions oI various committees
appointed by the RBI Irom time to time. The norms oI working capital Iinance Iollowed
by banks are mainly based on the recommendation oI Tandon committee and chore
committee.
These committees were appointed on the presumption that the existing system oI bank
lending oI number oI weakness industries in India have grown rapidly in the last three
decades as result oI which, the industrial system has become vary complex. The banks
role has shiIted Irom trade Iinancing to industrial Iinancing during this period.
However, the banks lending practices and styles have remained the same. Industries
today Iail to use bank Iinance eIIiciently. Their techniques oI managing Iunds are
unscientiIic and non-proIessional. The industries today lack in reducing costs,
optimizing the use oI inputs, conserving resources etc.
The weakness oI the existing system highlighted by the Dehejia committee in 1968 and
identiIied by the tondon committee in 1974, are as Iollows:
It is the borrower who decides how much he would borrow ;the bankers does not decide
how much he would lend and is, thereIore, not in a position to do credit planning. The
59
bank credit is treated as the Iirst sources oI Iinance and not as supplementary to other
sources oI Iinance.
The amount oI credit is extended is based on the amount oI security available and not on
the level oI operations oI the borrower.
Security does not by itselI ensure saIety oI bank. Funds since all bad sticky advances are
secure advances. SaIety essentially lies in the eIIicient Iollow up oI the industrial
operations oI the borrower.
We discuss the Iollowing committee`s important Iinding and recommendations Ior bank
Iinance: -
OTANDON COMMITTEE
OCHORE COMMITTEE.
60
TANDON COMMITTEE
INTRODUCTION:
The Tandon committee was appointed by the RBI in July 1974 and headed by Shri.
Prakash L. Tandon, the chairman oI the Punjab national bank, to suggest guidelines Ior
rational allocation and optimum use oI bank credit taking into consideration the weakness
oI the leading system. Bank credit, which had become a scare commodity, strictly
rationed to meet the credit requirement oI all the sectors. The larger sector oI the industry
needed strict rationing becomes
It was over relying on bank Iinance and pre empted most oI it while the other sectors
were not getting even their due share. ThereIore, the method and criterion adopted Ior
Iixing credit ration needed to be standardized so that there is minimum scope Ior miss-use
or part oI the credit uses. The Tandon committee was concern exactly with this problem.
Its report laid down as to how the credit ratio oI individual borrowers could be Iixed at
imposed certain obligation on them Ior the eIIicient use oI the credit made available.
The recommendation of the Tandon committee based on the Iollowing notions:
The borrower should indicate the demand Ior credit Ior which he should draw operating
plans Ior the ensuring year and supply them to the banker. This would Iacilitate credit
planning at the banks level and help the banker in evaluating the borrower`s credit needs
in a more realistic manner.
61
The banker should Iinance only the genuine production needs oI the borrower. The
borrower maintained reasonable levels inventories and receivables. EIIicient management
oI resources should thereIore be ensured to eliminate slow moving and Ilabby
inventories.
The working capital needs oI borrower cannot entirely Iinance by the banker. The banker
will Iinance only a reasonable part oI it Ior the remaining; the borrower should depend on
his own Iund. Recommendation oI Tandon committee accordingly, the Tandon
committee put Iorth in the Iollowing recommendations
Inventory and receivables norms
The borrower is allowed to hold only a reasonable level oI current asset, particularly
inventory and receivable. The committee suggested the maximum level oI raw material,
stock in process, Iinished goods, which corporate in an industry should be to hold.
nly the normal inventory based on a production plan, lead-time oI supplies, economic
ordering levels and reasonable Iactor saIety should be Iinanced by the banker.
62
Lending norms:
The banker should Iinance only a part oI the working capital gap; the other part should be
Iinanced by the borrower Iorm long-term sources.
The current asset will be taken on the estimate values or values as per the Tandon
committee norms, whichever is lower.
The current will consist oI inventory and receivables, reIerred as chargeable current
assets (CCA), and other current assets (CA).
MAXIMUM PERMISSIBLE BANK FINANCE:
The Tandon committee suggested the Iollowing three methods oI determining the
permissible level oI bank borrowings-
The borrower will contribute 25 oI the working capital gap Irom long term Iund i.e
owned Iund and term borrowings; the remaining 75 can be Iinanced Irom bank
borrowings. This method gives a minimum current ratio oI 1:1. This method was
considered suitable only Ior very small borrowers where the requirement 0 credit was less
than Rs 10 lacs
The borrower will contribute 25 oI the total current assets Irom long-term Iunds i.e.
owned Iunds and term borrowings. A certain level oI credit Ior purchases and other
current liabilities will be available to Iund the building up oI current assets and the bank
will provide the balance. Consequently, the current liabilities inclusive oI bank borrowing
could not exceed 75 oI current assets. This method gives a current ratio oI 1.3:1. This
63
method was considered Ior all borrowers whose credit requirements were more than Rs
10 lacs.
The borrower will contribute 100 oI core current assets, deIined at the absolute
minimum level oI raw material, processed stock, Iinished goods and stores, which are in
the pipeline. A minimum level oI the 25 oI the balance oI the current assets should be
Iinance Irom the long term Iunds and term borrowings. This method covers straightness
the current ratio. The third is the ideal method. Borrowers in the second stage are not
allowed to revert to the Iirst stage. This method applies to all borrowers having credit
limit in excess oI Rs.20 lacs Irom the bank. However this method was not accepted Ior
implementation.
In some cases, the net working capital was negative or 25 oI the working capital gap.
The new systems allowed this deIiciency to be Iinanced in addition to the permissible
bank Iinance by the bank. This kind oI credit Iacility is called working capital demand
loan, which was to be regulated over a period oI time depending on the Iunds generating
capacity and ability oI the borrower.
The working capital demand loan is not allowed to be raised in the subsequent year. For
additional credit in subsequent year, the borrower`s long-term sources were required to
provide 25 oI the additional working capital gap.
64
4. Style of credit:
The committee recommended the biIurcation oI total credit limit into Iixed and
Iluctuating parts.
The Iixed component is then treated as demand loan Ior the year representing minimum
level oI borrowing, which the borrower expected to use through out the year.
The Iluctuating component is taken care oI by a demand cash credit. It could be partly
used by way oI bills.
The new CC limit should be placed on a quarterly budgeting reporting system.
The interest rate on the loan components should be charged lower than the cash credit
amount. The RBI has stipulated the interest diIIerentiate at 1 .
The cash credit limits sanctioned (Iluctuating) are currently 205 and the loan components
(Iixed) are 80 .
5) INFORMATION SYSTEM:
The committee advocated Ior grater Ilow oI inIormation Irom borrower to the bank Ior
operational purpose and Ior the purpose oI supervision and Ilow oI up credit.
InIormation should be provided in the Iollowing Iorms:
65
QUARTERLY INFORMATION SYSTEM: FORM:
It should contain the production and sales estimates Ior the current and next quarter. also,
the current asset current liabilities estimates Ior the next quarter should be mentioned.
Quarterly information system: Form II:
It should contain the actual production and sales Iinger during the current year and the
latest completed year. Also, actual current asset and current liabilities Ior the latest
completed quarter should be mention.
Half year operating statement form IIIA:
Actual operating perIormance Ior the halI year ended against the estimate should be
mentioned.
Half year fund flow statement: Form IIIB:
It should contain the estimate as well as the actual sources and use oI Iund Ior the halI
year ended.
Borrowers with a credit limit oI more than1 crore are required to supply the quarterly
inIormation.
The bank to Iollow up and supervise the use oI credit should properly use the inIormation
supplied by the borrower.
66
The bank must ensure that the bank credit was used Ior the purposes Ior which it is
granted, keeping in view the borrowers operation and environment.
The bank should conIirm whether the actual result is in conIormity with the expected
results. A/- 10 variation is considered normal.
The banker should be treated as a partner in the business with whom inIormation should
be shared Ireely and Irankly.
The recommendations oI the Tandon committee have been widely debated and criticized.
The bankers have Iound a diIIicult to implement the committee`s recommendations.
However, the Tandon committee has brought about a perceptible change in the outlook
and attitude oI both the banker and their customers. They have become quite aware in the
matter oI making the best use oI a scare resource like bank credit. The committee has
help in bringing the Iinancial discipline through a balanced and integrated scheme oI
bank lending. Most oI banks in India, even today continue to look at the needs oI the
corporate in the light oI recommendation oI the Tandon committee
67
CHORE COMMITTEE
INTRODUCTION
In April 1979, the RBI constituted a working group to review the system oI cash credit
under the chairmanship oI Mr. K. B. Chore, ChieI IIicer, DBCD, RBI. The main
terms oI reIerence Ior the group were to review the cash credit discipline and relate credit
limit to production.
RECOMMENDATION OF CHORE COMMITTEE: -
Bank credit: -
Borrower should contribute more Iunds to Iinance their working capital requirement and
reduce their dependence on bank credit. The committee suggested placing the second
method of lending as explain in the Tandon committee report.
In case the borrower is unable to comply with this requirement immediately, he would be
granted excess borrowing in the Iorm oI working capital loan (WCTL).
The WCTL should be paid in seamy annual installments Ior a period not exceeding 5
years and a higher rate oI interest than under the cash credit system would be charged.
This procedure should apply to those borrowers, having working capital requirements oI
more than Rs 10 lacs.
68
LEVEL OF CREDIT LIMIT
Bank should appraise and Iix separate limits Ior the 'peak level and normal 'non pick
level credit requirements Ior all borrowers in excess oI Rs. 10 lacs indicating the
relevant periods.
With the sanctioned limits Ior these two periods, the borrower should indicate in advance
his need Ior Iunds during the quarter. Any deviation in utilization oI Iunds Beyond 10
should be considered irregular and is subject to penalty Iix by the RBI (2 p.a. over the
normal rate)
Bank should discourage ad hoc or temporary credit limits. II sanction under exceptional
circumstances the same should be given in the Iorm oI a separate demand loan and
additional interest oI at least 1 should charged.
Lending system:
The system oI three types oI lending should continue i.e. cash credit loan and bills
wherever possible; the bank should replace cash credit system by loan and bills.
Bank should scrutinize the cash credit accounts oI large borrowers one`s a year.
BiIurcation oI cash credit account into demand loan Iluctuating cash credit component, as
recommended by the Tandon committee should discontinue.
69
Advances against books debts should be converted to bills wherever possible and at least
50 oI cash credit limit utilize Ior Iinancing purchases oI raw material inventory should
also be charged to the bill system.
Information System
The discipline relating to the submission oI Quarterly Statements to be obtained Irom
the borrower should be strictly adhered to in respects oI all borrowers having working
capital limits oI more than Rs.50 lacs.
II the borrower does not submit report within the prescribed time, he should be penalized
by charging a penal rate oI interest, which is 2 p. a. more than the contracted rate.
Banks should insists the public sector undertakings and large borrower to maintained
control accounts in their books to give precise data regarding their dues to the small units
and Iurnish such data in their quarterly reports.
Other recommendations:
Request Ior relaxation oI inventory norms and Ior ad hoc increases in limits should be
subjected by banks to close scrutiny and agreed only in exceptional circumstances.
Delays on the part oI the banks in sanctioning credit limits should be reduced in cases
where the borrowers cooperate in giving the necessary inIormation about their past
perIormance and Iuture projection in time.
70
Autonomous institutions on the lines oI the discount houses in U.K may be set up to
encourage the bill system oI Iinancing and to Iacilitate all money operations.
There should be a 'cell attached to the chairmen`s oIIice at the central oIIice oI each
bank to attend to matters like immediate communication oI credit control measures at the
operational level.
The central oIIices oI bank should take a second look at the credit budget as soon as
changes in the credit policy are announced by the RBI and they should revised their plan
oI action in the right oI new policy and communicate the corrective measures at the
operational levels at the earliest.
Bank should give particular attention to monitor the key branches and critical accounts.
The communication channels and system and procedures with in the banking system
should be toned up so as to ensure that minimum time is taken Ior collection oI
instruments.
71
FINANCIAL RATIOS
CURRENT RATIOCURRENT ASSET/ CURRENT LIABITIES
Help to measure liquidity and Iinancial strength, indication oI availability oI current
assets to pay current liabilities. The higher the ratio betters the liquidity position.
Generally it should be at least 1.33.
TOL/TNWTOL/TANGIABLE NET WORTH
Indicate size oI stakes, stability and degree oI solvency. Indicates how high the stake oI
the creditors is. Indicate what proportion oI the company Iinance is represented by the
tangible net worth. The lower the ratio, greater the solvency. Anything over 5 should be
viewed with concern.
The ratio should be studied at the peak level oI operations.
OPERATING PROFIT RATIOOPERATING PROFIT/NET SALES100
This ratio indicates operating eIIiciency. Indication oI net margin oI proIit available on
Rs. 100 sales. Trend Ior company over a period should be encouraging.
72
DSCR(DEBT SERVICE COVERAGE RATIO)DEPRICIATION+INTREST ON
TERM LOAN/ INTREST ON TERM LOAN+INSTALLMENT OF TERM LOAN
It indicates the number oI times total debt service obligation consisting oI interest and
repayment oI the principal in installment is covered by the total Iund available aIter taxes.
With the help oI this ratio (popularly known as DSCR), we can Iind out whether the loan
taken Ior acquisition oI Iixed assets can be rapid conveniently.
This ratio oI 1.5 to 2 considered adequate.
We have already touched upon depreciation as non cash expenditure and since the Iunds
are available with the enterprise to that extent. It is in order to ask Ior this sum in
reduction oI loan.
INTEREST COVERAGE RATIOEARNINGS BEFORE TERM LOAN AND
TAXATION / INTEREST ON TERM LOAN
The ratio indicates adequacy oI proIit to cover interest. Higher the ratio more is the
security to the lender.
73
Analysis & Interpretation of the data
Case studies
Case study 1:
Comparative Balance Sheet and PerIormance / Financial Indicators:
Abridged Balance sheet
(Rs in lacs)
Liabilities 31.03.04 31.03.05 31.03.06 Assets 31.03.04 31.03.05 31.03.06
Audited Audited Prov. Audited Audited Prov.
Capital 17.53 18.41 84.84 FA 23.15 26.64 150.73
Reserves Depr. 5.85 6.38 21.42
NW 17.53 18.41 84.84 Net Block 17.30 20.26 129.31
TL 12.43 15.98 2.98 Cash &
Bank
1.47 0.84 2.51
Unsec Ln RM
TL Irom
BM
2.46 81.46 WIP
TL(car) 1.76 1.88 0.38 FG 12.77 16.53 15.00
Scred Rec- Dom 8.18 12.01 35.13
Bk Borr 9.11 13.08 15.00 Export
CL 0.09 0.15 CA 1.19 2.32 2.71
TCL 9.20 13.23 15.00 TCA 23.61 31.70 55.35
Inv
Tot NCA
Acc Loss
Tot.Intang
Ass.
Tot Liab 40.91 51.96 184.66 Tot Ass 40.91 51.96 184.66
31.03.2004 31.03.05 31.03.06
* Net Worth 17.53 18.41 84.84
Less: Revaluation Reserves - - -
Less: Intangible Assets - - -
Tangible Net Worth 17.53 18.41 84.84
74
PERFRMANCE / KEY FINANCIAL INDICATRS: (Rs in Lacs)
Particulars 31.03.04 31.03.05 31.03.06
Net Sales
Increase / Decrease
56.11
71.1
95.70
70.55
180.00
88
Net ProIit AIter Tax
to Net Sales
0.57
1.01
0.89
0.93
8.62
4.79
Cash Accruals 6.42 7.28 30.04
TNW excl Revaluation Reserve 17.53 18.41 84.84
TL / TNW Ratio 1.33 1.82 1.18
NWC 14.41 18.47 40.35
Current Ratio 2.57 2.40 3.69
1. Sales: As partners have been engaged in marketing the new technology to various
users Ior the initial 2/3 years vigorously and their eIIorts are started yielding results.
During the year 2005 the Iirm has obtained approval Irom BHEL, NTPC, and HAL Ior
use oI its products DSC & ESC. Agreement with NTPC through BHEL (Haridwar) is
exclusive supply (not to any other companies) Ior annual turnover oI Rs. 250.00 Lacs.
The orders are oI repetitive nature. Besides BHEL (Hyd) have also started placing sample
orders. The Iirm has also been able to secure orders Irom HAL (Koraptut) Ior DSC &
ESC.
During the year up to Nov`05 the Iirm has already done sale oI Rs. 100.00 lacs besides
the job work. rders worth Rs. 150.00 lacs Irom BHEL (Haridwar) are on hand
scheduled to be completed beIore March`06. Completion oI this oI these orders will
enable the Iirm to achieve a sale oI Rs. 250.00 lacs by this year end. This is acceptable.
2. Profit: Hitherto the net proIit in terms oI sales has been about 1.00. Against this
backdrop the estimated proIitability oI 4.79 in the current appears unreasonable. During
discussion it is clariIied that as the Iirm has shiIted its Iocus Irom mare job work to direct
75
selling the margin will be high. In Iact it has set up its own machining plant and has
secured approval Irom BHEL Ior the Quality oI its own materials.
It used to pay Ior job works to other companies/Iirms Ior the machining purpose. This
payment was to the tune oI 25 (appx) oI the job work revenue. For the year 2005 as the
job work is being done in-house the expenses are estimated to be hardly 5. Besides,
margin oI direct selling oI its materials is better. Moreover with increased sales the
marginal revenue would be proportionately high adding to the increased yield. In view oI
the above Iactors we may accept the proIitability estimates made by the Iirm. In the
coming 7 years the Iirm has estimated proIitability ranging Irom 8.5 to 12.5. This
appears to be on the higher side. As the sales are estimated to stabilize at Rs. 312.00 lacs
we may accept the proIitability oI 4.79 as acceptable Ior the year 2005. Accordingly the
net proIit Ior the 2nd year would be Rs. 13.70 lacs and then Rs. 14.95 lacs p. a.
3. Cash Accrual: With addition to Iixed assets the depreciation shall be high. Thus with
accepted proIitability the accrual would be Rs. 30.00 lacs Ior the year 2005 Iollowed by
Rs. 32.03 lacs, Rs. 30.62 lacs respectively. The position is acceptable.
4. TNW: Up to 2004-05 the TNW has been increasing with retention oI proIits. In the
year 2005 Ior the expansion plan the partner have agreed in bring in additional capital oI
Rs. 46.00 lacs, Remaining Rs 20.00 lacs Irom internal accrual. We have discussed the
issue oI inIusion oI capital by partners. It is inIormed that depending upon the advice oI
their auditors they would be either increasing the amount oI individual capital and/or
brings in unsecured loans Irom Iriends/relatives to be converted to capital over a period
oI time. Since the existing work is being carried out Irom their own sources the branch is
advised to obtain a CA`s certiIicate certiIying the amount investing that will be
76
considered as their contribution. Since the cash accrual Ior the year 2005 is accepted at
Rs. 30.00 lacs the remaining contribution oI Rs. 20.00 lacs Irom partners appears
reasonable.
5. TOL/TNW: The ratio has been below 2.00 up to 31.03.05 and with proposed capital
inIusion the same is estimated to be about 1.18 which is acceptable being well within
benchmark level.
6. NWC & C. R.: Both the parameters have been well above their respective benchmark
levels and are estimated to improve Iurther over the existing levels. It may be mentioned
that even though the Iirm is increasing its production capacity and consequently sales it
has not requested any additional working capital. During discussion it is gathered that
with direct selling the payment term would be 90 against supply oI materials which
would improve its cash Ilow and hence there will not be additional requirement oI
working capital. However the partners have inIormed that aIter the expansion is
completed in March 06 they may approach us Ior additional working iI required at that
point oI time.
Thus the overall Iinancial position oI the Iirm is satisIactory.
Assessment of present proposal: -
A. Working capital assessment:
A. Comments on: -
i. Sales projections: Already discussed.
ii. Inventory & receivables: Except the receivables the Iirm has estimated other current
asset as per past trend and hence acceptable. The holding level oI receivables has
been 1.5 month to 1.75 months sales. For the current year it has estimated the same to
77
be 2.33 months. It is clariIied that as the Iirm would be executing Rs 150.00 lacs
worth oI orders Irom BHEL in next 4 months ( At least Rs 80.00 lacs as accepted by
us) there will be concentration oI debtors at the year end. Hence the estimates appear
reasonable. Creditors have been nil and are estimated to be nil too.
Against this background PBF is calculated as under.
B. Working of MPBF: -
WRKING F MAXIMUM PERMISSIBLE BANK FINANCE: (Rs in lacs).
Particulars 31.03.04
Audited
31.03.05
Audited
31.03.06
Projected
a. Total current assets 23.61 31.70 55.35
b. CL Excl. short term BB 0.09 0.15 -
c. Working Capital Gap(a-b) 23.52 31.55 55.35
d. Min. Stipulated NWC
(25 oI TCA)
5.90 7.93 13.84
e. Actual/Projected NWC 14.41 18.47 40.35
I. Item c-d 17.62 23.62 41.51
g. Item c-e 9.11 13.08 15.00
h. MPBF 9.11 13.08 15.00
i. excess borrowings iI any - - -
78
Case Study 2:
Comparative Balance Sheet and PerIormance / Financial Indicators:
Bridged Balance Sheet:
(Rs in lacs)
Liabilities 31.03.04 31.03.05 31.03.06 Assets 31.03.04 31.03.05 31.03.06
(Audit) (Audit) (Estm) (Audit) (Audit) (Estm)
Capital 27.77 36.30 41.42 Net Block 3.10 2.45 1.71
Unsec Ln 1.00 1.00 5.00 Advance/Deposits
(NCA)
0.34 0.34 1.09
Term
Loan
1.18 0.68 - Sundry Debtors 24.17 28.59 58.69
Sundry
Creditors
1.15 13.87 11.71 Stock 34.52 59.92 70.36
Bank
Borrowing
29.75 45.80 100.00 Recurring Dep 0.75 1.53 1.60
Chits 6.20 - - Cash 2.74 2.30 3.21
ther
liabilities
1.63 4.24 3.86 CA 3.06 4.14 25.33
Chits - 2.62 -
Total 68.68 101.89 161.99 Total 68.68 101.89 161.99
31.03.2004 31.03.05 31.03.06 31.03.07
Net Worth 27.77 36.30 41.42 48.04
Less: Revaluation Reserves - - - -
Less: Intangible Assets - - - -
Tangible Net Worth 27.77 36.30 41.42 48.04
PERFRMANCE / KEY FINANCIAL INDICATRS: (Rs in Lacs)
Particulars 31.03.04
(audited)
31.03.05
(audited)
31.03.06
(estimated)
31.03.07
(projected)
Net Sales
Increase / Decrease
720.26 1126.16
56
1749.64
55
1866.08
6.63
Net ProIit AIter Tax 0.41 0.25 0.23 0.23
Cash Accruals 3.87 3.51 4.81 4.74
TNW excl Revaluation Reserve 27.77 36.30 41.42 48.04
TL / TNW Ratio 1.47 1.81 2.91 2.49
79
NWC 26.51 35.19 43.62 50.79
Current Ratio 1.68 1.55 1.38 1.44
Net Sales: The Iirm deals in the products oI Hindustan Lever Ltd and Bharti Tele Ltd
(Airtel). The estimated sale Ior 2004-05, as per last review, was Rs. 1405 lacs, with a
growth oI 95 over previous year. However the actual sales were Rs. 1126 lacs, with a
growth oI 56. Achievement is 80. In this connection, the Iirm has inIormed that the
estimated growth oI 20 in Hindustan Lever products could not be achieved and hence
the variation. This is due to policy changes contemplated by HLL to reduce the no. oI
dealers as well as product consolidation.
For the year 01.04.05 to 31.01.06, the Iirm has estimated a sale oI Rs. 1749.64 lacs and
Ior the next year, projected a sale oI Rs. 1866.08 lacs. Till September 05, the Iirm was
dealing in detergents, Lakme products oI Hindustan Ltd and the products oI Airtel. From
ctober 05, the Iirm added the business oI personal oI Hindustan Lever Ltd. The
perIormance oI the Iirm during the year 01.04.05 to 31.01.06 is as under:
Detergent oI Hindustan Lever Ltd : Rs. 536 lacs
Lakme oI Hindustan Lever Ltd : Rs. 135 lacs
Personal products oI HLL : Rs. 121 lacs (ct 05 to Jan 06)
Airtel : Rs. 642 lacs
Total : Rs. 1434 lacs
Considering the actual sale oI Rs. 1434 lacs in the Iirst ten months the estimated sales oI
Rs. 1750.00 lacs during the current year appears reasonable. As per the estimate, the
80
growth in sales during the year 05-06 is 55 compared to 04-05. in this connection, the
Iirm has inIormed that they were allotted more areas/jurisdiction by Hindustan Lever Ltd.
For the next year, the Iirm has projected a sale oI Rs. 1866 lacs, with the break up oI sales
as under:
Detergent oI Hindustan Lever Ltd : Rs. 602 lacs (12.3 growth)
Lakme oI Hindustan Lever Ltd : Rs. 168 lacs (24)
Personal products oI HLL : Rs. 388 lacs (7 annualized)
Airtel : Rs. 708 lacs (10.28)
Total : Rs. 1866 lacs
The growth oI the sale projected Ior the next year is around 7. The estimated/projected
sales, appears achievable in view oI the perIormance oI the Iirm in the past and during
the year till Jan 06.
Net Profit: The Iirm has been earning proIits consistently, but the margin is very thin.
During 2004-05 the proIitability Iurther dropped as compared to its previous year mainly
due to competitive pricing in the consume/personal goods segments oIIered by various
companies. The proIitability has been between 0.25 in 2004-05 and is estimated to be
0.23 in the year 2005-06 Iollowed by similar trend in the next year. The trend is
estimated/projected to continue. Hence it is acceptable.
Tangible Net Worth: The Iirm has been maintaining the TNW at a satisIactory level.
Major portion oI the proIits are retained in the business. During the year 2005-06 the Iirm
has proposed to inIuse additional capital oI Rs. 2.00 lacs Iollowed by Rs. 4.00 lacs in the
next year. The position is acceptable.
81
TOL/TNW: The ratio has been consistently below the bench mark level. However
compared to the previous years, the present level estimated/projected is higher in view oI
view oI the additional borrowings Ior the increased turnover. However the same is still
below the bench mark.
Net Working Capital: The Iirm has been maintaining NWC at more than 25 oI TCA
level which is above the stipulated bench mark and is estimated to well within the bench
mark too. The Iirm has proposed inIusion oI addition unsecured loan oI Rs. 4.00 lacs to
improve the NWC position. A suitable certiIicate Irom the CA is to be obtained to this
eIIect. An undertaking is to be obtained not to repay this unsecured loan during current oI
our credit Iacilities.
Current Ratio: The Iirm has been maintaining current ratio at a satisIactory level.
Through the estimated level Ior the year 2005-06, is slightly lower compared to year
2004-05 it is still above the bench mark level.
Thus overall Iinancial position is satisIactory.
Assessment oI Proposal:
A. Working capital assessment
Comments on:
i. Inventory:
As per past trend, the level oI stocks held by the Iirm is between 18 days
to 20 days during last tow years and the same is estimated to be 15 days in this
year 2005-06. This being an improvement over the past years is acceptable.
ii. Receivables:
82
As per past trend, the level oI credit allowed by the Iirm is between 0.30 to
0.40 month`s sales. However the Iirm estimated/projected a higher level oI
0.54 month`s sale this level appears on the higher side and thereIore bank
recast the Iigures oI receivables with a 0.40 month`s sales. Accordingly the
acceptable level oI debtors would be Rs. 58.50 lacs.
iii. ther Current Assets:
The current assets include cash and bank deposits (RD). The
estimated/projected level oI these assets is in conIormity with the earlier
levels.
ther than the above, the Iirm has another current asset in the Iorm oI
Claims Receivable`. These are amount receivables Irom M/s Hindustan Lever
Ltd Ior any breakage in stock supplied. Till year 2004-05 the level was quite
on lower side oaround Rs. 3 to 4 lacs. However during the year 2005-06 and
2006-07, the Iirm has estimated/projected a higher level oI Rs. 25 lacs and Rs.
30 lacs respectively. In this connection the Iirm has inIormed that present
outstanding claims receivable Irom Hindustan Lever Ltd is around 25 lacs and
the level is likely to continue. The branch is to obtain a CA`s certiIicate in this
regard.
iv. Sundry Creditors:
The Iirm is reportedly not getting any credit Irom either Hindustan Lever
Ltd oI Airtel. However the Iirm has estimated/projected a level oI Rs. 11 lacs
Ior miscellaneous credits. The level is in conIormity with the past trend.
v. ther Current Liability:
83
The other current liabilities include provisions Ior expenses and taxation.
The estimated/projected level is in conIormity with the past trend.
vi. Method Lending:
The method oI lending is based on build up oI current assets and
liabilities, with second method oI lending.
vii. Comments on NWC:
The estimated/projected NWC is adequate to meet the margin requirement
oI working capital.
B. Working oI MPBF:
Particulars 31.03.04
(audited)
31.03.05
(audited)
31.03.06
(Estimated)
31.03.07
(Projected)
A Total Current Assets 65.24 99.10 159.19 165.60
B TCL (except bank borrowings) 8.98 18.11 15.57 14.81
C Working Capital Gap 56.26 80.99 143.62 150.79
D Minimum stipulated margin (25
oI TCA)
16.31 24.78 39.80 41.40
E Actual/ estimated NWC 26.51 35.19 43.62 50.79
F Item (c-d) 39.95 56.21 103.82 109.39
G Item (c-e) 29.75 45.80 100.00 100.00
H MPBF (lower oI above two) 29.75 45.80 100.00 100.00
I Excess borrowings, iI any - - - -
84
Case Study 3:
Comparative Balance Sheet and PerIormance / Financial Indicators:
(Rs in lacs)
Liabilities 31.03.04 31.03.05 31.03.06 Assets 31.03.04 31.03.05 31.03.06
Audited Aud Estm Audited Aud Estm
Capital 16.20 17.20 17.20 FA 30.59 46.97 64.37
Reserves 4.70 4.82 15.10 Depr. 6.63 12.26 21.25
DeI tax 0.27 2.15 2.10
NW 21.17 24.17 34.40 Net
Block
23.97 34.71 43.12
TL 1.92 8.99 10.66 Cash
&
Bank
5.34 6.02 6.77
Unsec Ln 14.16 18.17 16.71 RM
TL WIP
TTL 16.08 27.16 27.37 FG 10.64 11.33 24.50
Scred 3.49 6.06 Rec-
Dom
7.23 12.70 40.80
Bk Borr 25.00 Export
CL 9.36 12.80 36.00 CA 2.82 2.49 4.64
TCL 12.85 18.86 61.00 TCA 26.03 32.54 76.71
Inv
th
NCA
- 2.86 2.86
Tot
NCA
Acc
Loss
th
Intang
Ass.
0.10 0.08 0.08
Tot Liab 50.10 70.19 122.77 Tot
Ass
50.10 70.19 122.77
31.03.2004 31.03.05 31.03.06
* Net Worth 21.17 24.17 34.40
Less: Revaluation Reserves
Less: Intangible Assets 0.10 0.08 0.08
Tangible Net Worth 21.07 24.09 34.32
85
PERFRMANCE / KEY FINANCIAL INDICATRS: (Rs in Lacs)
Particulars 31.03.04 31.03.05 31.03.06
Net Sales
Increase / Decrease
75.35
69.36
61.21
-ve
204.00
Net ProIit AIter Tax
to Net Sales
3.15
4.18
2.00
3.28
10.29
5.04
Cash Accruals 6.03 7.63 19.29
TNW excl Revaluation Reserve 21.07 24.09 34.32
TL / TNW Ratio 1.37 1.91 2.57
NWC 13.18 13.68 15.71
Current Ratio 2.02 1.73 1.26
Comments:
1. Sales: Sales mean service charges/ consultancy Iees received Ior the NDT inspection
and course Iees received Ior its various training programs on NDT. As mentioned earlier
the company is mainly doing NDT inspection oI oil reIineries oI Reliance Industries,
NGC, and NTPC. The consultancy Iees depend upon the volume oI machineries put
under NDT inspection. During 2004-05 the sales have declined due to this Iactor only. It
may be mentioned here that during the year the course Iees have grown by 200 whereas
consultancy Iees have declined by 65 (appx). In the year 2005-06 the company has
received contracts worth Rs 87.00 lacs Irom RIL Ior its Jamnagar Plant. The company
has estimated a sale oI Rs 204.00 lacs comprising consultancy Iee & component sale oI
Rs 180.00 lacs and training Iees oI Rs 24.00 lacs. The training Iee is slightly less than the
last year`s Iees. As on 30.11.05 the company has already booked a sale oI Rs129.00lacs.
Besides it has orders Irom small & medium companies. As such we are oI the view that
the company would be in a position to achieve a sale oI Rs150.00lacs. We may accept the
said level.
86
2. Net Profit: ProIit margins in consultancy works are comparatively more. ThereIore
with decline in consultancy Iees the proIitability has declined during 2004-05. During
2005-06 the company has estimated a net proIit oI Rs 10.29 lacs with proIitability oI
5.04. The company oIIicials have clariIied that with increased sales and without any
additional cost the marginal revenue will be more. Moreover net proIit as oI 30.11.05 as
declared by the company has been Rs. 10.10 lacs. Accordingly the estimates appear
reasonable.
3. TNW: With 100 retention oI net proIit the TNW acceptable as on 31.03.06 would be
Rs. 34.40 lacs.
4. TOL/TNW: The ratio Ior the last three years has been below the bench mark and is
expected to be so in the current year too.
5. NWC & C.R: During 2002-03 sundry creditor`s mode oI Iinancing was resorted to by
the company Ior its working Iunds and partly Ior its Iixed assets resulting in C.R. below
1.00. This imbalance is rectiIied in 2003-04 by raising capital and inIusing unsecured
loans Irom directors and others. The position as at 31.03.05 is also above the respective
bench mark. However during the current year the company proposes to add Iixed assets
Irom its internal accruals and partly out oI its existing built up oI NWC resulting in
reduction in NWC level to 20 oI the TCA. Consequently current ratio is estimated at
1.26. In Iact as the minimum acceptable NWC is 20 and current ratio is 1.25 the
87
proposed estimates can be acceptable as the purpose oI utilization oI NWC is Ior
acquiring Iixed assets required Ior business purposes only.
Thus overall Iinancial position is satisIactory.
Assessment oI Present Proposal:
A. Working Capital Assessment:
A. Comments on:
i. Sales Projections: Already dealt with elsewhere in the note.
ii. Comments on NWC: Already discussed.
Assessment:
The company had requested Ior project speciIic working capital (CC) Iacility oI Rs 25.00
lacs Ior its contract worth Rs 87.00 lacs Irom RIL which will be completed within 4
months. This job is completed. But the company is able to obtain similar contracts Irom
others like L&T, South Central railways etc in ensuing months Ior which it requires the
working capital. In Iact Ior the next year it has estimated a sale oI more than Rs. 200.00
lacs.
As at 30.11.05 the TCA level is Rs. 62.57 lacs which is 49 oI total sales as on that date.
For the current year it has estimated a TCA level oI Rs. 76.71 lacs which works out to
51 oI accepted sales level. Since the estimated level is more or less equivalent to the
actual level as on 30.11.05 we may accept the same. The company has estimated an CL
level oI Rs. 36.00 lacs which as per the actual level prevailing as on 30.11.05. This is
acceptable too. Accordingly PBF is arrived as under.
88
i. TCA level accepted Rs76.71lacs
ii. CL Rs36.00lacs
iii. WCG Rs40.71lacs
iv. Required NWC (20) Rs15.34lacs
v. Estimated level Rs15.71lacs
vi. MPBF Rs25.00lacs.
89
Conclusions
The requirement oI working capital Iinance is ever increasing.
Loans and advances Iormed a major portion oI the current assets oI the Iirm
because oI which the working capital gap is large.
The bank preIers to use the second method oI lending working capital under the
MPBF rather than evolving their own method.
In most oI the cases, hypothecation and/or mortgage are used to create securities
Ior the banks.
Bank has their own internal credit rating procedure to rate the clients (Borrowers).
AIter doing the assessment oI the Iinancial indicators it is up to the judgment oI
the top management oI the bank to sanction such loan. The very decision could be
against the assessment result.
II the company is with bank Irom inception stage then they are given preIerence,
as credible and loyal party over their Iinancial indicators.
There is a stiII competition to the nationalized banks Irom the Ioreign investors as
their lending rates are much lower than nationalized banks.
Today the Ioreign investors are very big threat to business and its existence.
Bank oI Maharashtra has kept a conservative look to banking.
90
Suggestions
Closely monitoring and inspecting the activities and stocks oI the borrowers Irom
time to time can avoid the misuse oI working capital
While working out the working capital limits, banks must exclude the loans and
advances Irom the current assets. The assessment should be done mainly stock
and the inventory level oI borrower.
Bank must extend working capital Iinance through non-Iund based Iacilities.
Another ideal method would be to use LC as the primary source oI extending,
working capital clubbed with bill discounting. This would ensure that the credit is
put to the right use by the borrower and repayment is guaranteed to the bank.
The bank must Iurther secure themselves by holding a second charge on all the
Iixed assets oI the borrower.
The time period taken by the banks to sanction the limits should be signiIicantly
reduced to allow the borrowers to make use oI the credit when the need is most
Ielt.
91
Bibliography
Books:
1. HAND BOOK ONWORKING CAPITAL FINANCE
D. P. SARDA, PUBLISHED BY S.J.D. IMPEX, MUMBAI, FURTH EDITIN
2. FINANCIAL MANAGEMENT
R. P. RUSTAGI, GALGTIA PUBLICATIN, NEW DELHI, SECND
EDITIN, 2000.
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