assecessment of working capital for borrowers account

THIS REPORT IS ONLY FOR STUDY PURPOSE IT CONTAINS INFORMATION FROM SEVERAL BOOKS AND POLICY GUIDELINES.

A Report on Assessment of Working Capital for Borrowers Account 2009

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A Project ReportOn

Assessment of Working Capital for Borrowers Account


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ReportOn

Assessment of Working Capital for Borrowers Account

This Report examines the ways in which assessment of working capital can be done and while assessing a borrowers account for working capital limits, certain features that need to be looked at and how actually assessment of working capital is been done in a bank.

ACKNOWLEDGEMENTS

TABLE OF CONTENTS

1. Introduction to Working Capital2.1 Working capital in terms of five components

3. Two Different Concepts of Working Capital3.1 Balance sheet or Traditional concept


3.2 Operating cycle concept

4. Working Capital Finance4.1 Sources of Working Capital.4.2 Types of Working Capital Finance

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

5.1 Application Forms for Financial Assistance: 5.2. Receipt of applications and acknowledgment5.3. Register of Credit Applications Received5.4. Time norms for disposal of loan applications:

6. Financial Ratios for Credit Appraisal

7. Methods for calculating Working Capital Limits 7.1 Turnover Method

7.1.1 Information on Nayak Committee for SSIs7.2 Cash Budget System7.3 Committee Recommendations

7.3.1 Tandon Committee on Follow-up of Bank Credit

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

9. Check-List for verification of the information/Data.9.1 Utilization of Existing Limits 9.2 Operating Statement 9.3 Analysis of Balance Sheet9.4 Computation of maximum Permissible Bank Finance 9.5 Funds-Flow Statement

10 Fixation of Find-based and Non-fund based Limits10.1 Bank Finance for Payment of Bonus

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11 Case Study on Assessment of Working Capital11.1 Background of company:11.2 Working Capital Assessment

11.2.1Utilization of Existing Limits11.2.2Working Result of The company11.2.3Financial position of the company11.2.4Current Assets and Current Liabilities11.2.5Assessment of working Capital

1. INTRODUCTION TO WORKING CAPITAL

“Working capital means the part of the total assets of the business that change from one form to another form in the ordinary course of business operations.”

The word working capital is made of two words

1. Working and

2. Capital

The word working means day to day operation of the business, whereas the word capital means monetary value of all assets of the business.

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Working capital may be regarded as the life blood of business. Working capital is of major importance to internal and external analysis because of its close relationship with the current day-to-day operations of a business. Every business needs funds for two purposes. Long term funds are required to create production facilities through purchase of fixed assets such as plants, machineries, lands, buildings etc and Short term funds are required for the purchase of raw materials, payment of wages, and other day-to-day expenses.. It is otherwise known as revolving or circulating capital It is nothing but the difference between current assets and current liabilities.

Working Capital = Current Asset – Current Liability.

2.1 Working capital in terms of five components:

(i) Cash and equivalents: -

This most liquid form of working capital requires constant supervision. A good cash budgeting and forecasting system provides answers to key questions such as: Is the cash level adequate to meet current expenses as they come due? What is the timing relationship between cash inflow and outflow? When will peak cash needs occur? When and how much bank borrowing will be needed to meet any cash shortfalls? When will repayment be expected and will the cash flow cover it?

(ii) Accounts receivable: -

Many businesses extend credit to their customers. If you do, is the amount of accounts receivable reasonable relative to sales? How rapidly are receivables being collected? Which customers are slow to pay and what should be done about them?

(iii) Inventory: -

Inventory is often as much as 50 percent of a firm's current assets, so naturally it requires continual scrutiny. Is the inventory level reasonable compared with sales and the nature of your business? What's the rate of inventory turnover compared with other companies in your type of business?

(iv) Accounts payable:-

Financing by suppliers is common in small business; it is one of the major sources of funds for entrepreneurs. Is the amount of money owed suppliers reasonable relative to what you purchase? What is your firm's payment policy doing to enhance or detract from your credit rating?

(v) Accrued expenses and taxes payable: -

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These are obligations of your company at any given time and represent a future outflow of cash

3. TWO DIFFERENT CONCEPTS OF WORKING CAPITAL ARE:-

Balance sheet or Traditional concept

Operating cycle concept.

3.1 Balance sheet or Traditional concept

It shows the position of the firm at certain point of time. It is calculated in the basis of balance sheet prepared at a specific date. In this method there are two type of working capital (i) Gross working capital and (ii) Net working capital

(i) Gross working capital:- It refers to the firm’s investment in current assets. The sum of the current assets is the working capital of the business. The sum of the current assets is a quantitative aspect of working capital. Which emphasizes more on quantity than its quality, but it fails to reveal the true financial position of the firm because every increase in current liabilities will decrease the gross working capital.

Gross Working Capital = Total of Current Asset

(ii) Net working capital:- It is the difference between current assets and current liabilities or the excess of total current assets over total current liabilities.

Working capital= current assets - current liabilities.

Net working capital: - It is also can defined as that part of a firm’s current assets which is financed with long term funds. It may be either positive or negative. When the current assets exceed the current liability, the working capital is positive and vice versa.

3.2 Operating cycle concept:-

The duration or time required to complete the sequence of events right from purchase of raw material for cash to the realization of sales in cash is called the operating cycle or working capital cycle.

The day to day business operations of a concern of any nature and, size involves many successive steps and final working results would depend on the effective combination of all these steps. The steps in general may include.

Acquisition and storage of raw material and other stores and spares required for manufacture of any product.

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Actual production process when the raw material is subjected to different processes to bring it to final shape of finished goods.

Storage of finished goods awaiting sales.

Sales of finished goods and realisations of sale proceeds.

We start from cash to buy raw material etc. and after completing all the steps end up with the cash. The intervening period required for completion of this entire process is the 'Operating Cycle'. The operating cycle may thus be defined as the intervening period from the time the goods or services enter the business till their realisation in cash. The study of this operating cycle is obviously very important as the actual requirement of the unit may be limited to the funds required to complete an operating cycle and the simplest formula for the working capital requirement may be represented as under:

Total working capital requirement = Total operating expenses expecting during the year No. of operating cycles in a year

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This system of calculation of working capital requirement is not in vogue as it only helps to assess the total requirement of a unit whereas the banks granting working capital limits would be interested in proper classification of its various components. The concept of operating cycle, however, throws light on various components of working capital required for the unit and these components may be classified as under:

Raw material stores and spares consumed in the production process. The unit must have some stocks of these items for uninterrupted production.

Manufacturing expenses such as wages, power and fuel etc. to be incurred during the process of manufacture.

Stocks of work-in-process/semi finished goods maintained by the unit to complete an operating cycle.

Stocks of finished goods awaiting sale. All the finished goods may not be immediately sold.

Administrative and selling expenses during this process.

Bills receivable/debtors for credit sales.

4. Working Capital Finance

4.1 Sources of Working Capital.Working Capital is financed by following sources:

Owned Fund:- A portion of long term funds, equity share capital and reserves & surplus is utilized to fund working capital

Bank Borrowing :- Various bank products like cash credit, packing credit, bills discounting etc.

Creditors :- Creditors of raw materials , suppliers etc.

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4.2 Types of Working Capital Finance

Cash Credit :- A cash-credit is an arrangement to extend short term working capital facility . Under the system, bank sanctions a limit called the cash-credit limit to each borrower upto which he is allowed to borrow against the security of stipulated tangible assets i.e. stocks, book debts etc.

Drawing against Un-Cleared effects (DAUE) :- When a customer wishes to draw cheques against unclear balance i.e. against the cheques deposited in his current account, sent for clearing but not yet realised, then the bank may allow payment of

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such cheques. It is allowed only to first class parties who maintain satisfactory and well conducted current accounts at the branch.

Working Capital loan :- This refers to the working capital limit of a borrower extended to him in the form of a loan. The loan component covers the permanent part of the working capital need while cash credit component caters to the fluctuating part of the limit.

Bills Financing :- Bills are negotiable instruments that the buyer (drawee) agrees to pay the drawer/ payee the value of the goods after a specified period of time. A seller of goods draws a bill of exchange (drawer) on buyer (drawee). Such bills can be routed through the banker of the seller to the banker of the buyer for effective control.

Letter of credit :- A binding document that a buyer can request from his bank in order to guarantee that the payment for goods will be transferred to the seller. Basically, a letter of credit gives the seller reassurance that he will receive the payment for the goods.

Bank Guarantee :- It is a contract to perform the promise or discharge the liability of a third person in case of his default.

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

Export Financing :- The Export Financing for the working capital is designed to provide short-term working capital to exporters.

Factoring :- The selling of a company's accounts receivable , at a discount, to a factor, who then assumes the credit risk of the account debtors and receives cash as the debtors settle their accounts.

Inter-corporate Deposits :- It involves movement of funds from funds-surplus companies to credit worthy corporate borrowers. The critical factor here is the rapid response time. The period of deposit varies from purely on call and to 180 days.

As the cost of funds for a corporate in much higher than a bank, the rates in this market are higher than those in the other markets.

Commercial Papers :- These are short term unsecured promissory notes issued by firms with a high credit rating at a discount to the face value. The maturity varies from 15 days to a year.

These are issued mainly by the corporate businessmen to fund their working capital needs.

5. COMMON GUIDELINES/INSTRUCTIONS FOR LENDING TO SME SECTOR IN BANK OF BARODA:

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5.1 Application Forms for Financial Assistance:

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

I. Application form for credit facilities upto Rs.10/- lacs. II. Application form for credit facilities of over Rs. 10/- lacs and upto Rs.50/-

lacs. III. Application form for credit facilities of over Rs. 50/- lacs and upto Rs. 2/-

crore. IV. Application form for credit facilities over Rs. 2/- crore.

Application forms as aforesaid are devised for assistance by way of either term loans or working capital or both and are applicable to new projects, expansion, diversification and modernisation of existing projects. Bank is in process of devising application forms for ME units and will be provided to the branches on its approval by the competent authorities. In the meantime, above forms may be used for ME units also.

5.2. Receipt of applications and acknowledgment

With a view to facilitate timely sanction of adequate credit facilities, the following guidelines have been issued to the branches:

An acknowledgment with the date of receipt for credit application received to be given. A definite date to be intimated to the applicant for discussions, clarifications etc. if considered necessary.

The bank’s decision regarding credit assistance to be communicated to the applicant within the prescribed period.

5.3. Register of Credit Applications Received

All applications received should be entered in a “Register of Loan Applications Received” for recording therein the complete particulars such as date of sanction, rejection, reasons for rejection etc.

5.4. Time norms for disposal of loan applications:

In order to provide better customer service and to ensure that applications for loans for all categories of borrowers are dealt with and disposed off expeditiously, the following norms shall be adhered to, provided the loan applications received are complete in all respects and duly accompanied by a check list.

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In respect of loans upto Rs.25,000/- within a maximum period of one week of receipt of loan applications complete in all the respects and duly accompanied by a check list.

In respect of other cases for loans above Rs.25,000/- and upto Rs.5.00 lacs, within a maximum period of two weeks on receipt of duly completed loan applications in all the respects and accompanied by a checklist.

In respect of loans over Rs. 5.00 lacs, within a maximum period of 4 weeks on receipt of duly completed loan applications in all respects and accompanied by a check list.

In respect of credit applications processed at SME loan Factories, it should be disposed off within 14 working days on receipt of full information if no TEV study is required and within 21 working days on receipt of full information if TEV study is required.

6 . FINANCIAL RATIOS FOR CREDIT APPRAISAL

Following ratios can be accepted for granting credit facilities to SME units falling as per regulatory guidelines or SMEs as per expanded coverage.

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The above ratios are indicative and deviations can be considered by the sanctioning authority / competent authority on case-to-case basis, depending on industry specific problems of unit, etc.

7.Methods for calculating Working Capital Limits:

Presently, the following guidelines are in place for financing Working capital facilities of SME units:

7.1 Turnover Method

The credit requirements of village industries, Micro Enterprises, Small Enterprises and Medium Enterprises having aggregate fund based working capital limits upto Rs.5.00 crores from the banking system, will be computed on the basis of a minimum of 20 % of their acceptable projected annual turnover for new as well as existing units as per Nayak Committee recommendations.

Working Capital Requirement = 25% of Turnover

Promoter Contribution (Margin) = 5% of Turnover

Bank Finance = 20% of Turnover

Proposed by The Nayak Committee

Used for assessment of working capital needs of small trading companies

Not appropriate for manufacturing and big trading companies

7.1.1 Information on Nayak Committee for SSIsConsidering the contribution of the SSI sector to the overall industrial production, exports and employment and also recognising the need to give fillip to this sector, a special package of measures was devised by RBI (during April 1993) to ensure adequate and timely credit to this sector. While doing so the recommendations of the PR Nayak committee were taken into account. Examination of bank finance profile of working capital to the small scale sector by the committee has revealed that this sector as a whole received a level of working capital which was only 8.1% of the its output. The village industries and the smaller tiny industries among them could get working capital finance to the extent of only about 2.7% of their output.

The salient features :

Banks have been advised to give preference to village industries, tiny industries and other small scale units in that order, while meeting the credit requirements of small scale sector.

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The banks should step up the credit flow to meet the legitimate requirements of the SSI sector in full during the 8th 5-year plan. For this purpose the banks should draw up annual credit budget for the SSI sector on a bottom-up basis. Each branch of the banks should prepare an annual budget in respect of working capital requirements of all SSIs before the commencement of the year. Such budgeting should cover (a) functioning units which already have borrowing limits with the branch (b) new units and units whose proposals are under appraisal and (c) sick units under nursing and also sick units found viable after discussion/ feedback received from the borrowing units. The budget should take into account, among other relevant aspects, normal sale growth, price rise during the past year, anticipated spurt in business etc.

It is desirable that a single financing agency meets both the requirement of the working capital and term credit for small scale units. The Single Window Scheme of SIDBI enables the same agency SFC or commercial bank, as the case may be, to provide term loans and working capital to SSI units having a project outlay upto Rs. 20 lac and working capital requirement upto Rs. 10 lac. The banks have been advised to adopt this approach.

At present norms for inventory and receivable are applicable to all units enjoying aggregate fund based working capital credit limits of Rs. 10 lac and above from the banking system. Units enjoying limit of Rs. 10 lac and above but upto Rs. 50 lac are subject to the 1st method of lending. Henceforth for the credit requirements of village industries, tiny industries and other SSI units having aggregate fund-based working capital credit limits upto Rs. 50 lac (subsequently raised to Rs. 1 crore and Rs. 200 lac during April 1997, to Rs.400 lac during August 1998 and further to Rs.500 lac during May 1999) from the banking system, the norms for inventory and receivables and also the 1st method of lending will not apply. Instead such units may be provided working capital limits computed on the basis of a minimum of 20% of their projected annual turnover for new as well as existing units.

The banks may satisfy themselves about the reasonableness of the projected annual turnover of the applicant on the basis of annual statements of account or any other documents such as returns filed with sales-tax/revenue authorities and also ensure that the estimated growth during the year is realistic. These SSI units would be required to bring in 5% of their annual turnover as margin money. In cases where output exceeds the projections or where the initial assessment of working capital is found inadequate, suitable enhancement in the working capital limits should be considered by the competent authority as and when this is deemed necessary. Drawals against the limits should be allowed against the usual safeguards so as to ensure that the same are used

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for the purpose intended. Banks will have to ensure regular and timely submission of monthly statements of stocks, receivables etc. and also periodical verification of such statements vis-a-vis physical stocks.

The banks can lend on the basis of 1st method of lending to those units (companies/ organisations) which are engaged in marketing/trading of products of SSI, village and cottage and tiny sector units. This would be subject to the condition that 100% dealing is with the above mentioned products. If there are dealings with other products also, then the relaxation of application of 1st method of lending will be only to that portion of the marketing business relating to products manufactured by above category of units. It is also a condition that dues of such units are settled by such borrowers within a maximum period of 30 days from date of supply and it is to be certified by the statutory auditors of the borrowing units on a quarterly basis.

Action on Nayak Committee recommendations by RBI:

Banks should take immediate steps to ensure full adherence in letter and spirit by all their branches and controlling offices to the RBI guidelines. With a view to ascertaining the position regarding implementation of these guidelines by the branches, banks themselves should carry out special studies on an annual basis on as large a sample or branches, as possible. The findings of the these studies should be reported to RBI periodically indicating among others, the steps taken for rectifying the deficiencies, if any, observed in the process.

The procedure and time frame laid down for disposal of loan application received from SSI borrowers should be strictly enforced. Whenever application for fresh limits/enhancement of existing limits was not considered favourably by the sanctioning official or where the limits applied for are proposed to be curtailed, the same should be referred to the next higher authority with all relevant particulars, to ensure scrutiny by any independent authority and the latter should confirm the decision of the sanctioning official or otherwise dispose of the same, within a time bound manner. Another alternative which would also help eliminate delays inherent in the consideration of the proposal by the successive tiers in the hierarchy and facilitate timely decisions on credit proposals it would be for banks to adopt a system of Committee approach, in which decisions are taken by the competent authority after a structured discussions with the branch managers and also the authorities at the intervening levels.

Problems faced by the SSI sector in regard to bank finance, to a large extent could be solved if the branch level officials have the right aptitude, skills and orientation. In understanding their role, the branch managers/officials at the branches should be made

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aware of the importance of small scale sector from the point of view of creation of additional employment opportunities, exports etc. A healthy growth of the sector will facilitate smooth loan recovery in the SSI borrowal accounts. Further, timely assistance will prevent these accounts from becoming sticky. The aforesaid aspects should therefore, form part of the inputs in the training imparted to the banks’ staff. There should an interaction between the banks’ staff and the SSI borrowers as part of the training programmes. Banks may also consider awarding trophies to branches for the outstanding performance in financing SSI units as a mark of public recognition.

One of the complaints frequently voiced by the SSI units pertains to insistence by some banks on compulsory deposit mobilisation as a quid pro quo for the sanction of credit facilities to the units. While enlisting the cooperation of banks’ customers for deposit mobilisation cannot be faulted, insisting on deposit mobilisation of stipulated amounts as a precondition to the sanction of credit or otherwise, has no justification.

The 2nd All India Census of SSI (1988) carried out by the Development Commissioner(SSI), Govt. of India, has revealed that there were 85 district in the county each with more than 2000 registered SSI units with Industries Deptt. of the State Govt. and another 110 districts each having between 1000 to 2000 registered SSI units. RBI decided during July 1993 that while SFCs would act as the principal financing agency for SSIs in 40 out of the 85 districts referred to above to take care of both the term loan and working capital requirements of all new SSI units which can be financed under Single Window Scheme (SWS) of SIDBI, the commercial banks should act as the principal financing agency under the SWS in the remaining 45 districts, as well as in rest of the country. Banks should also consider converting such of the branches as having a fairly large number of SSI borrowal accounts, into specialised branches.

Important banking operational clarification on Nayak Committee-Recommendations

The implementation of recommendations of Nayak Committee, relating particularly to the assessment of working capital, gave rise to certain operational problems. Reserve Bank has clarified these issues on the following lines:

The assessment of credit limits for all borrowers enjoying aggregate fund based working capital limits of less than Rs. 1 crore from the banking system, is to be done both as per the traditional method and on the turnover basis and the higher of the two limits is to be fixed as the permissible bank finance. However, the neither the inventory norms stipulated under Tandon Committee apply nor the PBF is subject to ceiling as per the first method of lending. In cases where the limits determined by the

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traditional method are less than 20% of the turnover, the assessment will have to be re-examined. Nayak Committee has stated that the working capital below the minimum level of 20% may be justified under special circumstances in which the requirement is demonstratively lower than the minimum level as in the case of ancillary units.

Where the working capital cycle is shorter than 3 months, the working capital required would be less than 25% of the projected turnover. In such case it is not required to still give PBF at 20% of the turnover.

If the liquid surplus available with the borrower is higher than 5% of the turnover, as stipulated under the recommendations, the limits can be fixed at a lower level than 20% of the turnover keeping in view that the genuine requirements of the unit are met adequately. If a unit has been managing its working capital efficiently, the limits can be set at a lower level.

The units having longer operating cycle for working capital than three months, should be provided proper limits to operate at a viable level taking into account the recommendation that 20% of the turnover is the minimum stipulation and not the maximum.

In case of seasonal industries the distinction between the peak and non-peak level of turnover has to be considered instead of annual turnover.

The creditors and other current liabilities are among the sources of funds required for building up the current assets and will be treated in the same manner as in the traditional method.

The borrower’s contribution (margin) will be 5% of the turnover in all cases except where the working capital cycle is not taken at three months. The margin will proportionately increase with the increase in the period of operating cycle. Care is to be taken that the proportion of margin to bank finance should be maintained in the ratio of 1:4 or even higher in case of availability of higher liquid surplus. If the borrower is not able to bring in minimum contribution of 5%, as a general rule, no dilution should be allowed except in special circumstance like sick units or when permitted being desirable due to peculiar circumstances in the sanction.

The sub-limits against the various components of stocks and receivables should be fixed taking into account the existing norms of inventory and receivables as bench mark and bankers should adopt flexible approach on case to case basis in a realistic manner while assessing the credit needs. While allowing deviations, the sanctioning authority must ensure that proper justification is available and given.

With regard to the aspects like allowing drawing power on the basis of stocks and receivables’ statements or calling data on actual turnover on a monthly basis or calling

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of certificate from auditor’s every 6 months in respect of actual sales, it has been clarified that calling for sales data on monthly basis and comparing with the drawings in the account would be helpful particularly in the matter of arriving at effective operational limits as also in the monitoring the borrowal accounts. The drawing power in any case is to be allowed on the basis of monthly stock statement.

In order to check the validity of projections for turnover, in case of existing units sales data pertaining to actuals of last five years, estimates for the current year and projections for the next year together with the true analysis of the industry to which the borrowing unit belongs would also be useful. Other relevant information i.e modernisation or expansion of the existing manufacturing capacity, Govt. policy on taxation and other relevant internal and external factors also need to be taken into account.

Seven Point Action plan

Govt. of India in budget for 1995-96 announced a 7 point action plan as under:

Time bound action for setting up specialised SSI branches in 85 identified districts of high small industry density.

Adequate delegation of powers at the branch and regional level.

Banks to conduct sample surveys of their performing SSI accounts to find out whether they are getting adequate credit.

Steps to be taken to see that as far as possible composite loans (covering both term loans and working capital) are sanctioned to SSI entrepreneurs.

Regular meetings by banks at Zonal and Regional levels with SSI entrepreneurs.

Need to sensitize bank managers and reorient them regarding working of the SSI sector.

Simplification of procedural formalities by banks for SSI entrepreneurs.

7.2 CASH BUDGET SYSTEM

Cash budget Approach :

RBI has appointed Mr.K.K.Kannan, the chairmen of the Bank of Baroda in 1996. the committee has recommended that the borrowers may be assessed based on cash Budget approach.

The recommendations of the Kannan committees are

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For all big companies enjoying money central limits of Rs.5 crores and above, a cash budget may be adopted to appraise their limits. The companies may be asked to submit quarterly cash budget.

The cash budgets will only contain pure cash transaction and will not reflect the movement of funds other then cash

The cash budgets may have 4 components.

(i) Cash flow from business operations (ii) Cash flow from non- business operations(iii) Cash flow from capital accounts.(iv)Cash flow from sundry items.

Banks were expected to grant working capital limits up to the gap in cash flow from business operations.

Cash Inflow –Cash Outflow = Bank Finance in the form of Working Capital

Cash budget system is mainly used for service sector companies

Eliminates traditional requirement of Stock and Debtors for assessment

7.3 Committee Recommendations

Limits above Rs. 5.00 crores: For assessment of Working Capital requirements beyond Rs.5 crores of Small Scale Industrial Units / Medium Enterprises, the guidelines on PBF method of lending will be followed.

7.3.1Tandon Committee on Follow-up of Bank Credit

The group (headed by Sh. Prakash Tandon) was appointed in July 1974 which was to frame guidelines for follow-up of bank credit and submitted its final report during 1975 and gave following recommendations, applicable to borrowers availing fund based working capital limits of Rs. 10 lac or more:

Norms for inventory and receivables

If the bank credit is to be linked with production requirements, it is necessary to fix curtained norms for inventory &receivables. The ” Study Group to frame guidelines for follow – up of bank credit ” (Tondon Study Group) appointed by Reserve Bank Of India had superseded norms for 15 major industries on the basis of company finance studies made by Reserve Bank , Process period in the different industries discussion with the industry experts & feed – back received on the interim report. The norms suggested by Tondon study Group are being

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reviewed from time to time by the Committee of Direction constituted by Reserve Bank to keep a constant review of working capital requirement. The committee of director has suggested norms for certain other industries also. A comprehensive & updated list of the norms of inventories & receivables as applicable to certain industries is given in the following table. The norms for raw materials, stocks in process, finished goods & receivables should not be normally interchanged. However, in the case of certain industries, combined norms have been suggested for finished goods & receivables. Similarly, combined norms have been suggested for raw materials & stock – in –process for a few industries.

Broad Indicators

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20


21


22


23


24


25


26


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The norms given in the above table are applicable to all industrial borrowers enjoying aggregate fund based working capital limits of Rs. 10 lacs & above from entire banking system. The spirit of norms has to be kept in view while giving finance to the unit requiring less than Rs. 10 lacs.

The norms indicate the maximum level for holding inventory & receivables in each industry & they should not be taken as entitlement to hold inventory or receivables up to the prescribed levels. If a borrower has maintained lower level in past, he should continue to do so.

Norms are also not absolute or rigid .Deviations from norms may be permitted under certain circumstances ,however relaxations from the norms should not be given as a matter of routine but must be fully justified and allowed only for a short period. Efforts should be made to revert back to the norms when conditions turn to normal. Further flexibility in the level of inventory and receivables may bhave be viewed both ways.

In the case of industries where no norms have been fixed, level of inventory and receivables should be computed on the basis of the process/lead time, trade practices, past trends etc.

Approach to lending

The committee suggested three methods of lending out of which RBI accepted two methods for implementation.

Method I :- According to the First Method the borrower can be allowed maximum bank finance upto 75% of the working capital gap (working capital gap denotes difference between total current assets required and amount of finance available in the shape of current liabilities other than short term bank borrowings). The balance 25% to be brought by the borrower as surplus of long term funds over the long term outlay.

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Method II :- As per Second Method of lending, the contribution of the borrower has to be 25% of the total current assets build-up instead of working capital gap. (Method of lending as per Vaz Committee will now apply to borrowers availing working capital fund based limits of Rs. 100 lac or more only)

Method III :- Same as 2 above, but excluding core current assets from total current assets on the theory that core current assets should be financed out of long term funds, i.e. owned funds plus term borrowings. Under this method, long term funds are required to finance the entire core current assets and another 25 per cent of the remaining current assets. However, this method has not been accepted for implementation by the Reserve Bank.

Other major recommendations

No slip back in current ratio, normally.

Classification guidelines for Current assets and current liabilities. Identification of excess borrowing.

Information system, which was modified by Chore Committee Recommendations.

Bifurcation of limits into loan and demand component.

All instructions relating to maximum permissible bank finance withdrawn by RBI as per Credit Policy announced on 15.04.1997)

Computation of Maximum Permissible Bank Finance by Method I and Method II

A part of the total current assets can be financed by credit for purchases and other current liabilities. Funds required to carry the remaining current assets may be called the working capital gap which can be bridged partly from the borrower’s owned funds and long term borrowings and partly by bank borrowings.

In the context of the above approach, the Tandon Study Group had suggested the following three alternatives for working out the maximum permissible level of bank finance:-

It may be observed from the above that borrower’s contribution from long-term funds would be 25 per cent of working capital gap (total current assets – current liabilities other than bank borrowings) under the First Method of Lending and 25 per cent of total current assets under the second method of lending. The above minimum contribution of long-term funds is called minimum stipulated Net Working Capital (NWC) which comes from owned funds and term borrowings. It may be mentioned that a borrower is export receivables. Therefore, export receivables should be excluded from the total current assets while calculating maximum contribution required from long term funds.

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The above two methods of lending may be illustrated by taking the following example of a borrower’s financial position, projected as the end of next year.

Current liabilities Amt. Current Assets Amt.

Creditors for purchases 200 Raw materials 380

Other current liabilities 100 Stock-in-process 40

300

Bank borrowings, including bills discounted with bnkers

400 Finished goods 180

Receivables, including bills discounted with bankers

110

Other current assets 30

700 740

As per suggested norms or past practice, whichever is lower, in relation to projected sales/ production for the next year.

First Method Amt. Second Method Amt.

Total current assets 740 Total current assets 740

Less: Current liabilities other than bank borrowings

300 25% of above from long term sources

185

Working Capital Gap 440 Working Capital Gap 555

Less: 25% of above from long-term sources

110 Less: current liabilities other than bank borrowings

300

Maximum permissible bank Finance

330 Maximum permissible bank finance

255

Excess bank borrowings 70 Excess bank borrowings 145

Current ratio 1.17:1 Current Ratio 1.33:1

It may be observed from the above that in the First Method, the borrower has to provide a minimum of 25 per cent of working capital gap from long-term funds (owned funds and term borrowings) and it gives a minimum current ratio of 1:1. In the Second Method, the borrower has to provide a minimum current ratio 1:1. In the Second Method, the borrower has to provide a minimum of 25 per cent of total current

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assets from long term funds (owned funds and term borrowings) and it gives a minimum current ratio 1.33:1.

If the existing net working capital (excess of current assets over current liabilities including bank borrowings) of a unit exceed 25 per cent of the working capital gap (in First Method) or 25 per cent of total current assets (in Second Method), the contribution from long term funds may be kept to the extent of the already existing net working capital. In other words, if a unit is already having more long-term funds than the minimum stipulated requirement, it should continue to maintain such long-term funds instead of reducing them to the minimum stipulated requirement.

All borrowers having aggregate fund based working capital limits of Rs. 50 lakhs and above from the banking system are expected to follow the Second Method of lending. Steps have taken to enforce this discipline in stages on borrowers enjoying credit limits of less than Rs. 50 lakhs also. In the case of sick/ weak units, maximum permissible bank finance may be computed under the first method of lending.

The Second Method of lending was implemented in December 1980 and a provision was made at that time to provide working capital term loan to finance the excess borrowings over the maximum permissible bank finance as per the Second Method of lending. It was also decided that the working capital term loan thus provided should be made repayable in half yearly installments within a definite period not exceeding five years. As many years are now over, working capital term loan should not be provided in the normal circumstances.

Estimating the total requirement of long term funds for new projects, financial institutions/ banks should calculate margin for working capital on the basis of norms prescribed for inventory and receivables and by applying the Second Method of lending. A project may suffer from shortage of working capital funds if sufficient margin for working capital is not provided as per the Second Method of lending while funding new projects. Proper co-ordination between banks and financial institutions is necessary to ensure availability of sufficient working capital finance to meet the production requirements.

8 Information/Data Required for Assessment of Working Capital.

In order to assess the requirement of working capital on the basis of production needs, it is necessary to get the data from the borrower regarding their past/projected production, sales, cost of production, cost of sales, operating profit, etc. In order to ascertain the financial position of the borrower and the amount of working capital needs to be financed by banks, it is necessary to call for the data from the borrower regarding their net worth, long term liabilities, current liabilities, fixed assets, current assets, etc. The reserve Bank prescribed he forms in 1975 to submit the necessary details regarding the assessment of the working capital requirements under its Credit Authorization Scheme. The Scheme of Credit Authorization was changed in to Credit monitoring Scheme in 1988. The forms used under Credit Authorization Scheme for

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submitting necessary information have also been simplified in 1991 for reporting the credit sanctioned by banks above the cut-off point of Reserve Bank under its scheme of Credit Monitoring Arrangement.

As the traders and merchant, exporters who do not have manufacturing activities are not required to submit the data regarding raw materials, consumable stores, goods-in-process, power and fuel, etc., a separate set of forms has been designed for traders and merchant exporters. In view of the peculiar nature of leasing and hire purchase concerns, a separate set of forms has been designed for them. Similarly, a separate set of forms has been prescribed for diamond exporters also. In case of certain agro-based seasonal industries like tea and sugar, requirements of finance for production may be at the peak during the season, while sale proceeds are realized throughout the year. In Such cases, limits are decided on the basis of projected monthly cash budgets to be submitted by the borrowers before the beginning of the season.

In order to assess the working capital requirements of Rs. 50 lakhs and over, banks obtain the basic information from the borrowers in the above mentioned forms prescribed by Reserve Bank for reporting under its scheme of Credit Monitoring Arrangement (Formerly Credit Authorization Scheme). In addition to the information/data in the prescribed forms banks may call for additional information required by them depending on the nature of the borrowers activities and their financial position. The information/ data is collected from he borrowers in he following six forms:-

I. Particulars of the existing/proposed limits from the banking system (Form I)

Particulars of the existing credit from the entire banking system as also the term loan facilities availed of from the term lending institution/bank are furnished in this form. Maximum and minimum utilization of the limits during the last 12 months and outstanding balance as on a recent date are also given so that a comparison can be made with the limits now requested and the limits actually utilized during the last 12 months.

II. Operating Statement (Form II)

The data relating to gross sales, net sales, cost of raw materials, power and fuel, direct labour, depreciation, selling, general and administrative expenses, interest, etc. are furnished in this from. It also covers information on operating profit and net profit after deducting total expenditure from total sale proceeds.

III. Analysis of balance Sheet (form III)A complete analysis of various items of the last year’s balance sheet, current year’s estimating and following year’s projections is given in this form. The details of

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current liabilities, term liabilities, net worth, current assets, fixed assets, other non-current assets, etc. are given in this form a per the classification accepted by the banks.

IV. Comparative statement of Current Assets and Current Liabilities (Form IV)

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

V. Computation of Maximum Permissible Bank Finance (Form V)

On the basis of the details of the current assets & current liabilities given in Form IV, Maximum Permissible Bank Finance is calculated in this form to find out the credit limits to be allowed to the borrowers.

VI. Fund Flow Statement (Form VI)

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

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

Banks should verify not only the arithmetical accuracy of the data furnished by the borrowers but also the logic behind various assumptions based on which the projections have been made. For this purpose, bank officials should hold discussions with the borrowers on projected sales, level of operations, level of inventory, receivables etc. If necessary, a visit to the factory may also be made to have a clear idea of the products and processes. An illustrative check-list is given below to indicate the various points to be examined by banks while finalizing the credit requirements of the borrowers.

9.1Utilization of Existing Limits :-

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It may be examined whether the limits have been adequately utilized during the last 12 months. If not, the justification for further enhancement may be ascertained. It may so happen that the past profits which were employed in working capital might be intended to be withdrawn for investment in fixed assets on account of modernization, expansion, diversification, etc., thereby creating need for recouping working capital funds. In such cases, additional limit might be sought although the existing limits were not utilized adequately during the year. The sanction of additional limits was not utilized adequately during the last year. The sanction of additional limits in such cases may lead to a slip-back in the current ratio, but slip-back should not be allowed to a level below 1.33.

If the Limits have been overdrawn ,its reasons may be ascertained. If the financial position of the unit is weak, steps for its improvement may be decided.

Tin case of borrowers coming under the purview of credit Monitoring Arrangement (i.e. Those borrowers who enjoy aggregate working capital facilities exceeding Rs. 5 crores),it is necessary that limits sanctioned to such borrowers against book-debts should not be more than 75percent of the aggregate limits sanctioned to them for financing their inland credit sales. In other words, at Least 25% of the aggregate limit for financing inland credit sales should be provided by the way of bills. If bill finance is lower than 25% , reasons for it may be as curtained and necessary steps may be taken to develop bill culture in case of such borrowers.

9.2Operating Statement

As the entire working capital assessment is directly linked to the sales figure, it may be ensured that the annual projection of sales is reasonable in relation to the installed/licensed capacities, availability of input, environmental conditions, marketing prospects, etc

. In case of existing units, projected sales should be in accordance with the past trend. If

the projected sales are not in tune with the past trend and appear to be over ambitious, the reasons should be ascertained to ensure that the sales projections are realistic.

If the unit is likely to implement a modernization/expansion/diversification project, its impact on sales may be assessed.

It may be ascertained whether the previous year’s projection of sales, on the basis of which limits were fixed last year, has been realized. If not , the reasons for the short fall may be examined. If a borrower approaches for additional limits on the basis of the projection higher than that given in the previous year which was not realized, the matter should be carefully examined.

If there is a declining trend in net sales, reasons therefore may be studied. A detailed study should be done if an increase in limits is sought in such case.

The valuation of sales projection should be based on the current running prices.34


Similarly, the valuation of various input constituting cost of sales in the projection should also be based on current prices. It should be ensured that the price escalation are not built into the projection of sales as well as cost of various input.

It may be ascertained whether the raw materials consumption as a percentage of cost of production is in keeping with the past trend. If it shows any undue increase, the reasons for it may be examined.

It may be ensured that consumable stores and other items used in the process of manufacture are included in raw materials. The norms for raw materials included consumable stores and other materials. The norms for raw materials included consumable stores and other materials used in process of manufacture.

It may be ascertained whether adequate depreciation has been provided. If the method of providing depreciation is charged, its impact on cost of production may be analyzed.

It may be ascertained whether selling, general and administrative expenses are in keeping with the past trend. If they show an increase in terms of percentage of sales, the reasons for it may be examined.

It may be examined whether the operating profit/profit before tax is increasing in line with the sales. If not, its reason may be ascertained and analyzed.

In the case of new units, the estimated production may be assumed at 40 to 80 percent of the installed capacity in the first year during on the nature of products, availability of input, marketing prospect , etc. The utilization of the capacity may gradually increase in subsequent years. In the case of new units financed by terms Lending Institutions. Projection accepted by them regarding sales, requirement of raw materials, cost of production, etc. may be taken as the basis for providing working capital. Bank and terms lending institutions should have joint/simultaneous appraisal of the projects.

9.3Analysis of Balance Sheet

The classification of current assets & current Liabilities should be made as per the usual accepted approach of bank and guidelines indicatives in this regard by reserve bank.

It may be ascertained whether the level of raw materials, stock in process, finished goods, and receivables are in conformity with the stipulated norms.

If a unit which has been maintaining in the past inventory and receivables at level lower than the norms wants to raise the level up to the norms, the reasons for it may be examined.

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If he norms for finished goods & receivables is a combined one, monthly average for the purpose of arriving at the combined norms may be worked out by combining the level of finished goods & receivables on the one hand and cost of sales and gross sales on other hand.

In the case of industries where the norms have not been stipulated, the levels of inventory and receivables should be in tune with the past trends.

The level of stock of spares may be estimated on the basis of past experience. The project stock of spares maybe estimated on basis of past experience. The projected stock of spares not exceeding 12 months’ consumption for imported items and 9months’ consumption for indigenous items may be treated as current assets. In case of fertilizer industry. Spares up to 12 months’ consumption even for indigenous item may be treated as current assets. Spares held beyond these levels may be treated as current assets. Spares held beyond this level may be treated as noncurrent assets.

If the levels of inventories and receivables are above the norms, a detailsed analysis may be done to find out the reasons. A time – bound programme may be prepared to bring them down in tune with the norms.

Some of te borrowers may have the tlndency to show the requirement of imported raw materials at an inflated level. The higher build-up of imported raw materials should be justified on basis of economic quantity for placing purchase order, lead time in getting replenishment, etc.

Normally, level of stock-in-process in terms of number of months related to the cost of product should not charge. Its change may be justified only on account of change in production process/technology or as a result of production bottlenecks.

If the level of inventories is very high, the details of age of inventory may be obtained to find out whether some of the item have become obsolete.

If the level of receivables is very high. The names of main buyers and the priod of credit offered may be ascertained. It may be examined whether a portion of the receivables is likely to be irrecoverable and if so , sufficient provision should be made for bad debts.

The details of inter-corporate investments and advances should be obtained and the reason for not liquidating them may be examined.

Some of the borrower may have a tendency to show the sundry creditors and other current liabilities in the projected figure at a reduced level. Although no norms have been fixed for sundry creditors, it is expected that the level of sundry creditors should be in terms of months, purchase may be verified with the past trend.

It may be ensured that intangible assets like patents, goodwill, etc. are written-off over a period of years.

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It may be ascertained whether the net worth shows an increasing trend. If the trends shows a decline in net worth, its reasons may be ascertained.

Net working capital should show an increasing rend from yea to year. If not reasons thereof should be ascertained.

If the data of balance sheet has been changed, the reasons for it should be ascertained to find out whether it has been done only for the purpose of showing a rosy picture.

Information may be obtained about contingent liabilities to know their impact on the working of the unit.

9.4Computation of maximum Permissible Bank Finance

Generally, Maximum Permissible Bank Finance (MPBF) should be calculated on the basis of the Second Method of Lending. If the Second Method of lending has been followed, reasons for it may be ascertained.

The second method of lending was implemented in December 1980 and three years were allowed to provide working capital term loan to finance the excess borrowing over the MPBF as per the Second Method o lending. As many years are now over, working capital term loan should not be given in the normal circumstances. In the case of sick/weak units, MPBF may be calculated on the basis of the First Method of Lending.

If export bills limit is to be allowed over and above the permissible bank finance, the export bills should be excluded from the total sales and export receivable should also be excluded from the build-up of current assets. Separate limits may be given for export receivable even without keeping the 25 per cent margin from long term sources.

The third party outstation cheques /drafts purchase limits should be within the MPBF. However, at the request of the borrowers, such limits may be allowed to a small extent over the above the MPBF.

It may be ascertained whether there is any co-relation between projected increase in production of sales and increase in limits. If not, the reasons for it may be studied.

9.5Funds-Flow Statement

The long-term sources should be adequate to cover the long term used and leave a reasonable surplus for being employed in working capital. If long term sources are

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less than the long term uses, it may be inferred that short term funds are being diverted for purpose other then working capital needs. Such cases should be properly examined.

Increase is carry of various items of inventory which is disproportionate to percentage rise in sales should be examined in detail.

The increase in short-term bank borrowings should be in line with the additional limits sought by the company over the previous year’s level of availment.

The increase in short term bank borrowings should be matched suitable by the increase in current asses, particularly inventory and receivables. If it is not so, short term funds might be utilized for repayment of other current liabilities or be diverted for fixed asset or for inter-corporate investments / advances. Such matters should be examined in detail.

It may be noted that the above check-list is not an end in itself. It only indicates broad aspects to be examined by banks and helps in analysis and interpretation of the data furnished by the borrowers for taking judicious decisions.

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

After arriving at the maximum permissible bank finance on the basis of the inventory and receivables norms and the appropriate method of lending, banks may decide about the various fund-based and non fund based limits and sub-limits. The bulk of the inventory limits is generally released by way of open cash credit based on the projected level of the borrower’s operations. Within the sanctioned credit limits, drawing power is fixed on the basis of monthly stock statements indicating actual holding of inventory. The receivables limit may be either by way of cash credit or overdraft against book debts or by way of bills limit. Efforts should be made to develop the bill culture for financing receivables. In case of the borrowers enjoying aggregate fund-based working limits of Rs. 5 crores and over, the limits sanctioned against book debt should not be more then 75 percent of the aggregate limits sanctioned to them for financing their inland credit sales. In other words, at least 25 per cent of the aggregate limits for financing inland credit sales should be provided by way of bills. In order to enforce the above discipline on large borrowers enjoying aggregate fund-based working capital limits of Rs.5 crores and above, it as been decided that with effect from January 1, 1991, interest at 2 percentage point above the relevant cash credit interest rate should be levied on that portion of the book debt finance which is in excess of the prescribed norm of 75 per cent of limits sanctioned to borrowers for financing inland credit sales.

Many borrowers do not utilize to a great extent the credit limits sanctioned to them. Such large unutilized credit limits may creates several problems in efficient management of funds and also implementing macro-credit policy. With a view to bringing about discipline in the availment of bank finance by borrowers and to facilitate better funds management, it has been decided to levy a commitment fees on the unutilized portion of the working capital limis with effect from January 1, 1991. In the case of borrowers with working capital limits of Rs. 1 crore and over, scheduled

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commercial banks are required to levy a minimum commitment charge of 1 % p.a. on the unutilized portion of the quarterly operating limit subject to a toleration level of 15 per cent of the quarterly operating limit.

In addition to the fund based limits, non-fund based limits like Inland Letter of Credit/Foreign Letter of credit, guarantees and acceptances are given keeping in view the genuine needs and the capacity of the borrowers. While considering foreign letter of credit, the requirement of imports, quantum of import license on hand/expected, sources of funds to retire the important bills when received, availability of funds to pay import duty, ect. Should be kept in view. In the case of financial/performance guarantees, it may be ensured that the borrower has the necessary experience, capacity and means to perform the required obligation under the contract without any default and that he will be in a position to reimburse the bank if default occurs due o unforeseen circumstances and the bank is required to make the payment under the guarantees.

Banks should not issue guarantee favoring financial institution fir the term loans extended by them, as the institutions are expected to appraise each proposal and bear the risk themselves. Similarly, banks should not issue guarantees/co-acceptances favoring risk themselves. Similarly, banks should not issue guarantees/co-acceptances favoring financial institutions for the assistance provided by them under buyer’s Line of credit Scheme (BLCS). Under the BLCS, the financial institutions assume the role of a primary lender by directly providing credit to the buyer to facilitate purchase of machinery, equipments, etc., covered by the transaction. As the primary lender is required to make a proper assessment of the proposal and secure a charge by hypothecation of the assets financed, it would not be in order for the financial institution of shift the risk of repayment by obtaining a bank guarantee. It may be clarified that BLCS is different from the bills rediscounting scheme operated by financial institutions for sale of machinery, where the primary credit is provided by the seller’s bank to the seller through bills drawn on the buyer and co-accepted by the buyer’s bank. As the seller’s bank has no access to the security covered by the transaction which remains with the buyer, the buyer’ bank can give co-acceptance in such cases. Similarly, buyer’s bank can give co-acceptance/guarantee for deferred payments after proper appraisal of the proposal.

Banks should examine the proposals made by borrowers for non-fund based limits keeping in view their genuine needs, financial position and capacity to meet the commitments. In the case of existing borrowers, bank’s past experience about retirement of bills under letters of credit and reimbursement to the bank when any guarantee was invoked may also be borne in mind. Non-fund based limits should not be out of proportion of the borrower’s genuine needs and his financial position.

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10.1 Bank Finance for Payment of Bonus

Bonus and other statutory liabilities are normal items of expenditure which may be financed from within the permitted working capital limits sanctioned to a borrower. However, if any borrower has liquidity problems and approaches a bank for temporary additional accommodation for the purpose, such applications may be considered by the banking in to account the special circumstances and merits of each case. While sanctioning accommodation for payment of bonus, banks should ensure the following points:-

The previous bonus loans should have been fully repaid on the due dates.

If not repaid, there should be valid grounds for the loans still remaining outstanding.

The proposed loan should be for payment of statutory bonus at the minimum level of 8.33 per cent only.

The loan should be repayable in not more than six monthly installments.

The repayment of the proposed loan is not likely to cause an irregularity in the cash credit account.

Cases of sanction of such bank finance for payment of bonus to borrowers enjoying working capital

Limits above Rs. 5 crores should be reported to Reserve Bank for post-sanction security.

11. Case Study on Assessment of Working CapitalThe procedure followed by banks for assessment of working capital requirement has been explained in this case study.In order to illustrate the information/data being submitted by the borrower and procedure being followed the banks.The case study may help in understanding the procedure followed by bank for determining the maximum permissible bank finance for a borrower.

11.1 Background of company:

ABC Ltd., a public limited company, is engaged in manufactureing buk drugs and formulations in the form of tablets, granules, powders, syrups, ointments, creams, lotions etc. The drugs manufactured by he company inclide antibiotics, surlphas,

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analgesics, anti-diabetics, anti – T.B. drugs , anti dysentery drugs and vitamins. The products of the company have good reputation in the market. It has approached the bank to increase its working capital limits from the existing level of Rs. 235.00 lakhs in the current year to Rs. 350 for the following year.

11.2 Working Capital Assessment

ABC Ltd. has submitted the necessary data in prescribed forms which are given as Annexures I to VI as under.

Form I : Particulars of existing/proposed limits from the banking systemForm II : Operating StatementForm III : Analysis of Balance SheetForm IV : Comparative Statement of Current Assets & Current LiabilitiesForm V : Computation of Maximum Permissible Bank FinanceForm VI : Fund Flow Statement

The information in Form I is compiled on the basis of various credit facilities enjoyed by the company from banks and financial institutes. The data in Form II and Form III are furnished on the basis of Proofit and loss account and balance sheet of company, respectively. Analysis of balance sheet in Form III should be done as per the classification of various assets and liabilities accepted by banks. The Form IV gives comparative position of current assets and current liabilities which is taken from analysis of balance sheet given in Form III. The norms prescribed for the industry are also mentioned in the Form. After completing the Form IV, maximum permissible bank finance can be calculated in Form V. The Form VI indicates sources and uses on the basis of the movements of various assets and liabilities indicated in Form III.

Bank should verified not only the arithmetical accuracy of the data furnished in these forms but also the various assumptions on the basis of which the projection have been made for the following years. An illustrative check list indicating the various points to be examined by banks while finalizing working capital. If necessary additional information may be called for from the borrowers.

After scrutinizing the data given by the company as per Annexure I to VI , the bank has made following observations for assessment of working capital requirements of this company.

11.2.1 Utilization of Existing LimitsIt is observed from the data given in Form I that the company is at present having working capital limits of Rs. 321lakhs .The company has now approach the bank to

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increase the limit for the existing level of Rs. 321 lakhs to Rs. 381 lakhs to meet the requirement of increase in level of operations. The company has been paying installments of the term loans in time and does not have any over dues.

11.2.2 Working Result of The company

Working Result of Company can be studied from the operating Statement (Form I ) submitted by the company. It may be observed that sales of the company are likely to increase from last year Rs. 1951 lakhs to Rs. 2444 lakhs during current year and further to Rs. 2755 lakhs during the following year. The estimated increase in net sales during next year at 12.26 percent as compare to increase of 22.76 percent during current year is quite reasonable. It is hoped that the company will be able to achieve the expected increase in sales. The company has assumed sale prices of its products as well as costs of various inputs required for production at current prices/costs. The company’s profit before tax is likely to increase from Rs. 60 lakhs during last year to Rs. 82 lakhs during current year and further to Rs. 10 lakhs during next year. The working results of the company can be considered satisfactory.

11.2.3 Financial position of the company

It may be observed from the analysis of balance sheet (From III) that the net worth of the company has increased from Rs. 410 lakhs at the end of last year to Rs. 435 lakhs at the end of current year. I is expected that the net worth will increase to Rs. 490 lakhs at the end of next year. As equity capital remains at the existing level of Rs. 163 lakhs, the increase in net worth is due to plough back of the profit earned by company. Its total reserves at the end of current year ratio has improved from 1.27 at the end of year before last to 1.40 at the end of last year. It is likely to be 1.37 at the end of current year. As per the project made by the company, the current ratio is likely to improve to 1.44 at the end of next year. As the company is having a good equity and maintaining current ratio above 1.33, its financial position can be considered satisfactory.

11.2.4 Current Assets and Current liabilities

The company has estimated total current assets at Rs. 1401 lakhs for the next year against Rs. 1086 lakhs for last year and Rs. 1241 lakhs for current year. Total current liabilities (other than bank brrowing) have been estimated at Rs. 595 lakhs for the next year against Rs. 550 lakhs for last year and Rs. 583 lakhs for current year. Comparative statement of current assets and current liabilities has been given in form IV. It is necessary to study this statement to know the level of current assets and current liabilities. Following observations can be made from this statement on the important items of current assets and current liabilities.

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(i) Raw Materials

The projected level of raw materials at 3.04 months is very high as compared to prescribed norm of 2.75 months for the industry. The break-up of raw material between imported and indigenous items indicates that the projected level of imported raw materials at 3.37 months is higher than the indigenous raw materials’ level of 2.67 months. However, no distinction has been made between imported and indigenous raw materials while fixing the norms for the industry and combined norm of 2.75 months has been fixed for raw materials. It can be observed that while the projected level of indigenous raw material is lower than the norm, stock of imported ram aerials is very high as compared to the norm. The company has stated that it is necessary for it to import raw materials in economic order quantity. Fr manufacturing bulk drugs, it has to keep the necessary raw materials to satisfy the requirement s of at least one batch. Further, the requirement of raw material holding has increased due o location of its factories at two places having a distance of 180 Kms. If a comparative study of raw materials (including imported raw materials) at 3.04 months for the next year will be quite low as compare to 3.47 months for the last year. It will be almost equal to current year’s level of 3.02 months. In view of the heavy requirements of imported raw materials and a declining company may be asked to gradually bring down the level of raw materials to the stipulated level of 2.75 months in future.

(ii) Consumable spares.

The company projected the stock of imported spares at 7.30 months and indigenous spares at 6.95 months against the current year’s level of 7.43 months for the imported spares and 7.06 months for indigenous spares. As per the norms prescribed by Reserve Bank, the stock of spares not exceeding 12 months consumption for imported items and 9 months consumption for indigenous items may be treated as current assets. As the projected levels of both the spares, imported as well as indigenous, are lower than the norms and are in tune with the past trend, imported as well as indigenous, are lower than the norms and are in tune with past trend, we may take them as quite reasonable.

(iii) Stocks-in-process

Stocks-in-process have been projected that the level of 1.08 months against the norm of 0.75 months stipulated for the industry. It has been stated by the company that more than 75 percent of its production is for such bulk drugs

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where the production cycle is very long. Further, its foreign collaborations undertake strict quality control which alone needs sox to eight weeks item for certain products. If a comparative study for the previous years is made, it is observed that the level of stock-in-process has come down from 1.25 months during last year to 1.09 months during current year. It has been projected at 1.08 months for the next year. As manufacturing process of the products of the company is very long, we may have to accept the level of 1.08 months for stock-in-process. However, the bank may emphasis the need to reduce the level of stocks-in-process to the extent possible.

(iv)Finished goods

The company has projected the level of finished goods at 1.70 months against the stipulated norm of 1.50 months for the industry. If a comparative study is made with the past it may be observed that the level of finished goods has been reduced from 1.99 months during last year to 1.74 months during current year. It is likely to be further reduced to 1.70 months in the next year. The company has stated that it is distributing some f its products (pharmaceutical formulations) through its 9 branches scattered throughout the country which requires high level finished goods. However, the reason given by the company is not satisfactory. About 75 per cent of the company’s total production is in bulk drugs where high level of finished goods stock is not required. In fact, higher level of raw materials and stock-in-process have been considered reasonable in view of the requirement of imported raw materials and the long production cycle for bulk for bulk drugs. Higher level of the stock of pharmaceutical formulations should be compensated by the low level of the stock of bulk drugs. Therefore, the level of finished goods is projected at norm of 1.5 months stipulated for the industry. If the level of finished goods is projected at 1.5 months of cost of sales, it comes to Rs. 207 lakhs against Rs. 235 lakhs projected by the company.

(v) Receivables

The company has projected domestic receivables at the level of 1.60 months as compared to norms of 1.50 months. The company has mentioned that about 30 % of its sales are made to central/state governments which results in payment being received 3-4 months after sales of goods. If the payment is received from the government in time, the receivables can be managed within the norms without any difficulty. If a comparative study with the past is done,

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level of receivables has come down from 1.74 months during last year to 1.60 months during current year and it is likely to be maintained at the same level during the next year. If export receivables are also added to the domestic receivables, the level of total receivables come to 1.59 months of total sales, i.e. domestic sales plus export sales. As the level of receivables is only marginally higher than the norm and it has shown a declining trend, we may accept it for this year. However emphasis should be made to reduce the level of receivables to 1.50 months by next year.

(vi) Sundry CreditorsThe company has projected the sundry creditors at the level of 1.75 months

as compared to 1.73 months for the current year and 1.72 months for the previous year. The level of sundry creditors may be considered reasonable.

11.2.5 Assessment of working Capital

The company has requested to increase the working capital limit from Rs. 321 lakhs for current year to Rs. 381 lakhs for next year on the basis of an expected increase of 12.26 percent in sales over the current year. It has projected total current assets at Rs. 1401 lakhs and total current Liabilities (other than bank borrowing ) at Rs. 595 lakhs. While analyzing the level of current assets in the above paragraphs, it has been observed that the company has been maintaining higher level of raw materials ,stock in process, finished goods and receivables than the prescribed norms for the industry. However, the levels have shown a declining trend as compred to the previous years. The company has also given justifiable reason for higher levels except for finished goods. If thee finished goods are projected at 1.5v months off the cost of sales, it comes to Rs. 207 lakhs against Rs. 235 lakhs projected by the company. If the finished goods are projected at Rs. 207 lakhs, instated of Rs. 235 lakhs., the total current assets will also come down by Rs. 28 lakhs from Rs. 1401 lakhs to Rs. 1373 lakhs. Maximum permissible bank finance for working capital will be Rs. 253 lakhs as under.

Particulars Amount (Rs. In lakhs)

1 Total Current assets 13732 Total Current Liabilities 5953 Working Capital Gap (1-2) 7784 Minimum stipulated net working capital as per the

second method of lending (25% of total current assets after excluding export receivables of Rs. 10 lakhs)

341

5 Actual / Projected net working capital available with the company (Item No. 45 of Form III – Analysis of

425

45


Balance Sheet)6 Item 3 minus Item 4 above 4377 Item 3 minus Item 5 above 3538 Maximum Permissable bank Finance (Item 6 or 7

whichever is lower – As the net working Capital available with the company at Rs. 437 lakhs is more than the minised stipulated net working capital at Rs. 341 lakhs, the MPBF will be Rs. 353 lakhs instead fo Rs. 437 lakhs)

353

It may be observed from the above calculation that the company can be given working capital limit s of Rs. 353 lakhs against its request for Rs. 381 lakhs. The reduction has been done due to lower level of finished goods at Rs. 207 lakhs (1.50 months) accepted by the bank against the projection of Rs. 235 lakhs (1.70 months) made by the company. Higher levels of raw materials, stock in process and receivables have been accepted due to the various justifiable reasons given by the company. Further, declining trend has been observed as compared to previous year and they are now projected only marginally higher than the stipulated norms for the industry. The bank may stipulate a condition that the company should gradually reduce the level of inventory and receivables to conform to the norms. In view of the good working results, sound financial position and good current ratio maintained by the company, working capital limits of Rs. 353 lakhs for the following year may be considered quite reasonable and safe.

Annexure – I

Form – I Assessment of Working Capital Requirement

Sr. No. Nature of facilities

Existing Limit

Proposed Limit

Outstanding as on 31 january

Excess/Over dues

1 Fund Based

46


Term Loan 190 - 120 -2 Working Capital:

Cash credit / Over draft / Packing Credit / Bills Discount 160 190 158 -Cash credit / Over draft / Packing Credit / Bills Discount 81 96 78 -Cash credit / Over draft / Packing Credit / Bills Discount 80 95 78 -Total Working Capital 321 381 314 -

3 Total Fund Based 235 355.75 149.88 -

Annexure II

Form II : Operating Statement

Year Ended 31st March Last year 2008

Current year 2009

Following year 2010

Act. Rs. Est. Rs. Projections

47


(I) (2) (3)1 Gross Sales

1. Domestic Sales 1903 2344 26552. Domestic Sales 48 100 100Total 1951 2444 2755

2 Less : Excise Duty & Sales Tax 224 324 3753 Net Sales (1-2) 1727 2120 23804 % Rise of Fall +10.56% +22.76% +12.26%5 Cost of Sales

1. Raw Materials A. Imported 429 575 612 B. Indigenous 362 479 540 2. Other Soares 18 21 23 A. Imported 15 17 19 B. Indigenous3. Power & Fuel 42 58 694. Direct Labour 179 197 2205. Other Mfg. Exp. 36 48 536. Depreciation 53 52 507. Sub - Total (1 To 6) 1134 1447 15868. Add : Opening Stock in process. 106 117 130Sub Total 1240 1564 17169. Less : Closing Stock in process 117 130 14210.Cost of Prod. 1123 1434 157411. Add : Op.Stk. Of Finished Goods 216 204 22012. Add : Purchase of finished goods 94 95 96Sub Total 1433 1733 189013. Less : Cl. Stk. Of Finished Goods 204 220 235114. Sub Total (Total Cost of Sales) 1229 1513 1655

6 Selling General And Adm. Exp. 348 414 4607 Sub Total (5+6) 1577 1927 21158 Operating Profit Before Interest (3-7) 150 193 2659 Interest 121 130 155

10 Operating Profit after Interest (8-9) 29 63 11011 (i) Add : Non Operating Income

a. Duty draw back, etc. 26 21 24b. Others 7 1 1 Sub-Total (income) 33 22 25(ii) Deduct other non- operating expensesa. Transfer to Export Business Reserve 2 3 5b. Others - - -

48


Sub Total(Expenses) 2 3 5(iii) Net of Other non-operating income / expenses[net of 11(i) & 11(ii)]

31 19 20

12 Profit Before Tax / loss [10 + 11(iii)] 60 82 13013 Prov. For Taxs 10 36 5514 Net Profit / Loss (12-13) 50 46 7515 a. Equity dividend 16 24 24

b. Dividend Rate 10% 15% 15%16 Retained Profit (14-15) 34 22 5117 Retained Profit / Net profit (%) 68.0% 47.83% 68.00%

Annexure III

Form III : Analysis of Balance Sheet

49


50

Year Ended 31st March

Last two year Actuals as per audited

balance sheet

Current year

estimates

Following year’s

projections

(i) (ii) (iii) (iv) LIABILITIES Current Liabilities

1 Short term Bank Borrowing (i) From applicant bank 112 114 160 190 (ii) From other banks 110 112 161 191 (iii)(of which BP and BD ) (17) (18) (20) (20) Sub Total (A) 222 226 321 381

2 Short Term Borr. From Others 35 37 37 37

3Sundry Creditors (Trade) Local 129 118 157

174

4 Adv. From Customers 26 4 5 55 Prov. For Taxes 236 142 178 2336 dividend Payable - 16 24 24

7Stat. Lia.( due with in one year) - - -

-

8

Deposit/Insalmens of term loan/BPG/Debentures etc.( due with in one year) 25 12 84

10

9 Other Cur. Lia.(i)Inter cooperate deposits 145 114 20 43(ii)others 106 107 78 69

Sub total (B) 702 550 583 595

10Total curr liab. (Total of 1 to 9) 924 776 904

976

Term liab.

11Debentures (not maturing with in one year) 175 175 175

225

12Pref. shares (Redimable after one year) - - -

-

13

Term loan (Excluding instalment payable within one year) 68 56 92

256

14

Defered payable credits ( Excluding instalment due within one year) 11 14 25

25

15Term Deposits (Repayable after one year) 71 73 86

93

16 other term liabilities - - - -

17 Total Term Liabilities (Total of 11 to 16) 325 318 378

599

18Total outside liabilities ( total 10 + 17) 1249 1094 1282

1575

Net worth19 Share capital 163 163 163 16320 a. General reserve 132 169 191 242

b. Development rebate reserve/investment allowance reserve 54 54 54

54

21 Revaluation Reserves - - - -

22Other Reserves (Excluding Provisions) 7 8 11

15


Annexure IV51


Form IV : Comparative Statement of Current Assets & Current Liabilities

Annexure V

52


Form V : Computation of Maximum Permissible Bank Finance

53


Annexure VI

Form VI : Fund Flow Statement

Bibliography54


Books

Handbook on Working Capital Finance By D. P. Sarda Introduction To Management Accounting By L. N. Chopde , D. H. Choudhari How to Read a Balance Sheet (Indian adaptation) By Prof. H. Bhattacharya.

Web Sites

http://www.caalley.com/ http://www.e-books.com http://www.googlebooks.com http://www.rushabhinfosoft.com/Webpages/BHTML/CH-16.HTM http://exim.indiamart.com/ssi-finance/credit-flow.html http://toostep.com/insight/approach-to-lending-working-capital http://www.ladderup.com/WORKING%20CAPITAL%20FINANCE%204%20final

%20mailed%20corrected.pdf

55

http://exim.indiamart.com/ssi-finance/credit-flow.html

http://www.rushabhinfosoft.com/Webpages/BHTML/CH-16.HTM

http://www.e-books.com/

assecessment of working capital for borrowers account

Documents

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working capital assessment

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sources of working capital

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liquid form of working

capitalworking capital

working result