working capital lending

8/13/2019 Working Capital Lending

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Measures liquidity

Gross Working Capital= Current Assets

Net Working Capital= Current Assets- Current Liabilities

Current assetsare the assets which can be converted into cash within one

year and include cash, short-term securities, debtors, bills receivable and

inventory.

Current liabilities (CL) are those claims of outsiders which are expected to

mature for payment within an accounting year and include creditors

(accounts payable), bills payable, and outstanding expenses.


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Cash Rs.74651.53 Rs.26285.89 Current portion of long-term debt

Other short-term financial investments 30125.67 155962.85 Accounts payable

Accounts receivable 249097.79 29180.15 Income tax provisions

16957.65 Dividend Provisions

Inventories 173214.88 63028.27 Other current liabilities

Total current assets Rs.527089.87 Rs.291414.81 Total current liabilities

Net working capital (current assets - current liabilities) = 527089.87 - 291414.81 = Rs.235675.06 crores

Current LiabilitiesCurrent Assets


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Permanentorfixed working capitalA minimum level of current assets, which is continuously

required by a firm to carry on its business operations, is

referred to as permanent or fixed working capital.

Fluctuatingor variable working capital

The extra working capital needed to support the changing

production and sales activities of the firm is referred to as

fluctuating or variable working capital.


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Nature of business Market and demand

Technology and manufacturing policy Credit policy Suppliers credit Operating efficiency Availability of Raw Material Inflation


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Operating cycle is the time duration required to convert sales, after the

conversion of resources into inventories, into cash. The operating cycle of

a manufacturing company involves three phases:

Acquisition of resourcessuch as raw material, labour, power and fueletc.

Manufacture of the product which includes conversion of raw

material into work-in-progress into finished goods.

Sale of the product either for cash or on credit. Credit sales createaccount receivable for collection.


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Inventory conversion period is the total time needed for

producing and selling the product. Typically, it includes:

raw material conversion period(RMCP) work-in-process conversion period(WIPCP)

finished goods conversion period(FGCP)

The debtors conversion period is the time required to collect the

outstanding amount from the customers.

Creditors orpayables deferralperiod(CDP) is the length of timethe firm is able to defer payments on various resource purchases.


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Gross operating cycle(GOC)

The total of inventory conversion period and debtors

conversion period is referred to as gross operating cycle

(GOC).

Net operating cycle(NOC)

NOC is the difference between GOC and CDP.


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Service

Length of Operating Cycle

Receivables

Cash

Trade Industry

CashCash

Stocks

Receivables Receivables

Finished Goods

Semi Finished Goods

Raw Materi


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Own funds

Trade Credit, Outstanding Expenses, advances from customers

Bank Finance

Cash Credit

Overdraft

Shot term Loans

Bills Discounting, Factoring & Forfaiting

Money Market Instruments: Call Money, Notice Money, Commercial

Paper & Certificate of Deposits


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Cash Credit: have limits, generally with

security Overdraft: With current Account

Shot term Loans, Demand Loans:


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In 1974, a committee headed by Ex Chairman of PNB- Mr.

P. L. Tandon for improvement in cash credit system.

Suggestions Three methods of MPBF.

Inventory holding period of 15 major industries was proposed

Classification guidelines for CA & CL

Bifurcation of limit into cash credit & demand loan component


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Current Liabilities Amount Current Assets Amount

Creditors 100 Raw Material 200

Other Current

Liabilities

50 Stock in Process 20

Bank Borrowing 100 Finished Goods 90

Receivables 50

Other Current Assets 10

250 370

Calculate Maximum Permissible Bank Finance according to three methods

of Tandon Committee (Core Current Assets are of Rs 95)


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MPBF 1 MPBF 2 MPBF 3

Companys

ContributionAt least 25% ofWorking Capital

Gap (CA- CLexcluding bankLending) shouldbe from long termsource

25% of CA shouldbe from long term

source

25% of CA + allcore CA should be

from long termsource

MPBF 0.75 (CA-OCL) 0.75 CA-O CL 0.75 CA- CCA-OCL

OCL means current liabilities excluding bank finance


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In April 1979, Committee under Chairmanship of Mr. K B Chore for gap between

sanctioned limit and utilization.

Recommendations

Review of limits once in a year

No Bifurcation of cash credit accounts

Separate Limit for peak level and non peak level

Excess/ under utilization (more than 10% on either side) considered as defective planning.

Penal interest of 1%

No frequent sanction of Ad Hoc or temporary limits

2ndMethod of MPBF compulsory for companys with limit more than Rs 50 lakhs

Encourage Bill Finance


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Cash Budget method(Reason: Based on procurement and cash inflow)

Seasonal Industries (Sugar/ RiceMills/Textiles/Tea/Tobacco/Fertilizers)

Contractors & Real Estate Developers

Educational Institutions


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Statement showing forecast of cash receipts, cashpayments and net cash balance over a period of time

Months-> 1 2 3 4 5 6 7 8 9 10 11 12

Cash Receipts

Cash Payments

Surplus/deficit

Cash credit

Peak deficit is financed and drawings regulated by monthly budgets


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Advantages:

Suitable for seasonal industries, contractors, software

exporters etc.

Limitations:Will not reflect changes in various current assets and

liabilities.

Will it give a clue whether a company is earning

profit or not.Funds flow statement is required to detect any diversion

of funds.


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For aggregate WC limit up to 200 lakhs (Currently Rs 500 lakhs), Tandon

Committee methods will not be implemented but Working Capital

requirement will be 20% of the projected annual turnover. SSI units have

to bring 5% of margin money

Other SSI units have Tandon Committee 1stMethod will be implemented.

Single Financial Agency for WC & Term loan for SSI.

Application should be processed in 15 days (up to 25000) and 8 weeks (for

more than 25000)


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After 1997, compulsiveness of MPBF have been

withdrawn

Banks can decide modalities to assess Bank Finance

limits

WC requirements upto 500 lakhs, Nayak Committee

Methods can be followed and above that cash budget

methods can be followed.

There is no objection of following of MPBF Method


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Working Capital Operating Cycle

Tandon Committee: MPBF Chore Committee: Cash Budget method for

seasonal industries Nayak Committee on SSI Lending: Turnover

Method Kannan Committee: Flexibility of Methods

working capital lending

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