HANDOUT ON WORKING CAPITAL – FUND BASED FACILITIES

Working Capital a!iliti"# or $nit# ar" !la##i i"% into & ● Fund-based facilities ● Non-fund based facilities. FUND BASED FACILITIES& CASH CREDIT AD'ACNES& Cash credit is granted for financing advance payment made by units for purchase of raw materials, purchase of raw materials, carry of goods in process, finished goods, consumable stores and spares and sundry debtors. BILLS( CHE)UES PURCHASE LI*ITS& The unit’s sales can be financed by means of bill financing / che ue purchase or factoring. NON+FUND BASED FACILITIES& !etters of guarantee !etters of credit "eferred #ayment $uarantee. %s we &now, wor&ing capital finance is given for maintaining the optimum level of current assets of an enterprise. For that, the basis on which we assess the re uirement of an enterprise is the pro'ected level of its current assets which are based on the pro'ected level of production and sales. !et us understand its assessment step by step as under( ASSESS*ENT OF NE,T -EAR PRODUCTION AND SALES The pro'ected level of production and sales will be the basis for assessing the wor&ing capital re uirements of a unit for the ne)t year which is to be critically e)amined in the light of the following ( *hether the unit has sufficient installed capacity+ *hether it has the re uisite mar&eting and distribution set up to sell at this volume of production, is the mar&et for the product on the up-swing or down-slide+ -ow the competitors are performing+ *hat are the e)pectations of similar units in the boo&s of the ban& or in the locality+ • .s there any bottlenec& in the infrastructure+ eg, power shortage, transport availability, lead time re uired for purchase of additional machinery etc. The ne)t step would be to assess the levels of inventory and debtors • •

" %ir"!t "7p"n#"# to t."n a%%ing op"ning #to!k an% #$/tra!ting !lo#ing #to!k o #to!k in poro!"## to it3. • "iscussions should be held with the management to ascertain their perceptions of the situation."2"r i# lo1"#t3 W" 0"a#$r" t." point to /" r"0"0/"r"% i# t." ra1 0at"rial #to!king in n$0/"r o %a6#(0ont." t." ra1 0at"rial# 1ill /" 2al$"% at in2oi!" or 0ark"t pri!" or !ontrol rat" i t.f the mar&et is dominated by monopoly suppliers." !on#$0ption o ra1 0at"rial %$ring t.which are sufficient and necessary for achieving the accepted targets. The unit might prefer to import in one/two lots so as to optimi1e the cost of import and reduce related wor&." ra1 0at"rial !on#$0ption an% t. they may stipulate minimum purchase of the materials for large uantum.# o t." !o#t o pro%$!tion %$ring t. the need for which has to be specially 'ustified for any specific reasons.oar%ing o #to!k#3 STOCKING OF RAW *ATERIAL& %t times anticipating supply bottlenec&s. T." it"0 i# #$/4"!t to !ontrol5 1.# o t.# will be held by the unit. FINISHED STOCK& The unit has to stoc& a good range of its products. . This is arrived at by considering ( • . the level of stoc&s/debtors during the previous //0 years." "n#$ing 6"ar3 STOCK IN PROCESS& The unit will have stoc& in process at any given time.n the case of e)isting units. T. W" 0"a#$r" t." "n#$ing 6"ar3 T. This happens in the case of machinery manufacturing units or units manufacturing customi1ed e uipments for other units.i!. it will be uneconomical to import in smaller uantities.f the production cycle is longer.. The funds loc&ed in stoc& in process depends on the processing time i. the unit may need to stoc& e)tra uantities." #to!k in pro!"## in n$0/"r o %a6#(0ont. each of them of .at 1orking !apital a%2an!" i# grant"% to a!ilitat" pro%$!tion an% not to a!ilitat" . . relatively higher level of 2.n the case of imported materials. The unit can avail high discounts for bul& purchases." !o#t o pro%$!tion !an /" 1ork"% o$t /6 a%%ing t. .e. • The levels of inventory/debtors held by similar units of comparable si1e will have to be studied.f the pro'ected level of stoc&/debtors is more. time ta&en for conversion of raw materials to finished goods.

space industry etc." t. • #re despatch inspection by indenting $ov."% goo%# to !o#t o pro%$!tion3 SUNDR. There is no bloc&ing of funds by the unit and hence no financing is needed to the e)tent of advance received. -ence. AD'ANCE PA-*ENT& . The last //0 years’ balance sheets. the position revealed by the study of similar units in the area and the management’s perceptions are all relevant in estimating the level of finished goods ." !o#t o #al"# %$ring t. • 4inimum uantity to be dispatched. These are ( .." "n#$ing 6"ar3 T. CREDIT SALES & Credit is e)tended by a unit for many reasons. no finance is needed for cash sales.# o t. Thus. • 2easonality of goods." !o#t o #al"# !an /" 1ork"% o$t /6 a%%ing op"ning #to!k an% #$/tra!ting !lo#ing #to!k o ini#. from an institution or an e)port order. 3ften times the unit may have to carry e)cess finished goods to cater to a bul& order. SALES ON CASH TER*S& . • 4ar&eting/distribution arrangements.t is rare that 5667 advance payment is received by an enterprise though in some highly sophisticated/technologically oriented units supplying its goods/services to defence industries. departments. W" 0"a#$r" t. it has to &eep a complement of the various items manufactured by it.ade uate uantity/numbers so as to be able to e)ecute the orders readily. 3ther aspects to be &ept in mind while determining the level of finished goods are ( • *hether goods are manufactured against firm orders or against anticipated orders.DEBTORS& % unit may sell its goods ( • against %dvance #ayment • on cash terms • on credit terms. a portion of the order amount is paid as advance payment."% #to!k in n$0/"r o %a6#(0ont." ini#.n this case also no funds are loc&ed up as receivables. say. • Transport arrangements and cost.

" #$n%r6 !r"%itor# in n$0/"r o %a6#(0ont.• • • • • Trade practice 4ar&et conditions 8ul& 2ale 2easonality #rice advantage. its location. the unit’s activity will grind to a halt for want of wor&ing funds. These two are important sources for the wor&ing capital re uirements of the unit." a0o$nt o !o#t o #al"# or "2"n #al"# %$ring t. The assessment of wor&ing capital re uirements and eligible credit facilities is to be done as follows ( . The uantum of credit available to the unit should be assessed by studying the position in the past //0 years. This is to be brought by the unit and the ban& does not finance it. These are to be applied with different degree of rigour based on nature of industry. mar&et practice and the unit’s perceptions. .stablished and reputed units and units which are buying raw materials in the situation of <buyers mar&et= will be able to command longer credit. The acceptable level of sundry debtors has to be decided based on the figures in the 8alance 2heets for the last few years. 2imilarly advance payment received from buyers should also be ta&en into account. Customarily one month e)penses 9both direct and indirect: are rec&oned as cushion." t.PENSES& % unit has to &eep cash for meeting e)penses as and when they fall due. Trade credit is interest-free and a unit should and would use it to the utmost e)tent.# o t.CREDITORS& The unit would get credit for its purchases from the mar&et. the trade practice and the unit’s perception of the e)tent of credit to be granted to the purchasers." "n#$ing 6"ar3 CUSHION FOR E. SUNDR. prevailing environmental factors etc." "n#$ing 6"ar3 The concepts discussed above are fundamental concepts relating to assessment of wor&ing capital re uirements of units. to win more mar&et as well as protect e)isting mar&et.# o t. Credit is a potent tool to e)pand sales. This is &ept by way of cushion and is in addition to the e)penses which have been incurred in the production process. si1e of the operations. W" 0"a#$r" t. W" 0"a#$r" t.a#"# %$ring t." a0o$nt o p$r!." #$n%r6 %"/tor# in n$0/"r o %a6#(0ont. 8ut uncontrolled credit will affect the li uidity and profitability of the unit and before long.

" Bank ." $nit ." t$rno2"r a# 0argin3 T.a# to /" tr"at"% a# 1orking !apital r">$ir"0"nt o t.Naya&.# in#tr$!tion# ar" & a: /: !: <8= o t. !et us wor& out the overall eligible *C limits for the unit as per the Naya& Committee method. T.o% or t."r# & Pro4"!t"% Balan!" S.>." pro4"!t"% t$rno2"r o a SSI $nit .a2" to /" arri2"% at on t." Co00itt"".a# r"!o00"n%"% a #i0pli i"% pro!"%$r" or a##"##ing 1orking !apital li0it#3 Ba#"% on t. #." $nit3 T." C3*3A3 or0at3 T.o%: % committee was constituted by >8.""t 0"t. the then "eputy $overnor of >8." tra%itional *"t.i# i# appli!a/l" to !ottag" an% 2illag" in%$#tri"# a# 1"ll a# tin6 #"!tor#3 T." /a#i# o pro4"!t"% ann$al t$rno2"r3 T. in %"tail /"lo1& NA-AK CO**ITTEE *ETHOD& 9Al#o !all"% pro4"!t"% T$rno2"r *"t." 1orking !apital li0it# or SSI $nit# . AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA A ." Co00itt"" .)ample( The pro'ected turnover of the unit is >s.i# #6#t"0 .o% For ot.a# to inan!" <?= o t.a# to /" ollo1"% or $nit# "n4o6ing WC li0it# $pto R#3 8 !ror"#3 .For li0it# $p to R#38 !ror" & Na6ak Co00itt"" 0"t. @6 la&hs. 8ased on the recommendations of the Committee report 95??0: the >8.o% in t. to e)amine the difficulties faced by 22.a# to /ring in 8= o t. under the chairmanship of 2hri. units in securing institutional credit." t$rno2"r a# WC li0it5 t."#" ar" %"alt 1it.# r"!o00"n%ation#5 RBI. has issued the following instructions.

"r li0it# #.B crore 9Ender Fa1 committee recommendations.nhancements to be sanctioned in time.an t. bills etc."r" i# a l"7i/l" approa!. advances upto >s.an t." "nt"rpri#" an% 1" $#" A##"##"% Bank Finan!" *"t.o$l% /" %on" /ot. The limits have to be sanctioned based on the pro'ected turnover.666----% ( >s /6.o% rat."03 F$rt.666." 0att"r . -ence.o% an% Na6ak Co00itt"" 0"t.T/2T statements."r5 i a $nit i# grant"% a li0it 1.66." tra%itional *"t.o%3 RBI ."r t.o% 1ork o$t to /" 0or" t.66.a# al#o a%2i#"% t. sub-limits for stoc&s. @6. %"p"n%ing $pon t. The turnover can be assessed by reference to . however. have to be wor&ed out based on realistic assessment.66. ( >s.o$l% /" grant"% to t." Na6ak Co00itt"" 0"t. i# l"## t.at 1orking !apital a##"##0"nt #. 5C. AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA This method is simple to wor& out. Tandon/Chore norms are not applicable to 22.D6. Pro4"!t"% t$rno2"r 0"an# pro4"!t"% #al"# in!l$%ing "7!i#" %$t63 %lso.i!." .666----8 @67 of the8 turnover as *C advance /67 of8 as margin to be met by the unit ( >s.o%@ al#o5 i t.Bcrore." "ligi/l" 1orking !apital li0it# a# p"r t.a# to /" %i#!$##"% 1it. ." /ank# t." n""% /a#"% r">$ir"0"nt o t. The units have to route the entire sale proceeds through the a/c.666." 0a7i0$0 p"r0i##i/l" Bank Finan!" *"t.66.ig.The pro'ected annual turnover Total *C >e uired is /B 7 of % ( >s.666." $nit. D. Tandon/Chore norms are not applicable to advances to medium/large units also up to >s. a# p"r tra%itional 0"t. L"t $# tak" anot. as per the conventional method.o%5 or #o0" r"a#on or ot." li0it "ligi/l" a# p"r Na6ak Co00itt"" 0"t. No1 Bank i# not $#ing t. the 4a)imum #ermissible 8an& Finance need not be calculated for such units:.# li>$i% #$rpl$# i# !o0 orta/l": t. t. .ts pro'ected annual turnover is >s."r "7a0pl"& % unit approaches the 8an& with a re uest for sanction of *C limit.66. /.o%5 t."r 9"3g35 t.." $nit an% it# a!!"ptan!" o/tain"%3 i: ii: iii: iv: The Committee also made the following recommendations ( .

the sources are 2undry Creditors. 5/ la&hs. Esually. The overall limit will be fi)ed as per Naya& Committee recommendations. /.66. C6 la&hs. a unit has to stoc& raw materials. *or&ing Capital >e uirements are calculated based on the pro'ected level of sales for the ne)t year at the pea& level of production. Ender this method also. The *or&ing Capital %ssessment format is given as per %ppendi) ( . >easonable margins will be prescribed on the various assets. %dvance #ayment >eceived and Net *or&ing Capital in the business. %s discussed earlier. carry stoc&s in process. The *or&ing Capital >e uirements for these purposes are assessed first. finished goods and sundry debtors so that smooth production can be carried on. provided the unit has satisfactory Net *or&ing Capital. The level of stoc&ing / carry of these items will be fi)ed as discussed in the earlier chapter/paragraphs. ( >s.D@ la&hs ( >s.D6.666. The shortfall will be met by 8an& finance. The sources from which the >e uirements will be met will be analysed ne)t.#ro'ected annual turnover is >s. AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA TRADITIONAL *ETHOD& Traditional method is to be used to determine the sub-limits to be fi)ed for a unit en'oying wor&ing capital limit up to >s. i: /B7 of the output value or turnover ii: D/Bth of 9i: to be sanctioned iii: 5/Bth of 9i: to be brought by the unit %s margin ( >s.B crores.

666 - .66.666 0.D6.666 >4 consumed >s.mported/.666 G month 5 month / months 5 month 0.666 Cost of #roduction ( >s.666.B66 5.66.B6.B66 Total *or&ing Capital >e uired >s.B/.666 4argin 7 /B7 005/07 /B7 D67 566.B66 ---% !i uid 2urplus in 8.B66 5B. /. Cost of #roduction >s.2.0C. The pro'ected turnover for the ne)t year >s.66./B.B66 D.C6.B66 >s.666 >4 2toc&ing ( / months 2toc& in #rocess ( G month Finished $oods ( 5 month 2undry "ebtors ( / months 2undry Creditors ( G month #lease calculate the %ssessment of *or&ing Capital >e uirements at pea& level of operations of ne)t year.A*PLE& 4/s %8C.B66 B.B/.666 This deficit should be brought in from own sources or tied up from the . The following information has been collected from the study of industry data.666 5.5/. 0.56./B.B6. /5.66.ndigeno us >aw 4aterial 2toc& in #rocess Finished $oods 2undry "ebtors .BD.tem 2toc&ing/ #ayment #eriod *or&ing Capital >e uired 9>upees: / months C.666 4a)imum #ermissible !imit D.66 7 4argin %mt.5B.0H.B6. 0. 5.66.E.)penses Total /D.B.666 >4 Consumed ( >s.666 5.666 ?.D.66.666 /.0H.B66 0./D.66.0.666 !imits >ecommended >s.0H./H.B6.666 N*C/!i uid surplus as per 82 >s.B6. a partnership firm has approached you for sanction of wor&ing capital facilities.C6.666 Credit on #urchase of >4 90/D month: >s.5/.0H. 0.666 .B6. unit’s pro'ection as well as discussions with the management. as at 05-5/-?B >s.B6. ----------------------------------------------------------------------------------------------------------4onthly 2ales ( >s.B66 ---8 "eficit 9%-8: I >s.

The wor&ing capital deficit of >s 0. by deducting the profit element from sales.66. C6. the unit has to bring in additional funds to bridge the li uid deficit and meet the margin on the current assets.66.DH. as the .. -ere we have calculated amount of finished stoc& and debtors on cost of production instead on cost of sales for the sa&e of simplicity. 5B. AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA The following points may be noted in *. This is easy wor& out the figures. otherwise it may be included for ease of calculation.0. if the profit accruals can bridge the deficit within say. .666.f the balance sheet shows a li uid deficit. the deficit has to be added to the wor&ing capital re uirements. • %dvance #ayment 9if any: is to be treated in the same way as 2undry Creditors. • 2ales ( 3nly the credit sales has to be ta&en into account.t is ta&en on Jsales’ basis for fi)ing the 4a)imum #ermissible !imit.66. also it is favourable to the unit. *hat is reasonable deficit will be determined by the profit accruals in the business. D to C months. 5/. the higher limit has to be sanctioned to the unit.666.: The eligible limit as per conventional method is >s. The rationale is that no outlay of funds is involved in the profit.B66 as against the limit of >s.666 arrived at by Naya& 4ethod. 5B. %lso.666. • 2ales to be computed at the ma)imum level of anticipated production during the ne)t 5/ months. assessment ( • The cost of production is defined as raw material consumed plus direct e)penses plus opening stoc& of stoc& in process minus closing stoc& of stoc& in process.B/.f the difference is material in any case. in this e)ample.66. the entire sales is assumed to be on credit basis. This is a simple way of calculating the cost of production for limits up to >s. Jdepreciation’ may be e)cluded. Total *or&ing Capital re uired 9/B7 of a: >s. *or&ing Capital !imit 9@67 of b: >s. . • 2F$ and F$ are valued on the basis of cost of production.can be met from future profit accruals in the business. Normally.666/. 9The unit should bring in a margin of >s. the deficit is reasonable.C. -ence. 5/. • The li uid surplus should be acceptable.666. 5 crore.66. .e. *e can also include <"epreciation= as cost of production.profits in future *or&ing Capital >e uirements as per Naya& Committee method ( #ro'ected annual turnover >s.. • 2undry debtors is ta&en on cost of production basis for assessing *or&ing Capital re uired i.

the stoc&s cannot be sold ultimately. ( >s. .months -. the fashions change fast and if 2.mported raw materials ii. . 8y Traditional 4ethod 5.K 5 %ssessment of *or&ing Capital >e uirements Name of the unit LLLLLLLLLLLLLLLLLLLL a.n some industries li&e garment manufacturing industries. Finished goods v. The other 4ethods for calculation of wor&ing capital finance for big limits generally more than >s. so that the ban& is alerted if accumulation of such category of assets ta&es place for some reason or the other.N".months -.months -. tea industry etc. 0. 2undry debtors vi. %##. . . The cash budget 4ethod is used for seasonal .months *or&ing Capital >e uired ( >s.months -. 4argin ---------.#/2F$/F$ e)ceed beyond a reasonable level.ING OF SUB LI*IT FOR DEBTORS& <2ub-limits= means limits for various items such as semi finished goods. ( >s..ndigenous raw materials iii.tem %nticipated monthly sales Cost of production per month Cost of raw materials per month 2toc&ing/ #ayment #eriod -.)penses T3T%! . /.7 value #ermissible !imit i.B crores are the #ro'ected 8alance 2heet 4ethod and Cash 8udget 4ethod. li&e sugar industry. finished goods etc. 2toc& in #rocess iv.month -. . the deficit is lin&ed to pea& level of operations which the unit may reach after C to @ months in the ne)t year. FI.assessment is made for pea& level of operations. and construction activities and software industry etc.ndustries.

%ny ma'or discrepancy should be en uired into. Credit on #urchases 9L. N3T. *or&ing Capital re uired in terms of Naya& 4ethod a.. 0. 98: "eficit 9%-8: >sLLLLLL.. ( .. !imits recommended >sLLLL. if any. 5.. value thereof at sale value less margin. 8. C. e. Cost of production includes cost of raw materials plus all e)penses.>sLLLL.. Calculate the pro'ected turnover more carefully where the operating cycle is for shorter period say.22 ( .. it comes to less than 8 using usual method.M a. c. under Jpermissible limit’. !i uid surplus in balance sheet as on --. profitability indicators should be closely monitored and realistic pro'ections should be made. B. ( 2ales to be computed at the ma)imum level of anticipated production during the ne)t 5/ months. e)cise and other statutory returns as well as the credit summations in the account. the Field 3fficer/ >ecommending 3fficial should rechec& the various parameters in % above in consultation with the borrower and record his/her assumptions for benefit of the sanctioning authority. For items 9ii: and 9iii: in the table above. the value of receivables at cost and. #ro'ected annual turnover.. the reasons for such variations should be substantiated. 2ub-limits should be fi)ed where necessary to ensure effective monitoring of the end use of funds. %s there is direct bearing of pro'ected turnover on wor&ing capital limits.month: >sLLLL. N3T.. The pro'ections made by the unit regarding turnover should be monitored on monthly/ uarterly basis.f pro'ected turnover e)ceeds by /67 of the previous year’s actual turnover. *or&ing Capital limit 9@67 of b: The wor&ing capital limit from ban& should be minimum of 8 as above.Total wor&ing capital re uired >sLLLLLL9%: !. . D. Total of 9i: to 9iii: above >sLLLL. in balance sheet to be added to wor&ing capital re uirements. . the basis of calculation would be the cost of production. ... income ta). d. b.n case. /.F. 2tate under J*or&ing Capital >e uired’. b. Total wor&ing capital re uired 9/B7 of a: c.. . Compare the turnover of the previous years with the sales ta). depending on the e)posure to the industry. . less than 0 months. The borrower’s views in this regard may be obtained in writing. "eficit.