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Apart from financing for investing in fixed assets, every business also requires funds
on a continual basis for carrying on its operations. These include amounts expenses incurred
for purchase of raw material, manufacturing, selling, and administration until such goods are
sold and the monies realized. Business transactions are generally carried on credit with a
number of days elapsing subsequent to the sale being effected for realization of proceeds1.
While part of the raw material maybe purchased by credit, the business would still need to
pay its employees, meet manufacturing & selling expenses (wages, power, supplies,
transportation and communication) and the balance of its raw material purchases. Working
capital refers to the source of financing required to by businesses on a continual basis for
meeting these needs.
Thus the need for working capital arises from the prevalence of credit in business
transactions, need to fund manufacturing and support and to account for the variations in the
supply of raw material and demand for finished goods.
The financing limits are granted based on assessment of the working capital
requirement. The assessment factors include various characteristics such as the nature of
industry, industry norms, actual level of activity for the previous year and the projected level
of activity for the subsequent year to arrive at the working capital requirement. The bank
financing limit is thereafter decided after factoring in margins on the different types of
current assets forming part of the working capital.
The Bank Financing Limit is fixed on an annual basis. However, since such limit is provided
to meet specific requirements, utilizing the limits is subjected to the Drawing Power, which is
decided on a monthly/ quarterly basis.
The effective bank financing is therefore to the extent of the lower of:
• Bank Financing Limit: Determined on an annual basis based on an assessment of the
current year’s projections and the actuals for the previous year.
• Drawing Power: Linked to the quantum of current assets (and current liabilities)
owned by the business with appropriate margins. Fixed on a monthly/ quarterly basis
depending on the submission of Monthly/Quarterly Information System returns
indicating the position of the stock statement, receivables, Work in Progress,
payables, etc.
Bank Financing (max. permissible) = Bank Financing Limit OR Drawing Power whichever is
less
Lack of adequate working capital is often stated as one of the major reasons for sickness in
industry (especially in case of SMEs). The counter arguments from the banks have been that
most firms face problems of inadequate working capital due to credit indiscipline (diversion
of working capital to meet long term requirements or to acquire other assets). In this context
it would be pertinent to understand the method adopted by banks in computing the working
capital requirement of the business and the quantum of bank financing to be provided by the
bank.
The main factors considered in the estimation of working capital requirement are:
• The nature of business and sector-wise norms
Factors such as seasonality of raw materials or of demand may require a high level of
inventory being maintained by the company. Similarly, industry norms of credit
allowed to buyers determine the level of debtors of the company in the normal course
of business.
• The level of activity of the business
Working Capital Requirement (WCR)= [Current assets i.e. CA (as per industry norms) –
Current Liabilities i.e. CL]
Permissible Bank Financing [PBF} = WCR – Promoter’s Margin Money i.e. PMM (to be
brought in by the promoter)
As per Formula 1: PMM = 25% of [CA – CL] and thereby PBF = 75% of [CA – CL]
Illustrative Example:
Turnover of a manufacturing unit: Rs. 750 lakh p.a (assumed uniform across the year)
Assumed value addition norm: 50% (i.e. cost of raw material = 50% of Realisation)
Promoter Projections
Current Assets Current Liabilities
- Raw materials Rs. 50 lakh - Payables Rs. 35 lakh
- Work in progress Rs. 25 lakh
- Finished Goods Rs. 60 lakh
- Receivables Rs. 125 lakh
Requirement assessed as per norms applicable for the industry:
Working Capital
Rs. 171.82 lakh Rs. 225.0 lakh Rs. 171.82 lakh
Requirement
Notes:
• Assumptions here include: No export turnover, uniform working capital requirement
through out the year
• Industry norms have been specified in the Tandon Committee Report for all important
industry categories
• Raw materials have been valued at cost of raw material (assumed at 50% of
realization)
• Work in progress has been valued at 50% complete basis
• Applicable norm (d) is the more conservative of (b) or (c) from the bank’s point of
view.
1
Or at (25% of CA) as per Formula 2
Small scale industries have a distinct set of characteristics such as low bargaining
power leading to problems of receivables and lower credit on purchases, poor financial
strength, high level of variability due to dependence on local factors, etc. Consequently, it has
been rightly argued that the industry norms on different current assets cannot be adopted.
The PR Nayak Committee that was appointed to devise norms for assessing the working
capital requirement of small-scale industries arrived at simplified norm pegging the Working
Capital bank financing at 20% of the projected annual turnover. However, in case of units
which are non-capital intensive such as hotels, etc. banks often assess requirements both on
the Nayak Committee norms as well as the working cycle norms and take the lower of the
two figures.
Eligibility and Norms for bank financing of SSIs as per Nayak Committee
a. Applicability:
In case of SSIs, with working capital requirement of less than Rs. 5 crores
In case of other industries, with working capital requirement of less than Rs. 1 crore
b. Quantum of Working Capital bank financing:
20% of the projected annual turnover
Cash flow is the most realistic means of assessing the operations of an enterprise.
Drawing up cash flow statements (monthly or quarterly) for the past few years clearly
indicate the seasonal and secular trend in utilization of working capital. The projections
drawn up by the entrepreneur may then be jointly discussed with the banker as modified in
light of the past performance and the banker’s opinions. The peak cash deficit is ascertained
from the cash budgets. The promoter’s share (margin money) for such requirement maybe
mutually arrived at by the banker and the borrower with the balance requirement forming the
Bank financed part of Working Capital.
Cash flow based computation of working capital requirement has been recommended by the
RBI for assessment of working capital requirement permitting the banks to evolve their own
norms for such assessment. The reason for this has been that Cash flow factors in the past
trends, takes into account the company specific factors and is based on mutual discussion
between the banker and the borrower thereby increasing its acceptability. Also, large
companies have adopted cash budgeting systems for managing their cash flows and hence
such a system does not impose additional requirements on the corporates.
Cash flow system is extremely relevant in case of the seasonal industries to assess the peak
credit requirement and in case of large companies (working capital requirements above Rs.
10 crores). However the reluctance to provide the cash budgets thereby revealing additional
information to the banks, has led to even larger companies shying away from Cash Budget
method of assessing Working Capital. Consequently Cash Budget method is currently
prevalent mainly in case of seasonal industries, construction sector as well as other entities
whose operations are linked to projects.
Bank financing based on cash budgets works well and is a good step form for the system.
A big failure in the working capital system hitherto followed by our banks has been that the
Drawing Power (within the PBF limit) is based on post facto stock statements and these are
reset typically on a monthly basis. This means:
• The borrowing unit is putting its money upfront and the Drawing Power is a form of
reimbursement.
• Responsiveness to sudden surges in demand/ seasonality/ other short term boom
conditions is non-existent, putting a burden on the company to finance this at
exorbitant rates from private financiers.
• Finally, a growing company will always be playing “catch-up” and its Permissible
Bank Financing will be lagging its cash requirements by atleast one year.
Procedures to avail working capital financing from banks
Banks exercise extreme caution in lending to first time applicants starting up their
business. A first time applicant would be asked for collateral in the form of land, building or
residential property. This would be in addition to a second charge on the fixed assets of the
enterprise. Sequence of steps to avail working capital
• Application for the working capital
Most of the large commercial banks are moving towards the trend of specialized SSI
branches near the industrial concentrations. The applications for working capital are
generally accepted and processed at these branches.
• List of Documents accompanying the application
The application for working capital would need to have a covering letter containing a
request for sanction of working capital limits. The following documents would need
to be enclosed alongwith:
○ Detailed Project Report containing the detailed financials at projected levels of
operations for the next 5 years
○ Memorandum and Articles of Association
○ Copies of Incorporation documents (relating to formalities with the Registrar
of Companies in case of corporates)
○ Statutory approvals obtained/ applied for such as for power, water, pollution
control, environment clearance, clearances from other agencies/ departments
with purview over the business.
○ Other relevant documents – Letters of intent/ confirmed orders from
prospective buyers.
○ Networth statement of promoters.
In case of the larger loans (above Rs. 5 crore in case of most banks), the projections
are generally submitted in the CMA format prescribed by Reserve Bank of India
(earlier mandatory).
Most of the large banks have specialized SSI branches at the industrial concentrations
in the country. These branches are headed by senior executives often with sanctioning
power of Rs. 5-6 crores at the branch. In such instances, delays for processing the
applications at the bank are limited. Infact the stage of in-principle sanction maybe
dispensed with and final sanction accorded on full appraisal.
In other cases, such processing may take 30-45 days for according In-Principle
Sanction to the project. The newer private sector banks are generally faster in
according such approval. The significance of the in-principle sanction of working
capital is that such sanction is necessary for obtaining term funding from the financial
institutions. While these financial institutions accord sanction to a industry,
• Appraisal and Final Sanction
The appraisal and final sanction of the request for working capital is based on a
thorough appraisal of the Detailed Project Report (DPR). The traditional banks
generally have specified formats for submission of the DPR. The usual coverage of
the DPR includes:
○ Overview of the business
○ Background of promoters
○ Details of products to be manufactured – manufacturing process and raw
material
○ Market overview and competition Sensitivity Analysis – ‘What if’ on Finished
Goods prices, raw material costs and so on
○ Detailed financial projections covering the Balance Sheet, Profit and Loss
Account, Funds Flow and the Financial Ratios.
The timeframe for a Final Sanction in cases where all the requirements have already
been submitted by the borrowing unit is 90 days from the submission of the
application.
• Post Sanction Requirements
Post sanction requirements involve completion of documentation creating a charge in
favour of the bank. This could include a charge on assets related to the business and
charge on collateral offered (if any). In case of the assets of the business already being
mortgaged with the term lending institution, a second or third charge maybe created in
favour of the bank.
The financing facilities sanctioned can thereafter be availed by the borrower.
• Monitoring and follow-up
Working capital financing is extended for the current asset build up of a business,
which is linked to its activity level. These assets are mobile (in case of inventory) and
also easily convertible into cash. At best, the banks have a second charge on the fixed
assets of the enterprise and without the power of Seizure (u/s Sec 29 as available to
the state financial institutions) realizing money from the security is time consuming.
Hence, banks pay extremely high importance to the monitoring and follow-up of the
loan.
The system of a current account through which all the transactions are routed acts as an in-
built check on the operations of the borrower. By studying the current account transactions in
detail, the banker is able to make an assessment of the business. In addition to this, the banks
also undertake other forms of monitoring.
These include:
• Stock Statements collected on a monthly basis from the borrower.
• Quarterly Operating Statement giving details of the operations for the quarter
Fear of NPAs, enquiries on bad loans and capital adequacy constraints make banks
credit averse
Over the past few years, a combination of circumstances has made banks averse to taking on
additional credit exposure. This is especially so in case of new projects where the promoter
does not have a track record.
○ The introduction of globally accepted norms of Asset Classification resulted in
high level of Non-Performing Assets showing up in the books of banks, which
had to be written off affecting profitability and eroding capital.
○ The erosion of capital meant that banks were in danger of not meeting the
newly introduced norm of 8% capital adequacy. Not achieving the 8% norm
would affect credibility of the bank and possibility of accessing the capital
markets for equity or debt.
○ In a number of public sector banks that faced massive erosion in capital,
enquiries were instituted against officials who sanctioned the bad loans
thereby making bankers more cautious of taking any kind of credit decisions.
In such circumstances banks increasingly resorted to investing in risk-free government debt
and avoided taking on industrial credit. The problem has been more acute in the small-scale
sector. The sector had witnessed a high level of directed lending in the past decade most of
which turned bad thereby putting off the banks from further credit to the sector. Even
otherwise, the adverse impact of liberalization has been felt more in the SME sector that
among larger industries.
At SBI, working capital loans are tailored to suit the precise requirements of the client, in any
of the various instruments available or structured as a combination of cash credit, demand
loan, bill financing and non-funded facilities.
The bank’s accomplished credit crew can gauge the credit needs of each client and frame the
exact solutions.
SBI’s dedicated credit team has a deep understanding of the intricacies of various industries
and is richly experienced in reckoning the business potential of companies.
These informed professionals can assess your specific credit requirements and tailor
customized financial solutions to suit your risk profile and the working capital cycle of your
company
Normally working capital finance is extended as a ‘limit’ for various facilities for tenors up to
one year. ‘Ad hoc’ requirements are also considered. How are SBI working capital loans
priced?
The loans normally carry on a floating interest rate linked to SBAR, the SBI prime lending
rate for working capital finance. Certain self-liquidating short-term loans are also linked to
the bank’s Short Term Advance Rate (SBSTAR).
Working capital finance limits are normally valid for one year and repayable on demand.
Specific, self-liquidating loans are linked to the natural tenor of the transaction (bill finance,
export credit etc.).
Micro enterprises and small scale industries with working capital limits up to Rs 10 crore will
be able to avail themselves of working capital finance at 10.25 per cent.
Other measures taken by the bank for MSMEs include extending the working capital cycle to
cover longer period of holding of inventory and receivables. The bank new product ‘SME
CARE’ for sanction of additional working capital limits up to 20 per cent over the earlier
limits, to meet the longer working capital cycle. The bank has also come forward with a
scheme to support MSMEs that require diesel generator sets to meet power shortage and
maintain their productive activity.
The bank’s MSME portfolio was at Rs 74,324 crore as at the end of March 2008 and it has
increased to Rs 81,794 crore as at the end of November 2008.
Bank of Baroda
Bank offers corporations Working Capital Finance to meet their operating expenses,
purchasing inventory, receivables financing, either by direct funding or by issuing letter of
credit.
Key Benefits
• Funded facilities, i.e. the bank provides funding and assistance to actually purchase
business assets or to meet business expenses.
• Non-Funded facilities, i.e. the bank can issue letters of credit or can give a guarantee
on behalf of the customer to the suppliers, Government Departments for the
procurement of goods and services on credit.
Eligibility :
1. Working Capital Finance is to be provided to those units, who have either availed
term loan from our bank or have not availed any loan facility from any other financial
institutions.
2. The term loan account of those should be Standard Regular.
3. Multiple banking arrangement is strictly prohibited under the scheme.
Security :
i. Salient features of the Credit Guarantee Fund Trust for Micro and Small
Enterprises (CGTMSE)
○ The eligible loan limit under the Scheme is now Rs.100 lakhs.
○ The credit guarantee cover has been raised from 75% to 85% for the following
category of loans:
a. Loans to Micro enterprises upto Rs. 5 lakh; and
b. Loans to Micro and Small enterprises operated and/ or owned by
women.
○ The coverage of the Scheme will now be extended to all new and existing
Micro and Small Enterprises (both in the Manufacturing Sector as well as
Service Sector).
Allahabad Bank
Purpose of Working Capital Loan:
• Financing of Stock & other assets including book debts to be used in trade.
• Development of shop /showroom / Acquiring block / fixed assets like air conditioners,
delivery vans etc.
• Purchase of shop/showroom upto 50% of the value of the shop as per Registered sale
deed or market value as assessed by Bank & valuer whichever is less ( to be secured
by mortgage of registered sale deed).
Eligibility:
• Traders both wholesalers & Retailers of goods and Commodities which are not
prohibited by Govt/RBI. Borrowers may be individual/ sole proprietorship/
Partnership firms/ HUF/ Joint stock companies/ co-operative societies.
• Traders having Registration/ License as applicable under local laws (i.e. Shops &
Establishments Act). The registration/ license may be as under: Sales Tax Registration
• Drug License for Retail Trade of Drugs/ Medicines (where ever applicable) Trade
license Ration & Civil supplies etc.
• The proponent should preferably be engaged in the line of business for at least 1(one)
year. New units can also be considered in deserving cases. In such cases, reasonable
projected sales should be estimated depending on the merchandise area, market
potential, capacity of the borrower etc.
Quantum of Loan:
Overall Ceiling (Working Capital and/or Term Loan) will be Rs.200.00 lakhs. Out of which
Term Loan component should not exceed 25% of the overall limit or Rs.25.00 lakhs which
ever is lower.
Types of Facility:
• Overdraft facility for working capital.
• Term Loan for purchase/ development of shop/showroom.
• Letter of Credit may be sanctioned keeping in view, the genuine requirement of the
borrower, only in favour of reputed suppliers within the overall ceiling.
Security:
• In addition to the Hypothecation of Stocks and other assets created out of the Bank
Loan, the loan will also be secured by mortgage of immovable property - Value of
Mortgaged property as assessed by Valuer & Bank Officials (as per instruction
Circular) should not be less than 100% of the loan.
• In cases where it is observed during the visit for stock verification that the normal
margin requirement of 25% of the Stocks for WC limit is not being regularly
maintained, the borrower will provide additional liquid security in the shape of our
FDR/ DDP etc. to the extent of 25% of the limit.
• 3rd party property / FDR/DDP may be accepted which will be backed by Personal
Guarantee.
Rate of Interest:
• Up to Rs.10.00 Lacs: PLR w.m.r.
• Above Rs.10 Lacs as per Risk rating (on CRG -02/4).
Processing Fee:
Rs.200/- per lakhs, Minimum Rs.1000/- & maximum Rs.20000/-
Period:
• Working Capital : One Year
• Term Loan: Five Years excluding gestation period of maximum 3 months.
Repayment of Loan:
• Working Capital: On Demand
• Term Loan: Equated Monthly/ quarterly Installments. At the time of disbursal 24
PDCs for the EMI are to be obtained and fresh set of PDCs should be obtained 3
months before expiry of the stock of PDCs.
Canara bank
NATURE OF LAGHU UDHYAMI CREDIT CARD SCHEME
LIMIT
Financing stock in trade, book debts and other assets to be used in the trade.
Acquiring of assets for furnishing of shop & show room like partition, fixture and
furnishing etc, purchase of air-conditioners, other gadgets and delivery van required for
running the business.
Eligibility
i) Traders, who are individuals, firms, HUFs, cooperative societies registered under any law
relating to cooperative societies and companies etc. Promoters /co-obligants must have
existing satisfactory relationship of minimum at least six months with the Bank.
ii) Traders should comply with applicable statutory requirements, such as
State/Central Sales Tax Registration Certificate, Licence under Shops &
Commercial Establishment Act, Registration with Excise Department, etc.
iii) Advances against goods or any other item prohibited by RBI/Govt. from time
to time will not be covered under this scheme.
Extent of Loan for Working Capital
Small Traders may be granted facility of term loan for working capital to extent of 60% to
70% of their requirement subject to maximum of Rs. 5 lac.
For other traders with a working capital requirement of above Rs. 5 lac, 60% to 70% of
their requirement can be financed with no upper limit.
Term Loan: 70% of the cost of assets to be purchased with a maximum of Rs.100
lac for Metro and Urban centre and Rs. 25 lac for SU and rural centre
Security
Repayment
Working capital limit upto Rs.5 lac granted by way of term loan (WCTL) will be
repayable in equal monthly/quarterly instalments within a period of 3 to 5 years.
The term loan for acquiring fixed assets will be repayable in equal monthly/quarterly
instalments within a period of 5 to 7 years including moratorium period of 3-6 months.
Disbursement
For term loan for fixed assets and working capital, the loan amount shall be payable
directly to the suppliers of the assets by draft/cash order.
For other working capital advances, cash credit limit shall be set up.
The quantum of working capital funds can be ascertained by looking into the working
capital cycle of the unit. Working Capital Cycle can be explained by way of flow chart as
below:
Cash > Raw Material > Work in Process > Finished Goods > Receivables > Cash
It is normally presumed that the working capital cycle will be of three months i.e. the
period taken for conversion of cash into raw material, raw material into finished goods,
finished goods into receivables and receivables into cash. Depending on the nature of
activity and various other factors it may be either more than 3 months or lesser than 3
months.
The working capital limits can be availed by way of cash credit, bills limit, Letter of
Guarantee, Letter of Credit etc.,