COMM.

BANKING SESSION V 08-09-2021

GIPE
MSc (FE)
SESSION V

COMMERCIAL BANKING

WORKING CAPITAL FINANCE - CONCEPTS AND ASSESSMENT

08-09-2021

COMMERCIAL BANKING – WORKING CAPITAL

FINANCE
Session V PLAN

1.Concept of Working Capital, Working

Capital Cycle

2. Methods of Assessment of Bank

Finance for working Capital

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COMM. BANKING SESSION V 08-09-2021

RECAP: Purpose of Analysis of Financial Statements by Bankers

M → (G/S)I → (G/S)O → M’
M is raised from M = Money value of M’ = Money value M’ is available for
Own funds (G/S)I = of (G/S)O = further business and / or
(Equity) + Σ( Σ
Borrowed funds
distribution to Owners
Σ (Pi x Qi)Pi x Σ (Po x Qo) and Lenders
Qi) Σ (Pi x Qi)
Balance Sheet : Balance Sheet : Assets Side Profit & Loss Statement
Liabilities Side

• Current & other • Inventory (Raw Mat., WIP, Finished Goods) • Cost of Input goods (M)
Liabilities • Debtors • Cost of input services (M)
(Sundry • Net Fixed Assets • Sales Revenue (M’)
Creditors, Bank • Other Assets • Other Income (M’)
finance) • Net Profit (M’- M) (VA)
• Term Liabilities
• Capital &
Reserves

Methods of Assessment of Bank Finance

... Mn : (G/S)in → (G/S)on : M(n+1) : (G/S)i(n+1) → (G/S)o(n+1) : M(n+2) …
---------------------------------------------------------------------
… (Working Capital Cycle)(n) …. (Working Capital Cycle)(n+1) ….

...(Own Funds + Borrowed Funds (WCL from Bank)): Mn: (Cash Purchases + Credit
Purchases): → (G/S)in → (G/S)on : (Cash Sales + Credit sales) : M(n+1) ……..

IF WE TAKE A FINANCIAL PHOTOGRAPH OF WCC AT ANY POINT OF THE WCC, WE WOULD SEE:

CURRENT LIABILITIES: LIABILITIES PART OF THE WCC :

• WCL from Bank, Credit Purchases outstanding (Sundry Creditors for G/S)

CURRENT ASSETS: ASSETS PART OF WCC :

• Cash, (G/S)i, (G/S)o, Credit Sales Outstanding (Sundry Debtors for G/S)

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COMM. BANKING SESSION V 08-09-2021

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN CREDIT PERIOD AND LEVEL OF S Cr (Credit period=7 days)
Day 1 2 3 4 5 6 7 8 9 10 … Annual

Day’s Purchase on credit Rs. 10 10 10 10 10 10 10 10 10 10 …

Cumulative Purchases on Credit 10 20 30 40 50 60 70 80 90 100 … 3,650
Day’s Payment to S Cr - - - - - - - 10 10 10 …
Cumulative payments to S Cr - - - - - - - 10 20 30 … 3,580
SCr Outstanding (Unpaid) 10 20 30 40 50 60 70 70 70 70 … 70

S Cr = Sundry Creditors i.e. Creditors for goods purchased

SCr Outstanding = Daily Purchases x Credit period in days = (3,650/365) x 7 = 70
= Monthly Purchases x Credit period in Months = (3,650/12) * 0.23 = 70

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN CREDIT PERIOD AND LEVEL OF SCr (Credit period=7 days)
Day 1 2 3 4 5 6 7 8 9 10 … Annual

Cumulative Purchases on 10 20 30 40 50 60 70 80 90 100 … 3,650

Credit

SCr Outstanding (Unpaid) 10 20 30 40 50 60 70 70 70 70 … 70

SCr Outstanding = Daily purchases x Credit period in days = (3,650/365) x 7 = 70

= Monthly Purchases x Credit period in Months = (3,650/12) * 0.23 = 70

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COMM. BANKING SESSION V 08-09-2021

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN CREDIT PERIOD AND LEVEL OF SCr (Credit period=7 days)
Day 1 2 3 4 5 6 7 8 9 10 … Annual

Cumulative Purchases 10 20 30 40 50 60 70 80 90 100 … 3,650

(P&L – Expense)

Cumulative payment to SCr - - - - - - - 10 20 30 … 3,580

SCr Outstanding (Unpaid) 10 20 30 40 50 60 70 70 70 70 … 70

(BS-Liability)

SCr Outstanding = Daily purchases x Credit period in days = (3,650/365) x 7 = 70

= Monthly Purchases x Credit period in Months = (3,650/12) * 0.23 = 70

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN CREDIT PERIOD AND LEVEL OF SCr (Credit period=7 days)
Day 1 2 3 4 5 6 7 8 9 10 11 … Annual

Purchase ...
Cumulative Purchases … 3,650
(P&L – Expense)
Payment to SCr ...
Cumulative payment to SCr …
SCr Outstanding (Unpaid) … 70
(BS-Liability)

SCr Outstanding = Daily purchases x Credit period in days

Credit Period in days = Daily Purchases / Sundry Cr. Outstanding

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COMM. BANKING SESSION V 08-09-2021

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN HOLDING / PROCESS PERIOD AND INVENTORY
DAY 1 2 3 4 5 6 7 8 9 … Annual Days
Raw material Opening stock 0 10 20 20 20 20 20 20 20 … 0
Raw material Purchased 10 10 10 10 10 10 10 10 10 … 3,650
Raw material sent for process 0 0 10 10 10 10 10 10 10 … 3,630
Raw material Closing stock 10 20 20 20 20 20 20 20 20 … 20 2
Work in Process Opening Stock 0 0 0 11 23 23 23 23 23 … 0
Raw material received for process 0 0 10 10 10 10 10 10 10 … 3,630
Manufacturing Cost expended 0 0 1 2 3 3 3 3 3 … 1,086
Finished goods sent to depot 0 0 0 0 13 13 13 13 13 … 4,693
WIP Closing stock 0 0 11 23 23 23 23 23 23 … 23 2
Finished goods opening stock 0 0 0 0 0 13 26 39 39 … 0
Finished goods received from 0 0 0 0 13 13 13 13 13 … 4,693
factory
Finished goods despatched 0 0 0 0 0 0 0 13 13 … 4,654
Finished goods closing stock 0 0 0 0 13 26 39 39 39 … 39 3
Total INVENTORY (RM+WIP+FG) 10 20 31 43 56 69 82 82 82 …

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN HOLDING / PROCESS PERIOD AND INVENTORY
DAY 1 2 3 4 5 6 7 8 9 … Annual Days
Raw material Opening stock
Raw material Purchased
Raw material sent for process (Consumed) 0 0 10 10 10 10 10 10 10 … 3,630
(P&L – Exp)
Raw material Closing stock (BS – A) 10 20 20 20 20 20 20 20 20 … 20 2
Work in Process Opening Stock …
Raw material received for process …
Manufacturing Cost expended (P&L – Exp) 0 0 1 2 3 3 3 3 3 … 1,086
Finished goods sent to depot …
WIP Closing stock (BS – A) 0 0 11 23 23 23 23 23 23 … 23 2
Finished goods opening stock … PC=4 D
Finished goods received from factory …
Finished goods despatched
Finished goods closing stock (BS – A) 0 0 0 0 13 26 39 39 39 … 39 3
Total INVENTORY (RM+WIP+FG) (BS – A) 10 20 31 43 56 69 82 82 82 … 82

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COMM. BANKING SESSION V 08-09-2021

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN HOLDING / PROCESS PERIOD AND INVENTORY
DAY 1 2 3 4 5 6 7 8 9 … Annual Days
Raw material sent for process (Consumed) 0 0 10 10 10 10 10 10 10 … 3,630 365
(P&L – Exp) (Actuals)
Raw material Closing stock (BS – A) 10 2 20 20 20 20 20 20 20 … 20 2
Valued @ Purchase cost 0
Manufacturing Cost expended (P&L – Exp) 0 0 1 2 3 3 3 3 3 … 1,086 365
@ Actuals
WIP Closing stock (BS – A) @ Process Cost 0 0 11 23 23 23 23 23 23 … 23 2
Finished goods closing stock (BS – A) 0 0 0 0 13 26 39 39 39 … 39 3
@Cost of production
Total INVENTORY (RM+WIP+FG) (BS – A) … 82 7
Other costs like other OH, SGA, etc. may eb loaded on FG valued @ Cost of Production to get FG valued @
Cost of Sales.
The Audit report will mention what is the basis adopted for valuation of Inventory (& other assets).

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN HOLDING / PROCESS PERIOD AND INVENTORY
DAY 1 2 3 4 5 6 7 8 9 … Annual Days
Finished goods opening stock 0 0 0 0 0 13 26 39 39 …
Finished goods received from factory 0 0 0 0 13 13 13 13 13 …
Mfg. Cost of Finished goods despatched 0 0 0 0 0 0 0 13 13 … 4,654
Finished goods closing stock 0 0 0 0 13 26 39 39 39 … 3
…
Daily Days Annu Stock
Stock al value
Mfg. Cost of Finished Goods despatched / sold 13 3 4,745 39
Selling General & Admin expenses 1 365
Cost of goods sold 14 3 5,110 42
Profit Margin 1 365
Sales 15 3 5,475 45
Bankers insist on most conservative valuation. Here, Banker would say FG should be valued at Cost of Production.
Valuation is important part of Assessment of loan requirement and the Terms and conditions/assessment.
One of the adjustment Banker will make is to adopt conservative valuation and recalculate BS where required.
CMA form does this automatically.

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COMM. BANKING SESSION V 08-09-2021

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN DEBTOR PERIOD AND LEVEL OF SDr (Credit period= 2 MONTH)

Month 1 2 3 4 5 6 7 8 9 10 11 12 Annu
al
Months Sales 10 10 10 10 10 10 10 10 10 10 10 10 120
Cumulative Sales 10 20 30 40 50 60 70 80 90 100 110 120 120
Month’s Realisation - - 10 10 10 10 10 10 10 10 10 10 100
Cumulative Realisation –SDr - - 10 20 30 40 50 60 70 80 90 100 100
S Dr Outstanding (Unpaid) 10 20 20 20 20 20 20 20 20 20 20 20 20

S DR = Sundry debtors for goods sold

S Dr Outstanding = Monthly Sales x Credit period in Months = 10*2 = 20

Concept of Working Capital, Working Capital Cycle

LINK BETWEEN DEBTOR PERIOD AND LEVEL OF SDr (Credit period= 2 MONTH)

Month 1 2 3 4 5 6 7 8 9 10 11 12 Annu
al
Months Sales

Cumulative Sales (P&L – Sales) 10 20 30 40 50 60 70 80 90 100 110 120 120

Month’s Realisation of SDr

Cumulative Realisation of SDr - - 10 20 30 40 50 60 70 80 90 100 100

S Dr Outstanding (To recv.) (BS-Assets) 20

S Dr Outstanding = Monthly Sales x Credit period in Months = 10*2 = 20

Credit Period in Months = Monthly Sales/S Dr. Outstanding

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COMM. BANKING SESSION V 08-09-2021

Concept of Working Capital, Working Capital Cycle

QUICK EXERCISE

Example 1 2 3 4

Annual Sales (Rs lac) 12,000 ? 30,000 30,000

Credit extended (months) 2 1 ? 2
Sundry Debtors (Rs.) 2,000 2,000 7,500 ?
Annual Purchases Rs 6,000 ? 18,000 24,000
Credit received (Months) 3 2 ? 5
Sundry Creditors (Rs.) 1,500 1,500 4,500 ?
S Cr Outstanding = Monthly Purchases x Credit received period in Months
SDr Outstanding = Monthly Sales x Credit extended period in Months

Concept of Working Capital, Working Capital Cycle

QUICK EXERCISE

Example 1 2 3 4

Annual Sales (Rs lac) 12,000 24,000 30,000 30,000

Credit extended (months) 2 1 3 2
Sundry Debtors (Rs.) 2,000 2,000 7,500 5,000
Annual Purchases Rs 6,000 9,000 18,000 24,000
Credit received (Months) 3 2 3 5
Sundry Creditors (Rs.) 1,500 1,500 4,500 10,000
S Cr Outstanding = Monthly Purchases x Credit received period in Months
SDr Outstanding = Monthly Sales x Credit extended period in Months

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COMM. BANKING SESSION V 08-09-2021

Concept of Working Capital, Working Capital Cycle

... Mn : (G/S)in → (G/S)on : M(n+1) : (G/S)i(n+1) → (G/S)o(n+1) : M(n+2) …
---------------------------------------------------------------------
… (Working Capital Cycle)(n) …. (Working Capital Cycle)(n+1) ….

DETERMINANTS OF WORKING CAPITAL REQUIREMENT

1. Purchases and Sales – Price and Quantity
2. Capacity – Overall and sub-processes
3. Technology (Production Time, Cost of production)
4. Terms of Credit / Advance payments - Purchases and Sales
5. Product mix
6. Procurement times - leads and lags
7. Minimum Order quantities (Input and Output)

1.Concept of Working Capital, Working

Capital Cycle

2. Methods of Assessment of Bank

Finance

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COMM. BANKING SESSION V 08-09-2021

Methods of Assessment of Bank Finance

3 models of Lending based on source of repayment, and their assessment

1. Cash Flow based : Source of Repayment is Cash Flow from activity financed
Assessment of bank finance involves projecting Cash flows – quantity and timing and stipulating
suitable margins to optimise safety of funds lent
e.g. Term loan by banks, Personal Loans

2. Asset based : Source of Repayment is Sale of Assets financed

Assessment involves projecting levels – quantity and value – of assets and stipulating suitable
margins to optimise safety of funds lent.

e.g. Working capital loans by banks, Comm. Real Estate finance

3. Refinance based : Source of Repayment is further borrowing

Usually banks do not go in for such finance for Non Govt. / Non-Bank borrowers

e.g. Borrowings by Banks and Governments, Ponzi Schemes

Methods of Assessment of Bank Finance

DEFINITIONS

1. NET WORKING CAPITAL (NWC) = CURRENT ASSETS (CA)–CURRENT LIABILITIES (CL)

2. WORKING CAPITAL GAP (WCG) = CA – (CL [Other than WCL from Bank])

3. CURRENT RATIO = CA/CL.

ASSETS LIABILITIES
A. INVENTORY 700 D. SUNDRY CREDITORS 200
B. SUNDRY DEBTORS 300 E. CURRENT LIABILITIES OTHER THAN WCL FROM BANK (D) 200
F. WORKING CAPITAL GAP (C-E) 800
G. WCL FROM BANK 500
C. CURRENT ASSETS (A+B) 1,000 H. CURRENT LIABILITIES 700
I. NET WORKING CAPITAL (CA-CL) 300
Fixed and Other assets 1,000 Long Term Debt & Capital 1,300

Total Assets 2,000 Total Liabilities 2,000

CURRENT RATIO = CA/CL = 1,000/700 = 1.43 : 1

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COMM. BANKING SESSION V 08-09-2021

Methods of Assessment of Bank Finance

WCL FROM BANK = WCG – NWC = CA - SCR – NWC

TO ASSESS REQUIREMENT OF WCL FROM BANK FOR Y(T+1):

1. PROJECT SALES AND PURCHASES FOR THE YEAR Y(T+1) – CAPACITY, MARKET CONDITIONS, PRICING
POWER, ETC.

2. PROJECT CREDITORS PERIOD, DEBTORS PERIOD, PROCESS PERIOD, AND STOCK HOLDING PERIOD,
BASED ON MARKET CONDITIONS, TECHNOLOGY USED, ETC.

3. PROJECT CA (STOCKS, DEBTORS) AS ON 31/3/Y(T+1)

4. PROJECT SCR AS ON 31/3/Y(T+1)

5. CALCULATE PROJECTED WCG = CA - SCR AS ON 31/3/Y(T+1)

6. CALCULATE MINIMUM NWC (Own OR Long term Funds) AS ON 31/3/Y(T+1)

1ST METHOD OF LENDING: MINIMUM NWC = 25% OF PROJECTED WCG
2ND METHOD OF LENDING: MINIMUM NWC = 25% OF PROJECTED CA

7. CALCULATE EXISTING NWC = (CA - CL) AS ON 31/3/Y(T)

8. MAXIMUM PERMISSIBLE BANK FINANCE (MPBF) =

LOWER OF (1) WCG – NWC (MIN) OR (2) WCG – NWC (EXISTING)

Methods of Assessment of Bank Finance : EXERCISE

CALCULATE MPBF, PROJECTED NWC AND PROJECTED CR
STEPS EQUATIONS
1. PROJECT CA, SCR 31/3/Y(T+1) 1. NWC = CA – CL
2. CALCULATE PROJ. WCG 2. WCL FROM BANK = WCG – NWC
3. CALCULATE MIN. & EXISTING NWC 3. CL = CA – NWC
4. CALCULATE MPBF = LOWER OF [WCG – NWC (MIN)] OR 4. CA = CL + NWC
[WCG –NWC (EXISTING)]
5. CR = CA/CL
ADDL. LT/OWN
EX. PROJ. PROJ. PROJ. EXISTING MPBF PROJ. PROJ.
MIN. NWC FUNDS PROJ. CL
NO CA SCR WCG NWC NWC CR
REQD
(1) (2) (3)= (4) = (5) (6) =Lower of (7) (8) (9) = (10) =
(1)-(2) M1: 25% OF (3) = CA- CL (3)-(4) = (4) – (5) IF (4) > = Higher of (2)+(6) (1)/(9)
M2: 25% OF (1) (Y(T) ) Or (3)-(5) (5), Else 0. (4) Or (5)
1 1,000 0 1,000 M1: 250 250 750 0 250 750 1.33
2 1,000 200 800 M1: 200 150 600 50 200 800 1.25
3 1,000 200 800 M1: 200 250 550 0 250 750 1.33

4 1,000 200 800 M2: 250 300 500 0 300 700 1.43

5 1,000 1,000 0 M2: 250 -100 0 100 0 1,000 1.00

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COMM. BANKING SESSION V 08-09-2021

IF YOU HAVE ANY QUESTIONS OR NEED ANY

CLARIFICATIONS, PLEASE CONTACT ME ON

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GUEST FACULTY:SHRIDHAR S 12