Wednesday, October 15, 2014

WORKING CAPITAL ASSESSMENT (By.CS Deepak P Singh )


WHAT IS WORKING CAPITAL ?
Funds required to acquire current assets to enable business/industry to operate  at the expected levels

CONCEPTS OF WORKING CAPITAL
GROSS WORKING CAPITAL = CA
(These are in the system used/ consumed on a day to day basis)

NET WORKING CAPITAL = CA – CL
OR
(SHF + TL) – (NFA + NCA)

NWC is the entrepreneur's margin available in the system from Long term Funds

WHAT ARE CURRENT ASSETS ? 
Assets which normally get converted into cash during the operating cycle of the firm.
  • Cash & Bank balances
  • Inventory
  • Receivables
  • Advances to suppliers/others
  • Other Current assets
WHAT ARE WORKING CAPITAL SOURCES ?
  • Own funds
  • Bank borrowings
  • Sundry Creditors
  • Advances from customers
  • Deposits due in a year
  • Other current liabilities

OPERATING CYCLE
begins with acquisition of raw materials and ends with collection of receivables

Stages:

1. Raw materials (RM/RM consumption)
2. Work-in-process (WIP/COP)
3. Finished Goods (FG/COS)
4. Receivables (Debtors/Credit sales)
    Less:
    Creditors (creditors/purchases)
 

FACTORS INFULENCING WORKING CAPITAL REQUIREMENT
  • Nature of business – service/trade/manufacturing.
  • Seasonality of operations – peak/non peak
  • Production Policy – Constant/seasonal
  • Market conditions- competition/credit terms
  • Conditions of supply of RM/stores/spares etc.
  • Quantum of production/Turnover (level of activity)
  • Operating Cycle
  • Current Assets to be maintained
DATA TO BE OBTAINED
  • Application.
  • Financial Statements of Previous years
  • Estimates/ Projections (with quantitative details)

WORKING CAPITAL FINANCE

A) Fund Based
  • Inventory finance and 
  • Bill Finance ( Post Sales Finance).
B) Non Fund Based
  •  Letter of Credit (LC)
  •  Bank Guarantee.
ASSESSMENT METHODS

-> Operating Cycle Method
  • Service Sector
  • Traders
  • Manufacturing Activity.
-> Drawing Power Method.
-> Turnover Method

-> MPBF method (II method of lending) for limits of Rs 6.00 crores and above
-> Cash Budget method 

 (Reason: Based on procurement and cash inflow)
  • Seasonal Industries (Sugar/ Rice Mills/Textiles/Tea/Tobacco/Fertilizers)
  • Contractors & Real Estate Developers
  • Educational Institutions
OPERATING CYCLE METHOD
Working capital requirement : Operating expenses/No. of operating cycles in a year.

A. Length of operating Cycle
 

 
Drawing Power Method 
(for units with small limits)
(Rs.in lacs)


Turnover  Method
(originally suggested by Nayak Committee for SSI units)
Applicable for limits upto Rs.6 crores


MPBF Method 
(Tandon’s II method of lending) 


Turnover  Method 
(originally suggested by Nayak Committee for SSI units)


MPBF Method
(Tandon’s II method of lending) 


Justifications of the Performance Projection

(Inventory/Receivable Norms – Comparison)
  • Intra firm Comparison
  • Comparison of estimates with previous years Actuals.
For New Units
  • Comparison of estimates with similar units in the area of operation.
  • Higher projections shall be justified.
MPBF Method
(Tandon’s II method of lending)
  • Excess borrowing ( short fall in NWC ) shall be ensured by additional funds to be brought in by the applicant or by additional bank finance over MPBF.
Important Aspects of MPBF method
  • Production/Sales estimates
  • Profitability estimates
  • Inventory/receivables norms
  • Build up of Net Working Capital
CASH BUDGET
Statement showing forecast of cash receipts, cash payments and net cash balance over a period of time

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
BIFURCATION OF FUND BASED LIMITS

Inventory: OCC/KCC/PC/COD/SOD
Bills        : CBP/DBP/SBP/FBP
                CUBD/DUBD/FUBD
Inventory: Limit
A. Total Inventory
B. Creditors
C.  Margin
D.  Paid Inventory  (A-B)
E. Inventory Limit ( D-C)

Bills /Book Debts Limit 
A. Receivables/ Sundry Debtors
B. Margin
C.Bills  Limit ( A-B).
Loan delivery system (FB W/C limits of Rs.10 crores & above from banking system)
Cash Credit  - 20%
Demand Loan – 80%

LOAN DELIVERY SYSTEM

Objectives
Loan delivery system (FB W/C limits of  Rs.10 crores & above from banking system)
  • Cash Credit  - 20%
  • Demand Loan – 80%  
Domestic Credit portion to be bifurcated into loan component and Cash Credit
Relaxation.


Bill Finance -Post Sales Finance (For Genuine Trade & Manufacturing Transactions) 
A. DBPs : Bills of Exchange accompanied with ;          
      i) Invoice and
      ii) Documents of title of the Goods - LRS/RRS
B. DUBD : Invoice /LRS / RRS – Maximum Tenor 180 days
C. CUBD  : Bill of Exchange / Promissory Notes.
  - Eligibility  Carved out of MPBF
D. Export Bills : FBP/FUBD
  - Security – Export Documents drawn against confirmed orders / LCs.

Book Debts Finance :
  • Service Industry / Contractors
  • Margin 50%
  • Age not more than 90 days
  • Collateral Security – 200% Urban / Semi Urban Security
Non Fund Based Limits
Letter of credit
  • ILC/FLC
  • Usance/Sight
Bank Guarantee 
   Performance
   Financial – Bid Bonds/Security Deposits/
                      Mobilisation advance/retention money
 
Deferred Payment Guarantee

LC Assessment

Guidelines to be followed
  • For constituents borrowers with regular sanctioned credit facilities for genuine transactions.
  • LCs shall not be opened with clause without recourse to drawer.
Bank Guarantees
  • Performance and Financial Guarantees
Purpose / Difference
  • Security: Cash Margin +Counter Guarantee +Collateral Security (Immovable / Liquid Security)
  • Restrictive Clause.
Important Ratios
  • Current Ratio (CA/CL) (norm – 1.15 upto Rs.6 crores/1.33 for above)
  • Adjusted Current Ratio (reduce export bills discounted from BB & CA)
  • Total debt equity (TOL/TNW) (Maximum norm : 6)
Gearing Ratio (for NFB Limits) Maximum Norm:10

Total Outside Liabilities + 100% of NFB Limits
Net Worth – (NCA+Investments in associate concerns)

Notes: TOL (excluding Sundry creditors representing stocks procured under LC/BG and 
mobilisation advance  outstanding against BGs)
NW  (excluding Intangible Assets)
NCA (excluding advances given for capital goods for business purpose)

Exposure Norms for some Categories


Cs Deepak P Singh 
(9920830041)

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