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Role of Banks in working capital management Executive Summery

The project is about role of banks in working capital management to know that how a bank is plays a major role in the managing the working capital of their clients (Business firms) to meat their day-to-day expenditure and other business requirements. The project also covers various credit facilities given by the banks to its clients, it functions and different aspects in working capital financing. The project includes case-study on Icici bank which would help to understand the concept of working capital financing. Maintaining of working capital at par level with the efficient and effective level the bank plays a vital role in that.

Role of Banks in working capital management Objectives of the study

The objective of undertaking a project on Role of Banks in Working

Capital Management is to have in-depth knowledge about the Strategy of Banks to lend the money to the business firms to run the business and mate the day to day expenses of business firms.

To know about the functions, organizational structure and objective of To understand the elements of working Capital and its functions. To have a broader view on nature of Working Capital which is current To know what are the RBI guidelines formulated for Working Capital

Banks lending policies to business firms.

assets & current liabilities and to know what are its components. financing. To know the future scope involved in Working Capital finances & role of information technology in Working Capital financing.

Role of Banks in working capital management Introduction


Working capital management is a significant in financial management due to the fact that it plays a pivotal (important) role in keeping the wheels of a business enterprise running. Working capital management is concerned with short term financial decisions. Shortage of funds for working capital has caused many businesses to fail and in many cases, has retarded their growth. Lack of efficient and effective utilization of working capital leads to earn low rate of return on capital employed or even compels to sustain losses. The need for skilled working capital management has thus become grater in recent years. A firm invests a part of its permanent capital in fixed assets and keeps a part of it for working capital I.e., for meeting the day today requirements. We will hardly find a firm which does not requires any amount of working capital for its normal operations. The requirement of working capital varies from firms to firms depending upon the nature of business, production policy, market conditions, seasonality of operations, conditions of supply etc. Working capital to a company is like the blood to human body. It is the most vital ingredient of a business. Working capital management if carried out effectively, efficiently and consistently, will assure the health of an organization.

Role of Banks in working capital management Definition of Working Capital


Working capital is defined as the excess of current assets over current liabilities. Current assets are those assets which will be converted into cash within the current accounting period or within the next year as a result of the ordinary operations of the business. They are cash or near cash resources. These include: Cash and Bank balances Receivables Inventory Raw materials, stores and spares Work-in-progress Finished goods

Prepaid expenses Short term advances Temporary investments The value represented by these assets circulates among several items. Cash is used to buy raw-materials, to pay wages and to meet other manufacturing expenses. Finished goods are produced. These are sold, accounts receivables are created. The collection of accounts receivable brings cash into the firm. The cycle starts again. This is shown in below mention diagram.

Role of Banks in working capital management

Cash

Inventories

Receivables
Current liabilities are the debts of the firms that have to be paid during the current accounting period or within a year. These include: Creditors for goods purchased Outstanding expenses i.e., expenses due but not paid Short term borrowings Advance received against sales Taxes and dividends payable Other liabilities maturing within a year. Working capital is also known as circulating capital, fluctuating capital and revolving capital. The magnitude and composition keep on changing continuously in the course of business. Accounts receivables: Trade credit creates book debts or accounts receivable. It is used as a marketing tool to maintain or expends the firms sales. A firms investment in accounts receivable depends on volume of credit sales collection period. The financial manager can influence volume of credit terms, and collection efforts. Credit standards are criteria to decide to whom credit sales can be made and how much. If the firm has soft
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Role of Banks in working capital management


standards and sells to almost all customers, its sales may increase but its costs in the form of bad-debt losses and credit administration will also increase. Therefore, the firm will have to consider the impact in terms of increase in profits and increase in costs of a change in credit standards or any other policy variable. The incremental return which a firm may gain by changing its credit policy should be compared with the cost of funds invested in receivables. The firms credit policy will be considered optimum at the point where incremental rate of return equals the cost of funds. The cost of funds is related to risk; it increases with risk. Thus, the goal of credit policy is to maximize the shareholders wealth; it is neither maximization of sales nor minimizations of bad-debt losses. The conditions for extending credit sales are called credit terms and they include the credit period and cash discount. Cash discounts are given for receiving payments before than the normal credit period. All customers do not pay within the credit period. Therefore, a firm has to make efforts to collect payments from customers. Collection efforts of the firm aim at accelerating collections from slow-payers and reducing bad-debt losses. The firm should in fact thoroughly investigate each account before extending credit. It should gather information about each customer, analyze it and then determine the credit limit. Depending on the financial condition and past experience with a customer, the firm should decide about its collection tactics and procedures. There are three methods to monitor receivables. The average collection period and again schedule are based on aggregate data for showing the payment patterns, and therefore, do not provide meaning information for controlling receivables. The third approach which uses disaggregated data is the collection experience matrix. Receivables outstanding for a period are related to credit sales of the same period. This approach is better than the two traditional method of monitoring receivables.
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Role of Banks in working capital management


Inventory Management: Inventories constitute about 60% (per cent) of current assets of public limited companies in India. The manufacturing companies hold inventories in the form of raw materials, work-in-process and finished goods. There are at last three motives for holding inventories. 1. To facilitate smooth production and sales operation (transaction motive). 2. To guard against the risk of unpredictable changes in usage rate and delivery time (precautionary motive). 3. To take advantages of price fluctuations (speculative motive). Inventories represent investment of a firms funds. The objective of the inventory management should be the maximization of the value of the firm. The firm should therefore consider: a. Costs, b. Return, and c. Risk factors in establishing its inventory policy. Two types of costs are involved in the inventory maintenance: 1. Ordering costs: requisition. Placing of order, transportation receiving, inspecting and storing and clerical and staff services. Ordering costs are fixed per order. Therefore, they decline as the order size increases. 2. Carrying costs: warehousing, handling, clerical and staff services, insurance and taxes. Carrying costs vary with inventory holding. As order size increases, average inventory holding increases and therefore, the carrying costs increase. The firm should minimize the total cost (ordering plus carrying). The economic order quantity (EOQ) of inventory will occur at a point where the total cost is minimum.

Role of Banks in working capital management


Cash Management: Cash is required to meet a firms transactions and precautionary needs. A firm needs cash to make payments for acquisition of resources and services for the normal conduct of business. It keeps additional funds to meet any emergency situation. Some firms any also maintain cash for taking advantages of speculative changes in prices of input and output. Management of cash involves three things: (a) (b) (c) Managing cash flows into and out of the firm, Managing cash flows within the firms, and Financing deficit or investing surplus cash and thus, controlling cash balance at a point of time. It is an important function in practice because it is difficult to predict cash flows and there is hardly any synchronization between inflows and outflows. Firms prepare cash budget to plan for and control cash flows. Cash budget is generally prepared for short periods such as weekly, monthly, quarterly, half-yearly or yearly. For making forecasts of cash receipts and payments, two approaches are used in practice: i. ii. The receipt and disbursements method, and The adjusted income method.

The individual items of receipts and payments are identified and analyzed. Cash inflows could be categorized as: i. ii. iii. i. ii. iii. iv. operating non operating, and Financial. operating capital expenditure contractual, and Discretionary.
8

Cash outflows could be categorized as:

Role of Banks in working capital management


Such categorization helps in determining avoidable or postponable expenditures. The adjusted income method uses proforma income statement (profit and loss statement) and balance sheet to work out cash flows (by deriving proforma cash flow statement). As cash flows are difficult to predict, a financial manager does not base his forecasts only on one set of assumptions. He or she considers possible and pessimistic scenarios can be worked out. Cash budget will serve its purpose only if the firm can accelerate its collection and postpone its payments within allowed limits. The main concerns in collection are: a. b. to obtain payment from customers within the credit To minimize the lag between the times a customer pays period, the bill and the time cheque etc. are collected. A number of methods such as concentration banking and lock-box system can be followed to expedite conversion of an instrument (e.g. cheque, draft, bills, etc.) into cash. The financial manager should be aware of the instruments of payments, and choose the most convenient and least costly mode of receiving payment. Disbursements or payment can be delayed to solve a firms working capital problem. But this involves cost which, in the long run, may prove to be highly detrimental. Therefore, a firm should follow the norms of the business. A firm should hold an optimum balance of cash, and invest any temporary excess amount in short-term (marketable) securities. In choosing these securities, the firm must keep in mind safety, maturity and marketability of its investment.

Role of Banks in working capital management

Objectives of Working capital management


The basic objectives of working capital management are as follows: By optimizing the investment in current assets and by reducing the level of current liabilities, the company can reduce the locking up of funds in working capital thereby; it can improve the return on capital employed in business. The second important objective of working capital management is that the company should always be in a position to meet its current obligations which should properly be supported by the current assets available with the firm. But maintaining excess funds in working capital means locking of funds without return. The firm should manage its current assets in such a way that the marginal return on investment in these assets is not less than the cost of capital employed to finance the current assets. Gross and Net Working Capital Generally the working capital has its significance in two perspectives Gross working capital and Net working capital, the term Gross working capital refers to the firms investment in current assets. The term Net working capital refers to the excess of current assets over current liabilities. These gross working capital and net working capital are called Balance sheet approach of working capital. Permanent and Temporary Working Capital Considering time as the basis of classification, there are two types of working capital viz, Permanent and Temporary. Permanent working capital represent the assets required on continuing basis over the entire year, whereas temporary working capital represents additional assets
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Role of Banks in working capital management


required at different items during the short term debt financing. For example, in peak seasons, more raw materials to be purchased, more manufacturing expenses to be incurred, more funds will be locked in debtors balance etc. In such times excess requirement of working capital would be financed from short-term financing sources. The permanent component current assets which are required through the year will generally be financed from long term debt and equity. Tendon committee has referred to this type of working capital as Core Current Assets. Core Current Assets are those required by the firm to ensure the continuity of operations which represents the minimum levels of various items current assets viz., stock of raw materials, stock of work in progress, stock of finished goods, debtors balances, cash and bank etc. This minimum level of current assets will be financed by the long-term sources and any fluctuation over the minimum level of current assets will be financed by the short-term financing. This is shown below. Some time core current assets are also referred to as hard core working capital.
T porarycurrent asset em Short term Financing

Rs.

Perm current assets anent Longterm + Equitycapital

FixedA ssets

T es im

The management of working capital is concerned with maximizing the return to shareholders within the accepted risk constraints carried by the participants in the company. Just as excessive long-term debt puts a company at risk, so an inordinate quantity of short-term debt also
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Role of Banks in working capital management


increases the risk to a company by straining its solvency. The suppliers of permanent working capital look for immediate return and the cost of such financing will also be costlier than the cost of permanent funds for working capital. Disadvantages of Insufficient Working Capital The disadvantages suffered by a company with insufficient working capital are as follows: The company is unable to take advantage of new opportunities or adopt to changes. Trade discounts are lost. A company with ample working capital is able to finance large stocks and can therefore place large orders. Cash discounts are lost. Some companies will try to persuade their debtors to pay early by offering them a cash discount off the price owed. The advantages of being able to offer a credit line to customers are foregone. Financial reputation is lost result in non-cooperation from trade creditors in times of difficulty. There may be concerted action by creditors and will apply to court for winding up.

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Role of Banks in working capital management

Operating Cycle Concept


A new concept which is gaining more and more importance in recent years is the Operating Cycle Concept of Working Capital. The operating cycle refers to the average time elapses between the acquisition of raw materials and the final cash realisation. Cash is used to buy raw materials and other stores, so cash is converted into raw materials and stores inventory. Then the raw materials and stores are issued to production department. Wages are paid and other expenses are incurred in the process and work-in-process comes into existence. Work-in-process becomes finished goods. Finished goods are sold to customers on credit. In the course of time, these customers pay cash for the goods purchased by them. Cash is retrieved and the cycle is completed. Thus, operating cycle consists of four stages: The raw materials and stores inventory stage The work-in-process stage The finished goods inventory stage The receivable stage The operating cycle of working capital is shown below:

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Role of Banks in working capital management


Collection of receivables

Cash

Purchase of Raw materials

Accounts Receivables

Raw material inventory

W ork-in-process
S ale s

Finished goods

Issue of materials of production and incurring expenses

The operating cycle being with the arrival of the stock, and ends when the cash is received. The cash cycle beings when cash is paid for materials, and ends when cash is collected from receivables.
R M aw aterial P urchased F inished O S rder tock C ash G S oods old P A laced rrived R eceivables ccountsR eceivablesP eriod W ork-in-processInventoryP eriod A T e im A ccountsP ayableP eriod C P F ash aid or Invoice M aterials R eceived O peratingC ycle C C ash ycle

Importance of Operating Cycle Concept The application of operating cycle concept is mainly useful to ascertain the requirement of cash working capital to meet the operating expenses of a going concern. This concept is based on the continuity of the flow of value in a business operation. This is a important concept because the longer the operating cycle, the more working capital funds needs. Management must ensure that this cycle does not become too long. This concept more precisely measures the working capital fund requirements,
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Role of Banks in working capital management


traces its changes and determines the optimum level of working capital level of working capital requirements. Reasons for prolonged Operating Cycle The following could be the reasons for longer operating cycle period: Purchase of materials in excess / short of requirements Buying inferior, defective materials Failure to get trade discount, cash discount Inability to purchase during seasons Defective inventory policy Use of protracted manufacturing cycle Lack of production planning, coordination and control Mismatch between production policy and demand Use of outdated machinery, technology Poor maintenance and upkeep of plant, equipment and infrastructural facilities Defective credit policy and slack collection policy Inability to get credit from suppliers, employees Lack of proper monitoring of external environment etc.

How to reduce Operating Cycle? The aim of every management should be to reduce the length of operating cycle or the number of operating cycle in a year. Only then the need for working capital decreases. The following a few remedies may become handy in contrasting the length of operating cycle period. Purchase management The purchase manager owes a responsibility in ensuring availability of right type of materials in right quantity of right price on right time and at right place. These six Rs contribute greatly in the improvement of
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Role of Banks in working capital management


length of operating cycle. Further, streamlining of credit from supplier and inventory policy also help the management. Production Management The production manager affects the length of operating cycle by managing and controlling manufacturing cycle, which is a part of operating cycle and influences directly. Longer the manufacturing cycle, longer will be the operating cycle and higher will be the firms working capital requirements. The following measures may be taken: Proper maintenance of plant, machinery and other infrastructural facilities. Proper planning and coordination at all levels of activity. Up-gradation of manufacturing system, technology. Selection of the shortest manufacturing cycle out of various alternative etc. Marketing Management The sale and production policies should be synchronized as far as possible. Lack of matching increase the operating cycle period. Production of Qualitative products at lower costs enhances sales of the firm and reduces finish goods storage period. Effective advertisement, sales promotion activities, efficient salesmanship, use of appropriate distribution channel etc., reduces the storage period of the finished products. Sound Credit and Collection Policies Sound credit and collection policies enable the Finance Manager in minimizing investment in working capital in the form of book debts. The firm should be discretionary in granting credit them to its customers. In order to see that the receivables conversion period is not increased, the firm should follow a rationalized credit policy
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Role of Banks in working capital management


based on the credit standing of customer are other relevant facts. The firm should be prompt in making collections. Slack collection policies will tie up funds for long period, increasing length of operating cycle. Proper Monitoring of External Environment The length of operating cycle is equally influenced by external environment. Abrupt changes in basic conditions would affect the length of operating cycle. Fluctuation in demand, competitors, production and sales policies. Government fiscal and monetary policies, changes on import and export front, price fluctuations, etc., should be evaluated carefully by the management to minimize their adverse impact on the length of operating cycle. Other Suggestions The personnel manager by framing should recruitment, selection, training, placement, promotion, transfer, wages, incentives and appraisal policies can contract the length of operating cycle. Use of Human Resources Development technique in the organization enhances the morale and zeal of employees thereby reduces the length of operating cycle. Proper maintenance of plant, machinery, infrastructural facilities, timely replacement, renewals, overhauling etc., will contribute towards the control of operating cycle. These measures, if adhered properly, would go a long way in minimizing not only the length of operating cycle period but also the firms working capital requirements. Gross and Net Operating Cycle In a manufacturing firm, the operating cycle for element of cost, say direct material, starts with the purchase of materials. Materials are not
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Role of Banks in working capital management


consumed immediately. There involves Raw Materials conversion period (RCMP). Once materials are issued to production, it again involves time gap between issue of materials and production of finished product. This time gap is called as Work-in-process conversion period (WIPCP). Industries produce the output in the expectation of demand or for the purpose of assembly. Till the demand for finished product materializes, the product would remain in the store. This period is termed as Finished goods conversion period (FGCP). The enterprise due to competitive reason and other reasons extended credit facilities to customers. This time gap between sale and realisation of cash is known as Book Debt conversion period (BDCP). Business enterprises receive credit in the purchase of raw materials from the suppliers. This period is called as Payment deferral period (PDP). This payment period reduced the length of operating cycle of business firm. The length of operating cycle of manufacturing firm in Direct material can be calculated with the help of following formulae. Gross Operating Cycle Net Operating Cycle Or = = RMCP + WIPCP + FGCP + BDCP = Gross Operating Cycle PDP RMCP + WIPCP + FGCP PDP

Similar conclusion can also be drawn for other elements of cost i.e., for Direct wages and overheads. In the case of Direct wages overheads, the operating cycle starts with the Work-in-progress Conversion Period (WIPCP) as there will be Raw materials Conversion Period (RMCP). The chart below shows the operating cycle for these elements of cost with hypothetical figures. Particulars
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Direct Materials

Direct Wages

Overheads

Role of Banks in working capital management


Raw materials conversion period 2 3 1 2 6 5 3 1 2 6 6

(RMCP) Work-in-progress conversion period 3 (RMPCP) 1 Finished goods conversion period 2 8 (FGCP) 1 Book debts conversion period (BDCP) 7 Gross operating cycle Less : Payment deferral period (PDP) Net operating cycle

Practical utility of Operating Cycle Concept


The net operating cycle represents the net time gap between investment of cash and its recovery of sales revenue. If depreciation is excluded from expenses in the computations of operating cycle, the net operating cycle also represents the cash conversion cycle. It is the net time interval between cash collection from sale of product and cash payments for resources acquired by the firm. It is the task of Finance Manager the operating cycle effectively and efficiently. The length of operating cycle is the indicator of operating management performance. The net operating cycle represents the time interval for which the firm has to negotiate for working capital from its Bankers. It enables to determine accurately the amount of working capital needed for the continuous operation of its activities. The operating cycle calls for proper monitoring of external environment of the business. Changes in Government policies like taxation, import restrictions, credit policy of Central Bank, price trend, technological advancement etc., have their own impact on the length of operating cycle.

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Role of Banks in working capital management

Role of Banks in Working Capital Management


Banks are the main institutional sources of working capital finance in India. After trade credit, bank credit is the most important source of financing working capital requirements of firms in India. A bank considers a firms sales and production plans and the desirable levels of current assets in determining its working capital requirements. The amount approved by the bank for the firms working capital is called credit limit. Credit limit is the maximum funds which a firm can obtain from the banking system. In the case of firms with seasonal business, banks may fix separate limits for the peak limit credit requirement and normal non-peak level credit requirement indicating the periods during which the separate limits will be utilized by the borrower. In practice, banks do not lend 100 per cent of the credit limit; they deduct margin money. Margin requirement is based on the principle of conservatism and is meant to ensure security. If the margin requirement is 30 per cent, bank will lend only upto 70 per cent of the value of the asset. This implies that the security of banks lending should be maintained even if the assets value falls by 30 per cent. Till the mid 1970s the principles of commercial banks lending in India was predominantly security oriented. It was more or less net worth based, collateralized financing. Major Banks were nationalized in 1969 and with
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Role of Banks in working capital management


that, approach to lending also changed in 1974, a study group under the chairmanship of P.L.Tandon was formed to examine the existing methods of lending and suggest changes. The group submitted its report in August 1975, which came to be popularly known as Tandon committees report. It was a Landmark in the history of bank lending in India. With the acceptance of major recommendations by RBI a new era of lending being in India.

Tandon Committee recommendations:


Introduction:With the nationalization of major commercial banks in 1969, the emphasis in bank lending shifted from security to purpose with a bias for production. The demand for bank credit also registered a phenomenal growth. While small industries, self-employed and agricultural sectors and public sector required an increasing share in bank credit, a sizable share thereof continued to flow into large and medium industries. Along with increasing demand for bank credit (making it scarce everyday), there was an ever-increasing inflation calling for control of bank credit. During 1973-74, inflation touched a level of 31%. Reserve Bank of India took both monetary and fiscal measures to curb the inflation. It was also thought that time was ripe to have a complete review of bank credit so as to gear it to the development role expected of banks in the economy. Reserve Bank of India, thus appointed in 1974 a study group with Sri P.L.Tandon, then chairman, Punjab National Bank as the chairman. This study group for Framing Guidelines for the following up of Bank Credit came to be popularly known as the Tandon Committee. The Reserve Bank of India has accepted the major recommendations and

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Role of Banks in working capital management


banks have to implement them. The major areas covered by the recommendations are: Norms for holding inventory and receivables; Maximum permissible bank finance; Style of credit; and Follow up and supervision of credit

Norms for Inventory receivables The Committee has given itself to the study of those items against which bank advance is made. In term of the production requirements, the committee has worked out the level of current assets which each industrial unit cash hold. These are called the norms. Norms are the maximum level of these assets that a unit cab hold. Norms are expressed in terms in terms of periods for which the assets can be held. The assets for which norms have been prescribed and the terms in which they are expressed are given below: Raw material Work-in-Progress Finished goods So many cost of raw materials consumed So many months cost of production So many months cost of sales

Receivables - So many months sales Norms in the beginning were prescribed for 15 selected industries, which together accounted for about 50% of the total bank credit to the industry. Further, they are applicable only to these units have working capital limits aggregating to Rs. 10 lakhs and above in the entire banking system. The banks are expected to apply the spirit of the recommendations to accounts having smaller limits also. The following factors may be noted while dealing with the norms:

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Role of Banks in working capital management


Norms are the maximum level of current assets that a unit can hold. They are not the optimum levels. Therefore, if a unit is having current assets at levels less that the norms, it should continue to hold at the same level. Norms have been prescribed separately for 49 different industries. If few cases, different norms are given for different regions for the same industry. The norms appropriate to the unit in question should be applied. Norms have been prescribed separately for individual current asset. The unit should satisfy the requirement of norms for individual component separately. For instance, for pharmaceutical industry, norms for raw materials and work-in-progress are 2 months and month respectively. The unit cannot have 2 months of raw materials and 1 month of work-in-progress. But in certain cases, a combined norm for finished goods and receivable is given. In such cases, the holding of finished goods and receivables can vary within the overall ceiling prescribed. It should be noted that the combined norms is 2 months, finished goods can be for 1 month and receivables for 1 months finished goods and 2 months receivable. No Norms is fixed for export receivables, imported raw materials and other current assets. For these items, the banker has to go by the past level of holding. The level of spares not normally exceeds 5% of the total inventory. The tendency is to consider spares as current assets only upto the level of 5% of the total current assets and treat the balance as miscellaneous assets.

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Role of Banks in working capital management


Maximum Permissible Bank Finance: The committee has suggested three methods of working out of the maximum amount that a unit may expect from the bank. The extent of bank finance will be more in the first method, less in the second method and the least in third method. The three alternatives may be illustrated by the following example taken from the report of the committee. The borrowers financial position projected as at the end of the next year are as under. (Rs. Lakh) Current Liabilities Creditors for purchases 100 Other current liabilities 50 150 Bank bankers borrowings, 50 Current Assets Raw material Stock in process Finished goods Receivables, including bills discounted with 200 bankers Other Current Assets 350 370 As per suggested norms or past practice, whichever is lower in relation to projected production level for the next year. (Rs. Lakh) 1st method Total Current 370 assets Less: Current liabilities (other long-term
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200 20 90

including discount with

10

2nd method Total Current 370 assets Less: 25% of above from long92

3rd method Total current 370 assets Less: Core Assets From term longsources current 95

150

than

term sources

Role of Banks in working capital management


borrowings) real assets 220 Less: 25% of above 55 form long-term sources Current liabilities (other long-term borrowings) than 150 278 25% of above from longterm sources Less: Current Liabilities (other bank MPBF* 128 Working capital (370-150) Excess borrowing Current ratio MPBF* = Maximum Permissible Bank Finance. Initially, all units were placed under method 1. It was expected that over year the units would progress and could be placed in successive methods. Accepting the recommendations of Tandon committee, the Reserve Bank has directed the banks in December 1980 that Method 2 should be applied for all accounts where the total working capital limit is Rs. 50 lakhs and above.
25

current

275 69 206 150

than

165

borrowings) MPBF* MPBF*

56

gap 220 35 1.71:1

220 72 1.33:1

220 144 1.79:1

Role of Banks in working capital management


The minimum current ratio under method 1 works out to 1.71:1 and to 1.33:1 under method 2. Deviation from norms Norms prescribed by the Tandon committee are not rigid. Deviation from norms can be allowed for agreed short periods and in situation satisfactory to the bankers. In the following cases deviation are usually allowed: Bunched receipt of raw material including imports. Power-cuts, strikes and other unavoidable interruptions in the process of production, transport delays and bottlenecks. Accumulating of finished goods due to non-availability of shipping space for exports or other disruptions in sales (but not under circumstance where sale stimulation is needed through reduction in prices). Build up of stocks of finished goods such as machinery due to failure (on the part of purchasers for whom those were specifically manufactured) take delivery. Need to cover full or substantial requirement of raw materials for specific export contract of short duration. Slip Back A unit whose current ratio is better than the minimum required under the first method should not be allowed so slip back or worsen it. There were, however, many representations from industry and Reserve Bank has allowed the slip back subject the condition that the relaxation does not result in the contribution of the unit to the working capital gap going

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Role of Banks in working capital management


below a minimum of 25%. The relaxation is allowed in the following cases: Fro undertaking either an expansion of existing capacity Fro fuller utilization of existing plant capacity. For meeting a substantial increase in the units working For bringing about a reduction in the level of deposits or for diversification.

capital requirement on account of abnormal price rise. accepted from the public for complying with statutory requirements. Fro repayment of the installments due; under foreign currency loans and other term loans. Style of credit and flow of information: The recommendation of the Tandon committee with regard to the above since been modified by the recommendation of the chore committee.

Chore Committee recommendations:


Introduction:On reviewing the monetary and credit trends for the busy session of 1978-79, the RBI felt that the extensive use of cash credit system was a deterrent factor in implementing the credit regulatory measures by the banks. The Tandon committee had recommended bifurcations of credit limits into a deemed loan and a fluctuating cash credit component. But implementation of this recommendation was very slow. The Reserve Bank, therefore, though that this problem needed a deep study and decision was taken to entrust the work to a working group. Accordingly a Working Group to review the system of cash credit was constituted in

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Role of Banks in working capital management


April 1979 under the chairmanship of Sri.K.B.Chore, Chief Officer, DBCOD, Reserve Bank of India.

Recommendations: The Committee submitted its final report in August 1979. The major areas covered by the recommendations are: Use of different types of advances, cash credit, loan and bills-all types to continue. Bifurcation of cash credit limit into demand loan and fluctuating cash credit portions not favored because: 1. For seasonal industries the different is too much; for sales season period the account may be in credit in which case the loan portion should be nil. 2. For non-seasonal industries the difference is too marrow to be of any help to the banker. Separate limits to be granted for peak level and normal non-peak level credit requirements. All borrowers (except sick units) with working capital requirement of Rs. 10 Lakh and above to be placed under second method of lending recommended by Tandon Committee. The flow of information from borrower to banks to be simplified.

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Role of Banks in working capital management


Bank to take up financing a portion of raw material by way of drawee bills. Implementation of recommendations: The recommendations of the committee have been accepted by the RBI subject to certain modifications. The directives of the RBI on implementing the recommendations were issued to the banks in December 1980. 1. Working capital advances of Rs. 10 Lakhs and over (aggregate working capital advances per borrower) Banks should review all borrowal accounts to verify the continued viability and also to assess the need based character of the advance. Bifurcation of cash credit accounts into demand loan component and cash credit portion charging different rates of interest is withdrawn. If already bifurcated steps should be taken to abolish the different interest rate with immediate effect. 2. Working capital advances of Rs. 50 Lakhs and over (aggregate working capital advance per borrower) While assessing the credit requirement of borrowers wherever feasible, the banks should sanction separate limits for peak level requirement and normal non-peak level requirements. Within the limits sanctioned withdrawals from the account are to be regulated through quarterly statements. Before the commencement of a quarter the borrower should indicate his requirements for the quarter by submitting the quarterly statement (Form I) giving estimates of current
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Role of Banks in working capital management


assets, current liabilities, bank borrowing, production and sales. This set operating limit for the quarter.

Ad hoc or temporary limits may be sanctioned in

exceptional cases for predetermined short periods to meet unforeseen contingencies. Such facilities should be in the form of a separate demand loan or a non-operable cash credit account. Except in exceptional cases like natural calamities and in the case of accounts under nursing programmer banks are to charge interest at 1% more than the normal rate.

Enhancement of borrowers contribution is to be

enforced through placing them under second method of lending recommended by Tandon committee. According to this working capital to the extent of at least 25% of the current assets should be financed by term finance and contribution from owned funds. This would give a minimum current ratio of 1.33:1.0. Discounting bills should be encouraged in place of cash credit against book debts for financing sales. Wherever possible existing cash credit against book debts should be converted into bill limits. Drawee bill financing should be encouraged for financing raw material under bill system. Under this, the seller draws a bill on the buyer. The bank accepts the bill thus enabling the seller to discount the bill with bank or any other bank may itself pay the bill amount to the seller. At least 50% of the cash credit limit against raw materials sanctioned to manufacturing units should be by way of drawee bill limits. For example, if the party has been
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Role of Banks in working capital management


sanctioned a total limit Rs. 200 Lakhs the individual limit would be as follows: Cash credit (margin 50%) Rs. 100 Lakhs Drawee bill discounting Rs. 100 Lakhs The stock statement may reveal the following particulars: Stock paid for Stock received under bill discounting Rs. 100 Lakhs Rs. 75 Lakhs

Unpaid stock Rs. 25 Lakhs Drawing limits would be determined as under: Cash credit (Rs. 100 Lakhs less 50% margin) Rs. 50 Lakhs Bill discounting Rs. 75 Lakhs When the bill is met by borrower, the stock would be taken under cash credit. Then it would subject to margin requirements.

Nayak Committee Recommendations:


Considering the contribution of SS! Sector to overall industrial production, exports and employment and als orecognizing the need to give a fillip to this sector, RBI has accepted the recommendations of Kayak committee ("Committee to examine the adequacy of Institutions Credit to SSI sector and related aspects headed by Sri. P.R. Nayak). The salient features of the committee's recommendations are: To give preference to village industries, tiny industries and other

small scale units in that order while meeting the credit requirements of small scale sector.
For the credit requirements of village industries, tiny industries and

other SSI units upto aggregate fund based working capital credit limits upto Rs. 50 lakhs from the banking system, the norms for inventory and receivables as also the methods of lending as per Tandon Committee will not apply. Instead, for such units the
31

Role of Banks in working capital management


working capital limit will be computed at 20% of their projected annual turn over (for both new as well as existing units). These SSI units will be required to bring in 5% of their annual turnover as margin money. In other words, 25% of the output value should be computed as working capital requirement, of which at least 4/5th should be provided by Banking Sector, the remaining 1/5th representing borrower's contribution towards margin money for the working capital. Branches have to satisfy themselves about the reasonableness of projected annual turnover of the applicants.
Preparation of annual Budget in respect of Working Capital

requirements of SSI sector on "bottom up" basis.


Sick SSI unit redefined.

Banks are advised to adopt "Single Financing Approach "for

meeting both Term Loan and working capital requirements of SSI sector. The "Single Window Scheme "(SWS) of SIDBI enables commercial banks to provide term loans and working capital to SSI units have a project outlay upto Rs. 20 lakhs and working capital requirement upto Rs. 10 lakhs. Banks to set up effective grievance cells to enable SSI borrowers to approach in case of difficulties. SSI loan applications should be disposed off within time frame laid down as follows: In case of credit upto Rs. 25,000 In all other case within 15 days 8 to 9 weeks

To help eliminate delay in sanction of limits to SSI units, Banks

should adopt a system of committee approach, in which decisions are taken by the competent authority after a structured discussion with the Branch Manager and also the authorities at the intervening level.
32

Role of Banks in working capital management


Rejection/curtailment of limits by sanctioning authority

should be referred to the next higher authority should be referred to next higher authority for confirmation. Branches should not insist on deposit mobilization of stipulated amounts as a precondition to the sanction of credit. However, they can enlist the co-operation of these customers for deposit mobilization.

Branch level officials should have the right aptitude, skills

and orientation with respect of financing SSI sector.

Vaz Committee Recommendations:


The Vaz committee has extended the concept of Nayak committee to all business enterprises, which also has been accepted and implemented. The borrower has to bring in a margin of 5% of the projected turnover from long-term sources as his contribution and 20% would be provided by the financing bank. Thus, the working capital limits have no relation to the current assets which is a total departure from Tandon and Chore Committees. In arriving at 25% of the projected turnover as the working capital requirement, the committee has assumed an average of four working capital cycles in a year. This method of determining the working capital has understandably made the small entrepreneur happy as he is assured of a working capital facility from his bankers bearing a direct relationship to his expected turnover. Further, he is also able to determine for himself his eligibility for a working capital limits, but banks, in spite of stiff instructions from the
33

Role of Banks in working capital management


RBI to abide by the new guidelines, still stick to the traditional method.

Bank

policy

to

lend

the

working

capital

The following approaches are generally followed by the banks in financing working capital needs of the business firms: Maximum Permissible Bank Finance (MPBF) - Under MPBF approach, the capital finance limits of a firm at either 75 per cent of the companys current assets or the different between 75 per cent of current assets and non-bank current liabilities. The inherent concept of the approach is that scarce credit must be rationed. Under this method, the minimum acceptable current ratio was specified, thus fixing the minimum contribution of the corporate to funding working capital gap. At the same time, the maximum current assets levels were prescribed through a series of inventories and receivables norms.

Current Ratio Financing - The liquidity of the

firm is said to be satisfactory if it is able to meet its obligations in the short - run. The measure of liquidity is the ratio of current assets to current liabilities. Hence current ratio is used by the
34

Role of Banks in working capital management


bankers in estimating and financing the working capital needs of the firms. The acceptable current ratio is, therefore, the ratio of bank funds to own funds. This ratio is fixed through negotiation between the Corporate and the Banker.

Cash flow Financing - The need for working

capital arises essentially because of uneven and uncertain nature of cash flows. This is because cash outflows to meet production expenses do not occur at the same time as cash proceeds from sales are realised. They are uncertain because sales and costs are not known in advance. By projecting future cash receipts and disbursements, the cash budget enables the corporate to determine its cash needs, and plan their financing accordingly. Under this approach, bank finance~ based on the submission of periodic say, quarterly, cash flow statements that would fit smoothly into a firms cash cycle. To determine the quantum of bank finance, banks must evaluate cash-flow risks, forcing them to be more involved in day to day operations of the borrower. Once the bank has appraised the cash budget, ad hoc requests for more funds will not be entertained. This will demand sound resource planning& receivable management, purchase planning and management of inventory.

35

Role of Banks in working capital management

D ifferen k d o w rk g ca ita t in s f o in p l fin n g a cin


The main source of working capital financing, namely, Trade credit, Bank credit, Factoring and Commercial papers. TRADE CREDIT: Trade credit refers to the credit that a customer gets from suppliers of goods in the normal course of business. In practice, the buying firms do not have to pay cash immediately for the purchases made. This deferral of payments is a short-term financing called trade credit. It is major source of financing for firms. In India, it contributes to about one-third of the short-term financing. Particularly, small firms are heavily dependent on trade credit as a source of finance since they find it difficult to raise funds from banks or other sources in the capital markets. Trade credit is mostly an informal arrangement, and is granted on an open account basis. A supplier sends goods to buyer on credit which the buyer accepts, and thus, in effect, aggress to as a debt: he does not sign any legal instrument. Once the trade links have been established between
36

Role of Banks in working capital management


routine activities which may be periodically reviewed by the supplier. Open account trade credit appears as sundry creditors (known as accounts payable in USA) on the buyers balance sheet. Trade credit may also take the form of bills payable. When the buyer signs a bill - a negotiable instrument to obtain trade credit, it appears on the buyers balance sheet as bills payable. The bill has a specified future date, and is usually used when the supplier is less sure about the buyers willingness and ability to pay, or when the supplier wants cash by discounting the bill from a bank. A bill is formal acknowledgement of an obligation to repay the outstanding amount. In USA, promissory notes a formal acknowledgement of an obligation with promise to pay on a specified date are used an alternative to the open account, and they appears as note payable in the buyers balance sheet. Credit Terms Credit terms refer to the conditions under which the supplier sells on credit to the buyer, and the buyer is required to repay the credit. These conditions include the due date and the cash discount (if any) given for prompt payment. Due date (also called net date) is the date by which the supplier discount is the concession offered to the buyer by the supplier to encourage him to make payment promptly. The cash discount can be availed by the buyer if he pays by a certain date which is quite earlier than the due date. The typical way of expressing credit terms is, for example, as follows; 3/1.5, net 45. This implies that a 3 per cent discount is available if the credit is repaid on the 15th day, and in case the discount is not taken, the payment is due by the 45th day. Benefits and Cost of Trade Credit: As stated earlier, trade credit is normally available to a firm: therefore, it is a spontaneous source of financing. As the volume of the firms purchase increases, trade credit also expands. Suppose that a firm
37

Role of Banks in working capital management


increases its purchases from Rs.50, 000 per day to Rs. 60,000 per day. Assume that these purchases are made on credit terms of net 45, and the firm makes payment on the 45th day. The average accounts payable outstanding (trade credit finance) will expand to Rs 27 lakh (Rs. 60,000 x 45) from Rs. 22.50 lakh (Rs. 50,000 x 45). Advantages of trade credit:

Easy availability: Unlink other sources of finance, trade

credit is relatively easy to obtain. Except in the case of financially very unsound firms, it is almost automatic and does not require any negotiations. The easy availability is particularly important to small firms. Which generally face difficulty in raising funds from the capital markets.

Flexibility: Flexibility is another advantage of trade credit.

Trade credit grows with the growth in firms sales. The expansion in the firms sales causes its purchases of goods and services to increase which is automatically financed by trade credit. In contrast, if the firms sales contract, purchases will decline and consequently trade credit will also decline.

Informality: Trade credit is an informal, spontaneous source

of finance. It does not require any negotiation and formal agreement. It does not have the restrictions which are usually parts of negotiated sources of finance.

Bank credit: Bank credit is the primary institutional source of working capital finance in India; in fact, it represents the most important source of financing of current assets. Form of Credit: Working capital finance is provided by banks in five ways:
38

Role of Banks in working capital management


Cash Credit/Overdrafts: Under cash credits, the bank specifies a predetermined borrowing/ credit limit. The borrows can draw/borrow up to the stipulated credit/overdraft limit. Similarly repayments can be made whenever desired during the period. The interest is determined on the basis of the running balance/amount actually utilized by the borrower and not on the sanctioned limit.

Loans: Under the arrangement the entire amount of borrowing is credited to the current account of the borrower or the released in cash. The borrower has to pay interest on the total amount. Bills purchased/discounted: The amount made available under this arrangement is covered by the cash credit and overdraft limit. Before discounting the bill, the bank satisfied itself about the credit-worthiness of the drawer and the genuineness of the bill. To popularize the scheme, the discounting banker asks the drawer of the bill (i.e. seller of goods) to have his bill accepted by the drawee (buyers) bank before discounting is latter grants acceptance against the cash credit limit, earlier fixed by it on the basis of the borrowing value of stocks therefore, the buyer who byes goods on credit cannot use the same goods as source of obtaining additional bank credit. Term loans for working capital: Under this arrangement, banks advance loans for 3-7 years repayable in yearly or half yearly installments. Letter of credit:

39

Role of Banks in working capital management


While the other forms of bank credit are direct forms of financing in which banks provide funds as well as bear risk, letter of credit is an indirect form of working capital financing and banks assume only the risk, the credit being provided by the supplier himself.

Mode of Security for Bank credit: Banks provide credit on the following modes of security: Hypothecation: Under this method of security, the banks provide credit to borrowers against the security of movable property, usually inventory of goods. Pledge: Pledge, as mode of security is different from hypothecation in that in the former, unlike in the latter the goods which are offered as security are transferred to the physical possession of the lender. Lien: The term Lien refers to the right of the party to retain goods belonging to another party until a debt due to him is paid. Mortgage:

40

Role of Banks in working capital management


It is the transfer of the legal stock equitable interest in specific immovable property for securing the payment of debts. Charge: Where immovable property of one person is, by the act of parties or by the operation of law, made security for the payment of money to another and the transaction does not amount to mortgage, the later person is paid to have a charge on the property and all provisions of simple mortgage will apply to such a charge.

COMMERCIAL PAPERS: Meaning: Commercial paper (CP), an important short term money market instruments made its debut in India in the beginning of 1990. It was, while adumbrating the credit policy for the first half of 1989, that the RBI Governor announced the introduction of CPs, "with a view to enabling highly rated corporate borrowers to diversifying their sources of short term borrowing and also providing an additional instrument to investors." Commercial paper is a short term financial instrument used by accompany for raising funds from the money markets. Thus, it is a money market instrument which is issued in the form of unsecured promissory note in bearer form with a maturity period of one year or even less. The issue of CP is expected to bring in financial discipline in the working capital management of an issuer company as it has to ensure its creditability in the money market by proper utilization of funds to finance the current or short term transactions and honoring payment of CP on the maturity date. CP can be issued either through direct placements or
41

Role of Banks in working capital management


through agents like banks, merchant bankers and financial institutions. CP is freely negotiable by endorsement and delivery. Advantages A CP has several advantages for both the issuer and investors. It is a simple instrument and hardly involves any documentation. It is additionally flexible in terms of maturities which can be tailored to march the cash flow of the issuer. Companies which are able to raise funds through CP's have better financial standing. The CP's are unsecured and there are no limitations on the end use of funds raised to them.

FACTORING: Factoring provides resources to finance receivables as well as facilitates the collection of receivables. Although such services constitute a critical segment of the financial services scenario in the developed countries, they appeared in the Indian financial scene only in early nineties as a result of RBI initiatives. There are two bank sponsored organizations which provide such services: (i) SBI factors and commercial services ltd., and (ii) can bank factors. The first private sector factoring company, foremost factors ltd. Started operations since the beginning of 1997. Definition and Mechanism: Definition: Definition factoring can broadly be defined as an agreement in which receivables arising out of sale of goods/services are sold by a firm (client) to the 'factors' (a financial intermediary) as a result of which the title of the goods/services represented by the said receivables passes on the factor. Hence forth, the factor becomes responsible for all credit control, sales accounting and debt collection from the buyers.
42

Role of Banks in working capital management


Mechanism: Credit sales generate the factoring business in the ordinary course of business dealing. Realisation of credit sales is the main function of factoring services. Once the sales transaction is completed, the factors steps into realize the sales. Thus the factor works between the seller and the buyer and sometimes with the sellers banks together. Function of a Factor: Depending on the type/form of factoring, the main functions of a factor, in general terms can be classified into following categories: 1. 2. 3. 4. Financing facility trade debts. Maintenance/administration of sales ledger. Collection facility of accounts receivables. Assumption of credit risk/credit control and credit restriction: and next provision of advisory services. Cost of Services It is the factors provide various services at a charge. The charge for collection and sales ledger administration is in the form of a commission expressed as value of debt purchase. It is collected up-front/in advance. The commission for short term financing as advance part-payment is in the form of interest charged for the period between the date of advance payment and the date of collection guaranteed payment date. It is also known as discount charge.

43

Role of Banks in working capital management

Methods for Estimating Working Capital Requirements


There are three methods for estimating the working capital requirements of a firm: (i) Percentage of sales method (ii) Regression analysis method (iii) Operating cycle method. Percentage of Sales Method - It is a traditional and simple method of determining the level of working capital and its components. In this method, working capital is determined on the basis of past experience. if, over the years, the relationship between sales and working capital is found to be stable, then this relationship may be taken as a base for determining the working capital for future. This method is simple, easy to understand and useful for projecting relatively short term changes in working capital. However, this method cannot be recommended for universal application because the assumption of linear relationship between sales and working capital may not hold good in all cases.

44

Role of Banks in working capital management


Regression Analysis Method - It is a useful statistical technique

applied for forecasting working capital requirements. It helps in making working capital requirement projection after establishing the average relationship between sales and working capital and its various components in the past year. The method of least squares is used in this regard. Operating Cycle Method In this method the requirement of

working capital is estimating through the operating cycle period. It varies from firm to firm and industry to industry. If the enterprise is trading firm than it does not have operating cycle because, they are directly buying goods from other and selling to others. If the enterprise is manufacturing firm than their operating cycle depends on their process of converting raw material into finished goods, availability of raw material, power, fuel and other required thing to manufacture. Individual component approach Detailed estimation is made using the individual components of the operating cycle.

45

Role of Banks in working capital management

Factors determining Working Capital Requirement


There is no set of universally applicable rules to ascertain working capital needs of a business organization. The factors which influence the need level are as below: Nature of Business: If we look at the Balance sheet of any trading organization, we find major parts of the resources are deployed on current assets, particularly stock-in-trade. Whereas in case of transport organization major part of funds would be looked up in fixed assets like motor vehicle, spares and work shed etc. and the working capital component would be negligible. The service organization or public utilities need lesser working capital than trading and financial organizations. Therefore, the requirement of working capital depends upon the nature of business carried by the organization. Manufacturing Cycle:

46

Role of Banks in working capital management


Time span required for conversion of raw materials into finished goods is a block period. The period in reality extends a little before and after the work-in-progress. This cycle determines the need of working capital. Business Cycle Fluctuation: This is another factor which determines the need level. Barring exceptional cases, there are variations in the demand for goods/services handled by any organization. Economic boom or recession etc., have their influence on the transactions and consequently on the quantum of working capital required.

Seasonal Variations: Variation apart, seasonality factor creates production or even storage problem. Muster and many other oil seeds are Rabi crops. There are to be purchased in a season o ensure continuous operation of oil plant. Further there are woolen garments which have demand during winter only. But manufacturing operation has to be conducted during the whole year resulting in working capital blockage during off season. Scale of Operations: Operational level determines working capital demand during a given period. Higher the scale, higher will be the need for working capital. However, pace of sales turnover (Quick or slow) is another factor. Quick turnover calls for lesser investment in inventory while low turnover rate necessitates larger investment. Credit Policy: Credit policy of the business organization includes to whom, when and to what extent credit may be allowed. Amount of money locked
47

Role of Banks in working capital management


up in account receivables has its impact on working capital. In

good many cases, account receivables are sterile and sticky and thereby they have forfeited the right to be classified as current assets. In view of such situation in ascertaining quick ratio instead of deducting stock-in-trade we find it worth while to deduct sundry debtors. The other component is credit policy of the suppliers, their terms and conditions of credit. Trade credit has its historical presence in the trading world. Availability of normal credit supplies as well as trade credit facilities working capital supply and reduce the need for bank finance.

Accessibility to Credit: Creditworthiness is the precondition for assured accessibility to credit. Accessibility in banks depends on the flow of credit i.e., the level of working capital. Growth and Diversification of Business: Growth and diversification of business call for larger volume of working fund. The need for increased working capital does not follow the growth of business operations but precedes it. Working capital need is in fact assessed in advance in reference to the business plan. Supply Situation: In easy and stable supply situation, no contingency plan is necessary and precautionary steps in inventory investment can be avoided. But in case of supply uncertainties, lead time may be longer necessitating larger basic inventory, higher carrying cost and working capital need

48

Role of Banks in working capital management


for the purpose. No aggressive approach can gain foothold in such situation. Environment Factors: Political stability in its wake brings in stability in money market and trading world. Things mostly go smooth. Risk ventures are possible with enhanced need for working capital finance. Similarly, availability of local infrastructural facilities road, transport, storage and market etc., influence business and working capital need as well.

Relaxation in Assessment of Working Capital by Banks In order to provide greater freedom is assessing the working capital requirements of borrowers, effective from April 15, 1997, all instructions relating to MPBF were withdrawn. Banks were instructed to evolve their own method such as turnover method, the cash budget system, the MPBF system with necessary modifications or any other system of assessing working capital requirements. The loan policy in respect of each broad category of industry is, however, required to be laid down by each bank with the approval of the respective Board.

49

Role of Banks in working capital management

Ratios for the Working Capital


Working Capital ratio includes the ability of business concern in meeting its current obligations as well its efficiency in managing its current assets in generation of sales. These ratios are applied to evaluate efficiency with the firm manages and utilizes its current assets. The following three categories of ratios are used for efficient working capital management. 1. Effective ratios 2. Liquidity ratios 3. Structural health ratios. Effective ratios:Working capital to sales ratio = sales Working capital
50

Role of Banks in working capital management


Inventory turnover ratio = sales Inventory Current Asset turnover ratio = sales Current Assets

Liquid ratios:Current ratio = Current Assets, Loans, Advances Current liabilities and Provisions

Quick ratio =

Current assets, Loans and Advances Inventories Current liabilities and Provisions Bank overdraft

Structural health ratios:Total Assets to total net assets = Net Asset Current Assets Debtors turnover ratio = Sales Debtors Average collection period (in days) = Creditors x 365 Sales Bad debts to Sales = Creditors x 365 Purchases

51

Role of Banks in working capital management

CASH STUDY
Steel Authority of India Limited. Balance sheet for the year ended 31.3.2008 (Amounts in crore) Particulars Sources of funds Shareholders fund Share capital Reserves and surplus Loan fund Secured loans Unsecured loans Deferred tax liability (net) Application of funds Fixed assets
52

Sch no.

Amount

1.1 1.2 1.3 1.4

4160.40 18933.17 925.31 2119.93

23063.57

3045.24 1568.60 27677.41

1.5

Role of Banks in working capital management


Gross block Less: Deprecation Net block Capital work-in-progress Investments Current assets, loans and advances Inventories Sundry debtors Cash and Bank balance Other current assets Loans and Advances Less: Current liability & Provisions Current liability Provisions Net Current Assets Miscellaneous Expenditure (to the extend of not written off or 30922.73 19351.42 11571.31 2389.55

1.6 1.7 1.8 1.9 1.10 1.11 1.12

13960.86 538.20

6857.23 3048.12 13759.44 273.08 2379.75 26317.62 6400.92 6797.83 13198.75 13118.87 59.48 27677.41

1.13 1.14

1.15

adjusted) Profit & Loss Account for the year ended 31.3.2008 (Amount in crore) Particulars Income Sales Less: Excise duty Finished products consumed Interest earned Other revenue Provisions no written back 41890.91 Expenditure
53

Sch No, 2.1 internally 2.2 2.3 2.4 45555.34 6046.89

Amount

39508.45 490.81 1184.76 646.27 60.62

longer

required

Role of Banks in working capital management


Accretion (-) to stocks Raw materials consumed Purchases of finished / semifinished goods Employees remuneration Benefits Stores & spares consumed Power & fuel Repairs & Maintenance Freight outward Other expenses Interest & finance charges Deprecation Total Less: Inter Account Adjustments Adjustments pertaining to earlier years 11468.73 Profit before tax Less: Provision for taxation Profit after tax Transfer to reserves Bal b/d from last year Amount for Appropriation Less: Appropriation Balance c/d to balance sheet Efficient ratios:W.C to sales ratio = Sales W.C = 39508.45 19916.7 =
54

2.5 2.6

-339.30 13960.14 3.63 7919.02 3293.90 2825.56 552.15 717.85 1836.32 250.94 1235.48 32255.69 1832.22

&

2.7

2.8 2.9 2.10 2.11

2.12 2.13

30423.47 11467.44 1.29

(3931.95) 7536.78 86.39 10811.65 18434.82 2557.16 18434.82

1.983

Role of Banks in working capital management


Inventory turnover ratio = Sales Inventory = 39508.45 -339.30 = Current asset turnover ratio 39169.15 = Sales W.C = 39508.45 19916.7 = Liquid ratios:Current ratio = C.A, Loans and Advances C.L, Provisions Bank O/D = 26317.62 13198.75 = 1.993: 1 1.983

Quick ratio

Q.A Q.L

C.A, Loans and Advances - Inventories C.L, and Provisions Bank O/D

26317.62 6857.23 13198.75 nil

19460.39 13198.45
55

Role of Banks in working capital management


= Structural health ratios:C.A to total net assets = Net assets C.A = 27079.73 26317.62 = Debtors turnover ratio = 1.028 Sales Debtors = 39508.34 3048.12 = 12.96 = Debtors x 365 Sales = 3048.12 x365 39508.34 = 1112563.8 39508.34 = Approx Bad debts to sales = = Bad debts Sales = 216.69 39508.48 = Creditors turnover ratio = 0.005 Creditors x 365
56

1.47:1

Average collection period (in days)

28.16 days 28 days

Role of Banks in working capital management


Purchases = 2981.55 13960.14 = 0.2135

Conclusion
Working capital management is concerned with short term financial decisions which have been relatively neglected in the literature of finance shortage of funds for working capital has caused many businesses to fail and in many cases, has recorded there growth, Lack of efficient and effective utilization of working capital leads to earn low rate of return on capital employed or even compels to sustain losses. The need for skilled
57

Role of Banks in working capital management


working capital management has thus become greater in recent years; every enterprise has to arrange for adequate funds for meeting day-to-day expenditure apart from investments in fixed assets. Working capital is the flow of ready funds necessary working of the enterprise. It consists of funds invested in current assets or those assets which in the ordinary course of business can be turned into cash within a brief period without undergoing diminution in value and without disruption of the organization. Concept of working capital is difference between current asset and current liabilities. It is the excess of current asset over current liabilities. The blood to the business enterprise working capital, if weak, the business cannot prosper and survive, although there may be a large investment of fixed assets. Inadequate as well as redundant working capital is dangerous for the health of industry. In other words Over and under working capital is the dangerous for the any business enterprise. A company must have working capital adequate to its requirements neither excessive nor inadequate. While inadequate working capital adversely affects the business operations and profitability, excessive working capital keeps idle and earns no profit. The primary objective of working capital management is to manage the firm's current assets and current liabilities in such a way that a satisfactorily level of working capital is maintained. The firm may become insolvent if it cannot maintain a satisfactory level of working capital. Working capitals assist in increasing the profitability of the concern. The working capital position decides the various policies in the business with receipt to general operations viz., importance of working capital management. To manage working capital at par level to meet with the day-to-day expenditure of the firm, the Banks role is very important as the bank lends the money to the firm to run the business and day-to-day business
58

Role of Banks in working capital management


activities. In this lending banks lending the advances to the business firms in various forms. Such as, Bank credit:Cash credit / Bank overdraft Loans Bill purchased & discount Term loan for working capital Letter of credit discounting Commercial paper Factoring By providing such kind of advances to the business firm, Banks plays the important role to managing the working capital of the business firm.

59

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