Small Scale Industries 6 Working Capital Management The management of working capital is an integral part of overall corporate management.

. Working capital is the amount of funds which small scale industry must have to finance its day to day operations. It also includes that portion of an industry s total capital which is employed in short!term operations. Such items include stocks of raw material and supplies need for manufacture" stocks of finished goods awaiting sale" semi processed items" sundry de#tors for pending collections against credit sales" short term investments" etc. Definition: The $ccounting %rinciples &oard of the $merican Institute of Certified %u#lic $ccountants" 'S$" has defined working as follows( Working capital, sometimes called net working capital, is represented by the excess of current assets over current liabilities and identified the relatively liquid portion of total enterprise capital which constitutes a margin of buffer for maturing obligations within the ordinary cycle of the business. !b"ectives of Working #apital: $ successful financial management is essential for sound and consistent asset management policies covering fi)ed and current assets. $n effective utili*ation of working capital results in the ma)imi*ation of productivity and profits. %rofita#ility and solvency are the twin o#+ectives of working capital management. These can #e achieved #y striving to maintain a correct ratio #etween working capital fi)ed capital. Such ratio will ensure a smooth and rapid flow of funds and enhance the efficiency and profita#ility of the enterprises. $ proper management of working capital synchroni*es the cash receipts and cash outlay" and a unit may function with minimum cash reserve. #redit $equirement of small scale industries % Draw figure no. & page no. '(&. )ross and *et Working #apital +tructure: The concept of working capital is #roadly understood in ,gross and ,net concept. The financial is the gross concept. The gross working capital is represented #y the sum total of all the current assets of the enterprises" while the net working capital is the difference #etween the current assets and current lia#ilities. In short" the gross and the net working capital concepts represent two distinct and important facets -aspects. of working capital management. *et Working #apital: /et working capital represents the e)cess of total current assets over total current lia#ilities and is measured #y the current ratio indicates that current assets has an edge over current lia#ilities vi*. current assets 0 current lia#ilities. 'nit has the current ratio of a large ratio 1(2 indicates greater solvency -in sound financial position. where as a very low ratio indicates insolvency. )ross Working #apital: It is e3ual to the total sum of current assets and may represent #oth owned capital and loan capital. The concept of gross capital is a financial concept" while that of net capital is an accounting concept.

,actors determining the -mount of Working #apital: The working capital re3uirements of small scale industries vary from one unit to another and from one type of unit to another type. Small scale units" which are located in rented premises and are engaged in processing works" need a larger amount of working capital than other units. The other important factors determining the amount of working capital are( &. +i/e of the +mall +cale 0nit( The amount of working capital depends directly upon the volume of #usiness. The #igger the si*e of a unit" the larger the amount of the working capital. 1. 2rocess of 2roduction( Simple short period processes of production re3uire a smaller amount of working capital and vice versa. '. 2roportion of $aw 3aterials to 4otal #ost( The price of raw materials and the 3uantity re3uired determine the amount of working capital. 5. 4erms of 2urchase and +ales( The amount of working capital varies directly with the use of credit facilities offered to customers and Credit facilities o#tained while purchase of raw materials. 6. 4urnover of 7nventories( If inventories are large and their turnover is slow" a small scale industry will need a #igger amount of working capital. If the inventories are small and their turnover is 3uick" the unit will re3uire a smaller amount of working capital. 8. 7mportance of 9abour( Small scale and cottage industries are la#our intensive units and therefore re3uire a larger amount of working capital. :. #ash requirements( the amount of working capital re3uired varies directly with the cash re3uirement of a unit. ;. +easonal <ariations( Seasonal small scale industries re3uire a large amount of working capital during the seasons in which the scale of operations is higher. 4. &anking 5acilities( If a small scale unit has good #anking connection" it may have minimum margin of regular working capital over current lia#ilities. &(. )rowth and =xpansion( The re3uirement of working capital varies directly in proportion to the growth and e)pansion of small scale unit. Working #apital ,inance and the 4andon #ommittee 0niform $ecommendations: $fter the nationali*ation of ma+or commercial #anks" the #anking system was asked to adopt a new approach as a credit agency" #ased on the development and potential" to assist the weaker sections of society and later" to lend to the pu#lic sector also. The financial assistance to the new credit users has gone up su#stantially since nationali*ation. The Indian industry has not always made the #est use of its resources. Traditionally cheap la#our" cheap money and a sheltered market have not #een conducive to efficient resource employment. 5ew #orrowers plan their credit needs and few #anks plan their resources mo#ili*ation and credit dis#ursal.

$gainst this #ackground" the 6eserve &ank constituted in 7uly 2489" a Study :roup to frame guidelines for follow!up of #ank credit. The :roup functioned under the chairmanship of Shri %rakash Tandon. 4erms of $eference: The following tasks were spelt out for the Study :roup( Suggest guidelines for commercial #anks to follow up and supervise credit dis#ursement. It will see that the funds are utili*ed properly and keep a watch on the safety of the advances. It also suggests the type of operational data and other information that may #e o#tained # #y #anks periodically from such #orrowers and #y the 6&I. Make recommendations for o#taining periodical forecasts from #orrowers of -2. #usiness;production plans -and -#. credit needs< Make suggestions for prescri#ing inventory norms for different industries" #oth in the private and pu#lic sectors and to indicate the #road criteria for deviation from these norms< Suggest criteria regarding satisfactory capital structure and sound financial #asis in relation to #orrowings Make recommendations regarding the sources of finance for minimum working capital re3uirements Make recommendations as to whether the e)isting pattern of financing working capital re3uirements #y cash credit ; overdraft system and to suggest any modifications if re3uired. Make recommendations on any other related matter as the :roup may consider.

4andon #ommittee approach to 9ending: Working Capital :ap and &ank finance( the #anker s main role" as a lender" is to supplement the #orrower s resources in carrying a reasona#le level of current assets in relation to his production re3uirements. The Committee e)pected the #orrower to hold only a reasona#le level of inventory and receiva#les. The total current assets will #e carried partly #y a certain level of credit for purchases and other current lia#ilities. 5unds re3uired to carry the remaining current assets may #e called the working capital gap" which may #e #ridged partly #y the #orrower s owned funds and long term #orrowings and partly #ank #orrowings. Coverage of the %roposed $pproach( The Study :roup recommended that the proposed approach to lending and the style of credit #e e)tended to all #orrowers having credit limits in e)cess of 6s. 2= lakhs from the #anking system. $s per the proposed information system" it was suggested that" to start with" it might #e introduced in respect of #orrowers with limit of 6s. 2 crore and a#ove from the entire #anking system. -dditional $equirement of #redit: The company sometimes re3uires additional credit facilities due to increase in production activity. If the additional funds re3uirements are on regular #asis" the #orrower should #ring a matching contri#ution re3uired under the relevant method of lending. The #orrower could #ring his contri#ution from the

retained profit or raising additional e3uity or #y issuing de#entures or #y #ringing in more funds in any other suita#le manner for this purpose. >n some special cases" when the #orrower is not a#le to raise the re3uisite funds immediately towards his own contri#ution" the #anks may consider giving a term loan to a reasona#le e)tent" provided that the cash raising capacity of the #orrower is good and that the proposed term loan within a short period is accepta#le to the #ank. When the additional fund needed is for a short period and cannot #e met from the e)isting credit arrangement" it should #e possi#le to consider additional credit for such need without necessarily insisting on a matching contri#ution to ena#le the #orrower to complete the specific transactions. Moreover" it should #e on the clear understanding that the #orrower would return the loan in the relevant method of lending within the stipulated period. 2roposed style of credit: >nce the 3uantum of #ank funds to finance a reasona#le level of current assets is agreed to" the style of e)tending #ank credit should #e changed. The draw#ack of the cash credit system of lending are well known" #ut may #e reiterated here( $ #ank has no control over the level of advances in cash credit accounts. /o notice is re3uired for drawing under limits that may remain unutili*ed for long periods. $ #ank is in no position to foresee demand for credit. This hampers its credit planning. The cost of the operation of the system to the #anker on account of attendant uncertainties is high #ecause whatever chances he may take in overselling credit" there will always #e a limit to how far he will oversell. It is practical that the level of #orrowings #y industrial units during the course of a year fluctuates from month to month. This depends upon the schedules of purchases of raw materials" dispatch of finished goods" wage structure" etc. ?owever" the non!seasonal industries do maintain their level of outstanding in a cash credit account and their fund re3uirement will #e sta#le during the year. The Tandon Committee suggested that instead of making availa#le the entire credit limit as a cash credit for a year" it may #e #ifurcated into a loan and a demand credit and the same shall #e reviewed annually. /on!seasonal industries and most agro #ased industries with some degree of seasonality can agree to the suggested system without difficulty. In case of high seasonal industries" the overall credit limit may have to make on the #asis of monthly re3uirements. The main intention is to introduce discipline in the lending system with higher rate of interest than the loan component. This approach will give the #orrower an incentive for good planning.

>ill ,inance: &ill 5inance is a way of shortening the transaction cycle through a movement of cash and carry system. Sometimes it is necessary for the manufacturing unit to e)tent credit to maintain sales. >n such conditions" apart from loan and demand cash credit" a part of the total credit re3uirement" within the overall eligi#ility" may #e provided #y way of #ill limits to finance receiva#les. It is desira#le that receiva#le should #e financed #y way of #ills rather than #y cash credit against #ook de#ts. These #ills may #e on a demand #asis or on a usance #asis" depending on the marketing practice in the industry. There is more advantage as mentioned hereunder" on a #ill arising out of the sale of goods over the cash credit against #ook de#ts( The transaction is easily identifia#le. There is a definite date of repayment The #ill will carry more than one signature if it is on a usance #asis. It represents an easily shifta#le asset. When goods are sold on credit to a wholesaler instead of to a user industry" #ank finance for the transaction would in effect #e credit trading purposes.

The Tandon Committee suggests that the #anking system should move towards financing the purchaser. The seller should #e paid off after the sale and the purchaser in fact should avail the credit facility from the #ank. The purchases should #e for the #enefit of #oth the parties" should #e on the #asis of #ills. This is #ecause 2. The amount should #e drawn only at the time of actual need. The end!use of credit is automatically taken care of. 1. Credit to the purchaser is directly related to his actual need which is not in the case with the seller s #ills" where credit is e)tended as a measure of sales promotion" irrespective of the purchaser s a#ility to pay of his need for credit. @. $ #ill imposes discipline in respect of payments for purchases it ensures timely payment to suppliers and also a sense of monthly installment on repayment of loan to #ank. There were few limitations on the a#ove suggestions. It was argued that the cash credit mode of financing is superior to #ill financing in respect of the #orrower s purchase operations on the following reasons( Withdrawals for non!approved purposes will #e detected #y the new information system proposed and also #y scrutiny of che3ues. The end use of credit will #e effectively taken care of #y the proposed information system. The cost of operations to the #orrower and the #ank will #e high. The #orrower will have to pay e)tra on stamp duty and the #anker has meet the administrative cost #ecause of additional work due to non! availa#ility of mechani*ation or computeri*ation. The advantages of centrali*ed #orrowing #y way of control over aggregate outstanding" de#it and credit summaries and the #orrowing trends would #e lost.

In view of the a#ove" the Tandon Committee suggested that each #ank might take its own in consultation with the #orrower. It will take into consideration the si*e of his operations" his individual transactions" the administrative set up and other re3uired norms. The Mechanics of Lending: The #anker will o#serve the following guidelines while lending financial assistance through &ills" to the small scale industries 2. The #anker is concerned with the #orrower s operating systems and not #y the stocks of inventories or receiva#les. The #orrowers operational plan for the ne)t few years re3uires special attention. The #orrower will plan his operations and satisfy the #anker a#out his profita#ility plans to get the assurance #y the #anker of ade3uate credit to meet his genuine production needs. 1. The #orrower should prepare a plan of operating statement" pro+ected #alance sheet and an application for advance for loan facility. The 5inancial $nalysis should cover an e)amination of the #orrower s past and current financial position" profita#ility" production operations for the ne)t year and pro+ected financial position at the end of the ne)t year. @. The current asset position should #e e)amined to ensure conformity with inventory and receiva#les norms in relation to the pro+ected production. 9. The financial assistance limit or the overall credit limit should #e fi)ed on the #asis of the a#ove pro+ected #alance sheet and the said limit shall #e furnished to the 6egistrar of Companies and Credit $uthorisation from the 6eserve &ank" at the time of the registration of the charge. A. In respect of e)isting advances" the re3uirement of additional finance over and a#ove the permissi#le level should #e identified and suggested on a repayment #asis. The repayment schedule shall #e ad+usted over a period of time" taking into account the customer s cash accruals" payment o#ligations and capacity to raise additional e3uity. 6. $ new separate account shall #e made availa#le for the agreed 3uantum of #ank finance. The minimum fund re3uired for 21 months shall #e released on fi)ed loan #asis and the #alance #y way of cash credit or #ills. 8. The #anker should #e fle)i#le in the matter of #ifurcation of the limit #etween loan and cash credit" which depends upon the customer s past plans" actual pattern of drawings and the e)pectation for the ne)t year. B. The 3uarterly operating statement" funds flow statement and the performance data should #e furnished to the #ank on regular #asis in the prescri#ed format. The #anker should satisfy that the 3uarterly plans drawn out #y the #orrower shall #e more or less in line with the earlier e)pectations and pro+ections drawn. 4. The actual drawings within the sanctioned limit should #e determined #y the customer s inflow and outflow of funds as reflected in the 3uarterly funds flow statement. $ny deficit in cash during the 3uarter calls for additional demand for cash credit re3uirement for that 3uarter. The 3uarterly withdrawal limit should #e maintained e3ual to the previous 3uarter. $dditional re3uirement of funds should #e specifically mentioned his need to that e)tent.

2=. Within the overall permissi#le limit of drawing" the day to day operations in the account #e regulated on the #asis of drawing power restricted for a month. The drawing power is assessed on the #asis of margins stipulated against the different components of inventory and receiva#les" as per the monthly stock statements. 22. $ny #udgeting or planning may not #e always 2==C accurate and it is #ound to #e fluctuating. Therefore" the #anker should #e fle)i#le in restricting the withdrawal limit to the e)tent of plus of minus 2=C on the overall sanctioned limit. 4erm 9oans to +mall +cale 7ndustries: 5or several years" the comprehensive criteria applied to the Term Doan $pplications from medium and large scale industries cannot #e used in respect of term proposals from small scale industries. Small units were finding it difficult to secure ade3uate finance from Institutional sources even for their working capital re3uirements. It may #e due to their!own inherent limitations on the one hand The generally high standards applied #y the lending institutions to #orrowers on the other. >rganised credit institutions feel that small units are generally poor risk takers. Small units have a low capital to turnover ratio. The availa#le #lock capital security is inade3uate in relation to a given level of production Small units markets are somewhat narrow %rospects for #usiness fre3uently uncertain.

Therefore" the #anks find it difficult to assess their credit worthiness and re3uire special treatment #ecause of their relatively high employment potential. Difficulties in Procuring Institutional Finance: Small Scale industries are generally not regarded as sufficiently credit worthy #ecause they are not a#le to satisfy the criteria of financial institutions. 2. 1. @. 9. A. 6. 8. B. 4. 2=. 22. 21. 2@. It involves assessment of credit worthiness of the #orrowers Euantum of securities offered #y the #orrower Fifficult to o#serve the rules and regulations governing the advances. The financial position of #orrower should #e fairly sound and show profit. ?e should have the prospect of improving its earning capacity. The e3uipment and technical processes employed in the production of goods and services should #e efficient. The unit concerned should have an assured market and there should #e demand for its product #y a #ig industry. The #orrowing concern should #e owned #y men of integrity and #usiness standing. The lending institutions are very rigid in their approach while dealing with #orrowers. The complicated nature of information re3uired from the #orrowers Strict re3uirements of security and rigid prescription of accepta#le collateral Felay involved in the sanction of loans. The assessment of risk factor in advancing to small industries natural poses a pro#lem for the lending financial institutions.

Dooking at the difficulties in o#taining the financial assistances from the large institutions" only the small #anks would respond to some e)tent to the needs of the small scale industries. Their field of activity is restricted to small area and is managed #y local men who would develop informal relationship with the small industrialists. The personal contact with customers helps the #anker to adopt a fle)i#le attitude and e)peditiously dispose of the applications for loans. ?owever" the resources of these #anks are limited and are governed #y their main head office and parent institutions. They are restricted to follow their standard of operations. The small industrialists should appreciate the fact that #anks have to operate on their #usiness principles and cannot lower their lending standards in order to meet their financial needs. Therefore" the small industries should make their earnest effort to meet the re3uirements of lending institutions. -pplication ,orms( $t the first instance" comprehensive information may #e o#tained in the application form a#out the credit worthiness and the pro+ect for which the finance is re3uired. This would assist the lending institution to +udge whether the proposal should #e accepted for the further detailed e)amination. $dditional information in greater detail may #e o#tained either #y a supplemental 3uestionnaire or #y the interview method which may #e suita#ly adopted #y the investigator. -udited -ccounts( many industrial units are either proprietary or partnership concerns or it is difficult to o#tain financial statement or furnish audited account for the last few years. In that case" latest account should #e audited and presented to the lending institution. 2ersonal 7nspection( an authori*ed representative and an e)perienced officer of the financing institution should inspect the units to satisfy that a proper evaluation may #e made of the proposal in the #eginning. $ny change in the application" guidance on the pro+ections made" slight modifications in the pro+ect" etc. shall #e incorporated and amica#ly settled #efore dis#ursement of the loan. +uggestions for improving ,acilities for 7nstitutional ,inance: While the institutions are playing an important role in catering to the financial re3uirements of the small scale industries" they have to take some drastic measures to overcome the difficulties and pro#lems faced #y the small units. This is the responsi#ility of #oth the lender and #uyer. The institutions have to make some ad+ustments in meeting the re3uirements of the lenders. The nature of ad+ustments is mentioned #elow( 9=*D7*) 7*+474047!*+: 2. Denders should take into account not only the value of the security offered" #ut also the character and technical a#ility of the #orrower" the prospect for the industry" nature and 3uality of goods manufactured" etc. 1. $cceptance of security #y way of pledge should #e fle)i#le and more commodities should #e listed as allowa#le security. @. Small and medium si*ed #anks may +oin together to form a common advisory #oard for the purpose marinating technical staff. They should #e allowed to utili*e the services of State Fepartment of Industries and Small Industries Service Institutes under the instructions from the :overnment of India. 9. Dending institutions may maintain personal contacts with #orrowing units through periodical visits" calling for weekly ; fortnightly progress reports" etc. A. The appraisal of the credit worthiness of the unit could #e made on the #asis of availa#le official data instead of calling for new technical data. Garious sources of data a providers could #e tapped to collect information on prospects" information on technical feasi#ility" competitiveness" investment pattern" demand!supply position" etc.

6. The interest charges should #e reasona#le. 6epayment period should #e determined according to earning capacity of the unit. The first installment may #e called for after a year or two to ena#le the #orrower to sta#ili*e his position and strengthen his repaying capacity. The margin of security should also #e li#eral. 8. :overnment of India has li#erali*ed the lending criteria through Credit :uarantee Scheme. This is operated through 6eserve &ank of India which ena#les the financial institutions a#out the guarantee facilities to cover some portion of the risk. Such guaranteed loans are refinanced in case of any risk on non!repayment" #y the 6efinance Corporation. B. The different agencies may supplement one another s resources and share the risks collectively #y participating in the loans of other agencies. 4. Dending institutions should #e practical and fle)i#le in their attitude" rather than strictly legal" looking at the temporary difficulties of the #orrowing units. Frastic step should not #e taken immediately on default cases. Timely advice and guidance and even the provision of additional financial assistance wherever so warranted" would ena#le them to tide over the crises. +3-99 +#-9= 7*D0+4$7=+: 2. It may not #e usually possi#le for small industries to provide financial and other data in a thorough and detailed manner. In such cases" as much information as is availa#le on the following aspects of the concern may #e given( ! Fetails of the nature of the industry and its products. ! Fata regarding performance" estimated cost of production and selling price. ! Hstimates regarding market prospects" invested capital" proportion of #orrowed capital. ! %urpose of the loan" result e)pected from the investment" etc. 1. Try to maintain audited accounts to facilitate the assessment of loan proposals #y the lending institution and also in the interest of small units. @. The units must #e a#le to produce accepta#le evidence for verification of the value of assets offered for security. 9. Doans sanctioned should not #e used for purposes other than those for which they have #een re3uested for. A. Where the loan is granted on an individual capacity" or the loan is given on a personal guarantee or personal security" such individual should insure on him ade3uately to the e)tent of loan availed and protect the interest of the lender. #onclusion: The working capital management is an internal part of overall management of small scale industries and it re3uires greater coordination #etween small scale industries and financial institutions. Towards this direction" Small Industries Fevelopment &ank of India -SIF&I. is shaped to provide a strong support to small scale industries. It is important that financial institutions should protect their interest with ade3uate security. Meanwhile" small industries should not deny the assistance for financial re3uirements. Small scale industries also re3uires non financial assistances on marketing" technical guidance and training in management" etc. Special institutions like the Small Industries Services Institutes" the /ational small Industries Corporation" etc. provides necessary services on this matters. %lanning and control of working capital centres facilitates the unit to control over the cash and credit policies.