WORKING CAPITAL

BY
R.K.GUPTA
B. Com (Hons); CAIIB; AIB (LONDON); L.L.B(I)
Consultant/visiting faculty (Banking Operations & Credit)

© Copyright 2009-2010 R.K.Gupta.

 WORKING CAPITAL
1) DEFINITION

2) WORKING CAPITAL CYCLE

3) FACTORS DETERMINING WORKING

CAPITAL

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 DEFINITION OF WORKING CAPITAL

• Funds deployed for managing business operations

• Working Capital refers to that part of the firm’s capital, which is

required for financing short-term or current assets such as cash,
marketable securities, debtors and inventories.

• Funds thus invested in current assets keep revolving fast and are
constantly converted into cash and this cash flows out again in
exchange for other current assets.

• Working Capital is also known as revolving or circulating capital or

short-term capital.

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 OVER /UNDER FINANCING
A. CASE OF UNDER FINANCING
(UNIT OF ROLLER FLOUR MILL)

B. CASE OF OVER FINANCING

(UNIT OF MANAFACTURING OF BUSES/ DAIRY)

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 FACTORS DETERMINING WORKING CAPITAL

a. Total Costs incurred on materials, wages and overheads.

b. The length of time for which raw materials remain in stores before
they are issued to production.
c. The length of the Production Cycle or Work-in-progress, i.e., the
time taken for conversion of raw materials to finished goods.
d. The length of the Sales Cycle during which finished goods are to
be kept waiting for sales.
e. The average period of credit allowed to customers.
f. The amount of cash required to pay day-to-day expenses of the
business.
g. The amount of cash required for advance payments, if any.
h. The average period of credit to be allowed by suppliers.

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 WORKING CAPITAL CYCLE
Cycle starts and ends with cash

Convert receivables
Into cash
Cash
COLLECT RECEIVABLES

Goods & Services Sales order to Supplier

Convert to Receivables

Cash converted to
Deliver goods & Produce goods &
Prepaid exp &
services services
inventory

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 WORKING CAPITAL FINANCING

• Working Capital is financed by following sources:

• OWNED FUNDS
-A portion of long term funds, equity share capital and reserves &
surplus is utilized to fund working capital
• BANK BORROWINGS
– Various bank products like cash credit, packing credit, bills
discounting, Letter of Credit/ Commercial Paper, Bank
Guarantee, Factoring, Securitization, Corporate Loan etc
• CREDITORS
– For goods supplied, expenses other creditors like short term
loan from relative and friends( Q. capital)

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 FORMS OF WORKING CAPITAL
a WORKING CAPITAL
PRODUCT

FUND BASED STRUCTURED

NON FUND BASED

DOMESTIC EXPORT COMMERCIAL

PAPER
BANK GUARANTEE
C/C-HYP & BYER’S &
PLEDGE PRESHIPMENT
SUPPLIER’S CREDIT
LETTER OF CREDIT
BOOK DEBTS/ POST SHIPMENT
RECEIVABLES CORPORATE LOAN

DOCUMENTARY
OVERDRAFT SECURITIZATION

USANCE/
BILL FINANCE CLEAN FACTORING

USANCE/
DOCUMENTARY FOREFEITING
CLEAN

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 ASSESSMENT OF WORKING CAPITAL
A) METHODS OF ASSESSMENT OF WORKING CAPITAL
– 1) Committee Recommendations
– 2) Turnover Method
– 3) Cash Budget Method
• B) CREDIT MONITORING ARRANGEMENT
• C) MAXIMUM PERMISSIBLE BANK FINANCE (MPBF) –
LIMITATIONS i.e.
– Represents position on a particular date
– Not tuned to Peak Time Assessment
– Not applicable for service industries
– In practice may differ with Drawing Power
– Situations like cyclical production, phased expansion programme with
enhancement for present working, bulk orders etc

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 METHODS OF ASSESSING WORKING CAPITAL

• COMMITTEE RECOMMENDATIONS
• Tandon Committee (Established in July 1974 & submitted in 1975)
• Recommendations for 15 major industries in respect of holding period
of raw material, stock-in-process, finished goods, receivables and
creditors. But still cushion left to the Banks keeping in view
circumstances. Committee has recommended the following methods:
Method I
– Borrowers to bring 25 % of the net working capital (Current Assets –Current
Liabilities)
Method II
– Borrowers to bring 25% of the Current Assets
Method III
– Borrowers to bring 100% of hard core assets + 25% of other current assets.

• Under Method I the promoter has to bring minimum margin whereas the
margin to be brought in under Method III is maximum

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 COMMITTEE RECOMMENDATIONS

• Chore Committee (March 1979)

• has discarded Method III and recommended Method II
– Method II is also known as Maximum Permissible Bank Finance
(MPBF)
– Banks mainly use this method for assessment of Working
Capital Requirements
– Periodical Review minimum once in a year
– Quarterly Information System (QIS) I, II, III for one Crore and
above
– I- estimates for ensuing Quarter
– II-comparison of actual and estimates of previous quarter
– III- Half Yearly performance
– Non-submission of QIS attracts penalty of 1% of interest

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 METHOD OF ASSESSING WORKING
CAPITAL
• TURNOVER METHOD (Nayak Committee)
– Working Capital Requirement = 25% of Turnover
– Promoter Contribution (Margin) = 5% of Turnover
– Bank Finance = 20% of Turnover
• Used for assessment of working capital needs of
small trading & manufacturing companies
• Not appropriate for large manufacturing and big
trading companies where the stock holding or
storage capacity is irrelevant to turnover.

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 METHODS OF ASSESSING
WORKING CAPITAL
• CASH BUDGET SYSTEM
• Cash Inflow –Cash Outflow = Bank
Finance in the form of Working Capital
– Mainly used for service sector/seasonal
/real estate companies
– Eliminates traditional requirement of Stock
and Debtors for assessment

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 CREDIT MONITORING ARRANGEMENT
(CMA)
• Form I
• Particulars of Existing & Proposed Limits
• Form II
• Operating Statement
• Form III
• Analysis of Balance Sheet
• Form IV
• Comparative Statement of Current Assets & Current Liabilities

• Form V
• Computation of Maximum Permissible Bank Finance (MPBF)
• Form VI
• Funds Flow Statement

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 NON FUNDS PRODUCTS
• Can be used to reduce cost of borrowed funds
• Banks charge a small commission on Non fund based products as
compared to interest on Fund based products
• Usage of these tools is subject to a mutual understanding between
the buyer and the supplier
• Commonly used Non fund based products are:
• BANK GUARANTEES
• Bank guarantee is issued by the bank undertaking the liability of
applicant in case of his default. Guarantees may broadly be divided
in two categories as under:
• Financial guarantees: Guarantee to discharge financial
obligation of the applicant
• Performance guarantees: Guarantee for due performance of a
contract by the applicant

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 NON FUND PRDUCTS
• LETTER OF CREDIT
• A document issued by a financial institution which provides an
irrevocable payment undertaking to a beneficiary against complying
documents as stated in the credit.
• L/C facility can be assessed in the following manner:
Rs. (In Lacs)
• Total purchases 1000
• Purchase under L/C (say 60%) 600
• Period under L/C (days) 90
• Lead time under L/C (days)
• (Only in case of Offsite) 30
• L/C Requirement (600 x (90 + 30)/365) 197.26

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 STRUCTURED PRODUCTS

• COMMERCIAL PAPER
• Commercial paper is one of the oldest instruments for raising short
term finance but introduced in 1990 in INDIA.
• •Some of the important guidelines issued by the RBI are as under:-
a. It is Usance Promissory Notes
b. Minimum TNW of Rs. 4 Crores latest audited B/S.
c. Has been issued within the sanctioned working capital limits by Banks/ all -India Financial
Institutions
d. Borrowal account must be standard asset .
e. Minimum credit rating of P2 by CRISIL or equivalent other agencies and should not be older
than 2 months.
f. Maturity between 7 days to 1 year
g. Issued in multiples of Rs. 5 lacs
h. Cheaper source of finance as compared to traditional bank finance

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 STRUCTURED PRODUCTS
• SUPPLIERS’CREDIT and BUYERS’CREDIT

• Suppliers’ Credit:
– Short term loans where the credit for imports into India is extended by
the overseas suppliers through a bank.
• Buyers’ Credit:
– Short term loans for payment of imports into India is arranged by the
importer from a bank or FI outside India.
– The funding banks primarily depend on the credit worthiness of L/C
opening bank
CORPORATE LOANS
• Secured/unsecured loan raised from financial institutions to meet
the working capital requirement of a company.
• Improves net working capital.
• Tenor 3 to 5 years

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 STRUCTURED PRODUCTS
• SECURITIZATION OF RECEIVABLES
– Discounting of future cash flow
– Cash Flows are not contingent on the performance of the
borrowers.
– Cash flows are directly collected by the lenders or approved
agencies.
• Examples:
– Rent Discounting
– Credit Card Discounting
– Royalty fees / Franchisee Fees Discounting
• Advantages:
– Better credit quality and hence easy in raising finance
– Lower cost of credit
– Without recourse financing in certain cases
– Balance sheet management

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 STRUCTURED PRODUCTS
A. FACTORING
a. Sale of receivables to outside agency specialized in the management of
receivables.
b. Factoring can be with or without recourse basis.
• Advantages:
i. A ready source of short term funds
ii. Simple procedures/ documentation
iii. Require lesser margins
iv. Off balance sheet financing (without recourse)
B. FORFEITING
a. Risk free option for exporters
b. Forfeiting agency purchases receivables at a discount from an exporter
on a without recourse basis.
• Advantages:
i. Improved liquidity
ii. Convert credit sales into sales
iii. Credit limit does not get blocked
iv. Free from political risks (Country Risk)
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 ENHANCEMENT DURING THE YEAR
CASE•
Business activities of the Company on rise. Sales and working
capital requirements are:
Year 2008-09 2009-10
Sales 500.00 800.00
Working Capital 125.00 200.00

•The Company approaches Bank in November 2008

Question: For which year should the assessment be done?
• ACTION
• •Working Capital requirement should be assessed on 2009-10
basis.
• •Drawing Power will be released on the built up of Current assets
and Current Liabilities
• •Advantages: No under-finance and no multiple assessment

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 CORPORATE LOAN
Corporate loan is an effective Working Capital Management tool, when:
– Short term funds used in acquisition of long term assets
– Low current ratio, with very low debt equity gearing
– Acquisition of businesses
EXAMPLE
• Current Financial Position of the Company
• Net Worth : Rs. 100 crores
• Net Block: Rs. 100 crores
• Term Loan: Rs. 20 crores
• Current Assets: Rs. 145 crores
• Working Capital Limits: Rs. 110 crores
• Creditors : Rs 15 crores
• Current ratio: 1.16
• Debt to Equity: 0.20
• Company may avail a Corporate Loan of Rs. 20 crores or more to
shore up the Current Ratio to 1.33:1 subject to adequate ration of FACR
(Fixed Asset Coverage Ratio)

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 Devaluation / Erosion of Current Assets
• There are various reasons for the
Devaluation / Erosion of Current Assets as
follows:
• •Sudden drop in prices
• •Cancellation of order
• •Regulatory reasons
• •Technical obsolescence
• •Insolvency/Bad book debts

• SOLUTION
• In such cases the Banks may consider for
Working Capital Term Loans.
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 THANK YOU
AND
WISHING YOU ALL
GREAT SUCCESS IN YOUR CARRIER

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