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Working CapitalN.GopalDeputy General Manager & MoFRBI CAB PuneWorking CapitalBusiness needs long term and short term funds Long term funds needed for fixed assets, permanent assetsMet through Fixed or Permanent Capital or Long term DebtShort term funds needed for acquiring short term assets, meet day to day business expenditureMet through Temporary capital, circulating capital or Working CapitalBusiness requirementsLong Term LoansProject FinanceCash Credit or ODShort term loansBanksBanksPrivate InvestorsNBFCsFIsBanker and Working CapitalBanker meets both long term and short term needsShort term finance from banksUsed for working capital Procuring short term assets Meeting short term or day to day expenditureFinanced as Cash Credit, Overdraft, Short Term Working Capital loan etcTenure One year, assessed and renewed annually

Short Term assets and LiabilitiesCurrent Assets: Assets which are part of the operating cycle or which get converted into cash within the operating cycle or within one year E.g. inventory (raw and finished), debtors, cash

Current Liabilities:Liabilities which are part of the operating cycle or which need to be paid off within the operating cycle or within one yearE.g. Sundry creditors, provision for taxesCurrent AssetsAssets which get liquidated in short term (say one year)As per Companies Act 1956 Current Assets areInterest accrued on InvestmentsSpares and Spare partsLoose toolsStock-in-TradeWork-in-ProgressSundry Debtors less bad debtsCash and Bank BalancesLoans and advances to subsidiaries Bills of ExchangeAdvances recoverable in cash or receivablesBalance with customs, port authorities, municipal authoritiesCurrent Assets for BankersAny Asset that gets converted into cash within the Operating Cycle or which forms part of the operating cycle is current Asset for bankersLogic- Bank finance to be used only for creation of assets which will be sold and reconverted into cash Investments in subsidiaries, deposits with customs, electricity boards, municipal authorities, advances to staff etc would not be current assets to bankers Operating Cycle for BankersOnly those assets which are involved in completing the Operating Cycle or Cash Cycle or part of it.Current Assets for bankers Cash and Bank BalancesShort term investments/advances/loans purely connected with the operating cycle or which helps in completing the cycle Receivables / Sundry DebtorsBills purchased and discounted with bankInstallments receivable on loans falling due within one yearInventory- Raw materials, Work-in-Process and Finished goodsConsumable sparesAdvance payment of taxPrepaid ExpensesAdvance for purchase of raw materials, components, stores &&Deposits with public bodies refundable within the cycleAny money or receivable due within one yearCurrent LiabilitiesLiabilities payable on demand or within one yearAs per companies Act current Liabilities areShort term bank borrowingsUnsecured loans Sundry Creditors and Trade CreditorsDeposits from public maturing within one yearAdvances and deposits from dealersAccrued Interests and ChargesProvision for taxationDividend payableStatutory liabilities Installment of term loans repayable in one yearOther liabilities and provisionsCurrent Liabilities for a bankersAll those liabilities which are part of the Operating Cycle or Cash Cycle Liabilities which complete the cycleShort term bank borrowings (W.C. loans)Unsecured short term loans (12 months)Public deposits maturing within 12 monthsSundry creditors for raw materials, consumables or trade creditorsInterest and charges accrued but not yet dueAdvance from customers Installment of term loans falling due within one yearStatutory liabilities- PF dues, provision for taxes, Sales tax dues, Excise duty etcDividendGratuity ProvisionsWorking Capital Cycle15

Gross and Net Working CapitalGross Working Capital: All the investment in Current AssetsNet Working Capital: Current Assets Current Liabilities Liabilities AssetsCapital (Equity +Reserves)Fixed Assets (Plant and Machinery, Land and Building)Long term Debt (Deferred Liabilities)Other Non current AssetsCURRENT LIABILITIESCURRENTASSETSNWCWorking Capital and sources of financeWorking Capital Requirement (Current Assets)Source of Finance1Raw Material and stores (inventory)Sundry Creditors or Bank Finance2.Stock-in-ProcessAdvance payments received or Bank Finance or Liquid Surplus3.Finished Goods (inventory)Liquid Surplus or Net working Capital or Bank Finance4.Sundry DebtorsBank Finance short term 5.Cash for expensesNet Working Capital or Liquid SurplusValuation of Current AssetsComponents of Working Capital or Current AssetsValuation1.Stock of Raw MaterialsPurchase cost of Raw materials2.Stock of Work in processAt cost or market value whichever is lower.3.Stock of finished goodsCost of production4.Debtors or receivablesCost of Sales or sale value5.Cash for expensesActual working expensesMethods of Assessing W.COperating Cycle method: Time period from purchase of raw materials, creation of work-in-process, creation of finished goods, holding them till sale, converting them into sundry debtors and realization of debtors and receipt of cash. Nayak Committee method or turnover method: Based on the projected sales turnover of the borrower. It is presumed that W.C requirements would be 25% of the projected turnover and the banker would finance 75% to 80% of the same and the borrower to bring in 20%-25%.Traditional Method: Assessment based on the current asset level for the level of activity

19Methods of Assessing W.CProjected Balance Sheet Method: The old Committee approach to lendingCash Budget Method of Assessing working CapitalOperating Cycle MethodA= Acquisition timeB=Process timeC= Process to Finished Goods

D=Stock of finished goods before saleE= Credit SalesF= Debtors conversion to cash

Operating Cycle Operating cycle = Time lapsed from A.FWorking capital= Funds required to complete the cycle from A.FE.g. A=20 days B=10 days C= 20 days D= 30 days E=20 days F=20. Cycle = 120 days (i.e. 3 cycles in a year)E.g. Sales Rs.1,00,000 per annum Exp. Rs. 72,000 per annumWCR (for expenses)= 72,000/3 = 24,000/- per cycleWorking capital requirement would go down if the cycle is increased or if the operating efficiency is increasedWorking capital would be more if the cycle is reduced or if there is operating inefficiency working capital required will be more.

Permissible Bank finance using Operating Cycle E.g. Unit ABC has furnished the below mentioned dataSales =Rs. 50,000 per monthRaw Materials =Rs. 12,000 per monthWages = Rs. 6,000 per monthManufacturing Exp. =Rs. 3,000 per month Operating CycleRaw materials = Rs. 15 daysStock in process = Rs. 2 daysFinished Goods = Rs. 3 daysSundry Debtors = Rs. 15 daysWorking Capital = Operating Expenses x Operating Cyclei.e. 2+3+4 = Rs.21,000 Cycle = i+ii+iii+iv= 35 daysWC Assessed would be (21,000 x 35)/30= Rs.24500/- Projected Turnover MethodNayak Committee method:SSI units upto Rs.5.00 croreOther units upto Rs.1.00 croreProjected Turnover Methodi.e. 25% of the projected annual turnover to be reckoned as WCBorrower to bring in 5% Bank finance 20%

Projected Turnover20092010201120122013Rs. In LacsAnnual Sales Turnover15.0018.0020.00

30.00 40.00Working Capital Requirement 25% 10.00Margin to be brought in by the borrower 5% of the Annual turnover 2.00Maximum Permissible bank finance (20%) of the turnover 8.00Projected TurnoverCare to be exercised in turnover method.Projected turnover is gross turnover inclusive of excise duty etc.The other financial strengths of the firm also to be kept in mindMargin requirement of at least 5% of the turnover not to be dilutedProjected annual turnover to be reasonable, achieved in the past, achievable in future and realistic in the presentReasonableness of projections to be assessed and verified with returns filed by the borrowerSales achieved till the date of sanction to be obtained from the borrowerAny projection beyond 15% of the previous years actual need closer attention.

Traditional MethodIt is the sum total of Raw Materials required Less Margin XXXWork-in-Process Less Margin XXXFinished Goods Less Margin XXXSundry Debtors Less Margin XXXMiscellaneous expenses (reasonable level) XXX Less: Advance if any received aaa Less: Sundry Creditors aaa aaa Total Working Capital Finance cccThe margin will come from NWC

27The MPBF MethodsMETHOD IMETHOD IIMETHOD IIIC.A200C.A200C.A200OCL4025% of CA50Non core CA56WCG160GAP150Core CA14425% of WCG40OCL4025% of Real CA36GAP108OCL40MPBF120MPBF110MPBF 68 NWC40NWC50NWC92C.A200C.A200C.A200C.L160C.L150C.L108CURRENT RATIO1.25CURRENT RATIO1.33CURRENT RATIO1.85Projected Balance Sheet Projected Balance Sheet Method: The level of Current Assets and Current Liabilities are projected and the working capital gap is arrived at. The banker finances 75%-80% of the gap and the balance has to come from NWC (Net Working Capital)Balance sheet for the future year is projectedBasis of projection actual audited balance sheet of the past two- three years29Cash Budget MethodUsed to assess working capital requirements of contractors Used where there cannot be specific hypothecation or where the cash flow is irregular.Where the bank wants to keep a close watch on the inflows and outflows of cash of the business

Cash Budget ParticularsMarchJuneSeptember DecemberIEstimated Cash InflowsCash SalesDebtors receipts.Other receiptsIIEstimated cash OutflowsCash purchasesCash payment to CreditorsExpenses/Loans InterestIIIOpening Cash balCash Budget MethodParticularsMarchJuneSeptember DecemberIVAdd/Deduct/Surplus/ Deficit (I - II)V Closing Cash balance (III IV)VIMinimum Level of cash BalanceVIIEstimated Excess or Shortfall (V VI )Bank Finance on Shortfall less MarginRatios to help in assessmentCurrent Ratio

Solvency Ratio

Quick Ratio or Acid Test Ratio

Profit to Sales Ratio

Turnover ratio (Inventory + Receivables)/Net SalesLiquidity Ratio Current Assets x 100 Current Liab.

(Quick Ratio or Acid test Ratio) C.A- Inventory x100 C.L-Bank borrowings Whether current assets are enough to cover current liabilitiesHigher ratio could be bad or goodLower ratio not necessarily badWhether current liabilities are funding current assets

Solvency RatioTotal Outside Liabilities Tangible Networth

Total term liabilitiesTangible Networth or Debt EquityIndicates SolvencyIndicates size of owners stake Indicates stake of creditorsIndicates the coverage of liabilities by the net-worthLower ratio indicates greater solvency

Some ratios explainedPBIT/Interest (Times)Interest coverage ratio, explains how many times the firm earns to cover the interest payable by Higher ratio means comfortable debt servicing capacity from cash accrualsA ratio of 3 or 4 is very comfortable.A ratio of 2 could be risky(Inventory + Receivables) / Net SalesExpressed in days ratio captures turnover time for major current assetsHigher ratio indicates slower turn over and higher risk Turnover RatioAnnual Sales x 100 Closing Stock

High ratio indicates good turnover of stockEfficient management of salesLow ratio indicator of large unsold stockOther Aspects of Working Capital AssessmentThe non financial aspects of Working capital assessment Character of the borrowerBackground or brief history of the borrower, nature of activity, expertise available (technical and Managerial)Capacity of the borrowerNetworth, repayment history, viability of the business activity, income generating ability of the business, security available for fall backCapital of the borrowerWhat is the owners stake, equity, margin, ability to increase the margin, source of financing the marginCredibility of the borrowerWhat is the market opinion about the borrower, does he have a track record?Other Aspects of Working Capital AssessmentPurpose of the loanWhy does the borrower want a bank loan?, is it a permitted activity, what asset is being createdSafety of funds lentIs there sufficient primary security available, will the collateral back up in the event of default Customer ratingA mechanism to assess the riskiness of the borrower and his venture, to help in having a good risk return trade off, to get adequate price for a risky loanCovenants for uncovered risksEnhanced margins, additional equity, special or specific stipulations (stock audit, certificate from a Chartered Accountant etc)THANK YOU