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A

PROJECT REPORT

ON

“WORKING CAPITAL MANGEMENT”

A Detailed study done in

“OLIVEBEE TRADE RESOURCES (INDIA) PVT LTD”

Submitted in partial fulfillment of the requirement for the award of degree of Masters of

Management Studies (MMS) under University of Mumbai.

Submitted by

RUSHIKESH SHAH

ROLL NO: 46

BATCH: 2011-13

Under the guidance of

Prof. ANIL DESHMUKH

Bharati Vidyapeeth‟s Institute of Management Studies & Research

Sector 8, CBD-Belapur, Navi Mumbai –400614

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ACKNOWLEDGEMENT

I have taken efforts in this project. However, it would not have been possible without the kind

support and help of many individuals and organization. I would like to extend my sincere

thanks to all of them.

I am grateful to Mr. Anil Deshmukh for his guidance and constant supervision as well as for

providing necessary information regarding the project & also for their support in completing

the project.

I am highly indebted to Mr. Leo Gerard Andrews, CEO and Mr. Ashish Lunkad, CFO –

Olivebee Trade Resources (India) Private Ltd. for providing me such a great opportunity

to work with their organization and for extending their kind co-operation and encouragement

which helped me in completion of this project.

I would like to express my special gratitude and thanks to industry persons for giving me

such attention and time.

My thanks and appreciation also goes to my colleague in developing the project and people

who have willingly helped me out with their abilities.

----------------------------------

(Signature of Student)

Rushikesh Shah

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CERTIFICATE

This is to certify that the project titled "Working Capital Management" is

successfully done by Mr. Rushikesh Shah during the two months summer

internship of her course (1st May 2012 – 30

th June 2012) in partial fulfillment of

the Masters in Management Studies under the University of Mumbai through

Bharati Vidyapeeth`s Institute of Management Studies and Research, Navi

Mumbai.

Date:

-------------------- -------------------- Dr. D. Y. Patil Prof. Anil Deshmukh

(Director) (Project Guide)

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Index Acknowledgement

Certificates

Executive Summary

SR.NO. CONTENTS PG NO.

1 INTRODUCTION

1.1 Objective of the Project 1

1.2 Research Methodology 1

2 INTRODUCTION TO THE INDUSTRY

2.1 Meaning 2

2.2 Overview 3

2.3 Present Scenario 4

2.4 Types of NBFCs (Regulated by RBI) 5

2.5 Significance of NBFCs in INDIA 7

2.6 Funding sources of NBFCs 8

3 INTRODUCTION TO THE COMPANY

3.1 Introduction 10

3.2 Brand Identity: The Logo 11

3.3 Services/ Products 12

4 INTRODUCTION TO WORKING CAPITAL

4.1 Introduction 16

4.2 Types of Working Capital 20

4.3 Need of Working Capital 22

4.4 Factors affecting Working Capital 23

4.5 Reasons for adequate Working Capital 27

4.6 Sources of Working Capital 28

4.7 Assessment of Working Capital 31

5 CONCLUSION 39

6 BIBLIOGRAPHY 40

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EXECUTIVE SUMMARY

Working Capital Management refers to the administration of all aspects of current

assets, namely cash, marketable securities, debtors and stock (inventories) and current

liabilities. The financial manager must determine levels and composition of current assets. He

must see that right sources are tapped to finance current assets, and that current liabilities are

paid in time. He must see that right sources are tapped to finance current assets, and that

current liabilities are paid in time.

There are many aspects of working capital management, which make it an important

function of the Financial Manager:

1. Time: Working Capital Management requires much of the financial manager‟s time.

2. Investment: Working Capital represents a large portion of the total investments in

assets.

3. Significance: Working Capital Management has great significance for all firms but it

is very critical for small firms.

4. Growth: The need for working capital is directly related to the firm‟s growth.

Investment in current assets represents a very significant portion of the total

investment in assets. Working capital management is critical for all firms. A small firm may

not have much investment in fixed assets, but it has to invest to in current assets. Small firms

in India face a severe problem of collecting their debtors.

It may, thus, be concluded that all precautions should be taken for the effective and

efficient management of working capital. The Finance Manager should pay regular attention

to the levels of current assets and the financing of current assets.

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CHAPTER 1: INTRODUCTION 1.1 Objective of the Project:

The main objectives of the project are:

To analyze in detail the assessment of working capital finance.

To know the various types of working capital finance provided by banks.

To apply these procedure at a practical level.

1.2 Research Methodology:

Sources of data:

Secondary data Sources those helpful in research were:-

Secondary data relating to the procedure of assessment of working capital finance, old

sanction proposals, RBI guidelines etc. have been sourced from reference books.

Websites.

Books and Magazines.

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CHAPTER 2: INTRODUCTION TO INDUSTRY

NON-BANKING FINANCIAL SERVICES SECTOR 2.1 Meaning:

Non-Banking Financial Services Company

The financial sector in any economy consists of several intermediaries. Apart from

banking entities, there are investment intermediaries (such as mutual funds, hedge funds,

pension funds, and so on), risk transfer entities (such as insurance companies), information

and analysis providers (such as rating agencies, financial advisers, etc.), investment banks,

portfolio managers and son. All such entities that offer financial services other than banking,

may be broadly called non-banking financial institutions.

What is banking?

Banking is commonly understood to mean taking of deposits withdrawable on

demand or notice - that is, banks can hold people's deposits and promise to pay them on

demand. There are varieties of other entities that may accept deposits - hence, acceptance of

deposits is not the essence of banking.

In India, the term "non-banking financial companies" acquires a new meaning,

and a huge significance. The meaning of the term is such entities which are not banks,

and yet carry lending activities almost at par with banks. They may also accept deposits

- however, these deposits are term deposits and not call deposits.

The significance of non-banking financial companies in India lies in the massive

capabilities of NBFCs - short of acceptance of call deposits and remittance function, NBFCs

can virtually do everything that a bank can. Compared to this disability, the ease of entry and

lightness of regulation applicable to NBFCs makes it a tremendous focus of interest,

particularly for foreign investors wanting to enter India's financial sector.

For instance, it is possible to hold 100% foreign ownership of NBFCs, while in case

of banks, there are serious caps. It is possible to either start an NBFC or buy one of the

17000-odd companies many of which are formed for sale. On the other hand, getting a

banking license requires a real penance.

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2.2 Overview:

Non-banking financial companies (NBFCs) are fast emerging as an important

segment of Indian financial system. It is a heterogeneous group of institutions (other than

commercial and co-operative banks) performing financial intermediation in a variety of ways,

like accepting deposits, making loans and advances, leasing, hire purchase, etc. They raise

funds from the public, directly or indirectly, and lend them to ultimate spenders. They

advance loans to the various wholesale and retail traders, small-scale industries and self-

employed persons. Thus, they have broadened and diversified the range of products and

services offered by a financial sector. Gradually, they are being recognised as complementary

to the banking sector due to their customer-oriented services; simplified procedures;

attractive rates of return on deposits; flexibility and timeliness in meeting the credit needs of

specified sectors; etc.

Under the Act, it is mandatory for a NBFC to get itself registered with the RBI as a

deposit taking company. This registration authorises it to conduct its business as an NBFC.

For the registration with the RBI, a company incorporated under the Companies Act, 1956

and desirous of commencing business of non-banking financial institution, should have a

minimum net owned fund (NOF) of Rs 25 lakhs (raised to Rs 200 lakhs w.e.f April 21,

1999). The term 'NOF' means, owned funds (paid-up capital and free reserves, minus

accumulated losses, deferred revenue expenditure and other intangible assets) less, (i)

investments in shares of subsidiaries/companies in the same group/ all other NBFCs; and (ii)

the book value of debentures/bonds/ outstanding loans and advances, including hire-purchase

and lease finance made to, and deposits with, subsidiaries/ companies in the same group, in

excess of 10% of the owned funds.

The activities of non-banking financial companies (NBFCs) in India have undergone

qualitative changes over the years through functional specialisation. The role of NBFCs as

effective financial intermediaries has been well recognised as they have inherent ability to

take quicker decisions, assume greater risks, and customise their services and charges more

according to the needs of the clients. While these features, as compared to the banks, have

contributed to the proliferation of NBFCs, their flexible structures allow them to unbundle

services provided by banks and market the components on a competitive basis. The

distinction between banks and non-banks has been gradually getting blurred since both the

segments of the financial system engage themselves in many similar types of activities.

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2.3 Present Scenario:

At present, NBFCs in India have become prominent in a wide range of activities like

hire-purchase finance, equipment lease finance, loans, investments, etc. By employing

innovative marketing strategies and devising tailor-made products, NBFCs have also been

able to build up a clientele base among the depositors, mop up public savings and command

large resources as reflected in the growth of their deposits from public, shareholders,

directors and other companies, and borrowings by issue of non-convertible debentures, etc.

Consequently, the share of non-bank deposits in household sector savings in financial assets,

increased from 3.1 per cent in 1980-81 to 10.6 per cent in 1995-96. In 1998, the definition of

public deposits was for the first time contemplated as distinct from regulated deposits and as

such, the figures thereafter are not comparable with those before.

The importance of NBFCs in delivering credit to the unorganised sector and to small

borrowers at the local level in response to local requirements is well recognised. The rising

importance of this segment calls for increased regulatory attention and focused supervisory

scrutiny in the interests of financial stability and depositor protection.

In response to the perceived need for better regulation of the NBFC sector, the

Reserve Bank of India (RBI) Act, 1934 was amended in 1997, providing for a comprehensive

regulatory framework for NBFCs. The RBI (Amendment) Act, 1997 conferred powers on the

RBI to issue directions to companies and its auditors prohibit deposit acceptance and

alienation of assets by companies and initiate action for winding up of companies. The

Amendment Act provides for compulsory registration with the RBI of all NBFCs,

irrespective of their holding of public deposits, for commencing and carrying on business of a

non-banking financial institution; minimum entry point norms; maintenance of a portion of

deposits in liquid assets; and creation of reserve fund and transfer of 20 per cent of profit

after tax but before dividend annually to the fund. Accordingly, to monitor the financial

health and prudential functioning of NBFCs, the RBI issued directions to companies on:

acceptance of public deposits; prudential norms like capital adequacy, income recognition,

asset classification, provisioning for bad and doubtful assets, exposure norms and other

measures. Directions were also issued to the statutory auditors to report non-compliance with

the RBI Act and regulations to the RBI, and Board of Directors and shareholders of the

NBFCs.

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2.4 Types of NBFCs (Regulated by RBI)

Non-Banking Financial Entity Principal Business

1) Non-banking financial

company

In terms of the Section 45-l(f) read with Section 45-

i(c) of the RBI Act, 1934, as amended in 1997, their

principal business is that of receiving deposits or that

of a financial institution, such as lending, investment

in securities, hire purchase finance or equipment

leasing.

a) Equipment Leasing

Company (EL)

Equipment Leasing or financing of such activity.

b) Hire Purchase Finance

Company (HP)

Hire purchase transactions or financing of such

transactions.

c) Investment Company (IC)

Acquisition of securities. These include Primary

Dealers (PDs) who deal in underwriting and market

making for government securities.

d) Loan company (LC)

Providing finance by making loans or advances, or

otherwise for any activity other than its own;

excludes EL/HP/Housing Finance Companies

(HFCs).

e) Residuary non-banking

company (RNBC)

Company which receives deposits under any scheme

or arrangement by whatever name called, in one

lump-sum or in installments by way of contributions

or subscriptions or by sale of units or certificates or

other instruments, or in any manner. These

companies do not belong to any of the categories as

stated above.

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2) Mutual Benefit Financial

Company (MBFC) i.e. Nidhi

Company

Any company which is notified by the Central

Government as a Nidhi Company under section 620A

of the Companies Act, 1956.

3) Mutual Benefit Company

(MBC) i.e. potential Nidhi

Company

A company which is working on the lines of a Nidhi

company but has not yet been so declared by the

Central Government, has minimum net owned fund

(NOF) of Rs.10 lakh, has applied to the RB1 for CoR

and also to Department of Company Affairs (DCA)

for being notified as Nidhi company and has not

contravened directions/ regulations of RBI/DCA.

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2.5 Significance of NBFCs in INDIA:

According to the Economic Survey 2010-11, it has been reported that NBFCs as a

whole account for 11.2 per cent of assets of the total financial system. With the growing

importance assigned to financial inclusion, NBFCs have come to be regarded as important

financial intermediaries particularly for the small-scale and retail sectors. In the multi-tier

financial system of India, importance of NBFCs in the Indian financial system is much

discussed by various committees appointed by RBI in the past and RBI has been modifying

its regulatory and supervising policies from time to time to keep pace with the changes in the

system. NBFCs have turned out to be engines of growth and are integral part of the Indian

financial system, enhancing competition and diversification in the financial sector, spreading

risks specifically at times of financial distress and have been increasingly recognized as

complementary of banking system at competitive prices. The Banking sector has always been

highly regulated, however simplified sanction procedures, flexibility and timeliness in

meeting the credit needs and low cost operations resulted in the NBFCs getting an edge over

banks in providing funding.

Number of NBFCs Registered with RBI:

The following table shows the number of NBFCs registered with the Reserve Bank of

India and the trend of registration of companies as NBFC since the last decade. The table as

given below also indicates registration of deposit accepting NBFCs of the total NBFCs

registered with RBI.

End June

Number of

Registered NBFCs

Number of

NBFCs-D

(NBFCs accepting

Public Deposits)

Number of

NBFCs-ND-SI*

(NBFCs Not

accepting Public

Deposits)

2006 13,014 428 149

2007 12,968 401 173

2008 12,809 364 189

2009 12,740 336 234

2010 12,630 308 260

2011 12,409 297 330

*systematically important NBFCs - An NBFC–ND with an asset size of Rs.100 crore and

more as per the last audited balance sheet is considered as systemically important.

2.6 Funding sources of NBFCs: Funding sources of NBFCs include debentures, borrowings from banks and FIs,

Commercial Paper and inter-corporate loans.

Table below provides for funding sources of Non- Banking Financial Companies –

Non Deposit Taking – Systematically Important:

Major Sources of Funds

Source of Fund

March 2008

(Percentage to total

Liabilities)

March 2009

(Percentage to total

Liabilities)

Debentures 21.7 28.3

Commercial papers 4.9 4.5

Borrowings from Banks & FIs 19.8 18.5

Inter-corporate Loans 5.4 2.8

Others 14.1 15.2

Source: RBI Report on Trend & Progress of Banks

Banks are also a major source of funding for NBFCs either directly or indirectly. So

in a way NBFCs have a dependence on banks making them vulnerable to systemic risks in

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the financial system.

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Funding by NBFCs:

Historically, banks have played the role of intermediaries between the savers and the

investors. However, in the last few decades, the importance and nature of financial

intermediation has undergone a dramatic transformation the world over. The dependence on

bank credit to fund investments is giving way to raising resources through a range of market

based instruments such as the stock and bond markets, new financial products and

instruments like mortgage and other asset backed securities, financial futures and derivative

instruments like swaps and complex options. Besides transferring resources from savers to

investors, these instruments enable allocation of risks and re-allocation of capital to more

efficient use. The increase in the breadth and depth of financial markets has also coincided

with a pronounced shift among the ultimate lenders who have moved away from direct

participation in the financial markets to participation through a range of intermediaries. These

developments in international financial markets have been mirrored in the financial market in

India.

NBFCs are typically into funding of:

Construction equipment Commercial vehicles and cars

Gold loans Microfinance

Consumer durables and two wheelers Loan against shares, etc.

List of major products offered by NBFCs in India:

Funding of commercial vehicles Funding of infrastructure assets

Retail financing Loan against shares

Funding of plant and machinery Small and Medium Enterprises

Financing

Financing of specialized equipment Operating leases of cars, etc.

Types of instrument generally executed:

Loans

Hire purchase

Financial lease

Operating lease

CHAPTER 3: INTRODUCTION TO THE COMPANY

OLIVEBEE TRADE RESOURCES (INDIA) PVT LTD

3.1 Introduction: Olivebee Group have local companies, representative offices and agents throughout

the world, fully qualified to act as business partners of international and central banks,

government bodies as well as exporting and trading corporations

Olivebee is a global business development consultancy associated with a global

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network of private investors. Our specialists are committed to achieve full customer

satisfaction, as a fully coordinated organization we guarantee the fastest replies and

contiguously high quality service throughout our staff. Our major goal is helping you

accomplishing your goals on a timely manner and take pleasure on the best customer service

of all times.

Principles:

Good business lead to win-win scenarios. We dedicate our time, talent and resources

to each client and consider our goals unmet until your goals are realized.

Who we are?

Olivebee is structured upon the foundation of good ethics, strong morals, and proven

business practices. We combine creativity and hard work together with integrity to ensure our

clients the best service possible that can be relied upon for all business needs. We are a select

group of professionals and partners custom designed to meet the strenuous demands of

business. We work with a select group of professionals and partners, custom designed to meet

the strenuous demands of business in today‟s difficult economy.

What we believe?

We believe that a sense of pride and satisfaction is essential to our clients and we

therefore take the same approach as we work: taking the utmost pride in what we do. Our

satisfaction comes from seeing our clients succeed. Our greatest asset is the people we have

business with and that can testify what we write here, referring our services. There is no

greatest advertisement than the one provided from our clients. We believe that each of us

needs a sense of pride and satisfaction in what we do, and our commitment is bringing the

best business relationship someone deserves. Because satisfying our clients depends on the

united effort of both parties, we are therefore most effective by the creativity we structure in

our deals, with mutual interest, and through this we can power the success of unlimited

people, because faith and perseverance makes all things possible.

Why we succeed? We believe in ourselves, we believe in our clients, and we believe that working

together…all things are possible.

3.2 Brand Identity: The Logo:

The Name: Olivebee

Olivebee represents the combination of two most strong natural words.

Olive:

The word olive is derived from Latin word olīva which in turn comes from the Greek

ἐλαία (elaía). The leafy branches of the olive tree – the olive leaf as a symbol of abundance,

glory and peace– were used to crown the victors of friendly games and bloody wars. As

emblems of benediction and purification, they were also ritually offered to deities and

powerful figures. Over the years, the olive has been the symbol of peace, wisdom, glory,

fertility, power and purity.

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Bee: Honeybee:

Honey bees, signifying wealth creators, immortality & resurrection, were royal

emblems of the Merovingians, revived by Napoleon. Honey Bee is a metaphor indicating

ethical as well as professional values, our innovative and ethical approach to knowledge &

wealth extraction, our sincere attempt to build up people to people communication and our

commitment to let benefit be shared with our shareholders holders, qualifies us to identify

ourselves with the great metaphor of Honey Bee.

About the Logo:

The central highlight of the logo is the honeycomb. Honey comb depicts great

teamwork, professionalism and strong bond of the organization. All this values when applied

together give birth to a star. The Five hexagon represent five continents, five fingers (hand)

Five elements &Five physical senses. The five-pointed star has become a symbol of fame or

"stardom". In our logo the star is symbol of fame & Quality.

The Color:

Green is the color of nature, fertility, life. Grass green is the most restful color. Green

symbolizes self-respect and well being. Green is the color of balance. It also means learning,

growth and harmony. The green also represents freshness & purity.

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3.3 Services/Products:

1. Financial Consulting:

Olivebee deals strictly with private money sources, investors, and other

investment groups we have relationships with. When it comes to funding your project

we do not use the conventional world of guidelines and parameters that you would

find at a conventional lender or banking institution. This gives us the ability to be

extremely creative in the way we structure our financing with our investors, this is

why we are able to get even the most complex of deals done. Through our network of

Hard Money Lenders, Private Investors, and other banks worldwide regardless of the

situation at hand, we can make your project come to fruition. Our investors may have

interest in Joint Venture (JV) financing partnership opportunities as well as Debt and

Equity financing. Interest rates vary on a project-by-project basis. Terms may range

from 12months up to as much as 60 months with interest only option may be available

on a project per project basis, rates and terms are depending upon the program

provided to us by our investor. Most of our Investors expect to see a full professional

presentation package that should include:

Executive Summary and / or complete Business Plan

Pro Forma Balance Sheet

Financials

Contract Agreements

Profile with resumes

Expected breakdown of sources and uses of funds

2. Project Funding:

Up to 100% LTV Domestic and International Project Financing

a. Primary Project Types:

Asset Based Financing

Bridge Financing

Commercial Loans

Commercial real estate developments

Oil, Gas Refineries and Energy projects such as Power Plants

Jumbo-Sized Infrastructure such as Major Real Estate projects (i.e.

Highways, Bridges, Railroads)

b. Global focus includes:

Acquisition and Development – up to 100% total project funding.

Bridge Loans

Development and Construction

Commercial Property Acquisitions & Refinancing

Up to 65% Loan-to-Value Hard money

Foreign and domestic projects

Mines; gold, diamonds, oil, coal, precious stones and metals, shell

Bio chemical/bio diesel/energy plants/natural gas

Blanket Mortgage loans

3. Bridge Loan Funding:

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Criteria for Hard Money/Bridge Loans:

Minimum loan size: $500,000

Minimum property value: $1,000,000

Property types: raw land, residential, commercial, industrial,

hospitality, rehabs, etc.

Maximum loan percentage: up to 70% assuming there are no other

liens on the property.

First lien position only: However, lender may be able to work with

other lenders to have them take the 2nd position.

Use of funds: The Lender does not have restrictions on the use of

funds. Borrower must be able to demonstrate an ability to make the

payments and demonstrate that loan request is realistic and financially

sound.

Terms:

Real Estate collateralized loans with up to 3 years to repay.

Prepayment:

No prepayment penalties.

Use of Proceeds:

Business or real estate related purposes.

Loan to value:

Up to 70% of the quich sale value of the property.

Rates:

Depends On Prevailing Interest Rates

Loan Size:

Minimum loan size: $5,000,000

Maximum loan size: $100,000,000.

Location:

The Lender funds loans throughout the Asia Pacific

Collateral:

Real estate (and will consider other assets.)

Closing:

Typically, within 3 weeks, (sooner if required)

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4. Project Finance:

In alliance with our associates and financiers, we provide finance and

development services for a very wide range of international project types. Most, but

not all, of the projects we finance and develop are in the tourist, leisure,

entertainment, sport, hospitality, construction, transport and allied industries.

In order to obtain a fuller understanding of the broad range of projects which

have been developed worldwide by our associates please consider the following list of

example projects. Some of these projects are valued at several hundred million

dollars.

Bio-Tech Parks

Botanical Gardens

Casinos

Cruise Ships

Ecological Projects

Environmental Projects

Golf Courses and Driving Ranges

Harbors

Hotels and Hotel Complexes

Housing Developments

Industrial Buildings and Complexes

Office Buildings and Complexes

Real Estate

Retail Centers and Complexes

Shipping Cruises

Shopping Malls

Theme Parks

Water Parks

5. Credit Enhancement:

Olivebee International Financial, services and products are offered to clients

worldwide from its worldwide sources Olivebee International Financial consultant

have prime sources which these Principals, Financials, Lenders, providers located

USA – EUROPE – ASIA - and Australia where the financial environment is free of

the constraints that hamper the sourcing of this type of finance in the United States

and worldwide. Credit Enhancement includes:

Asset Enhancement

Asset Securitization

Credit Enhancement

Collateral Enhancement

6. Venture Capital:

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One of the most modern modes of financing, venture capital, will support

dynamic Enterprises. Venture capitals have particular advantages over other methods

of financing. The venture capital firms offer medium-long term financing, while

creating a strong capital basis for the future growth of the company. At the same time,

they can satisfy future financing needs in cooperation with other investors, if this is

necessary for their further growth.

Venture capital firms become associates of the company and receive some

combination of risks and success. Venture capital firms offer their advice in the

strategic, organizational and financial management of companies based on the

experience they have from similar companies.

Venture capital firms have expanded contacts with several sectors, which is

very useful for a company. This helps attracting clients, recruiting executives, as well

as searching for strategic allies and investors. The participation of a venture capital

firm gives prestige to a company and facilitates the access to traditional forms of

financing, i.e. bank lending. Finally, we note that venture capital firms are

experienced in preparing a company to enter the stock market as well as in buying-

outs and mergers.

In order we proceed in this form of financing we need to receive an executive

summary and full business plan (if available) with clear data of present financial

status from the applicant for venture capital, as well as the amount he wishes and the

progress of business when he gets this funding.

7. Financial Instruments:

Bank Guarantees (BG)

Standby Letter of Credit (SBLC)

Certificate of Deposits (CD)

Medium Term Notes (MTN)

8. Due Diligence:

Olivebee funding process has been structured to maximize the efficiency of

our funding process. In order to best help achieve this, we ask that you take time to

understand our protocol and provide the required information and documents in a

timely manner.

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CHAPTER 4: INTRODUCTION TO WORKING CAPITAL

MANAGEMENT

“CASH IS THE LIFEBLOOD OF BUSINESS” 4.1 Introduction:

Working Capital Management is concerned with the problems arise in attempting to

manage the current assets, the current liabilities and the inter-relationship that exist between

them. The term current assets refer to those assets which in ordinary course of business can

be, or, will be, turned into cash within one year without undergoing a diminution in the value

and without disrupting the operation of the firm. The major current assets are cash,

marketable securities, account receivables and inventory. Current liabilities are those

liabilities which intended at their inception to be paid in ordinary course of business, within a

year, out of current assets or the earnings of the concern. The basic current liabilities are

account payable, bills payable, bank overdraft and outstanding expenses.

The goal of Working Capital Management is to manage the firms current assets and

current liabilities in such a way that the satisfactory level of working capital is mentioned.

The current assets should be large enough to cover its current liabilities in order to ensure a

reasonable margin of the safety.

Definition:

“Excess of current assets over current liabilities”

-Guttman and Dougall

“The excess current assets of a business (i.e. cash, accounts receivables, inventories) over

current items owned to employees and others (such as salaries and wages payable, accounts

payable, taxes owned to government)”

-Park and Gladson

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Every business needs investment to procure their fixed assets,which remain ina use

for longer period. Money invested in these assets is called „Long-term funds‟ or „Fixed

Capital‟. Business also needs funds for short-term purposes to finance current operations.

Investments in short-term assets like cash, inventories, debtors etc., are called “Short-term

funds” or “Working Capital”. The „Working Capital‟ can be recognized, as funds needed for

carrying day-to-day operations of business smoothly. The management of “Working Capital”

is equally important as the management of long-term financial investment.

Working Capital is a financial metric which represents the amount of day-by-day

operating liquidity available to a business. Along with fixed assets such as plant and

equipment, working capital is considered a part of operating capital. It is calculated as current

assets minus current liabilities. A company can be endowed with assets and profitability, but

shorter of liquidity, if assets cannot be converted into cash.

WORKING CAPITAL = CURRENT ASSETS – CURRENT

LIABILITIES

Every running business needs a working capital. Even a business which is fully

equipped with all types of fixed assets is bound to collapse without:

(i) Adequate supply of raw materials for processing;

(ii) Cash to pay for wages, power and other costs;

(iii) Creating a stock of finished goods to feed the market the demand regularly; and;

(iv) The ability to grant credit to its customers.

All these require Working Capital.

Working Capital is thus like the lifeblood of a business. The business will not be able

to carry on day-to-day activities without the availability of adequate Working Capital. The

diagram shown on the next page clarifies it:

Working Capital Cycle involves conversions and rotations of various constituents/

components of the Working Capital. Initially „Cash‟ is converted into raw materials.

23 | P a g e

Subsequently, with the usage of fixed assets resulting in value additions, the raw materials get

converted into work-in-progress and then to finished goods. When sold on credit, the finished

goods assume the form of debtors who give the business cash on due date. Thus „Cash‟

assumes its original form again at the end of one such Working Capital Cycle but in the

course it passes through various other forms of current assets too. This is how various

components of current assets keep on changing their forms due to value addition. As a result,

they rotate and business operations continue. Thus, the working capital cycle involves

rotation of various constituents of the working capital.

While managing the Working Capital, two characteristics of current assets should be

kept in mind viz.

(i) Short life span, and;

(ii) Swift transformation into other form of current asset.

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Each constituent of current asset has comparatively very short life span Investment

remains in a particular form of current asset for a short period. The life span of current assets

depends upon the time required in the activities of procurement; production, sales and

collection and degree of synchronization among them. A very short life span of current assets

results into swift transformation into other form of current assets for a running business.

These characteristics have certain implications:

Decision regarding management of the working capital cycle has to be taken

frequently and on a repeat basis.

The various components of working capital are closely related and mismanagement of

any one component adversely affects other components too.

The difference between the present value and the book value of profit is not

significant.

The Working Capital has the following components, which are in form of

Current Assets:

Stock of Cash

Stock of Raw Materials

Stock of Finished Goods

Value of Debtors

Miscellaneous current assets like short term investment loans and advances.

Current Liabilities:

Sundry Creditors

Trade advances

Borrowings

Commercial Banks

Provisions.

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4.2 Types of Working Capital:

Working Capital requirements of an organization can be broadly divided into two

categories:

(i) On the basis of Time.

(ii) On the basis of Concept.

The following diagrammatic presentation of classification of the working capital gives the

better perception.

Working Capital

On the basis of Time

Permanent/Fixed Working Capital

Temporary/Variable Working Capital

On the basis of Concept

Gross Working Capital

Net Working Capital

26 | P a g e

On the basis of time:

(i) Permanent/Fixed Working Capital:

This refers to that minimum amount of investment in all current assets which

is required at all times to carry out minimum level of business activities. It represents

the current assets are the characteristics of this type of working capital:-

a. Amount of permanent working capital remains in the business in one form or

another. This is particularly important from the point of view of financing. The

suppliers of such working should not expect its return during the lifetime of the

firm.

b. It also grows with the size of the business.

Permanent working capital is permanentlyneeded for business and therefore it

should be financed out of long-term funds. This is the reason why the current ratio has

to be substantially more than „1‟.

(ii) Temporary/Variable Working Capital:

The amount of such working capital keeps on fluctuating from time-to-time on

the basis of business activities. In other words, it represents additional current assets

required at different times during the operating year. The quantum of temporary

working capital is mainly dependent on the nature of the industry an organization its

functioning and its seasonal requirement.

On the basis of concept:

(i) Gross Working capital:

The gross working capital refers to the firms investments in all the current

assets taken together i.e. the sum total of all current assets of the business. For

example, if a firm has a cash balance of Rs. 100000, debtors of Rs. 70000 and

inventory of raw materials and finished goods has been assessed at Rs. 50000, then

the gross working capital of the firm is Rs.220000.

Gross Working Capital = Sum Total of Current Assets

(ii) Net Working Capital:

The term net working capital may be defined as the excess of total current

assets over current liabilities. The extent, to which these current liabilities are delayed,

the firm gets availability of funds for that period.

Net Working Capital = Difference between Current Assets and Current

Liabilities

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4.3 Need of Working Capital:

Given the objective of financial decision making to maximize the shareholders‟

wealth, it is necessary to generate sufficient profits. The extent to which profits can be earned

will naturally depend, among other things, upon the magnitude of sales. A successful sales

program is, in other words, necessary for earning profits by any business enterprise.

However, sales do not convert into cash instantly; there is invariably a time lag between sale

of goods and the receipt of cash. There is therefore, a need for working capital in the form of

current assets to deal with the problem arising out of the lack of immediate realization of cash

against goods sold. Therefore sufficient working capital is necessary to sustain sales activity.

Technically this is referred to operating cycle. The operating cycle can be said to be at the

heart of the need for the working capital. In other words the operating cycle refers to the

length of time necessary to complete the following cycle of events:

Conversion of cash into raw materials;

Conversion of raw materials into inventory;

Conversion of inventory into receivables;

Conversion of receivables into cash.

If it were possible to complete the sequences instantaneously, there would be no need

for current assets (working capital). But since it is not possible, the firm is forced to have

current assets. Since the cash inflows and outflows do not match, firms have to necessarily

keep cash or invest in short term liquid securities so that they will be in position to meet

obligations when they become due. Similarly, firms must have adequate inventory to guard

against the possibility of not being able to meet demand for their products. Adequate

inventory, therefore, provides a cushion against being out of stock. If firms have to be

competitive, they must sell goods to their customer on credit which necessitates the holding

of accounts receivables. It is in these ways that an adequate level of working capital is

absolutely necessary for smooth sales activity which, in turn, enhances the owner‟s wealth.

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4.4 Factor affecting Working Capital:

The factors affecting working capital are discussed below in brief:

1. Nature of working capital:

The nature and the working capital requirements of an enterprise are

interlinked. While a manufacturing industry has a long cycle of operation of the

working capital, the same would be short in an enterprise involved in providing

services. The amount required also varies as per the nature; an enterprise involved in

production would require more working capital than a service sector enterprise.

2. Manufacturing/Production Policy:

Each enterprise in the manufacturing sector has its own production policy,

some follow the policy of uniform production even if the demand varies from time to

time, and others may follow the principle of 'demand-based production' in which

production is based on the demand during that particular phase of time. Accordingly,

the working capital requirements vary for both of them.

3. Operations:

The requirement of working capital fluctuates for seasonal business. The

working capital needs of such businesses may increase considerably during the busy

season and decrease during the slack season. Ice creams and cold drinks have a great

demand during summers, while in winters the sales are negligible.

4. Market condition:

If there is high competition in the chosen product category, then one shall need

to offer sops like credit, immediate delivery of goods etc. for which the working

capital requirement will be high. Otherwise, if there is no competition or less

competition in the market then the working capital requirements will be low.

5. Availability of raw materials:

If raw material is readily available then one need not maintain a large stock of

the same, thereby reducing the working capital investment in raw material stock. On

the other hand, if raw material is not readily available then a large inventory/stock

needs to be maintained, thereby calling for substantial investment in the same.

6. Growth and expansion:

Growth and expansion in the volume of business results in enhancement of the

working capital requirement. As business grows and expands, it needs a larger amount

of working capital. Normally, the need for increased working capital funds precedes

growth in business activities.

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7. Price level changes:

Generally, rising price level requires a higher investment in the working

capital. With increasing prices, the same level of current assets needs enhanced

investment.

8. Manufacturing cycle:

The manufacturing cycle starts with the purchase of raw material and is

completed with the production of finished goods. If the manufacturing cycle involves

a longer period, the need for working capital would be more.

At times, business needs to estimate the requirement of working capital in

advance for proper control and management. The factors discussed above influence

the quantum of working capital in the business. The assessment of working capital

requirement is made keeping these factors in view. Each constituent of working

capital retains its form for a certain period and that holding period is determined by

the factors discussed above. So for correct assessment of the working capital

requirement, the duration at various stages of the working capital cycle is estimated.

Thereafter, proper value is assigned to the respective current assets, depending on its

level of completion. The basis for assigning value to each component is given below:

Component of Working Capital Basis of Valuation

Stock of Raw materials Purchase cost of Raw materials

Stock of Work-in-progress At Cost or Market Value

(whichever is low)

Stock of Finished goods Cost of Production

Debtors Cost of Sales or Sales Value

Cash Working expenses

Each constituent of the working capital is valued on the basis of valuation

enumerated above for the holding period estimated. The total of all such valuation

becomes the total estimated working capital requirement.

The assessment of the working capital should be accurate even in the case of

small and micro enterprises where business operation is not very large. We know that

working capital has a very close relationship with day-to-day operations of a business.

Negligence in proper assessment of the working capital, therefore, can affect the day-

to-day operations severely. It may lead to cash crisis and ultimately to liquidation. An

inaccurate assessment of the working capital may cause either under-assessment or

over-assessment of the working capital and both of them are dangerous.

9. Operating cycle analysis:

The operating cycle of the firm begins with the acquisition of raw materials

and ends with the collection of receivables. It may be divided into four stages:

a) Raw materials and stores storage stage,

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b) Work-in-progress stage,

c) Finished goods inventory stage, and

d) Debtors collection stage.

Duration of operating cycle:

The duration of operating cycle is equal to the sum of the duration of each of these

stages less the credit period allowed by the suppliers to the firms. It can be given as

O = R + W + F + D – C

Where, O is Duration of Operating cycle

R is Raw materials and storage store period

W is Work-in-progress period

F is Finished goods storage period

D is Debtors collection period

C is Creditors payment period

WORK-IN-

PROGRESS

RAW

MATERIALS

ACCOUNTS

RECEIVABLE FINISHED

GOODS

CASH

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The components of operating cycle will be calculated as follows:

R = Average stock of raw materials and stores

Average raw material and stores consumption per day

W = Average work-in-progress inventory

Average cost of production per day

F = Average finished goods inventory

Average cost of goods sold per day

D = Average book debts

Average credit sales per day

C = Average trade creditors

Average credit purchase per day

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4.5 Reasons for Adequate Working Capital

A firm must have adequate working capital, i.e. as much as needed by the firm. It

should neither have excessive nor inadequate. Both situations are dangerous. Excessive

working capital means the firm has idle funds, which earn no profit for the firm. Inadequate

working capital means the firm does not have sufficient funds for running its operations,

which ultimately results in production interruptions, and lowering down the profitability. It will be interesting to understand the relation between working capital, risk and

return. In a manufacturing concern, it is generally accepted that higher levels of working

capital decrease the risk and decrease the profitability too. While lower levels of working

capital increase the risk but have the potentiality of increasing the profitability also. This principle is based on the following assumptions:

There is a direct relationship between risk and profitability – higher is the risk, higher

is the profitability; while lower is the risk, lower is the profitability.

Current assets are less profitable then fixed assets.

Short-term funds are less expensive then long-term funds.

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4.6 Sources of Working Capital:

The working capital requirements should be met both from short-term as well long-

term sources of funds. It will be appropriate to meet at least 2/3rd

(if not the whole) of the

permanent working capital requirements from long-term sources and only for the period

needed. The financing of working capital through short-term sources of funds has the

benefits of lower cost and establishing close relationship with the banks. Financing of

working capital from long-term resources provides the following benefits:

It reduces risk, since the need to repay loans at frequent intervals is eliminated.

It increases liquidity, since the firm has not to worry about the payment of these

funds in near future.

Although long-term funds partly finance current assets and provide the margin money

for working capital, such working capitals are virtually exclusively supported by short-term

sources. The main sources of working capital financing are as follows:

1. Trade Credit:

Trade credit refers to the credit extended by the supplier of goods and services

in the normal course of business of the firm. According to trade practices, cash is not

paid immediately for purchases but after an agreed period of time. Thus, trade credit

represents a source of finance for credit purchases. There is no formal/specific

negotiation for trade credit. It is an informal agreement the buyer and the seller. Such

credit appears in the books of buyers as sundry creditors/accounts payable. The most

of trade credit is open account as accounts payable; the supplier of goods does not

extend credits indiscriminately. Their decision as well as quantum is based on a

consideration of factors such as earnings record over a period of time, liquidity

position of the firm and the past record of the payment.

2. Bank Credit:

Bank credit is primarily institutional source of working capital finance in

India.

In fact, it represents the most important source for financing of current assets.

Working capital finance is provided by banks in following ways:

Cash Credit/Overdrafts:

Under cash credit/overdraft agreement of bank finance, the bank

specifies a predetermine borrowing/credit limit. The borrower can borrow up

to the stipulated credit. Within the specified limit, any number of drawings is

possible to the extent of his requirements periodically. Similarly, repayment

can be made whenever desired during the period. The interest is determined

on the basis of the running balance/amount actually by the borrower and not

on the sanctioned limit.

Loans:

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Under this arrangement, the entire amount of borrowing is credited to

the current account of the borrower or released in the cash. The borrower has

to pay interest on the total amount. The loans are repayable on the demand

or in the periodic installments. They can also be renewed from time-to-time.

As a form of financing, loans simply a financial discipline on the part of the

borrowers. From a modest beginning in the early nineties, at least 80% of

Maximum Permissible Bank Finance (MPBF) must be in the form of loans

in India.

Term-loans for Working Capital:

Under this arrangement, banks advance loans for 3-7 years payable in

yearly or half-yearly installments. Generally this forms the part of special

working capital.

Letter of Credit:

The other form 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 assumes only the risk, the credit being

provided by the suppliers himself. The purchaser of the goods on credit

obtains a letter of credit from bank. The bank undertakes the responsibility

to make payment to the supplier in case the buyer fails to meet his

obligations. Thus, the modus operandi of letter of credit is that the supplier

sells goods on credit/extends credit to purchaser, the bank gives a guarantee

and bears risk only in case of default by the purchaser.

3. Commercial Papers (CP):

Commercial Papers (CP) is a short-term unsecured negotiable instrument,

consisting of promissory notes with a fixed maturity. It is issued on a discount on a

face value basis but it can also be issued in interest bearing form. A Commercial

Paper when issued by a company directly to the investor is called a direct paper. The

companies announce the current rates of Commercial Papers of various maturities,

and investors can select those maturities which closely approximate their holding

period. When Commercial Papers are issued by security dealer on behalf of their

corporate customers, they are called Dealer Paper. They buy at a price less than the

commission and sell at the highest possible level.

4. 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 the early nineties as a result of RBI initiatives.

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Mode of security necessary for the finance of working capital:

1. Hypothecation:

Under this mode of security, the banks provide credit to borrowers against the

security of movable property, usually inventory of goods. The goods hypothecated,

however, continue to be in the possession of the owner of these goods (i.e. the

borrower). The rights of the lending bank (hypothecate) depend upon the terms of the

contract between the borrower and the lender. Although the bank does not have

physical possession of the goods, it has a legal right to sell the goods realize the

outstanding loan. Hypothecation facility is normally not available to new borrowers.

2. Pledge:

Pledge as a mode of security, is different from hypothecation in that in the

former, unlike in the later, the goods which are offered as security are transferred to

the physical possession of the lender. An essential perquisite of pledge, therefore, is

that the goods are in the custody of the bank. The borrower, who offers the security is

called „Pawnor (Pledger)‟, while the bank is called „Pawnee (Pledgee). The lodging of

goods by the „Pledgor‟ to the „Pledgee‟ is a kind of bailment. Therefore, pledge

creates some liabilities for the bank. It must take reasonable care of goods pledged

with it. In case of non-payment of the loans, the bank enjoys the right to sell the

goods.

3. Lien:

The term lien refers to the right of a part to retain goods belonging to another

party until a debt due to him is paid. Lien can be of two types:

i. Particular Lien:

Particular lien is a right to retain goods until a claim pertaining to these

goods is fully paid.

ii. General Lien:

General lien can be applied till all dues of the claimant are paid. Banks

usually enjoy general lien.

4. Mortgage:

It is a transfer of legal/equitable interest in specific immovable property for

securing the payment of debt. The person who parts with the interest in the property is

called „Mortgager‟ and the bank in whose favour the transfer takes place is the

„Mortagagee‟. The instrument of transfer is called „Mortgage Deed‟. Mortgage is,

thus, conveyance of the interest in the mortgaged property. The mortgage interest in

the property is terminated as soon as the debt is paid.

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4.7 Assessment of Working Capital:

A company needs working capital funds mainly to carry its current assets for its

operation. Proper assessment of working capital funds is needed to be done for the interest of

the company and also for the interest of the scarce credit according to the production

requirement. Inadequate or low level of working capital may result in under-utilisation of

capacity and financial difficulties. On other hand excessive or high level of working capital

may lead to unproductive use of cash and unnecessary interest burden on company.

Following can be used for the proper assessment of working capital:

1. Norms for inventory and receivables:

If the credit is taken from the bank for the production requirement, it is

necessary to assess the requirements on the certain norms. “A study group under the

chairmanship of Mr. P. L. Tandon was constituted for framing guidelines for

commercial banks for follow-up and supervision of bank credit for ensuring proper

end-use of funds.” Major recommendations by this committee were:

Assessment of need based credit of the borrower on a rational basis on the basis

of their business plans.

Bank credit would only be supplementary to the borrower‟s resources and not

replace them, i.e. banks would not finance one hundred percent of borrower‟s

working capital requirement.

Working capital finance would be available to the borrowers on the basis of

industry wise norms (Prescribe first by the Tandon Committee and then by

Reserve Bank of India) for holding different current assets. ( E.g. Raw Materials,

Stock-in-Progress, Finished Goods, Accounts Receivables)

Credit would be made available to the borrowers in different components like

cash credit; bills purchased and discounted working capital, term loan, etc.,

depending upon nature of holding of various current assets.

In order to facilitate a close watch under operation of borrowers, bank would

require them to submit at regular intervals, data regarding their business and

financial operations, for both the past and the future periods.

Norms by Tandon Committee:

Raw materials as so many months‟ consumption. They include stores and other

items used in the process of manufacture.

Stock-in-process, as so many months‟ cost of production.

Finished goods and accounts receivable as so many months‟ cost of sales and

sales respectively.

Stock of spares was not included in the norms. In financial terms, these were

considered to be a small part of total operating expenditure. Banks were expected

to assess the requirement of spares on case-by-case basis. However, they should

keep a watchful eye if spares exceed 5% of total inventories.

The committee itself visualized that there might be deviations of norms in the

following circumstances.

a) Bunched receipt of raw materials including imports.

b) Interruption of production due to power cuts, strikes or other

unavoidable circumstances.

c) Transport delays or bottlenecks.

37 | P a g e

d) Accumulation of finished goods due to non-availability of shipping

space for exports or other disruption in sales.

2. Computation of Maximum Bank Permissible Finance (MBPF):

The Tondon Committee has suggested the following for Working out

Maximum Permissible Bank Finance:

Bank can work out Working Capital Gap i.e. Total Current Assets less Total

Current Liabilities other than Bank Borrowings and Finance a maximum of 75%

of the Gap, the balance to come out of Long term Loans i.e., owned funds and

term borrowings.

Borrowers should provide Minimum of 25% of Total Current Assets out of

Long term Funds, i.e. Owned Funds and Long term Borrowings. A certain level

of credit for purchases and other Liabilities inclusive of Bank Borrowings will

not exceed more than 75% of Current Assets.

It may be observed from the above that borrower‟s contribution from long

term funds would be 25 per cent of the working capital gap under the first method of

lending and 25 per cent of total current assets under the second method of lending.

The above minimum contribution of long-term funds is called minimum stipulated

Net Working Capital (NWC) which comes from owned funds and term borrowings.

Above two methods of lending may be illustrated by taking the following

example of the borrower‟s financial position, projected at the end of year.

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Current Liabilities Amount

(Rs.)

Current Assets Amount

(Rs.)

Creditors for Purchase 100 Raw Materials 380

Other Current Liabilities 200 Stock-in-Progress 40

300 Finished Goods 180

Bank Borrowing‟s, including

Bills Discounted with Bankers

400 Receivables, including Bills

Discounted with Bankers

110

Other Current Assets 30

Total Current Liabilities 700 Total Current Assets 740

Computation by First Method:

It is observed that, the borrower has to provide minimum of 25% of Working Capital

Gap from the Long-term funds and it gives minimum Current Ratio of 1.17:1.

Computation by Second Method:

It is observed that, the borrower has to provide minimum of 25% of Total

Current Assets from the Long-term funds and gives a minimum Current Ratio of 1.33:1.

While estimating total requirements of Long-term funds for a new project,

Financial Institutions/Banks should calculate Working Capital on the basis of norms

prescribed by Inventory and receivables and by applying Second method of lending as it

Total Current Assets 740

Less: Total Current Liabilities

(Excluding Bank Borrowings)

300

Working Capital Gap 440

25% of above from Long term Source 110

Maximum Permissible Bank Limit 330

Excess Borrowings from Banks 70

Current Ratio 1.17:1

Total Current Assets 740

25% of above from Long term Sources 185

555

Less: Total Current Liabilities

(Excluding Bank Borrowings)

300

Maximum Permissible Bank Finance 255

Excess Bank Borrowings 145

Current Ratio 1.33:1

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provides good Working Capital Ratio (Current Ratio). A project may suffer from

shortage of Working Capital Funds if sufficient margin of Working Capital is not

provided as per Second method of lending while funding new project. Proper co-

ordination between Banks and Financial Institutions is necessary to ensure the

availability of sufficient Working Capital Finance to meet the production requirement.

3. Classification of Current Assets and Current Liabilities:

In order to calculate Net Working Capital and Maximum Bank Permissible

Finance, it is necessary to have a proper classification of various items of Current

Assets and Current Liabilities. Following are the items included in Current Assets and

Current Liabilities to assess the Working Capital:

Current Assets:

Cash and Bank balances.

Investments.

Receivables arising out of sales excluding deferred receivables. (Including

bills receivables and discounted by bankers)

Raw Materials and components used in the process of Manufacturing

including those in transit.

Stock-in-Progress including Semi-Finished Goods.

Finished Goods Including those in transit.

Installment by Deferred Receivables due within one year.

Advance payment of Tax.

Advances of Purchases of Raw Materials, Components and Consumable

Stores.

Payments to be received from Contracted Sale of Fixed Assets during the next

12 months.

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Current Liabilities:

Short-term Borrowings (Including Bills Purchased and Discounted) from

o Bank

o Others.

Unsecured loans.

Sundry creditors for raw materials, components and spares.

Interest and other charges accrued but no due for payments.

Advance/progress payments from customers.

Deposits from dealers, selling agents, etc.

Statutory liabilities:

o Provident fund dues.

o Provision for taxation.

o Sales-tax, Excise etc.

o Obligation towards workers considered as statutory.

Miscellaneous Current liabilities:

o Dividends.

o Liabilities for Expenses.

o Gratuity Payable within 1 year.

o Any other payments due within 1 year.

Notes of Current Assets and Current Liabilities:

Investment in Shares, Debentures etc and Advances of other Firms/Companies, not

connected with business of the borrowing Firm, should be excluded from Current

Assets. Similar investments made in Unit Trust of India and Other Mutual Funds in

associate Companies/Subsidiaries as well as made and/or Loans extended as inter-

corporate Deposits should not be included in build-up of Current Assets while

assessing Maximum Permissible Bank Finance.

The borrowers are not expected to make the required contribution of 25% from Long-

term Sources in respect of Export Receivables. Therefore, Export Receivables may be

included in Total Current Assets for arriving at Maximum Permissible Bank Finance

but the minimum stipulated Net Working Capital may be reckoned after excluding the

quantum of Export Receivables from the Total Current Assets.

Dead Inventory i.e. Slow Moving or Obsolete items should not be classified as

Current Assets.

Security Deposits/Tender Deposits given by the Borrower should be classified as

Non-Current Assets irrespective of whether they mature within normal Operating

Cycle of 1 year or not.

Advances/Progress Payments from Customers should be classified as Current

Liabilities. However, they were part of Advances received is required by Government

Regulations to be invested in certain approved Securities, the benefit of netting may

be allowed to the extent of such Investment and Balance may be classified as Current

Liabilities.

Deposits from Dealers, Selling Agents, etc. received by the Borrower may be treated

as Term Liabilities irrespective of their tenure if such deposits are accepted to be

41 | P a g e

repayable only when the Dealership/Agency is terminated. The Deposits, which do

not fulfill the above condition, should be classified as Current Liabilities.

In case of other Statutory Dues, Dividends etc. estimated amount payable within 1

year should be shown as Current Liabilities even if the specific provisions have not

been made for their Payment.

4. Information/Data required for assessment for working capital:

In order to assess the requirements of Working Capital on the basis of

Production needs, it is necessary to get the data from the borrowers regarding their

past/projected Production, Sales, Cost of Production, Cost of Sales, Operating Profit

etc. in order to ascertain the financial position of the Borrower and the amount of

Working Capital needs to be financed by the banks, it is necessary to call for the data

from the Borrowers regarding their Net Worth, Long-term Liabilities, Current

Liabilities, Fixed Assets, Current Assets etc.

The Reserve Bank of India prescribed the forms in 1975 to submit the

necessary details regarding the assessment of working capital under its Credit

Authorization Scheme. The Scheme of Credit Authorization was change into Credit

Monitoring Agreement in 1988. The forms used under Credit Authorization Scheme

for submitting necessary information have also been simplified in 1991 for reporting

the Credit sanctioned by the Banks above the cut-off point of Reserve Bank of India

under its Scheme for Credit Monitoring Agreement.

As the traders and merchant exporters who do not have manufacturing

activities are not required to submit the data regarding raw materials, consumable

stores, goods-in-process, power and fuel, etc., a separate set of forms has been

designed for traders and merchant exporters. In view of the peculiar nature of leasing

and the hire purchase concerns, a separate set of forms has also designed for them.

In addition to the information/data in the prescribed forms, bank may also call

for additional information required by them depending on the nature of the borrowers‟

activities and their financial position. The data is collected from the borrowers in the

following six forms:

A. Particulars of existing/proposed limits from banking system (Form I):

Particulars of the existing credit from the entire banking system as also the

term loan facilities availed of from the term lending institutions/banks are furnished in

this form. Maximum and minimum utilization of the limits during the last 12 months

outstanding balances as on a recent date are also given so that a comparison can be

made with the limits now requested and the limits actually utilized during the last 12

months.

B. Operating system (Form II):

The data relating to last sales, net sales, cost of raw material, power and fuel,

direct labour, depreciation, selling, general expenses, interest, etc. are furnished in this

form. It also covers information on operating profit and net profit after deducting total

expenditure from total sale proceeds.

C. Analysis of the Balance Sheet (Form III):

A complete analysis various items of last year‟s balance sheet, current year‟s

estimate and following year‟s projections is given, in this form. The details of current

liabilities, term liabilities, net worth, current assets, other non-current assets, etc. are

given in this form as per the classification accepted by banks.

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D. Comparative Statement of Current Assets and Current Liabilities (Form IV):

This form gives the details of various items of current assets and current

liabilities as per classification accepted by banks. The figures given in this form

should tally with the figures given in the form III where details of all the liabilities

and assets are given. In case of inventory, receivables and sundry creditors; the

holding/levels are given not only in absolute amount but also in terms of number of

month so that a comparative study may be done with prescribed norms/past trends.

They are indicated in terms of numbers of months in bracket below their amounts.

E. Computation of Maximum Permissible Bank Finance (Form V):

On the basis of details of current assets and liabilities given in form IV,

Maximum Permissible Bank Finance is calculated in this form to find out credit limits

to be allowed to the borrowers.

F. Fund Flow Statement (Form VI):

In this form, fund flow of long term sources and uses is given to indicate

whether long term funds are sufficient for meeting the long term requirements. In

addition to long term sources and uses, increase/decrease in current assets is also

indicated in this form.

5. Checklist for verification of the Information/Data:

Bank should verify not only the arithmetical accuracy of the data furnished by

the borrowers but also the logic behind various assumptions based on which the

projections have been made. For this purpose, bank officials should hold discussions

with the borrowers on projected sales, level of operations, level of inventory,

receivables, etc. if necessary, a visit to the factory may also be made to have a clear

idea of products and processes.

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Consequences of under assessment of Working Capital:

Growth may be stunted. It may become difficult for the enterprise to undertake

profitable projects due to non-availability of working capital.

Implementation of operating plans may become difficult and consequently the profit

goals may not be achieved.

Cash crisis may emerge due to paucity of working funds.

Optimum capacity utilization of fixed assets may not be achieved due to non-

availability of the working capital.

The business may fail to honour its commitment in time, thereby adversely affecting

its credibility. This situation may lead to business closure.

The business may be compelled to buy raw materials on credit and sell finished goods

on cash. In the process it may end up with increasing cost of purchases and reducing

selling prices by offering discounts. Both these situations would affect profitability

adversely.

Non-availability of stocks due to non-availability of funds may result in production

stoppage.

While underassessment of working capital has disastrous implications on business,

over assessment of working capital also has its own dangers.

Consequences of over assessment of Working Capital:

Excess of working capital may result in unnecessary accumulation of inventories.

It may lead to offer too liberal credit terms to buyers and very poor recovery system

and cash management.

It may make management complacent leading to its inefficiency.

Over-investment in working capital makes capital less productive and may reduce

return on investment.

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Conclusion

The requirement of working capital finance is ever increasing.

Proper assessment of working capital funds is needed to be done for the interest of the

company and also for the interest of the scarce credit according to the production

requirement.

Inadequate or low level of working capital may result in under-utilisation of capacity

and financial difficulties.

Excessive or high level of working capital may lead to unproductive use of cash and

unnecessary interest burden on company.

Loans and advances formed a major portion of the current assets of the firm because

of which the working capital gap is large.

In most of the cases, hypothecation and/or mortgage are used to create securities for

the banks.

Bank has their own internal credit rating procedure to rate the clients (Borrowers).

After doing the assessment of the financial indicators it is up to the judgment of the

top management of the bank to sanction such loan. The very decision could be against

the assessment result.

.

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Bibliography Financial Management – Khan & Jain.

Financial Management & Working Capital Management (Welingkar Institute,

PGDBM course)

Procedure of assessment of working capital finance, old sanction proposals, RBI

guidelines etc. have been sourced from reference books.

Websites:

o www.investopedia.com

o www.wikipedia.com