how to assess working capital requirement
TRANSCRIPT
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WORKING CAPITAL
ASSESSMENT
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Funds required to acquire current assets to enable business/industry to operate at the expected levels.
What is Working Capital ?What is Working Capital ?
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CONCEPTS OF WORKING CAPITALCONCEPTS OF WORKING CAPITAL
GROSS WORKING CAPITAL = CA
These are in the system used/ consumed on a day to day basis.
NET WORKING CAPITAL = CA – CL OR
(SHF + TL) – (NFA + NCA)NWC is the entrepreneur's margin available in
the system from Long term Funds
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What are Current Assets ?What are Current Assets ?Assets which normally get converted into cash during the operating cycle of the firm. Cash & Bank balances Inventory Receivables Advances to suppliers/othersOther Current assets
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What are Working Capital Sources?What are Working Capital Sources?
Own fundsBank borrowingsSundry CreditorsAdvances from customersDeposits due in a year Other current liabilities
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OPERATING CYCLE
Stages:
1) Raw materials (RM/RM consumption)
2) Work-in-process (WIP/COP)
3) Finished Goods (FG/COS)
4) Receivables (Debtors/Credit sales)
Less:
Creditors (creditors/purchases)
…...begins with acquisition of raw materials and ends with collection of receivables.
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Service
Length of Operating Cycle
Receivables
Cash
Trade Industry
CashCash
Stocks
Receivables Receivables
Finished Goods
Semi Finished Goods
Raw Material
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FACTORS INFULENCING WORKING FACTORS INFULENCING WORKING CAPITAL REQUIREMENTCAPITAL REQUIREMENT
Nature of business – service/trade/manufacturing.Seasonality of operations – peak/non peakProduction Policy – Constant/seasonalMarket conditions- competition/credit termsConditions of supply of RM/stores/spares etc.Quantum of production/Turnover(level of activity)Operating CycleCurrent Assets to be maintained
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DATA TO BE OBTAINEDDATA TO BE OBTAINED
Application.Financial Statements of Previous yearsEstimates/ Projections (with quantitative details)
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Working Capital FinanceWorking Capital Finance
A) Fund BasedInventory finance and Bill Finance ( Post Sales Finance).
B) Non Fund Based Letter of Credit (LC) Bank Guarantee.
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Assessment MethodsAssessment Methods
Operating Cycle MethodService SectorTradersManufacturing Activity.
Drawing Power Method.Turnover Method.
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……. Assessment Methods. Assessment Methods
MPBF method (II method of lending) for limits of Rs 6.00 crores and aboveCash Budget method
(Reason: Based on procurement and cash inflow)
Seasonal Industries (Sugar/ Rice Mills/Textiles/Tea/Tobacco/Fertilizers)
Contractors & Real Estate Developers Educational Institutions
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Operating Cycle MethodOperating Cycle Method
Working capital requirement
Operating expenses
---------------------------------------
No. of operating cycles in a year
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Operating Cycle MethodOperating Cycle MethodA. Length of operating Cycle
a. Procurment of Raw Material 30 days
b. Conversion / Process time 15 days
c. Average time of holding of FG 15 days
d. Average Collection Period 30 days
e.Operating Cycle (a+b+c+d) 90 days
f. Operating Cycle in a year (365days/e) 4 cycle
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……..Operating Cycle Method..Operating Cycle Method
B. Total Operating Expenses per
Annum
Rs 60.00 lakhs
C. Total Turnover per Annum Rs 70.00 lakhs
D. Working Capital Requirement
= Total Operating Expenses (B)/ No. of operating Cycle (f as said earlier)
Rs 15 lakhs
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Drawing Power MethodDrawing Power Method(for units with small limits)(for units with small limits)
Particulars Stock value Margin DP
Paid stocks (RM-Creditors) 4 25% 3
Semi Finished goods 4 50% 2
Finished goods 4 25% 3
Book debts 4 50% 2
Total 16 10
(Rs.in lacs)
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Turnover MethodTurnover Method(originally suggested by Nayak Committee for SSI units)(originally suggested by Nayak Committee for SSI units)
A Sales Turnover
B 25% of sales Turnover
C 5% of Sales Turnover projected as margin
D Actual NWC existing as per Last Financial Statement
E B – C
F B – D
G MPBF (E or F whichever is less)
H Additional margin to be brought in (C-D)
Applicable for limits upto Rs.6 croresApplicable for limits upto Rs.6 crores
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MPBF Method MPBF Method Tandon’s II method of lending)Tandon’s II method of lending)
A Current Assets
B Current Liab. other than Bank Borrowings
C Working Capital gap (A-B)
D Minimum Stipulated NWC (25% of CA excluding export receivables)
E Actual/projected NWC
F C – D
G C – E
H MPBF (F or G whichever is less)
I Excess borrowings/short fall in NWC (D-E)
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Justifications of the Performance ProjectionJustifications of the Performance Projection
(Inventory/Receivable Norms – Comparison)
Intra firm Comparison Comparison of estimates with previous
years Actuals.For New Units Comparison of estimates with similar
units in the area of operation. Higher projections shall be justified.
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MPBF Method MPBF Method Tandon’s II method of lending)Tandon’s II method of lending)
Excess borrowing ( short fall in NWC ) shall be ensured by additional funds to be brought in by the applicant or by additional bank finance over MPBF.
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Important Aspects of MPBF methodImportant Aspects of MPBF method
Production/Sales estimatesProfitability estimatesInventory/receivables normsBuild up of Net Working Capital
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Cash BudgetCash Budget
Statement showing forecast of cash receipts, cash payments and net cash balance over a period of time
Months-> 1 2 3 4 5 6 7 8 9 10 11 12
Cash Receipts
Cash Payments
Surplus/deficit
Cash credit – OB
Cash credit - CB
Peak deficit is financed and drawings regulated by monthly budgets
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Cash BudgetCash BudgetAdvantages:
•Suitable for seasonal industries, contractors, software
exporters etc.
Limitations: •Will not reflect changes in various current assets and
liabilities.•Will it give a clue whether a company is earning
•profit or not.
Funds flow statement is required to detect any diversion of funds.
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BIFURCATION OF FUND BASED LIMITSBIFURCATION OF FUND BASED LIMITS
Inventory: OCC/KCC/PC/COD/SODBills : CBP/DBP/SBP/FBP
CUBD/DUBD/FUBD Inventory Limit
A. Total Inventory
B. Creditors
C. Margin
D. Paid Inventory (A-B)
E. Inventory Limit ( D-C)
(Cont…)
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…….BIFURCATION OF FUND BASED .BIFURCATION OF FUND BASED LIMITSLIMITS
Bills /Book Debts Limit
A. Receivables/ Sundry Debtors
B. Margin
C. Bills Limit ( A-B). Loan delivery system (FB W/C limits of
Rs.10 crores & above from banking system)
Cash Credit - 20%
Demand Loan – 80%
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Loan Delivery SystemLoan Delivery System
Objectives Loan delivery system (FB W/C limits of
Rs.10 crores & above from banking system)
Cash Credit - 20%
Demand Loan – 80% Domestic Credit portion to be bifurcated into
loan component and Cash Credit Relaxation.
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Bill Finance -Post Sales FinanceBill Finance -Post Sales Finance(For Genuine Trade & Manufacturing Transactions)(For Genuine Trade & Manufacturing Transactions)
A. DBPs : Bills of Exchange accompanied with ; I) Invoice and
ii) Documents of title of the Goods - LRS/RRSA. DUBD : Invoice /LRS / RRS – Maximum Tenor
180 daysB. CUBD : Bill of Exchange / Promissory Notes.
- Eligibility Carved out of MPBFC. Export Bills : FBP/FUBD
- Security – Export Documents drawn against confirmed orders / LCs.
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……Bill Finance -Post Sales FinanceBill Finance -Post Sales Finance(For Genuine Trade & Manufacturing Transactions)(For Genuine Trade & Manufacturing Transactions)
A. Book Debts Finance :A. Service Industry / Contractors B. Margin 50%C. Age not more than 90 daysD. Collateral Security – 200% Urban /
Semi Urban Security.
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Non Fund Based LimitsNon Fund Based Limits
Letter of credit ILC/FLC
Usance/Sight
Bank Guarantee Performance Financial – Bid Bonds/Security Deposits/ Mobilisation advance/retention money
Deferred Payment Guarantee
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LC AssessmentLC Assessment
1 Annual purchase/import FLC/ILC
2 Out of (1) on credit basis
3 Out of (2) on usance LC basis
4 Average of (3) per month
5 Lead time (no. of months)
6 Usance period (no. of months)
7 Usance LC requirement (5+6) X (4)
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Guidelines to be followedGuidelines to be followed
For constituents borrowers with regular sanctioned credit facilities for genuine transactions.LCs shall not be opened with clause without recourse to drawer.
Bank Guarantees:Performance and Financial Guarantees
Purpose / DifferenceSecurity: Cash Margin +Counter Guarantee +Collateral Security (Immovable / Liquid Security)
Restrictive Clause.
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Important RatiosImportant Ratios
Current Ratio (CA/CL)
(norm – 1.15 upto Rs.6 crores/1.33 for above)
Adjusted Current Ratio (reduce export bills discounted from BB & CA)
Total debt equity (TOL/TNW) (Maximum norm : 6)
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Gearing Ratio Gearing Ratio (for NFB Limits)(for NFB Limits)
Total Outside Liabilities + 100% of NFB Limits---------------------------------------------------------------------------
Net Worth – (NCA+Investments in associate concerns)
Notes: TOL (excluding Sundry creditors representing stocks procured under LC/BG and
mobilisation advance outstanding against BGs)
NW (excluding Intangible Assets)
NCA (excluding advances given for capital goods for business purpose)
Maximum Norm:Maximum Norm: 10
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Exposure Norms for some CategoriesExposure Norms for some Categories
Category Ceiling on borrowings
Constructions contractors
FB + NFB limits shall not exceed 15 times net owned funds
Housing Finance Institutions
Borrowings shall be restricted to 3 times the net owned funds