METHODS FOR WORKING CAPITAL APPRAISAL

• METHODS FOR WORKING CAPITAL APPRAISAL

• MEANING OF WORKING CAPITAL

1. WORKING CAPITAL REFERS TO THAT PART OF THE FIRM’S CAPITAL WHICH REQUIRED FOR FINANCING SHORT TERM OR CURRENT ASSETS SUCH AS CASH, MARKETABLE SECURITIES, DEBTORS AND INVENTORIES.
2. CIRCULATING CAPITAL MEANS CURRENT ASSETS OF A COMPANY THAT ARE CHANGED IN THE ORDINARY COURSE OF BUSINESS FROM ONE FORM TO ANOTHER AS FOR EXAMPLE, FROM CASH TO INVENTORIES, INVENTORIES TO RECEIVABLES, RECEIVABLES INTO CASH.

• OPERATING CYCLE

1. OPERATING CYCLE MEANS THE LENGTH OF TIME REQUIRED TO CONVERT
2. RAW MATERIAL INTO WORK PROCESS
3. WIP INTO FINISHED GOODS
4. FINISHED GOODS INTO RECEIVABLE
5. RECEIVABLE INTO CASH AND THIS CYCLE CONTINUE AGAIN FROM CASH TO PURCHASE AND SO ON
6. THE SPEED DURATION REQUIRED TO COMPLETE THE REQUIREMENTS OF WORKING CAPITAL LONGER THE PERIOD THE LONGER IS THE REQUIREMENT OF WORKING CAPITAL

• OPERATING CYCLE
• CALCULATION OF OPERATING CYCLE

1. GROSS OPERATING CYCLE = RMCP+WIPCP+FGCP+RCP
2. WHERE RMCP =RAW MATERIAL CONVERSION
3. WIPCP = WORK IN PROGRESS CONVERSION
4. FGCP =FINISHED GOOD CONVERSION PERIOD
5. RCP = RECEIVABLE CONVERSION PERIOD
6. NET OPERATING CYCLE =GROSS OPERATING CYCLE PERIOD –PAYABLE DEFERRAL PERIOD

• FORMULAS FOR CALCULATING OPERATING CYCLE

1. RAW MATERIAL CONVERSION PERIOD =(AVERAGE STOCK OF RAW MATERIAL)/(RAW MATERIAL CONSUMPTION PER DAY)
2. WORK –IN PROCESS CONVERSION PERIOD = (AVERAGE STOCK OF WORK IN PROCESS)/(TOTAL COST OF PRODUCTION PER DAY )
3. FINISHED GOODS CONVERSION PERIOD =(AVERAGE STOCK OF FINISHED GOODS)/(TOTAL COST OF GOODS SOLD PER DAY
4. RECEIVABLE CONVERSION PERIOD = =(AVERAGE ACCOUNT RECEIVABLES)/(NET CREDIT SALES PER DAY)
5. PAYABLE DEFERRAL PERIOD = (AVERAGE PAYABLE )/(NET CREDIT PURCHASE PER DAY)

• METHODS OF WORKING CAPITAL APPRAISAL

1. BANKS IN INDIA HAVE EVOLVE THEIR OWN METHOD OF LENDING AS THEY HAVE BEEN GIVEN FREE HAND BY RBI TO DECIDE THEIR OWN LENDING METHOD
2. NORMALLY BANKS USE THE TURNOVER METHOD (ALSO CALLED NAYANK COMMITTEE NORMS) FOR THE ASSESSMENT OF WORKING CAPITAL LIMIT UP TO 2 CRORES(7.50 CRORE FOR SME)
3. THE OTHER TWO TRADITIONAL METHODS OF ASSESSMENT OF WORKING CAPITAL LIMITS ARE:

1. MAXIMUM PERMISSIBLE BANK FINANCE
2. OR CASH BUDGET METHOD

• METHODS OF WORKING CAPITAL APPRAISAL
• MAXIMUM PERMISSIBLE BANK FINANCE(MPBF): WILL DEPEND UPON :

1. NATURE OF THE CURRENT ASSETS LESS SUITABLE MARGIN
2. RBI FROM TIME TO TIME PRESCRIBE NORMS OF WORKING CAPITAL
3. RBI HAS ACCEPTED I AND IIND METHOD OF TANDON COMMITTEE RECOMMENDATION

• FIRST METHOD BY TANDON COMMITTEE
• CA-CL=WORKING CAPITAL GAP AND HERE THE BORROWER HAS TO CONTRIBUTE 25% OF WORKING CAPITAL GAP FROM LONG SOURCES
• EXAMPLE
• TOTAL CURRENT ASSETS=50,000
• CURRENT LIABILITIES OTHER THAN BANK BORROWING=20,000
• CORE CURRENT ASSETS=5,000
• WORKING CAPITAL GAP=50,000-20,000=30,000
• 25% OF 30,000=7500 FROM LONG TERM SOURCES
• 75% IS MAXIMUM PERMISSIBLE BORROWING=22,500
• SECOND METHOD BY TANDON COMMITTEE
• BORROWER WILL HAVE TO PROVIDE A MINIMUM OF 25% OF TOTAL CURRENT ASSETS FROM LONG TERM FUNDS AND MINIMUM CURRENT RATIO OF 1,33 TO 1
• CA=50,000
•  LESS 25% OF CA=12,500
•   --------------------------37,500
• LESS CL                              10,000
• ----------------------------------------27,500 MAXIMUM PERMISSIBLE WORKING CAPITAL LOAN
•  

• CHORE COMMITTEE

1. HEADED BY K.B CHORE IN 1979 RECOMMEND THAT:
2. ALL BORROWERS EXCEPT SICK UNIT HAVING WORKING CAPITAL OF 50 LACS AND OVER MUST BE PLACED UNDER METHOD II OF TANDON COMMITTEE WHICH GIVES CURRENT RATION OF 1.33 IS TO ONE. RELAXATION TO THE CURRENT RATIO IS AVAILABLE TO EXPORT ORIENTED UNITS
3. PRODUCTS MANUFACTURED BY MSME UNITS WHEREIN BANKS MAY APPLY THE FIRST METHOD

• TURN OVER METHOD
  ( NAYAK COMMITTEE)
• UNDER TURNOVER METHOD,THE AGGREGATE FUND BASED WORKING CAPITAL LIMITS ARE COMPUTED ON THE BASIS OF MINIMUM OF 20% OF THEIR PROJECTED ANNUAL TURNOVER
• THE BORROWER HAS TO BRING MARGIN OF 5% OF THEIR PROJECTED ANNUAL TURNOVER AS MARGIN MONEY
• IF PROJECTED SALE TURNOVER IS =100,000,00
• WORKING CAPITAL IS 25% OF TURNOVER= IS 25 LACS
• MINIMUM PERMISSIBLE IS 20% OF TURNOVER =20 LACS
• MARGIN MONEY FROM THE BORROWER IS 5% =5 LACS
• CASH BUDGET METHOD

1. FORECAST CASH FLOW STATEMENT SHOWING ESTIMATE OF CASH RECEIPTS,CASH PAYMENTS AND NET CASH BALANCE OVER THE PROJECTED TERM
2. PEAK DEFICIT IS FINANCED
3. FINANCE TO SUCH UNITS WILL BE ON THE BASIS OF PROJECTED MONTHLY CASH FLOWS ESTIMATED AND APPROVED BY THE BANK
4. THE CURRENT RATIO SHOULD BE 1.33:1(1.25 : FOR MSE)
5. BANKS AND FINANCIAL INSTITUTIONS SUPERVISE THE END USE OF THE FUNDS SANCTIONED THROUGH ACTUAL CASH FLOW.

• CONSIDERATIONS IN ASSESSMENT OF WORKING CAPITAL

1. TIME PERIOD TAKEN FOR HOLDING RAW MATERIALS,WORK IN PROCESS,FINISHED GOODS AND COLLECTION OF RECEIVABLE IS VERY SIGNIFICANT
2. EXAMINATION OF FINANCIAL STATEMENTS
3. LOOK INTO FOLLOWING CONSIDERATIONS BY BANK
4. PAST TRENDS IN PRODUCTION AND SALES
5. THE EXTENT OF INSTALLED AND AVAILABLE PRODUCTION CAPACITY
6. AVAILABILITY OF RAW MATERIALS,LABOUR,POWER SUPPLY
7. COMPETITIVE STRENGTH OF THE BORROWER
8. PRICING POLICY
9. RESEARCH RENOVATION AND DEVELOPMENT
10. ECONOMIC FACTORS LIKE DEMAND FOR THE PRODUCT,IMPORT RESTRICTION ETC

11. PROFITABILITY RATIO HELP BANKERS TO ASSESS THE ABILITY OF THE ENTERPRISE TO EARN PROFIT FROM THE SALES.VARIOUS RATIOS LIKE RETURN ON EQUITY,RETURN ON TOTAL ASSETS ACCOUNT RECEIVABLES TURNOVER RATION IS COMPARED WITH THE INDUSTRY
12. CHECKING OF THE LIMITS UTILIZED BY THE BORROWER FROM:
13. TRANSACTIONS
14. STOCK STATEMENTS
15. TOTAL PURCHASE AND SALE REFLECTED IN THE BALANCE SHEET SHOULD MATCH WITH TURNOVER OF DEBIT /CREDIT IN THE CURRENT CC ACCOUNT