CONCEPT OF WORKING CAPITAL :
Working Capital is defined as the excess of current assets over current liabilities. It is the same as net current
assets. It represents the investment of a company's funds in assets which are expected to be realised within a relatively short period of time. It is not
an investment in an asset with a long life but, as the name implies, represents funds which are continually in use and are turned over many times in a
year. It is capital used to finance production, to support levels of stock and to provide credit for customers. The three main current assets are stock,
debtors and cash. They can be funded by short-term finance, i.e. current liabilities, or by medium and long-term finance in case of permanent
current assets or core current assets.
Components of Working Capital :The firm's Working Capital may be viewed as being comprised of two components:
1. Permanent working capital: These funds represent the current assets required on a continuing basis over the entire year. it represents the
amount of cash, receivables and inventory maintained as a minimum, to carry on operations at any time, as a safety measure.
2.Variable working capital: These funds represent additional assets required at different times during the operating year. Added inventory must
be maintained to support the peak selling periods. Receivables increase and must be financed following periods of high sales. Extra cash may be
needed to pay for increased supplies preceding high activity.
Working Capital Cycle :Working Capital cycle is the length of time that elapses between the company's outlay on raw materials, Wages and other
expenditures and the inflow.of cash from the sale of the goods. The length of the cycle depends upon(I) stock of raw material required to be held.
(ii) The work in process which depends on the process involved in manufacturing or processing the raw material.
(iii) Credit required to be provided to the purchasers.
Longer the working capital cycle, the more is the working capital requirement i.e. need for maintaining the current assets.
Working capital & Net working Capital Working capital (or gross working capital) refers to the amount of total current assets.
Liquid surplus or net working capital refers to the surplus of long term sources over long term uses as per RBI prescription (also
calculated by banks as difference between current assets and current liabilities). It is desirable, that the net working capital
should be positive which would signify liquidity and availability of. Adequate working funds. If in a particular case, the net working
capital is negative, the difference will be called the working capital deficit.
The working capital can also be classified as:
a Permanent working capital which is minimum amount of current assets necessary for carrying out operations for a
period.
b Fluctuating working capital : Additional assets required at different times during an operating period due to cyclic factors.
c Seasonal working capital means requirement for additional current assets due to seasonal nature of the industry.
d Adhoc working capital : Additional funds for meeting the needs arising out of special circumstances e.g. execution of special order,
delay in receipt of payment of receivables.
e Working capital term loan : A long term loan given to meet the working capital margin needs of a borrower. The concept was
introduced by. Tandon Committee.
f Working capital gap = total current assets less other current liabilities. It is financed by net working capital and bank finance for
working capital (called MPBF).
SUMMARY - WORKING CAPITAL TERMS
Particulars Classification
Working capital Current assets such as cash, stocks, book-debts, other current assets
Net capital working Current assets — current liabilities OR Long term sources — long term uses
Working gap capital Current assets — current liabilities (other than bank borrowing — i.e. OCL)
Working limits capital Bank facilities needed to purchase current assets. These facilities are cash credit,
overdraft, bills purchase/discounting, pre-shipment or post-shipment loans etc.
Factors which determine the working capital The following factors determine the overall working capital levels of the
industrial units: Policies for production, Manufacturing process, Credit Policy of the unit, Pace of turnover , Seasonality
Process for assessment of working capital requirements Generally there are three methods followed by banks for assessing working
capital of a firm i.e. (i) traditional method suggested under Tandon Committee, (ii) turnover method suggested by Nayak Committee
and (iii) cash budget method followed in case of seasonal industries.
Methods of Assessing Bank Finance
Holding Norms based Method of Assessment of Bank Finance Various steps used in the
process include following
(a) Deciding on the level of turnover: : in case of existing units, past performance can help in ascertaining projected turnover. In
case of new enterprise, it is based on production capacity, proposed market share, availability of raw materials, industry norms etc.
(b) Assessment of Gross working capital: This is sum total of various components of working capital
(i) inventory: For assessment of stock levels of raw material, work in process and finished goods, information like lead
time, minimum order quantity, location and number of suppliers, percentage of imported material, manufacturing process etc are
considered. Industry norms may be helpful in this regard.
(ii) Receivables/bills: it can be assessed easily. It is governed by market practice relating to a particular business.
(iii) Other Current assets: A reasonable estimate of other current assets like cash level, advance to suppliers, advance tax
payment etc is calculated. Sources of Meeting Working Capital Requirement
(i) Own sources: This represents available net working capital. Further, as the estimate of limits is based on the projected balance sheet at the
end of the current accounting year, some internal accruals are also taken into account. Bank may stipulate additional NWC if available NWC and
anticipated internal accruals are not enough to maintain desired current ratio.
(ii) Suppliers's credit based on market practice
(iii) Other current liabilities like salary payable, advance from customers etc.
(iv) Bank Finance
Cash Budget Method
In any economic activity there will be outflows to meet the expenses of production and inflows from the sale of output. Any firm requires
working capital from the bank to meet the gap between these inflows and outflows. Therefore, under this method, cash flows are projected on
monthly or quarterly basis to ascertain the deficit. Bank finance will be equal to cash deficit. This method is used while financing seasonal
industries like tea, sugar, service oriented industries like software, Non banking finance companies, construction contracts.
Turnover Method:
This method was suggested by Nayak Committee. This method is to be applied in the case of working capital limits up to Rs 5 crore in the case of
Small Manufacturing enterprises and up to Rs 2 crore in other cases. This method is simple in nature. According to this method, working capital
requirement is equal to 25% of the accepted projected annual sales; bank finance is 20% of the projected annual sales or 80% of the
working capital requirements and margin is 5% of the projected annual sales or 20% of the working capital requirements. For
example, if the current sales are Rs 400 lac, projected growth is 25%, then projected annual sale will be Rs 500 lac. Accordingly, working
capital requirement will be Rs 125 lac, bank finance Rs 100 lac and borrower's margin Rs 25 lac. However, actual drawing power will be allowed as per
security available. if net working capital available with the borrower (i.e. borrower's margin) is more than 5% of the projected annual sale, the limits
can be adjusted accordingly.
The requirement as per this method is minimum assuming working capital cycle of the unit at 3 months. If working capital cycle is more, Bank may
consider higher requirement depending on the business of the borrower.
Turnover Method (Nayak Committee) It is used where the aggregate fund-based working capital credit limits are upto Rs. 500 lac from the
banking system. Working capital : Minimum 25% of the projected turnover (or 3 months's sale).
Working capital limits : Minimum of 20% of projected annual turnover after satisfying about reasonableness of the projected annual turnover.
Borrowers' margin : 5% of projected turnover. If it is higher than 5%, the bank limits can be fixed at a lower level than 20%.
The margin proportionately increases with increase in period of operating cycle (ratio of margin to bank finance should be 1:4.
Calculation of working capital
Estimated sale turnover (projected sale) Rs.80 lac
Minimum Working Capital @ 25% estimated sales (which represents 03 months' sales) Rs.20 lac
Contribution of borrower @ 5% Rs.4 lac
Minimum Bank credit for working capital @ 20% of projected sales Rs.16 lac
Traditional method
As per traditional method (Tandon Committee), the level of working capital is determined both by the length of the
operating cycle and the size of the sales. The method is applicable to working capital limits above Rs.5 lac. In a circular dated
04.11.97, RBI withdrew the mandatory application of this method and allowed banks to use their own method.
The total of anticipated level of current assets calculated on the basis of estimated sales and by applying the norms for inventory and
receivables, is the level of working capital. The amount of bank limit, can be determined as under :
a: Assess the level of net working capital
(surplus of long term sources over long term uses) available, which normally should not be less than 25% of total current assets.
Work out bank finance to be sanctioned being gap of total current assets less NWC and other current liabilities.
Working Capital is defined as the excess of current assets over current liabilities. It is the same as net current
assets. It represents the investment of a company's funds in assets which are expected to be realised within a relatively short period of time. It is not
an investment in an asset with a long life but, as the name implies, represents funds which are continually in use and are turned over many times in a
year. It is capital used to finance production, to support levels of stock and to provide credit for customers. The three main current assets are stock,
debtors and cash. They can be funded by short-term finance, i.e. current liabilities, or by medium and long-term finance in case of permanent
current assets or core current assets.
Components of Working Capital :The firm's Working Capital may be viewed as being comprised of two components:
1. Permanent working capital: These funds represent the current assets required on a continuing basis over the entire year. it represents the
amount of cash, receivables and inventory maintained as a minimum, to carry on operations at any time, as a safety measure.
2.Variable working capital: These funds represent additional assets required at different times during the operating year. Added inventory must
be maintained to support the peak selling periods. Receivables increase and must be financed following periods of high sales. Extra cash may be
needed to pay for increased supplies preceding high activity.
Working Capital Cycle :Working Capital cycle is the length of time that elapses between the company's outlay on raw materials, Wages and other
expenditures and the inflow.of cash from the sale of the goods. The length of the cycle depends upon(I) stock of raw material required to be held.
(ii) The work in process which depends on the process involved in manufacturing or processing the raw material.
(iii) Credit required to be provided to the purchasers.
Longer the working capital cycle, the more is the working capital requirement i.e. need for maintaining the current assets.
Working capital & Net working Capital Working capital (or gross working capital) refers to the amount of total current assets.
Liquid surplus or net working capital refers to the surplus of long term sources over long term uses as per RBI prescription (also
calculated by banks as difference between current assets and current liabilities). It is desirable, that the net working capital
should be positive which would signify liquidity and availability of. Adequate working funds. If in a particular case, the net working
capital is negative, the difference will be called the working capital deficit.
The working capital can also be classified as:
a Permanent working capital which is minimum amount of current assets necessary for carrying out operations for a
period.
b Fluctuating working capital : Additional assets required at different times during an operating period due to cyclic factors.
c Seasonal working capital means requirement for additional current assets due to seasonal nature of the industry.
d Adhoc working capital : Additional funds for meeting the needs arising out of special circumstances e.g. execution of special order,
delay in receipt of payment of receivables.
e Working capital term loan : A long term loan given to meet the working capital margin needs of a borrower. The concept was
introduced by. Tandon Committee.
f Working capital gap = total current assets less other current liabilities. It is financed by net working capital and bank finance for
working capital (called MPBF).
SUMMARY - WORKING CAPITAL TERMS
Particulars Classification
Working capital Current assets such as cash, stocks, book-debts, other current assets
Net capital working Current assets — current liabilities OR Long term sources — long term uses
Working gap capital Current assets — current liabilities (other than bank borrowing — i.e. OCL)
Working limits capital Bank facilities needed to purchase current assets. These facilities are cash credit,
overdraft, bills purchase/discounting, pre-shipment or post-shipment loans etc.
Factors which determine the working capital The following factors determine the overall working capital levels of the
industrial units: Policies for production, Manufacturing process, Credit Policy of the unit, Pace of turnover , Seasonality
Process for assessment of working capital requirements Generally there are three methods followed by banks for assessing working
capital of a firm i.e. (i) traditional method suggested under Tandon Committee, (ii) turnover method suggested by Nayak Committee
and (iii) cash budget method followed in case of seasonal industries.
Methods of Assessing Bank Finance
Holding Norms based Method of Assessment of Bank Finance Various steps used in the
process include following
(a) Deciding on the level of turnover: : in case of existing units, past performance can help in ascertaining projected turnover. In
case of new enterprise, it is based on production capacity, proposed market share, availability of raw materials, industry norms etc.
(b) Assessment of Gross working capital: This is sum total of various components of working capital
(i) inventory: For assessment of stock levels of raw material, work in process and finished goods, information like lead
time, minimum order quantity, location and number of suppliers, percentage of imported material, manufacturing process etc are
considered. Industry norms may be helpful in this regard.
(ii) Receivables/bills: it can be assessed easily. It is governed by market practice relating to a particular business.
(iii) Other Current assets: A reasonable estimate of other current assets like cash level, advance to suppliers, advance tax
payment etc is calculated. Sources of Meeting Working Capital Requirement
(i) Own sources: This represents available net working capital. Further, as the estimate of limits is based on the projected balance sheet at the
end of the current accounting year, some internal accruals are also taken into account. Bank may stipulate additional NWC if available NWC and
anticipated internal accruals are not enough to maintain desired current ratio.
(ii) Suppliers's credit based on market practice
(iii) Other current liabilities like salary payable, advance from customers etc.
(iv) Bank Finance
Cash Budget Method
In any economic activity there will be outflows to meet the expenses of production and inflows from the sale of output. Any firm requires
working capital from the bank to meet the gap between these inflows and outflows. Therefore, under this method, cash flows are projected on
monthly or quarterly basis to ascertain the deficit. Bank finance will be equal to cash deficit. This method is used while financing seasonal
industries like tea, sugar, service oriented industries like software, Non banking finance companies, construction contracts.
Turnover Method:
This method was suggested by Nayak Committee. This method is to be applied in the case of working capital limits up to Rs 5 crore in the case of
Small Manufacturing enterprises and up to Rs 2 crore in other cases. This method is simple in nature. According to this method, working capital
requirement is equal to 25% of the accepted projected annual sales; bank finance is 20% of the projected annual sales or 80% of the
working capital requirements and margin is 5% of the projected annual sales or 20% of the working capital requirements. For
example, if the current sales are Rs 400 lac, projected growth is 25%, then projected annual sale will be Rs 500 lac. Accordingly, working
capital requirement will be Rs 125 lac, bank finance Rs 100 lac and borrower's margin Rs 25 lac. However, actual drawing power will be allowed as per
security available. if net working capital available with the borrower (i.e. borrower's margin) is more than 5% of the projected annual sale, the limits
can be adjusted accordingly.
The requirement as per this method is minimum assuming working capital cycle of the unit at 3 months. If working capital cycle is more, Bank may
consider higher requirement depending on the business of the borrower.
Turnover Method (Nayak Committee) It is used where the aggregate fund-based working capital credit limits are upto Rs. 500 lac from the
banking system. Working capital : Minimum 25% of the projected turnover (or 3 months's sale).
Working capital limits : Minimum of 20% of projected annual turnover after satisfying about reasonableness of the projected annual turnover.
Borrowers' margin : 5% of projected turnover. If it is higher than 5%, the bank limits can be fixed at a lower level than 20%.
The margin proportionately increases with increase in period of operating cycle (ratio of margin to bank finance should be 1:4.
Calculation of working capital
Estimated sale turnover (projected sale) Rs.80 lac
Minimum Working Capital @ 25% estimated sales (which represents 03 months' sales) Rs.20 lac
Contribution of borrower @ 5% Rs.4 lac
Minimum Bank credit for working capital @ 20% of projected sales Rs.16 lac
Traditional method
As per traditional method (Tandon Committee), the level of working capital is determined both by the length of the
operating cycle and the size of the sales. The method is applicable to working capital limits above Rs.5 lac. In a circular dated
04.11.97, RBI withdrew the mandatory application of this method and allowed banks to use their own method.
The total of anticipated level of current assets calculated on the basis of estimated sales and by applying the norms for inventory and
receivables, is the level of working capital. The amount of bank limit, can be determined as under :
a: Assess the level of net working capital
(surplus of long term sources over long term uses) available, which normally should not be less than 25% of total current assets.
Work out bank finance to be sanctioned being gap of total current assets less NWC and other current liabilities.
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