Beruflich Dokumente
Kultur Dokumente
Page | 1
Working Capital Loans
Page | 2
Working Capital Loans
Page | 3
Working Capital Loans
Working capital
Working capital occupies a peculiar position in the capital structure of
a company. The decision as to the adequacy of working capital is a
complicated and yet a very important decision.
∗ If the business has enough working capital, it can maintain its operating
efficiency. It can buy materials and other goods on reasonable terms, can
take benefits of quantity discount and cash discount. It can keep the
interest burden to the minimum.
∗ Only those enterprises which have adequate working capital can survive
in times of depression. The investment in raw materials becomes long-
term investments during depression and cash flow declines due to fall in
sale. In such circumstances only enterprises with adequate working
capital can survive.
∗ It has been observed that number of business units have failed due to lack
of working capital.
Page | 4
Working Capital Loans
∗ Fixed assets are not efficiently utilized for the lack of working capital
funds. Thus the firm’s profitability would deteriorate.
∗ The firm loses its reputation when it is not in a position to honor its short
term obligations. As a result, the firm faces tight credit terms.
Definitions:
Working capital like many other accounting terms and financial terms
has been used by different people in different senses.
One school of thought believes that, as all capital resources available
to a business organisation – From shareholders, bondholders, and creditors
Page | 5
Working Capital Loans
Page | 6
Working Capital Loans
Page | 7
Working Capital Loans
(5) Liquidity:
Working capital is more liquid than fixed capital. If need arises,
working capital can be converted into cash within a short period and without
much loss. A company in need of cash can get it through the conversion of
its working capital by insisting on quick recovery of its bills receivable and
by expediting sales of its product. It is due to this trait of working capital
that the companies with a larger amount of working capital feel more
secure.’
Page | 8
Working Capital Loans
Page | 9
Working Capital Loans
Page | 10
Working Capital Loans
Page | 11
Working Capital Loans
Page | 12
Working Capital Loans
reduce the industrial and trading activities show a downward trend. Hence
the demand for working capital is low.
If the company is operating in the time of boom, the working capital
requirement may be more as the company may like to buy more raw
material, may increase the production and sales to take the benefit of
favourable market, due to increase in the sales, there may more and more
amount of funds blocked in stock and debtors etc. similarly in the case of
depressions also, working capital may be high as the sales terms of value
and quantity may be reducing, there may be unnecessary piling up of stack
without getting sold, the receivable may not be recovered in time etc.
Page | 13
Working Capital Loans
6. Profitability
The profitability of the business may be vary in each and every
individual case, which is in turn its depend on numerous factors, but high
profitability will positively reduce the strain on working capital requirement
of the company, because the profits to the extend that they earned in cash
may be used to meet the working capital requirement of the company.
Page | 14
Working Capital Loans
7. Operating efficiency
If the business is carried on more efficiently, it can operate in profits
which may reduce the strain on working capital; it may ensure proper
utilization of existing resources by eliminating the waste and improved
coordination etc. However, if there is improper co-ordination between
production and distribution policies/ department more working capital
maybe needed.
9. Dividend Policies
A firm having liberal dividend policy requires high working capital to
pay cash dividends, whereas a firm following a conservative dividend policy
will require less amount of working capital.
10.Expansion
An expanding business will require increased working capital
proportionate to the rate of expansion.
Page | 15
Working Capital Loans
11.Taxation Policies
Government taxation policy affects the quantum of working capital
requirements. High tax rates demand more amount of working capital.
Page | 16
Working Capital Loans
Page | 17
Working Capital Loans
Page | 18
Working Capital Loans
Page | 19
Working Capital Loans
1. Time Basis
Page | 20
Working Capital Loans
Page | 21
Working Capital Loans
material, finished goods and cash to ensure its smooth working and to meet
its immediate obligations.
Thus permanent working capital is the quantum of funds required
permanently for the production of goods and services on a continuing basis
to satisfy the demands of the customers
Page | 22
Working Capital Loans
1. Measurement Basis
∗ Positive Working Capital
∗ Negative Working Capital
∗ Zero Working Capital
Page | 24
Working Capital Loans
# Retained earnings
A firm can meet its working capital requirement by reinvesting the
profits earned by it. Retain earning accumulated profits are a permanent
sources of regular working capital. It is regular and cheapest.
# Reserves:
Page | 25
Working Capital Loans
Like retained earnings, the use of reserves for financing the working
capital requirement is also a costless sources of finance. Various funds of the
company like depreciation fund, provision for tax and other provisions kept
with the company can be used as temporary working capital.
# Issue of debentures
It crates a fixed charge on future earnings of the company. The
company is obliged to pay interest. Management should make wise choice in
procuring funds by issue of debentures.
# Commercial bank
A commercial bank constitutes significant sources for short term or
temporary working capital. Normally companies obtain short-term working
capital from banks in the form of short-term loans, cash credit, and overdraft
and through discounting the bill of exchange.
Page | 26
Working Capital Loans
# Public deposits
Most of the companies in recent years depend on this source to meet
their short term working capital requirements ranging fro six month to three
years.
Business firms sometimes succeed in mobilizing enough funds by
way of short-term deposits from publics. By and large attraction of higher
rate of interest prompts the public to put their savings as short-term deposits
with business firms.
# Trade credit:
Usually the manufacturing concerns, wholesalers and retailers avail
this type f credit. Such credit is extended by suppliers of goods or raw-
materials. This facility is given for a short period which may extend for a
few weeks or a few months, based on prevailing market usage. No interest is
charged by the suppliers if payment is made by the customer before the
expiry of the credit period.
# Various credits
Trade credit, business credit papers and customer credit are other
sources of short term working capital. Credit from suppliers, advances from
customers, bills of exchanges, promissory notes, etc helps to raise temporary
working capital.
Page | 27
Working Capital Loans
The company should meet its working capital needs through both long
term and short term funds. It will be appropriate to meet at least 2/3 of the
permanent working capital equipments form long term sources, whereas the
variables working capital should be financed from short term sources. The
working capital financing mix should be designed in such a way that the
overall cost of working capital is the lowest, and the funds are available on
time and for the period they are really required.
Page | 28
Working Capital Loans
Current Assets:
Current assets are those assets which can be converted into cash in the
normal course of business within a short period- say a maximum of one
year. They are also called floating or circulating assets because they cannot
be put to constant use. They are meant for resale or produced for the purpose
of sale i.e., converting them into cash. In brief, the list of current assets
comprises of:
Page | 29
Working Capital Loans
Current Liabilities:
Current liabilities are those liabilities which are intended to be paid in
the ordinary course of business within a short period of normally one
accounting year out of the current assets or the income of the business. Such
as:
# Bills Payable;
# Sundry creditors or accounts payable;
# Accrued or outstanding Expenses;
# Short-term loan, advances and deposits;
# Dividends Payable;
# Bank overdrafts;
# Provision for taxation.
Page | 30
Working Capital Loans
Page | 31
Working Capital Loans
Page | 32
Working Capital Loans
each of these stages less the credit period allowed by the suppliers of the
firm.
Symbolically the duration of the working capital cycle can be put as follows:
O=R+W+F+D-C
Where,
O = Duration of operating cycle;
R = Raw materials and stores storage period;
W = Work-in-progress period;
F = Finished stock storage period;
D = Debtors collection period;
C = Creditors payment period.
Each of the components of the operating cycle can be calculated
as follows:-
After computing the period of one operating cycle, the total number of
operating Cycles that can be computed during a year can be computed by
dividing 365 days with number of operating days in a cycle. The total
Page | 33
Working Capital Loans
expenditure in the year when year when divided by the number of operating
cycles in a year will give the average amount of the working capital
requirement.
Page | 34
Working Capital Loans
x
xx
7. Less: Creditors for supply of Raw
Materials……………
8. Time lag in payment of salaries, wages&
expenses……. x
9. Advances received from
x
customers……………………
10. Add: Provision for xx
contingencies………………………..
Page | 35
Working Capital Loans
xxx
Alternative Form
Statement showing the requirements of working capital for the
period___________
Rs. Rs.
Page | 36
Working Capital Loans
1. Materials
a) In stock
x
b) In Process
c) In finished Goods x
d) Credit to Debtors
x
xx
x
1. Overheads
a) In Process x
b) In finished Goods
x xxx
c) Credit to Debtor
1. Profit
Credit to debtors
2. Bank Balance as per balance sheet x
Total Working Capital x
x xx
xxx
xxx
xxx
Or
Page | 37
Working Capital Loans
= Cost of raw materials per year x No. of months/ days/ weeks raw
12 or 365 or 52 materials will remain in store
Note: If material is fed in the beginning of the process, 100% of the raw
material cost for the period should be considered, and if other expenses
(wages and overheads) are evenly spread throughout the year, average i.e.
half of these expenses should be considered.
Page | 38
Working Capital Loans
This is the cost of raw materials, labour and overheads for the period
for which finished stock will remain in warehouse.
# Advance payments
This is the amount of expenses paid for the period which has not
expired
Page | 39
Working Capital Loans
Page | 40
Working Capital Loans
Approach
The question is; what the proper amount of working capital is. It is not
an absolute amount. It depends upon the needs and circumstances available
in the company.
(2) Objective Tests: Some objective tests are suggested for determining
whether the working capital is adequate. (1) Whether the company is able to
make cash purchases and can avail of cash discount. (2) Whether the
company has enough credit worthiness to get finance from banks easily as
and when needed? (3) Whether the creditors allow enough credit on
purchases? (4) Whether the company experiences any difficulty in paying
dividend? On the basis of answers to the above questions, it can be said
whether working capital is adequate.
Page | 41
Working Capital Loans
company can have different levels of current assets. The Level of current
assets can be measured by the ratio of current assets to fixed assets. The
proportion of the two can be measured by dividing current assets by fixed
assets. From the viewpoint of this ratio, there are three types of policy. (1)
Conservative approach (2) Aggressive approach and (3) Average capital
approach. The high ratio of current assets to fixed assets suggests
conservative approach. It suggests greater liquidity and lower risk. The low
ratio shows aggressive approach in which the firm undertakes higher risks
and smaller liquidity. Generally most of companies adopt current assets
policy which falls between these two extreme policies. The following figures
show these three policies.
Page | 42
Working Capital Loans
Page | 43
Working Capital Loans
Example:
From the following information pertaining to Century Ltd. prepares a
statement showing the working capital requirement:
Budgeted Sales Rs.2, 60, 000 per annum
Solution:
Statement of Working Capital Requirements for the year ending______
Weeks Rs. Rs.
Current Assets
Stock:
Debtors 8 26000 x 8 x 10 =
Page | 44
Working Capital Loans
52 40000
62500
Current Liabilities
55000
Working Note:
1. Budgeted sales = Rs.2,60,000
Sales per unit =Rs.10
Number of Units to be sold = 2,60,000 = 26,000
10
2. Requirements per week:
A B
(per annum) (per week)
Rs. Rs.
(A/52)
Raw materials 26000 x 3 78000 1500
Direct labour 26000 x 3 1,04,000 2000
Overheads 26000 x 2 52,000 1000
2,34,000 4,500
3. Work –in- progress
It is stated that production and overhead accrue evenly. This wages
and overheads to be included on average basis.
Page | 45
Working Capital Loans
Efficiency Ratios:
# Working Capital to sales Ratios: = Sales .
Working Capital
Page | 46
Working Capital Loans
The ratio indicates the efficiency in which current assets turn into
sales. A lower current asset to sales ratio implies by and large a more
efficient use of funds. Thus, a high turnover rate indicates reduced lock-up
of funds in current assets. An analysis of this ratio over a period of time
reflects working capital management of a firm.
Liquidity Ratio:
# Current Ratio = Current Assets .
Current Liabilities
This ratio indicates the extent of the soundness of the current financial
position of an undertaking and the degree of safety provided to the creditors.
The higher the current ratio, the larger amount of rupee available per rupee
of current liability, the more the firm’s ability to meet current obligations
and the greater safety of funds of short-term creditors. Current assets are
those assets which can be converted into cash within a year. Current
liabilities and provisions are those liabilities that are payable within a year.
A current ratio of 2:1 indicates a high solvent position. A current ratio of
1.33:1 is considered by banks as minimum acceptable level for providing
working capital finance. The constituents of the current assets are as
important as the current assets themselves for evaluation of company’s
solvency position
Page | 47
Working Capital Loans
This ratio explains the relationship between current assets and total
investment in assets. A business enterprise should use its current assets
effectively and economically because it is out of the management of these
assets that profits accrue. A business will end up in losses if there is any lack
in managing the assets to the advantage of business. Investment in fixed
assets being inelastic in nature, there is no elbow room to make amends in
this sphere and its impact on profitability remains minimal.
Page | 48
Working Capital Loans
This ratio shows the extent of trade credit granted and the efficiency
in the collection of debts. Thus, it is an indicative of efficiency of trade
credit management. The lower the debtors to sales ratio, the better the trade
credit management and the better the quality (liquidity) of debtors. The
lower debtors mean prompt payment by customers. An excessively long
collection period, on the other hand, indicates a very liberal, ineffective and
inefficient credit and collection policy.
Page | 49
Working Capital Loans
Page | 50
Working Capital Loans
#
Committee’s related to working Capital
# Tandon Committee
# Chore Committee
# Nayak Committee
Like many other activities of the banks, method and quantum of short-
term finance that can be granted to a corporate was mandated by the Reserve
Bank of India till 1994. This control was exercised on the lines suggested by
the recommendations of a study group headed by Shri Prakash Tandon.
The study group headed by Shri Prakash Tandon, the then Chairman
of Punjab National Bank, was constituted by the RBI in July 1974 with
eminent personalities drawn from leading banks, financial institutions and a
wide cross-section of the Industry with a view to study the entire gamut of
Bank's finance for working capital and suggest ways for optimum utilization
of Bank credit. This was the first elaborate attempt by the central bank to
organize the Bank credit. The report of this group is widely known as
Tandon Committee report. Most banks in India even today continue to look
at the needs of the corporate in the light of methodology recommended by
the Group.
Page | 51
Working Capital Loans
Page | 52
Working Capital Loans
balance current assets should be financed out of the long term funds plus
term borrowings.
On reviewing the monetary and credit trends for the business session
of 1978-79, the RBI felt the extensive use of case credit system was a
deterrent factor in implementing the credit regulatory measures by the banks.
The Tandon committee had recommended the bifurcation of credit limits
into a deemed and a fluctuating cash credit component. But implementation
of this recommendation was very slow. The Reserve Bank therefore thought
that this problem needed a deep study and a decision was taken to entrust the
work to a working group. Accordingly a working group to review the system
of cash credit constituted in April 1979 under the chairmanship of Shri. K.
B. Chore, chief officer DBCOD reserve bank of India.
Recommendations:
The committee submitted its final report in August 1979. The major areas
covered by there commendations are
# Use different types of advances, cash credit, and loan and bills all
types to continue.
Page | 53
Working Capital Loans
# Bifurcation of cash credit limit into demand loans and fluctuating cash
credit portions not favored because:
∗ 1. For seasonal industries is too much; for sales season period
the account may be in credit in which case the loan portion
should be nil.
∗ For non-seasonal industries the difference is too narrow to be of
any help to the banks
# Separate limits to be granted for peak level an d non peak level credit
requirements.
# All borrowers (except sick units) with working capital requirements of
rupees ten lakhs and above to be placed under second method of
lending by the Tandon committee.
# The flow of information from borrower to banks to be simplified.
# Bank to take up financing a portion of raw materials by way of
drawee bills.
Nayak Committee:
Considering the contribution of the SSI sector to the overall industrial
production, exports and employment and also recognising the need to give
fillip to this sector, a special package of measures was devised by RBI
(during April 1993) to ensure adequate and timely credit to this sector.
While doing so the recommendations of the PR Nayak committee were
taken into account. Examination of bank finance profile of working capital
to the small scale sector by the committee has revealed that this sector as a
whole received a level of working capital which was only 8.1% of the its
output. The village industries and the smaller tiny industries among them
could get working capital finance to the extent of only about 2.7% of their
output.
Page | 54
Working Capital Loans
# The banks should step up the credit flow to meet the legitimate
requirements of the SSI sector in full during the 8th 5-year plan. For
this purpose the banks should draw up annual credit budget for the
SSI sector on a bottom-up basis. Each branch of the banks should
prepare an annual budget in respect of working capital requirements
of all SSIs before the commencement of the year. Such budgeting
should cover
(a) Functioning units which already have borrowing limits with the
branch
(b) New units and units whose proposals are under appraisal and
(c) Sick units under nursing and also sick units found viable after
discussion/ feedback received from the borrowing units.
The budget should take into account, among other relevant aspects,
normal sale growth, price rise during the past year, anticipated spurt in
business etc.
Page | 55
Working Capital Loans
lac and working capital requirement upto Rs. 10 lac. The banks have
been advised to adopt this approach.
Page | 56