ENTERPRISE SUNIL CHAWLA BIRD, LUCKNOW B I R D 5/30/2014 2 Credit important for development ? CREDIT Establishment of Enterprises Running of Enterprises Investment / Block Capital Working Capital + Productive Unit 5/30/2014 3 BLOCK CAPITAL Capital required for acquisition and maintaining durable assets necessary for enterprises
Source of funding - MT/LT loans from FIs and equity capital of entrepreneurs
Needed for New units & Existing units - expansion & modernization 5/30/2014 4 BLOCK CAPITAL - Components Land and land development - cost of purchased land or imputed value of owned land upto margin required can be considered Construction of workshed, godown, marketing outlet, amenities, etc. Plant and Machinery Equipment & tools Cost of technical upgradation, knowhow, engineering fee, etc. Transport Vehicle Preliminary & pre-operative expenses Project formulation & consultancy, etc. 5/30/2014 5 WORKING CAPITAL - DEFINITION Working Capital is defined as
the capital required for maintaining optimum level of current assets 5/30/2014 6 IMPORTANT CONCEPTS CURRENT ASSETS : Assets which can be converted into cash within an accounting year viz. Cash, short term securities, sundry debtors, bills receivable, stock/inventories CURRENT LIABILITIES : Claims of outsiders expected to mature for payment within an accounting year viz. short term borrowing, sundry creditors, bills payable statutory liabilities, term loan installment. 5/30/2014 7 Current Assets Cash and bank balance Investments Raw material and components used in manufacturing and those in transit Stock in process Finished goods including those in transit Other consumable spares Advance payment of tax Pre-paid expenses /advance payments Receivables arising out of sales/fixed assets,etc. 5/30/2014 8 Current Liabilities Short term borrowings including bills purchased and discounted Unsecured loans Public deposits maturing within a year Sundry creditors for RM, consumable stores and spares Deposits from dealers, selling agents, etc. Installment of term loan, deferred payments payable within a year Statutory liabilities viz. provident fund, provision for taxes, sale tax, etc. Miscellaneous current liabilities viz. dividend, any payment payable within a year CURRENT RATIO Current Ratio : CA / CL Helps to measure liquidity and financial strength Higher ratio indicates better liquid position Desirable current ration is 2 :1 i.e. even if the current assets reduce to half, even then current liabilities could still be paid. Ratio below 1.33:1 generally not considered acceptable Limitation of Current Ratio applied at a single point of time. Doesnt take into account revolving nature of CAs & CLs
5/30/2014 9 ACID TEST RATIO OR QUICK RATIO Acid Test Ratio: Quick Assets / Current Liabilities Quick Assets = Current assets (-) Inventories Inventories excluded since they are not so liquid Stringent measure of liquidity & shows ability of enterprise to pay its obligations without relying on sale and collection of inventories. Quick Ratio below 1 : 1 is considered unsatisfactory
5/30/2014 10 5/30/2014 11 INFLUENCING FACTORS FOR WORKING CAPITAL Nature of business Seasonality of operations Production policy Market conditions Conditions of supply of raw materials 5/30/2014 12 DANGERS OF INADEQUATE WORKING CAPITAL Difficult to implement operating plans & achieve profit target
Operating inefficiency creeps in
Fixed assets are not used efficiently- deteriorating firms profitability
Firm loses reputation - short term obligations not honoured 5/30/2014 13 DANGERS OF EXCESSIVE WORKING CAPITAL Diversion for long term assets
Unnecessary accumulation of inventories and current assets
Indication of defective credit policy
Makes management complacent- managerial inefficiency
Tends to make speculative profits grow. 5/30/2014 14 SOME IMPORTANT TERMS GROSS WORKING CAPITAL Is the Firms Investment in Current Assets
Focus on how to optimise investment in current assets to avoid over/ under financing. Also how should current assets be financed.
5/30/2014 15 NET WORKING CAPITAL
NET WORKING CAPITAL = CURRENT ASSETS CURRENT LIABILITIES
Also Called as LIQUID SURPLUS
Indicate liquidity position of the unit.
5/30/2014 16 SPONTANEOUS/ OTHER CURRENT LIABILITIES
Represent CURRENT LIABILITIES arising spontaneously from the functioning of the unit
It include sundry creditors, bills payable, provision for expenses, outstanding expenses, etc.
Does not include bank borrowings. 5/30/2014 17 WORKING CAPITAL GAP
WORKING CAPITAL GAP = CURRENT ASSETS - OTHER CURRENT LIABILITIES
Only a PORTION of the WORKING CAPITAL GAP needs to be considered for BANK FINANCING
5/30/2014 18 ASSESSMENT OF WORKING CAPITAL - Methods Balance Sheet Method Tandon Committee Method Turnover Method (Nayak Committee Method) Operation Cycle Method Cash Flow/ Budget Method 5/30/2014 19 1- BALANCE SHEET METHOD LIABILITES ASSETS CURRENT LIABILITIES SUNDRY CREDITORS, BILLS PAYABLE, PROV.FOR EXP. O/S EXPENSES CASH, MARKETABLE SECURITIES CURRENT ASSETS SUNDRY DEBTORS BANK BORROWING STOCK LONG-TERM LIABILITIES DEBNTURES BONDS SECURED LOANS N ET BLOCK (Gross block-Depreciation) Plant & Mach, Land & Building, etc FIXED ASSETS LONG TERM INVESTMENTS NET WORTH NET WORTH PREPAID INSURANCE , TAXES receivable, RENT receivable, INTEREST receivable, NON- CONSUMABLE STORES OTHER NON CURRENT ASSETS (receivable after one yr) 5/30/2014 20 2 -TANDON COMMITTEE Appointed by RBI in July 1974 to suggest guidelines for RATIONAL allocation and OPTIMUM utilization of BANK CREDIT
Cheap Credit available from BANKS was used to Build-up Disproportionate Stocks of raw materials to realise TRADING PROFITS 5/30/2014 21 TANDON COMMITTEE Double Financing from BANKS and Trade CREDITORS
Limits Increased whenever INVENTORY & RECEIVABLE levels went up
Diversion of BANK FUNDS to FIXED Assets, Investments 5/30/2014 22 TANDON COMMITTEE - recommendations Borrowers to draw Operating Plans- Submit to Banker Only REASONABLE part of WORKING CAPITAL Requirement to be financed by BANKS Bank Finance to be based on future requirement of current assets for next one year. INVENTORY & RECEIVABLE Norms for 15 industries excluding HEAVY ENGG.& HIGHLY Seasonal Industries like SUGAR were Suggested by TANDON COMMITTEE 3 Methods for Computing MAXIMUM PERMISSIBLE BANK FINANCE Suggested. 5/30/2014 23 MAXIMUM PERMISSIBLE BANK FINANCE- I METHOD Borrower to contribute 25% of WORKING CAPITAL GAP (from own fund and/or term loan), Remaining 75% can be financed from Bank Borrowings. To be used for new units, sick units and units going for modernization and diversification 5/30/2014 24 MAXIMUM PERMISSIBLE BANK FINANCE- I METHOD Particulars Rs. Current Asset 100 OTHER CURRENT LIABILITIES (excluding bank borrowings) 20 WC Gap 80 Borrowers contribution 25% of WCG (To come from long term funds i.e. owned funds and term borrowings) 20 Permissible Bank Finance 60 5/30/2014 25 MAXIMUM PERMISSIBLE BANK FINANCE- II METHOD
Borrower to contribute 25% of TOTAL CURRENT ASSETS, Remaining of WORKING CAPITAL GAP can be bridged from Bank borrowings. To be used for existing units 5/30/2014 26 MAXIMUM PERMISSIBLE BANK FINANCE- II METHOD Particulars Rs. Current Asset 100 OTHER CURRENT LIABILITIES (excluding bank borrowings) 20 WC Gap 80 Borrowers contribution 25% of CA (To come from long term funds i.e. owned funds and term borrowings)
25 Permissible Bank Finance 55 5/30/2014 27 MAXIMUM PERMISSIBLE BANK FINANCE-III METHOD
Borrower to contribute 100% of CORE CURRENT ASSETS & 25% of Balance CURRENT ASSETS.
The remaining portion of WORKING CAPITAL GAP can be met from BANK BORROWINGS.
This method will further strengthen the CURRENT RATIO. RBI did not accept it. 5/30/2014 28 Maximum Permissible Bank Finance (MPBF) by Tandon committee- Summary Method 1: MPBF = 0.75 (CA- OCL) =0.75 (WCG)
Method 2: MPBF = 0.75 (CA) OCL
Method 3: MPBF = 0.75 (CA-CCA) - OCL
5/30/2014 29 3- TURNOVER METHOD OR NAYAK COMMITTEE METHOD APPOINTED BY RBI IN 1991 TO EXAMINE DIFFICULTIES FACED BY SSIs FOR SECURING FINANCE
SUITABLE ARRANGEMENTS FOR ENSURING ADEQUATE FLOW OF INSTITUTIONAL CREDIT FOR WORKING CAPITAL & TERM FINANCE TO SSI SECTOR 5/30/2014 30 TURNOVER METHOD OR NAYAK COMMITTEE METHOD MODIFICATIONS/ RELAXATIONS IN NORMS OF TANDON COMMITTEE
METHODS TO MINIMISE DELAY IN REALISATION OF BILLS
CHANGES REQUIRED IN PRESENT GUIDELINES FOR REHABILITATION OF SICK UNITS. 5/30/2014 31 TURNOVER METHOD OR NAYAK COMMITTEE METHOD VILLAGE INDUSTRIES RECEIVE SUBSTANTIALLY LOWER CREDIT THAN TINY AND SSI UNITS
WORKING CAPITAL ASSISTANCE TO VILLAGE & SMALLER TINY UNITS ALMOST NON-EXISTENT 5/30/2014 32 TURNOVER METHOD OR NAYAK COMMITTEE METHOD DELAYS IN SANCTION OF CC LIMITS
LONG WAIT FOR INCREASE IN WORKING CAPITAL LIMITS
BRANCH MANAGERS TO HAVE RIGHT APTITUDE, SKILLS AND ORIENTATION 5/30/2014 33 3) TURNOVER METHOD OR NAYAK COMMITTEE METHOD Working capital requirement assessed at 25% of the annual turnover Bank finance to be 20% of the projected annual turnover To satisfy about reasonableness of the projected turnover on the basis of actual financial statements or any other documents such as return filed with sales tax/ revenue authorities and ensure that estimated growth is achievable. Mostly used for trading companies
STEPS IN WORKING OUT TURNOVER Step 1 - Validate projected gross sales in the light of past trends and future prospects Step 2 Compute working capital gap (25 % of the projected turnover / sales) Step 3 - Calculate margin money (5% of the projected turnover/ sales) Step 4 Calculate W.C. ( 2 minus 3)
5/30/2014 34 5/30/2014 35 4 -OPERATING CYCLE Operating cycle may be described as the duration required to convert resources into inventories, inventories into sales & sales into cash In other words - cash to cash 5/30/2014 36 OPERATING CYCLE CASH RAW MATERIALS WORK IN PROGRESS FINISHED GOODS SUNDRY DEBTORS 5/30/2014 37 OPERATING CYCLE These phases affect cash flows which most of the time are neither synchronised nor certain
First CASH OUTFLOWS then CASH INFLOWS 5/30/2014 38 Operating Cycle - Manufacturing Conversion of Cash to RM Conversion of RM to stock in process Conversion of stock in process to finished goods Conversion of finished goods into receivables Conversion of receivables into Cash 5/30/2014 39 Operating Cycle - Trading Conversion of Cash into inventories Conversion of inventories into receivables Conversion of receivables into Cash 5/30/2014 40 Operating Cycle - Services Conversion of Cash into services Conversion of services into receivables Conversion of receivables into Cash 5/30/2014 44 OPERATING CYCLE AN EXAMPLE Time to acquire raw material - 45 days
Conversion process time - 15 days
Storage time of finished goods - 10 days
Collection period of receivables - 20 days TOTAL 90 DAYS NO. OF OPERATING CYCLES= 360/90=4 5/30/2014 46 ASSESSMENT OF WORKING CAPITAL REQUIREMENTS Compute Net Operating Cycle
From this calculate Working Capital Turn-over Ratio (WCTR): WCTR = No. of Working Days in a Year No. of Days in 1 Operating Cycle