Borrower's Requirement Of Bank Finance

In practice, when a borrower approaches the bank for financial assistance and announces the project which he is going to get interested in, the lender should prepare himself to certain specific aspects as indicated below.

Generally the borrowers have a tendency to highlight only the merits of the project so as to convince the lender to take a favorable decision. For example, a borrower intending to manufacture a pen-set used as a complimentary item would indicate that there is ample scope for the product proposed to be manufactured. He would further indicate that while the cost of manufacture would be around Rs.20/- per set, there would be ready market to sell them at a price not less than Rs.40/-, leaving sizeable margin of profit. He would go on to indicate that even if the input costs go up by 25% to 50%, he would be left with a profit of not less than 25%. A term loan of Rs.5 lacs or Rs.10 lacs asked for would be optimistically made out to be repaid within 3 years and yet on the safe side, he would ask for a 5 year repayment period to provide for marginal fluctuation in demand. Any attempt to cross check with the facts made out would be vehemently resisted by the borrower emphasizing repeatedly what he has been saying.

Under the circumstances like this, every banker should endeavor to get detailed information before accepting the rosy profit projections made out by the applicant, which according to him are too obvious to be further verified. It is here that we should mobilize experience and expertise to collect the relevant information. During the initial processing of the proposal, the lending banker should ascertain the critical areas of the proposal and visualise what are the weaknesses in the proposition.

Most business concerns depend largely on bank finance for their working capital needs. The amount of working capital needed depends upon a number of factors. It would be necessary to ascertain the quantum of working capital required based on the industry's needs, the type of raw materials used - their value, availability and their input in terms of percentage to total sales value and the approximate profit margin with depreciation added back (since depreciation as part of tax-benefit can be reckoned as total profit).

Some industries are predominantly raw material based, some industries are predominantly labor based and some others are overheads based. Some industries, strangely, are fuel based. For instance, calcium carbide and charge-chrome manufacturing units are power intensive. Unless, the lending banker has some reasonable knowledge of the basic factors, he is likely to accept the borrower's statement, and would make a mistake.

If the raw materials used are basically not valuable to form security such as air and water as in the case of a soda manufacturing unit or oxygen manufacturing unit, it is at this stage of understanding itself, the lender should plan for seeking adequate collaterals.

Given below are some of the type of industries having different composition of inputs viz, basic raw materials and other costs of production including administrative and other expenses, and margin of profit.

Type of industry	Value of raw material consumption	Raw material consumption	Other costs	Profit Margin
1. Gold ornament manufacture	Predominant	90	5	5
2. Chemicals, automobile ancillaries	Fairly sizeable	65	25	10
3. Heavy Engineering Ship Building	Average	40	40	20
4. Tiles, Earthenware and Curies manufacture	Insignificant	15	70	15
5. Mining	Negligible	5	85	10

The above examples may give reasonable indication of the requirement of working capita! and the purpose for which it is likely to be expended. Besides, the nature of activity and the production cycle, the scarce availability or otherwise of the raw materials will determine the number of months holding of such current assets. Having a fairly reasonable knowlege of these, would help the lender to properly evaluate the borrower's requirements when the application for working capital assistance in a structured format is received.

Estimating working capital requirements:

In a manufacturing unit, working capita! is required to finance the holding of current assets such as raw materials, work-in-process, finished goods and receivables. The overall requirement of working capital is not common to industries in general and to their size whether they are in the small scale or medium scale sector.

There are industries which are predominantly raw material based or having long process time or inventory holding of large inventory of finished goods or having the need to extend fairly large credit period depending upon the prevailing trade practice.

A few examples are given below to indicate the factors which determine the quantum of working capital.

1. Nature of business

There are businesses in which working capital needed is small in relation to the amount required for investment in fixed assets. On the other hand, there are businesses which require large working capital in comparison with fixed capital. Businesses engaged in selling their services like public transport and hospitals operate mainly on cash basis and they have little need for working capital In the case of trading and manufacturing concerns, the holding of current assets represents a major investment so that they are expected to make a greater use of working capital. A banker should bear in mind that amount of working capital should be appropriate to the type of business.

2. Envisaged level of activity

The levei of activity which a business enterprise proposes to achieve, determines to a large extent, the quantum of working capita! requirement. Market analysis has to be done on the assumptions of the level of activity made by the borrower. A medium scale unit which embarked on the manufacture of vernier-calipers for the first time in India found that it could not compete in quality and price with the imported instruments. There are several products for which market cannot be assessed easily. For instance, the market for perfumes cannot be assessed easily and their marketability can only be determined mainly or, the basis of the selling arrangements made by the manufacturer.

3. Size of the enterprise

A small business would require lesser amount of working capital than a large business engaged in the same fine. For instance, the working capital requiement of an exporter of marine products having small orders will be lesser than that of an exporter in the same line having large orders.

4. Fluctuations in the supply of raw materials

Certain units have to obtain and maintain large stocks of raw materials due to their irregular source and intermittent supply. For an industrial unit engaged in the manufacture of industrial valves requiring a special kind of steel as raw material, there are only one or two sources of supply in the U.K. The unif has to order supplies well in advance of their actual use and a large quantity has to be stored by the unit to ensure uninterrupted production. In such cases adequate working capital is needed by the unit for building up the reserves of raw material.

5. Rapidity of Turnover

The quantum of working capital is dependent to a large extent on the speed with which sales are effected. If a business enterprise has to carry a large siow-moving stock, it must have a larger investment in working capital than a business enterprise whose turnover is quick. Some of the heavy engineering industries have to compulsorily hold slow moving finished goods necessitating large investment in working capital.

6. Length of the processing period or merchandising cycie

In a manufacturing operation, when the raw materials have to be carried for a considerable time in the processing stage, the unit has to maintain a large investment in working capital than in industries in which the processing period is shorter (e.g. manufacture of transformers for Electricity Boards). Similarly, the larger the merchandising cycle i.e., from cash to inventory to sales to receivables to cash, the greater the need for working capital.

7. Impact of seasonal variations

The working capital needs of seasonal industries like sugar and tea, fluctuate in tune with the season. They have to concentrate their production within a very short period of the year, while the sales and deliveries are spread throughout the year. As a result, larger amount of working capital is needed as compared to those businesses wherein operations are carried out throughout the year with part of the working capital needs being met from day to day sales.

8. Terms of purchase and sale

If long periods of credit are allowed to customers, a large amount of working capital will get tied up in receivables. Under such conditions, the need for working capital would be more, in the absence of similar facilities being availed of from the suppliers on the purchases made. However, the period of credit allowed to the buyers should be in tune with the market practice.

Having reasonably estimated the borrower's requirement of working capital, it is the responsibility of the lending bank to ensure how much of the estimated working capital is to be financed by the bank and by the borrower. The borrower's share represents not only his stake as capital but also the profit retained in the business and that portion of the long term funds such as term loan, unsecured loan, subsidy etc. set apart for part-financing the working capital. It should also be noted that market credit and other undercharged liabilities also part- finance the working capital requirement. That portion of the working capital required to be financed by the borrower's stake and residuary long term sources often determine the margin provided for the bank's working capital finance. Therefore, while stipulating margin for working capital, we should not only have in view the borrower's stake representing the margin, but also the rationale' behind stipulating it.