Assessment Of Working Capital

In the past, in our country, for Commercial Banks, the basis of granting credit was security oriented. The borrowers were granted working capital limits against the security by way of hypothecation/pledge of stocks and the borrowers were allowed to draw funds freely within the limits sanctioned. Depending upon the strength and bargaining powers the borrowers could get more credit from the banking system than what was actually required to meet the working capital needs. The Dehejia Committee constituted in October 1968 to study the problems of inflation of the credit needs of trade and industry observed that the cash credit system of financing led to diversion and misuse of short-term funds of banks for acquisition of non-current assets and increase the dependence on bank finance still further, quite out of proportion to the increase in production and sales. In order to have a permanent solution for monitoring industrial advances, Reserve Bank of India, in July 1974, appointed a study Group, headed by Shri. P.L Tandon to frame guidelines for follow-up of bank credit.

Major Recommendations of Tandon Committee

Norms for inventory/receivables

The committee suggested norms for holding inventories and receivables for 15 industries which claim a major share of bank credit. (Subsequently, RBI from time to time prescribed norms for various other industries)

Approach to Lending

For arriving maximum permissible bank finance to meet the working capital gap, the committee suggested three alternative methods. These methods were suggested in order to progressively improve and strengthen the current ratio.

(Rs. in lacs)

Under Method I the borrowers will have to contribute a minimum of 25% of working capital gap from long term sources which will give minimum current ratio ranging from above 1 to 1.33:1. Under Method II, 25% of total current assets will have to be provided from long term sources in order to give a current ratio of 1.33:1. The borrower's contribution from long term sources under Method III should be to the extent of entire core current assets (minimum level of current assets which is required to be held for maintaining a given level of production) and a minimum 25% of the total current assets excluding core current assets (R.B.I, accepted Method I and Method II only).

Post-sanction follow-up of bank credit

The committee prescribed certain forms to be obtained from the borrowers on quarterly basis for effective monitoring and supervision by banks.

Major Recommendations of Chore Committee

In order to exercise continued restraint in further expansion of credit, Reserve Bank of India constituted another committee in April 1979 under the chairmanship of Shri. K.B. Chore to review the system of cash credit and credit management policy pursued by the banks. The major recommendations of the committee are given below.

Enhancement of borrower's contribution

All borrowers (except sick units) having working capital limits of Rs.50 lacs and over from the banking system must be placed under second method of lending, recommended by the Tandon committee, which gives a current ratio of 1.33:1. In cases where the borrowers are not in a position to conform to second method of lending, the excess borrowing should be converted into working capital term loan which should be made repayable within a period not exceeding 5 years.

Encouragement of Bill finance

Borrowers must be encouraged to seek credit through bills rather than book debts. Advances against book debts should be converted into bill finance, wherever possible.

Introduction of drawee bill finance

Atleast 50% of cash credit limit against raw materials to manufacturing units whether in the public or private sector should be extended by way of drawee bills only. To start with, this was introduced by RBI to borrowers having aggregate working capital limits of Rs.50 lacs and above from the banking system.

Separate limits for peak-level and normal non-peak level periods in respect of seasonal industries

The banks should fix separate limits for peak-level and normal non-peak level in respect of seasonal industries indicating the periods during which the separate limits would be utilised by the borrowers.

Adhoc or temporary limits

Adhoc or temporary limits should be discouraged. However, this may be granted to meet unforseen contingencies. But such limits should be considered carefully and should be provided through a separate demand loan or 'non-operable' cash credit account.

Regulation of drawings through quarterly statements

The borrower should indicate the quarterly requirement of funds in that quarter before the commencement of the quarter. The drawal of funds within the sanctioned limits should be regulated through quarterly statements. The submission of quarterly Information System (QIS) statements is compulsory in the case of borrowers having working capital limits of Rs.50 lacs and above from the banking system.

Trade and Industry had been representing that the norms prescribed by Reserve Bank of India for bank lending for working capital purposes (mainly based on Tandon Committee and Chore Committee recommendations) had become outdated in the changing economic scenario and needed immediate review. Accordingly, Reserve Bank of India constituted a committee in January 1993, under the chairpersonship of Ms.l.T. Vaz, to review the need for continuing to determine the quantum of credit for a borrower based on norms for holding of inventory/receivables as also allocation of credit to industry by fixing maximum permissible bank finance based on such norms. Based on the committee's report, Reserve Bank of India has issued revised guidelines which are summarised below.

Norms for inventory/receivables

Banks can decide the levels of holding of each item of inventory as also of receivables, which in their view would represent a reasonable build-up of current assets for being supported by bank finance. Reserve Bank of India will not prescribe detailed norms for inventory/receivables; it would only advise the overall levels of inventory and receivables for different industries for the guidance of banks to serve as broad indicators. Banks may also consider evolving suitable internal guidelines for accepting the projections for 'sundry creditors (goods)'. These guidelines would apply to all borrowers enjoying aggregate working capital limits of Rs.1 crore and above from the banking system.

Method of lending

The working capital facilities for borrowers enjoying aggregate fund based working capital limits of less than Rs.1 crore from the banking system should be computed on the basis of a minimum of 20% of their projected annual turnover. The banks should ensure maintenance of minimum margin of 5% of the annual turnover of such borrowers as margin money.

Sanction of aggregate fund-based working capital limits of Rs. 1 crore and above from the banking system would be subject to the second method of lending so as to ensure a minimum current ratio of 1.33:1. The following credit facilities will be exempt from the application of second method of lending.

(a) Export oriented units need not bring in any contribution from long term sources towards financing that portion of current assets as is represented by export receivables.

(b) Additional credit needs of exporters arising out of firm orders/confirmed letters of credit (and which were not taken into account while fixing the regular credit limits) should be met in full.

(c) Borrowing units marketing/trading exclusively (100%) the products and merchandise manufactured by village, tiny and SSI units will be subject to method of lending provided dues of such village, tiny and SSI units have been settled by them within 30 days from the date of supply. This relaxation is also available to that portion of marketing business relating to products of village, tiny and S.S.I, units, in cases where borrowing units also market products of M.L.I, units and or having manufacturing activity of their own.

(d) Sick/Weak units under rehabilitation.

Adhoc limits

Banks themselves should decide the quantum as also period of any adhoc credit facilities based on their commercial judgement and merits of individual cases. It will not be mandatory to charge additional interest of 1% over and above the normal rate of interest for sanction of adhoc limits.

Quarterly Information System

Banks must obtain from all borrowers enjoying aggregate fund-based working capital limits of Rs. 1 crore and more from the banking system, the statements prescribed under the Quarterly Information System. (In our bank, we are continuing with the existing practice of getting QIS statements from all borrowers enjoying aggregate fund based working capital limits of Rs.50 lacs and above)

The working capital assessment is made based on the projected figures for the ensuing year as determined by the borrower's business plan. The projected figures are furnished in the projected financial statements viz. Operating statement, Balance-sheet and Fund-flow statement. (The borrowers are required to submit the projected financial statements in CMA forms.)

The operating statement is the starting point in the assessment of working capital requirement. The assumptions made for future production/sales form the key figures in the preparation of operating statement. As the projected levels of production/sales, determine to a great extent, the quantum of working capital requirement, the banker should examine whether they are capable of being achieved. He should enquire whether the following factors have been taken into consideration while arriving the assumptions of future production and sales.

Internal factors

(1) Past trends in production/sales

(2) Extent of installed and available production capacities

(3) Availability of raw materials, labour, power supply, etc.

(4) Competitive strength of the borrower

(5) Pricing policy of the management

(6) Competition from substitutes

(7) Research, renovation and development

External factors

(1) Economic factors like demand for the product, import restriction, changes in the overall economic situation and national economic condition.

(2) Other external factors like change in fashion, Monsoon conditions, Nature of harvest and Government policies, controls and regulations.

After being satisfied with the validity of the assumptions of future production and sales (both in terms of quantity and value), the bankers has to examine how the projections have been made of the various components of cost of sales. In this connection, computation of the following ratios will be helpful to see how they compare with the past trends and also with the similar units in the same industry.

(1) Raw materials consumption to cost of production

(2) Power and fuel to cost of production

(3) Direct labour to cost of production

(4) Repairs and Maintenance to cost of production

(5) Interest to Net Sales

(6) Selling, general and administrative expenses to Net Sales

(7) Gross profit to Net Sales

(8) Operating profit to Net Sales

(9) Net profit before tax to Net Sales

(10) Net profit after tax to Net Sales

(1) Raw-materials:

The holding period of Raw-materials is mainly dependent on the lead time involved in the procurement and the quantity required to ensure uninterrupted production.

(2) Work-in-progress :

The holding period of work-in-progress is dependent on the length of the production cycle i.e., from the time Raw-materials are issued and till the finished goods are ready for despatch.

(3) Finished goods :

The holding period of finished goods is dependent on the length of sales cycle i.e., the period of time finished goods have to be kept in the ware-house before sales.

(4) Receivables:

The holding period of receivables is dependent on the period of credit extended to the customers.

The holding periods of inventories and receivables, as discussed above, are expressed in relation to months' holding. The method of computation of their holding periods is given below :

(1) Raw-materials :

The value of Raw-materials as reflected in the balance-sheet is related to be consumption of Raw-materials as observed in the operating statement and expressed as equivalent to so many months consumption. The value of annual consumption of Raw-materials divided by 12 will give the value of average monthly consumption. The value of Raw-materials divided by the average monthly consumption will give the holding period in terms of so many months consumption. If the annual consumption of Raw-materials is Rs.24 lacs and the value of Raw-materials is Rs.6 lacs, the holding period of Raw-materials is 3 months consumption.

(2) Work-in-progress:

The value of cost of production indicated in the operating statement divided by 12 will give the value of average monthly cost of production. The value of work-in-progress as given in the balance-sheet divided by the average monthly cost of production will give the holding period on terms of so many months cost of production.

(3) Finished goods :

The value of cost of sales indicated in the operating statement divided by 12 will give the value of average monthly cost of sales. The value of Finished goods divided by average monthly cost of sales will give the holding in terms of so many months cost of sales.

(4) Receivables:

The value of gross sales turnover indicated in the operating statement, divided by 12 will give the value of average monthly gross sales. The value of receivables divided by average monthly gross sales will give the holding period in terms of so many months gross sales.

The last step is computation of Maximum Permissible Bank Finance. As indicated above, the sum total of projected current assets is the working capital requirement of the borrower. Other current - liabilities which have been projected by the borrower, such as creditors for purchases, advances from customers, accrued expenses and provision for taxation, represent an external source of financing the working capital requirement. Excess of total current assets over other current liabilities determines the working capital gap. This gap is to be financed partly by Net working capital and partly by bank borrowings. The Net working capital represents borrower's contribution from long term sources (the excess of Tangible Net worth and long term liabilities over Net fixed assets and non-current assets). As per the revised guidelines of Reserve Bank of India, the Second Method of lending is applicable with certain exceptions as indicated in paragraph 3.3.2 to borrowers enjoying fund-based working capital limit of Rs.1 crore and above from the banking system. Under the Second Method a minimum of 25% of the Total current assets must be financed from Net working capital i.e., out of long term sources. From the working capital gap 25% of Total current assets or projected Net working capital whichever is higher is deducted to arrive at the Maximum Permissible Bank Finance.

The projected fund flow statement is examined to ensure that there is no diversion of short -term funds affecting the Net working capital position and to verify that the long term uses of funds are covered by long term sources of funds.

CONCLUSION :

We have furnished case studies involving assessment of working capital relating to Medium and large Industry (MLI) small scale industry (SSI) and Trade sector. These case studies may be gone through by the readers in order to understand and appreciate the critical aspect of working capital assessment for the three sectors.

The case study on SSI sector also contains the details regarding recent policy changes as well as the environment in which SSI units operate

ABC Ltd. incorporated in 1970 is engaged in manufacture of bicycle and automobile tubes and tyres. The company enjoys credit facilities from a consortium of banks led by XYZ Bank.

The installed capacity of the Company is

The performance of the Company, hitherto was satisfactory. The advances given to ABC Ltd. have been classified as performing and standard under Income Recognition and Asset classification norms.

The working capital facilities extended to the company during 92-93 and that requested for 93-94 are given below:

(* of which fresh 90 days DALC would be Rs.300 lacs)

The company has submitted its CMA data for enhancing the existing credit facility for the year 1993-94 which is reproduced below :

ASSESSMENT OF WORKING CAPITAL REQUIREMENTS FORM II : OPERATING STATEMENT

Name : ABC Ltd.

FORM III ANALYSIS OF BALANCE SHEET

Name : A B C Ltd.

FORM IV

COMPARATIVE STATEMENT OF CURRENT ASSETS & CURRENT LIABILITIES

Name: ABC Ltd.

FORM V

COMPUTATION OF MAXIMUM PERMISSIBLE BANK FINANCE FOR WORKING CAPITAL

Name: ABCTtd,

FORM VI FUNDS

FLOW STATEMENT

Upon receipt of the above CMA data and on its scurtiny, the most striking feature observed is the estimated fall in net sales and almost double of the existing working capital limit requested for the next year. The following queries are raised by the bank, on the CMA data submitted by the Company.

1. An increase of 2.71 % over last year only is envisaged in domestic sales turnover during 1993-94. Also there is a fall in export turnover by 50%. Please clarify, under such estimated turnover, why a steep increase in bank borrowing is requested?

2. When the estimated turnover is projected at a lower level, what is the extent to which the installed capacity would be kept idle?

3. An increase is estimated in power cost during 1993-94 though production druing the year would be less. Please advise the reason.

4. Export trunover estimated is less by 50% during 1993-94 whereas export incentives receivable are indicated at a higher level. Please clarify.

5. Fixed assets are estimated to increase by Rs. 1053 lacs during 1993-94. Term liabilities are estimated to increase only by Rs. 188 lacs. Please advise the balance source of funds to meet the acquisition of fixed assets.

6. The company has requested for fresh DALC limit of Rs. 3.00 crores additionally during the year. It is not clear from the CMA data submitted whether the goods received under DALC have been reflected in the sundry creditors level. Please advise us the details.

7. Though domestic sales is estimated to increase by 2.7% (which is meagre) operating profit is less by almost 50%. Please advise the reasons for the same.

8. Please advise the reason for higher holding of raw materials, stock in process and finished goods.

9. Actual holding level of receivables has gone upto 3.08 months as on 31.3.93 as against previous year's 2.26 months. Please advise the reason for projecting lower level of receivable holding at 2.44 months as on 31.3.94.

10. Estimated interest payment during 1993-94 is less as compared to earlier year though bank borrowing is estimated to increase substantially during the year. Please advise the basis of calculation of interest.

To the above queries raised by the bank, the following replies were given by the Company.

1. The company received a one time bulk order for Rs.500 lacs from Kuwait during 1992-93. While last year was a nation rebuilding year for Kuwait, it was possible to secure the order. Such a possibility to secure such huge export order during 1993-94 appears remote. Hence export sales has been estimated at Rs.529 lacs, which is in line with 1991-92 export sales.

Domestic sales are estimated to increase by 1.5% only during 93-94 for the following reasons.

a. The country is going through a recessionary phase and revival is predicted to be a slow one onty.

b. The major production of the company goes to cater to the needs of bicycle market both primary alnd secondary. The sale of bicycles during the year is not predicted to grow at a healthy rate.

c. Automobile industry is going through one of the worst recessions it has ever faced. Hence sale of automobile tyres may not increase by great extent.

2. At the proposed ievel of turnover a capacity utilisation of 68% is envisaged. Balance 32% may not be utilised considering the recessionery trend the industry is facing now.

3. There has been a steep increase in power tariff from January 93 onwards. The power bill during last two months has been atieast 30% more than earlier months though production levels had remained more or less static.

4. The export incentive receivable for the bulk order export to Kuwait is to be received during 93-94 only. The company follows cash basis for accounting the incentive receivable and not mercantile basis. Hence part of 92-93 incentives which are drawn during 93-94 are accounted for only during 93-94.

5. As stated in CMA data source of funds for acquisition of fixed assets is through issue of Debentures and increase in term deposits.

6. The break-up of sundry creditors during the period called for is given below.

The company is getting goods under LC on 90 days DA terms. Considering that there would be transit period involved, sundry creditors under DALC level of Rs.240 lacs may be accepted.

7. The profit margin in export sales during 92-93 has been almost double as that of the one earned from domestic sales due to.

a. cheaper interest rate and

b. favourable exchange rate fluctuation which the company was able to take advantage of.

The lesser export sales estimated during 93-94 as well as the increase in power cost has reduced the operating profit.

8. From the data available for Agro based agencies, it is observed that the supply of rubber the basic raw-material for the company may not meet the demand during 93-94. Hence higher holding of raw material is estimated.

Tyre manufacture consists of various process. Each process has a start up cost and would be economical only if bulk produce is put through the process. With the offtake of finished product being sluggish and is expected to take some time to revive, holding period of stock in process is estimated to be longer than previous year.

Again the recession which the industry is now going through is the reason for higher holding of finished goods.

9. A bulk order for domestic sale worth Rs.5 crores was executed during last fortnight of March '93 which had boosted the receivable level. For 1993-94, the holding level has been based on past trend and average holding level during 1992-93.

10. It is anticipated that interest rate on bank borrowings will come down substantially during 1993-94. Hence interest cost is estimated at lower level.

Based on the reply received from the company the following stand is taken by the bank.

1. The reason attributed for iow increase in sales estimated is acceptable.

2. a. There is idle capacity to the extent of 32%

b. There js a demand recession in the industry.

There seems to be no need for increasing the installed capacity by acquiring more fixed assets.

3. An analysis of fund flow statement for 92-93 and 93-94 is made as given below

It could be seen that in 1993-94, Long Term Uses were projected at Rs.1091 lacs which included acquisition of fixed assets for Rs. 1053 lacs. But long term sources were available to the extent of Rs.528 lacs only and the deficit of Rs.563 lacs was proposed to be met out of diversion of surplus short term funds. Though the Current ratio was comfortable at 1.33:1, the requested increase in working capital limits was more or less equal to the proposed diversion of funds to long term uses.

Also there is no corresponding increase in sales in line with increase in working capital requested.

With the recession anticipated to continue and idle capacity of 32% already existing coupled with above observation regarding diversion, acquisation of fixed assets need not be permitted.

4. The reason stated for increase in power tariff is acceptable.

5. The reason given for increase in export incentives is acceptable.

6. The explanation given for level of sundry creditors is acceptable.

7. The reason given for decrease in operating profit is acceptable.

8. With the anticipated increase in demand for rubber, the higher holding proposed for raw material appears acceptable. With the capacity installed being utilised only to the extent of 68%, work in process period may be longer. With the industry undergoing recession, higher holding of finished goods may also be accepted.

9. Though interest rate is anticipated to come down, bank borrowings are estimated to double. Hence the interest payable amount is required to be re-worked.

From the above it can be seen that clarification is required for points no.1, 2 and 8 and the same was conveyed to the company with a request for its officials to call on the bank to discuss the above. (Please refer circular no.4 of this series wherein the need to discuss with the borrower is explained in detail).

During the course of the discussion the following decisions were taken.

1. The company officials agreed the interest payment estimated in CMA was not correct and the interest payable by the company was calculated as follows.

2. The company officials advised the Bank that though the market was experiencing recessionary trend, with the liberalisation policy announced by Govt. and the Govt's commitment not to go back on liberalisation policy, boom conditions are expected in the market.

It was observed by the Bank, that the possibility of boom in the market may not happen in near future. Even if the market picks up immediately, it can reach its peak level only in next one or two years. The company already anticipates idle capacity of 32% during the present year. Full utilisation of installed capacity itself may take care of additional demand the market can create as a result of liberalisation policy of the Government. Hence the Company was advised to defer its plan to acquire fixed assets.

3. It was also pointed out to the Company that increase in long term sources is not in line with proposed increase in fixed assets. Such a situation may give rise to possibility of diversion of short term resources for long term uses.

The company officials assured the bank that they would never divert funds as indicated above and agreed to defer fixed assets acquisition plan.

The company officials also advised that they would defer their plan to raise funds through Debentures and Deposits as fixed assets are not to be acquired now. Bank agreed for the same.

Based on the points discussed above the Company was advised to submit its revised CMA data.

The revised CMA data submitted by the Company is given below. (Since alteration would be in the figures for the year 93-94, only the same is reproduced).

ASSESSMENT OF WORKING CAPITAL REQUIREMENTS FORM II : OPERATING STATEMENT

Name : A B C Ltd.

FORM III ANALYSIS OF BALANCE SHEET

Name ABC Ltd.

FORM IV

COMPARATIVE STATEMENT OF CURRENT ASSETS & CURRENT LIABILITIES

Name : ABC Ltd.

Quantum of instalments of term loan & DPG falling due within one year to the extent of Rs.60 lacks, is not taken as current liability, only for the purpose of arriving at Maximum Permissible Bank Finance.

FORM V COMPUTATION OF MAXIMUM PERMISSIBLE BANK FINANCE FOR WORKING CAPITAL

Name ABCLtd.

FORM VI FUNDS FLOW STATEMENT

Name : A B C Ltd.

NOTE : Increase/decrease under items 4 to 8, as also under break-up of (4) should be indicated by ( + ) (—).

Assessment of Working Capital at the Bank

(in line with office note generally prepared)

Financial Position of the Company

Comments

TNW has improved substantially during 1992-93 due to Public Issue of equity shares with premium which was fully subscribed.

The Company received a one time bulk export order during 92-93 for Rs.500 lacs from Kuwait and the possibility of repeat order is remote. Hence there is a fall in turnover estimated during 1993-94.

The operating profit and net profit estimated during '93-94 are comparitiveiy less due to following reasons.

1) increase in power tariff and

2) the profit earned in export transaction during 92-93 was substantial which is not available during 93-94. The overall financial position of the company is satisfactory.

NWC and CR of the Company are satisfactory.

The Company advised the bank of its intention to acquire fixed assets to the tune of Rs.1053 lacs. The Company was advised to defer the same due to following reasons.

1) The industry is going through demand recession and it would take a couple of years before a boom period can set in and

2) There is already an idle capacity to the extent of 32% out of the installed capacity.

Fund Flow Analysis

From the above fund flow analysis it can be seen that the increase in NWC by Rs.191 lacs is supported by long term surplus of Rs.191 lacs.

Based on the revised CMA submitted by the Company, the bank would proceed to assess the Working Capital requirements of the Company as follows.

Holding level

Calculation of Maximum Permissible Bank Finance (MPBF):-

Term loan/DPG instalments falling due within one year was net treated as current liability for arriving at MPBF while the same would be reckoned for calculating current ratio.

Hence the existing fund based facility of Rs.900 lacs only is renewed to the Company. However the Company's request for fresh 90 days DALC limit of Rs.300 lacs is sanctioned to it.

While stipulating terms and conditions the following two important aspects is to be included.

I. DALC LIMIT (as in 7 above)

The breakup of creditors level of Rs.709 lacs is as given below.

While auditing the stock statement submitted by the Company every month bank should reckon the sundry creditor level of both trade creditors and outstandings of goods received under DALC for arriving at Drawing Power (in this connection reference is also invited to our Central Office. Advances permanent circular No.548/94-95 dated 4.7.94)

II. The Company at the time of original submission of CMA data had envisaged acquisition of fixed assets which would have resulted in diversion of funds. The company subsequently agreed to defer the plan to acquire fixed assets. The monitoring of the account should specifically take into account this aspect.

We should see how the account would require to be monitored upon sanction of working capital limits through the instruments of Quarterly Information System (QIS) forms, stock statements, continuous surveillance statement etc., in future circulars in this series.

SSI sector plays a vital role in Indian economy contributing nearly 33% of country's industrial production 29.69% of India's exports and offers employment to 95 Lacs persons.

However, the mortality rate of SSI sector is very high and the causes for the same can be classified into two broad categories namely

a) Internal factors and

b) External factors.

Internal factors are generally due to inherent nature of a SSI unit and some of them are stated below.

1) SSI units are mostly partnership firms and hence have a small capital base. As a result they find it difficult to withstand any fluctuations in production/market.

2) SSI units plan their project according to the available capital. Generally capital base of SSI units is small, which restricts units capability to take advantage of any windfall opportunities due to limitaitons in margin paying capacity. Growth of SSI units is generally on a small and steady scale and

3) SSI Units in general face considerable dificulties in collecting their receivables in time. Defaults/delays in collection of receivable erodes the units profit.

External factors which influence SSI sector have both positive and negative impact on this sector. The important strengths and weaknesses / shortfall of SSI units arising due to external factors are given below

It should be said to the credit of SSI sector that it's contribution to country's overall industrial production, exports and generation of employment have been commendable. However timely availability of credit to the required extent is a major impediment to the smooth functioning and growth of SSI units. A vast majority of SSI units suffer from inadequate credit and delayed sanctions. As a resut SSI units in order to maintain continuity in production and to keep up delivery time schedule are forced at times to depend on funds, borrowed from family members and friends, money lenders and private financiers and such borrowings are always at a high cost.

Banks on their part have been doing their level best to extend financial assistance to SSI sector. To help borrowers requiring credit facilities below Rs. 50 Lacks, banks were following I method of lending so that margin requirements are less.

RBI considering the liquidity constraints faced by many SSI units, has directed recently that for credit requirements of village industries, tiny industries and other SSI units having aggregate working capital limits upto Rs. 50 lacs from banking system, the norms for inventory and receivables as also first method of lending will not apply.

Instead such units may be provided with working capital limits computed on the basis of a minimum of 20% of their accepted projected annual turnover. The SSI unit should bring in 5% of their annual turnover as margin.

The above directive of RBI has been further extended to all units enjoying working capital credit limits from the banking system to the extent of Rs. 100 lacs.

RBI had also given further directives for implementation of above schemes such as

1) Banks may satisfy themselves about the reasonableness of the projected annual turnover of the applicants on the basis of annual statement of accounts or any other documents such as returns filed with Sales Tax/Revenue authorities and ensure that the estimated growth during the year is realistic.

2) In cases where output exceeds the projections or where the intial assessement of working capital is found inadequate suitable enhancement in working capital limit should be considered.

3) End use of credit extended should be properly verified and

4) Regular and timely submission of monthly statement of stocks, receivables etc., and also periodical verification should be ensured.

While implementing the above directives of RBI the following doubts/issues requiring clarificaitons for the same may arise. Given below are some of issues and clarifications for it.

Assessment of working capital limit to an SSI unit has to be done both in

1) Traditional method (based onTandon Committee) and

2) as per revised guidelines of RBI (based on Nayak committee)

In practice it is observed that some of the borrowers are eligible for higher credit facilities when traditional method is followed and hence they prefer traditional method.

We can also come across instances of a SSI unit achieving sales as per projections and at times even exceeding it but continue to suffer from lack of net working capital (NWC) or have even negative NWC. Non availability of NWC could be due to diversion. Diversion can be classfied as external and internal. External diversion signifies drawal of funds outside the system which should not be permitted. Internal diversion establishes utilising short term funds for long term purposes like acquisation of Fixed Assets, repayment of term loan etc., Such units with internaf diversion are characterised by mismatch of funds rather than lack of it. A proper restructuring of funds available with the unit is required to set right its financial structure.

The following may illustrate the above referred mismatch of funds.

PQR ltd. has achieved the following sales (which is in line with its projections)

The Company's balance sheet-as on 31.3.92 and 31.3.93 was as given below.

Net fixed assets value of the unit has increased by Rs. 16.20 lacs, whereas term loans availed by the unit has come down by Rs. 10.20 lacs. Hence acquisation of fixed assets was possible only be utilising short term sources evidencing diversion. Further, assessment of working capital for the unit is given as an example in case study no III.

In the foregoing the relative strengths and weaknesses of a SSI unit are dealt in general. It can be seen that SSI sector has emerged as an employment generating sector as well as significnat contributory to boost India's export. However when it comes to handling its finance, SSI units suffer from inadqeuate managerial ability (as they are generally run by family members) and lack of professional management of funds resulting in funds mismatch. This often puts strain on units liquidity. Hence banks have to have a detailed discussion with the unit to understand well, its strenght and weakness and should be capable of offering in case of need, a financial package to help the unit to rectify its funds mismatach.

In this connection reference is also to be made to Credit Administration circular number 4/93 date 17.4.93.

Taking into consideration the above situation, three case studies are given below to illustrate working capital assessment.

I) In Line with latest RBI directives

II) as per traditonal method and

III) for a unit which suffers from lack of NWC, though performance otherwise is satisfactory.

XYZ Ltd. is a SSI unit engaged in manufacture of tools and Dyes for machinery manufacturers. Established in 1980, the unit is enjoying working capital facilities from A Bank. The dealings of the company with A Bank is satisfactory. The company was keeping up its commitments in general though delays upto tolerable extent were noticed at times.

The company has submitted its CMA data and has requested for renewal / enhancement of working capital facilities enjoyed by it. The company has also requested to consider its request under revised guidelines of RBI for assessing working capital requirements.

The performance of the company during last three years was as given below

The company has submitted its CMA data with actuals for 1993-94 and estimates for 1994-95 as detailed below.

The company in line with latest RBI guidelines has requested for fund based working capital facility of Rs. 26.40 lacs.

The company at present is enjoying fund based working capital facility of Rs. 17.00 lacs.

Working Capital Assessment

1. The projected turnover for 1994-95 shows an increase of 17.33% over previous year. The company has put up a second unit in its existing premises with assistance from state financial coroporation. With the increase in capacity installed, it could be possible for the company to achieve the projected sales.

2. The level of NWC has been estimated at Rs. 14.25 lacs.

Working Capital Assesment

(The estimated level of total current assets and other current liabilites of the company are as given below)

I. As per traditional method

II. As per revised guidelines of RBI

NWC is more than the required Rs.6.60 lacs by Rs.7.65 lacs (14.25 - 6.60). Hence PBF is to be reduced to Rs.18.75 lacs [(26.40 - 7.65)].

ABC Ltd. is engaged in manufacture of inlet and exhaust valve for internal combustion engines which are used in automobile industry. The performance of the Company is progressive with steady growth in sales and profits as detailed below.

The Company has been enjoying working capital limit of Rs.650 lacs from 'B' Bank. It has approached the bank for an enhancement in working capital facility to Rs.800 lacs. The Company has estimated sales of Rs.3000 lacs for the year 1994-95 and the same has been accepted by the bank.

To assess the company's working capital requirement the holding level of inventory and receivables usually allowed to such industry alongwith actual holdings for 1993, 1994 and accepted for 1995 are given below.

Higher holding levels have been allowed to the company for the following reasons.

RAW MATERIAL

Imported

The main imported raw material for the company are special nickel steel bars. The availability of these bars is subject to the Vagaries of the world nickel market and suppliers commence production only on receipt of LCs in their favour. The total lead time in reaching the bars to the company's factory from the commencement of manufacture is 6-8 months. Hence holding level of 6 months was accepted.

Indigeneous

The main raw material procured indigenously by the company is special steel. Company's like SAIL and TISCO manufacture special steel. Unless orders for supply of considerable quantity is placed by borrower, they may not supply special steel to the company. SAl L and TlSCO take up manufacture of special steel only in alternate months. Hence a holding level of 2.26 M was accepted.

Stocks in Process

Valve manufacturing involves between 30 to 50 operations depending on design parameters. The company manufactures approximately 250/300 patterns. Of these, about 100 patterns will be active patterns which are produced almost every month. In order to ensure a balanced flow of materials on the production line, it is necessary to maintain in-process stock after each operation, for a minimum of one day. In addition, in critical areas like forging heat treatment plating deposit, etc., stock holding is larger, upto 3 to 4 days.

Hence holding level was accepted at 1.42 months.

Receivables

In the Domestic market about 90 days credit is provided to original equipment manufacturers and about 120 days credit to replacement market. In the export market about 120 days credit is extended as per international practice.

It can be seen from above that the working capital cycle of the company is very long. Assessment of working capital based on 20% of sales may not be sufficient to the Company. The illustration given below would throw light on the same.

Working Capital Assessment

I. As per traditional method

A. Total Current Assets

II) As per revised guidelines of RBI

Considering the long working capital cycle of the company PBF has been fixed at Rs 800 Lacs.

Minimum stipulated NWC of 398 lacs has been worked out as follows

The details of sales achieved by PQR Ltd during last three years and the latest balance sheet of the company are given in the earlier part of this circular. The details of profit earned by the company during last three years are given below.

Considering the profit earned and cash generated by the company it can be seen that reduction in term loan to the extent of Rs. 10.20 lacs has depleted the company's net working capital.

The assesssment of working capital requirement of the company is to be carried out as given below. For this purpose the level of estimated current assets and other current liabilities are also given below. The estimated NWC is to improve to Rs. 4.25 lacs as on 31.3.94 from -ve Rs. 5.80 lacs through estimated profit of Rs. 1.25 lacs and fresh infusion of long term funds.

I Traditonal Method

A fund based working capital limit of Rs. 37.50 lacs may be considered for the company. In order to augment the company's NWC, a term loan of say Rs. 8.25 lacs may be considered against unencumbered fixed Assets of the company subject to the proceeds being utilised to improve NWC. The unit, thus will be fit under traditional method.

Conclusion

The environment in which SSI units funcion in India have been detailed in gerneral in this circular. Also the strengths and weakness of SSI unit and various circumstances which lead to liquidity constraint have been given. Case studies to explain the same have been furnished which can be considered only as illustrative and not exhaustive. To understand the needs of a SSI unit, a detailed discussion with the borrower is a must which will go a long way in proper assessment of working capital needs of a SSI unit.

Towelmart a partnership firm, is a merchant exporter engaged in export of bath towel. The unit also exports beach towel which is a seasonal item. The firm was established in 1975 and is banking with "MNP" Bank since 1976. The partners of the firm are having about more than three decades of experience in this line of activity.

The unit at present enjoys following credit facilities from the bank

The unit has submitted its CMA data for 1994-95 requesting for working capital limit of Rs. 394 lacs and important details of the same are given below.

The actual performance of the company vis-a-vis its estimates during 1993-94 was as given below

The reasons attributed by the firm for not achieving the estimates are given below

1) The firm has 2 units one in Sholapur, Maharastra and the other in Madurai, Tamilnadu.

2) There was an unprecedented flood in Madurai during middle of 1993-94 damaging the goods stored in the unit to a great extent.

3) As a result, the company could not keep up its delivery schedule and lost orders from abroad and

4) The international market for towels also had recessionary trends during 1993-94. Hence the firm could not achieve its estimated sales.

The firm has now stablised its operations in Madurai and international market also has started picking up. The market for Indian textile goods is also showing upward trend in international market. The liberalisaiton policy of Govt. of India will also be helpful to the firm. Hence the firm is confident of achieving its projected sales of Rs. 1300 lacs.

The bank while appraising the firm's working capital needs has considered the following points.

1) The projected increase in sales by the firm for 1994-95 indicates nearly 69% over last year.

2) The maximum growth the firm has achieved during last three years was 44% and the growth rate during 1993-94 was only 24%.

3) The firm during first two months i.e. April and May 1994 had acheived a total sales of Rs. 180 Lacs and if the trend continues the firm would achieve during 1994-95 sales Rs. 1080 lacs.

Keeping the above in view the bank has accepted an estimated sales of Rs. 1050 lacs for 1994-95 which represents a 37% increase in sales over previous year.

The firm was advised to submit a revised CMA 95 in line with accepted sales and working capital in line with revised CMA was sanctioned as given below.

Hence the following credit facilities are sanctioned to the firm

Full interchangeability among Packing Credit and Foreign bills limit is also permitted.