280 Corporate Finance
in the specified groups of industries including small scale industries (SSI) with fund-based working capital
limits in excess of Rs10 lac and public sector units were also covered. The norms cover major industries
accounting for 50 percent of industrial advance by banks. The norms take geographical location of the units
and seasonality of demand into account. They represent the levels of units with average efficiency. There can
be temporary deviations from inventory norms for reasons such as bunched receipt of raw materials, power
cuts, strikes, transport delays, etc.
The group suggested that the level of bank finance may be determined by the working capital gap arrived
at after taking into account the projected levels of current assets and current liabilities (other than bank
borrowings). So the items that can be classified under current assets and current liabilities need to be defined.
The list of items is given in Appendix 5.
Current assets comprise cash and other assets or resources commonly identified as those which are expected
to be realized in cash or sold or consumed or turned over during the operating cycle of the business usually
not exceeding one year.
Current liabilities include items payable or expected to be turned over within one year from the date of
balance sheet and the item is used principally to designate obligations whose liquidation is reasonably expected
to require the use of existing resources properly classified as CA or the creation of other liabilities.
NORMS FOR LENDING
The norms recommended by the Tandon Study Group for inventory and receivables for 15 major industries
are reviewed from time to time by the Committee of Direction constituted by the Reserve Bank of India (RBI).
These norms pertain to raw materials, stock-in-progress, finished goods and receivables. They are not absolute
and deviations are permitted under certain circumstances. These norms indicate maximum levels for holding
inventory and receivables in each industry and are not to be taken as entitlements to hold inventory or
receivables up to the prescribed levels. Inventory and receivables, suggested by RBI from time to time, are
only broad indicators and banks are free to decide the norms based on their own experience.
In the case of industries where no norms have been fixed, levels of inventory and receivables may be
computed on the basis of process/lead time, trade practices, past trends, etc. It should be noted that since sundry
creditors are taken as a source of current assets, it is necessary to project them correctly, while calculating
the need for bank finance for working capital.
Computation of Maximum Permissible Bank Finance
Once the estimation of the reasonable level of current assets required for the operation of the unit is completed,
the source of financing the same is decided. A part of the total current assets can be financed by credit for
purchases and other current liabilities. The funds for financing the working capital gap are bridged from the
borrower’s own funds and long-term borrowings and partly from bank borrowings.
The Tandon Study Group suggested the following three alternatives for arriving at the MPBF:
- First method of lending: Finance a maximum of 75 percent of the working capital gap (total current assets
minus total current liabilities other than bank borrowings), with the balance to come out of long-term
funds, namely owned funds and term borrowings.
MPBF = 0.75 (CA – Other current liabilities)
This method ensures a current ratio of 1. - Second method of lending: Borrower to provide for a minimum of 25 percent of total current assets out of