Corporate Finance

Estimation of Working Capital 
 281

their long term funds, i.e., owned funds and term borrowings. Credit for purchases and other current liabilities

will be available to finance a part of the remaining amount of current assets with banks financing the

remaining portion. Thus, total current liabilities inclusive of bank borrowings will not exceed 75 percent

of the current assets.

MPBF = (0.75 × CA) – CL

This method ensures a current ratio of 1.33

• Third method of lending: Methodology is the same as above, but core current assets are excluded from
  total current assets. Core current assets are expected to be financed by long-term funds. Under this method,
  long-term funds are required to finance core current assets and an additional 25 percent of the remaining
  current assets. RBI did not accept this method for implementation.
  MPBF = 0.75 (CA – CCA) – CL
  The borrower’s contribution from long-term funds would be 25 percent of working capital gap under the
  first method of lending, and 25 percent of total current assets under the second method of lending. The
  borrower’s contribution of long-term funds described is called the minimum stipulated net working capital
  (NWC), which comes from owned funds and term borrowings.
  Banks generally calculate MPBF using the second method of lending. The exceptions include where fund
  based limits are less than Rs 1 crore (turnover based method), sick/weak units, etc. Borrowing units engaged
  in exports need not bring 25 percent contribution from long-term funds in respect of export receivables.
  Other methods of assessing working capital requirements are:


• Turnover method: The working capital requirements are estimated at 25 percent of the projected turnover.
  Of the working capital requirement, banks cane finance to the maximum extent of 20 percent of the pro-
  jected turnover, and the balance 5 percent is the net working capital to be brought in by the borrower as
  his margin.


• Cash budget method: The borrower submits cash budgets for the future period. Bank finance is limited to
  cash deficit, i.e., the excess of payments over receipts. While assessing under this method, the profitability
  statement, balance sheet for the future period is taken into account to prepare the cash budget. The operating
  cycle is also considered for cash flow assessment. Generally, this method of assessment is used for seasonal
  industries like tea, sugar, construction, etc.

STYLE OF LENDING

The Tandon committee suggested that the total credit limit be bifurcated into a loan component and cash
credit component. The loan component corresponds to the minimum level of borrowing that the party will
use during the year. The fluctuating part is the cash credit component. The obvious reason for bifurcating
credit limit is to ensure financial discipline from the borrower. The committee also suggested that bill financing,
wherever possible, be encouraged.
Another working group was set up in 1979, under the chairmanship of K B Chore, to recommend
modification to the existing system. Here is a summary of the committee’s recommendations:

1. The three types of lending—loan, cash credit and bill finance—to continue.


2. The dependence of medium and large size borrowers to be reduced by inducing them to use surplus cash
   generated by the unit.


3. Second method of lending to be made compulsory for all units with fund-based working capital limit of
   Rs 50 lac and above.