Working Capital :

Typically for every business there needs to be some source of financing

needed for the capital generation. The business capital need are mainly
classified into two major categories:
1. Fixed capital
2. Working capital
Fixed capital:
The fixed capital is a capital that is invested on the fixed assets of the business, that
cannot be converted into cash within a year.
Working capital:
The working capital is a capital that is invested in the current assets of the
business, that can be easily converted into cash within a year.
 Gross Working capital : Current assets
 Net working capital : Current assets – Current liabilities
Working capital is the fund required to meet the cost of day to day operations
i.e Operating cycle or Working capital cycle like
 Pay suppliers and other creditors
 Pay employees
 Financing the gap between supply of goods and payment(TC)
Operating cycle :
Operating cycle or Working capital cycle are also known as business cycle. It is the
process cycle involved from procuring a raw material till the finished goods and
sell it.
The financing needed for this cycle is called as Working capital financing.
There is a minimum amount current assets required by every firm to operate
continuously and this minimum amount of current assets is called as Fixed
Working capital or Core Current assets.
This Core Current Assets must also be treated as such as Fixed asset that is it has
its source of funding like share capital, reserves, debentures and such like long
term borrowings.
The temporary Working capital is only considered as a source of short term
borrowings and the bank's should consider only funding to the temporary WC.
Here the sources of funding for short term basis I. E for temporary Working capital
are
 Trade credit
 Bank credit
 Commercial paper
METHODS OF ASSESSMENT
Till 1997, the RBI(Reserve Bank of India) had a assessment method for the
working capital requirement, based on MPBF, by Tandon committee but
later it withdrew and gave the banks the operational freedom for credit
dispensation I. E the banks were given freedom to have a own method of
assessing Working capital requirements.
The assessment of Working capital requirement of a borrower is under
anyone of the following three methods,
1. Turnover method
2. Maximum Permissible Bank Finance (MPBF) method
3. Cash flow budget method

1. Turnover method:
Turnover method is one of the method to assess the working capital
requirement of the borrower based on the turnover of the firm or business.
This method was originally suggested by the P.J. Nayak Committee for the
SSI (Small Scale Industries) in India in need of working capital from banks.
Method description:

 The working capital requirement of the MSME unit is calculated at 25% of

annual projected turnover.
 Out of the said Working Capital requirement, 5% requirement to be met by
the borrower from his own sources and balance 20% to be financed by
lending bank.

Example

For example, the projected annual turnover of ABC Company is Rs 100 lakh for
the FY 2018-19.

According to turnover method, working capital requirement of the unit is 25% of

Rs.100 lakh = Rs.25 lakh
 The margin of the borrower will be 5% of the projected sales turnover (5% of
100) = Rs.5 lakh

Hence, the working capital to be financed by bank is (25-5) – Rs.20 lakh.

Working capital limits

MSEs - Up to 5crores

Non MSEs – Up to 2crores

2. MPBF method:

1. Working Capital Gap:

Working capital gap = Current assets – Current liabilities (Exclude Bank

borrowings)

2. Net Working Capital:

It is the one which indicates the long term resource provided by the borrower
for financing his Working capital requirement as a part of current assets.

There are two primary methods in MPBF

Method 1:

For corporate whose credit requirement is less than Rs.10 lakhs, banks
can find the working capital required. Working capital is calculated as
difference of total current assets and current liabilities other than bank
borrowings (called Maximum Permissible Bank Finance or MPBF).
Banks can finance a maximum of 75 per cent of the required amount and
the rest of the balance has to come out of long-term funds.
Reference : https://www.mbaskool.com/business-concepts/finance-
accounting-economics-terms/6941-maximum-permissible-banking-
finance.html
 Method 2 :
For corporate with credit requirement of more than Rs.10 lakhs this
method is used. In this method, the borrower finances minimum of 25%
of its total current assets out of long term funds. The rest will be provided
by the bank through MPBF. Thus, total current liabilities inclusive of
bank borrowings could not exceed 75% of current assets.

Reference : https://www.mbaskool.com/business-concepts/finance-
accounting-economics-terms/6941-maximum-permissible-banking-
finance.html
CMA ARRANGEMENT:
The client who approaches for a credit facility has to submit the detailed
proposal along with financial statements.
The lender (bank) analyses the below criteria’s before a taking a decision
1. Particulars of current and proposed limits
2. Operating statement (Profit and loss statement)
3. Analysis of balance sheet
4. Holding period of current asset and current liabilities
5. Calculation of MPBF
6. Funds flow statement
7. Ratio analysis

CASHFLOW BUDGET METHOD

The cash budget method is used by the industries which are most
likely to be seasonal based, for example like sugar and tea industries,
construction activities and such like. The requirements of finance
maybe peak during certain calendar months whereas the realizations
of sales takes place at a length of time.
 It is sanctioned based on projected monthly cash flows
estimated by the borrower and approved by the bank.
 A cash budget statement shows depicts the projected movement
of cash and bank balances at a future period.
 The three main groups for principal cash flows are prescribed
as:
a. Operating activities
b. Investing activities
c. Financing activities
LIQUIDITY RATIO:
Liquidity ratio are the measurements used to examine the ability of an
organization to pay off its short term obligations.
This liquidity ratio is commonly used by prospective lenders and creditors to
decide whether to extend credit or debit to companies.
A higher liquidity ratio shows a company is more liquid and has better
coverage of outstanding debts.
 Current ratio = Current assets / Current liabilities
 Quick ratio = (Current assets – inventory – prepaid expenses)/ Current
liabilities
 Cash ratio = (Total cash + cash equivalents) / Current liabilities
Both liquidity ratio and Working capital management ratios are similar. Both
are used to examine the short term obligations of the company.
SOLVENCY RATIO:
The solvency ratio indicates whether a company’s cash flow is sufficient to
meet its short-and long-term liabilities.
The lower a company's solvency ratio, the greater the probability that it will
default on its debt obligations.
 Debt to equity ratio
 Debt to Assets ratio

1. Debt to equity ratio:

Debt / Equity = Total liabilities / Total shareholder equity
The D/E ratio is an important metric used in corporate finance.
It is a measure of the degree to which a company is financing
its operations through debt versus wholly owned funds.
More specifically, it reflects the ability of shareholder equity to
cover all outstanding debts in the event of a business downturn.
 2. Debt to asset ratio
Debt / Asset = Total liabilities / Total assets

Total-debt-to-total-assets is a measure of the company's assets

that are financed by debt, rather than equity.

Creditors use the ratio to see how much debt the company
already has and whether the company has the ability to repay its
existing debt, which will determine whether additional loans
will be extended to the firm.
WORKING CAPITAL MANAGEMENT
Receivable turnover (Domestic) in days
The credit extended by a corporate to the domestic clients.
Receivable turnover (Export) in days
The credit extended by a corporate to the overseas clients.
Inventory turnover in days
Represents the day’s inventory held by the corporates.
Accounts payable turnover in days
Represents trade credit enjoyed by the corporate in respect of its
purchases.
PROFITABILITY ANALYSIS
The profitability analysis is to access the company’s stands with its
competitors.
Like, the first quarter gross margin maybe lower than the fourth quarter ,here
the customer turnout is tend to be max in the year-end so it is optimistic to
see with previous year first quarter.
1. Margin ratios
 Profit margin
 Gross margin
  Operating margin
 Pre-tax margin
 Net profit margin
2. Return ratios
 Return on assets
 Return on equity