Page 228 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes 2. How is the quantum of bank advance to be determined?

3. Can norms be evolved of current assets and for debt equity ratio to ensure minimal
dependence on bank finance?
4. Can the current manner and state of lending be improved?

5. Can an adequate planning, assessment and information system be evolved to ensure a
disciplined flow of credit to meet genuine production needs and its proper supervision?
The final recommendations of this Committee regarding the approach of the banks towards the
assessment of the working capital requirements of industrial units are very significant. The
major recommendations have been discussed as below:
1. Banks’ finance essentially for meeting working capital needs: Banks’ credit is essentially
intended to finance working capital requirements only; for other requirements, other
sources have to be found. Even for working capital requirements, some portion of the
contribution must come from source other than bank finance, viz. from owner’s own
funds, plough back of surpluses and long term borrowed funds. With increased scale of
operation and production, the owner’s own stake in the business should keep on rising.
While it is not practicable to lay down absolute standards of debt equity ratio, each
borrower should take appropriate steps to strengthen his equity base.
2. Working capital gap: The study group has emphasized the concept of ‘the working capital
gap’, which represented the excess of current assets over current liabilities other than bank
borrowing. The maximum permissible bank finance shall be limited to 75% of this working
capital gap. In other words, the balance of 25% will have to be provided by the borrower
from equity and long-term borrowings. For the purpose of arriving at the working capital
gap, the current assets and the current liabilities will have to be estimated on the basis of
the production plan submitted by the borrower. The level of inventories under raw
materials, work-in-process, finished goods, consumable stores and also the level of
receivables shall be projected on the norms prescribed by the study group.

3. Norms: The borrowing requirements of any industrial unit basically depend on the length
of the working capital cycle, from building inventories of raw material to getting the sale
proceeds. If norms of inventory and other current assets are laid down for different
industries, the bank can easily work out the standard working capital required by a unit
and sanction the advance accordingly. The study group has, therefore, prescribed norms
for inventory and receivables for fifteen industries. The industries covered by the report
are cotton and synthetic textiles, manmade fibres, jute, textiles, rubber products, fertilizers,
pharmaceuticals, dyes and dyestuffs, basic industrial chemicals, vegetable and
hydrogenated oils, paper, cement, consumer durables, automobiles and ancillaries,
engineering ancillaries and components supplies and machinery manufacturers. The study
group has not suggested any norms for the heavy engineering industry because each unit
in this industry has certain special characteristics.

The norms for the various items are described below:
(a) Raw materials Consumption in terms of months
(b) Stock-in-process Cost of production in terms of months
(c) Finished goods Cost of sales in terms of months
(d) Receivables Sales in terms of months

4. Three different methods of calculating the borrowing limit to finance the working capital
requirements: The group views the role of banker only to “supplement the borrower’s
resources in carrying a reasonable level of current assets in relation to his production

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