Page 229 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 10: Working Capital Management

requirement”. It proposed three progressive stages by which the banks may finance the Notes
working capital requirements of their industrial borrowers. In the first stage, the current
assets may be worked out as per norms and the current liabilities (excepting bank
borrowing) may be deducted there from. This amount would represent the working
capital gap, 25% of which must be financed by the borrowers out of long-term funds. The
maximum permissible bank borrowings would, therefore, be only 75% of the working
capital requirements calculated as per the norms laid down regarding inventories and
receivables. The Committee suggests, that as a first step, the banks may adopt this method
of sanctioning advances. In cases where the banks have already sanctioned advances higher
than the requirements as calculated above, the excess should be converted into a term loan
to be phased out gradually. Thus, the Committee does not support that the banks should
finance excessive inventory build up by industrial enterprises.
In the second stage, the borrower will have to provide a minimum of 25% of total current
assets from term funds (as against his providing 25% of working capital gap from long
term funds in the first alternative.)
In the third stage and the ‘ideal’ method of calculating the borrowing limits, the group
makes a distinction between core current assets and the other current assets. Accordingly,
the total current assets need to be divided into these two categories. The borrower should
finance the entire core current assets plus a minimum of 25% of the other current assets.
The group feels that the classification of current assets and current liabilities be as per the
accepted approach of the bankers.
The recommendations of the Committee aim at reducing the reliance of the borrowers on
the bank finance. Implementation of these recommendations would result in a better
current ratio for the industrial borrowers. This would avoid unfortunate stringencies on
account of lack of working capital as those faced by the industrial units. There can be no
two opinions that the industrial units must maintain a sound current ratio–something
which can be achieved only if a good part of working capital is financed through long-
term funds.

5. Style of credit: The group also recommends a change in ‘style of credit’ i.e., the manner in
which bank finance is extended to the borrower. Further, the total credit limit of borrower
should be bifurcated into two components; the minimum level of borrowing which the
borrower expects to use throughout the year (loan) and a demand cash credit, which
would take care of his fluctuating requirements. Both these limits should be reviewed
annually. It is recommended that the demand for cash credit should be charged a slightly
higher interest rate than the loan component, so that the borrower is motivated to take
higher level of fixed component and a smaller limit of cash credit. This would enable the
bankers to forecast the demand for credit more accurately.
6. Information system for banks: The following points may be noted in this regard:
(a) To ensure that the customers do not use the new credit facility in an unplanned
manner, the financing should be placed on a quarterly budgeting reporting system
for operational purposes in the prescribed forms.
(b) Actual drawings within the sanctioned limit will be determined by the customer’s
inflow and outflow of funds as reflected in the quarterly funds flow statements and
the permissible level of drawings will be the level as at the end of the previous
quarter plus or minus the deficit or surplus shown in the funds flow statements.
(c) Variances are bound to arise in any budget or plan. The variances to the extent of say
10% should be permissible and beyond this, the banker and the customer should
discuss the reason.

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