Page 60 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 4: The Financing Mix

prevalent practices of banks in this regard were so varied that they were unlikely to Notes
prevent the emergence of excess demand for credit from certain borrowers. By and large,
the scheduled banks were inclined generally to relate their credit limits to the security
offered by their constituents but many do not appear to make any attempt to assess the
overall financial position of the borrowers through a cash flow analysis and in the light of
this study fixed their credit limits.
3. Valuation of Stock and Margin Requirements: Banks did not generally adopt a uniform
method of valuation of stocks. The usual method, for indigenous goods was based on
‘cost’ or ‘market value’ whichever is lower and for imported goods on landed cost.
Similarly, there was considerable divergence in practice as regards the prescription of
margins by the banks. Some banks stipulated a lower margin or pledge advances against
hypothecation of stocks, while a few others did not make this distinction. In the opinion of
the Group, the varying practice could not be said to constitute an important factor in the
emergence of excess credit.

4. Diversion of Short-term Credit to Acquisition of Long-term Assets: A study of 255
companies over the period from 1961–62 to 1966–67 showed a deterioration in their current
ratio and the increase in short-term liabilities was utilized for financing the gap between
long-term assets and long-term liabilities. One-fifth of the gross-fixed assets of these
companies were financed by expansion in short-term liabilities including the bank loans.

The tendency on the part of a number of industrial units to utilize short-term bank credit
and other current liabilities for acquisition of non-current assets was, in the Group, due to
(a) generally sluggish condition in the capital market since 1962 (b) the limited nature of
the appraisal of application for short-term loans as compared to medium term loans and
(c) stipulation of repayment schedules for medium loans.

5. Lending System: The Group considered that the lending system, as was prevalent in India
banking, would have appeared greatly assisted prevalent in India banking, would have
appear greatly assisted certain units in industry on increased reliance on short-term debt
to finance their non-current investment. The working capital advances of banks were
grated by way of cash credit limits which were only technically repayable on demand. The
system was found convenient in view of the emphasis placed by banks on the security
aspect. These short-term advances though secured by current assets were not necessarily
utilized for short-term or self-liquidating in as much as although cash accruals arising
from sales were adjusted in a cash credit account from time to time. The Group found that
on a large number no credit balance emerged or debt balances fully wiped out over a
period of years as the withdrawals were in excess of receipts. The possibility of heavy
reliance on bank credit by industry arose mainly out of the way in which the system of
cash credit-which accounted from about 70% of total bank credit, had been operated.

Suggestions

The Group was of the opinion that unless measures were taken to check the tendency for
diversion of bank credit for acquiring long term assets, it might assume wider dimensions. The
Group made following suggestions for a change in the lending system:
1. Method of Appraisal of Credit Applications: The appraisal of credit applications should
be made with reference to the total financial situation, existing and projected, as shown by
cash flow analysis and forecasts submitted by borrowers. This would help a diagnosis of
the extent to which current liabilities of industrial units had bee put to non-current use and
the manner in which liabilities and assets of borrowers were likely to move over a period
of time. Initially, advances of, say ` 50 lakh and over should be analyzed this way and then
the system may gradually be extended to borrowers with advances of over ` 10 lakh.

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