Page 61 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes 2. Segregation of the Credit Market: The out standings in the existing as well as further cash
credit accounts should be distinguished as between (i) ‘the hard core’ which would represent
the minimum level of raw materials, finished goods and stores which the industry was
required to hold for maintaining given level of production and (ii) the strictly short-term
component which would be the fluctuating part of the account. The latter part of the
account would represent the requirements of funds for temporary purchases, e.g.
short-term increases in inventories, tax, dividend and bonus payments etc., the borrowing
being adjusted in a short period out of sales. In the case of financially sound companies,
the Group was of the opinion to segregate the hard ore element in the cash credit
borrowings and put on a formal term loan basis and subject to repayment schedule. But
when the borrowers’ financial position was not too good or the size of the hard core was
so large that repayment could not be expected within 7/10 years, it would be difficult for
the banks to continue to carry these liabilities over along period of time. The possible
solutions the promoters and their friends, additional issue of equity or preference capital,
a debenture issue with a long maturity. When the hard core was to be placed on a formal
should contain covenants in regard to the end-use of the loan, maintenance of minimum
financial ratios, repayment obligations restrictions on investments on shares and
debentures. To determine the hard core element of the cash credit account, the Group
considered that it would be worthwhile to attempt to study of industry-wise norms for
minimum inventory levels.
3. Double or Multiple Financing: Double or multiple financing may result where credit
facilities are granted against receivables either by way of documents against acceptance
bills or drawing against book debts; the purchases is also in position to obtain bank credit
by way of hypothecation/pledge of the stock which have not been paid for. For eliminating
double or multiple financing, the Group suggested that a customer should generally be
required to confine his dealings to one bank only. In case the credit requirements of
borrowers were to be large and could not be met out of resources of one bank, the Group
has recommended the adoption of ‘consortia’ arrangement.
4. Period of Trade Credit: To prevent undue stretching of the period of trade credit and the
typing up of resources of banks for unproductive purpose, the group suggested that the
period of trade credit should not normally exceed 60 days and in special circumstance up to
90 days (excluding sales of capital equipment on deferred payment term). The undue delay
in the settlement of bills by governments could be discouraged by stipulating that the latter
should pay interest on bills if they were not paid within 90 days after their receipt.
5. Commitment Charges on Unutilised Limits: As a complementary measure to check the
extension of extra credit, the group suggested that a levy of commitment charge on
unutilized limited coupled with, if necessary, a minimum interest charge could be
considered. The commitment levy might be progressively raised with the size of the
unutilized limits. As the initial stages, limits sanctioned upon ` 10 lakh might be exempted
from the point of view of administrative convenience.

6. Need for Greater Recourse to Bill Finance: The Study Group emphasized the need for
greater recourse to bill finance. The Group recommended that commercial banks, industry
and trade should try, where feasible and administratively convenient, to initiate and
develop the practice of issuing usance bills as this would not only impose financial
discipline, on the purchaser out also help supplier or producer to plan his financial
commitments in a realistic manner. An adequate growth in the volume of usance bills
would also facilitate the development of a genuine bill market in India. With a view to
encouraging the development of such Group to the government. The Group believed that
the loss in revenue following a reduction in stamp duty would be more than made good
by the resultant larger volume of usance bills.

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