Page 71 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Third Method of Lending

Under this method, the borrower’s contribution from long-term funds will be to the extent of
the entire core current assets, which has been defined by the Study Group as representing the
absolute minimum level of raw materials, process stock, finished goods and stores which are in
the pipeline to ensure continuity of production and a minimum of 25% of the balance current
assets should be financed out of the long term funds plus term borrowings.

!
Caution This method was not accepted for implementation and hence is of only academic
interest.

Notes The RBI does not insist on a rigid formula of maximum permissible bank finance
for lending by commercial banks to industries for working capital purposes.

This was given up sometime in 1997. Banks, however, are free to follow the earlier norms of
MPBF based on norms for stock, debtors, and so on.

Example: Metalman co. Ltd. is a pipe manufacturing company. Its production cycle
indicates that materials are introduced in the beginning of the production cycle; wages and
overhead accrue evenly throughout the period of the cycle. Wages are paid in the next month
following the month of accrual. Work-in-process includes full units of raw materials used in the
beginning of the production process and 50% of wages and overheads are supposed to be
conversion costs. Details of production process and the components of working capital are as
follows:
Production of pipes 12, 00,000 units
Duration of the production cycle one month

Raw materials inventory held one month consumption
Finished goods inventory held for Two months
Credit allowed by creditors one month
Credit given to debtors Two months

Cost price of raw materials ` 60 per unit
Direct wages ` 10 per unit
Overheads ` 20 per unit
Selling price of finished pipes ` 100 per unit

Required to calculate:
(a) The amount of working capital required for the company.
(b) The maximum permissible bank finance under all the three methods of lending norms as
suggested by the Tandon Committee, assuming the value of core current assets:
` 1,00,00,000

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