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The project is about role of banks in working capital management to know that how a bank is plays a major role in the managing the working capital of their clients (Business firms) to meat their day-to-day expenditure and other business requirements. The project also covers various credit facilities given by the banks to its clients, it functions and different aspects in working capital financing. The project includes case-study on Icici bank which would help to understand the concept of working capital financing. Maintaining of working capital at par level with the efficient and effective level the bank plays a vital role in that.
Capital Management is to have in-depth knowledge about the Strategy of Banks to lend the money to the business firms to run the business and mate the day to day expenses of business firms.
To know about the functions, organizational structure and objective of To understand the elements of working Capital and its functions. To have a broader view on nature of Working Capital which is current To know what are the RBI guidelines formulated for Working Capital
assets & current liabilities and to know what are its components. financing. To know the future scope involved in Working Capital finances & role of information technology in Working Capital financing.
Prepaid expenses Short term advances Temporary investments The value represented by these assets circulates among several items. Cash is used to buy raw-materials, to pay wages and to meet other manufacturing expenses. Finished goods are produced. These are sold, accounts receivables are created. The collection of accounts receivable brings cash into the firm. The cycle starts again. This is shown in below mention diagram.
Cash
Inventories
Receivables
Current liabilities are the debts of the firms that have to be paid during the current accounting period or within a year. These include: Creditors for goods purchased Outstanding expenses i.e., expenses due but not paid Short term borrowings Advance received against sales Taxes and dividends payable Other liabilities maturing within a year. Working capital is also known as circulating capital, fluctuating capital and revolving capital. The magnitude and composition keep on changing continuously in the course of business. Accounts receivables: Trade credit creates book debts or accounts receivable. It is used as a marketing tool to maintain or expends the firms sales. A firms investment in accounts receivable depends on volume of credit sales collection period. The financial manager can influence volume of credit terms, and collection efforts. Credit standards are criteria to decide to whom credit sales can be made and how much. If the firm has soft
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The individual items of receipts and payments are identified and analyzed. Cash inflows could be categorized as: i. ii. iii. i. ii. iii. iv. operating non operating, and Financial. operating capital expenditure contractual, and Discretionary.
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Rs.
FixedA ssets
T es im
The management of working capital is concerned with maximizing the return to shareholders within the accepted risk constraints carried by the participants in the company. Just as excessive long-term debt puts a company at risk, so an inordinate quantity of short-term debt also
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Cash
Accounts Receivables
W ork-in-process
S ale s
Finished goods
The operating cycle being with the arrival of the stock, and ends when the cash is received. The cash cycle beings when cash is paid for materials, and ends when cash is collected from receivables.
R M aw aterial P urchased F inished O S rder tock C ash G S oods old P A laced rrived R eceivables ccountsR eceivablesP eriod W ork-in-processInventoryP eriod A T e im A ccountsP ayableP eriod C P F ash aid or Invoice M aterials R eceived O peratingC ycle C C ash ycle
Importance of Operating Cycle Concept The application of operating cycle concept is mainly useful to ascertain the requirement of cash working capital to meet the operating expenses of a going concern. This concept is based on the continuity of the flow of value in a business operation. This is a important concept because the longer the operating cycle, the more working capital funds needs. Management must ensure that this cycle does not become too long. This concept more precisely measures the working capital fund requirements,
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How to reduce Operating Cycle? The aim of every management should be to reduce the length of operating cycle or the number of operating cycle in a year. Only then the need for working capital decreases. The following a few remedies may become handy in contrasting the length of operating cycle period. Purchase management The purchase manager owes a responsibility in ensuring availability of right type of materials in right quantity of right price on right time and at right place. These six Rs contribute greatly in the improvement of
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Similar conclusion can also be drawn for other elements of cost i.e., for Direct wages and overheads. In the case of Direct wages overheads, the operating cycle starts with the Work-in-progress Conversion Period (WIPCP) as there will be Raw materials Conversion Period (RMCP). The chart below shows the operating cycle for these elements of cost with hypothetical figures. Particulars
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Direct Materials
Direct Wages
Overheads
(RMCP) Work-in-progress conversion period 3 (RMPCP) 1 Finished goods conversion period 2 8 (FGCP) 1 Book debts conversion period (BDCP) 7 Gross operating cycle Less : Payment deferral period (PDP) Net operating cycle
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Norms for Inventory receivables The Committee has given itself to the study of those items against which bank advance is made. In term of the production requirements, the committee has worked out the level of current assets which each industrial unit cash hold. These are called the norms. Norms are the maximum level of these assets that a unit cab hold. Norms are expressed in terms in terms of periods for which the assets can be held. The assets for which norms have been prescribed and the terms in which they are expressed are given below: Raw material Work-in-Progress Finished goods So many cost of raw materials consumed So many months cost of production So many months cost of sales
Receivables - So many months sales Norms in the beginning were prescribed for 15 selected industries, which together accounted for about 50% of the total bank credit to the industry. Further, they are applicable only to these units have working capital limits aggregating to Rs. 10 lakhs and above in the entire banking system. The banks are expected to apply the spirit of the recommendations to accounts having smaller limits also. The following factors may be noted while dealing with the norms:
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200 20 90
10
2nd method Total Current 370 assets Less: 25% of above from long92
3rd method Total current 370 assets Less: Core Assets From term longsources current 95
150
than
term sources
current
than
165
56
220 72 1.33:1
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capital requirement on account of abnormal price rise. accepted from the public for complying with statutory requirements. Fro repayment of the installments due; under foreign currency loans and other term loans. Style of credit and flow of information: The recommendation of the Tandon committee with regard to the above since been modified by the recommendation of the chore committee.
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Recommendations: The Committee submitted its final report in August 1979. The major areas covered by the recommendations are: Use of different types of advances, cash credit, loan and bills-all types to continue. Bifurcation of cash credit limit into demand loan and fluctuating cash credit portions not favored because: 1. For seasonal industries the different is too much; for sales season period the account may be in credit in which case the loan portion should be nil. 2. For non-seasonal industries the difference is too marrow to be of any help to the banker. Separate limits to be granted for peak level and normal non-peak level credit requirements. All borrowers (except sick units) with working capital requirement of Rs. 10 Lakh and above to be placed under second method of lending recommended by Tandon Committee. The flow of information from borrower to banks to be simplified.
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exceptional cases for predetermined short periods to meet unforeseen contingencies. Such facilities should be in the form of a separate demand loan or a non-operable cash credit account. Except in exceptional cases like natural calamities and in the case of accounts under nursing programmer banks are to charge interest at 1% more than the normal rate.
enforced through placing them under second method of lending recommended by Tandon committee. According to this working capital to the extent of at least 25% of the current assets should be financed by term finance and contribution from owned funds. This would give a minimum current ratio of 1.33:1.0. Discounting bills should be encouraged in place of cash credit against book debts for financing sales. Wherever possible existing cash credit against book debts should be converted into bill limits. Drawee bill financing should be encouraged for financing raw material under bill system. Under this, the seller draws a bill on the buyer. The bank accepts the bill thus enabling the seller to discount the bill with bank or any other bank may itself pay the bill amount to the seller. At least 50% of the cash credit limit against raw materials sanctioned to manufacturing units should be by way of drawee bill limits. For example, if the party has been
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Unpaid stock Rs. 25 Lakhs Drawing limits would be determined as under: Cash credit (Rs. 100 Lakhs less 50% margin) Rs. 50 Lakhs Bill discounting Rs. 75 Lakhs When the bill is met by borrower, the stock would be taken under cash credit. Then it would subject to margin requirements.
small scale units in that order while meeting the credit requirements of small scale sector.
For the credit requirements of village industries, tiny industries and
other SSI units upto aggregate fund based working capital credit limits upto Rs. 50 lakhs from the banking system, the norms for inventory and receivables as also the methods of lending as per Tandon Committee will not apply. Instead, for such units the
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meeting both Term Loan and working capital requirements of SSI sector. The "Single Window Scheme "(SWS) of SIDBI enables commercial banks to provide term loans and working capital to SSI units have a project outlay upto Rs. 20 lakhs and working capital requirement upto Rs. 10 lakhs. Banks to set up effective grievance cells to enable SSI borrowers to approach in case of difficulties. SSI loan applications should be disposed off within time frame laid down as follows: In case of credit upto Rs. 25,000 In all other case within 15 days 8 to 9 weeks
should adopt a system of committee approach, in which decisions are taken by the competent authority after a structured discussion with the Branch Manager and also the authorities at the intervening level.
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should be referred to the next higher authority should be referred to next higher authority for confirmation. Branches should not insist on deposit mobilization of stipulated amounts as a precondition to the sanction of credit. However, they can enlist the co-operation of these customers for deposit mobilization.
Bank
policy
to
lend
the
working
capital
The following approaches are generally followed by the banks in financing working capital needs of the business firms: Maximum Permissible Bank Finance (MPBF) - Under MPBF approach, the capital finance limits of a firm at either 75 per cent of the companys current assets or the different between 75 per cent of current assets and non-bank current liabilities. The inherent concept of the approach is that scarce credit must be rationed. Under this method, the minimum acceptable current ratio was specified, thus fixing the minimum contribution of the corporate to funding working capital gap. At the same time, the maximum current assets levels were prescribed through a series of inventories and receivables norms.
firm is said to be satisfactory if it is able to meet its obligations in the short - run. The measure of liquidity is the ratio of current assets to current liabilities. Hence current ratio is used by the
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capital arises essentially because of uneven and uncertain nature of cash flows. This is because cash outflows to meet production expenses do not occur at the same time as cash proceeds from sales are realised. They are uncertain because sales and costs are not known in advance. By projecting future cash receipts and disbursements, the cash budget enables the corporate to determine its cash needs, and plan their financing accordingly. Under this approach, bank finance~ based on the submission of periodic say, quarterly, cash flow statements that would fit smoothly into a firms cash cycle. To determine the quantum of bank finance, banks must evaluate cash-flow risks, forcing them to be more involved in day to day operations of the borrower. Once the bank has appraised the cash budget, ad hoc requests for more funds will not be entertained. This will demand sound resource planning& receivable management, purchase planning and management of inventory.
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credit is relatively easy to obtain. Except in the case of financially very unsound firms, it is almost automatic and does not require any negotiations. The easy availability is particularly important to small firms. Which generally face difficulty in raising funds from the capital markets.
Trade credit grows with the growth in firms sales. The expansion in the firms sales causes its purchases of goods and services to increase which is automatically financed by trade credit. In contrast, if the firms sales contract, purchases will decline and consequently trade credit will also decline.
of finance. It does not require any negotiation and formal agreement. It does not have the restrictions which are usually parts of negotiated sources of finance.
Bank credit: Bank credit is the primary institutional source of working capital finance in India; in fact, it represents the most important source of financing of current assets. Form of Credit: Working capital finance is provided by banks in five ways:
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Loans: Under the arrangement the entire amount of borrowing is credited to the current account of the borrower or the released in cash. The borrower has to pay interest on the total amount. Bills purchased/discounted: The amount made available under this arrangement is covered by the cash credit and overdraft limit. Before discounting the bill, the bank satisfied itself about the credit-worthiness of the drawer and the genuineness of the bill. To popularize the scheme, the discounting banker asks the drawer of the bill (i.e. seller of goods) to have his bill accepted by the drawee (buyers) bank before discounting is latter grants acceptance against the cash credit limit, earlier fixed by it on the basis of the borrowing value of stocks therefore, the buyer who byes goods on credit cannot use the same goods as source of obtaining additional bank credit. Term loans for working capital: Under this arrangement, banks advance loans for 3-7 years repayable in yearly or half yearly installments. Letter of credit:
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Mode of Security for Bank credit: Banks provide credit on the following modes of security: Hypothecation: Under this method of security, the banks provide credit to borrowers against the security of movable property, usually inventory of goods. Pledge: Pledge, as mode of security is different from hypothecation in that in the former, unlike in the latter the goods which are offered as security are transferred to the physical possession of the lender. Lien: The term Lien refers to the right of the party to retain goods belonging to another party until a debt due to him is paid. Mortgage:
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COMMERCIAL PAPERS: Meaning: Commercial paper (CP), an important short term money market instruments made its debut in India in the beginning of 1990. It was, while adumbrating the credit policy for the first half of 1989, that the RBI Governor announced the introduction of CPs, "with a view to enabling highly rated corporate borrowers to diversifying their sources of short term borrowing and also providing an additional instrument to investors." Commercial paper is a short term financial instrument used by accompany for raising funds from the money markets. Thus, it is a money market instrument which is issued in the form of unsecured promissory note in bearer form with a maturity period of one year or even less. The issue of CP is expected to bring in financial discipline in the working capital management of an issuer company as it has to ensure its creditability in the money market by proper utilization of funds to finance the current or short term transactions and honoring payment of CP on the maturity date. CP can be issued either through direct placements or
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FACTORING: Factoring provides resources to finance receivables as well as facilitates the collection of receivables. Although such services constitute a critical segment of the financial services scenario in the developed countries, they appeared in the Indian financial scene only in early nineties as a result of RBI initiatives. There are two bank sponsored organizations which provide such services: (i) SBI factors and commercial services ltd., and (ii) can bank factors. The first private sector factoring company, foremost factors ltd. Started operations since the beginning of 1997. Definition and Mechanism: Definition: Definition factoring can broadly be defined as an agreement in which receivables arising out of sale of goods/services are sold by a firm (client) to the 'factors' (a financial intermediary) as a result of which the title of the goods/services represented by the said receivables passes on the factor. Hence forth, the factor becomes responsible for all credit control, sales accounting and debt collection from the buyers.
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applied for forecasting working capital requirements. It helps in making working capital requirement projection after establishing the average relationship between sales and working capital and its various components in the past year. The method of least squares is used in this regard. Operating Cycle Method In this method the requirement of
working capital is estimating through the operating cycle period. It varies from firm to firm and industry to industry. If the enterprise is trading firm than it does not have operating cycle because, they are directly buying goods from other and selling to others. If the enterprise is manufacturing firm than their operating cycle depends on their process of converting raw material into finished goods, availability of raw material, power, fuel and other required thing to manufacture. Individual component approach Detailed estimation is made using the individual components of the operating cycle.
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Seasonal Variations: Variation apart, seasonality factor creates production or even storage problem. Muster and many other oil seeds are Rabi crops. There are to be purchased in a season o ensure continuous operation of oil plant. Further there are woolen garments which have demand during winter only. But manufacturing operation has to be conducted during the whole year resulting in working capital blockage during off season. Scale of Operations: Operational level determines working capital demand during a given period. Higher the scale, higher will be the need for working capital. However, pace of sales turnover (Quick or slow) is another factor. Quick turnover calls for lesser investment in inventory while low turnover rate necessitates larger investment. Credit Policy: Credit policy of the business organization includes to whom, when and to what extent credit may be allowed. Amount of money locked
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good many cases, account receivables are sterile and sticky and thereby they have forfeited the right to be classified as current assets. In view of such situation in ascertaining quick ratio instead of deducting stock-in-trade we find it worth while to deduct sundry debtors. The other component is credit policy of the suppliers, their terms and conditions of credit. Trade credit has its historical presence in the trading world. Availability of normal credit supplies as well as trade credit facilities working capital supply and reduce the need for bank finance.
Accessibility to Credit: Creditworthiness is the precondition for assured accessibility to credit. Accessibility in banks depends on the flow of credit i.e., the level of working capital. Growth and Diversification of Business: Growth and diversification of business call for larger volume of working fund. The need for increased working capital does not follow the growth of business operations but precedes it. Working capital need is in fact assessed in advance in reference to the business plan. Supply Situation: In easy and stable supply situation, no contingency plan is necessary and precautionary steps in inventory investment can be avoided. But in case of supply uncertainties, lead time may be longer necessitating larger basic inventory, higher carrying cost and working capital need
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Relaxation in Assessment of Working Capital by Banks In order to provide greater freedom is assessing the working capital requirements of borrowers, effective from April 15, 1997, all instructions relating to MPBF were withdrawn. Banks were instructed to evolve their own method such as turnover method, the cash budget system, the MPBF system with necessary modifications or any other system of assessing working capital requirements. The loan policy in respect of each broad category of industry is, however, required to be laid down by each bank with the approval of the respective Board.
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Liquid ratios:Current ratio = Current Assets, Loans, Advances Current liabilities and Provisions
Quick ratio =
Current assets, Loans and Advances Inventories Current liabilities and Provisions Bank overdraft
Structural health ratios:Total Assets to total net assets = Net Asset Current Assets Debtors turnover ratio = Sales Debtors Average collection period (in days) = Creditors x 365 Sales Bad debts to Sales = Creditors x 365 Purchases
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CASH STUDY
Steel Authority of India Limited. Balance sheet for the year ended 31.3.2008 (Amounts in crore) Particulars Sources of funds Shareholders fund Share capital Reserves and surplus Loan fund Secured loans Unsecured loans Deferred tax liability (net) Application of funds Fixed assets
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Sch no.
Amount
23063.57
1.5
13960.86 538.20
6857.23 3048.12 13759.44 273.08 2379.75 26317.62 6400.92 6797.83 13198.75 13118.87 59.48 27677.41
1.13 1.14
1.15
adjusted) Profit & Loss Account for the year ended 31.3.2008 (Amount in crore) Particulars Income Sales Less: Excise duty Finished products consumed Interest earned Other revenue Provisions no written back 41890.91 Expenditure
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Amount
longer
required
2.5 2.6
-339.30 13960.14 3.63 7919.02 3293.90 2825.56 552.15 717.85 1836.32 250.94 1235.48 32255.69 1832.22
&
2.7
2.12 2.13
1.983
Quick ratio
Q.A Q.L
C.A, Loans and Advances - Inventories C.L, and Provisions Bank O/D
19460.39 13198.45
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1.47:1
Conclusion
Working capital management is concerned with short term financial decisions which have been relatively neglected in the literature of finance shortage of funds for working capital has caused many businesses to fail and in many cases, has recorded there growth, Lack of efficient and effective utilization of working capital leads to earn low rate of return on capital employed or even compels to sustain losses. The need for skilled
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