ASSESSMENT OF BLOCK &

WORKING CAPITAL FOR

ENTERPRISE
SUNIL CHAWLA
BIRD, LUCKNOW
B I R D
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Credit important for
development ?
CREDIT
Establishment
of Enterprises
Running of
Enterprises
Investment /
Block
Capital
Working
Capital
+
Productive Unit
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BLOCK CAPITAL
Capital required for acquisition and
maintaining durable assets necessary
for enterprises

Source of funding - MT/LT loans from
FIs and equity capital of entrepreneurs

Needed for New units & Existing units -
expansion & modernization
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BLOCK CAPITAL - Components
Land and land development - cost of purchased
land or imputed value of owned land upto margin
required can be considered
Construction of workshed, godown, marketing
outlet, amenities, etc.
Plant and Machinery
Equipment & tools
Cost of technical upgradation, knowhow, engineering fee,
etc.
Transport Vehicle
Preliminary & pre-operative expenses
Project formulation & consultancy, etc.
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WORKING CAPITAL -
DEFINITION
Working Capital is defined as

the capital required
for maintaining optimum level
of current assets
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IMPORTANT CONCEPTS
CURRENT ASSETS : Assets which
can be converted into cash within an
accounting year viz. Cash, short term
securities, sundry debtors, bills receivable,
stock/inventories
CURRENT LIABILITIES : Claims of
outsiders expected to mature for payment
within an accounting year viz. short term
borrowing, sundry creditors, bills payable
statutory liabilities, term loan installment.
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Current Assets
Cash and bank balance
Investments
Raw material and components used in
manufacturing and those in transit
Stock in process
Finished goods including those in transit
Other consumable spares
Advance payment of tax
Pre-paid expenses /advance payments
Receivables arising out of sales/fixed assets,etc.
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Current Liabilities
Short term borrowings including bills purchased and
discounted
Unsecured loans
Public deposits maturing within a year
Sundry creditors for RM, consumable stores and
spares
Deposits from dealers, selling agents, etc.
Installment of term loan, deferred payments payable
within a year
Statutory liabilities viz. provident fund, provision for
taxes, sale tax, etc.
Miscellaneous current liabilities viz. dividend, any
payment payable within a year
CURRENT RATIO
Current Ratio : CA / CL
Helps to measure liquidity and financial strength
Higher ratio indicates better liquid position
Desirable current ration is 2 :1 i.e. even if the
current assets reduce to half, even then current
liabilities could still be paid.
Ratio below 1.33:1 generally not considered
acceptable
Limitation of Current Ratio applied at a single
point of time. Doesnt take into account
revolving nature of CAs & CLs

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ACID TEST RATIO OR QUICK RATIO
Acid Test Ratio: Quick Assets / Current
Liabilities
Quick Assets = Current assets (-) Inventories
Inventories excluded since they are not so
liquid
Stringent measure of liquidity & shows ability of
enterprise to pay its obligations without relying
on sale and collection of inventories.
Quick Ratio below 1 : 1 is considered
unsatisfactory

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INFLUENCING FACTORS FOR
WORKING CAPITAL
Nature of business
Seasonality of operations
Production policy
Market conditions
Conditions of supply of raw
materials
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DANGERS OF INADEQUATE
WORKING CAPITAL
Difficult to implement operating plans &
achieve profit target

Operating inefficiency creeps in

Fixed assets are not used efficiently-
deteriorating firms profitability

Firm loses reputation - short term
obligations not honoured
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DANGERS OF EXCESSIVE
WORKING CAPITAL
Diversion for long term assets

Unnecessary accumulation of inventories and
current assets

Indication of defective credit policy

Makes management complacent- managerial
inefficiency

Tends to make speculative profits grow.
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SOME IMPORTANT TERMS
GROSS WORKING CAPITAL
Is the Firms Investment in Current Assets

Focus on how to optimise investment in
current assets to avoid over/ under
financing.
Also how should current assets be
financed.

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NET WORKING CAPITAL

NET WORKING CAPITAL =
CURRENT ASSETS CURRENT LIABILITIES

Also Called as LIQUID SURPLUS

Indicate liquidity position of the unit.

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SPONTANEOUS/
OTHER CURRENT LIABILITIES

Represent CURRENT LIABILITIES arising
spontaneously from the functioning of the
unit

It include sundry creditors, bills payable,
provision for expenses, outstanding
expenses, etc.

Does not include bank borrowings.
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WORKING CAPITAL GAP

WORKING CAPITAL GAP =
CURRENT ASSETS - OTHER CURRENT LIABILITIES

Only a PORTION of the WORKING CAPITAL
GAP needs to be considered for BANK
FINANCING

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ASSESSMENT OF WORKING
CAPITAL - Methods
Balance Sheet Method
Tandon Committee Method
Turnover Method
(Nayak Committee Method)
Operation Cycle Method
Cash Flow/ Budget Method
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1- BALANCE SHEET METHOD
LIABILITES ASSETS
CURRENT
LIABILITIES
SUNDRY
CREDITORS,
BILLS PAYABLE,
PROV.FOR EXP.
O/S EXPENSES
CASH,
MARKETABLE
SECURITIES
CURRENT
ASSETS
SUNDRY DEBTORS
BANK BORROWING STOCK
LONG-TERM
LIABILITIES
DEBNTURES
BONDS
SECURED LOANS
N ET BLOCK
(Gross block-Depreciation)
Plant & Mach, Land &
Building, etc
FIXED
ASSETS
LONG TERM
INVESTMENTS
NET WORTH NET WORTH PREPAID INSURANCE ,
TAXES receivable, RENT
receivable, INTEREST
receivable, NON-
CONSUMABLE STORES
OTHER NON
CURRENT
ASSETS
(receivable
after one yr)
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2 -TANDON COMMITTEE
Appointed by RBI in July 1974 to suggest
guidelines for RATIONAL allocation and
OPTIMUM utilization of BANK CREDIT

Cheap Credit available from BANKS was
used to Build-up Disproportionate Stocks
of raw materials to realise TRADING
PROFITS
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TANDON COMMITTEE
Double Financing from BANKS and Trade
CREDITORS

Limits Increased whenever INVENTORY &
RECEIVABLE levels went up

Diversion of BANK FUNDS to FIXED Assets,
Investments
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TANDON COMMITTEE - recommendations
Borrowers to draw Operating Plans- Submit to
Banker
Only REASONABLE part of WORKING CAPITAL
Requirement to be financed by BANKS
Bank Finance to be based on future requirement of
current assets for next one year.
INVENTORY & RECEIVABLE Norms for 15 industries
excluding HEAVY ENGG.& HIGHLY Seasonal
Industries like SUGAR were Suggested by TANDON
COMMITTEE
3 Methods for Computing MAXIMUM PERMISSIBLE
BANK FINANCE Suggested.
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MAXIMUM PERMISSIBLE BANK
FINANCE- I METHOD
Borrower to contribute 25% of WORKING
CAPITAL GAP (from own fund and/or
term loan),
Remaining 75% can be financed from
Bank Borrowings.
To be used for new units, sick units and
units going for modernization and
diversification
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MAXIMUM PERMISSIBLE BANK
FINANCE- I METHOD
Particulars Rs.
Current Asset 100
OTHER CURRENT LIABILITIES (excluding
bank borrowings)
20
WC Gap 80
Borrowers contribution 25% of WCG
(To come from long term funds i.e. owned funds and term
borrowings)
20
Permissible Bank Finance 60
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MAXIMUM PERMISSIBLE BANK
FINANCE- II METHOD

Borrower to contribute 25% of TOTAL
CURRENT ASSETS,
Remaining of WORKING CAPITAL GAP
can be bridged from Bank borrowings.
To be used for existing units
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MAXIMUM PERMISSIBLE BANK
FINANCE- II METHOD
Particulars Rs.
Current Asset 100
OTHER CURRENT LIABILITIES (excluding bank
borrowings)
20
WC Gap 80
Borrowers contribution 25% of CA
(To come from long term funds i.e. owned funds and term
borrowings)

25
Permissible Bank Finance 55
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MAXIMUM PERMISSIBLE BANK
FINANCE-III METHOD

Borrower to contribute 100% of CORE
CURRENT ASSETS & 25% of Balance
CURRENT ASSETS.

The remaining portion of WORKING
CAPITAL GAP can be met from BANK
BORROWINGS.

This method will further strengthen the
CURRENT RATIO. RBI did not accept it.
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Maximum Permissible Bank Finance
(MPBF) by Tandon committee- Summary
Method 1: MPBF = 0.75 (CA- OCL)
=0.75 (WCG)

Method 2: MPBF = 0.75 (CA) OCL

Method 3: MPBF = 0.75 (CA-CCA) - OCL


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3- TURNOVER METHOD OR
NAYAK COMMITTEE METHOD
APPOINTED BY RBI IN 1991 TO
EXAMINE DIFFICULTIES FACED BY
SSIs FOR SECURING FINANCE

SUITABLE ARRANGEMENTS FOR
ENSURING ADEQUATE FLOW OF
INSTITUTIONAL CREDIT FOR
WORKING CAPITAL & TERM FINANCE
TO SSI SECTOR
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TURNOVER METHOD OR NAYAK
COMMITTEE METHOD
MODIFICATIONS/ RELAXATIONS IN
NORMS OF TANDON COMMITTEE

METHODS TO MINIMISE DELAY IN
REALISATION OF BILLS

CHANGES REQUIRED IN PRESENT
GUIDELINES FOR REHABILITATION OF
SICK UNITS.
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TURNOVER METHOD OR NAYAK
COMMITTEE METHOD
VILLAGE INDUSTRIES RECEIVE
SUBSTANTIALLY LOWER CREDIT
THAN TINY AND SSI UNITS

WORKING CAPITAL ASSISTANCE TO
VILLAGE & SMALLER TINY UNITS
ALMOST NON-EXISTENT
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TURNOVER METHOD OR NAYAK
COMMITTEE METHOD
DELAYS IN SANCTION OF CC LIMITS

LONG WAIT FOR INCREASE IN
WORKING CAPITAL LIMITS

BRANCH MANAGERS TO HAVE RIGHT
APTITUDE, SKILLS AND ORIENTATION
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3) TURNOVER METHOD OR
NAYAK COMMITTEE METHOD
Working capital requirement assessed at
25% of the annual turnover
Bank finance to be 20% of the projected
annual turnover
To satisfy about reasonableness of the
projected turnover on the basis of actual
financial statements or any other documents
such as return filed with sales tax/ revenue
authorities and ensure that estimated growth
is achievable.
Mostly used for trading companies

STEPS IN WORKING OUT
TURNOVER
Step 1 - Validate projected gross sales in
the light of past trends and future prospects
Step 2 Compute working capital gap (25
% of the projected turnover / sales)
Step 3 - Calculate margin money (5% of the
projected turnover/ sales)
Step 4 Calculate W.C. ( 2 minus 3)

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4 -OPERATING CYCLE
Operating cycle may be described
as the duration required to convert
resources into inventories,
inventories into sales & sales into
cash
In other words - cash to cash
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OPERATING CYCLE
CASH
RAW
MATERIALS
WORK
IN PROGRESS
FINISHED
GOODS
SUNDRY
DEBTORS
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OPERATING CYCLE
These phases affect cash flows
which most of the time are neither
synchronised nor certain

First CASH OUTFLOWS then CASH
INFLOWS
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Operating Cycle - Manufacturing
Conversion of Cash to RM
Conversion of RM to stock in process
Conversion of stock in process to finished goods
Conversion of finished goods into receivables
Conversion of receivables into Cash
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Operating Cycle - Trading
Conversion of Cash into inventories
Conversion of inventories into receivables
Conversion of receivables into Cash
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Operating Cycle - Services
Conversion of Cash into services
Conversion of services into receivables
Conversion of receivables into Cash
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OPERATING CYCLE AN
EXAMPLE
Time to acquire raw material - 45 days

Conversion process time - 15 days

Storage time of finished goods - 10 days

Collection period of receivables - 20 days
TOTAL 90 DAYS
NO. OF OPERATING CYCLES= 360/90=4
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ASSESSMENT OF WORKING
CAPITAL REQUIREMENTS
Compute Net Operating Cycle

From this calculate Working Capital Turn-over Ratio
(WCTR):
WCTR = No. of Working Days in a Year
No. of Days in 1 Operating Cycle

Assess Total Operating Expenses

WKG. Capital Reqd. = Operating Expenses
WCTR

BANK LIMIT = WKG. CAP. REQ. - MARGIN
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THANK
YOU