The term working capital means sum of the funds invested at various current assets used in the operating cycle, by the industrial and trading establishments. Operating cycle means the length of time required to convert ‘Non-Cash current assets’, (like raw material (RM), work in process (WIP), finished goods (FG), and receivables) into cash. The appraisal of working capital finance means assessment of gross working capital, net- working capital and working capital gap for assessment of working capital limits for a company.
Banks in India have evolved their own method of lending as they have been given free hand by the Central Bank (that is RBI) to decide the lending methods. The method of assessment of working capital limits up to Rs.2 crore (Rs.7.50 Crore for SME) assessed under turn over method is called as limits assessed under Nayak Committee Norms. Under turnover method the aggregate fund based working capital limits are computed on the basis of Minimum of 20% of their projected annual turnover. The borrower has to bring margin of 5% of the annual turn-over of such borrowers as margin money.
If projected sales turn-over is = Rs.100, 000.00
Then, working capital gap is 25% of turnover = Rs. 25000.00
Minimum permissible Bank Finance should be 20% of turnover = Rs. 20,000.00
Margin money from the borrower should be 5% of Rs.100000.00 = Rs. 5000.00
The following types of loans and advances are considered as working capital finance.
- Cash Credit/ Overdraft against inventories and book debts.
- Demand Loan portion under Loan System for Delivery of Bank Credit
- If, permissible bank finance is Rs.10 Crore and above.
- Packing Credit against inventories.
- Bills purchased /Discounted (inland & foreign)
- Cash Credit against book debts/Cheque purchase.
- Working capital term loan (for excess borrowing)
Related articles (Category: Financial Analysis)
- Things to know before starting appraisal of working capital limit
- How the length of operating period (Holding period for stocks and receivables) is measured?
- MPBF/Cash Budget methods of working capital appraisal
- Ratio analysis: learn the techniques & get into saddle