final project ubi

A PROJECT ON
Case study on working capital
Project Report submitted to
University of Calcutta
Period: 15th June 2016 to 15th August 2016
Submitted By:
Name: Jhinuk Roy Roll No.: 93/ECO/151127
Year: 1st
Semester: 2nd
Department: MSc. (Economics)
Under the guidance of
United Bank OF India
11, HemantBasuSarani, Kolkata- 700001
Kolkata, West Bengal

Case Study on Working Capital | 2016
University of Calcutta i
STATEMENT BY THE CANDIDATE
I hereby state the Project Report entitled Case Study on Working Capital has been
prepared by me to fulfill the requirements of the internship during the period 15th June
2016 to 15th August 2016.
Dated: 14/08/2016
Jhinuk Roy,
(Roll No-93/ECO/151127)

University of Calcutta ii
ACKNOWLEDGEMENT
I deem it a pleasure to acknowledge my deep sense of gratitude to the officials and
staffs of United Bank of India who directed and guided me with their timely advice
and constant inspiration, which eased to task the completing of this project report.
I would also like to thank Calcutta University and the HOD of Economics department
and all the others faculty members, without whom this project would have been a
distant reality.
Finally I must say that no height is ever achieved without some sacrifice made at some
end and it is here I owe my special debt to my parents and family members for
showing their love throughout this period of time.
Jhinuk Roy.

University of Calcutta iii
ABSTRACT
I student of Calcutta University),pursuing Masters in Economics(M.sc),have
undergone summer internship program in United Bank of India .I was assigned to the
Credit Department at The United Bank of India, Head Office at Kolkata and has
undergone training on Working Capital. This project discusses the theory and practice
of working capital and the assessment of working capital. In this project assessment of
the factors was done on the basis of a case study which was given to me.
This project deals with the loan appraisal methodology of a bank for a proposal
received for working capital. Several variables affect the working capital of the
companies such as current ratio, debt service coverage ratio, quick ratio, asset
coverage ratio, Asset Coverage Ratio etc. These variables were analyzed during the
period of study.
The factors were compared with the standards as mentioned in the Lending Policy of
the bank, on the basis of which it is decided whether the loan will be sanctioned or not.
The projected balance sheet and the projected cash flow statement were also assessed.
As part of the appraisal process, credit rating is done for the proposal is conducted by
the bank itself and approved external agencies.
In this study, the important findings and conclusions derived from analyzing the
collected data is presented.

University of Calcutta Contents
TABLE OF CONTENTS
Statement by the Candidate (i)
Acknowledgement (ii)
Abstract (iii)
List of tables (vi)
List of figures (vii)
Objective 1
Chapter- 1 A Brief Introduction on Bank 2-6
1.1 Introduction 2
1.2 History 2
1.3Main Functions of Bank 3
1.4Secondary Functions 4
Chapter- 2 Evolution of Bank 7-12
2.1 Structure of the Organized Banking Sector 8
2.2 Business Segmentation 10
Chapter- 3 Methodology 13-13
3.1 Limitations of the study 13
Chapter- 4 Discussion 14-35
4.1 Working Capital 14
4.2 Sources of Working Capital 17
4.3Types of Working Capital 18
4.4Working Capital Management 20
4.5Working Capital Assessment 23
4.6Methods for Assessment of Working Capital 24
4.7Types of Banking 30
4.8Bank Rating 31
4.9Types of Securities 33
4.10Some Common Terms used in Working Capital Assessment 33
Chapter- 5 Case Study 36-54
5.1 About the Company 35

University of Calcutta Contents
5.2 Gist of Proposal 36
5.3 Analysis of the Balance Sheet of XYZ Private Limited 37
5.4Sanction of Working Capital Limits 43
5.5Credit Rating by Agencies with Purpose of such Rating 43
5.6Financial Position of the Company as on Close of Financial Years for Last Three Years 44
5.7Ratio Analysis 45
5.8Movement of TNW 46
5.9Fund Flow Analysis 46
5.10Computation of ACR for the Working Capital Limit 48
5.11Assessment of Working Capital 49
5.11.1 Computation of maximum permissible Bank Finance (MPBF) 49
5.12Loan Policy 52
5.13 Rationale for Recommendation 53
Chapter- 6 Learning Points 55-71
6.1 Characteristics of Working Capital 55
6.2 The Pros & Cons of Working Capital 56

University of Calcutta vi
LIST OF TABLES
Table 1: Sources of Working Capital 17
Table 2: Types of Working Capital 19
Table 3: Balance Sheet of ABC Company Limited 28
Table 4: SMA Sub-categories 33
Table 5: Analysis of the Balance Sheet of XYZ Private Limited 36
Table 6: Sanction of Working Capital Limits 43
Table 7: Credit Rating by Agencies with Purpose of such Rating 43
Table 8: Financial Position of the Company as on Close of Financial Years for Last Three Years 44
Table 9: Ratio Analysis 45
Table 10: Movement of TNW 46
Table 11: Fund Flow Analysis 46
Table 12: Computation of ACR for the Working Capital Limit 48
Table 13: Computation of maximum permissible Bank Finance (MPBF) 49
Table 14: Holding levels for different items of current assets and current liabilities 50
Table 15: Other Current Assets 51
Table 16: Assessment of PC & FBP/FBN Limit 51
Table 17: Benchmark Parameters as per Lending Policy 52

University of Calcutta vii
LIST OF FIGURES
Figure 1Evolution of Banking 7
Figure 2 Structure of Indian Banking System 8
Figure 3 Business Segmentation 10
Figure 4 Operating Cycle in manufacturing firm 15

University of Calcutta 1
OBJECTIVES
The main objective of the study is to understand working capital and also the concepts
related to working capital. This project has helped me to:
 To study how bank loans function;
 To understand the procedures to be followed for availing loan;
 To know about the lending policy of UBI;
 To understand the concept of working capital;
 To understand the various concepts associated with working capital.

Chapter 1- A Brief Introduction on Bank
1.1 Introduction:
Banking is defined as “Accepting for the purpose of lending and investment, of deposit of money
from the public, repayable on demand order or otherwise and withdraw able by cheque, draft or
otherwise.”Thus, banking means transacting business with a bank; depositing or withdrawing funds
or requesting a loan etc.
A bank is a financial institution licensed to receive deposits. This type of bank is referred to as a
commercial or retail bank. Some banks also engage in the issuance of new securities to the public.
This type of bank is usually referred to as an investment bank. Due to deregulation, a single bank is
allowed to do both.
A bank that operates as a commercial bank accepts customer deposits in the form of demand deposit
accounts, savings accounts, money market accounts and timed accounts such as certificates of
deposits (CDs). Banks pay interest to the depositors on some of these accounts.
Banks loan the deposited money to borrowers who pay interest to the bank as long as the loan is
outstanding. Typical loans include short-term loans, car loans, mortgages, large loans to businesses
to fund capital purchases and lines of credit. Some commercial banks also issue credit cards as part
of their services.
Just like any other business, a bank’s goal is to earn a profit for its owners. It does this by earning
more on the interest it charges its borrowers than it loses on the interest it pays to depositors.
For example, if in a year, a bank has 100 million in deposits for which it pays 2% to the depositors
and then loans that 100 million to borrowers at a rate of 5%, the bank earns a profit of 3% (3 million)
for the year.
1.2 History:
The development of banking is evaluation in nature. The origin of the word ‘bank’ can be traced
back to the German word ‘Banck’ and Italian word ‘Banco’ which means heap of money.
Banking is an old concept in India. It was present in ancient Vedic times .There were bankers known
as ‘Sheth’ ,’Shah’ ,’Shroff’ or ‘Chettiar’ who were performing the function of bank.
1.3 Main Functions of Bank:
Primary Functions:
The main functions of banks are accepting deposit and lending loans:
I. Accepting deposits:
a. Fixed deposits- These deposits mature after a considerable long period like 1 year or more
than that the rate of interest is fixed the amount deposited cannot be withdrawn before maturity date.
b. Current A/C deposit- These are mainly maintained by business community to facilitate
frequent transaction with big amounts .Generally no rate of interest or very low rate of interest is
paid on this account.
c. Saving bank A/C- It is kind of demand deposits which are generally kept by the people for
the sake of safety. These facilities are given for small saver and normally a small rate of interest is
paid.

d. Recurring deposit A/C- In case of recurring deposit the fixed amount is deposited in a bank
every month for a fixed period of time.
II. Lending loans:
a. Call/Demand loans- These loans are called back at any time. Normally, these loans are taken
by bill brokers or stock brokers.
b. Short term loans- These are sanctioned normally for a period up to 1 year.
c. Medium term loans- These are sanctioned normally for the period varying between 1 and 5
years.
III. Long Term Loans:
These loans are sanctioned for a period of more than 5 years. It includes:
a. Overdraft- The bank grants overdraft facility to its reliable and respectable depositors. It
enables companies, firms and businessmen to withdraw amount over and above their actual balance
in their current account.
b. Cash Credit- Under this facility, the bank allows the borrower to withdraw cash against
certain security.
c. Bills of Exchange- The bank provides funds to their customers by purchasing or discounting
bills of exchange. The bank charges commission up to the maturity period of bills.
1.4 Secondary Functions:
The secondary functions of commercial bank can be classified under the following heads.
1. Agency functions
2. General utility functions
3. Miscellaneous functions
1. Agency Functions- The banks render important services as agent on behalf of their customers in
return for a small commission. When banks act as agent, law of agency applies. The agency
functions or services of bank are as follows:
a. Collection of Cheques: Commercial banks collect the cheques, bills of exchange, etc, on
behalf of their customers. Banks collect local and outstation cheques and bills of exchange through
clearing house facilities provided by the central bank.
b. Collection of Income: The commercial banks collect dividends, interest on investment,
pension and rent of property due to the customers. When any income is collected by the bank, a
credit voucher is sent to the customer for information.
c. Payment of expenses: The banks make payment of insurance premiums, rent, trade
subscription, school fee and other obligation of the customers. When any expense is paid by the
bank, a debit voucher is sent to the customer for information.

d. Dealer in securities: The banks carry out purchase and sale of securities on behalf of their
customers. Banks do it well because they are aware of the market conditions.
e. Acts as trustee: The banks act as trustee to manage trust property as per instructions of
property owners. Banks are required to follow the terms and conditions of trust deed.
f. Acts as an agent: Commercial bank sometimes acts as an agent on behalf of its customers at
home or abroad in dealing with other banks or financial institutions.
g. Executing standing instructions: Sometimes customer may order his bank to do something
on his behalf regarding the conduct of his account. This written order is called standing instruction.
The bank being the agent of its customer obeys the standing instructions.
h. Acts as tax consultant: Commercial bank acts as tax consultant to its client. The commercial
bank prepares general sales tax return, income tax return, etc. Tiles the same with tax authorities.
2. General Utility Functions- Commercial bank performs different utility functions for their
customers. When bank performs utility functions, it does not act as an agent of the customers.
The general utility functions are as follows:
a. Provides lockers facilities: Commercial banks provide lockers facilities to its customers for
safe custody of Jeweler, shares, securities and other valuables. This has minimized the risk of losing
due to theft.
b. Issue of traveler'scheque: Bank issues traveler's cheques to the customers for traveling in
and outside the country.
c. Foreign exchange: Commercial banks deal in foreign exchange. This enables the
individuals and businessmen to obtain foreign currency in exchange of their home currency. For
dealing in foreign exchange, commercial banks have to obtain permission from the central bank.
d. Transfer of money: Commercial banks provide facilities for the transfer of money to any
place within and outside the country. The funds are transferred by means of draft, telephonic transfer,
electronic transfer etc.
e. Finances foreign trade: A commercial bank finances foreign trade by accepting foreign
bills of exchange. Bank also issues letter of credit on behalf of its customers to facilitate foreign
trade.
f. Trade information: Commercial banks collect and provide trade information and tender
advice to its customers about financial matters. Issues credit cards: Banks issue credit cards to their
trustworthy and valued customers. This facilitates the customers to pay for their necessities of life.
g. Purchase PTCs: Commercial banks underwrite or purchase Participation Term Certificate
(PTCs), Term Finance Certificates (TFCs). This helps the companies to raise their capital.
h. Financial standing: Commercial banks answer reference letters regarding the financial
standing and business reputation of customers. Banks provide this information with great care and
utmost secrecy.

3. Miscellaneous Functions-Commercial banks perform the following miscellaneous functions.
a. Collection of utility bills: Commercial banks provide facilities for the collection of utility
bills from general public on behalf of government bodies. This facilitates the public to pay utility
bills in time.
b. Electronic banking and E-banking:Electronic banking is offering improved services to the
customers as follows:
1) ATM Cards
2) Credit Cards and
3) Electronic transfer of money

CHAPTER-2 EVOLUTION OF BANK
The Indian banking industry has its foundations in the 18th century, and has had a varied
evolutionary experience since then. The initial banks in India were primarily traders’ banks engaged
only in financing activities. Banking industry in the pre-independence era developed with the
Presidency Banks, which were transformed into the Imperial Bank of India and subsequently into the
State Bank of India. The initial days of the industry saw a majority private ownership and a highly
volatile work environment. Major strides towards public ownership and accountability were made
with nationalization in 1969 and 1980 which transformed the face of banking in India. The industry
in recent times has recognized the importance of private and foreign players in a competitive
scenario and has moved towards greater liberalization.
.
 Phase I- Pre-Nationalization Phase (prior to 1955)
 Phase II- Era of Nationalization and Consolidation (1955-1990)
 Phase III- Introduction of Indian Financial & Banking Sector Reforms and Partial
 Liberalization (1990-2004)
 Phase IV- Period of Increased Liberalization (2004 onwards)
2.1 Structure of the Organized Banking Sector:
The organized banking system in India can be classified as given below:

Reserve Bank of India (RBI):
The country had no central bank prior to the establishment of the RBI. The RBI is the supreme
monetary and banking authority in the country and controls the banking system in India. It is called
the Reserve Bank’ as it keeps the reserves of all commercial banks.
Commercial Banks:
Commercial banks mobilize savings of general public and make them available to large and small
industrial and trading units mainly for working capital requirements.
Commercial banks in India are largely Indian-public sector and private sector with a few foreign
banks. The public sector banks account for more than 92 percent of the entire banking business in
India—occupying a dominant position in the commercial banking. The State Bank of India and its 7
associate banks along with another 19 banks are the public sector banks.

Scheduled and Non-Scheduled Banks:
The scheduled banks are those which are enshrined in the second schedule of the RBI Act, 1934.
These banks have a paid-up capital and reserves of an aggregate value of not less than Rs. 5 lakhs,
hey have to satisfy the RBI that their affairs are carried out in the interest of their depositors.
All commercial banks (Indian and foreign), regional rural banks, and state cooperative banks are
scheduled banks. Non- scheduled banks are those which are not included in the second schedule of
the RBI Act, 1934. At present these are only three such banks in the country.
Regional Rural Banks:
The Regional Rural Banks (RRBs) the newest form of banks, came into existence in the middle of
1970s (sponsored by individual nationalized commercial banks) with the objective of developing
rural economy by providing credit and deposit facilities for agriculture and other productive
activities of all kinds in rural areas.
The emphasis is on providing such facilities to small and marginal farmers, agricultural laborers,
rural artisans and other small entrepreneurs in rural areas.
Cooperative Banks:
Cooperative banks are so-called because they are organized under the provisions of the Cooperative
Credit Societies Act of the states. The major beneficiary of the Cooperative Banking is the
agricultural sector in particular and the rural sector in general.
The cooperative credit institutions operating in the country are mainly of two kinds: agricultural
(dominant) and non-agricultural. There are two separate cooperative agencies for the provision of
agricultural credit: one for short and medium-term credit, and the other for long-term credit. The
former has three tier and federal structure.
At the apex is the State Co-operative Bank (SCB) (cooperation being a state subject in India), at the
intermediate (district) level are the Central Cooperative Banks (CCBs) and at the village level are
Primary Agricultural Credit Societies (PACs).
Long-term agriculture credit is provided by the Land Development Banks. The funds of the RBI
meant for the agriculture sector actually pass through SCBs and CCBs. Originally based in rural
sector, the cooperative credit movement has now spread to urban areas also and there are many urban
cooperative banks coming under SCBs.
2.2 Business Segmentation:
The entire range of banking operations are segmented into four broad heads- retail
bankingbusinesses, wholesale banking businesses, treasury operations and other banking
activities.Banks have dedicated business units and branches for retail banking, wholesale
banking(divided again into large corporate, mid corporate) etc.

Treasury Operations:
Treasury operations include investments in debt market (sovereign and corporate), equitymarket,
mutual funds, derivatives, and trading and forex operations. These functions can beproprietary
activities, or can be undertaken on customer’s account. Treasury operations areimportant for
managing the funding of the bank.
Apart from core banking activities, which comprises primarily of lending, deposit takingfunctions
and services; treasury income is a significant component of the earnings of banks.Treasury deals
with the entire investment portfolio of banks (categories of HTM, AFS andHFT) and provides a
range of products and services that deal primarily with foreignexchange, derivatives and securities.
Treasury involves the front office (dealing room), mid office (risk management
includingindependent reporting to the asset liability committee) and back office (settlement of
dealsexecuted, statutory funds management etc.)
Other Banking Businesses:
This is considered as a residual category which includes all those businesses of banks that do not fall
under any of the aforesaid categories. This category includes para banking activities like hire
purchase activities, leasing business, merchant banking, factoring activities etc.
Lending:
One of the banking activities is lending.
Lending Services of Bank
a. Cash Finance
b. Overdraft
c. Loans ( Term Finance)
d. Purchase and Discounting of Bills
e. Hire- purchase and Leasing Finance
Loans:
A loan is a debt provided by an entity (organization or individual) to another entity at aninterest rate,
and evidenced by a promissory note which specifies, among other things. , aloan is a debt provided
by an entity (organization or individual) to another entity at an interest rate, and evidenced by a note
which specifies, among other things, the principal amount, interest rate, and date of repayment. A

loan entails the reallocation of the subject asset(s) for a period of time, between the lender and the
borrower.
Bank Loans often referred to as C & I loans, falls into four main categories which are:
1. Transaction Loans: A transaction loan is negotiated for a specific purchase and is tailored to the
particular needs of the purchaser. The demandfor these loans from a particular borrower is
typicallyepisodic and hence each loan is negotiated separately.
2. Working Capital Loans: These loans are used by firms to finance routine day -to-
daytransactions. Thus, they are general purpose, short-term borrowings, and are often usedeither to
purchase current assets (like inventories) or to repay debts incurred in purchasingcurrent assets.
3. Term Loans: These are longer maturity loans used to by fixed assets requiring largeoutlays of
capital. Maturities typically run from 3 to 10 years. Repayment is normallyamortized because it
comes out of the cash flows generated by the assets financed withthe loan.
4. Combinations: Working capital loans often include provisions that permit the conversionof short-
term borrowings into term loans at the borrower’s request.

Chapter-3 Methodology
The methodology includes the following:
 Types of study
 Scope of study
 Sources of data collection
Types of Study:
The UBI has warmly welcomed us to be a in the financial organization and to gain varioustypes of
knowledge about how the bank provides credit facilities to the public. In the bankwe get to interact
with bankers. As we are in the credit department, they helped us inunderstanding various types of
credit facilities that they provide.
Scope of the Study:
The study deals with the various factors taken into consideration during appraisal of the term loans
and financial analysis of the same.
Collection of Data:
The data is used in this study collected from secondary data sources, i.e. Bank’s lendingpolicy, the
bankers, the files in the bank etc.
3.1: Limitations of the study:
Although this research was carefully prepared, there may be limitations and short comingsdue to the
following reasons:
 The duration of the study was quite short.
 Study was based on secondary sources of data
 The study is limited only to a single bank
 Study was based on documents of complex nature which was difficult for us to understand.

CHAPTER-4 DISCUSSION
4.1 Working Capital:
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 assets’,(like raw materials(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.
Working capital is calculated as:
Working capital=Current asset-Current liabilities
The working capital ratio (Current Assets/Current Liabilities) indicates whether a company has
enough short term assets to cover its short term debt.
Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the
company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
Also known as "Net Working Capital".
Operating Cycle: The operating cycle is also known as the cash conversion cycle. In the context of
a manufacturer the operating cycle has been described as the amount of time that it takes for a
manufacturer's cash to be converted into products plus the time it takes for those products to be sold
and turned back into cash. In other words, the manufacturer's operating cycle involves:
 Paying for the raw materials needed in its products.
 Paying for the labor and overhead costs needed to convert the raw materials into products.
 Holding the finished products in inventory until they are sold.
 Waiting for the customers' cash payments for the products that have been sold.
Holding Period: Operating cycle means the length of time required to convert ‘Non-Cash current
assets’ like raw material,work- in- process,finished goods and receivables into cash. At each stage of
operating cycle i.e. stock of raw material, work- in- process, finished goods a manufacturing unit
needs to hold the stock for a length of time in the workplace before dispatching the final products to

the customers. The tendency of some manufacturing units holding the current assets (stocks and
receivables) beyond the requirement of holding period has the financial implication,as more amount
of interest payable on current liabilities for the time taken in converting the current assets into cash.
There are several financial ratios that pertain to working capital:
Liquidity Ratio: A liquidity ratio is an indicator of whether a company’s current assets will be
sufficient to meet the company’s obligations when they become due. The liquidity ratios include the
current ratio and the acid test or quick ratio. The current ratio and quick ratio are also referred to as
solvency ratios. Working capital is an important indicator of liquidity or solvency, even though it is
not technically a ratio.
Current Ratio: The current ratio is a financial ratio that shows the proportion of current assets to
current liabilities. The current ratio is used as an indicator of a company’s liquidity.
Quick Ratio: The quick ratio is a financial ratio used to gauge a company’s liquidity. The quick
ratio is also known as the acid test ratio. This ratio compares the total amount of cash+ marketable
securities+ accounts receivable to the amount of current liabilities. The quick ratio differs from the
current ratio in that some current assets are excluded from the quick ratio. The most significant
current asset that is excluded is inventory. The reason is that inventory might turn into cash quickly.
Example:
Cash 50000
Debtors 100000
Inventories 150000
Current Liabilities 100000
Total Current Assets 300000
Current Ratio = > 3, 00,000/1, 00,00 = 3: 1
Quick Ratio = > 1, 50,000/1, 00,000 = 1.5: 1
Debt-Equity Ratio:Debt/Equity Ratio is a debt ratio used to measure a company's financial
leverage, calculated by dividing a company's total liabilities by its stockholders' equity. The D/E
ratio indicates how much debt a company is using to finance its assets relative to the amount of value
represented in shareholders' equity.
Debt - Equity Ratio = Total Liabilities / Shareholders' Equity
TOL/TNW Ratio:TOL/TNW is a measure of a company’s financial leverage calculated by dividing
the total liabilities of the company by the total net worth of the business. Total outside liability is the
sum of all the liabilities of the business and total net worth is the sum of share capital and surplus
reserves of the company.
Asset Coverage Ratio (ACR):The asset coverage ratio is a test that determines a company's ability
to cover debt obligations with its assets after all liabilities have been satisfied. When calculating the
asset coverage ratio, investors should exercise caution with respect to asset value; using the coverage
ratio of the actual liquidation value of assets is significantly less.

4.2 Sources of Working Capital:
Sources of working capital can be spontaneous, short term and long term.
Spontaneous Sources of Working Capital Finance: The word ‘spontaneous’ itself explains that
this source of working capital is readily or easily available to the business in the normal course of
business affairs. The quantum and terms of this credit depend on the industry norms and relationship
between buyer and seller. These sources include trade credit allowed by the sundry creditors, credit
from employees, and other trade-related credits. The biggest benefit of spontaneous sources as
working capital is its effortless raising and insignificant cost compared to traditional ways of
financing.
Short Term Sources of Working Capital Finance: Short term sources can be further divided into
internal and external sources of working capital finance. The short-term internal sources include tax
provisions, dividend provisions etc. Short-term external sources include short-term working capital
financing from banks such as bank overdrafts, cash credits, trade deposits, bills discounting, short-
term loans, inter-corporate loans, commercial paper, etc.
Long Term Sources of Working Capital Financing: Long term sources can also be divided into
internal and external sources. Long term internal sources of finance are retained profits and provision
for depreciation whereas external sources are Share Capital, long-term loan, and debentures.
Spontaneous
Sources
Short Term Sources Long Term Sources
Internal Sources
External
Sources
Internal Sources
External
Sources
TradeCredit Tax Provisions Bank Overdraft Retained Profits Share Capital
Sundry
Creditors
Dividend
Provisions
Trade Deposits
Depreciation
Provision
Long Term
Loans
Bills Payable Public Deposits Debentures
Notes Payable BillsDiscounting
Accrued
Expenses
Short Term
Loans
4.3 Types of Working Capital:
Working Capital is divided into various types based balance sheet view and operating cycle view.
Balance sheet view divides working capital into gross working capital and net working capital and
the operating cycle view divides the working capital into permanent and temporary working capital.
Permanent working capital is further divided into seasonal and special working capital whereas
temporary working capital into regular and reserve working capital.
Working capital is classified into different types and the classification is based on the following
views:
Balance Sheet View:
On the basis of Balance Sheet View, types of working capital are described below:
Gross Working Capital (GWC): Current assets in the balance sheet of a company are known as
gross working capital.

Net Working Capital (NWC): Net working capital is a very frequently used term. There are two
ways to understand networking capital. First, one says it is simply the difference between current
assets and the current liabilities on the balance sheet of a business. The other understanding discloses
little deeper or hidden meaning of the term. As per that, NWC is that part of current assets which are
indirectly financed by long-term assets. Compared to gross working capital, net working capital is
considered more relevant for effective working capital financing and management.
Operating Cycle View:
On the basis of Operating Cycle View, types of working capital are as below:
Permanent / Fixed Working Capital: Dealing with current asset and fixed assets is totally
different. Determining the financing requirement in the case of fixed assets is simply the cost of the
asset. Same is not true for current assets because the value of current assets is constantly changing
and it is difficult to accurately forecast that value at any point of time. To simplify the complexity to
some extent, on the basis of past trend and experience, we can find a level below which current asset
has never gone. The current assets below this level are called permanent or fixed working capital.
As an example:
(Rs. in crores)
Types of Working Capital
Net Working Capital Permanent / Fixed
Working Capital
Temporary / Variable Working Capital
Requirement
3000 2500 500
2500 2500 0
2800 2500 300
3200 2500 700
In the example, Rs.2500crores is the permanent working capital below which the net working capital
has not gone.
Regular Working Capital: It is the permanent working capital which is normally required in the
normal course of business for the working capital cycle to flow smoothly.
Reserve Working Capital: It is the working capital available over and above the regular working
capital. It is kept for contingencies which may arise due to unexpected situations.
Temporary / Variable WC: Temporary working capital is easy to understand after getting hold
over the permanent working capital. In simple terms, it is the difference between net working capital
and permanent working capital. The main characteristic which can be made out of the example is
“fluctuation”. The temporary working capital, therefore, cannot be forecasted. In the interest of
measurability, this can be further bifurcated as below which can create at least some base to forecast.

Seasonal Working Capital: Seasonal working capital is that temporary increase in working capital
which is caused due to some relevant season for the business. It is applicable to businesses having
the impact of seasons, for example, the manufacturer of sweaters for whom relevant season is the
winters. Normally, their working capital requirement would increase in that season due to higher
sales in that period and then go down as the collection from debtors is more than sales.
Special Working Capital: Special working capital is that rise in the temporary working capital
which occurs due to a special event which otherwise normally does not take place. It has no basis to
forecast and has rare occurrence normally. For example, a country where Olympic Games are held,
all the business requires extra working capital due to a sudden rise in business activity.
It was all about the types of working capital. It needs to be managed with several working capital
techniques so as to have the effective working capital management.
4.4 Working Capital Management:
Each business has its uniqueness and style which decides the nature and the form of working capital
it require. An exporter for example will need packing credit limit instead to OD limit in compare to a
trader who will ask for OD limit. In view of above and as per industry practices following are the
possible forms of the working capital:
I. Fund Based Limits: Fund Base Limit is a limit in which the Company gets the money from bank
or financial institution in cash.
a. Cash Credit (CC) - To meet working capital requirements of the company the Bank gives the CC
limit against the hypothecation of Stock and Debtors. But While deciding the limit, the bank deducts
the Trade Creditors also. Further a monthly stock and debtor’s statement need to be submitted with
the bank showing the position of the stock and aging of the debtors. Client opens the Cash Credit
Account which allows the withdrawal up to the limit sanctioned by the bank. Bank charges the
prevailing interest and other bank charges as per norms. This facility is sanctioned for a year and
need to review at the closing of the year for renewal subject to the requirement of client. Bank
normally asks for the collateral security for securing its hand in case of any default. A regular
inspection is conducted on the factory and go downs of the client, to check the stock levels, by the
bank officers along with a Stock Audit conducted by a Chartered Accountant on yearly basis.
b. Working Capital Term Loan: Some time the borrower fails to bring immediately its own
contribution as margin while enjoying the working capital limits. In that case the bank may sanction
WCTL which need to be adjusted as soon as possible. It normally carry higher rate of interest in
comparison to working capital limit.
c. Factoring: The selling of a company’s accounts receivables, at a discount to a factor that then
assumes the credit risk of the account debtors and receives cash as the debtors settle their account.
There is no need to open the Letter of Credit (LC). There is specialize financial institutions such as
SBI Factors, Global Trade Finance, IFCI Factors which gives services of factoring (Domestic as well
as International).
f. Overdraft (OD): It is a tool to aid cash-flow by a bank providing a reserve of easily accessible
money to meet any shortfall in working capital. The facility is usually repayable "on demand" which

means whenever the bank demands. Consequently, it is usually shown as a current liability on the
balance sheet. It may be secured or unsecured.
g. Line of Credit: An arrangement between a financial institution and a customer that establishes a
maximum loan balance that the bank will permit the borrower to maintain. The borrower can draw
down on the line of credit at any time, as long as he or she does not exceed the maximum set in the
agreement. The advantage of a line of credit over a regular loan is that interest is not usually charged
on the part of the line of credit that is unused, and the borrower can draw on the line of credit at any
time that it needs to.
h.Packing Credit: PC is available to exporters, for financing purchase, processing, manufacturing or
packing of goods prior to shipment. This is basically a loan or advance extended to exporter by the
bank on the basis of:
 Letter of Credit opened in favor of exporter or in favor of some other person, by an overseas
buyer.
 A confirmed and irrevocable purchase order for the export of goods from India.
 Any other evidence of an order or export from India
B. Non-fund Based Limits: The credit facilities given by the banks where actual bank funds are not
involved are termed as 'non-fund based facilities'
a. Letter of Credit: A standard, commercial letter of credit is a document issued mostly by a
financial institution on the request of the buyer in favor of supplier of goods which usually provides
an irrevocable payment undertaking. It may be Inland LC or Foreign LC.
In this case the buyer bank gives guarantee on behalf of its client to supplier for supplying of
material or goods subject to that invoices, bill of lading, shipment documents will come directly to
the bank. Bank will mark lien on the goods and will stand as lender/creditor in the books of the client
(buyer). The supplier could opt for discounting of LC. In this case he will approach his
bankers/agent/factor that wills again approach to the buyer client. The buyer bank will make
payment (after deducting the margin) on behalf of its client for a fee.
The margin is normally in the range of 10 to 25%, and bank put the money in the form of FDR at
prevailing rate till the settlement of the final claim.
LC could be at sight LC or usance LC. A 'sight' LC means that payment is made immediately to the
beneficiary/seller/exporter upon presentation of the correct documents in the required time frame. A
‘usance/time’ LC will specify when payment will be made at a future date and upon presentation of
the required documents.
b. Bank Guarantee: In BG the bank guarantees a sum of money to a beneficiary. The sum is only
paid if the opposing party does not fulfill the stipulated obligations under the contract. This can be
used to essentially insure a buyer or seller from loss or damage due to nonperformance by the other
party in a contract. The real estate companies for example normally need to furnish the BG to the
Local Bodies or Authorities who sanction and approve the land for commercial/ residential or
industrial use.
c. Deferred Payment Guarantee

That is paid a fixed number of days after shipment or presentation of prescribed documents. It is used
where a buyer and a seller have close working relationship because, in effect, the seller (beneficiary
of the L/C) is financing the purchase by allowing the buyer a grace period for payment. It differs
from a sight draft or time draft in that no drafts are involved but the payment is guaranteed on the
stated date. However, there being no draft, the beneficiary party's ability to discount or sell his or her
right to payment is restricted.
4.5 Working Capital Assessment:
For running any business activity the unit/firm requires mainly two types of assets i.e. Current Assets
and Fixed Assets. For financing Fixed Assets we generally sanction Term Loan or Deferred Payment
Guarantees (DPG) and for Current Assets, we sanction Cash Credit Limit, Bills
Purchase/Discounting and/or Over Draft against Book Debts Limits.
Mainly there are three types of Borrowers approaching banks for working capital finance.
 Trading Concerns
 Manufacturing Units (Small/Medium and Large)
 Service Sector
Incase of manufacturing units, Current Assets comprise Raw Materials, Semi Finished goods,
Finished Goods, Receivables, cash etc. these assets go through the operating cycle of the business
units and based on operating cycle requirement/quantum for working capital are decided.
In case of Trading concerns, Current Assets comprise Stocks, Debtors, receivables and advance paid
to supplier of stocks. Where as in service activity, Current Assets comprise, expenses on Wages,
Rent, Electricity etc., Working capital or Gross Working Capital means funds required for Current
Assets. Current Assets in any unit/firm are funded from mainly three sources:
 Trade Creditors.
 Margin (Net Working Capital) from the party.
 Bank Finance in the form of Cash Credit, Bills Limit and/or Over Draft against Book
Debts
With a view to streamlining credit delivery system of commercial banks so as to falling line with the
International Practice and uniformity in the Banking system, RBI had appointed several committees
in the past.
Some of the important committee are-
 Daheja Committee in 1968;
 Tandon Committee in 1975;
 Chore Committee in 1978 and
 Nayak Committee in 1993.
As part of Financial Sector Reforms, RBI bestowed operational freedom in the area of credit
dispensation upon banks in its monetary and Credit policy for the first Half Year of 1997-98. The
prescription in regard to Assessment of Working Capital needs based on the concept of Maximum
Permissible Bank Finance (MPBF) enunciated by Tandon.
Committee was withdrawn and Banks were advised to evolve an appropriate system for assessing the
Working Capital Credit needs of borrowers subject to observance of prudential guidelines and
exposure norms. In tune with liberalized environment the following system is being adopted
generally for assessment of Working Capital Requirement of the Borrowers.

4.6:Methods for AssessmentofWorking Capital:
i. Operating Cycle Method.
ii. Drawing Power Method.
iii. Cash Budget methodTurnover Method.
iv. MPBF method /Projected Balance Sheet Method
i. Operating Cycle Method:
 Meaning of operating cycle:
It begins with acquisition of raw materials and ends with collection of receivables.
 Stages:
1) Raw materials (RM/RM consumption)
2) Work-in-process (WIP/COP)
3) Finished Goods (FG/COS)
4) Receivables (Debtors/Credit sales)
Less: Creditors (creditors/purchases)
 Example of Operating Cycle:
Length of operating Cycle:
a) Procurement of raw material : 30 days
b) Conversion/process time : 15 days
c) Average time of holding of finished goods: 15 days
d) Average collection period : 30 days
e) Total operating cycle : 90 days
f) Operating cycle in a year : 4
g) Total operating expenses per annum : Rs.60 lacs
h) Total turnover per annum : Rs.70 lacs
i) Working capital requirement : 60/4= 15 lacs
ii.Drawing Power (DP) Method:
(For units with small limits)
Drawing power is arrived at on the basis of valuation of current assets charged to the bank in the
shape of hypothecation and assignment, after deducting the stipulated margin.
 Illustration:
Paid stock – 4 Margin 25% - DP = 3
Semi-finished goods – 4 Margin 50% - DP=2
Finished goods -4 Margin 25% - DP = 3
Book Debts – 4 Margin 50% - DP = 2
Total DP= 10
iii. Cash Budget method:

Based on procurement and cash inflow). It is mainly used for Seasonal Industries (Sugar/ Rice
Mills/Textiles/Tea/Tobacco/Fertilizers) Contractors & Real Estate Developers, Educational
Institutions, etc.
iv.Turnover Method:
(Originally suggested by Nayak Committee for SSI units)
The WC requirements may be worked out on the basis of Nayak Committee recommendations for
working capital limit up to Rs.6 crores from the banking system, on the basis of minimum of 20% of
their projected annual turnover for new as well as existing units, beyond which WC be computed on
the basis of WC cycle, after fixing stipulated margins, on each component of the WC. In case of
borrowers desiring facilities under Nayak Committee recommendations and having a WC cycle of
more than 3 months in a year, the WC requirements will be funded after assessing his requirements
on the basis of his WC cycle, after fixing proper margins.
 Example:
Applicable for limits up to Rs.6 crores:
(a) Projected sales = Rs.10,00,000
(b) Working capital requirements: 25% of projected sales i.e. Rs.2,50,000
(c) Margin (contribution of Owner) : 5% of projected sales i.e. Rs.50,000
(d) Working capital to be funded by bank : Rs.2,00,000
v. Maximum Permissible Bank Finance (MPBF) Method:
In July 1974, the study group headed by Shri. P.I Tandon has framed guidelines for working capital
finance by banks. The recommendations made by above study group are known as Tandon
Committee recommendations. Out of three methods for assessment of working capital limits
proposed by Tandon Committee, RBI has accepted method I and method II, which are explained
below:
 First Method:
As per Tandon’s-I method (also called as ‘first method’) of lending the borrower has to arrange 25%
of Working Capital Gap as margin.
The first method can be explained from the following illustration:
Let us take an example of a company which has Total Current Assets (TCA) of Rs.100.00 and Other
Current Liabilities(OCL)i.e.(without working capital facilities from the bank) is Rs.20.00.Now we
will compute the Maximum Permissible Bank Finance(MPBF) under method-I.
TCA=100 and OCL=20
WCG is (TCA-OCL) =100-20=80----------------------Let us call it as (A)
25% of WCG =80*25/100=20-----------------Let us call it as (B)
( i.e. Minimum Net Working Capital)
In this case, Maximum Permissible Bank Finance (MPBF) = (A)-(B) =80-20=60
Therefore, MPBF from Bank under first method is Rs. 60 if Total Current Asset is Rs. 100.

Current Ratio in first method: Since Total Current Liabilities (including Bank finance) would be
Rs.80 against Total Current Assets of Rs. 100,the minimum Current Ratio under method I would be
100:80 i.e. minimum Current Ratio is 1.25:1.
 Second Method:
Tandon’s-II method: In this method of lending the borrower has to arrange 25% of Total Current
Assets (TCA) as margin.
Illustration:
Let us again take an example of TCA of a company is Rs. 20.00.Now the MPBF is calculated under
second method.
WCG=CA-CL=100-20=80--------------------------------Let us call it (x)
25% of TCA=100*25/100=25------------------------------Let us call it as (y)
The MPBF under second method is (x)-(y) =80-25=55
MPBF, from Bank under the second method is Rs. 55.When Total Current Assets (TCA) is Rs.100
and working capital gap is 80.
• Working capital gap : Current assets – current liabilities (other than bank borrowings)
• Minimum stipulated net working capital= 25% of current assets (excluding exports
receivables)
• Actual projected NWC
Current Ratio in second method: Since Total Current Liabilities would be (20+55)=75 against
Total Current Assets of Rs.100,the minimum Current Ratio under method-II would be 1.33:1.
Under Turnover method, the aggregate fund-based working capital limits are computed on the basis
of Minimum 20% of their projected annual turnover. The borrower has to bring the margin of 5% of
the annual turnover of such borrowers as margin money.

 Projected Balance Sheet Method:
The traditional approach towards projection of working capital requirement of a firm is the ‘Balance
Sheet Approach’. Under this method, the working capital requirement of a firm is sought to be
determined with reference to the position of current assets and current liabilities deducting the latter
from the former.
Balance Sheet of ABC Company Ltd.
as on 31.03.2016
(Rs. in crore)
2000 2001
Cash and equivalents 4,846 3,922
Short-term investments 18,952 27,678
Total cash and short-term investments 23,798 31,600
Accounts receivable 3,250 3,671
Deferred income taxes 1,708 1,949
Other 1,552 2,417
Total current assets 30,308 39,637
Property, Plant and Equipment, Net 1,903 2,309
Equity and other investments 17,726 14,141
Other assets 2,213 3,170
Total assets 52,150 59,257
Accounts payable 1,083 1,188
Accrued compensation 557 742
Income taxes 558 1,468
Unearned revenue 4,816 5,614
Other liabilities 2,714 2,120
Total current liabilities 9,755 11,132
Deferred income taxes 1,027 836
Common stock and paid-in capital 23,195 28,390
Retained earnings, accumulated other comprehensive income of 1,527 and
587
18,173 18,899
Total stockholders' equity 41,368 47,289
Total liabilities and stockholders' equity 52,150 59,257

Formulas & Calculations for the Balance Sheet
Breaking up each balance sheet formula, ratio, or calculation into one of two groups. The first
covers those that demonstrate a company's financial strength and liquidity, while the second gives us
a glimpse into a company's efficiency in using its asset base to generate earnings
Inventory Turn & Average Age of Inventory
As this company carries no inventory. It is absolutely efficient. Its products are already sold before
they are manufactured.
Receivable Turn and Age of Receivables
As per income statement of the company, credit sales are not listed as a separate item. Instead, we
have to use the less accurate total sales or revenue figure to calculate receivable turn. Take the
Rs.25.296 crores in revenues and divide it by the average receivables, Rs.3.4605 crores (3250 + 3671
divided by 2). You will end up with 7.30 turns. To calculate the number of days this translate into,
take 365 divided by 7.3. In this case, it is 50 days.
Debt to Equity Ratio
This company is debt free. It has no long or short term debt. If you take 0 (the amount of the
company's debt) and divide it by the shareholder equity (Rs.47.289 crores) you will get 0. This
means that 0% of the company's equity consists of debt; the shareholders own it all.
Final Thoughts
All of our calculations have shown one thing; the company has virtually no risk of bankruptcy.
The company has 3x the cash it needs to survive, no long term debt, no inventory to worry about, and
extremely strong current and quick ratios. Its working capital per dollar of sales is 112%, excessive
by any standard (especially compared to its competitors. Adobe Software had a ratio of 36%, while
Oracle Systems came in at 46.5%).
The ‘Balance Sheet Approach’ to working capital is now criticized on the ground that it does not
indicate the exact position of working capital and working capital derived under this approach
indicates the status of a firm at a particular point of time and does not reflect the movement of value
occurring in the same during the entire accounting period. Hence, the traditional ‘Balance Sheet
Approach’ to project Working Capital requirement of a firm is now replaced by modern approach,
viz., ‘Operating Cycle Approach’ or ‘Cash Working Capital Approach’ to Working Capital
requirement .Unlike the conventional approach, consistent with the definition, this approach views
working capital as a function of the volume of operating expenses. This approach suggests that actual
level of working capital requirement of a firm in a period can be appropriately determined with
reference to the length of Net Operating Cycle and the operating expenses needed for the period.
4.7Types of Banking:
There are mainly three types of banking arrangements:

Sole banking: Sole banking is an arrangement where a borrower avails of finance independently
from only one bank, no other banks are involved.
Multiple banking:Multiple banking is an arrangement where a borrower avails of finance
independently from more than one bank. Thus, there is no contractual relationship between various
bankers. Also, in such arrangements, each banker is free to do his own credit assessment and hold
security independent of other bankers. In multiple banking there is a principal lender.
Consortium banking: Under consortium financing, several banks (or financial institutions) finance
a borrower with common appraisal, common documentation, joint supervision and follow-up
exercises. In consortium banking there is a lead bank.
The practice of multiple banking has increased tremendously during the last years. This is due to the
increasing competition and the bankers desire to grow in a short span of time.
4.8 Bank Rating:
What is Credit Rating?
Credit Rating is an assessment of the creditworthiness of a borrower in general terms or with
respect to a particular debt or financial obligation. A credit rating can be assigned to any entity that
seeks to borrow money – an individual, corporation, state or provincial authority, or sovereign
government. Credit assessment and evaluation for companies and governments is 0generally done by
a credit rating agency such as Standard & Poor’s, Moody’sorFitch. These rating agencies are paid
by the entity that is seeking a credit rating for itself or for one of its debt issues.
Credit ratings generally reflect a relative ranking of credit risk. For example, an obligor or debt
security with a high credit rating is assessed by the credit rating agency to have a lower likelihood of
default than an issuer or debt security with a lower credit rating.
Credit rating scales, symbols, and definitions may vary among credit rating agencies. Credit ratings
typically are expressed on a scale of alpha and/or numeric symbols, and these symbols are defined by
the particular credit rating agency issuing those ratings. A typical credit rating scale, as shown in the
table below, has a top rating of ‘AAA’ and may have a lowest rating of ‘D’ (indicating default).
Some credit rating agencies’ scales distinguish between investment grade and non-investment grade
(i.e., “speculative” or “high yield”) ratings and they draw this distinction between the ‘BBB’ and
‘BB’ rating categories (in other words, a rating that is ‘BBB-minus’ or higher is investment grade
and a rating that is lower than ‘BBB-minus’ is non-investment grade).
Bank Rating Process:
The rating process should guarantee the objectivity and independence of the determination of the
rating as well as the supervision of the system itself. In practice, this is ensured by establishing
independent rating units and rating committees (sometimes referred to as credit committees) in the
bank as well as through the automation of the process. The rating systems should assess all relevant
credit risks.
Internal Credit Risk Rating:

For the first time, banks that meet certain minimum criteria will be able to factor their internal
assessment of their credit risk into the regulatory capital allocation process. This supports one of the
goals of Basel II, which is to increase the risk sensitivity of the regulatory capital allocation process
in the banking industry. Regulators want to encourage banks to continue to improve their internal
risk management practices as this should help improve the safety of the entire banking system.
External Credit Risk Rating:
Banks lacking sufficient data can use external ratings. Ratings by credit rating agencies are often
used in the corporate debt markets because of the depth of their issuer and default databases and
because their ratings have been tested and confirmed over time. As a result, some banks match their
internal risk ratings against external ratings. They also use external ratings to create credit models or
to supplement their own default and loss data.
Rating Agencies:
SMERA: SMERA Ratings Ltd (SMERA) is a full service credit rating agency exclusively set up for
micro, small and medium enterprises (MSME) in India and has grown to rate SME, mid & large
corporate . It provides ratings which enable MSME, SMEs, and Corporate to raise bank loans at
competitive rates of interest
CRISIL: CRISIL Ratings is India's leading rating agency. It pioneered the concept of credit rating in
India in 1987. With a tradition of independence, analytical rigor and innovation, it has a leadership
position. They are a full-service rating agency. They rate the entire range of debt instruments: bank
loans, certificates of deposit, commercial paper, non-convertible debentures, bank hybrid capital
instruments, asset-backed securities, mortgage-backed securities, perpetual bonds, and partial
guarantees.

4.9 Types of Securities:
Primary Security: Assets created out of Bank finance.
Collateral Security: A form of secondaryprotection sometimes required by a bank and intended to
guarantee a borrower'sperformance on a debtobligation. The primarysecurity on a
substantialbusinessloan is typically the thing that is being financed, such as a factory, company car or
shipment, but secondary or collateral security might also be requested by a bank to help assure that
the loan will be repaid.
4.10Some Common Terms used in Working Capital Assessment:
 SMA – Special Mention Accounts (SMAs) are those standard accounts which exhibit early
warning signal and lie in between the Standard and Sub Standard (NPA) category. These accounts
require special attention to reverse their downward movement i.e. slippage to NPA. As a corollary,
any account classified as NPA should have appeared for some time in the SMA category unless any
reason abrupt thereof (like fraud, malfeasance, etc.). Different SMA and their corresponding
character are shown below.
SMA Sub-
categories
Basis for classification
SMA-0/SMA-NF Non-financial(NF) signals of incipient stress
SMA-1 Principal or interest payment overdue between 31-60 days
SMA-2 Principal or interest payment overdue between 61-90 days
While SMA-1 and SMA-2 are of financial character i.e. nonpayment of Principle and interest thereon
the other one i.e. SMA-NF is of non-financial character.
 MCLR -The Reserve Bank of India has brought a new methodology of setting lending rate
by commercial banks under the name Marginal Cost of Funds based Lending Rate (MCLR). It has
modified the existing base rate system from April 2016 onwards.
As per the new guidelines by the RBI, banks have to prepare Marginal Cost of Funds based Lending
Rate (MCLR) which will be the internal benchmark lending rates. Based upon this MCLR, interest
rate for different types of customers should be fixed in accordance with their riskiness. The base rate
will be now determined on the basis of the MCLR calculation.
The MCLR should be revised monthly by considering some new factors including the repo rate and
other borrowing rates. Specifically the repo rate and other borrowing rates that were not explicitly
considered under the base rate system.
As per the new guidelines, banks have to set five benchmark rates for different tenure or time periods
ranging from overnight (one day) rates to one year.
The new methodology uses the marginal cost or latest cost conditions reflected in the interest rate
given by the banks for obtaining funds (from deposits and while borrowing from RBI) while setting

their lending rate. This means that the interest rate given by a bank for deposits and the repo rate (for
obtaining funds from the RBI) are the decisive factors in the calculation of MCLR.
 ACR- The asset coverage ratio is a test that determines a company's ability to cover debt
obligations with its assets after all liabilities has been satisfied. When calculating the asset coverage
ratio, investors should exercise caution with respect to asset value; using the coverage ratio of the
actual liquidation value of assets is significantly less.
Companies have two primary ways to raise capital: through debt and through equity. Equity does not
need to be paid back if earnings fall, but debt must be paid back no matter what. As a result, banks
and investors holding debt want to know that company's earnings are sufficient to cover future debt
obligations, but they also want to know what happens if earnings falter. One option, just as it is for
the average person, is to start selling assets. The asset coverage ratio tells bankers and investors how
many times the company's assets can cover its debts.
The asset coverage ratio is calculated with the following equation:
((Assets – Intangible Assets) – (Current Liabilities – Short-term Debt)) / Total Debt
If a company wants a loan, it goes to its banker first. The banker then analyzes the company's
balance sheet to see if it can afford the loan. In particular, and especially if the company has a poor
credit rating, the bank is likely to require the company to provide collateral in the form of assets that
can be sold if the company defaults on the loan.
 SME- Small and medium enterprises (SMEs) are critical for the economic and social
development of emerging markets. They play a major role in creating jobs and generating income for
low income people; they foster economic growth, social stability, and contribute to the development
of a dynamic private sector.
 Escrow Account- An escrow account is a temporary pass through account held by a third
party during the process of a transaction between two parties. This is a temporary account as it
operates until the completion of a transaction process, which is implemented after all the conditions
between the buyer and the seller are settled.
Description: In real estate, the fund flows for the development of the project from any source is kept
in the escrow account and the funds utilized for the same are also generated from the escrow account.
Even the buyers of the housing units in a project transfer the home price to the escrow account and
the amount is not transferred to the seller until the project is completed.
Sometimes the construction linked payments are disbursed to the seller from the escrow account so
that the builder has sufficient funds for completion of the project. Sellers also benefit from the
prioritization mechanism, also called waterfall mechanism, wherein the priority based payments are
made to the concerned parties.

CHAPTER-5 CASE STUDY
Name of the A/C: XYZPrivateLimited
5.1 About the Company:
Incorporated in 1998, XYZ Exports Private Limited is a 100% export oriented unit, engaged into
manufacturing and export of gloves and aprons made from leather. The company is mainly promoted
by Mr. Ram who has around two decades experience in the similar line of activity.
Company mainly exports its products to European Countries and has established contacts with the
overseas buyers by regular visit to get orders on a continuous basis. Raw materials required for
production are raw hides, finished leather and various types of chemicals. Raw hides are procured
from various suppliers situated across the country.
The major stages of processing are :- washing by detergent & liming, leashing, reliming, hand
fleshing for total cleaning of hairs, wet blue processing bydrums, piling & edging, trimming,
shaving, fat liquoring, nailing for sun drying, drum milling. Through all these process, finished
leather is produced. These finished leathers are turned into finished goods, i.e., hand gloves & aprons
through cutting, stitching, turning, checking and packaging.
5.2 Gist of the Proposal:
In the case study, XYZ Exports Private Limited has done review of the account along with reduction
in overall limit from Rs.13.89 crore to Rs.13.86 crore by way of continuation of existing PC limit of
Rs.8.55 croreat0.25% concession over card rate with CC sub limit of Rs.4.50 crore, FBP/FBD limit
of Rs.3.00 Crore at 0.25% concession over card rate, standby limit under gold card facility of Rs.2.31
at 0.25% concession overcard rate under sole banking arrangement,
Continuation of existing both way interchangeability from PC to FBP/FBN limit and vice-versa,
restricted up to Rs.3.00 crore.

5.3 Analysis of the Balance Sheet of XYZ Private Limited:
(Rs. In crore)
Financial Year ended on 31.03.2013 31.03.2014 31.03.2015 31.03.2016
Audited Audited Audited Audited Audited
EQUITY SHARE CAPITAL 0.56 0.56
PREFERENCE SHARE
CAPITAL
SECURITY PREMIUM
RESERVE & SURPLUS 4.46 4.82
DEFERRED TAX
LIABILITIES
0.00 -0.02
LESS: REVALUATION
RESERVE
Less: INTANGIBLE ASSETS
TANGIBLE NET WORTH 0.00 0.00 5.02 5.36 0.00
ADJUSTED TNW (net of
group investment)
NET OWNED FUND 1
TERM LIABILITIES 0.00 0.05 0.05 0.00
NET BLOCK (NET OF REV.
RES)
0.00 0.49 0.41 0.00
NON-CURRENT ASSETS 0.00 0.00 0.11 0.12 0.00
CURRENT ASSETS [Other
Assets2]
0.00 0.00 17.77 19.43 0.00
CURRENT LIABILITIES
[Other Liabilities2]
0.00 0.00 13.30 14.55 0.00
Total Financial Asset under
Management 1
NET WORKING CAPITAL 0.00 0.00 4.47 4.88 0.00
DISBURSEMENT 1
GROSS SALES 23.72 20.15
NET SALES
INTEREST INCOME 1
OTHER OP INCOME 2.61 2.33
GROSS PROFIT
OTHER INCOME 0.17 0.22
PBDIT (excl. Other income) 1.89 1.88
PBDIT 2.06 2.10
DEPRECIATION 0.09 0.15
PBIT 1.97 1.95
INTEREST 1.12 1.33
PROFIT BEFORE TAX 0.85 0.62

PROV. FOR CURRENT TAX 0.26 0.21
PROV. FOR DEFERRED
TAX
-0.02
PROFIT AFTER TAX 0.00 0.58 0.42
ADD: DEPRECIATION 0.09 0.15
ADD: PROV. FOR DEF.
TAX
-0.02
ADD: NON-CASH EXP.
LESS: NON-CASH INCOME
GROSS CASH
GENERATION
0.67 0.55
LESS: DIVIDEND
NET CASH GENERATION
NON-CURRENT ASSETS
INVESTMENT IN
ASSOCIATE/GROUP
INVESTMENT IN OTHERS
RECEIVABLES OVER 6
MONTHS
LOANS/ADV TO
ASSOCIATE/GROUP
LOANS/ADV TO OTHERS 0.11 0.12
LONG TERM MARGIN
MONEY
ADV FOR CAPITAL
GOODS
ADV TOWARDS SHARE
INTER CORPORATE
DEPOSITS
OTHERS
TOTAL 0.00 0.00 0.11 0.12 0.00
BLOCK ASSETS
GROSS BLOCK (NET OF
REV RES)
1.34 1.36
LESS ACCUMULATED
DEPRECIATION
0.85 0.95
OPERATING FIXED
ASSETS
0.00 0.00 0.49 0.41 0.00
Assets givenunder Operating
Lease 1
0.00
CAPITAL WORK IN

PROGRESS
NET BLOCK (NET OF REV.
RES)
0.00 0.00 0.49 0.41 0.00
CURRENT ASSETS
Inventories 10.18 9.94
Trade Receivables 3.25 3.67
Cash & Cash Equivalents 1.87 3.43
Short Term Loans and
Advances
1.50 1.67
Other Current Assets 0.97 0.72
TOTAL 0.00 0.00 17.77 19.43 0.00
CURRENT LIABILITIES
SHORT TERM
BORROWING
12.57 13.24
TRADE PAYABLES 0.53 1.16
CREDITOR FOR
EXPENSES
ADVANCE FROM
CUSTOMERS
PROVISION FOR TAXES
SHORT TERM
PROVISIONS
0.07 0.08
INSTALMENTS OF
TL/DEB/PREF SHARE,ETC.
OTHERS 0.13 0.07
TOTAL 0.00 0.00 13.30 14.55 0.00
TERM LIABILITIES
OCD
NCD
BONDS
Other Rupee Long Term
Borrowings
Unsecured Borrowings from
related parties
0.05 0.05
Other Long Term Liabilities
& Provisions
TOTAL 0.00 0.00 0.05 0.05 0.00
INTANGIBLE ASSETS

ACCUMULATED LOSS
MISC. EXP. NOT WRITTEN
OFF
DEFERRED TAX ASSETS
INTANGIBLE FIXED
ASSETS (if any)
OTHERS
TOTAL 0.00 0.00 0.00 0.00 0.00
RATIO ANALYSIS
TOL/TNW 2.65936255 2.7238806
TOL/ Adjusted TNW
DEBT/EQUITY 3 0.71 0.00996016 0.00932836
TOL / NOF 1
Current Ratio 1.33609023 1.33539519
Current Ratio without
installment
1.33609023 1.33539519
CRAR 1
GROSS NPA % 1
NET NPA % 1
COLLECTION
EFFICIENCY % 1
GROWTH % IN
DISBURSEMENT 1
% of Gold Loan in Financial
Asset 1
Average Loan to Value % 1
GROWTH % IN NET
SALES/REVENUE
GROSS PROFIT/NET
SALES %
INTEREST COVERAGE
RATIO 4
NWC/TCA%
BANK
BORROWING/TCA%
OCL (including sundry
creditor)/TCA%
PBDIT(EXCL OTH
INC)/NET SALES%
ROACE 5
ROAOCE 6

DSCR 3
PRIORITY OBLIGATION
RATIO 4
5.4 Sanctionof Working Capital Limits:
(Rs. in crore)
Proposed
Packing Credit (PC) 8.55
(Cash Credit-sub limit of PC) (4.50)
FBP/FBD 3.00
Standby limit under Gold Card Facility 2.31
TOTAL 13.86
5.5 Credit Rating by Agencies with Purpose of such Rating:
Agency Rating Date of Rating Significance of Rating Purpose Valid till
XXX A4+ May 15
Minimal degree of
safety regarding timely
payment of financial
obligations.
ST Bank loan
rating
May 2016
Comments:
XXX has re-affirmed rating at A4+ for company’s short term bank loan facilities of Rs.13.86 crore
which include PC of Rs.8.55 crore, FBP of Rs.3.00 crore and stand by limit under gold card facility
of Rs.2.31 crore, indicating minimal degree of safety. The ratings remain constrained by the
company’s small scale of operations, working capital intensive business and high leverage (debt
equity ratio). The ratings note that the company’s profit margins are susceptible to volatility in raw
material prices. The ratings are also constrained by the company’s exposure to geographical
concentration risk. However, the ratings are supported by the company’s experienced management
and moderate liquidity position. The ratings also draw comfort from the company’s entitlement to
export incentives.
5.6 Financial Position of the Company as on Close of Financial Years for Last
Three Years:
(Rs. in crore)
31-Mar-14 31-Mar-15 31-Mar-16 31-Mar-17
Audited Audited Prov. Estimated
Share Capital 0.56 0.56 0.56 0.56
Security Premium -- -- -- --
Reserves & Surplus (Excluding rev. reserve) 4.46 4.82 5.23 5.75
Deferred Tax Liability -- (0.02) -- --
Tangible Net Worth 5.02 5.36 5.79 6.31

Adjusted TNW 5.02 5.36 5.79 6.31
Term Liabilities 0.05 0.05 0.05 0.05
-Unsecured borrowings 0.05 0.05 0.05 0.05
Net Block incl. CWIP 0.49 0.41 0.85 1.14
Non-Current Assets 0.11 0.12 0.14 0.14
-Loans & advances to others 0.11 0.12 0.14 0.14
Current Assets 17.77 19.43 19.74 20.10
-Cash & bank balance 1.87 3.43 2.53 2.85
-Trade Receivables 3.25 3.67 3.60 3.50
-Inventories 10.18 9.94 10.61 11.00
-Short term loans & advances 1.50 1.67 3.00 2.75
-Others 0.97 0.72 -- --
Current Liabilities 13.30 14.55 14.88 15.01
-Bank borrowings 12.57 13.24 13.86 13.86
-Creditors 0.53 1.16 0.90 1.00
-Provision for taxes 0.07 0.08 0.05 0.05
-Current maturities of long term debt -- -- -- --
-Others 0.13 0.07 0.07 0.10
Net Working Capital 4.47 4.88 4.86 5.09
Net Sales/ Revenue Income 23.72 20.15 20.00 23.00
Other Income (Operational) 2.61 2.33 2.15 2.37
Other income(non-operational) 0.17 0.22 -- --
PBDIT (excl. non-operational income) 1.89 1.88 1.81 2.06
PBDITA 2.06 2.10 1.81 2.06
Depreciation 0.09 0.15 0.10 0.11
PBIT 1.97 1.95 1.71 1.95
Interest 1.12 1.33 1.04 1.20
Profit Before Tax 0.85 0.62 0.67 0.75
Provision for Tax 0.27 0.20 0.21 0.18
Profit After Tax 0.58 0.42 0.46 0.57
Depreciation 0.09 0.15 0.10 0.11
Prov. For deferred tax -- (0.02) -- --
Gross Cash Generation(Net) 0.67 0.55 0.56 0.68
Less: Dividend 0.04 0.04 0.04 --
Net Cash Generation 0.63 0.51 0.52 0.68
5.7 Ratio Analysis:
31-Mar-14 31-Mar-15 31-Mar-16 31-Mar-17
Audited Audited Prov. Estimated
TOL/TNW 2.65 2.72 2.54 2.35
TOL/ Adjusted TNW 2.65 2.72 2.54 2.35
Debt/Equity -- -- -- --
Current Ratio 1.34 1.33 1.33 1.34

Current Ratio Without Installment 1.34 1.33 1.33 1.34
Growth % in Net Sales/Revenue 43.23% -ve -- 15%
PBDIT(Excl Other Inc)/Net Sales% 7.97% 9.33% 9.05% 9.36%
PBT / Sales % 3.58% 3.07% 3.35% 3.41%
PAT / Sales % 2.44% 2.08% 2.30% 2.60%
5.8 Movement of TNW:
(Rs. /crore)
31-Mar-15 31-Mar-16
Audited Prov.
Opening TNW 5.02 5.36
Increase in Share Capital -- --
Increase in Security Premium -- --
Increase in Share Application -- --
Increase in Reserve & Surplus 0.36 0.41
Increase in deferred tax liability (0.02) 0.02
Closing TNW 5.36 5.79
5.9 Fund Flow Analysis:
(Rs. / crore)
31st March 2015 2015 31st March 2015 2016
Inc in TNW 0.34 0.43 Inc in Net Block (0.08) 0.44
Inc in Term Liabilities -- -- Inc in non-current
assets
0.01 0.02
Total long term sources 0.34 0.43 Total Long term uses (0.07) 0.46
Long Term Deficit 0.03 Long Term Surplus 0.41
Short Term Sources Short Term uses
Cont. from Long Term 0.41 Cont. towards Long
Term
0.03
Inc in current liabilities (excl. Bank
Borrowings)
0.58 Increase in Current
Assets
1.66 0.30
Decrease in current assets Decrease in current
liabilities
0.29
Total short term sources 0.99 -- Total Short term uses 1.66 0.62
Short Term Deficit 0.67 0.73 Short Term Surplus
Dec in Bank Borrowings Inc in Bank
Borrowings
0.67 0.62
Comments:
 Reasons for change in TOL/TNW TOL/Adjusted TNW, D/E, and limit/TNW: - Company’s
TNW has been growing consistently over the years. TNW has improved from Rs.5.36 crore in
FY 2015 to Rs.5.79 in FY 16 on account of retention of profit into the business. TOL/TNW has

improved from 2.72 as on 31.03.2015 to 2.54 as on 31.03.16 on account of more than
proportionate increase in TNW compared to outside liabilities. TOL/TNW is well within our
benchmark level.
 Movement in non-current assets: Non-current assets constitute a small portion of total assets as
on 31.03.2016.
 Movement in Current Ratio / NWC:-. Company’s liquidity position is satisfactory with current
ratio at 1.33 as on 31.03.2016 and above ratio is in compliance with our benchmark level. Even
though company’s nature of business is working capital intensive, it has been able to maintain
moderate liquidity profile based on its inherent strength in export market. Company has
established a long term business relationship with its European customers and payment from
customers are received in time, thereby enabling the borrower to maintain a healthy liquidity
profile. Based on the above established strength/creditworthiness, our bank has extended gold
card facility to the captioned borrower.
 Movement in sales/revenue: Company is an export oriented unit and its revenue income mainly
consists of income from export operations. Like any other export oriented unit, company’s
revenue has remained stagnant during the last two fiscals on account of sluggish global market
condition. During FY ended 31.03.2016, company has achieved export turnover of Rs.20.00
croreas per provisional figure. However company’s long standing business relationship with
European customers and demand for industrial leather aprons in mines provide cushion against
downturn in overseas market.
 Profitability: Company’sprofit margins are susceptible to volatility in raw material prices, given
that raw materials costs account for 87% of total sales. EBDITA margin has marginally declined
from 9.33% as on 31.03.2015 to 9.05% as on 31.03.2016. However PBT and PAT margins have
shown improvement on account of savings in depreciation expenses and lower interest outgo.
While PBT margin expanded from 3.07% to 3.35%, PAT margin stood at 2.30 % as against last
year level of 2.08%.
 Status of statutory obligations: No adverse reporting is made by the statutory auditors in its
Report for the FY 2014-15 with respect to payment of undisputed statutory obligations.
5.10 Computation of ACR for the Working Capital Limit:
(Rs. In crore)
Type Particulars Basic of Valuation Value
Primary
Exclusive charge on company’s entire current assets
including raw materials, WIP, finished goods and
receivables (both present & future)
As per Prov. 2015-16 19.74
Collateral
Tangible Equitable mortgage of office premises As per valuation
report dated
11.07.2015
3.41
Intangible Personal Guarantee of the Directors - -
Total Securities - 23.15
Proposed Loan - 13.86

Asset Coverage Ratio (ACR) 1.67

5.11 Assessment of Working Capital:
5.11.1 Computation of maximum permissible Bank Finance (MPBF):
31.03.2014 31.03.2015 31.03.2016 31.03.2017
(AUDITED) (AUDITED) (Prov) (Est)
RAW MATERIAL
CONSUMPTION
-INDIGENOUS
23.63 18.07 17.90 19.80
COST OF PRODUCTION 23.66 20.06 19.65 21.62
COST OF SALES 23.67 19.86 19.62 21.52
SALES 23.72 20.15 20.00 23.00
CURRENT ASSETS
RAW MATERIALS-INDIGENOUS 2.72 2.42 2.80 3.00
MONTH CONSUMPTION (1.38) (1.61) (1.88) (1.82)
STOCK IN PROCESS 4.58 4.44 4.70 4.80
MONTH COST OF PRODUCTION (2.32) (2.65) (2.87) (2.66)
FINISHED GOODS 2.88 3.08 3.10 3.20
MONTH COST OF SALES (1.46) (1.86) (1.73) (1.78)
EXPORT RECEIVABLES 3.25 3.67 3.60 3.50
MONTH SALES (1.64) (2.18) (1.96) (1.83)
OTHERS* 4.34 5.82 5.54 5.60
TOTAL (A) 17.77 19.43
19.74 20.10
SUNDRY CREDITOR FOR
GOODS
0.53 1.16
0.90 1.00
MONTH PURCHASE (0.51) (0.74) (0.59) (0.60)
ADVANCE FROM CUSTOMERS -- -- -- --
STATUTORY LIABILITIES 0.07 0.08 0.05 0.15
OTHERS 0.13 0.07 0.07 --
TOTAL (B) 0.73 1.31 1.02 1.15
WORKING CAPITAL GAP (A-B) 17.04 18.12 18.72 18.95
25% OF TOTAL CURRENT
ASSETS EXCLUDING EXPORT
RECEIVABLES (C)
3.63 3.94 4.03 4.15
ACTUAL/PROJECTED NWC
(D)
4.47 4.88
4.86 5.08
WCG -(C) (E) 13.41 14.18 14.69 14.80
WCG -(D) (F) 12.57 13.24 13.86 13.87
MPBF (MIN. OF E & F) 12.57 13.24 13.86 13.87
While calculating the MPBF, the holding levels for different items of current assets and
current liabilities are considered as under:-

(in months)
Particulars
Actual
As on 31.03.14
Actual
As on 31.03.15
Prov. as on
31.03.16
Estimation for FY
2016-17
Raw materials
(Indigenous)
1.38 1.61 1.88 1.82
WIP 2.32 2.65 2.87 2.66
Finished goods 1.46 1.86 1.73 1.78
Export
Receivables
1.64 2.18 1.96 1.91
Creditors 0.51 0.74 0.59 0.60
The above estimation/projection of holding period appears to be to be realistic considering the past
trend.
Other Current Assets include Cash & Bank Balance, Short Term Loans & Advances as
under:
(Rs. In crore)
Particulars FY 14 FY 15 FY 16 FY 17
Short term loans & advances 1.50 1.67 3.00 2.76
Cash & bank balance 1.87 3.43 2.54 2.84
Others 0.97 0.72 -- --
TOTAL 4.34 5.82 5.54 5.60
PC & FBP/FBN Limit has been Assessed as under:-
Projected Export Turnover for FY 16-17 Rs.23.00 crore
Usance period 180 days
Limit for usance period (23.00*180/360) Rs.11.50 crore
PC and FBP/FBN limit proposed Rs.11.55 crore
Comments:.
 Renewal of the limit is now recommended at existing level of Rs.11.55 crore. The above limit
includes PC of Rs.8.55 crore and FBP/FBN of Rs.3.00 crore. As per estimated financial for 2016-17,
export receivables are estimated at Rs.3.50 crore which seems to justify FBP/FBN limit of Rs.3.00
crore.
 Conduct of the account is satisfactory with timely realization of PC and FBP/FBN liabilities
and there are no instances of crystallization of foreign bills.
 Continuation of existing CC limit of Rs.4.50 crore as sub limit of PC limit of Rs.8.55
crore:TheCompany is presently enjoying cash credit limit to the tune of Rs.4.50 crore within the
overall packing credit limit of Rs.8.55 crore. The company has proposed that though it is a 100%
export oriented unit, yet it might need cash credit limit for execution of domestic orders if need

arises. Considering the same it has requested for the continuation of the existing cash credit limit of
Rs.4.50 crore within the overall packing credit limit, which has been duly recommended by RO as
well. Considering company’s satisfactory operation and long standing credit relationship, we
recommend for continuation of our existingcash credit limit of Rs.4.50 crore within the overall
packing credit limit of Rs.8.55 crore may be considered.
 Continuation of Standby limit under Gold Card Facility of Rs.2.31 crore :
The company is presently enjoying Gold Card facility of Rs.2.31 crore to meet urgent credit needs
arising out of executing sudden orders. Conduct of the account is satisfactory. As per lending Policy
of the bank, the exporter shall be sanctioned an additional standby limit not less than 20% of the
assessed fund based limit under export credit to facilitate urgent credit needs arising out of executing
sudden orders. The export credit limit as earlier assessed is at Rs.11.55 core and 20% of Rs.11.55
crore comes to Rs.2.31 crore, which can be maximum limit under Gold Card Scheme outside MPBF.
 All credit worthy exporters with good track record including those in the small and medium
sector shall be eligible under gold card scheme subject to fulfillment of certain criteria and
compliance status with respect to eligibility criteria for availing standby limit under Gold Card
facility as per Bank’s Lending Policy.
5.12 Loan Policy:
Benchmark parameters as per Lending Policy:-
Parameter
As per Lending
Policy
As per Audited
Financials of 31.03.15
Status of compliance
Credit Risk
Rating
Minimum UBICR 3 CR 3 Complied
Promoters’
contribution in
the Equity
Minimum 20% 100% Complied
TOL/TNW Maximum 4:1 2.72 Complied
DER Maximum 3:1 -- Complied
Current Ratio
(without term
loan installments)
At least 1.18 (For
export credit)
1.33 Complied
ACR
Preferably be 1.33 or
more but not less
than 1.20
1.67 Complied
Overall limit
(FB+NFB) /TNW
Maximum 5 times 2.59 Complied

5.13 Rationale for Recommendation:
 Company is one of our prestigious clients of overseas branch maintaining a satisfactory credit
relationship with us since 1998,
 Company has been engaged into manufacturing of leather accessories since 1991 and
successfully exporting its products to European countries,
 Company’s overall financial position is satisfactory with moderate liquidity profile.
 The operation and conduct of the account are satisfactory.
 Exposure is coming under export and MSE segment which is a thrust area of lending.
 Exposure is adequately covered by the securities.
 ECGC coverage is available for export credit limit.
Strengths & Weakness:
Strengths:
 Experienced management with two decades experience in similar field.
 Company’s overall financial position is satisfactory.
 Company is entitled to receive export incentives under schemes proposed by Ministry of
Commerce & Industry, GOI.
 Our long standing satisfactory business relationship with the company since 1991,
 The operation and conduct of the account are satisfactory.
 Company is a gold card holder exporter which indicates its creditworthiness with good track
record as exporter.
Weakness:
 Company’s profit margins are susceptible to volatility in raw material prices, given that raw
materials costs account for 87% of total sales.
 Exposure to geographical concentration risk as its business is concentrated in Europe and decline
in demand for leather accessories in the European market.
 Company’s small scale of operations limits its bargaining power.

CHAPTER-6 LEARNING POINTS
A business requires funds in order for it to be successful in the wide industry of corporations. This
will serve as the lifeblood of the company for without it, the business will also be nothing.
Aside from serving as fixed assets financing, all business definitely need funds on a regular basis in
order for its operations to continue. This will encompass the expenses made for raw material
purchases, manufacturing, followed by selling and finally administrating the sold until money is
realized. Business transactions are usually made on credit with several days elapsing before the
proceeds of the sale will be able to pay for it. Although most of the materials can be bought on credit,
any business will still have to pay the employees, meet the expenses for manufacturing and selling
such as power, wages, transportation, supplies and communication as well as balance the purchases
of the raw materials. Working capital basically means as the financing source needed by the business
entities on a regular basis so that needs will be met.
6.1 Characteristics of Working Capital:
 Needs that are Short Term: Working capital is being utilized in acquiring current assets which
will be converted to cash for a short period only.
 Circular Movement: Working capital is being converted to cash constantly which will just be
turned as a working capital all over again.
 Permanency: Although it is just a kind of short term capital, working capital is needed by a
business forever and always.
 Fluctuation: Working still fluctuates every now and then even it is something permanent.
 Liquidity: It is very liquid for it can be converted as cash any time without losing anything.
 Less Risky: Investments in current assets such as working capital comes with less risk for it is
just for short term.
 No Need for Special Accounting System:Since working capital is a short term asset that will
last for a year only, there will be any need for adoption of a special accounting system.

6.2 The Pros & Cons of Working Capital:
 Positive Working Capital: Positive working capital is the excess of current assets over current
liabilities. In other words, when the net working capital is a positive figure, it is said that the firm
has a positive working capital.
Pros:
 Fight against Bankruptcy: It is an obvious fact that we should have more dollars in a pocket
than the list of expenses we have planned. On the similar lines, from a liquidity and bankruptcy
point of view, it is always desirable to have positive working capital. It ensures more incoming
dollars than the planning of outgoing dollars.
 Grab New Opportunities: A company with positive working capital is better positioned to take
advantage of new business opportunities. Since the company has available supplier’s support and
the additional funds also which are a prerequisite to encash the new opportunity.
 Funds Availability from Banks: Under normal circumstances, banks fund only the working
capital gap and not the whole current assets. Working capital gap means net working capital. If
the gap between current assets and liabilities is positive, the bank is keen to fund otherwise not.
As per banks, the company does not require funds.
 Cheaper Financing: If the current assets are financed by the trade credit i.e. current liabilities,
by forgoing the discount allowed. The cost of trade creditis normally higher compared to bank
finance. It is desirable to take bank finance and avail the trade discount given by the supplier.
Cons:
 Dependency on Banks: Companies having positive working capital requires funds from the
banks or financial institutions for running the operating cycle of their business. On the contrary,
if the company is dependent upon the supplier’s for their business cycle, bank dependency is
avoided. It is not necessary that the bank will definitely finance the working capital gap. They
may have their own reservations on the same.
 Cheaper Financing: If the Cost of Trade Creditis less than the bank finance, it is very obvious
that the company will save on the cost of funds i.e. their interest cost and increase its
profitability.
 Negative Working Capital (NeWC): It is not always bad to have negative working capital. A
lot of giant companies with established brands have negative working capital because they are
able to bargain very well with their suppliers. They have the muscle power of bulk demand.
Pros:
 Low Cost of Funding Current Assets: The first thing that would come to our mind is the
interest cost of funds if funded by banks. It is because trade credit has no explicit interest cost.
The funds are provided by the suppliers and the time limit to pay is also flexible to a great extent.
This will depend on a company to company and supplier to supplier.
 Cash Richness and Earnings from Investments: Companies having negative working capital
may not always have fixed assets financed by current liabilities i.e. suppliers.

 Some company may be smart enough who at one side negotiate hard with the suppliers to get
credit and on the other side collect money from the customer faster. The money received from
the customer is not paid to the supplier but are invested in short-term investments to earn interest.
These companies not only save the interest cost of working capital but also earn some interest out
of investments.
 Must for Some Industries: Take example of companies like Amazon, eBay etc. They purchase
goods on credit but sell the goods on cash and their inventory movement is also fast. The shelf
life of the product is also not long. For such companies, it is obvious to have negative working
capital. On the contrary, if the management is not able to achieve negative working capital, they
would be considered inefficient. Similar is the case of retailers who purchase on credit but sell in
cash. They also can develop free cash. Telecom companies are famous for having NeWC.

Cons:
 Bankruptcy Risk: Companies with negative working capital are using the money of creditor to
finance current assets as well as a part of fixed assets. Buying fixed assets with this money can
pose some financial trouble anytime. When the payment of accounts payable will be due, the
company may fall short of cash and it will be difficult to sell the fixed assets where the money
from current liabilities is stuck. This will leadto bankruptcy risk for the company.
 Lower Rating Resulting in Higher Interest Rate: Business with NeWC are
struggling to make payment to the creditors and not able to collect money or sell
the lying stock with it. The credit rating of such companies is bound to go down. Lower rating
results in higher interest rates charged by the banks.
 Growth Opportunities Missed: Negative working capital effectively means no working capital.
No growth crop up without money. Without spare working capital, a company is not able to take
up any seasonal and special growth opportunities. This is how companies with NeWC misses the
growth opportunities.
 Investors and Bankers don’t find it worth Investing: Positive working capital is a sign
indicating growth and profitability in the business. Also, negative working capital implies over
funding by suppliers. In both of the situations, a banker or investor would not find it worth
investing in such a company.
 Lost Trade Discount: Normally, if a company is having NeWC, it is understood that the
accounts payables are not paid on time and that will definitely vanish the trade discount which is
only allowed if paid within a certain period of time.
 Bad Financial Reputation: Not only does a company having NeWC lose on trade discounts but
also lose the financial reputation in the market.
 Non-paying and late paying, both are crimes for supplier relationships. Bad financial reputation
is a slow poison and it reaches a point when all suppliers in the market stop releasing credit to the
company.
 Winding up petition by Creditors: When the creditor’s concern changes from late payment to
probably no payment, there are good chances that they may file a petition for winding up of the
company for the sake of their hard earned money.
 Bad Fixed Asset Turnover: Fixed asset turnover ratio indicates that how many sales are
generated using the fixed assets of the company. Higher the sales generated using the fixed
assets, higher will be the ratio and higher would be the leverage of the using the fixed assets.
Without working capital, it is not possible to push the sales. This leads to inefficient use of the
fixed assets also.

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