Working Capital Financing.

PROJECT REPORT

ON

WORKING CAPITAL FINANCING

By

VENUS CHAUHAN

Summer Internship Project

(Batch of 2011)

Declaration

I hereby declare that this report on Working Capital Financing has been written and prepared by me during the academic year 2010-2012. This project was done under the able guidance and supervision of Mr. Rajesh Sudan and Mr.P.K.Vaid of Jammu & Kashmir bank.

I also declare that this project is the result of my own effort and has not been submitted to any other institution for the award of any Degree or Diploma.

Place: New Delhi

Venus Chauhan

Acknowledgement

If words are considered to be signs of gratitude then let these words convey the very same.

My sincere gratitude to Jammu & Kashmir Bank for providing me with an opportunity to work with it and giving me necessary directions on doing this project to the best of my abilities.

I am highly indebted to Mr. Rajesh Sudan, Person and company project guide, who has provided me with the necessary information and also for the support given to me in the completion of this report and the valuable suggestions and comments on bringing out this report in the best way possible.

I also thank ,University of Jammu Bhaderwah Campus ,J&K, who has sincerely supported me with the valuable insights for the completion of this project.

I am grateful to all faculty members of University of Jammu Bhaderwah Campus,J&K and my friends who have helped me in the successful completion of this project.

CONTENTS

Sr. No.

Topic

Page no.

1.

2.

3.

4.

5.

1. JAMMU & KASHMIR BANK1.1. INTRODUCTION:

The origin of Jammu and Kashmir Bank Limited, more commonly referred to as J&K Bank, can be traced back to the year 1938, when it was established as the first state-owned bank in India. The bank was incorporated on 1st October 1938 and on 4th July 1939 it commenced its business in Kashmir (India). It was initially set up as a semi-state bank, with its capital being contributed by State as well as the public under the control of State Government.

Jammu and Kashmir Bank had to face serious problems in 1947 i.e. at the time of independence. With the partition of Pakistan, two out of the total ten branches of the bank, namely the ones in Muzaffarabad and Mirpur, fell to the other side of the line of control (now Pak Occupied Kashmir), along with cash and other assets. At that point of time, in keeping with the extended Central laws of the state, J&K Bank was categorized as a Government Company, as per the provisions of Indian Companies Act 1956.

It was in the year 1971 that Jammu and Kashmir Bank was granted the status of a 'Scheduled Bank'. Five years later, it was declared as "A" Class Bank, by the Reserve Bank of India (RBI). As the years passed on, the bank started achieving more and more success. Today, it boasts of more than 500 branches across the country. It was only recently that Jammu and Kashmir Bank became a billion dollar company. Governed by the Companies Act and Banking Regulation Act of India, it is regulated by RBI and SEBI. It finds a listing on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) as well. [1]

Unique Characteristics & Services

J&K Bank carries out banking business of the Central Government

Inspite of a government equity holding of 53 per cent, Jammu & Kashmir Bank (J&K Bank) is regarded as a private sector bank

J&K Bank is the one and only banker and lender of last resort to the Government of J&K

Plan and non-plan funds, taxes and non-tax revenues are routed through the J&K Bank

J&K Bank claims the distinction of being the only private sector bank that has been designated as agent of RBI for banking

The services of J&K Bank are utilized for the purposes of disbursing the salaries of Government officials

J&K Bank collects taxes pertaining to Central Board of Direct Taxes, in Jammu & Kashmir

1.2. PRODUCTS & SERVICES Support Services

Anywhere Banking

Internet Banking

SMS Banking

ATM Services

Debit Cards

Credit Cards

Merchant Acquiring

Depository Services

Demat Account

Other Services

Third Party Services

Mutual Funds

Insurance Services - Life & Non Life

Remittance Services

Cash Management Services

Real Time Gross Settlement (RTGS)

National Electronic Fund Transfer (NEFT)

1.3. PROFILE

1. Incorporated in 1938 as a limited liability company.

2. Government by RBI & SEBI.

3. Listed on National Stock Exchange (NSE) & Bombay Stock Exchange (BSE)

4. 53% owned by government of Jammu & Kashmir.

5. Rated P1+ by standard & poor CRISIL connoting highest degree of safety.

6. Four decades of uninterrupted profitability & dividends.[1]

1.4. BRAND IDENTITY

Figure: 1. J & K Bank Logo

The new identity for J&K bank is a visual representation of the Banks philosophy and business strategy. The three colored squares represent the regions of Jammu, Kashmir and Ladakh. The counter-form created by the interaction of the squares is a falcon with outstretched wings a symbol of power and empowerment. The synergy between the three regions propels the bank towards new horizons. Green signifies growth and renewal, blue conveys stability and unity, and red represents energy and power. All these attributes are integrated and assimilated in the white counter-form.

1.5. CUSTOMER SERVICE

The Bank continued its emphasis on maintaining high standards of service to its customers. In this direction, the bank introduced various hi-tech & customer friendly products during the year, providing value added service to achieve customer satisfaction. Customer complaints received are dealt promptly & expeditiously. The bank is a member of the banking codes & standards board of India & has adopted code of banks commitment to customers, a voluntary code providing protection & Right to Know to the customers. The bank has established a 24 X 7 help desk to address customer queries & the desk id slated to be converted into a full fledged call centre in 2007-08. The bank is also keenly pursuing for ISO 9000 certification for its customer service.

The bank has revamped its delivery channels & added Business Development & Promotion centers (BDPCs) with an aim to get closer to & provide hassle-free service to the customers. Marketing managers & business promotion officers have been placed in all the zones for execution of the marketing initiatives.

1.6. UNIQUE CHARACTERISTICS

1. Private sector Bank despite government holding 53 percent of equity.

2. Sole banker and lender of last resort to the Government of J&K.

3. Plan and non-plan funds, taxes and non-tax revenues routed through the bank.

4. Only private sector bank designated as agent of RBI for Banking.

5. Carries out banking business of the Central Government.

6. Collects taxes pertaining to Central Board of Direct Taxes in J&K.

7. Salaries of Government officials disbursed by the Bank.

8. The bank is now a 10 billion dollar company.[9]

1.7. ORGANISATIONAL STRUCTURE

Board of Directors

Chairman & Chief Executive

Executive Director

President (CPO/CHI)

1.8. BOARD OF DIRECTORS

1. Haseeb A Drabu (Chairman & Executive Officer)

2. M S Verma

3. B B Vyas (IAS)

4. G P Gupta

5. B L Dogra

6. Umar Khurshid Tramboo

1.9. CSR ASPECT OF BANK

The Corporate Social Responsibility (CSR) of the J&K Bank seeks to recognize obligations towards society and aims to integrate the CSR ideals into its mission for optimizing both business and social performance.

It stresses on promoting work life balance, give attention to social and environmental concerns and host of factors that facilitate business pursuits and accomplishment of economic goals.

The Bank besides playing its role in economic development of the State and country contributes significantly towards the social cause. Be it victims of natural calamity, like fire, flood, snowstorm or tsunami and disabled or patients with serious ailment who lack reliable means of survival, the bank has been all through supporting them.

Heritage preservation is an important responsibility of every conscious individual, institution or agency. The thrust areas to assist in this respect for the bank will be preservation of historical / religious monuments, development of tourist sites, national properties, museums, libraries, protection of environment/ ecology etc.

The Bank has been playing a vital role in the promotion of tourism and it is in this backdrop that the Bank has been shouldering the responsibility of registering yatris for the Shree Amarnath ji yatra though its extensive network of branches spread across the country.

In addition to this, accidental insurance cover facility of Bajaj Allianz General Insurance Co. Ltd. to the pilgrims at a nominal premium is made available to yatris.

Apart from above activities the Bank has been constructing/developing the public parks, bus stands, drinking water posts, laboratories, conveniences, rain shelters.

In addition to this, the Bank organizes relief camps, service camps, night shelters, health resorts, health clinics, disaster calamity management centres etc.[1]

1.10. SPECIALISED FINANCES

Help Tourism (For Kashmir valley only)

All Purpose Agri Term loan

Fruit Advances Scheme (Apple)

Zafran Finance

Roshni Financing Scheme

Craft Development Finance

Dastkar Finance

Giri Finance Scheme

Khatamband Craftsmen Finance

Commercial Premises Finance

1.11. POLICY INITIATIVES / OBJECTIVES FOR FY 2009-10

Credit policies are essentially aimed at supporting the business strategies, achieving target earnings with satisfaction of customer needs and maintaining a sound credit portfolio.

Main Objectives:

Create a framework to ensure smooth and timely flow of credit to the Banks customers, ensure a prudent credit growth- both qualitative and quantitative and to augment interest & non-interest income within the statutory framework prescribed by RBI.

Adhere to the leading norms prescribed by the Bank, RBI & Govt. from time to time.

Ensure consistency in and standardization of credit practices.

Ensure balanced sectoral & diversified growth of credit so as to have a proper risk spectrum within prudential exposure norms.

Concentrate on growth of SME credit & lending to other priority sector categories, particularly in J&K state through innovative loan products for realization of social commitments and ensuring dispersal of risk as well as improvement in yield.

With a view to establishing an efficient credit system, following policy decisions have been taken by the bank:

Establishment of Corporate Finance Branches

Establishment of SSI Finance branches

Formation of matching Credit Delivery Channels

Large Corporate Branches

Exclusive BDPCs at district Levels

Formation of Credit Communities[1]

1.12. THRUST AREAS OF BANK

Retail Segment:

a) Agriculture & Horticulture

b) Trade & small business

c) Medium, small and micro enterprises under Mfg. & services sector

d) Housing, consumer and consumption loans

e) Education loans

Export credit:

Industries:

a) Cement

b) Automobiles

c) IT

d) Iron & steel

e) Infrastructure[1]

2. PROJECT FINANCING

Banks & financial institutions play an important role in the development of a country. They provide not only financial assistance to viable projects but also assist the entrepreneurs during all phases of a project, viz., identification, selection, appraisal, implementation & follow-up. All the phases are inter-related & the experience gained during appraisal of projects & supervision helps the financial institution & banks to guide the entrepreneurs in identification & selection of new projects.

Lending is considered the principle activity of a Commercial Bank. Advances made by the Bank constitute the bulk of its assets and form the backbone of banks structure. A sizeable portion of the income of the Bank is derived through lending activities. The strength of a Bank is primarily judged by the quality of its advances. It is necessary that the Banks lending activities are handled with utmost prudence.

Advances not only play an important part in earning of the bank but also promote the economic development. Bank credit plays a pivotal role in industry, agriculture, trade and exports, poverty alleviation, creating new employment avenues and removing regional economic imbalance.

2.1. PROJECT IDENTIFICATION

Projects can be divided into following categories:-

i. New projects - For setting up of new industrial units

ii. Expansion Projects - For increasing the capacity of existing projects by existing units

iii. Diversified Projects - For manufacturing new products by existing units.

iv. Backward Integration - For manufacturing certain products which are projects being used as raw material by existing unit.

v. Forward Integration Projects - For manufacturing certain products which require the products of the existing unit as raw material.

vi. Modernization Projects - It can be for any one or more than one of the following objects-

a. Change obsolete machinery

b. Enlargement the product mix/product range to meet changing requirements of the market

c. Changing the requirement of raw material

d. Reducing the manufacturing cost or for improving the quality of the project

vii. Rehabilitation Project - For reviving sick units & making them viable with Normal/healthy units.

2.2. PROJECT SELECTION & PREPARATION OF PROJECT REPORTS

If an entrepreneur approaches a bank to assist him in selecting a project, it is better to have preliminary discussions with regarding various projects which can be promoted by him. The bank may guide him in selecting a project depending on his ability, aptitude & financial resources. A preliminary discussion with the promoter helps the bank in getting necessary information. A Bank may not be interested in financing certain types of projects at a particular point of time owing to excessive involvement already committed in that field, difficulties of marketing faced by existing units, difficulties regarding availability of raw material, government guidelines, etc . A Bank may not like to have a bad reputation of rejecting many proposals. It is therefore, important that promoters have the benefit of preliminary discussions at senior level & are guided by the expertise available with the bank for selecting a suitable project. If a branch has a separate officer for processing loan applications, it be should be associated with the manager during the preliminary discussions.

2.3. PROJECT APPRAISAL

A detailed study is usually done by financial institution and banks while providing project finance, so as to ensure that the project will generate sufficient returns on the resources invested in it. The viability of a project depends on technical, commercial, financial and managerial feasibilities. A detailed viability study is necessary before agreeing to provide working capital finance, term loan and other non-fund based facilities.

The past performance and the future viability can be ascertained by examining the financial statements for the past 2-3 years as well as the estimated / projected statement for the current and the next year. It is implicit that the concern will have to submit an acceptable business plan or forecast in the form of estimated/ projected financial statements to the bank.

With the shift from security oriented lending to purpose/need based lending, the study of the viability of a project has become more vital for lending institution. In order to ensure that a project is viable, its viability should be appraised/gauged/examined from different aspects which are:

Technical Appraisal

Commercial Appraisal- Appraisal of demand forecast

Financial Appraisal

Economic Appraisal

Appraisal of Management

Technical Appraisal:

1. Manufacturing process

2. Technical arrangements

3. Size of the plant

4. Product mix

5. Selection of plant & machinery

6. Procurement of plant & machinery

7. Plant layout

8. Location of the project:

a) Land

b) Raw material

c) Market

d) Labour

e) Utilities

f) Effluent disposal

g) Transportation

h) Community infrastructure

i) Development of other industries

Commercial Appraisal:

1. Demand-techniques of forecasting:

a) Import substitution

b) Past trend method

c) End-use method

d) Correlation and regression

e) Export market

2. Supply-depth of competition

3. Pricing policy

4. Lifecycle of the product

5. Brand name for the product

6. Packing and transport

7. Distribution channels

8. Sales promotion

9. Sources of market information

Financial Appraisal:

1. Demand-Techniques of forecasting:

a) Import substitution

b) Past trend method

c) End-use method

d) Correlation & regression

e) Export market

2. Supply-depth of competition

3. Pricing policy

4. Lifecycle of the product

5. Brand name for the product

6. Packing and transport

7. Distribution channels

8. Sales promotion

9. Sources of market information

Economic Appraisal:

1. Ratio for economic appraisal

2. Economic rate of return

3. Domestic resources cost

4. Comparative study of financial rate of return and economic rate of return

Management Appraisal:

1. Qualities of an entrepreneur

a) Honesty & integrity

b) Involvement in the project

c) Financial resources

d) Competence

e) Risk taking

f) Initiative

g) Intelligence

h) Self confidence

i) Frankness

2. Various forms of organization

a) Proprietary concern

b) Partnership firm

c) Corporate sector

3. SOURCE OF FUNDS

A project can be financed by any one or more than one of the following sources:-

Issue of ordinary / preference shares :-

Within the issue of shares, choice between ordinary shares & preference shares is simple. As stated earlier, the ordinary share capital does not involve any fixed charge on the company. On the other hand, preference shareholders are entitled to dividend as a predetermined rate. Although dividend on preference share is payable out of profits, in case of cumulative preference shares, dividend has to accumulate to be paid in future even if the company incurs loss in a particular year. As soon as the company earns profit, it has to pay arrears of dividend to cumulative preference shareholders before declaring any dividend on equity shares.

Issue of secured debentures:-

In order to encourage industrial units to meet their financial & public requirements from the public, all restrictions on interest rates on debentures & public sector bonds other than tax free bonds have been removed companies issuing such instruments are free to decide the interest rates depending on the market forces. In order to guide the investing public, companies are required to obtain a credit rating before floating these instruments. The terms of the issue can also provide for buy back arrangements. In spite of the above steps, public may not be very enthusiastic to subscribe to secured debentures unless some additional incentives are offered to them.

Issue of convertible debentures & bonds:-

Issue of convertible debentures (secured) & convertible bonds (unsecured) is another method of raising loan funds. These debentures/bonds combine the benefits of equity capital & loan capital. Interest payable on convertible debentures/bonds till their conversion into equity shares is deducted from the profit of the company for the purpose of calculating taxable profit.

Term loans:-

Term loans are provided by banks, state financial corporation (SFCs), State Industrial development corporation (SIDCs), State Industrial & Investment corporations (SIICs) & all India financial institutions, viz industrial Development Banks of India (IDBI), Industrial finance corporation of India (IFCI), Industrial credit & investment corporation if India (ICICI), Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC) & Unit Trust of India (UTI).

As per the present practice, small & medium projects having cost upto Rs 5crores are financed singly or jointly by SFCs, SIDCs/SIICs & banks. They can obtain refinance from SIDBI/IDBI for the term loan provided by them for such projects. It may be mentioned that small industries Development Bank of India (SIDBI) was setup on 2 April, 1990which provides refinance for the term loans given to small scale industries.

Deferred credits:-

Many times, the machinery suppliers provide the facility of deferred credits. In such cases, banks may be approached to give guarantee for the payment of deferred installment to the machinery suppliers. Banks should examine the viability of the project before giving guarantee for such deferred credits.

Leasing Finance:-

Leasing has become an important method of financing during last decade & it is provided in our country by exclusive leasing companies in the private sector, finance companies transecting leasing business, manufacturer-lessons, leasing companies set up by financial institutions & subsidiaries of commercial banks. Promoters of a project may have a contract with the leasing company under which an asset is given by the lessor to the lessee for a fixed period during which the lessee pays periodical rent for the use of the asset.

Unsecured Loans & deposits:-

Many existing companies prefer to raise public deposits instead of taking term loans from institutions. However, public deposits cannot be accepted for more than 3 years at a time.

Non-banking non financial companies can accept public deposits up to 25 percent of net owned funds. In addition, companies can accept unsecured loans from shareholders or unsecured loans from public guaranteed by directors or issue unsecured debentures up to 10 percent of net owned funds.

Capital Subsidy or development loans/sales tax loans:-

Government & development agencies provide subsidy, development loans/sales tax loans for setting up industries in certain notified backward districts. While reckoning the above subsidy as a source of finance, the term lending institutions & banks should ensure that such assistance will be provided by central governments/State governments /State development agencies well in time during implementation of the project.

Internal accruals:-

Whenever existing companies promote an expansion / diversification / modernization project, they use their internal accruals to finance it. If internal accruals are reckoned as a source of project finance, the appraising officer should study future cash flow statements estimates of the company & ensure that the internal accruals stated by the company will be available to it at the appropriate time.

4. CREDIT APPRAISAL

Credit appraisal is the basic requirement for determining merits of a proposal before sanctioning financial assistance. While appraising the proposal, the branch manager carefully study the applicant, his integrity, nature of activity & future prospects of the business. With regard to financing credit proposals, the following aspects are to be carefully analyzed:

Management: - Management behind the project is very important. Management is both a key to success as also a common reason for the failure of an enterprise. Proper evaluation of management is highly essential part of appraisal of a project/ business activity.

Nature of industry & its status in the economy & future prospects: - Various aspects of the particular industry/activity should be judiciously evaluated before selecting a project. The following points are:

i. Examination of the market study report

ii. Demand supply gap

iii. Type of product

iv. Future demand

v. Product differentiation

vi. Availability of other competitive products

Operations: - Constraints in the availability of infrastructural facilities of raw material & other input required in day to day operations.

Financial: - Planning & management, past record, net worth, debt equity mix etc.

Credit requirement: - Purpose & repayment programme & probability of fulfilment as scheduled & other terms.

4.1. STUDY OF THE BORROWER

The first & most aspect to be evaluated, while appraising a loan proposal is to study/know the borrower i.e. his integrity & honesty & whether it is safe to entrust the Banks money to the applicant or applicants. Even when the Bank has a proper security, it is the borrower to whom the lending is primarily made & an honest borrower is our best security. Branch manager should have confidence in his customer before deciding to make an advance. The following may be noted in the appraisal of the borrower in order to make an assessment if standing, respectability & credit worthiness.

1. Character: - Character is the greatest single asset, any individual can have. It is essentially/primary ingredient under-lying the granting of credit. Men deficit in character cannot be trusted. The assessment of a persons character is done on the following basis:-

i. Extent & nature of his education.

ii. State of his health, capacity & energy for the hard work.

iii. General reputation among social & business circles acquaintances, associates, employers & creditors.

iv. His behaviour & dealing with the bank & other.

2. Capacity: - The branch manager must ascertain the capacity of the borrower i.e. his ability & experience to run the business in a profitable manner. The earning capacity of the borrower will depend on efficient managerial ability and is the guiding factor for determining whether to lend and how much to lend. Other guiding factors include:

i. The ability and experience to run the business in a profitable manner.

ii. The earning the capacity of the borrower will depend on efficient managerial ability and is the guiding factor for determining whether to lend and how much to lend.

iii. Past business results and income and expenses of a borrower are extremely important in appraising his capacity.

iv. Technical expertise of borrower.

v. Is surplus being built up? Paying habits of the borrower.

vi. Whether the borrower is prepared to put in sufficient time and hard work in the business?

vii. Are the plans of the borrower on sound and realistic line?

3. Capital: - Capital or financial strength of the borrower as measured by the equity or net worth should be enquired into so as to assess his credit worthiness, ability to pay etc. In case of new business the sources for required capital contribution must be clearly identifiable.

Character + capacity + capital = Safety in credit limit

Character + capacity + Insufficient capital = Fair credit risk

Character + Insufficient capacity + capital = Fair credit risk

Impaired Character + capacity + capital = Doubtful credit risk

Character + capacity - capital = Limited success

Capacity - Character + capital = High risk

Character - capacity + capital = Inferior credit risk

Capital capacity - Character = Distinctly poor risk

Character - capacity - capital = Fraudulent credit risk

4. Experience: - The borrower should have adequate experience in the line of the business or should have employed competent personnel for management of the business.

5. Purpose: - It should be ensured that the purpose of the advance is acceptable to the bank & the borrower has the capacity & ability to conduct his affair in a successful manner and that he can be trusted for not misusing the facilities and divert the funds available in the business.

6. Quantum of advance: - The amount of advance needs to be carefully assessed to ensure that

i. The amount of advance together with other resources available to the borrower is reasonable.

ii. The amount of advance is need based & as per the actual requirements of the business.

iii. Adequate cushion is provided to meet the unforeseen contingencies on account of a possible escalation in the cost.

7. Security: - Where security is available it should be seen that the value is sufficient to cover the advance & the borrowers title is valid & transferable. Security is obtained as an insurance against any unforeseen development. It cannot turn a bad loan a good one but it will make a good loan better.

8. Repayment: - The repayment programme offered by the borrower should be reasonable & acceptable with definite source of repaying the loan. The repayment programme of an advance will essentially depend on the earning of the borrower & the type of facility provided. Three important types of credit facilities are :-

Temporary facility or bridge loan finance against expected inflows.

Provision for working capital for normal trade/business requirements

Term loan for capital expenditures.

The repayment of an advance can be made through three sources:-

Conversion of assets into cash

Collection of sundry debtors

Sale of merchandise

Sale of investments

Sale of fixed assets

Income, earning or fresh equity contribution

Personal income and/or salary

Profits after tax

Issue of fresh/ additional equity/ share capital/ bringing in additional capital by proprietor/partner

Borrowing from other sources

Issue of debentures

Loans from financial institutions, private sources.

4.2. PROCESSING OF PROPOSALS:-

1. Application form: - A customer seeking an advance from the bank is required to submit an application on the prescribed form together with various supporting statements. The usual information furnished in the application form relates to applicants personal bio data, business details of credit facilities required including the purpose & security offered etc. The branch manager on receiving the application should process the same & have detailed discussions with the applicants on various aspects of the proposed borrowing arrangement.

2. Sources of credit information:- Various sources of credit information are as under:-

i. Financial statements submitted by the borrower.

ii. Personal discussions with the borrower.

iii. Personal visits & inspection carried out in the borrowers factory.

iv. Market sources i.e. the press, other clients of the bank and any source other the borrower.

3. Personal interview: - A personal interview with the prospective borrower is one of the most important steps in credit appraisal & this should be done by the experienced Branch Manager. During the course of the interview, the Manager should learn about the past history, present performance and future plans of the borrower.

4. Market reports: - Information regarding character & integrity of the borrower should be tactfully gathering from sources close to the borrower i.e. those with whom borrower deals, his friend, relatives & associates. All such reports, sometimes contradictory to each other, have to weight independently and a balanced opinion has to be formed about the character and capacity of the borrower.

5. Study of accounts: - In case of new customers having dealing opinion of his existing bankers should be obtained.

6. Study of accounts: - Customers, who already have an account currents or cash credit / overdraft with the branch, the Banks record should be looked into.

i. Resume of his dealing with the bank will throw light as to the fulfilment of commitments by him, business integrity etc.

ii. The banks record will reveal the manner in which the borrower has handled his credit.

7. Financial statements: - Balance sheet & profit & loss account of the borrower for the last years duly audited should be obtained. This analysis will help answer the following question.

i. Whether the concern is financial sound & stable?

ii. Whether its profitability or earning capacity is up to required standard?

iii. Whether its liquidity position is satisfactory?

iv. Whether it is well managed?

8. Income tax, wealth tax & sales tax assessment orders: - The branch manager should call for the originals of income tax, wealth & sales assessments orders. Wherever income tax, wealth tax & sales tax assessments are not completed, copies of such returns filed should be obtained. Income tax assessment will give an idea of the borrowers profits & comments, if any in such orders on the maintenance of accounts will be helpful in knowing the pitfalls of the borrowers business.

9. Statement of assets & liabilities: - The property statement of a borrower will give an idea of his worth, liabilities & his income from real estate. A complete list of property, their location, approximate valuation should be obtained.

10. Personal visits: - The manager either alone or accompanied by other officer should visit unit or place of business of the borrower. The manager during the visit should try to find out:

i. Its area where the business is located having all the infrastructure facilities for the unit.

ii. Does the borrower own the real estate or its leased, it is on favourable terms.

iii. Companys policy regarding replacement / up gradation of machinery & equipments.

iv. If expansion is undertaken in the future, will adequate space be available for its within the existing premises.

11. Decision of the manager: - Loan application should be processed with due care. After collecting all the information & studying it, the manager has to take a final decision. The decision to lend or not to lend the money will be based on the careful analysis of all the information obtained about the borrower, the project / activity & credit worthiness etc.

4.3. PROPOSED, RECEIVED & DISPOSED REGISTER:-

All applicants for grant of loans & advances should be entered in a proposed, received & disposed register containing the following details.

1

2

3

4

5

6

7

8

9

S.No

Date

Name of applicant

Category

Nature & Amount of facilities required

Date of disposal

Amount of facilities

If declined, by whom & reasons thereof

Initials of manager

Figure 3: Format of Proposed, Received & Disposed Register

All such applicants should be serially numbered. The registration number of the applicants will also be serial number of proposal. Besides this number the proposal will carry the identification number of the branch as a prefix. Decisions i.e. sanction or refusal of the proposal should be recorded in the appropriate columns under the initials of the manager. Other sanctioning authorities will similarly maintain a proposal receipt & disposal registers.

4.4. REJECTION OF PROPOSAL:-

In case a request for grant of an advance has to be declined, the recommending/sanctioning authority should put forth reasons for his approach while refusing to entertain the proposal. The branch manager / sanctioning authority should not decline the proposal at their own level but refer such cases to next higher authority. Only upon hearing from the higher authority the final decision should conveyed to the party.

5. WORKING CAPITAL

5.1. NATURE OF WORKING CAPITAL

Working capital management is concerned with the problem that arises in attempting to manage the current assets, the current liabilities and the inter-relationship that exists between them. The current assets refer to those assets which in the ordinary course of business can be converted into cash within one year without undergoing a diminution in value and without disrupting the operations of the firm. The major current assets are cash, marketable securities, accounts receivables and inventory. Current liabilities are those liabilities which are intended to be paid in the ordinary course of business, within one year, out of the current assets or earnings of the concern. The basic current liabilities are accounts payable, bills payable, bank overdraft, and outstanding expenses. The goal of working capital management is to manage the firms current assets and liabilities in such a way that a satisfactory level of working capital is maintained. This is so because if the firm cannot maintain a satisfactory level of working capital, it is likely to become insolvent and may even be forced into bankruptcy. The current assets should be large enough to cover its current liabilities in order to ensure a reasonable margin of safety. Each of the current assets must be managed efficiently in order to maintain the liquidity of the firm while not keeping too high a level of any one of them. Each of the short term sources of financing must be continuously managed to ensure that they are obtained and used in the best possible way. The interaction between current assets and current liabilities is, therefore, the main theme of the theory of working capital management.

5.2. CONCEPTS AND DEFINITION OF WORKING CAPITAL

There are two concepts of working capital: Gross and Net.

The term gross working capital, also referred to as working capital, means the total current assets. Gross working capital means the current assets which represent the proportion of investment that circulates from one form to another in the ordinary conduct of business.

The term net working capital can be defined in two ways:

I. The most common definition of net working capital (NWC) is the difference between current assets and current liabilities.

II. Alternate definition of NWC is that portion of current assets which is financed with long term funds.

The task of the financial manager in managing working capital efficiently is to ensure sufficient liquidity in the operations of the enterprise. The liquidity of the business firm is measured by its ability to satisfy short term obligations as they become due. The basic measures of a firms overall liquidity are:

I. The current ratio

II. The acid-test ratio

III. The net working capital

They are very useful in inter-firm comparisons of liquidity. Net working capital (NWC), as a measure of liquidity is not very useful for comparing the performance of different firms, but it is quite useful for internal control. NWC helps in comparing the liquidity of the same firm over time. For the purpose of working capital management, therefore, NWC can be said to measure the liquidity of the firm. In other words, the goal of working capital management is to manage the current assets & current liabilities in such a way that an acceptable level of NWC is maintained.

NWC is commonly defined as the difference between the current assets and current liabilities. Efficient working capital management requires that firms should operate with some amount of NWC, the exact amount varying from firm to firm and depending, among other things, on the nature of industry. The theoretical justification for the use of NWC to measure liquidity is based on the premise that the greater the margin by which the current assets cover the short term obligations, the more is the ability to pay obligations when they become due for payment. NWC is necessary because the cash flows and inflows do not coincide. In other words, it is the non synchronous nature of cash flows that make NWC necessary. In general, the cash outflows resulting from payment of cash liabilities are relatively predictable. The cash inflows are, however, difficult to predict. The more predictable the cash inflows are, the less NWC will be required. A firm, say an electricity generation company, with almost certain and predictable cash inflows can operate with little or no NWC. But where cash inflows are uncertain, it will be necessary to maintain current assets at a level adequate to cover current liabilities, that is, there must be NWC.

NWC can alternatively be defined as that part of current assets which are financed with long term funds. Since current liabilities represent sources of short-term funds, as long as current assets exceed the current liabilities, the excess must be financed with long term funds. Desirably, net working capital should be positive i.e. current assets should exceed current liabilities or Current Ratio (current assets divided by current liabilities) should be higher than 1:1. This would signify liquidity and availability of adequate working funds. For a banker, it would connote a cushion of safety for the funds lent.

For e.g.

Assuming the balance sheet of ABC ltd Company

Balance sheet at the year ending 31.3.2009(in lacs)

LIABILITIES

ASSETS

Capital

6.00

Fixed assets

5.00

Unsecured loans

1.00

Securities

0.45

Term Loans

2.00

Current liabilities:

Current assets:

--Sundry creditors

2.50

--Stock

3.00

--Bank overdraft

0.75

--Debtors

1.80

--Bills payable

0.50

--Cash/ bank

2.50

Total liabilities

12.75

Total assets

12.75

Net working capital= CA - CL = 7.30 3.75 = 3.55 OR

Net Working Capital= Long term sources Long term uses.

Where,

Long term sources = Capital + unsecured loans + term loans

=6.00+1.00 + 2.00 =9.00

Long term uses= Fixed assets+ securities

= 5.00+0.45=5.45

Thus, NWC= 9.00 - 5.45= 3.55

Though both the formula are applicable for calculating, mostly applicable is :

NWC = Long term sources - Long term uses. It is applicable to avoid complexity of solution.

Working capital gap (WCG): WCG represents the difference between total current assets (TCA) and current Liabilities excluding bank borrowing.

Working capital gap = Total current assets (TCA) Total current liabilities (TCL)

(Excluding bank borrowing)

Projected NWC Vis--vis projected build-up of current assets:

The levels of the current assets as projected by the borrower are on many occasions not acceptable to the banker. In such cases, the banker slashes down the levels and arrives at PBF on the basis of such reduced levels. It is a practice with many banks to assume the levels of availability of NWC to be correct as projected by the borrower. The higher level of NWC consequently reduces the PBF and the borrower get less than the projected bank borrowing as shown in following example: (Figures in value)

Liabilities

Previous years actual

Projected by the borrower

Accepted

By bank

Assets

Previous years actual

Projected by the borrower

Accepted by bank

Net worth

Term loans

LongTerm deposits

Total long term funds

Other current liabilities

Bank borrowing

Total current liabilities

Grand total

50

130

5

185

35

190

225

410

50

120

20

190

50

250

300

490

50

120

20

190

50

210

260

450

Non- current assets.

Total current assets.

Grand total

110

300

410

90

400

490

90

360

450

Where,

Liabilities:

Actual: Previous years actual

Projected: Projected by the borrower

Accepted: Accepted by Bank

Assets:

Actual: Previous years actual

Projected: Projected by the borrower

Accepted: Accepted by Bank

NWC (actual/projected) 75 100 100

Current ratio 1.33:1 133:1 1.33:1

`The bank has in the above examples reduced the level of current assets but by keeping the projected NWC has reduced the PBF. The projected current ratio has, therefore, improved. It, however, needs to be pointed out that the borrower might have decided to increase the NWC margin, considering that he would have to maintain the current assets at a higher level. In the case under illustration, he had decided to bring in additional long term funds in the form of deposits and has also projected higher level of OCL, in which the level of sundry creditors for purchases might have been included.

However, if the level of current assets is to be increased only to 360 and not to 400 he may decide to borrow less in the form of deposits and because of the lower level of sundry creditors for purchases may also come down.

It is therefore, incorrect to insist that the projected NWC should always be the same even when the banker decides to reduce the level of current assets. On the other hand, if the increased NWC is solely because of increase in profit, it need not be changed. What is, therefore, needed is an analysis of the factors which increase the NWC.

Many bankers plead that the borrower should bring in as much as possible (in the form of increased NWC) and the bank is there only to supplement the financial needs. It can, however, be argued on behalf of the borrower that he had decided to bring in additional funds only for higher build up of current assets and he should not be compelled to bring in funds whereby the current ratio is increased to a level much above the stipulated minimum. Had the ratio been 1.38:1 in the previous year also, the banker would have been justified in insisting on the maintenance of the same ratio for the projected year.

NWC and security margin:

The emphasis of J&K Bank (as per Tandon Committee norms) had been on the maintenance of overall margin in the form of NWC rather than on security margin. This was of course necessary because banks were required to shed their security- oriented approach and attach more importance to production related credit. However, banks must avoid financing against unpaid stocks. The inter-relationship between NWC and security margin has therefore to be clarified. The NWC represents the amount of funds brought in by the borrower in the form of own funds and other long term resources, whereas the security margin is the stipulation made by the banker to ensure that the borrower avails the limit only after he brings in the margin. The security margin is a practical safety value for monitoring the operations in the account on a monthly basis. The banker can avoid financing against unpaid stocks and maintain a secure position regarding security by calculating the PBF and the drawing power (DP). This has been shown in the following example:

Liabilities

Unit A

Unit B

Assets

Unit A

Unit B

Net worth

90

90

Fixed assets

80

80

Term liabilities

110

110

Other Non C A

20

20

Total long term loans

200

200

Total Non C A

100

100

Short term bank borrowings

200

130

Inventory(stock)

200

130

Other C L out of (5) above

100

170

Receivables(debtors)

150

100

Other C A

50

170

Sundry creditors

60

90

Chargeable C A

350

230

Total C L

300

300

Total C A

400

400

Grand Total

500

500

Grand Total

500

500

The current ratios as well as the NWC are the same for Unit A and Unit B. However, PBF is different, as shown below:

UNIT A

UNIT B

Total Current Assets

400

400

Less: Other current liabilities

100

170

Working Capital Gap

300

230

Less: Minimum Stipulated NWC (25% of TCA)

100

100

Permissible Bank Finance

200

130

The security margins for the two units would have to be different to ensure that the units do not avail the bank finance to the full extent of PBF without attaining the current asset level as envisaged in the projection and acceptable by the banker. This would not happen if the security margin is uniform for both the units (Generally accepted Security margin is 25% on stock and 50% on Debtors). The units in that case would be able to draw the sanctioned PBF at much lower levels of chargeable current assets than in the earlier example, as indicated here under:

UNIT A

UNIT B

Total Chargeable CA

350

230

Security Margin:

Stock @ 25%

Debtors @ 50%

50

75

32.5

50

Total Margin

125

82.5

Drawing Power

225

147.5

Now we can see that for Unit A, the PBF is 200lacs but the drawing power comes out to be 225lacs. So, the borrower is able to enjoy an enhanced limit in comparison to what has been sanctioned to him. This should be taken care by the appraising officer that the drawing power should be within the limits of PBF. So, in the case the security margin is to revised, say 37.5% on stock and 50% on debtors.

In the case of Unit B, the drawing power comes out to be 147.5lacs but the PBF is 200lacs, so the borrower is not able to enjoy his full limit. This is due to the fact that the amount of other current asset is quite large, thus rendering the amount of Chargeable current asset to be comparatively small with regard to Unit A. The appraising officer should accept only that amount of other CA as would leave sufficient Chargeable assets for security margin.

5.3. CLASSIFICATION OF WORKING CAPITAL

Figure 4: Kinds of Working CapitalWorking capital may be classified in two ways:

1. On the basis of concept

2. On the basis of time.

On the basis of concept, working capital is classified as gross working capital and net working capital. Gross working capital means the current assets which represent the proportion of investment that circulates from one form to another in the ordinary conduct of business and net working capital is the difference between current assets and current liabilities or alternatively the portion of current assets financed with long-term funds.

On the basis of time, working capital may be classified as:

a) Permanent or fixed working capital.

b) Temporary or variable working capital

a) Permanent or Fixed working capital: Permanent or Fixed working capital is the minimum amount which is required to ensure effective utilisation of fixed facilities and for maintaining the circulation of current assets. There is always a minimum level of current assets which is continuously required by the enterprise to carry out its normal business operations. For example, every firm has to maintain a minimum level of raw materials, work-in-progress, finished goods and cash balance. The minimum level of current assets is called permanent or fixed working capital as this part of capital is permanently blocked in current assets. As the business grows, the requirements of permanent working capital also increase due to increase in current assets. The permanent working capital can further be classified as regular working capital and reserve working capital required to ensure circulation of current assets from cash to inventories, from inventories to receivables and from receivables to cash and so on. Reserve working capital is the excess amount over the requirement for regular working capital which may be provided for contingencies that may arise at unstated periods such as strikes, rise in prices, depression, etc.

B) Temporary or Variable working capital: Temporary or Variable working capital is the amount of working capital which is required to meet the seasonal demand and some special exigencies. Variable working capital can further be classified as seasonal working capital and special working capital. Most of the enterprises have to provide additional working capital to meet the seasonal and special needs. The capital required to meet the seasonal needs of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing campaigns for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense that it required for short periods and cannot be permanently employed gainfully in the business.

5.4. PLANNING OF WORKING CAPITAL

The need for working capital (gross) or current assets cannot be overemphasized. Given the objective of financial decision making to maximise the shareholders wealth, it is necessary to generate sufficient profits. The extent to which profits can be earned will naturally depend, among other things, upon the magnitude of the sales. A successful sales programme is, in other words, necessary for earning profits by any business enterprise. However, sales do not convert into cash instantly; there is invariably a time-lag between the sale of goods and the receipt of cash. There is, therefore, a need for working capital in the form of current assets to deal with the problem arising out of the lack of immediate realisation of cash against goods sold. Therefore, sufficient working capital is necessary to sustain sales activity. Technically, this is referred to as operating or cash cycle. The operating cycle can be said to be at the heart of the need for working capital. The continuing flow from cash to suppliers, to inventory, to accounts receivable and back into cash is what is called the operating cycle.

Working capital cycle or the Operating cycle represents the time span within which the cash utilized for procuring raw materials, payment of wages and incurring overheads is reconverted into cash through sales realization. Therefore the total time span within which the business activity rotates is called an operating cycle or production cycle. In a trading concern, there is a series of activities starting from procurement of goods (saleable goods) and ending with the realization of sales revenue (at the time of sale itself in case of cash sales and the time of debtors realizations in cash of credit sales). In case of manufacturing concern, this series starts from procurement of raw materials and ending with the sales realization of finished goods (after going through the different stages of production). The time gap between the happening of first event and happening of last event. This gap is called the operating cycle.

Thus, the operating cycle of a firm consists of the time required for the completion of the sequence of some or all of the following:

1. Procurement of raw materials and services.

2. Conversion of raw materials into work in progress.

3. Conversion of work in progress into finished goods.

4. Sale of finished goods into cash or credit.

5. Conversion of receivables into cash.

The constituents of operating cycle namely cash, raw materials, stock-in-progress, finished goods and receivables represent a portion of total current assets. Thus, investment in operating cycle represents a part of working capital finance.

Operating Cycle Period:-

The length or time duration of the operating cycle of any firm can be defined as the sum of its inventory conversion period and the receivable conversion period.

Inventory Conversion Period (ICP):-

It is the time required for the conversion of raw materials into finished goods sales. In a manufacturing firm the ICP consists of Raw Material Conversion Period (RMCP); Work in Progress (WPCP), and the Finished Goods Conversion Period (FGCP).

The RMCP refers to the period for which the raw material is generally kept in stores before it is issued to the production department.

The WPCP refers to the period for which the raw materials remain in the production process before it is taken out as a finished unit.

The FGCP refers to the period for which finished units remain in stores before being sold to the customers.

Receivables Conversion Period(RCP):-

It is the time required to convert the credit sales into cash realization. It refers to the period between the occurrence of credit sales and collection of debtors.

The total of ICP and RCP is also known as Total Operating Period (TOCP).

The firm might be getting some credit facilities from the supplier of raw materials, wage earners etc. This period for which the payments to these parties are deferred or delayed is known as Deferral Period (DP).

The Net Operating Cycle (NOC) of the firm is arrived at by deducting the DP from the TOCP. Thus,

NOC = TOCP-DP

= ICP+RCP-DP

5.5. DIAGRAMMATIC REPRESENTATION OF OPERATING CYCLE

Figure 5: Operating Cycle

Example: The following example very clearly illustrates how the numbers of days for RMCP, W.I.P, Finished Goods, Debtors are to be calculated for the purpose of assessment of working capital requirements:

From the following information taken from taken from the books of a manufacturing concern, compute the operating cycle in days:

Period covered ------------------------------------------------------ 365days

Average period of credit allowed by suppliers ---------------- 16 days

(Rs. In 000)

Average debtors outstanding ------------------------------------- 480

Raw material consumption --------------------------------------- 4400

Total production cost --------------------------------------------- 10000

Total cost of goods sold ------------------------------------------ 10500

Sales for the year -------------------------------------------------- 16000

Value of average stock maintained:

Raw material -------------------------------------------------------- 320

Work-in-progress -------------------------------------------------- 350

Finished goods ------------------------------------------------------ 260

Solution:

RAW MATERIAL = Average Raw material stock X 365

Total Raw material consumption

= 320 X 365

4400

= 27 days

WORK-IN-PROGRESS = Average Work-in-progress X 365

Total cost of production

= 350 X 365

10000

= 13 days

FINISHED GOODS = Average Finished Goods X 365

Total cost of goods sold

= 260 X 365

10500

= 9 Days

DEBTORS = Average Receivable X 365

Total Sales

= 480 X 365

16000

= 11 Days

The credit allowed by creditors = 16 days.

Therefore, TOCP = RMCP + WPCP + FGCP + RCP

= 27 + 13 + 9 +11

= 60 Days

Therefore, NOC = TOCP DP

= 60 16

= 44 Days

Therefore, the firm has a Net Operating Cycle of 44 Days.

5.6. QUANTUM OF WORKING CAPITAL:

The quantum of working capital requirements (gross working capital) depends on nature of activities of an enterprise. The two main factors taken into consideration are:

i. Level of activity or operation.

ii. Duration or length of the operating cycle.

The level of activity refers to the level of production or sales. An increased sales turnover would normally require increased working capital for its achievement.

For instance,

If a unit producing 1000 units per month desires to produce 1200 units in the coming months, then it requires more working funds to attain the increased production target.

On the other hand, if for the same production level of 1000 units per month, the raw material availability changes from 10 days to 15 days, then more raw material is to be stored which means requirement of additional working funds.

Another factor which may affect the quantum of working capital required for the smooth working of the unit is the increase in the cost of the inputs i.e. raw material. In Indian scenario, even if the unit is operating at the same level i.e. the same capacity utilization, it would be requiring more working funds to meet its working capital requirements of all such units have gone up substantially though level of operations has been the same.

For estimation of gross working capital requirement we must also know the level of operating expenses required for attaining projected level of sales.

For e.g.

If the sales forecast of a unit for a next year are Rs 8lacs, its operating expenses are Rs 6lacs, and the estimated length of its operating cycle is 4 months (120 days).What shall be total working capital requirement to achieve the sales target?

Since each rupee of working capital employed during the year will be turned over 3 times (360 day120 days) the total working capital required by the unit on an average will be Rs 2lacs (Rs6lacs3).

Any reduction in the length of operating cycle will improve the working capital turnover ratio. Thus if the same unit is able to reduce the length of operating cycle from 120 days to say 90 days, its working capital turnover will improve from 3 times to 4 times per year(36090). Accordingly the gross working capital requirement will be Rs 1.50lacs (Rs6 lacs4) instead of Rs 2lacs. This means better utilization of resources of resources on account of better management of one or more phases of operating cycle.

5.7. IMPORTANCE OF WORKING CAPITAL

The main advantages of maintaining adequate amount of working capital are as follows:

1. Solvency of the business: Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production.

2. Goodwill: Sufficient working capital enables a business concern to make prompt payments and hence helps in creating and maintaining goodwill.

3. Easy loans: A concern having adequate working capital, high solvency to make prompt payments and hence helps in creating and maintaining goodwill.

4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts on the purchases and hence it reduces cost.

5. Regular supply of raw materials: Sufficient working capital ensures regular supply of raw materials and continuous production.

6.Regular payments of salaries, wages and other day to day commitments:- A company which has ample working capital can make regular payment of salaries, wages and other day to day commitments which raises the morale of its employees increases their efficiency, reduces wastage and cost and enhances production and profits.

7. Ability to face crisis:- Adequate WC enables a concern to face business crises in emergencies such as depression because during such periods, generally, there is much pressure on working capital.

8. High Morale: Adequate of working capital creates an environment of security, confidence, and high morale and creates overall efficiency in a business.

6. ASSESSMENT OF WORKING CAPITAL (WITH SPECIAL REFERENCE WITH J&K BANK)

The assessment of correct amount of working capital is extremely important for any financing institution.

Any overestimation of the requirement resulting in blockage of scare funds in idle assets is both, a drain on profitability as also a reflection on performance of the management of the financing institution.

At the same time any paucity of funds due to an underestimation may cripple the unit and deprive it of many profitable opportunities. Scarcity of funds will also adversely affect the liquidity of the unit and in turn its reputation, due to its inability to meet its commitments in time.

Operating with thin working capital is like walking on a tight rope and any unforeseen blockage of funds may instantaneously imperil the very existence of the unit. It is, therefore, of prime importance that the assessment of working capital is judiciously and meticulously done. The exercise becomes all the more important for bankers because a major portion of their working funds is tied in financing of working capital needs of their constituents. Proper and prudent calculation of working capital needs of the prospective borrowers contribution of his adequate share in the shape of margin. The exercise of assessing working capital requirement centers around ascertaining the operating cycle of the unit and then converting this period into monetary values based on the cost of components involved.

In J&K bank for instance, the share of term loans has touched around 60% and the bank now proposes to cap this limit at 65% of credit portfolio, the said rise has been due to the advent of loans for housing, consummation loans, educational loans, capacity expansion of industries etc. Nevertheless, working capital component remains to be very significant for any bank in its overall credit portfolio. The exercise of assessing working capital requirement centers around ascertaining the operating cycle of the unit and then converting this period into monetary values based on the cost of components involved.

6.1. VARIOUS METHODS FOR APPRAISING WORKING CAPITAL LIMITS:

Currently banks are following the under mentioned methods for appraising working capital limits for various classes of borrowers:

1. Turnover Method:

Assessment of working capital (fund based) finance based on projected turnover/sales of the unit will be applicable in case of following category of borrowers subject to fulfilment of conditions described herein.

Category of

Borrower

Max. amount of WC under turnover method

Conditions to be

Fulfilled

Micro and Small

Enterprise in the

manufacturing

Sector.

Rs 5.00 crores

Required Working Capital Margin is available as per first method of lending.

It shall be fully established with the support of relevant documentary evidence that reflect sales as shown in the latest financial statements are based on actual figures.

A reasonable growth in sales by amount ranging between 15% and 25% over the actual sales of current year may be accepted.

Micro and Small Enterprise providing services

In the event of working capital margin being available for amount less than the required margin contribution as per First Method of lending, MPBF worked out on the basis of turnover method shall be sanctioned after prescribing condition to the effect that the borrower has sufficient resources to induct the deficit in working capital margin. In the absence to this arrangement MPBF shall be worked out the basis of First Method of lending.

2. Second Method of Lending:

In cases, other than those specified above, assessment of working capital will be made in the basis of Second Method of Lending.

3. Cash Budget System:

This system shall be followed in following cases:

a) For assessing WC requirements for seasonal industries like tea, coffee, sugar and for construction activity and service sector.

b) For assessing WC finance above Rs 2crore for borrowers engaged in information technology (I.T) and software industry.

c) Any other borrower who is desirous of shifting monthly cash budget system will be encouraged.

d) In case of construction companies, the fund based limits (not exceeding the peak level deficit projected in the cash flow statement) and the non-fund based limits sanctioned to a borrower, put together, should also not exceed ten times the net owned funds of the company. Considering the especial features of such companies, it is preferable to follow the cash budget system for assessment of the working capital requirements.

6.2. WHICH METHOD OF LENDING IS BETTER?

After estimating the reasonable level of current assets based on norms/past trends, required for operation of a unit, sources of financing the same are decided. The total current assets will be financed partly by creditors for purchases & other current liabilities (excluding bank borrowing).

The remaining current assets called the working capital gap should be financed partly from net working capital (i.e. from owned funds & long term borrowings) and partly by bank borrowings.

In the context of above approach, maximum permissible level of bank borrowing can be assessed as per the two suggested methods of lending:

Method 1: Borrower is required to contribute a maximum of 25% of the working capital gap from long term (i.e. owned fund + term borrowings) and the balance 75% of the working capital gap will be the maximum bank finance. The first method will give a minimum current ratio of 1:1.

Method 2: Borrower is required to contribute a minimum of 25% of total current assets from term sources and the maximum permissible bank finance will be equal to W.C. Gap less by this minimum contribution. In the method total current liabilities inclusive of bank borrowings will not exceed 75% of current assets. The minimum current ratio under the 2nd method will be 1.33:1.

Minimum NWC at 25% of WCG under Method 1st and 25% of total current assets under method 2nd ensures the basic financial discipline that the borrower must observe if the WC finance is required from the bank. The availability of stipulated NWC accompanied by satisfactory current ratio assures the bank about the short term financial solvency of the borrower.

Illustration for calculation of Maximum Permissible Bank Finance (MPBF):

Current liabilities Amount Current assets Amount

(Excluding Bank Borrowing)

Creditors for purchases 100 Raw material 200

Other current liabilities 40 Stock-in-process 20

Finished Goods 80

Receivables 50

Other current assets 10

Total 140 Total 360

Maximum permissible bank finance (MPBF):-

First Method Second Method of lending

1. Total current assets 360 1. Total current asset 360

2. Less: Current liabilities 140 2. Less: Current liabilities 140

Other than bank borrowing Other than bank borrowing

3. WCG 220 3. WCG 220

4. Minimum stipulated 4. Minimum stipulated

NWC- 25% of WCG 55 NWC-25% of TCA 90

5. M.P.B.F. 165 5. M.P.B.F. 130

Current ratio 1.18:1 Current ratio 1.33:1

Method second ensures higher contribution of borrower by way of NWC.

6.3. ASSESSMENT OF WORKING CAPITAL (FUND BASED)

Format 1

Particulars

Holding periods

(days/week/month)

Amount

(lacs of Rs.)

A

Current Assets

(-)Raw Material

(-) Work in Process

(-) Finished Goods

(-) S. Debtors/Receivables

(-) Others(specify)

Total (A)

B

Current Liabilities

S. creditors on purchase

Others if any

Total (B)

C

Working Capital Gap (A-B)

D

Stipulated NWC@-----% of C or

Projected NWC (w.e.h)

E

M.P.B.F (C-D)

Format 2:

Under Mortgage loan Scheme

Last year sales: Rs --------------------

Add: 25% of last year sales: Rs --------------------

Total (A): Rs --------------------

Projected Sales (B): Rs --------------------

Accepted sales (A) or (B) (w.e.h): Rs --------------------

20% of Accepted sales (C): Rs --------------------

Value of the Property: Rs --------------------

Forced Realizable value of the property

(85%) of the value (D): Rs --------------------

75% of the value (D): Rs --------------------

Permissible Bank Finance: Rs --------------------

(C) or (D) whichever is less

Recommendation of the Branch: Rs ---------------------

6.4. MEASUREMENT OF WORKING CAPITAL

In order to calculate the working capital needs, what is required is the holding period of various types of inventories, the credit collection period and the credit payment period. The calculation of working capital is based on the assumptions that the production or sales is carried on evenly throughout the year and all costs accrue similarly.

For calculation of TOCP and NOC, various conversion periods may be calculated as follows:

RMCP = Average Raw Material Stock X 365

Total Raw Material Consumption

WPCP = Average Work-in-Process X 365

Total Cost of production

FGCP = Average Finished Goods X 365

Total cost of goods sold

RCP = Average Receivable X 365

Total Credit Sales

DP = Average Creditors X 365

6.5. TANDON COMMITTEE:

A study group under the chairmanship of Sh. P.L. Tandon was constituted in 1974 by the Reserve Bank of India to frame the guidelines for the effective regulation of the bank credit and other related aspects. The basic terms of reference of the Tandon Committee were as:

a) To suggest guidelines for commercial banks to follow-up and supervise credit from the point of view of ensuring proper end-use of funds and keeping a watch on the safety of the advances.

b) To make recommendations for obtaining periodical forecast from borrowers of production plans and credit needs.

c) To make suggestions for prescribing inventory norms for different industries.

d) To suggest criteria regarding satisfactory capital structure and sound financial basis in relation to borrowings.

e) To make recommendations as to whether the existing pattern of financing working capital requirements by cash credits/ overdraft systems etc. requires to be modified.

On the basis of findings, the Tandon Committee noted various shortcomings of the then prevailing cash credit system such as:

a) The cash credit system which allows the withdrawal of any amount up to a given limit hinders credit planning.

b) The security based approach to lending has led to diversion of funds to purchase of fixed assets, and

c) The working capital finance should be made available only for a short period as it has otherwise, led to accumulation of inventories with the industry.

Recommendations Regarding the Bank Practices:

1. Inventory and Receivables Norms: The norms for reasonable level of inventory are needed to avoid the undesirable holding and financing of Current Assets. The norms should also be specified to bring uniformity in the banks approach in assessing the working capital requirements. The Tandon Committee, in his final report, suggested norms for raw material, work in progress, finished goods, receivables and bills purchased for different industries.

This norms now has been dispened by RBI, now RBI give the authority to the Bank to take decisions regarding Inventory norms.

2. Lending Norms or Maximum Permissible Bank Finance (MPBF): The Tandon Committee introduced the concept of MPBF and suggested that bank should attempt to supplement the borrowers resources in financing the Current Assets should be financed by the trade credits and other Current Liabilities. The remaining part of the current assets, which is termed by the owners funds and long term borrowings and partly by the short term bank credit. The Tandon Committee has suggested three alternative methods for working out the MPBF. These methods are as follows:

In the First Method, the borrower will contribute 25% of the working capital gap; the remaining 75% can be financed from the Bank borrowings. This method will give a minimum Current ratio of 1:1.

In the second method, borrower will contribute 25% of the Total Current Assets. The remaining of the working capital gap can be bridged from the Bank borrowings. This method will give a Current Ratio of 1.3:1

In the Third Method, borrower will contribute 100% of core assets, and 25% of the balance of the current assets. The remaining of the working capital gap can be met from the borrowings. This method will further strengthen the current ratio.

3. Style of Credit: The Tandon Committee also suggested the form of Bank financing. The total MPBF should be bifurcated into the fixed portion and the fluctuating portion.

The fixed portion refers to loan components and represents the minimum level

of borrowing throughout the year.

The fluctuating component refers to demand cash credit component which would take care of the fluctuating needs and required to be reviewed periodically. The demand cash credit component should be charged a slightly higher interest rate than the loan component.

Apart from the loan and cash credit, a part of the total financing requirement should also be provided by the way of bills limit to finance the sellers receivables.

4. Information and Reporting System: Another suggestion of the Tandon Committee was that there should be a regular flow of information to the borrower to the bank. The Committee advocated comprehensive information and reporting system which seeks to

a) Introduce the borrower to plan his credit needs and carefully maintaining a greater discipline in its use,

b) Promote a free flow of information between the borrower and the banker so that the latter can monitor the credit situation better, and

c) To ensure recommended a quarterly budgeting cum a reporting system.

To sum-up, the Tandon Committee was in fact, the first concerted effort on the part of RBI to regulate the Bank credit.

6.6. CHORE COMMITTEE:

The Reserve Bank of India constituted another working group under the chairmanship of Sh. K.B. Chore in April 1979, with the terms of reference to review the cash credit system to promote greater credit discipline and to make the cash credit system more amenable to rational management of funds by commercial banks.

Recommendations of Chore Committee:

System of Credit: The advantages of the existing system of extending credit by a combination of three types of lending i.e. cash credit, loan and bill should be retained.

Bifurcation of credit limit: Bifurcation of cash credit limit into a demand loan portion and a fluctuating cash credit component has not found acceptance either on the part of the banks or the borrowers.

Reduction in over-dependence on bank finance: The need for reducing the over-dependence of the medium and large borrowers on the bank finance for their production/trading purposes is recognized. The net surplus cash generation of an established industrial unit should be utilized partly at least for reducing borrowing for working capital purposes.

Increase in owners contribution: In order to ensure that the borrowers do enhance their contribution to working capital and to improve their current ratio, it is necessary to place them under the second method of lending recommended by the Tandon Committee which would give a minimum current ratio of 1.33:1.

Separation of normal non-peak level and peak level requirements: While assessing the credit requirements, the bank should appraise and fix separate limits for the normal peak level as also for the peak level credit requirements.

Penal Interest: The borrower should be asked to give his quarterly requirements of funds before the commencement of the quarter on the basis of his budget.

Reduction of norms: Request for relaxation of inventory norm and for adhoc increases in limits should be subjected banks to close security and agreed to only in exceptional circumstances.

Bill system: As one of the reasons for the slow growth of the bill system is the stamp duty on nuance bills and difficulty in obtaining the required denominations of stamps, these questions may have to be taken with the state government.

6.7. NAYAK COMMITTEE:

A Committee under the chairmanship of Sh. P.R. Nayak, Deputy Governor, Reserve Bank of India was constituted to examine the adequacy of institutional credit to small scale industry (SSI) sector and other related aspects. Considering the contribution of SSI sector to overall industrial production, exports and employment and also recognizing the need to give a fillip to this sector, Banks were advised by RBI in 1938 to ensure adequate and timely credit to this sector.

Salient features of the package:

a) The banks should set up the credit flow to meet the legitimate requirements of the SSI sector. For this purpose, the banks should prepare an annual budget in respect of working capital requirements of all SSI before the commencement of the year.

b) It is desirable that a single financing agency meets both the requirements of the working capital and term credit for small scale units. The Single Window Scheme (SWS) of SIDBI enables the same agency- State Financial Corporation (SFC) or commercial bank as the case may be, to provide term loans and working capital requirements up to Rs. 10Lacs. The banks are advised to adopt this approach.

c) It has been decided by the RBI that for requirements of SSI units having aggregate fund based working capital credit limit upto Rs. 100lacs. from the banking system, the norms for inventory and receivables and the first method of lending will not apply. Instead such units may be provided working capital limits computed on the basis of a maximum of 20% of their projected annual turnover for new as well as existing units. Subsequently, in February 1993, this system of computing Maximum Permissible Bank Finance (MPBF) on the basis of an annual projected turnover was extended to All Borrowers enjoying fund based working capital limits of less than Rs. 100lacs from banking system.

d) These units would be required to bring in 5% of their annual projected turnover as margin money. In other words, 25% of the output value should be computed as working capital requirement for which at least four-fifth should be provided by the bank one-fifth representing the borrowers contribution towards margin for the working capital.

Objectives of the Study

And

Research Methodology

3.1 Objective of the Study are:

1) To understand the meaning of working capital and various prudential guidelines for financing given by Reserve bank of India.

2) To study about the working capital financing techniques followed by J&k bank.

3) To study about scoring system parameters followed by J&K bank for working capital financing of the client.

4) To find out reason behind the J&k bank failure in working capital financing

3.2 Research Methodology:

The Methodology is Exploratory in nature as the study is to gain new insights in Management in working capital financing. The data used is secondary in nature as my study is observational and data is collected through Annual Reports, manual of J&K Bank, Circulars, past studies conducted in purview of the working capital financing.

Sources of Data:

Secondary Data is collected through the annual reports and various past studies conducted in the purview of working capital.

Various books of Credit Management and risk Management, J&K Bank Manual on Loans and Advances, Journals, Circulars, Case Studies are consulted in-depth to analyze the Management of working capital financing.

Data Presentation:

Data is presented through:

Charts

Tables

Graphs

Data analysis:

Ratio analysis

Trends

Scope and significance of the study:

Scope of my study is quite narrow and limited to Jammu & Kashmir only. But, it will definitely be helpful for further descriptive studies.

3.3 Limitations:

Secondary data may not give true picture of concern.

More details could not be elicited due to tight schedule of the officials.

Area of study was some part of Jammu region. Findings may not hold true for large cross section of Population.

The constraint of time also prevented an in-depth study of the subject.

The Study is not comprehensive due to the external environment i.e. Curfews, Strike in Jammu Province for more than 25 days during my training.

CHART SHOW RELATIONSHIP BETWEEN CURRENT ASSETS AND CURRENT LIABILITIES FOR ABC INDUSTRIES

*(REFER TO APPENDIX FOR CASE I) CHART4(a)

YEAR

2004-05

30.09.06

2006-07

2007-08

Current Assets

119.34

67.27

85.21

100.44

Current Liabilities

79.16

44.38

52.87

61.48

TABLE4(a)

INTERPRETATION

In 2004-05 year, current assets were 119.34 lacs as compared to 30.09.06 it was 67.27 lacs due to fall in sales. But in case of year 2006-07 it was shown increasing trend up to projected year 2007-08.simultaneously current liabilities shown a decreasing trend from year 2004-05 to projected year 2007-08. In order to conclude the, current assets and current liabilities management of the concern was good.

CHART SHOWING RELATIONSHIP BETWEEN COST OF SALES TO INVENTORY (TAKEN 365 IN DAYS)

*(REFER TO APPENDIX FOR CASE I) CHART4(b)

YEARS

2005-06

2006-07

2007-08

2008-09

INVENTORTY TURNOVER RATIO (IN DAYS)

191

354

98

98

TABLE4(b)

INTERPRETATION

In 2004-05 year, inventory turnover ratio of the concern was 191 days as compared to 30.09.06 it was 354 days due to Sluggish in sales. But in case of year 2006-07 it was shown decreasing trend