Working Capital — Concept & Assessment
Relevent for JAIIB PPB | CAIIB ABM | CCP Module C
Why It Matters in Branch:
Working capital loans — CC, OD, LC — form the largest portion of a bank’s loan book. Understanding how to assess them correctly is the core skill of a credit officer.
SHORT NOTES
CONCEPT OF WORKING CAPITAL:
Working Capital = Current Assets – Current Liabilities (Net Working Capital)
Or simply: Funds needed to run day-to-day business operations.
Gross Working Capital = Total Current Assets (CA)
Net Working Capital (NWC) = CA – CL
COMPONENTS OF CURRENT ASSETS:
- Raw Material Inventory
- Work-in-Progress (WIP)
- Finished Goods Stock
- Sundry Debtors / Book Debts
- Advance payments to suppliers
- Cash and Bank Balance
COMPONENTS OF CURRENT LIABILITIES:
- Creditors / Sundry Creditors
- Advance received from customers
- Short-term bank borrowings (CC, OD)
- Other payables due within 12 months
WORKING CAPITAL CYCLE (Operating Cycle):
Raw Material → WIP → Finished Goods → Debtors → Cash → Raw Material
Length of cycle determines the quantum of working capital required.
Longer cycle = more funds required.
METHODS OF ASSESSING WORKING CAPITAL LIMITS:
Three methods prescribed by RBI (based on Tandon Committee):
Method I (Turnover Method — for limits up to Rs.5 crore MSME):
Bank finance = 20% of projected annual turnover
Simple, fast assessment for small businesses.
Method II (MPBF Method — for limits above Rs.5 crore):
Max Permissible Bank Finance (MPBF) = 75% of (CA – CL excluding bank borrowings)
Borrower must fund minimum 25% of net current assets from own sources (long-term funds).
Method III (Cash Budget Method):
Used for seasonal industries, construction, film production.
Bank releases funds based on actual monthly cash budget.
DRAWING POWER (DP):
In CC accounts, drawing power is calculated monthly based on actual stock and debtors statements.
DP = Paid Stock + Eligible Debtors – Creditors (as per bank’s margin requirements)
The CC limit cannot be drawn beyond DP even if the sanctioned limit is higher.
BRANCH CONTEXT
✦ We should review stock statements from CC account holders timely as per the policy of the loan and calculate drawing power. The most common irregularity we see is borrowers inflating stock values to maintain drawing power. Physical stock verification and reconciliation with purchase and sales records is mandatory — not optional.
