Maximum permissible bank finance?

As per the recommendations of Tandon Committee, the corporates should be discouraged from accumulating too much of stocks of current assets and should move towards very lean inventories and receivable levels. The committee even suggested the maximum levels of Raw Material, Stock-inprocess and Finished Goods which a corporate operating in an industry should be allowed to accumulate These levels were termed as inventory and receivable norms. Depending on the size of credit required, the funding of these current assets (working capital needs) of the corporates could be met by one of the following methods: First Method of Lending: Banks can work out the working capital gap, i.e. total current assets less current liabilities other than bank borrowings (called Maximum Permissible Bank Finance or MPBF) and finance a maximum of 75 per cent of the gap; the balance to come out of long-term funds, i.e., owned funds and term borrowings. This approach was considered suitable only for very small borrowers i.e. where the requirements of credit were less than Rs.10 lacs Second Method of Lending: Under this method, it was thought that the borrower should provide for a minimum of 25% of total current assets out of long-term funds i.e., owned funds plus term borrowings. A certain level of credit for purchases and other current liabilities will be available to fund the build up of current assets and the bank will provide the balance (MPBF). Consequently, total current liabilities inclusive of bank borrowings could not exceed 75% of current assets. RBI stipulated that the working capital needs of all borrowers enjoying fund based credit facilities of more than Rs. 10 lacs should be appraised (calculated) under this method. The committee suggested norms, i.e., ceilings for inventory and receivables, which could be considered for bank finance. The 15 industries included cotton and synthetic textiles, paper, cement, pharmaceuticals and engineering. Thus, for instance, the norms proposed for the pharmaceutical industry were : Raw materials : 2.75 months' consumption Stocks in process : month's cost of production Finished goods : 2 months' cost of sales Receivables : 1.25 months' sales For determining the maximum permissible bank finance (MPBF), the methods suggested were : Method I : 0.75 (CA - CL) Method II : 0.75 CA - CL Method III : 0.75 (CA - CCA) - CL Here CA stands for CURRENT ASSETS corresponding to the suggested norms or past levels if lower, CL represents CURRENT LIABILITIES excluding bank lending and CCA stands for the 'Core Current Assets', i.e., permanent current assets. Method I and, following the CHORE COMMITTEE recommendations, Method II have been used by banks in assessing working capital needs of businesses, for the last several years. In October 1993, the RBI infused operational autonomy by

permitting banks to determine appropriate levels of inventory and receivables, based on production, processing cycle, etc. These lending norms were made applicable to all borrowers enjoying an aggregate (FUND-BASED) working capital limit of Rs.1 crore and above from the banking system. However, the requirement of the CURRENT RATIO at 1.33 was retained.

Assessment of LCBD limit (Rs. in million) A B C D E F G Sales (Projected Turnover in FY 2012) Total Current assets Current Liabilities other than Bank Borrowings Working Capital Gap Min. stipulated Net Working Capital (25% of Total Current Assets) Projected Net Working Capital (Total Current Assets Total Current Liabilities) Max. Permissible Bank Finance Lower of following:-

842.4 473.6 318.9 154.7 118.4 134.7

D-E D-F H I J K L M N
Total Turnover (As per last audited balance sheet in FY 2010) Debtors (Less than 6 months maturity As per last audited balance sheet [Debtors Turnover (I /HI)*12] Proposed bill discounting limits [(Projected turnover * J)/12] Margin (25% of K) Max. Permissible bill discounting limits (K- L) Recommended Limits (Lower of G or M)

36.3 20.0 522.6 73.8 1.7 119.3 29.8 89.5 20.0

Methods of lending
Like many other activities of the banks, method and quantum of short-term finance that can be granted to a corporate was mandated by the Reserve Bank of India till 1994. This control was exercised on the lines suggested by the recommendations of a study group headed by Shri Prakash Tandon. The study group headed by Shri Prakash Tandon, the then Chairman of Punjab National Bank, was constituted by the RBI in July 1974 with eminent personalities drawn from leading banks, financial institutions and a wide cross-section of the Industry with a view to study the entire gamut of Bank's finance for working capital and suggest ways for optimum utilisation of Bank credit. This was the first elaborate attempt by the central bank to organise the Bank credit. The report of this group is widely known as Tandon Committee report. Most banks in India even today continue to look at the needs of the corporates in the light of methodology recommended by the Group. As per the recommendations of Tandon Committee, the corporates should be discouraged from accumulating too much of stocks of current assets and should move towards very lean inventories and receivable levels. The committee even suggested the maximum levels of Raw Material, Stock-in-process and Finished Goods which a corporate operating in an industry should be allowed to accumulate These levels were termed as inventory and receivable norms. Depending on the size of credit required, the funding of these current assets (working capital needs) of the corporates could be met by one of the following methods:

First Method of Lending: Banks can work out the working capital gap, i.e. total current
assets less current liabilities other than bank borrowings (called Maximum Permissible Bank Finance or MPBF) and finance a maximum of 75 per cent of the gap; the balance to come out of long-term funds, i.e., owned funds and term borrowings. This approach was considered suitable only for very small borrowers i.e. where the requirements of credit were less than Rs.10 lacs Second Method of Lending: Under this method, it was thought that the borrower should provide for a minimum of 25% of total current assets out of long-term funds i.e., owned funds plus term borrowings. A certain level of credit for purchases and other current liabilities will be available to fund the build up of current assets and the bank will provide the balance (MPBF). Consequently, total current liabilities inclusive of bank borrowings could not exceed 75% of current assets. RBI stipulated that the working capital needs of all borrowers enjoying fund based credit facilities of more than Rs. 10 lacs should be appraised (calculated) under this method.

Third Method of Lending: Under this method, the borrower's contribution from long term
funds will be to the extent of the entire CORE CURRENT ASSETS, which has been defined by the Study Group as representing the absolute minimum level of raw materials, process stock, finished goods and stores which are in the pipeline to ensure continuity of production and a minimum of 25% of the balance current assets should be financed out of the long term funds plus term borrowings. (This method was not accepted for implementation and hence is of only academic interest).

As can be seen above, the basic foundation of all banks' appraisal of the needs of creditors is the level of current assets. The classification of assets and balance sheet analysis, therefore, assumes a lot of importance. RBI has mandated a certain way of analysing the balance sheets.

The requirements of this break-up of assets and liabilities differs slightly from that mandated by the Company Law Board (CLB). The analysis of balance sheet in CMA data is said to give a more detailed and accurate picture of the affairs of a corporate. The corporates are required by all banks to analyse their balance sheet in this specific format called CMA data format and submit to banks. While most qualified accountants working with the firms are aware of the method of classification in this format, professional help is also available in the form of Chartered Accountants, Financial Analysts for this analysis.