WORKING CAPITAL

MANAGEMENT AND CONTROL

Dr. Monika Goel
monikagoel@gmail.com

Working Capital Management
Working capital
= current assets current liabilities
Working capital management refers to
choosing the levels and mix of:
cash, marketable securities, receivables and
inventories.
different types of short-term financing
Classification of Working Capital
Gross and net working capital
Permanent and temporary working capital
Three Broad Decisions
the level of current asset
the structure/composition of current assets
the financing of current asset.

Determinants of Working Capital
Nature of Business
Degree of Seasonality
Production Policies
Growth
Position of the Business Cycle
Competitive Conditions
Production Collection Time Period
Dividend policy and sales policy

The Balance-Sheet Model of the Firm

Current Assets

Fixed Assets
1 Tangible
2 Intangible


Shareholders
Equity

Current
Liabilities
Long-Term
Debt

What long-
term
investments
should the
firm engage
in?
The Capital Budgeting Decision
The Balance-Sheet Model of the Firm
How can the firm
raise the money
for the required
investments?
The Capital Structure Decision

Current Assets

Fixed Assets
1 Tangible
2 Intangible


Shareholders
Equity

Current
Liabilities
Long-Term
Debt

The Balance-Sheet Model of the Firm
How much short-
term cash flow
does a company
need to pay its
bills?

The Net Working Capital Investment Decision
Net
Working
Capital

Current Assets

Fixed Assets
1 Tangible
2 Intangible


Shareholders
Equity

Current
Liabilities
Long-Term
Debt

The Operating Cycle and the Cash Cycle
Time
Accounts payable period
Cash cycle
Operating cycle
Cash
received
Accounts receivable period Inventory period
Finished goods sold
Firm receives invoice Cash paid for materials
Order
Placed
Stock
Arrives
Raw material
purchased
The Operating Cycle and the Cash Cycle
In practice, the inventory period, the
accounts receivable period, and the accounts
payable period are measured by days in
inventory, days in receivables and days in
payables.
Cash cycle = Operating cycle
Accounts
payable
period
Review question
Silver Coin Ltd. is a manufacturing company. It has received an export order of 1,80,000 units.
The finance manager of the company is estimating working capital requirements for the
production to meet export order. Following information is given for the year 2009-10 :
(i) Production in 2008-09 was 1,80,000 units and it is estimated that in 2009-10 the level will
be maintained.
(ii) Each unit will remain in process for one month. Raw material being channelised into the
pipelines immediately and the labour and overhead costs accruing evenly during the
month.
(iii) Final production will be stored in warehouse awaiting despatch for 3 months.
(iv) Credit allowed by creditors is 1.5 months from the date of delivery of raw materials.
(v) Credit permitted to debtors is 2.5 months from the date of despatch.
(vi) Selling price per unit is Rs.15.
(vii) The expected ratios of cost to the selling price are raw material 50%, direct wages 15% and
overheads 20%.
(viii) Raw materials are expected to remain in store for an average of 1.5 months before issue to
production.
(ix) There is regular production and sales cycle.
(x) The company maintains Rs.60,000 as cash in hand.
(xi) Wages and overheads are paid on the first of each month for the previous month.
You are required to submit the working capital requirement to the finance manager of Silver
Coin Ltd.
Review Question
The management of Laxmi Ltd. has called for a statement showing the working capital needed to
finance a level of activity of 6,00,000 units of output for the year 2009. The cost structure for the
companys product for the abovementioned level is given as under :
Cost Per Unit
(Rs.)
Raw materials 20
Direct labour 5
Overheads 15
Total costs 40
Profit 10
Selling price 50
Past trends indicate that raw materials are in stock on an average for three months.
Work-in-progress will approximate to half a months production.
Finished goods remain in warehouse on an average for two months.
Suppliers of materials extend one months credit.
Two months credit is normally allowed to debtors.
A minimum cash balance of Rs.1,00,000 is expected to be maintained.
The production pattern is assumed to be even during the year.
You are required to prepare the statement of working capital determination.
Review Question
Mona Machines Ltd. has provided you the following information :
Production for the year ... 69,000 units
Finished goods in store ... Average 3 months
Raw materials in store ... Average 2 months consumption
Work-in-progress (assume 50% completion stage with full material consumption) ...
Average 1 month
Credit allowed by creditors ... Average 2 months
Credit given to debtors (assume at selling price) ... Average 3 months
Selling price per unit ... Rs. 50
Raw material cost ... 50% of selling price
Direct wages ... 10% of selling price
Overheads ... 20% of selling price
Company keeps Rs. 1,00,000 in cash. There is regular production and sale cycle,
and wages and overheads accrue evenly. Wages are paid in the next month of
accrual. Material is introduced in the beginning of production cycle.
You are required to calculate working capital requirement of Mona Machines Ltd.
Some Aspects of Short-Term Financial
Policy
There are two elements of the policy that a firm
adopts for short-term finance.
The Size of the Firms Investment in Current Assets
Usually measured relative to the firms level of total
operating revenues.
Flexible
Restrictive
Alternative Financing Policies for Current Assets
Usually measured as the proportion of short-term
debt to long-term debt.
Flexible
Restrictive
Carrying Costs and Shortage Costs
Carrying costs increase with the level of
investment in current assets. They include the
costs of maintaining economic value and
opportunity costs (Eg., Interest, warehousing
costs)
Shortage costs decrease with increases in the
level of investment in current assets. They include
trading costs and the costs related to being short
of the current asset (for example, sales lost as a
result of a shortage of finished goods inventory).
Carrying Costs and Shortage Costs
$
Investment in
Current Assets ($)
Shortage costs
Carrying costs
Total costs of holding current
assets.
CA*
Minimum
point
The Size of the Investment in Current Assets
Determined by its short-term financial policies.
These financial policies can be flexible or restrictive
Flexible policy actions include:
Keeping large cash and securities balances
Keeping large amounts of inventory
Granting liberal credit terms
Restrictive policy actions include:
Keeping low cash and securities balances
Keeping small amounts of inventory
Allowing few or no credit sales
Appropriate Flexible Policy
$
Investment in
Current Assets ($)
Shortage costs
Carrying costs
Total costs of holding current
assets.
CA*
Minimum
point
A flexible policy is most appropriate when carrying costs are low
relative to shortage costs.
When a Restrictive Policy is Appropriate
$
Investment in
Current Assets ($)
Shortage
costs
Carrying costs
Total costs of holding current assets.
CA*
Minimum
point
A restrictive policy is most appropriate when carrying costs are high
relative to shortage costs.
Alternative Financing Policies for
Current Assets
In an ideal world, short-term assets are always
financed with short-term debt and long-term
assets are always financed with long-term
debt.
In this world, net working capital is always
zero.
Alternative Asset Financing Policies
Flexible Policy = conservative
Flexible Policy always implies a short-term cash surplus and a large
investment in cash and marketable securities.
Alternative Asset Financing Policies
Restricitve Policy = aggressive
Restrictive Policy uses long-term financing for permanent asset
requirements only and short-term borrowing for seasonal variations.
A Compromise Financing Policy

With a compromise policy, the firm keeps a reserve of liquidity
which it uses to initially finance seasonal variations in current
asset needs. Short-term borrowing is used when the reserve is
exhausted.
Which Financing Policy is Best?
Cash Reserves
+ Low chance of Financial Distress
+ Less Time in searching ST financing
- Do not earn any interest
Maturity Hedging
+ Use LT financing for LT assets and ST financing for ST assets
- ST interest rates are more volatile: so avoid using ST
financing for LT assets
Relative Interest Rates
If LT interest rates are lower, finance core part of ST needs
from LT funds
If ST interest rates are lower, better to use ST financing
Maturity Matching Approach
Hedge risk by matching the maturities of
assets and liabilities.
Permanent current assets are financed with
long-term financing, while temporary current
assets are financed with short-term financing.
There are no excess funds.
Maturity Matching Approach
Review Questions
Comment on the following
Most businesses need cash funds to meet
contingencies.
Playing with float is a risky proposition.
Failure of a firm is technical if it is unable to meet
its current obligations.
Inventory Management
Two basic questions in inventory management
are (1) how much to order (or produce), and
(2) when to order (or produce).

29
ABC Analysis
Class A items are those on which the annual dollar volume is
high.
They represent 70-80% of total inventory costs, but they
account for only 15% of total inventory items.
Class B items are those on which annual dollar volume is
medium.
They represent 15-25% of total dollar value, and they account
for 30% of total inventory items on the average.
Class C items are low dollar volume items.
They represent only the 5% of total dollar volume, but they
include as many as 50-60% of total inventory items.
30
ABC Analysis
Percent
of
Annual
Dollar
Volume
Percent of
Inventory Items
80
Class
A
Items
20
20
50 100
Class
C Items
31
ABC Analysis
Some of the Inventory Management Policies
that may be based on ABC analysis include:

a) Class A items should have tighter inventory
control.
b) Class A items may be stored in a more secure
area.
c) Forecasting Class A items may warrant more care.
32
Just-in-Time Inventory
Just in Time Inventory is the minimum inventory that is
necessary to keep a system perfectly running.
With just in time (JIT) inventory, The exact amount of items
arrive at the moment they are needed, Not a minute before
OR not a minute after.
To achieve JIT inventory, Managers should Reduce the
Variability Caused by some Internal and External Factors.
(Goldratts boys scout example Apply the pace of the slowest
boy).
A production line cannot work faster than the slowest
workstation
Existence of Inventory hides the variability.
What causes variability?
33
Rocks located along the way
Others
Waiting
Time
Move
Time
Queue
Time
Set-up
Time
Run
Time
Input Output
Lead Time
Cycle Time
The section called Others are the Rocks on the river.

Those rocks include Quality Variability, In-transit Delays, Machine Breakdowns,
Large Lot-sizes, Inaccurate drawings, Employee attendance variability.
34
Just-In-Time Production
JIT production means
(1) Elimination of Waste,
(2) Synchronized Manufacturing, and
(3) Little Inventory.
Reducing the order batch size can be a major help in reducing
inventory.
Average Inventory = (Maximum Inventory + Minimum
Inventory) / 2
Average Inventory drops as the inventory re-order quantity
drops because the maximum inventory level drops.
35
Inventory Related Costs:
Holding, Ordering and Set-up Costs
Holding Costs are the costs associated with holding or
carrying inventory over time.
It includes costs related to storage; such as insurance, extra
staffing, interest, and so on.
Some example holding costs are:
building rent or depreciation,
building operating cost,
taxes on building, insurance on building,
material handling equipment leasing or depreciation,
equipment operating cost, handling manpower cost,
taxes on inventory, insurance, etc.
36
Inventory Related Costs:
Ordering and Set-up Costs
Ordering Costs include, cost of supplies, order processing,
clerical cost, etc.
The ordering cost is valid if the products are purchased NOT
produced internally.
Set-up cost is the cost to prepare a machine for
manufacturing an order.
Set-up cost is highly correlated with set-up time.
Machines that traditionally have taken long hours to set up Are
Now being set up in less than a minute by employing FMSs or
CIM systems.
Reducing set up times is an excellent way to Reduce Inventory.
37
Inventory Models
Demand for an item is either dependent on the demand for
other items or it is independent.
For example, demand for refrigerator is independent of the
demand for cars.
But, demand for auto tires is certainly dependent on the
demand of cars.
We will deal with the Independent Demand Situation.
In the dependent demand situation we use Material
Requirement Planning (MRP) systems.
38
What to answer?
In the independent demand situation, we
should be interested in answering:

a) When to place an order for an item, and
b) How much of an item to order.
39
Independent Demand Inventory Models
There are Four Basic Independent Demand
Inventory Models:
1) Economic Order Quantity (EOP) Model (the most
known model).
2) Production Order Quantity Model.
3) Back order inventory model.
4) Quantity discount model.
40
Economic Order Quantity (EOQ) Model
EOQ model makes a number of assumptions:
1-) Demand is known and constant.
2-) Lead time (the time between placement of order and receipt of
the order) is constant and known.
3-) Orders arrive in one batch at a time, and they arrive in one
point in time.
4-) Quantity discounts are not possible.
5-) The costs include only setup cost (or ordering cost when
buying) and holding cost.
6-) Orders are always placed at the right times. Therefore, stock
outs (or shortages) can be completely avoided.
41
With these assumptions in EOQ Model, the graphic of
inventory usage over time is as follows:
Inventory
Level
Time
Q
Average
Inventory
Level
Usage
Rate
0
Q = order quantity
(That is also equal to the
Maximum Inventory)

Minimum Inventory = 0
When inventory level reaches 0, a new order is
placed and received.
42
Objective: Minimize total cost
The objective of inventory models is to
minimize total cost.

If we minimize the setup and holding costs,
we will be able to minimize total cost.

As the quantity ordered (Q) increases, holding
cost increases, and setup cost decreases.
43
Where the total cost is minimum?
Annual
Cost
Order Quantity
(Q)
Annual
Holding
Cost
Setup Cost
(Ordering
Cost)
Total
Cost
Minimum
Total
Cost
Optimal Order
Quantity (Q*)
Optimal order quantity (Q*) occurs at a point where setup cost is
equal to the total (annual) holding cost.
44
Finding the optimum
Optimal order quantity (Q*) occurs at a point where setup cost is
equal to the total (annual) holding cost.

By using this fact, we can write an equation for Q* as follows:

D: Annual Demand in units for the inventory item.

S: Setup cost (or the ordering cost) for each order.
Notice: (Setup cost for production, order cost for buying).

H: Annual Holding cost of inventory per unit.
45
Finding the optimum
There will be (D/Q) times of ordering in a
whole year.

Therefore, Annual Setup Cost = (D/Q) . S

Average Annual Holding Cost = (Average Inventory) . H
= (Q/2) . H
46
Finding the optimum
We get optimum point by setting:

Annual Setup Cost = Annual Holding Cost
(D/Q) . S = (Q/2) . H

Therefore,
Q
2
= 2DS / H
Q* = [2DS / H]
1/2

Q* value is also called as the EOQ.
47
Example
An Inventory model has the following
characteristics:

Annual Demand (D) = 1000 units
Ordering (Setup) cost (S)= $10 per order;
Holding cost per unit per year (H) = $.50

Assume that there are 270 working days in a year
(excluding holidays and weekends).
48
Example
Questions:
a) Find the Economic Order Quantity (Q*) for this
inventory model.
b) How many orders should be placed during one
year?
c) What is the expected time between two
consecutive orders?
d) What is the total annual cost of this inventory
model?
49
Example
Answers:
a) EOQ= Q* = [2(1000)10 / .50]
1/2
= 200 units
b) Expected number of orders placed during the year (N) = D /
Q* = 1000 / 200 = 5 times.
c) Expected time between orders (T) = (Working days in a year) /
N = 270 / 5 = 54 days.
d) Total Annual Cost = Annual Setup Cost + Annual Holding Cost
= DS / Q* + (Q*) H / 2
= 1000 (10) / 200 + (200) (.50) / 2
= $100
50
Considering the Reorder Point
So far, we only decided how much to order
(That is Q*).
Now, we should find what time to order.
We assumed that firm will wait until its
inventory reaches to zero before placing an
order.
And, we also assumed that the Orders will
receive immediately.
However, there is a time between placement
and receipt of an order.
51
Considering the Reorder Point
This is called LEAD TIME or delivery time.
Here, we will use the term Reorder Point
(ROP) for when to order.
ROP (in units) = (Demand Per Day) x (Lead
time for a new order in days)

ROP = d x L
52
Reorder Point
Inventory
Time
(Days)
Q* Slope = d (units/day)
ROP
(units)
L = Lead Time
ROP = d . L
When the inventory level reaches the ROP, a new order is required.

It will take a time that is equal to the Lead Time (L) to receive the
new order.
53
Reorder Point
Here, Demand per day (d) is found by the
following equation:
d = D / Number of working days in a year

This ROP equation assumes that demand is
uniform and constant.

If this is not the case, an extra (safety) stock is
added (because of uncertainty).
54
Example
Annual demand for an item is D = 8000/year.

This year there will be 200 working days in a
year.

Delivery of an order for this item takes 3
working days (L = 3 days).
55
Example
Questions:

a) Find the demand per day for this item.

b) What is the ROP for this item?
56
Example
Answers:
a) Demand per day for this item (d) = 8000 / 200 =
40 units / day.

b) ROP = d . L = 40 . 3 = 120 units.
When inventory level becomes 120 units, an Order
should be placed.
57
Production Order Quantity Model
In EOQ Model, We assumed that the entire
order was received at one time.
However, Some Business Firms may receive
their orders over a period of time.
Such cases require a different inventory
model.
Here, we take into account the daily
production rate and daily demand rate.
58
Production Order Quantity Model..
Inventory
Time
Maximum
Inventory
t
Production
occurs at a
rate of p
Demand
occurs
at a rate
of d
59
Production Order Quantity Model..
Since this model is especially suitable for
production environments, It is called Production
Order Quantity Model.
Here, we use the same approach as we used in EOQ
model.
Lets define the following:
p: Daily Production rate (units / day)
d: Daily demand rate (units / day)
t: Length of the production in days.
H: Annual holding cost per unit
60
Production Order Quantity Model..
Average Holding Cost = (Average Inventory) . H
= (Max. Inventory / 2) . H

In the period of production:
Max. Inventory = (Total Produced) (Total Used)
= p x t d x t

Here, Q is the total units that are produced.
Therefore,
Q = p x t and t = Q / p
61
Production Order Quantity Model..
If we replace the values of t in the Max.
Inventory formula:
Max. Inventory = p (Q/p) - d (Q/p)
= Q - dQ/p
= Q (1 d/p)
Annual Holding Cost = (Max. Inventory / 2) . H
= Q/2 (1 d/p) . H
Annual Setup Cost = (D/Q) . S
62
Production Order Quantity Model..
Now we will set:
Annual Holding Cost = Annual Setup Cost
Q/2 (1 d/p) . H = (D/Q) . S
(

=
p
d
H
DS
Q
1
2
2
(

=
p
d
H
DS
Q
1
2
*
This formula gives us the optimum production quantity for the
Production Order Quantity Model.

It is used when inventory is consumed as it is produced.


Banking
Norms and
Macro Aspect
of Working
Capital
Management
Regulation of bank finance

Implemented by RBI in mid 1960s in order to
Measure of discipline among industrial borrowers.
Redirect credit to the priority sector of the economy

RBI has been issuing guidelines and directives
to the banking sector toward this end.


Committees
To control the tendency of over-financing and the
diversion of the banks funds.

Tandon committee.
Daheija committee.
Chore committee.
Marathe committee.

Tandon committee
Reserve Bank of India setup a committee under the
chairmanship of Shri P.L. Tandon in July 1974.

The practices of most of the banks are still influenced by
tandon committee recommendations though financial
liberalization occurred in 1990s.
67
Backorder Inventory Model
In this model, we assume that stock outs (and backordering) are
allowed.
In addition to previous assumptions, we assume that sales will
not be lost due to a stock out.
Because, we will back order any demand that can not be
fulfilled.
B: Backordering cost per unit per year
b: The amount backordered at the time the next order arrives
Q b: Remaining units after the backorder is satisfied
68
Backorder Inventory Model
Inventory
Time
(Q - b)
b
T1 T2
b
Q
0
69
Backorder Inventory Model
Total Annual Cost = Annual Setup Cost + Annual Holding Cost +
Annual Backordering Cost

Annual Setup (Ordering) Cost = (D/Q) . S

Annual Holding Cost = (Average Inventory Level) . H

Average Average inventory Proportion of time
Inventory = level during there is inventory
Level in stock period in stock

= (Q b) / 2 . T1 / T
70
Backorder Inventory Model
By using the graphical ratios, we know that:
T1 / T = (Q b) / Q
Therefore, if we replace T1/T in the above equation
we get
Average Inventory Level = (Q b)
2
/ 2Q

(Q b)
2
Annual Holding Cost = ---------- . H
2Q
71
Backorder Inventory Model
Annual Backordering Cost = (Average Backordering) . B

Average Backordering = (Average number of stock outs during out of stock
period) x (Proportion of time inventory is on backorder)

Average Backordering = b / 2 . T2 / T

By using the graphical ratios, we know that:
T2 / T = b / Q Therefore, if we replace T2/T in the above equation we get:

Average Backordering = b
2
/ 2Q and

b
2
Annual Backordering Cost = ---------- . B
2Q
72
Backorder Inventory Model
DS (Q b)
2
b
2

Total Cost (TC) = ------- + ---------- . H + --------- . B
Q 2Q 2Q
We find optimum order quantity (Q*) and optimum
backordering quantity (b*) by taking the derivatives of
dTC/dQ = 0 and dTC / db = 0 and then putting the values
in their places.
We find that:
|
.
|

\
|
+
|
.
|

\
|
=
B
B H
H
DS
Q
2
*
H B
H Q
b
+
=
*
*
73
Quantity Discount Model
A quantity discount is simply a reduced price (P) for an item when
it is purchased in LARGER quantities.

A typical quantity discount schedule is as follows:

Alternative Quantity Discount (%) Discount (unit) Price
1 0-999 0 $5.00
2 1000-1999 4 $4.80
3 2000- 5 $4.75
74
Quantity Discount Model
Since the unit cost for the Third discount is the
lowest, We might be tempted to order 2000 or
more units.
However, this quantity might not be the one
that minimizes the Total Cost.
Remember that, As the quantity goes up, the
holding cost increases.
Here, there is a trade off between reduced
product price (P) and increased holding cost
(H).
75
Quantity Discount Model
Total Cost = Setup Cost + Holding Cost + Product Price (Cost)
Total Cost = DS / Q + QH / 2 + PD
where P is the price per unit
To determine the minimum Total Cost, we perform the following
process which includes 4 steps:
Step 1: Assume that
I: is a percentage value, and
I . P represents the holding cost as a percentage of price per unit
(P).
76
Quantity Discount Model
For each discount alternative, calculate a
value of Q* = [2DS / IP]
1/2
Here, instead of using a value of H, the holding
cost is equal to I . P
That is, If the item is expensive (such as a Class
A Item), Its holding cost will be higher.
Since the price of item (P) is a factor in Annual
Holding Cost, we can no longer assume that
the holding cost is constant (such as H) when
price changes.
77
Quantity Discount Model
Step 2: For any discount alternative,
If the calculated optimum order quantity (Q*) is too low to
qualify for the discount range,
Then, Adjust the order quantity upward to the lowest quantity
that will qualify for the particular discount alternative.
Step 3: Using the total cost (TC) equation above, compute a
total cost for every order quantity (Q). Use the adjusted Q
values.
Step 4: Select the discount alternative which has the
minimum Total Cost (TC).
78
Example
Consider the quantity discount schedule given
in the beginning (above).
Assume that the Ordering (Setup) Cost (S) is
$49 per each order.
Annual Demand (D) is 5000 units, and
Inventory carrying charge is a percentage
(I=0.20) of product cost (P).
Question: What order quantity will minimize
the total inventory cost.
79
Example
Answer:
Step 1: Compute Q* for every discount range.
order units
IP
DS
Q / 700
) 5 )( 2 (.
) 49 )( 5000 ( 2 2
*
1
= = =
order units
IP
DS
Q / 714
) 8 . 4 )( 2 (.
) 49 )( 5000 ( 2 2
*
2
= = =
order units
IP
DS
Q / 718
) 75 . 4 )( 2 (.
) 49 )( 5000 ( 2 2
*
3
= = =
80
Example
Step 2: Adjust values of Q* that are below allowable discount
ranges.
- For Q1, allowable range is 0-999. Since Q1* = 700 is between 0
and 999, It does not have to be adjusted.
- For Q2, allowable range is 1000-1999. Since Q2* = 714 is not in
the allowed range, we adjust it to the lowest allowable value,
That is Q2* = 1000.
- For Q3, allowable range is 2000-. Since Q3* = 718 is not in the
allowed range, we adjust it to the lowest allowable value, That
is Q3* = 2000.
81
Example
Step 3: Compute total cost for each of the
order quantities (Q*):


5000 x Unit price
$49 x (5000 / 700)
(Average Inventory x Holding Cost) =
(Q / 2) x (I x P) =
(700 / 2) x (5 x 0,20)
82
Example
Step 4: An Order quantity of 1000 units will
minimize the total cost.

However, if the third discount cost is lowered to
$4.65, selecting this discount alternative (2000
units) would be the optimum solution.
Tandon committee
The terms of reference of the Committee were:

1. 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 advances;

2. To suggest the type of operational data and other
Information that may be obtained by banks periodically from the
borrowers and by the Reserve Bank of India from the leading banks;

3. To make suggestions for prescribing inventory norms for
the different industries, both in the private and public sectors and
indicate the broad criteria for deviating from these norms ;
Tandon committee
4. To make recommendations regarding resources for
financing the minimum working capital requirements ;

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

6. To make recommendations as to whether the existing
pattern of financing working capital requirements by cash
credit/overdraft system etc., requires to be modified, if
so, to suggest suitable modifications
Tandon committee
Recommendations

Norms of current asset.

Maximum permissible bank finance.

Emphasis on loan systems.

Periodic information and reporting system.
Tandon committee
Norms for current assets.

They defined the norms(15 industries) for

Raw materials
Stock in progress
Finished goods
Receivables


Tandon committee
Maximum permissible bank finance (MPBF)

Three methods for determining MPBF
Method 1: MPBF=0.75(CA-CL)
Method 2: MPBF=0.75(CA)-CL
Method 3: MPBF=0.75(CA-CCA)-CL

CA- current asset, CL- current liabilities,
CCA- core current assets (permanent component of
working capital).

Tandon committee
Current Assets Rs.(in millions)

Raw material 18
Work in process 5
Finished goods 10
Receivables(including billsDiscounted) 15
Other current assets 2

50

Current Liabilities
Trade Creditors - 12
Other current liabilities - 3
Bank borrowings (including Bills discounted)- 25

40


MPBF for Mercury Company Limited as per above methods are:

Method 1: 075(CA-CL) = 075(50-15) = Rs.26.25 million
Method 2: 0.75(CA)-CL = 0.75(50)-15 = Rs.22.5 million
Method 3: 0.75(CA-CCA)-CL = 0.75(50-20)-15 = Rs.7.5 million

Method 2 is adopted.
Tandon committee
Style of credit
Only a portion of MPBF must be cash credit component
and the balance must be in the form of working capital
demand loan.
Information system:.
quarterly information system-form I
Estimate production and sale for current and ensuring quarter.
The estimate of current asset and liabilities for the ensuing
quarter.




Quarterly information system-form II
Production and sales during current year and for the
latest completed year.
Asset and liabilities for the latest completed year.

Half yearly operating statements- form III
Actual and estimated operating performance for the
half year ended.

Half yearly operating statements- form IIIB
Actual and estimated sources and uses of funds for
the half year ended.

Chore Committee(1979)
This committee was formed by RBI to review the cash credit
system of banks.

The important recommendations of the Committee are as
follows:

1. The banks should obtain quarterly statements in the
prescribed format from all borrowers having working capital
credit limits of Rs. 50 lacs and above.

2. The banks should undertake a periodical review of limits of
Rs. 10 lacs and above.



Chore Committee
3. The banks should not bifurcate cash credit accounts into
demand loan and cash credit components.

5. Banks should discourage sanction of temporary limits by
charging additional one per cent interest over the normal rate
on these limits.

6. The banks should fix separate credit limits for peak level and
non-peak level, wherever possible.

7. Banks should take steps to convert cash credit limits into bill
limits for financing sales.
Marathe committee

A committee set up to review the licensing policy for new urban co-
operative banks. Headed by S. S. Marathe of the Reserve Bank of
India (RBI) Board, the committees prescriptions submitted in May
1992, favour a liberal entry policy and include :

Establishment of new urban co-operative banks on the basis of need
and potential, and achievement of revised viability norms. The one-
bank-per-district approach is to be discarded.

Achieving prescribed viability norms in terms of share capital, initial
membership and other parameters within a specified time.

Introduction of a monitoring system to generate early warning
signals and for the timely detection of sickness.
Dahejia committee(1968)

Existing deficiencies.

It is the borrower who decides how much would borrow, the
banker does not decide how much he would lend and is,
therefore not in a position to do credit sales.

The bank credit is treated is considered as first source of
finance.

Amount of credit extended is based on the amount of securities
available and not the level of operations of the borrower.

Present practice
Assessment of working capital requirement.

Projected balance sheet method.
Cash budget method
Turnover method

Current ratio norm.

1.33 is considered only as benchmark and banks do
accept a lower current ratio.



Present practice
Emphasis on loan system
Bulk of the working capital limit is in the form of working
capital demand loan and only a small portion in cash
credit component.

Financial follow up results
FFR I- simplified form of form II used under tandon. Has
to be submitted on quarterly basis.
FFR II- simplified form of form III. Has to be submitted in
half yearly basis.
Cash Budgeting
A cash budget is a primary tool of short-tun
financial planning.
The idea is simple: Record the estimates of
cash receipts and disbursements.
Cash Receipts
Arise from sales, but we need to estimate when
we actually collect.
Cash Outflow
Payments of Accounts Payable
Wages, Taxes, and other Expenses
Capital Expenditures
Long-Term Financial Planning
Cash Budgeting
The cash balance tells the manager what
borrowing is required or what lending will be
possible in the short run.

The Short-Term Financial Plan
The most common way to finance a temporary
cash deficit to arrange a short-term loan.
Unsecured Loans
Line of credit down at the bank
Secured Loans
Accounts receivable financing can e either assigned or
factored.
Inventory loans use inventory as collateral.
Other Sources
Bankers acceptances
Commercial paper.