Anand Bagri

download Anand Bagri

of 82

Transcript of Anand Bagri

  • 8/4/2019 Anand Bagri

    1/82

    WORKING CAPITAL MANAGEMENT

    APROJECT REPORT

    WorkingCapital

    ManagementSUBMITTED BY:

    Anand Bagri(MMS-Corporate Finance)

    Submitted to :PROF. P.L.ARYA

    THE DirectorN.L.DIMSR

    UNIVERSITY OF MUMBAI(2008-2010)

    NIRANJAN LAL DALMIA INSTITUTE OF MANAGEMENT

    STUDIES AND REASERCH

    MUMBAI- 401104

    N.L. DALMIA INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH

  • 8/4/2019 Anand Bagri

    2/82

    WORKING CAPITAL MANAGEMENT

    SHRISHTI, SECTOR-1, MIRA ROAD (E)

    ACKNOWLEDGEMENT

    I take immense pleasure in submitting the project on

    Working Capital Management .

    As this project comes to an end, I would like to take the

    opportunity to thank all those persons who supported me

    directly or indirectly in this project.

    I would like to thank project guide Prof. P.L. ARYA for the

    support and guidance throughout the project.

    Last but not the least I would like to thank all the students and staff

    members of N.L. Dalmia Institute of Management Studies and Research

    who helped me in my endeavor.

    Anand Bagri

    MMS (Corporate Finance)

    N.L.Dalmia Institute of Management Studies and Research

    N.L.Dalmia Institute of Management Studies & Research 2

  • 8/4/2019 Anand Bagri

    3/82

    WORKING CAPITAL MANAGEMENT

    INDEX

    Sr.No. Topic Page No.

    1. Executive Summary 32. Objectives and Scope of the project 53. Working Capital 64. Management of Working Capital 85. Need for adequate Working Capital 106. Factors determining Working Capital 127.

    Assessment of Working Capital 168. Working Capital Finance 209. Modes of Working Capital Finance 24

    i. Cash Credit 25ii. Working Capital Demand Loan 29iii. Bill Discounting 31iv. Export Packing Credit 34v. Commercial Paper 40vi. Inter-Corporate Deposit 47vii.FCNR(B) Loans 50

    10. Statement Of Working Capital 53

    11. Inventory Management 55

    12. Cash Management 6413. Receivables Management 73

    14. Conclusion 79

    15. Bibliography 80

    N.L.Dalmia Institute of Management Studies & Research 3

  • 8/4/2019 Anand Bagri

    4/82

    WORKING CAPITAL MANAGEMENT

    Executive summary

    Working capital management refers to the administration of all aspectsof current assets, namely cash, marketable securities, debtors and stock

    (inventories) and current liabilities. The financial manager must determine

    levels and composition of current assets. He must see that right sources are

    tapped to finance current assets, and that current liabilities are paid in time.

    There are many aspects of working capital management, which

    make it an important function of the financial manager:

    Time : working capital management requires much of the financial

    managers time. Investmen t: working capital represents a large portion of the total

    investments in assets. Significance : working capital management has great significance

    for all firms but it is very critical for small firms. Growth : the need for working capital is directly related to the

    firms growth.

    Investment in current assets represents a very significant portion of the total

    investment in assets. Working capital management is critical for all firms. A

    small firm may not have much investment in fixed assets, but it has to invest to

    in current assets. Small firms in India face a severe problem of collecting their

    debtors.

    N.L.Dalmia Institute of Management Studies & Research 4

  • 8/4/2019 Anand Bagri

    5/82

    WORKING CAPITAL MANAGEMENT

    It may, thus, be concluded that all precautions should be taken for the

    effective and efficient management of working capital. The finance manager

    should pay regular attention to the levels of current assets and the financing of

    current assets.

    N.L.Dalmia Institute of Management Studies & Research 5

  • 8/4/2019 Anand Bagri

    6/82

    WORKING CAPITAL MANAGEMENT

    OBJECTIVES AND SCOPE OF THE PROJECT

    Objectives of the Project:

    To study working capital management process.

    To study receivable management of the company.

    To study the process of cash and inventory management.

    Scope of the project:

    The scope of the project includes elaborate discussion on:

    Statement of working capital.

    Inventory management

    Cash management.

    Debtors management.

    The above-mentioned topics form the core part of working capital

    management.

    Limitations:

    Not considered other current assets and their ratios, which form a part of

    working capital like Stock of raw material, work in progress, outstanding

    expenses, labor, etc as too many calculations may lead to confusion.

    Methodology: Acquisition of primary and secondary data.Primary data: The first hand data obtained from the company

    sources (E.g.; information about the company.

    Secondary data: Annual reports, balance sheets, trial balance, etc.

    N.L.Dalmia Institute of Management Studies & Research 6

  • 8/4/2019 Anand Bagri

    7/82

    WORKING CAPITAL MANAGEMENT

    Working Capital

    The objective of running any Company is to earn profits. A Company

    will require funds to acquire Fixed Assets like Land, Building, Plant &

    Machinery, Equipment, Tools, etc and also to run business viz, for its

    day to day operations (working). Capital or Funds required for a

    Company can therefore be bifurcated as Fixed Capital & Working

    Capital.

    Funds required for day to day working would be to finance production

    and sales. For production, funds are needed for purchase of Raw

    Materials / Stores / Fuel, for payment of Labour, Power Charges, etc, for

    storing Finished Goods, and for financing the sales, by way of sundry

    debtors / receivables.

    Concept:

    Working Capital is often defined as the excess of Current Assets over

    Current Liabilities. Current Assets are those, that in the ordinary course

    of business can be or will be converted into cash within one year (during

    operating cycle of the industry). Current Liabilities are those liabilities

    intended, at their inception, to be paid in the ordinary course of business

    within a reasonably short time (normally one year) out of current assets or the income of the business.

    The above definition of Working Capital, however, takes into account

    only the funds available to the Company from long term sources like

    capital and long-term borrowings. It does not represent the total funds

    required by the Company towards Working Capital, to sustain its level

    of operations. The excess of CA over CL is therefore, known in working

    N.L.Dalmia Institute of Management Studies & Research 7

  • 8/4/2019 Anand Bagri

    8/82

    WORKING CAPITAL MANAGEMENT

    parlance, as Net Working Capital (NWC) or Liquid Surplus (LS) and

    represents that portion of the Working Capital, which has been provided

    from the long-term sources.

    N.L.Dalmia Institute of Management Studies & Research

    LIABILITY ASSETS

    DL

    CL

    C &R

    CA

    FA

    M & NCA

    ITA

    L.S. (or) NWC

    8

  • 8/4/2019 Anand Bagri

    9/82

    WORKING CAPITAL MANAGEMENT

    Management of working capital

    Management will use a combination of policies and techniques for the

    management of working capital. These policies aim at managing the

    current assets (generally cash and cash equivalents , inventories and

    debtors ) and the short term financing, such that cash flows and returns are

    acceptable. It simply refers to management of the working capital, or in

    more precise terms, the management of current assets. A firms working

    capital consist of its investment in current asset which include short term

    asset such as cash and bank balance, inventories, receivables, andmarketable securities.

    Cash management : Identify the cash balance which allows for the

    business to meet day to day expenses, but reduces cash holding costs.

    Inventory management: Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials -

    and minimizes reordering costs - and hence increases cash flow, supply

    chain management ; Just In Time (JIT); Economic order quantity (EOQ);

    Economic production quantity (EPQ).

    Debtors management: Identify the appropriate credit policy , i.e. creditterms which will attract customers, such that any impact on cash flows

    and the cash conversion cycle will be offset by increased revenue and

    hence Return on Capital (or vice versa ); Discounts and allowances .

    Short term financing: Identify the appropriate source of financing, given

    the cash conversion cycle: the inventory is ideally financed by credit

    N.L.Dalmia Institute of Management Studies & Research 9

    http://en.wikipedia.org/wiki/Asset#Current_assetshttp://en.wikipedia.org/wiki/Cashhttp://en.wikipedia.org/wiki/Cash_and_cash_equivalentshttp://en.wikipedia.org/wiki/Inventoryhttp://en.wikipedia.org/wiki/Debtorhttp://en.wikipedia.org/wiki/Cash_managementhttp://en.wikipedia.org/wiki/Just_In_Timehttp://en.wikipedia.org/wiki/Economic_order_quantityhttp://en.wikipedia.org/wiki/Economic_production_quantityhttp://en.wikipedia.org/wiki/Credit_(finance)http://en.wikipedia.org/wiki/List_of_Latin_phrases#Vhttp://en.wikipedia.org/wiki/Discounts_and_allowanceshttp://en.wikipedia.org/wiki/Asset#Current_assetshttp://en.wikipedia.org/wiki/Cashhttp://en.wikipedia.org/wiki/Cash_and_cash_equivalentshttp://en.wikipedia.org/wiki/Inventoryhttp://en.wikipedia.org/wiki/Debtorhttp://en.wikipedia.org/wiki/Cash_managementhttp://en.wikipedia.org/wiki/Just_In_Timehttp://en.wikipedia.org/wiki/Economic_order_quantityhttp://en.wikipedia.org/wiki/Economic_production_quantityhttp://en.wikipedia.org/wiki/Credit_(finance)http://en.wikipedia.org/wiki/List_of_Latin_phrases#Vhttp://en.wikipedia.org/wiki/Discounts_and_allowances
  • 8/4/2019 Anand Bagri

    10/82

    WORKING CAPITAL MANAGEMENT

    granted by the supplier; however, it may be necessary to utilize a bank

    loan (or overdraft), or to "convert debtors to cash" through " factoring ".

    The term working capital may be used in two different ways:

    1. Gross working capital: The gross working capital refers to the

    firms investment in all current assets taken together.

    2. Net working capital: The term net working capital may be defined

    as the excess of total current assets over total current liabilities.

    A firm should maintain an optimum level of gross working capital. This

    will help avoiding the unnecessarily stoppage of work or liquidation due

    to insufficient working capital. Effect on profitability because over

    flowing working capital implies cost. Therefore, a firm should have just

    adequate level of total current assets. The gross working capital alsogives an idea of total funds required for maintaining current assets.

    On other hand, net working capital refers to amount of funds that must be

    invested by the firm, more or less regularly in current assets. The net

    working capital also denotes the net liquidity being maintained by the

    firm. This also gives an idea of buffer available to the current liability.

    N.L.Dalmia Institute of Management Studies & Research 10

    http://en.wikipedia.org/wiki/Loanhttp://en.wikipedia.org/wiki/Factoring_(trade)http://en.wikipedia.org/wiki/Loanhttp://en.wikipedia.org/wiki/Factoring_(trade)
  • 8/4/2019 Anand Bagri

    11/82

    WORKING CAPITAL MANAGEMENT

    Need for adequate working capital

    Every firm must maintain a sound working capital position otherwise; its

    business activities may be adversely affected.

    The excess working capital , i.e. when the investment in working capital

    is more than the required level, it may result in unnecessary accumulation

    of inventories resulting in waste, theft, damage etc. Delay in collection of

    receivables resulting in more liberal credit terms to customers than

    warranted by the market conditions. Adverse influence on the performance of the management.

    On the other hand, inadequate working capital is not good for the firm.

    It may result in the following:

    The fixed asset may not be optimally used.Firm growth may stagnate.

    Interruptions in production schedule may occur ultimately resulting

    in lowering of the profit of the firm.

    The firm may not be able to take benefit of an opportunity.

    Firm goodwill in the market is affected if it is not in a position to

    meet its liabilities on time.

    Working Capital Needs:

    A business need for working capital can come as a result of several

    reasons that include the following:

    Increasing sales growth or seasonal growth.

    Customers paying slower.

    N.L.Dalmia Institute of Management Studies & Research 11

  • 8/4/2019 Anand Bagri

    12/82

    WORKING CAPITAL MANAGEMENT

    Need to increase inventory to support sales growth and/or adding

    product lines.

    Desire to take discounts on purchases from vendors.

    Recent operating losses have reduced your cash reserves.

    Increased expenses due to additional marketing efforts, new

    employees, office relocation, etc.

    N.L.Dalmia Institute of Management Studies & Research 12

  • 8/4/2019 Anand Bagri

    13/82

    WORKING CAPITAL MANAGEMENT

    Factors determining working capital requirement

    Though there is no set of universally applicable rules to ascertain working

    capital needs, the following factors may be considered:

    Nature of business:

    The Working capital requirement depends upon the nature of business

    carried on by the organization. In a manufacturing firm the requirement is

    generally high, but it also depends on the type and nature of the product.The proportion of current asset to total assets measures the relative

    requirements of working capital of various industries.

    Manufacturing cycle:

    Time span required for the conversion of raw materials into finished

    goods is a block period. The period in reality extends a little before andafter the work-in-progress. The manufacturing cycle and the fund

    requirements vary in direct proportion. The funds blocked in

    manufacturing cycle vary from industry to industry. Further, even within

    the same group of industries, the operating cycle may be different due to

    technological considerations.

    Business cycle:

    Business fluctuations lead to cyclical and seasonal changes, which, in

    turn, cause a shift in working capital position particularly for working

    capital requirement. The variations in business conditions may be in two

    directions: Upward phase when boom conditions prevail, and

    Downswing phase when economic activity is marked by a decline.

    During the upswing of business activity, the need for working capital is

    N.L.Dalmia Institute of Management Studies & Research 13

  • 8/4/2019 Anand Bagri

    14/82

    WORKING CAPITAL MANAGEMENT

    likely to grow and during the downswing phase the working capital

    requirement is likely to be less. The decline in economy is associated

    with a fall in the volume of sales, which, in turn, leads to a fall in the

    level of inventories and book debts.

    Seasonal variation:

    Variation apart, seasonally factor creates production or even shortage

    problem. This is the reason as to why manufacturing concerns producing

    seasonal products purchase their raw material throughout the year and

    carry on the manufacturing activity. For example woolen garments have ademand during winter. But the manufacturing operation for the same has

    to be conducted during the whole year resulting in working capital

    blockage during off-season.

    Production policy:

    While working capital requirements vary because of seasonal factors, theimpact can be minimized by suitably gearing the production schedule.

    There are two choices- either the production is periodically adjusted to

    meet the seasonal requirements or a steady level of production is

    maintained throughout, consequently allowing the inventories to build up

    in the off-season.

    Scale of operations:

    Operational level determines the working capital demand during a

    particular period. Higher the scale, higher will be the need for working

    capital. However, pace of sales turnover is another factor. Quick turnover

    calls for lesser investment for inventory while low turnover rate

    necessitates larger investments.

    N.L.Dalmia Institute of Management Studies & Research 14

  • 8/4/2019 Anand Bagri

    15/82

    WORKING CAPITAL MANAGEMENT

    Credit policy :

    The credit policy influences the requirement of working capital in two

    ways:

    Through credit terms granted by the firm to its

    customers/buyers of goods.

    Credit terms available to the firm from its creditors.

    Growth and expansion:

    It is, of course difficult to determine precisely the relationship between

    the growth and volume of business and the increase in working capital.

    The composition of working capital also shifts with economic

    circumstances and corporate practices. However, it is to be noted that the

    need for increased working capital funds does not follow the growth in

    business activity but precedes it.

    Dividend policy:The payment of dividend consumes cash resources and, thereby, effects

    working capital to that extent. However, if the firm does not pay dividend

    but retains the profit, working capital increases. There are wide variations

    in industry practices as regards the inter relationship between working

    capital requirement and dividend payment. In some cases, shortage of

    working capital is sometimes a powerful reason for reducing or evenskipping dividends in cash (resolved by payment of bonus shares).

    Depreciation policy:

    There is an indirect effect of depreciation policy on working capital.

    Enhanced rates of depreciation lower the profits and tax liability and,

    thus, more cash profits. Higher depreciation means lower disposable profits and a smaller dividend payment. Thus cash is preserved. If the

    N.L.Dalmia Institute of Management Studies & Research 15

  • 8/4/2019 Anand Bagri

    16/82

    WORKING CAPITAL MANAGEMENT

    current capital expenditure falls short of the depreciation provision, the

    working capital position is strengthened and there may be no need for

    short-term borrowing. If the current capital expenditure exceeds the

    depreciation provision, either outside borrowing will have to be resorted

    to or a restriction on dividend payment coupled with retention of profits

    will have to be adopted to prevent working capital position from being

    adversely affected.

    Price level changes:

    Rising prices necessitate the use of more funds for maintaining anexisting level of activity. However, the implications of rising price levels

    on working capital position may vary from company to company

    depending on the nature of its operation, its standing in the market and

    other relevant considerations.

    Operating efficiency:The efficient utilization of resources by eliminating waste, improved

    coordination and full utilization of existing resources would increase the

    operating efficiency. Efficiency of operations accelerates the pace of cash

    cycle and improves the working capital turnover. It releases the pressure

    on working capital by improving profitability and improving the internal

    generation of funds.

    N.L.Dalmia Institute of Management Studies & Research 16

  • 8/4/2019 Anand Bagri

    17/82

    WORKING CAPITAL MANAGEMENT

    Assessment of Working Capital

    Funds required to carry the required levels of current assets, to enable the

    Company to carry on its operations at the expected levels uninterruptedly,

    are the Working Capital Requirements. Therefore Working Capital

    Requirement (WCR) is proportional to:

    a. The volume of activity (i.e. level of operation )

    b. The type of business carried on viz. manufacturing

    process, production programme.

    Though there are various methods for assessing the quantum of WCR for

    an industry, the following three are commonly known and used.

    1) Operating Cycle Method (for W/C limits upto

    Rs.25000)

    2) Usual or Traditional Method (for W/C limit upto

    Rs.10 lacs)

    3) Using Tandon & Chore Committee Norms (for W/C limitabove Rs.10 lacs)

    1. Operating Cycle Method:

    Any manufacturing activity is characterized by a cycle of operations

    consisting of purchase of raw materials for cash, converting these into

    FGs and realising cash by sale of these finished goods.

    The cycle consists of:1) Time taken to acquire RMs &

    Ave. period for which they are in

    stores.

    2) Conversion process time.

    3) Ave. period for which finished

    goods are in stores.

    N.L.Dalmia Institute of Management Studies & Research

    O.C.

    CASH

    S.Dr.

    F.G.

    RM

    SIM/WIP

    17

  • 8/4/2019 Anand Bagri

    18/82

    WORKING CAPITAL MANAGEMENT

    4) Ave. collection period of

    receivable (Sundry Debtors) operating cycle is also called cash to cash

    cycle & indicates how cash is converted into RM, WIP, FG & Bill

    receivables and finally cash.

    If length of operating cycle is, say 120 days. Then it means 365 / 120 = 3

    cycles of operations in a year. This means each rupee of WCR employed

    in the unit is turned over 3 times in a year. This is also known as Working

    Capital Turnover Ratio.

    WCR =Operating Expenses

    No. of Cycles per annum

    Factors, which influence WCR, are:

    1) Level of operating Expense &

    2) Length of operating Cycle.

    2. Usual (Traditional) Method of Assessment of WCR:

    The operating cycle concept serves to identify the areas requiring

    improvement for the purpose of control and performance review. But

    bankers require a more detailed analysis to assess the various components

    of WCR viz. finance for stocks, bills, etc. Hence usual method is

    different.

    Bankers provide working capital finance for holding an acceptable level

    of Current Assets, viz. RM, SIP, FG, and SDrs for achieving a pre-

    determined level of production and sales.

    Quantification of these funds, required to be blocked, in each of these

    items of CA at any time is as follows:

    1) R.M. requirement is generally

    expressed as so many months requirement (consumption).

    2) W.I.P. a rough & ready formula

    for computing the requirement of funds is to find the Cost of

    N.L.Dalmia Institute of Management Studies & Research 18

  • 8/4/2019 Anand Bagri

    19/82

    WORKING CAPITAL MANAGEMENT

    Production for the period of processing. viz.( RM consumed /

    month + Expenses / month) * period of processing in months.

    3) F.G. the requirement of funds

    against FG is expressed as so many months cost of production.

    4) Sundry Debtors: WCR against

    Sundry Debtors will be computed on the basis of Cost of

    Production (where as the Permissible Bank Finance will be on

    the basis of the sale value)

    WCR is normally expressed as so many months of Cost of

    Production (CoP).Working Capital of any industry can thus be summerised as:

    RM Months Requirement Rs . A

    WIP Weeks (CoP) Rs. B

    FG Months (CoP) to be stocked Rs. C

    SDrs Months (CoP) outstanding Credit Rs. D

    Expenses One Month Rs. E Less: Credit received on purchases Rs. F

    Less: Advance payment on received Rs. G

    WCR (Rs. H ) = (A+B+C+D+E)-(F+G)

    The purpose of assessing the Working Capital Requirement of the

    company is to determine how the total requirement of funds will be met.

    The two resources are: 1) Long term Borrowing and Capital2) Short term Bank Borrowing.

    3. Method using Tandon / Chore Committee Norms:

    The Reserve Bank of India constituted study groups in 1974 and 1979

    viz. Tandon Committee and Chore Committee to frame suitable

    guidelines for Working Capital Finance. The recommendations of

    Tandon / Chore Committee relate to:

    N.L.Dalmia Institute of Management Studies & Research 19

  • 8/4/2019 Anand Bagri

    20/82

    WORKING CAPITAL MANAGEMENT

    Norms for Inventory and Receivables

    a. Approach to Lending

    b. Follow-up, Supervision & Control of Advances

    The Tandon Committee prescribed definitive norms as to the reasonable

    level of inventory and the receivables the unit should carry and the extent

    to which the total Current Assets are supported by long-term funds.

    The lending norms comprise of three methods as under:

    1st method : The quantum of the banks short-term advances

    will be restricted to 75% of the Working Capital gap; remaining25% is to be met from NWC.

    2nd method : NWC should be atleast be equal to 25% of the

    total value of acceptable current assets. The remaining 75% should

    first be financed by other CL and then the banker may finance the

    balance of the requirement.

    3 rd method : Borrower should provide for entire core CA and

    25% of the CA over the core CA. RBI has not implemented this

    method.

    All the units with Fund Based Working Capital limits of Rs.50 lacs and

    over should be straightaway placed under 2 nd method of lending.

    N.L.Dalmia Institute of Management Studies & Research 20

  • 8/4/2019 Anand Bagri

    21/82

    WORKING CAPITAL MANAGEMENT

    Working Capital Finance

    Banks normally provide Working Capital Finance by way of advances

    against stocks and sundry debtors. Banks do not finance the full amount

    of the funds required for carrying inventories and receivables. Bank

    finance is normally restricted to the amount of funds locked up less a

    certain percentage of margins. Margins are imposed with a view to have

    adequate stake of the promoter in the business both to ensure his adequate

    interest in the business and to act as a bulwark against any shocks that the

    business may sustain. The margins stipulated will depend on various

    factors like saleability, whether imported or indigenous, quality

    durability, price fluctuations in the market for commodity. Taking into

    account the total WCR as assessed earlier, the permissible limit upto,

    which the bank finance can be granted, is arrived at as shown below:

    Permissible Limit

    Raw Materials Rs.

    Less: % margin Rs.

    _____________

    ___________________ P

    Stocks-in-Process Rs.

    Less: % margin Rs.

    _____________ ___________________ Q

    Finished Goods Rs.

    Less: % margin Rs.

    _____________

    ___________________ R

    Sundry Debtors Rs.

    N.L.Dalmia Institute of Management Studies & Research 21

  • 8/4/2019 Anand Bagri

    22/82

    WORKING CAPITAL MANAGEMENT

    Less: % margin Rs.

    _____________

    ___________________ S

    Total Permissible Limit ( P+Q+R+S )

    ___________________ T

    (P+Q+R ) indicates the total limit against stocks and S indicates the limit

    against sundry debtors. The difference between the working capital

    requirement ( H ) and the total permissible bank borrowing ( T ) is the

    Long-Term Working Capital and should be met from the Net Working

    Capital. When the NWC is not sufficient to meet the Long Term WCRs,there will be a deficit in the WCR. It will be necessary for the Company

    to either arrange to meet the funds from borrowings or arrange for more

    Short-Term funds from bank, by reduction in margins temporarily or

    granting separate advances to be repaid out of the units future profits.

    The Computation of Bank finance is facilitated by the new set of formsintroduced by RBI commonly known as CMA format. The format

    provides, a fund of information/data to the Banker in respect of the past,

    present and future financial position of borrower. Complete and prompt

    submission of data by the borrower is a sine-qua non for speedy credit

    decisions by Banks.

    CMA Format:

    For appraising the Working Capital requirement the borrower has to

    submit the financial data to the Bank in the prescribed format. This is

    known as the CMA format (Credit Monitoring Arrangement).

    There are total six forms to be filled up according to the CMA format.

    These forms give the following details:

    FORM I:

    N.L.Dalmia Institute of Management Studies & Research 22

  • 8/4/2019 Anand Bagri

    23/82

  • 8/4/2019 Anand Bagri

    24/82

    WORKING CAPITAL MANAGEMENT

    Computation of Maximum Permissible Bank Finance for Working

    Capital Requirement for 3 years. Audited figs. for the last year,

    estimated figs. for the current year & projected figs. for the next year.

    Other than sick/weak units, the computation is done as per II nd method

    of lending.

    In case of I st method of lending specific reasons thereof are furnished.

    FORM VI:

    Details of funds flow statement for 3 years. Audited figs. for the last

    year and projected figs. for the current and the next year.

    In case increase in inventory, decrease in CL or WC gap is

    disproportionate with % change in sales, the same is given in details

    separately.

    Along with the above forms a statement of Analytical and Comparative

    Ratios is also submitted. These data are also for 3 years as mentioned

    above. The various ratios include current ratio, Debt/Equity ratio, Bank borrowing/Total outside liabilities, net sales/Total tangible assets,etc.

    Also stock of raw material in terms of No. of months consumption, WIP

    in terms of No. of months cost of production, FG in terms of No. of

    months cost of sales, Sundry debtors in terms of No. of months sales are

    also given.

    N.L.Dalmia Institute of Management Studies & Research 24

  • 8/4/2019 Anand Bagri

    25/82

    WORKING CAPITAL MANAGEMENT

    Modes of Working Capital Finance

    The bank can provide the Working Capital Finances in different ways.Basically these are of two types: a) Fund Based Working Capital Finance

    and b) Non Fund based Working Capital Finance.

    The scope of this project is restricted to the Fund Based Finance only.

    The Fund Based Finances can be availed in many ways. Different

    facilities and instruments are made available to the borrower to avail the

    finances. In the following pages an attempt has been made to explainsome of them in brief. These are as follows:

    Cash Credit

    1. Working Capital demand Loan

    2. Bill Discounting

    3. Export Packing Credit

    4. Commercial Paper

    5. Inter-Corporate Deposit

    6. FCNR(B) Loans

    N.L.Dalmia Institute of Management Studies & Research 25

  • 8/4/2019 Anand Bagri

    26/82

    WORKING CAPITAL MANAGEMENT

    Cash Credit

    Cash Credit is the part of fund based facility given by the Bank to the

    company. With this the company, which is the customer to the bank, can

    draw amounts upto pre-defined limits specified by the bank. The

    company can use this money to fulfill its every day working capital

    needs. As and when the company receives the sales proceeds, it can

    deposit the same to its cash credit account with the Bank. These

    payments can be in parts or in full depending upon the sales receipts. The

    company can issue cheques to its suppliers as well as deposit the

    cheques given by its customers. This form of advance is highly attractive

    from the borrowers point of view because while the borrower has the

    freedom of drawing the amount in installments as and when required,

    interest is payable only on the amount actually outstanding.

    Availment of Cash Credit Facility:

    For availing the cash credit facility, the company or the borrower has to

    make an application to the consortium of banks or a particular bank as the

    case may be. The application should be accompanied with the financial

    statement for the current year (estimated figs) and projected figs for the

    next year. Along with this one copy of audited financial statement of the

    last year is also to be submitted. These will also give the working capitalneeds of the company. These statements should be given in the proper

    CMA format only.

    Where there is consortium, the lead bank shall do the assessment of credit

    requirement. It is based on the following parameters:

    1. Past performance as evidenced by audited Financial Statement.

    N.L.Dalmia Institute of Management Studies & Research 26

  • 8/4/2019 Anand Bagri

    27/82

    WORKING CAPITAL MANAGEMENT

    2. Present performance indicated by current statement of stocks, sales,

    proforma, Balance sheet, etc.

    3. Future performance indicated by projected Balance Sheet, Cash flow,

    etc.

    Where there is no consortium the concerned bank does the assessment

    and sanctions the credit limits.

    Once the facility is made available to the company or the borrower, then

    the borrower can draw as much as needed and as and when needed, to the

    extent that the amounts outstanding in the account does not cross theDrawing Power limits specified / sanctioned to it. There is no restriction

    on the amount of transactions, involving deposits and withdrawals, which

    can be done during a day.

    Drawing Power limits:

    The Drawing Power for the company is calculated on the monthly basis.It is changes every month. The companys utilization of working capital

    limits can not cross the Drawing Power limits. These limits can be equal

    to or less than the total sanctioned limits for a particular year. But it can

    not be more than that.

    The Drawing Power is calculated on the basis of the stocks and debtors of

    the company, for the previous month. The borrower has to submit astatement, giving the stock and debtor position, at the end of every

    month. These are hypothecated with the bank against which the bank

    provides the credit. The stock includes Raw Materials, intermediate

    stocks and Finished Goods. To compute the Drawing Power, 75% of total

    stocks (reduced by amount payable for Letter of Credit creditors) and

    60% of debtors outstanding for a period of less than six months are

    considered. Then Drawing Power is divided, on prorata basis, among all

    N.L.Dalmia Institute of Management Studies & Research 27

  • 8/4/2019 Anand Bagri

    28/82

    WORKING CAPITAL MANAGEMENT

    the banks in the consortium. It may happen that the amount, so calculated

    above, will exceed the total sanctioned limits for the company. In such

    cases, the sanctioned limits will be the ceiling for the Drawing Power.

    Hence in any case the Drawing Power can not exceed the sanctioned

    limits.

    Further more, if the borrower is enjoying, Bill Discounting, EPC or

    WCDL facilities, then the Drawing Power will be blocked by that amount

    for the period till such facilities are enjoyed. Generally all banks divide

    the Drawing Power limit into two parts. 50% each for Cash Credit and

    WCDL.

    Interest rate:

    The borrower has to pay the interest on the limit utilisation at the day end

    and not on the entire amount of sanctioned limit. This is where the cash

    credit account comes in very handy for the borrower, as he has to pay the

    interest only for the amount he has utilised.The interest rate is negotiable. It depends upon the borrower and the

    bank, which is giving the facility. The interest is calculated on daily basis,

    but charged to the account on a monthly basis. The closing balance, for

    the day, is liable for the interest charges.

    The borrower will not be paid any interest if he has any surplus amount in

    his account. A minimum charge may be payable, irrespective of the levelof borrowing, for availing this facility. This is to make sure that the bank

    is not at a loss.

    Duration of the facility:

    Normally such facilities are given for a period of one year. After one year

    the bank does the review. This is to find out, upto what extent the

    borrower is using the facility given to him. Is he making the maximum

    N.L.Dalmia Institute of Management Studies & Research 28

  • 8/4/2019 Anand Bagri

    29/82

    WORKING CAPITAL MANAGEMENT

    possible use of the facility provided? Depending on the review, the bank

    may lower the sanctioned limits. If every thing is in place then the

    agreement is automatically renewed for the next year.

    Changes in the sanctioned limits for the subsequent Year:

    For every subsequent Year, the company or the borrower has to submit to

    the bank the CMA data, as mentioned earlier, in the proper CMA format

    giving the details. The details contain the estimated financial statements

    for the subsequent Year and projected financial statements for the next

    year henceforth. These details will also give the working capitalrequirement for the subsequent Year. Then the bank will renew the terms,

    for giving the Cash Credit / Overdraft facility. If there is any

    increase/decrease in the working capital requirement, then accordingly,

    the changes are made to the sanctioned limits.

    If, in the review of the current year, the bank finds that the borrower is

    not using the facility then the bank may even refuse to renew the facility,in the subsequent Year. Depending on the financial position of the

    borrower the bank can even increase / decrease the interest rate.

    In case of consortium of banks, as said earlier, the lead bank decides on

    the cash credit limit for the borrower or the company. Then this limit is

    divided among number banks, in the consortium, depending upon their capacity to give the facility.

    Hence, the borrower can have cash credit account with different banks.

    But while doing this, it is made sure that the total limit, taken together, is

    within the sanctioned limits.

    N.L.Dalmia Institute of Management Studies & Research 29

  • 8/4/2019 Anand Bagri

    30/82

    WORKING CAPITAL MANAGEMENT

    Working Capital Demand Loan

    Working Capital Demand Loan (WCDL) is also a fund-based facility

    given by the bank to the company. These loans are linked with the cash

    credit account of the company with the bank. They are given at the same

    interest rate as that of the cash credit account. The loans are supported by

    a demand promissory note executed by the borrower. There is often a

    possibility of renewing the loan.

    Availment of Working Capital Demand Loan:

    This facility comes with the cash credit facility. These loans are available

    on demand and hence are called Working Capital Demand Loans. For

    getting the loan the company or the borrower has to apply for it. This

    application has to be made 2 to 3 days in advance. This application

    doesnt, normally, involve a lengthy procedure. A mere request, for the

    same, is enough for getting the loan, provided sanction is available.

    As explained earlier, the Drawing Power of the borrower is divided

    between Cash Credit and WCDL equally, if the borrower enjoys no other

    facility. But if the borrower is enjoying other facilities, like Bill

    Discounting and EPC, then he can request to the bank to block the

    WCDL facility for the said facilities. The borrower then can not get the

    WCDL, if the Drawing Power, against WCDL, is exhausted due to theavailment of the said facilities. When the amounts, raised against these

    facilities, are fully repaid, then the blocked part is released and the

    borrower can get the WCDL to its full extent.

    For example,

    If the Drawing Power limit of a company for a month is, say Rs.100

    Crores. Then Company can avail WCDL of Rs.50 Crores. Now, if the

    N.L.Dalmia Institute of Management Studies & Research 30

  • 8/4/2019 Anand Bagri

    31/82

    WORKING CAPITAL MANAGEMENT

    company avails an EPC of say Rs. 40 Crores and requests the bank to

    block its WCDL facility for that much amount, then the company can get

    WCDL upto Rs. 10 Crores only. And can only enjoy the entire WCDL

    limit only when it repays the EPC.

    Duration of the loan:

    The WCDLs are given for some minimum period. This period varies

    from bank to bank and for customer to customer. It can be negotiated.

    Generally this period varies between 15 days to one month. One can not

    repay the loan before this period, even if he is capable of paying.

    Interest rate and method of payment:

    As mentioned earlier, the interest rate is same as it is for the Cash Credit.

    Only difference is in calculating and charging the interest. Here the

    interest is to be paid on the month end or on repayment of WCDL

    whichever is earlier. The interest is calculated on the entire loan amount,for the period for which the loan was used. Interest, from the date on

    which the loan was given to the end of that month, is charged at the end

    of that month. The balance interest is charged on the end of the next

    month. The payment of the principal amount can be made on any date

    after the minimum period is over. As mentioned above the principal can

    not be repaid before this period. If one pays before this period then hewill be penalised for that. In this case he has pay additional 2% interest

    over and above the agreed interest rate for the period the loan is used. In

    most cases, these loans are renewed.

    N.L.Dalmia Institute of Management Studies & Research 31

  • 8/4/2019 Anand Bagri

    32/82

    WORKING CAPITAL MANAGEMENT

    Bill Discounting

    Bill discounting is one of the facilities for supporting the working capital

    requirements.

    In bill discounting facility generally three parties are involved, which are

    the drawer (seller), drawee (buyer), and the bank.

    The seller sells the products to the customer and raises an invoice against

    it. Then on the basis of this invoice, the seller will make a Bill of

    Exchange. The B/E contains the details like the invoice date, name of the

    bank to whom the payment has to be made, the due date of payment and

    the amount to be paid. The B/E and the invoice are send to the buyer for

    his acceptance. After the acceptance by the buyer, the same are returned

    to the drawer.

    The drawer then submits the invoice and the B/E, along with the covering

    letter, to the bank. The bank, after receiving these documents, credits the

    B/E amount, less the discount charges (i.e. interest), immediately to the

    drawers account. The entire procedure takes 3 to 4 days.

    The drawee shall make the payment of the B/E amount to the bank on the

    due date.

    If the drawee fails to make the payment on the due date then the bank

    takes the necessary action, according to the terms and conditions

    mentioned in the Bill Discounting Agreement/Sanction Letter. The bank,in this case may, register a protest, for the dishonor of the bill, with a

    notary public. On the dishonor of the bill, the bank intimates the drawer

    of the bill, about the fact of dishonor, and requests the drawer to make the

    payment on the bill with the additional interest on the delayed payment

    and other expenses that the bank has incurred for the recovery of the bill

    amount.

    N.L.Dalmia Institute of Management Studies & Research 32

  • 8/4/2019 Anand Bagri

    33/82

    WORKING CAPITAL MANAGEMENT

    Discounting Rate:

    The discounting rates differ from bank to bank and from customer to

    customer. It mainly depends upon the credit rating of the borrower,

    drawee of the bill (B/E drawn on reputed drawees attract lower rate of

    interests), tenure of the bill and also whether the bill is with recourse or

    without recourse. Hence the discount rates are negotiated. The discount

    rate varies between 9.25 to 10.5%. The bank generally gives the discount

    rate 1 to 2%below their PLR.

    Bill discounting is cheaper as compared to cash credit and working

    capital demand loan.

    Bill Discounting Agreement:

    At the request of the company the bank has granted the company bill

    discounting facility by way of discounting of sales bills raised by the

    company on customers, with certain overall limit (termed as the

    facility) on terms and conditions mutually agreed.

    On presentation of the documents the bank shall discount the

    documents for an amount equivalent to 100% of the value of the bill

    and pay to the company/credit to the companys account with the bank

    the discounted value of the bill. Provided that the bank may at its

    entire discretion refuse to entertain the companys request to discount

    any bill, without being obliged to assign any reason therefore. Each bill presented to the bank for discounting shall be made payable

    not later than 90days from the date of the bill and shall have been duly

    accepted by the customer and endorsed in favour of the bank

    In respect of each bill discounted by the bank the company shall be

    liable to pay to the bank the interest at the rate specified by the bank in

    its sole discretion from time to time from the date on which the bill

    N.L.Dalmia Institute of Management Studies & Research 33

  • 8/4/2019 Anand Bagri

    34/82

    WORKING CAPITAL MANAGEMENT

    has been discounted upon the date on which the payment is received

    from the customer.

    On maturity of the discounted bill the bank shall cause the said bill to

    be presented to the customer for payment.

    In the event of any of the bill drawn on any customer remaining over

    due for more than 15 days the bank may at its entire discretion

    discontinue discounting of any bills drawn on such customer until the

    overdue payment is fully regularised. Even after such regularisation

    the bank may delete the name of such customer from the schedule and

    refuse to discount bills drawn on such customers. In the event of any of the discounted bill remaining unpaid for a

    period of the 30 days from the due date the bank shall be entitled to

    initiate proceedings against the defaulting customer and all cost,

    charges and expenses incurred by the bank for recovery of such

    outstanding bill amount shall be to the account of the company.

    N.L.Dalmia Institute of Management Studies & Research 34

  • 8/4/2019 Anand Bagri

    35/82

    WORKING CAPITAL MANAGEMENT

    Export Packing Credit

    Exports:

    Exports have come to be regarded as an engine of economic growth in thewake of liberalization and structural reforms in the economy. A sustained

    growth in exports is, however, not possible in the absence of proper and

    adequate infrastructure, as adequate and reliable infrastructure is essential

    to facilitate unhindered production, cut down the cost of production and

    make our exports internationally competitive.

    Various export-financing facilities are available with the exporters.Export Packing Credit is one of them.

    The banks give Export Packing Credit (EPC) to the exporter for

    encouraging the exports and allow more foreign currency to come into

    the country. These are of two types:

    1. Pre-shipment Export Packing Credit

    Post-shipment Export Packing Credit

    The Export Packing Credit can be availed in both Indian Currency as well

    as in Foreign Currency.

    Pre-Shipment EPC:

    Pre-shipment EPC is extended prior to shipment for the purchase of raw

    materials, processing, packing, transportation, warehousing, etc of goods

    meant for exports. Pre-shipment EPC is extended in both Indian Currency

    as well as Foreign Currency. Pre-shipment Rupee Credit is extended to

    finance temporary funding requirement of export contracts. This facility

    enables provision of rupee mobilisation expenses for construction/

    turnkey projects. Exporters could also avail of pre-shipment credit in

    foreign currency (PCFC) to finance cost of imported inputs for

    manufacture of export products to be supplied under the projects.

    N.L.Dalmia Institute of Management Studies & Research 35

  • 8/4/2019 Anand Bagri

    36/82

    WORKING CAPITAL MANAGEMENT

    Exporters with a good track record are allowed a running account facility

    with the bank for PCFC. The specified eligibility factor is that the

    export's overdues should not exceed 5% of the average annual export

    realizations during the preceding three calendar years. Commercial banks

    also extend this facility for definite periods.

    Post-shipment EPC:

    Post-shipment is extended after shipment, to bridge the time lag between

    the shipment of goods and the realization of proceeds. Exporter can avail

    this facility in both Rupee as well as Foreign Currency. In case of ForeignCurrency, no Foreign Currency loan is granted. Loan is given in rupees

    but the liability is in dollars. The loan is to be liquidated from the export

    proceeds. This scheme is optional for Banks. RBI declares the rate of

    interest on such loans.

    In this case, the interest amount in US $ is deducted from the amount of

    the bill. Only the net amount will be converted into rupees and credited toexporters account.

    Availment of Facility: For availing such credits, the exporter has to make an application to the

    bank for granting the export credit facility. The documents attached with

    the application are the Letter of Credit (LC)/ Contracts/ confirmed ordersalong with a covering letter, furnishing therein an undertaking that the

    relative export bills will be negotiated with the bank. Further that, the

    finance granted against such LC/s Contracts/ orders will be liquidated

    within a period of 180 days from the date of availment of the advances or

    within the prescribed time limit as per the directives issued by RBI from

    time to time.

    N.L.Dalmia Institute of Management Studies & Research 36

  • 8/4/2019 Anand Bagri

    37/82

    WORKING CAPITAL MANAGEMENT

    Exporters with firm export orders or confirmed letters of credit are

    eligible for the EPC, provided they satisfy the other credit norms. The

    credit will be available for maximum period of 180 days from the date of

    first disbursement. In some cases, the credit can also be extended for a

    period of 270 days with a higher rate of interest. Moreover a corporate

    can also book forward contract in respect of future export credit drawls.

    In case LC/ Contract/ confirmed order is expected in the near future, the

    relevant evidence which may be in the form of a cable / telex is also

    applicable, subject to the condition that such communication contains at

    least the following information:1. Name of the buyer

    2. Value of the order

    3. Quantity and particulars of the

    goods to be exported

    4. Date of shipment

    5. Terms of paymentFinal LC/ contract should be produced at a later stage, as and when

    available.

    For getting the credit, the exporter has to submit the following documents

    to the concerned bank in case of pre-shipment EPC.

    1. Exporters tender document

    2. Offer confirmed order document.In case of postshipment EPC one extra document, that is required to be

    attached along with the above two, is the Bill of Lading.

    In case of Rupee denominated EPC, the tender amount is converted into

    Indian Currency. This application contains the tender amount in Indian

    Currency and the unit Rate of the material in $/unit. Where as in foreign

    Currency denominated EPC no such conversion is done.

    N.L.Dalmia Institute of Management Studies & Research 37

  • 8/4/2019 Anand Bagri

    38/82

    WORKING CAPITAL MANAGEMENT

    After approving such application, the bank immediately credits the entire

    amount to the exporters account / makes the payment. This may be in

    Indian Currency or Foreign Currency as the case may be. For example, at

    SBI, Pre-shipment EPC in Foreign Currency can be availed in US Dollar,

    Pound, Sterling, Euro and the Japanese Yen. At the same time, the bank

    blocks the CC / WCDL account for an amount equivalent to the tender or

    credited amount. This is done to make sure that exporters withdrawal

    does not cross the sanctioned limits. Generally, the pre-shipment advance

    granted to the exporter does not exceed FOB value of the goods or

    domestic market value of the goods, whichever is less.

    Repayment:

    On realization of the proceeds from the export, the exporter has to repay

    to the bank on or before the due date. Such credits are to be repaid only

    with the proceeds of the export bill tendered, under the export bill

    rediscounting scheme, and not with foreign exchange acquired from anyother source.

    Interest rate:

    The rate of interest on the EPC differs from bank to bank and for exporter

    to exporter, depending on the credit rating of the exporter. Hence these

    are negotiable. But it is always lower than the banks PLR. The interestrate for the EPC in Indian Currency and EPC in Foreign Currency is

    different. Interest rate is generally between 8 to 10% for the Indian

    Currency EPC, where as it is LIBOR+ some spread for Foreign Currency

    EPC, which works out to around 3%. The interest rate on EPC is lower

    than CC / WCDL rate. This is to encourage the exports.

    N.L.Dalmia Institute of Management Studies & Research 38

  • 8/4/2019 Anand Bagri

    39/82

    WORKING CAPITAL MANAGEMENT

    The amount recovered through such export trade should be equal to or

    greater than the EPC availed, to make sure that more foreign currency

    comes in. If the exporter fails to achieve this, then he is penalized. In such

    cases, he has to pay the interest at a rate applicable for CC / WCDL, for

    the under recovered amount.

    If the exporter fails to pay on the due date, then an extra interest of 2% is

    charged over and above the CC / WCDL rate as applicable.

    Regulatory Aspects of Export Credits:

    While extending such facilities banks are mainly governed by theguidelines issued by the Reserve Bank of India under the Export Credit

    (Interest Subsidy) Scheme 1968. It is necessary that the exporter applies

    for and obtains sanction of limits suitable and according to his needs. At

    the pre-safe stage bifurcation of working capital limits for domestic and

    export purposes is essential so that the quantum of packing credit advance

    could be determined. At the post stage, quantum of post-shipment creditfacilities would be based on export sales and export receivables.

    Export Credit (Interest Subsidy) scheme 1968:

    In order to maintain the cost of export credit at a reasonably low level, the

    RBI prescribed in August 1967, a ceiling on the rates of interest that

    could be charged by banks on export credit. The ceiling rates, which weresubsequently replaced, by fixed rates were lower than the rates of interest

    charged for other commercial advances.

    Operational Features:

    The factors taken into consideration by banks before disbursal of export

    credit facilities are

    N.L.Dalmia Institute of Management Studies & Research 39

  • 8/4/2019 Anand Bagri

    40/82

    WORKING CAPITAL MANAGEMENT

    1. Banks adopt a flexible attitude with regard to debt / equity ratio,

    margin and security but there could be no compromise in respect of

    viability of the proposal and the integrity of the borrower.

    2. Exporters should be able to satisfy their bankers about their capacity

    to execute the orders within the stipulated time and to manage the

    export business.

    3. The quantum of finance sought for should be commensurate with the

    expected export turnover and the needs of the exporter.

    4. Banks would need to be satisfied about the standing of the credit

    opening banks.5. Banks would also look into, the political and financial conditions of

    the importers country.

    6. In working out the need-based requirements of the exporter, the banks

    keep in view the past performance, orders on hand etc.

    7. The terms and conditions of the credit facilities are advised by banks

    to the exporter by an arrangement letter.

    N.L.Dalmia Institute of Management Studies & Research 40

  • 8/4/2019 Anand Bagri

    41/82

    WORKING CAPITAL MANAGEMENT

    Commercial Paper

    Introduction:

    Commercial Paper (CP) is an unsecured money market instrument issued

    in the form of a promissory note. CP, as a privately placed instrument,

    was introduced in India in 1990 with a view to enabling highly rated

    corporate borrowers to diversify their sources of short-term borrowings

    and to provide an additional instrument to investors. Subsequently,

    primary dealers and satellite dealers were also permitted to issue CP to

    enable them to meet their short-term funding requirements for their

    operations.

    Terms and conditions for issuing CP like eligibility, modes of issue,

    maturity periods, denominations and issuance procedure, etc., are

    stipulated by the Reserve Bank of India. There are no interest rate

    restrictions on CP.

    Eligibility for issue of CP:

    Corporates, Primary Dealers (PDs) and Satellite Dealers (SDs), and the

    all-India Financial Institutions (FIs) that have been permitted to raise

    short-term resources under the umbrella limit fixed by Reserve Bank of

    India are eligible to issue CP.

    A Corporate would be eligible to issue CP provided it satisfies thefollowing requirements:

    1. Tangible net worth of the company, as per the latest audited Balance

    Sheet, is not less than Rs. 4 Crores.

    2. Working Capital (fund based) limits of the company, sanctioned by

    bank/s or all-India Financial Institution/s, is not less than Rs. 4 Crores.

    N.L.Dalmia Institute of Management Studies & Research 41

  • 8/4/2019 Anand Bagri

    42/82

    WORKING CAPITAL MANAGEMENT

    3. The company should obtain the specified credit rating from an agency

    approved by RBI, for the purpose, from time to time.

    4. The borrowal account of the company is classified as a Standard Asset

    by the financing bank/s/ institution/s.

    Rating Requirement:

    All eligible participants shall obtain the credit rating for issuance of

    Commercial Paper from either the Credit Rating Information Services of

    India Ltd. (CRISIL) or the Investment Information and Credit Rating

    Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd.(CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating

    agency (CRA) as may be specified by the Reserve Bank of India from

    time to time, for the purpose. The minimum credit rating shall be P-2 of

    CRISIL or such equivalent rating by other agencies. The issuers shall

    ensure at the time of issuance of CP that the rating so obtained is current

    and has not fallen due for review.

    Denomination and minimum size of CP:

    CP can be issued in denominations of Rs.5 lacs or multiples thereof.

    Amount invested by single investor should not be less than Rs.5 lacs

    (face value).

    Minimum and Maximum Period of CP:

    CP can be issued for maturities between a minimum of 15 days and a

    maximum upto one year from the date of issue. The maturity date of the

    CP should not go beyond the date up to which the credit rating of the

    issuer is valid. There shall be no grace period of payment of CP. If the

    maturity date happens to be a holiday, the company shall be liable to

    make payment on the immediate preceding working day.

    N.L.Dalmia Institute of Management Studies & Research 42

  • 8/4/2019 Anand Bagri

    43/82

    WORKING CAPITAL MANAGEMENT

    Limits and the Amount of Issue of CP:

    The aggregate amount to be raised by issuance of CP by a corporate

    should not exceed the working capital (fund-based) limit sanctioned to it

    by bank/banks. Corporates can automatically raise CP to the extent of

    50% of working capital limits without prior clearance from the bank/s.

    (The 50% limit would also be inclusive of any outstanding CP).

    However, companies intending to issue CP in excess of 50% of working

    capital limits can do so after getting prior clearance from bank/s.

    The total amount of CP proposed to be issued should be raised within a

    period of two weeks from the date on which the issuer opens the issue for subscription. CP may be issued on a single date or in parts on different

    dates provided that in the latter case, each CP shall have the same

    maturity date.

    Every CP issue should be reported to the Chief General Manager,

    Industrial and Export Credit Department (IECD), Reserve Bank of India,

    Central Office, Mumbai through the Issuing and Paying Agent (IPA)within three days from the date of completion of the issue.

    Investment in CP:

    CP may be issued to and held by individuals, banking companies, other

    corporate bodies registered or incorporated in India and unincorporated

    bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors(FIIs). However, investment by FIIs would be within the limits set for

    their investments by Securities and Exchange Board of India (SEBI).

    A CP shall be issued to a non-resident Indian (NRI) only on conditions

    that (1) the proceeds will be non-repatriable and (2) the CP shall not be

    transferable.

    N.L.Dalmia Institute of Management Studies & Research 43

  • 8/4/2019 Anand Bagri

    44/82

    WORKING CAPITAL MANAGEMENT

    Mode of issue:

    CP can be issued either in the form of a promissory note or in a

    dematerialised form through any of the depositories approved by and

    registered with SEBI. As regards the existing stock of CP, the same can

    continue to be held either in physical form or can be dematerialised, if

    both the issuer and the investor agree for the same.

    CP will be issued at a discount to face value as may be determined by the

    issuer. CP can be issued as Front Ended or Rear Ended, depending upon

    the terms agreed upon between the borrower and investor.

    No issuer shall have the issue of Commercial Paper underwritten or co-accepted.

    Payment of CP:

    The initial investor in CP shall pay the discounted value of the CP by

    means of a crossed account payee cheque to the account of the issuer

    through IPA. On maturity of CP, when the CP is held in physical form,the holder of the CP shall present the instrument for payment to the issuer

    through the IPA. However, when the CP is held in Demat form, the

    holder of the CP will have to get it redeemed through the depository and

    receive payment from the IPA.

    Standby facility with banking companies:A company issuing CP may request the sole bank / the consortium leader

    to provide standby facility for an amount not exceeding, the amount of

    issue, for meeting the liability of CP on maturity. In view of CP being a

    stand alone product, it would not be obligatory in any manner on the

    part of bank to provide stand-by facility to the issuers of CP. Where

    standby facility has been arranged for, such company may fall back on

    N.L.Dalmia Institute of Management Studies & Research 44

  • 8/4/2019 Anand Bagri

    45/82

    WORKING CAPITAL MANAGEMENT

    the working capital (fund based) limit with the sole bank / consortium

    banks, if there is no Roll Over of commercial paper.

    Procedure for Issuance:

    1. A resolution, for the proposed CP program, shall be passed in the

    Board Meeting.

    2. Any company proposing to issue CP should submit a proposal

    incorporating details in the form, as modified from time to time by the

    Reserve Bank of India, to the financing banking company together

    with the certificate issued by the credit rating agency. The financing banking company, on receipt of the proposal for issuance of CP, shall

    scrutinise the same and on being satisfied shall take the proposal on

    record.

    3. A Company proposing to issue CP upto 50 per cent of working capital

    limits may, after submitting the proposal as stated above, open the

    issue for subscription.4. However, a company proposing to issue CP in excess of 50 per cent of

    working capital limits can open the issue for subscription only after

    the proposal has been taken on record by the financing banking

    company.

    5. Companies must ensure that the proposed issue of CP is complete

    within the period of two weeks from the date of opening of the issuefor subscription.

    6. After the exchange of deal confirmation between the investor and the

    issuer, issuing company shall issue physical certificates to the investor

    or arrange for crediting the CP to the investor's account with

    depository. Investors shall be given a copy of IPA agreement, copy of

    IPA certificate to the effect that documents are in order and a

    statement of account from depository (in case of Demat form).

    N.L.Dalmia Institute of Management Studies & Research 45

  • 8/4/2019 Anand Bagri

    46/82

    WORKING CAPITAL MANAGEMENT

    7. The initial investor in CP shall pay the discounted value of the CP by

    means of a crossed account payee cheque to the account of the issuing

    company with the financing banking company only.

    8. The working capital (fund-based) limit of every company issuing the

    CP shall be correspondingly reduced by the financing banking

    company, once the CP is issued and the financing banking company

    shall make necessary adjustments in the account of such company

    respectively, with the banking company/the other member banking

    companies.

    9. Every company issuing CP shall within three days from the date of completion of issue, advise the Reserve Bank of India {Industrial and

    Export Credit Department, Central Office, Mumbai (IECD)}, through

    the financing banking company, the amount of CP actually issued.

    Documents for issue of CP:

    The following are the documents relating to issue of CP:1. Incumbency certificate to be issued by the company issuing CP

    2. Certificate issued by the Credit Rating Agency.

    3. Issuing and Paying Agency Agreement to be signed by A Scheduled

    Bank and the CP issuing company and

    4. Standby Agreement to be signed by Standby Bank and the CP issuing

    company.

    Issue Expenses:

    A Company issuing CP shall bear the expenses of the issue including

    dealers fees, rating agency fee. The charges by the banking company for

    providing standby facilities and of IPA commission. Also stamping duty

    at the rate of 0.05% is to be paid for the Stamp Office Agreement.

    N.L.Dalmia Institute of Management Studies & Research 46

  • 8/4/2019 Anand Bagri

    47/82

    WORKING CAPITAL MANAGEMENT

    Issuing and Paying Agency:

    At the request of the issuer, the Issuing and Paying Agent (IPA), agrees to

    act as the IPA in respect of all the CPs to be issued by the issuer during

    the validity of the IPA agreement, as per the terms and conditions

    mentioned. Only a scheduled bank can act as an IPA for issuance of CP.

    As and when the Issuer proposes to issue the CPs, the IPA allows the

    issuer to withdraw such number of blank forms of CPs from its safe

    custody sufficient to meet the requirement of the issuer for issuing the

    CPs. Then, on the receipt of the duly filled CPs from the issuer, the IPA

    intimates the Dealer that the CPs along with the Certificate of IPA areready for delivery and delivers them to the dealer for distributing to the

    investors. After receiving the discounted face value of the CPs, the IPA

    credits the account of the investor.

    On maturity of the CP, the holder presents the document to the IPA at the

    place and office as indicated in the CP for payment. The IPA may pay the

    amount thereafter depending upon the availability of the funds in theissuers account.

    IPA will get a commission, at a rate as may be mutually agreed between

    the Issuer and the IPA, from time to time, within the overall limit

    prescribed by the RBI, for the services of handling the receipt and

    payment of the CPs and for monitoring the Account of the issuer with the

    IPA in connection therewith and for maintenance of Registers andRecords therefore.

    Conclusion:

    The average discount rate of the CP in India, is around 7 to 9%, which is

    less than the usual CC / WCDL interest rate, which is close to 14 to 15%.

    N.L.Dalmia Institute of Management Studies & Research 47

  • 8/4/2019 Anand Bagri

    48/82

    WORKING CAPITAL MANAGEMENT

    Inter-Corporate Deposits

    Apart from CPs, corporates also have access to another market called theInter Corporate Deposits (ICD) market. An ICD is an unsecured loan

    extended by one corporate to another. This market allows funds surplus

    corporates to lend to other corporates. Also the better-rated corporates

    can borrow from the banking system and lend in this market. As the cost

    of funds for a corporate is much higher than a bank, the rates in this

    market are higher than those in the other markets.ICDs are unsecured, and hence the risk inherent in high. The ICD market

    is not well organised with very little information available publicly about

    transaction details. The instrument is non negotiable and hence is not

    transferable or tradable.

    ICDs are given outside the working Capital limits, unlike CPs. But there

    is limit on the outstanding amount.

    Interest rate:

    The instrument carries a coupon rate, which is market determined.

    It depends on:

    Prevailing market rate, call money rate, Bank rate, etc.

    Financial strength and credit rating of borrower.

    The coupon rate mostly remains fixed upto the maturity.

    Issuance:

    These are issued at the face value. The issue can be single or in parts,

    which depends upon the size of the issue. If the issue size is big and there

    is no single investor interested in investing for the entire amount, then the

    issue can be divided into small parts and issued to number of investors.

    N.L.Dalmia Institute of Management Studies & Research 48

  • 8/4/2019 Anand Bagri

    49/82

    WORKING CAPITAL MANAGEMENT

    Such issues can be made at different coupon rates depending upon the

    negotiations with different investors.

    Transaction size is mostly in the region of Rs.1 Crore to Rs. 5 Crores. the

    transactions are mostly routed through financial intermediary. i.e.

    Brokerage House.

    Duration:

    These are generally for a period of 90 days. However one may also have

    money invested for even short term of 3 to 5 days on call. Rate of interest

    is generally low compared to interest on higher tenure.

    Types of Deposits:

    Such deposits are usually of Fixed Period ICDs, Pure Call ICDs and a

    combination of both. These are as follows:

    1. Call Deposits:

    These deposits carry a call option. The lender on notice can terminatethese. The maturity period can be as short as one day, to as long as one

    year. For example, 5 days and call, which means, the lender can call

    back the deposit on any day after the 5 th day.

    In theory, a call deposit is withdrawable by the lender on a days

    notice. However, in practice, the lender has to give 1 to 2 days notice.

    2. Three Months Deposits:These are more popular in practice. These deposits are taken by

    borrowers to fulfill the short-term cash inadequacy. There will not be

    any call option. The maturity period is fixed at 3 months.

    3. Six Months deposits:

    Normally lending companies do not extend deposits beyond this time

    frame. Such deposits are usually made with first class borrowers. The

    maturity period is fixed at 6 months.

    N.L.Dalmia Institute of Management Studies & Research 49

  • 8/4/2019 Anand Bagri

    50/82

    WORKING CAPITAL MANAGEMENT

    Payment:

    The payment of such deposits is to be done on maturity. The interest is

    also payable on maturity. In case of the Call Deposits the payment is to

    made when the notice from the lender is received. In case of default in

    payment, there will be some penalty payable, as per the terms agreed

    upon in the agreement.

    Characteristics of ICD Market:

    Following are some of the characteristics of the ICD market.

    1. Lack of regulation:The lack of legal hassles and bureaucratic red tape makes an ICD

    transaction very convenient. In a business environment otherwise

    characterised by a plethora of rules and regulations, the evolution of

    the ICD market is an example of the ability of the corporate sector to

    organise itself in a reasonably orderly manner.

    2. Secrecy:ICD market is shrouded in secrecy. Brokers regard their lists of

    borrowers and lenders as guarded secrets. Tightlipped and

    circumspect, they are somewhat reluctant to talk about their business.

    Such disclosures they apprehend would result in unwelcome

    competition and undercutting of rates.

    3. Importance of Personal Contacts:Brokers and lenders argue that they are guided by a reasonably

    objective analysis of the financial situation of the borrowers. However

    the truth is that lending decisions in the ICD markets are based on

    personal contacts and market information which may lack reliability.

    N.L.Dalmia Institute of Management Studies & Research 50

  • 8/4/2019 Anand Bagri

    51/82

    WORKING CAPITAL MANAGEMENT

    FCNR(B) Loans

    FCNR(B) stands for Foreign Currency Non-Residence (Borrowings).

    FCNR(B) loans are given by the banks to the borrowers from the

    FCNR(B) deposits. FCNR(B) deposits are the deposits kept by NRI in

    foreign currencies. Bank provides loan in foreign currency out of dollar

    deposit of NRI available with them. These loans are generally provided

    out of the Working Capital limit sanctioned to the company.

    Availment of FCNR(B) loans:

    The corporate needing funds make an application to the bank having the

    FCNR(B) deposit account. The bank after scrutinising such application to

    their satisfaction extends the loan to the company. The bank provides

    dollars to the borrower or the company, the company utilises the dollar

    either to meet its immediate requirement of dollar payment either

    towards imports or other foreign currency payments. However, generally

    the dollars provided by the bank are sold back to the bank at the

    prevailing exchange rate and rupee amount is credited to the companys

    account. It may be noted that the liability of the company is always in

    foreign currency.

    Duration:

    Depending upon the type of loan the tenure is determined. These loansare given for a short duration. Since banks lend foreign currency loans

    out of their FCNR(B) deposits, which typically span over 6-12 months

    period, they cannot lend FCNR(B) loans for periods of more than one

    year. Normally such loans are given for a period of 90-180 days.

    Interest Rate:

    N.L.Dalmia Institute of Management Studies & Research 51

  • 8/4/2019 Anand Bagri

    52/82

    WORKING CAPITAL MANAGEMENT

    Interest is charged by applying a spread over LIBOR (London Inter-Bank

    Offer Rate). The spread can be in range of 50-300 basis points (0.50% -

    3.00%) over the LIBOR. Currently the 6 month LIBOR is around 2.00%

    p.a. The spread is levied by the bank depending upon the credit rating of

    company, prevailing market condition, etc.

    The currency risk is borne by company. However company by booking a

    forward contract, upto maturity of loan, can limit any adverse movement

    in currency rates. Also the effective rate of interest can be determined.

    Assuming premium rate to be 5.50% and that the rate of interest quoted

    by bank is LIBOR + 1% p.a., the effective cost will be 8.50% p.a.The mechanism provides for cheaper financing. Even after taking forward

    cover the effective cost is much less than the rate levied by the bank on

    Working Capital funds in Rupees.

    Further in case company does not take a forward cover and the rate of

    depreciation is less than the premium payable on booking of forward

    contract, the effective cost can still be cheaper. Assuming that thecompany had not covered the exposure and in case the rupee depreciates

    only, by say 2% p.a. vis--vis the premium of 5.50% p.a. the effective

    cost will come to 5% p.a. only.

    Repayment:

    As mentioned earlier, the liability of the company remains in foreigncurrency only. The interest is calculated on the foreign currency. The

    repayment of the principal amount, along with the interest thereon, is to

    be made on maturity.

    N.L.Dalmia Institute of Management Studies & Research 52

  • 8/4/2019 Anand Bagri

    53/82

    WORKING CAPITAL MANAGEMENT

    Characteristics of FCNR(B) loans:

    1. With the interest rate on these loans linked to the dollar exchange rate

    and rates prevailing in the international market, these loans work out

    to be cheaper than rupee credit.

    2. The RBI has allowed banks lend at sub-PLR rates in its recent credit

    policy, which has made this avenue very attractive in recent months.

    3. For banks, too, FCNR(B) loans is a profitable avenue of business as

    the cost of funds here are cheaper than rupee funds. This helps banks

    manage their spreads better as cost of funds and loans linked to

    FCNR(B) move with international benchmarks and Libor.4. The abolishing of incremental CRR on FCNR(B) loans has further

    helped in reducing cost of funds for banks.

    Conclusion:

    Corporates and banks are suddenly discovering the benefits of foreign

    currency loans that are available from the FCNR(B) deposits banks.However, the availability of FCNR(B) funds for lending purposes is very

    limited. The funds requirement of corporates, however, is many times

    higher. Besides, this special source of funds is concentrated mostly in

    three public sector banks SBI, BoB and Bank of India. Also, corporates

    still feel there are problems on the FCNR(B) loan front. For one, these

    funds are unable to meet their entire credit needs. Second, they aretypically of six months to one-year duration.

    N.L.Dalmia Institute of Management Studies & Research 53

  • 8/4/2019 Anand Bagri

    54/82

    WORKING CAPITAL MANAGEMENT

    STATEMENT OF WORKING CAPITAL

    PARTICUL

    ARS

    For the year ended

    Changes In W-cap

    Increase Decrease2004 2005 2006 2004-05 2005-06 2004-05 2004-05

    CurrentAssetsInventories 29490.66 28756.59 31904 .16 3147.57 734.07

    Sundry Debtors 24614.52 22627.67 24846.74 2219.07 1986.85

    Cash and Bank 2675.92 1324.83 2503.17 1178.34 1351.09

    Other Current

    Assets 1887.79 2277.723315.06

    389.93 1037.34

    Loans and

    Advances12122.14 12206.35 14442.06 84.21 2235.71

    Total CurrentAssets

    70791.03 67193.16 77011.19 9818.03 3597.87

    CurrentLiabilities

    Acceptances 89.75 42.17 45.09 2.92 47.58

    Sundry

    Creditors10491.99 11009.37 16427.41 517.38 5418.04

    Advances

    against sales449.05 459.52 560.35 10.47 100.83

    Due to

    Subsidiary Cos137.82 207.25 177.84 69.43 29.41

    Deposits from

    Dealers and

    Agents

    4874.25 5134.95 5318.21 260.7 183.26

    Overdrawn

    Bank Balances 186.60 484.16 1125.67 297.56 641.61

    Other liabilities 1491.91 1689.99 2044.72 198.08 354.73

    Interest accrued

    but not due 315.87 477.20528.05 161.33

    50.85

    Provisions 8373.15 5605.17 6770.84 1165.67 2767.98

    Total CurrentLiabilities

    26410.39 25109.78 26227.34 1117.56 1300.61

    N.L.Dalmia Institute of Management Studies & Research 54

  • 8/4/2019 Anand Bagri

    55/82

    WORKING CAPITAL MANAGEMENT

    Net

    Working

    Capital

    (CA CL)

    44380.64 42083.38 50783.858700.47

    2297.26

    N.L.Dalmia Institute of Management Studies & Research 55

  • 8/4/2019 Anand Bagri

    56/82

    WORKING CAPITAL MANAGEMENT

    INVENTORY MANAGEMENT

    Inventory refers to the stock of products a firm is offering for sale and thecomponents that make up the product. It includes raw materials; work in

    process (semi-finished goods). Managing inventory is a juggling act.

    Excessive stocks can place a heavy burden on the cash resources of a

    business. Insufficient stocks can result in lost sales, delays for customers

    etc. The key is to know how quickly the overall stock is moving or, put

    another way, how long each item of stock sit on shelves before being

    sold. Obviously, average stock-holding periods will be influenced by the

    nature of the business.

    Inventory Financing:

    As with accounts receivable loans, inventory financing is a secured loan,

    in this case with inventory as collateral. However, inventory financing is

    more difficult to secure since inventory is riskier collateral than accounts

    receivable. Some inventory becomes obsolete and looses value quickly,

    and other types of inventory, like partially manufactured goods, have

    little or no resale value.

    Firms with an inventory of standardized goods with predictable prices,

    such as automobiles or appliances, will be more successful at securing

    inventory financing than businesses with a large amount of work in

    process or highly seasonal or perishable goods. Loan amounts also vary

    with the quality of the inventory pledged as collateral, usually ranging

    from 50% to 80%. For most businesses, inventory loans yield loan

    proceeds at a lower share of pledged assets than accounts receivable

    financing. When inventory is a large share of a firms current assets,

    N.L.Dalmia Institute of Management Studies & Research 56

  • 8/4/2019 Anand Bagri

    57/82

    WORKING CAPITAL MANAGEMENT

    however, inventory financing is a critical option to finance working

    capital.

    Lenders need to control the inventory pledged as collateral to ensure that

    it is not sold before their loan is repaid. Two primary methods are used to

    obtain this control: (1) warehouse storage; and (2) direct assignment by

    product serial or identification numbers. Under one warehouse

    arrangement pledged inventory is stored in a public warehouse and

    controlled by an independent party (the warehouse operator).

    A warehouse receipt is issued when the inventory is stored, and the goods

    are released only upon the instructions of the receipt-holder. When the

    inventory is pledged, the lender has control of the receipt and can prevent

    release of the goods until the loan is repaid. Since public warehouse

    storage is inconvenient for firms that need on-site access to their

    inventory, an alternative arrangement, known as a field warehouse, can be established.

    Here, an independent public warehouse company assumes control over

    the pledged inventory at the firms site. In effect, the firm leases space to

    the warehouse operator rather than transferring goods to an off-site

    location. As with a public warehouse, the lender controls the warehousereceipt and will not release the inventory until the loan is repaid.

    Direct assignment by serial number is a simpler method to control

    inventory used for manufactured goods that are tagged with a unique

    serial number. The lender receives an assignment or trust receipt for the

    pledged inventory that lists all serial numbers for the collateral. The

    company houses and controls its inventory and can arrange for product

    N.L.Dalmia Institute of Management Studies & Research 57

  • 8/4/2019 Anand Bagri

    58/82

    WORKING CAPITAL MANAGEMENT

    sales. However, a release of the assignment or return of the trust receipt is

    required before the collateral is delivered and ownership transferred to the

    buyer.

    This release occurs with partial or full loan repayment. While inventory

    financing involves higher transaction and administrative costs than other

    loan instruments, it is an important financing tool for companies with

    large inventory assets. When a company has limited accounts receivable

    and lacks the financial position to obtain a line of credit, inventory

    financing may be the only available type of working capital debt.Moreover, this form of financing can be cost effective when inventory

    quality is high and yields a good loan-to-value ratio and interest rate.

    Factors to be considered when determining optimum stock levels

    include:

    What are the projected sales of each product?How widely available are raw materials, components etc.?

    How long does it take for delivery by suppliers?

    Can the company remove slow movers from their product range

    without compromising best sellers?

    It should be noted that stock sitting on shelves for long periods of timeties up money, which is not working.

    For better stock control, the following may be considered:

    Review the effectiveness of existing purchasing and inventory

    systems.

    N.L.Dalmia Institute of Management Studies & Research 58

  • 8/4/2019 Anand Bagri

    59/82

    WORKING CAPITAL MANAGEMENT

    Know the stock turn for all major items of inventory.

    Apply tight controls to the significant few items and simplify

    controls for the trivial many.

    Sell off outdated or slow moving merchandise - it gets more

    difficult to sell the longer the company keeps it.

    Consider having part of the companys product outsourced to

    another manufacturer rather than make it yourself.

    Review your security procedures to ensure that no stock is going

    out the back door!

    Higher than necessary stock levels tie up cash and cost m