Working Capital Financing PDF
Working Capital Financing PDF
Working Capital Financing PDF
FINANCING OF
WORKING CAPITAL
7.1. INTRODUCTION
The object of present chapter is to study the structure of working capital finance
in the selected SSI units of Orissa, with a view to highlight the relative roles played by
different sources of finance in meeting working capital needs of the SSI units. Besides,
attempt has also been made here to evaluate the adequacy or otherwise of the bank
borrowings and contribution of long term funds to finance the working capital requirements
with reference to the norms suggested by the various committees study groups of RBI in
There exists a basic difference in capital structure and the method of financing of
SSIs as against the medium and large scale corporate sector, while in the case of latter,
the choice of the sources of capital, both fixed and variable working capital, is fairly
broad-based, it is very much restricted in the case of SSIs. A large and medium undertaking
can trap a large number of alternatives, besides its internal resources i.e retained earnings
and depreciation reserves. Besides, it can issue shares to the public, float debentures /
bonds, borrow from term lending institutions and can also depend on trade credit. But in
the case of SSIs, most of which are sole proprietorship or partnerships or private limited
companies, the issue of shares or debentures to public and loans from large financial
The major sources of finance for SSIs include owner’s capital, borrowings from
friends, borrowings from banks, borrowings from relatives and internal resources. The
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availability of there sources of finance to SSI depends on factors like form of organisation,
reputation of owners / partners, stage of operation, size of organization and fiscal policies
of the government.
Credit forms the life blood of industry; and one of the perennial problems of
small industry is the easy availability of credit both for fixed assets and for working capital.
Many developing countries have an inadequate banking system; even where it is developed,
it is geared primarily to trading operations and, in some cases, lending to larger industry.
Small industry, inspite of its significant contribution to the country’s total production, gets
a less than proportionate share of the total volume of credit available; this is specially so
outside the metropolitan areas where, till recently, the banking system was hardly present.
Even where it does, the attitude of the bank personnel is based on conventional
banking norms where the approach is security oriented and a ‘collateral’ to cover two or
three times the value of the loan is insisted upon as a guarantee against risk. Further, the
procedural formalities in getting a loan are so cumbersome that small units are often scared
away by the appraisal procedures and the long delays experienced in getting a loan. The
result is that few of them like to deal with a bank; they would rather rely on friends and
relatives or even the money lender (inspite of his exorbitant rate of interest) than the local
bank.
On the other hand, if properly organised, the banking system can be very beneficial
to small industry. Apart from making funds available at reasonable rates of interest (as
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determined by the Reserve Bank of India), banks require financial prudence and discipline
which is vital, even if at times tiresome, to the success of small industry. A bank is also
the first to be able to detect signs of danger in the working of a unit and can therefore
sound an ‘early warning system’ to the owner—who may be blissfully ignorant of the
dangers ahead of ‘approaching sickness’. For this reason, banks can play a useful, even
crucial, role in not only providing credit but, more importantly, in monitoring it.
Apart from credit, fiscal and taxation policies have an important role to play in
the healthy growth of small industry. While undue preference to small industry in exemption
from taxes may not be desirable, it has to be recognised that a uniform tax policy for both
large and small industry may, in practice, be an ‘unintended disadvantage’. It is the wisdom
of fiscal policy makers to balance the disadvantage which small size imposes with a pattern
of rebates and exemptions which can provide suitable incentives to small industry.
Even more important than the formulation of such incentives is to ensure that they
can be easily availed of and, in fact, reach the small units for whom they are intended. All
too often, government policies, (and this is particularly true of fiscal measures) however
well meaning, seem to be lost in a maze of procedures and returns and, coupled with the
proverbial delay in government offices, provide little tangible relief to the small industrialist.
It is necessary to ensure that such policies are worked in a manner as to really benefit the
small-scale sector.
which will benefit the industry in the long run. Programmes like modernisation to improve
the efficiency and productivity of the unit and utilisation of in-house test facilities to obtain
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better quality control are at times costly and therefore, not likely to be taken up by the
small entrepreneur who looks to short-term gains unless encouraged by the special
The financial system in a country needs to be ‘tuned’ to the needs of the small
industry sector; it has also to mesh with the broad policies of the government so that their
impact is pronounced and visible. This includes also such matters as important policies
where a too liberal attitude may make it difficult for small units against indiscriminate
imports and too rigid an attitude may make it difficult to obtain raw materials and
components which are vital to ensure the good quality of the product. In India credit is
cooperative basis;
basis;
* The Industrial Development Bank of India (IDBI) and the National Bank for
the banks and SFCs for lending to small and village industries respectively.
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The Reserve Bank of India has designated that credit to the small scale sector
may be given on a priotiry basis; other priority sectors include agriculture and transport.
advances made to small units by SFC and SIDCs. In each district, one bank is designated
as the ‘Lead Bank’ to draw up the credit plans for all the sectors in the district. There is
a District Credit Committee with the District Collector as chairman to ensure adequate
years as major lenders of term loans to the small-scale sector. More than 70 per cent of
A special scheme for artisans has been in force under which, very small loans (up
to Rs. 50,000) are provided on a ‘composite’ basis for both fixed assets and working
capital. A unique feature of the scheme is that the credit guarantee (normally 75 per cent)
is increased to 90 per cent and there is no ‘penal interest’ on defaulted payments. Interest
is fixed at 11 per cent and repayment is for a period of 7-10 years. A time limit of 30
A Credit Guarantee Scheme has been in force since I960 and placed on a
permanent footing since 1963 under which an automatic guarantee up to 75 per cent is
provided to all advances made to small units by the financial institutions. This enabled the
latter to take risks which they would otherwise have not done, and made credit more
The scheme was modified in April 1981 and a new agency— Deposit Insurance
and Credit Guarantee Corporation of India— was created to operate the scheme. This
Corporation is a fully owned subsidiary of IDBI. The guaranteed cover varied from 90
per cent in respect of small loans (up to Rs. 5 0,000 to 75 per cent (up to Rs.2 lakhs) and
50 per cent for sums above that amount. The claim liability for an individual borrower is
not to exceed Rs.10 lakhs. In the backward areas, however, credit guarantee is up to 66-
One major demand of small industry for many years has been to establish an
Apex Institution to provide and monitor credit for the small-scale sector. It was felt that
such an institution would .make credit more easily available and apply more meaningful
norms which are now applied across the board for both the large and small sectors.
NABARD was set up in 1980 for funding rural development activities which included a
component for rural industries: IDBI set up a Small Industry Development Fund in 1986
with an initial corpus of Rs.2,500 crores to fund specialised programmes for small industry.
But the working of NABARD has been of limited benefit to small industries since the
focus of its interest is on agriculture and rural development: the SID Fund also does not
substantially increase the total credit made available to the small sector, though it will
enable special programmes to be taken up. The question of setting up an apex financial
agency for the small industry sector (as is the case in Japan, where as many as four such
institutions operate) is still to be resolved. Another problem that has been repeatedly
brought up is to provide for limited liability for partnership—which is the structure for the
majority of small industry units today. The Partnership Act provides only for unlimited
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liability which acts as a disincentive for funds to be invested in any venture. It has, therefore,
been suggested that a modified Partnership Act with limited liability should be formulated
to attract venture capital more easily for small industrial units. At present, such a provision
A basic reform that has been demanded frequently is to simplify the forms and
procedures for obtaining loans from the banks. A high-powered committee appointed in
1977 had recommended various reforms relating to systems and procedures of bank credit
to small-scale industry and the Reserve Bank of India had issued instructions in 1978 to
forms and standardisation of forms for all banks. Such forms should be accepted by all
the financing institutes and should also form the basis for reports by the consultancy
reduced; a maximum period of 8-9 weeks has been recommended but delays continue to
occur. There is a need for much greater delegation of powers to bank managers so that
unnecessary references to the head office is avoided. Uniformity of margins for working
capital, norms for determining the working capital requirements, and stipulation of collateral
Above all, what is needed is a more flexible development approach on the part
of the branch manager to view the problem of small industry with greater empathy and
understanding. The ‘credit worthiness’ of a small entrepreneur consists not in the collateral
he can produce but his own dedication and background and the stake of his career—far
more important than money—in a venture. Unfortunately, progress in this regard has been
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limited and many branch managers continue to exhibit the same rigid attitude in dealing
This has been primarily responsible for the rapid increase in ‘sick units’ as
estimated by the Reserve Bank of India, which defines a unit-as sick if ‘it has incurred
cash losses for one year and in the judgment of the bank is likely to continue to incur such
losses for the current year as well as the following year and has an imbalance in its financial
structure such as a current ratio of less than 1:1 and worsening debt-equity ratio (total
outside liabilities to the net worth)'. More simply, a sick unit is one which fails to generate
* Shortage of working capital (inadequate and untimely assistance from the banks)
30 percent
Another major cause is the delayed payments by the large enterprises which
causes a ‘liquidity crisis’ leading to default and heavy penal interest—creating a vicious
circle from which the small unit finds it difficult to extricate itself. Power cuts experienced
in almost all the States, and which are applied uniformly for all undertakings, is another
contributing factor. Diversion of funds from productive to unproductive uses also creates
Provisions) Act to secure timely detection of sick (and potentially sick) units so as to
take preventive or remedial measures. The Act is not applicable to the small or ancillary
industry. Similarly the guidelines issued by the Reserve Bank of India in a Circular dated
5 November 1985 outlines the relief measures that may be taken to rehabilitate sick units
but these are not normally applicable to the sick units in the small sector. These include a
‘package programme’ of relief from the banks, the State and Central Governments, and
There is, in fact, a need for a comprehensive policy towards prevention of sickness
and the rehabilitation of sick units. In this regard, it is the commercial banks that can play
a useful role in monitoring the ‘health' of the unit and sounding a note of warning well in
advance, since by the time a unit is declared ‘sick' it is too far gone to merit rehabilitation.
Any such programme of rehabilitation must be based on a fair and objective determination
of the potential viability of the unit and whether it would he worthwhile for additional
money to be invested in it. This is so, if the sickness is not due to any intrinsic weakness
in management or technology: in view of the structure of most small units, the ability to
take over the management of the unit for a limited period or inject more capital into it is
The District Industries Centre, now functioning in almost every State, needs to
be more actively involved in such a rehabilitation programme as also the state government
agencies such as SKC or SSIDC. The Inter-Institutional Committee set up by the Reserve
Bank of India and the state governments jointly should be empowered to take decisions
The Small Industry Development Fund, recently created, may “be utilised
assistance should be in the form of soft loans for modernisation and training; equity capital
may also have to be provided to reduce the debt burden on the unit. The seed capital
scheme, now operated by the SFCs, by which margin money up to 10 per cent of fixed
capital (15 percent in the case of Scheduled Castes and Tribes) is given, may also be
extended by the commercial banks. Bank personnel may be trained at the various Institutes
that the entrepreneurial spirit is inculcated and risk taking is encouraged, at the same time
providing relief to small units. What is needed is a taxation policy which will restore
initiative, encourage entrepreneurial activity and improve the liquidity position of small
business. While undue protection in favour of small units is not desirable, there are areas
where small industry suffers inequalities or unnecessary disabilities as a result of the present
tax system which need to be corrected. Small-scale industrialists, on their part, need to
he educated that money has a ‘cost’ and that money, made too cheap, distorts the economic
The working capital management does not end with estimating and forecasting of
working capital requirement, but also includes the financing of this requirement. It is prudent
to bifurcate the total working capital requirement in to permanent and temporary working
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capital .The permanent working capital which is required, irrespective of the fluctuations
in the sales level should be financed by arranging funds from long term sources such as
long term loans and owners capital. However, the temporary working capital requirement
Short term financing consists of obligations which are expected to mature within
a period of one year, supports a major portion of current assets. In this chapter we shall
examine (i) the different sources of finance from where the funds on short term basis may
be arranged, and (ii) the banking policy in India in relation to financing of working capital.
There are different sources of short term financing. It is essential to consider the
* The financing source selected should have the lowest annual interest cost.
* The impact of source on the credit rating of the firm should be assessed.
* There should be scope for flexibility, so that additional founds, if necessary can be
* The source should not impose restrictions on the working of the firms.
These sources result from normal business activities. In the normal course of
business, a firm purchases goods and services for which payment can be made at a later
date. To the extent the payments are delayed, the funds are available to the firm. These
sources are insecured and vary in line with sales level. These are referred as trade liabilities
★ Trade Credit
The trade credit may be defined as the credit extended in connection with goods
and services purchased for resale. It is the ‘resale which distinguishes trade credit from
other sources. For example, fixed assets maybe purchased on credit, but since these are
to be used in the production process rather than for resale, such credit purchase of fixed
assets is not called the trade credit. The credit extended in connection with the goods
in producing its products is called the trade credit. Thus, the consumer credit which is the
credit extended to individual customers for purchase of goods for ultimate consumption,
rather than for resale, is also excluded from trade credit. There are two common ways to
i) Open Account: The trade credit under open account is usually extended only
after the seller conducts a fairly extensive investigation of the buyer’s standing and
reputation. The open account derives its name from the fact that the buyer does not sign
a formal debt instrument evidencing the amount due. The only evidence the seller has that
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has that credit has been extended is the copy of the invoice that the goods have been
deliverd. When trade credit is arranged, this is all that is done and all that is required to
ii) Bills Payable: In such a case, the buyer will have to give a written promise to pay
the amount of the bill/invoice on demand or at a fixed future date to the seller or the
bearer of the note. The buyer may be required to sign the bills payable in case where (a)
the seller wishes to obtain a formal acknowledgment of the debt, a maturity date, and (b)
Open account purchases are major sources of unsecured short term financing for
business firm. They include all transactions in which goods are purchased but no formal
bill is signed. Although, the obligations of the purchaser to the supplier may not seem as
legally binding as it would be ifthe supplier had required the buyer to sign the bill, however,
★ Credit Terms : The credit terms refer to the set of conditions on which a seller
sells goods and services to the buyer and in particular, on which the buyer has to make
i) The size of the cash discount, if any, from the net invoice price which is given for
ii) The period within which payment must be made, if the cash discount is to be
availed, and
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iii) The maximum period that can elapse before payment of the net invoice price
Terms of trade credit usually vary from one industry to another and are specified
on the invoice
Cost of Trade Credit: In view of the cash discount offered by the supplier, the
buying firm has the discretion to use or not to use the trade credit as a source of fund. By
altering its payment period, a firm can expand or contract its account payable. Theoretically,
a firm could reduce payable to zero and use no trade credit at all by paying in cash on the
desirable source of financing. If used beyond certain limits it is not without its costs. The
cost of using trade credit as a source of short term finance depends upon several factors,
the most important being the credit terms upon which the goods are supplied. For the
purpose of measuring the true cost, or the effective annual rate of interest associated with
the use of trade credit as a discretionary source of short term finance, it is necessary to
consider the effects of its use, both, when (i)a firm fails to take its cash discounts but
nevertheless pays within the net period, and ii) a firm fails to take its discount and allows
These two situations involve an actual cost to the paying debtors. If no cash
discount is offered, then there is no cost for the use of credit during the net period, however
long it maybe. By the same token, if a discount is available and the buyer avails it, there
is also no cost for the use of credit during the discount period. However, if a cash discount
is offered and is not availed, there is an implicit opportunity cost. Say, a firm is offered
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credit terms of 2/10 net 30. It means that the firm has two options : To avail or not to
avail the discount. If the firm opts to avail the discount then it shall pay 98% of the invoice
amount by the end of 10th day of the bill date. The firm in this case has no implicit cost
associated with availing the discount. However, if the firm does not avail the discount
then it can delay the payment by 30days, without any extra cost. Apparently, there is no
explicit cost associated with foregoing the discount, nevertheless, there is an implicit cost.
Stretching Trade Credit: Stretching the trade credit means that the firm delays
the payment to creditors until some time after the credit period. This has the impact of
extending-free credit if cash discount are not offered and of reducing the financing cost if
cash discount are offered and foregone. Stretching the payments is sometimes suggested
as a reasonable strategy for a firm as long as it does not damage its credit rating. Although,
this strategy may be financially attractive, yet it may cause the firm to violate the agreement
it entered into with the supplier. Obviously, a supplier would not look kindly to a customer
who purposely postponed the payments on a regular basis. As a consequence, the firm
may find it increasingly difficult to obtain trade credit on good terms and may be forced
to accept unfavourable credit terms. The suppliers may reduce the firm’s line of credit or
decrease the length of net period or suspend altogether the credit lines. Some suppliers
may not be willing to grant trade credit terms and may offer goods only on cash basis.
The firm may find it necessary to borrow funds in order to purchase raw materials and
other supplies. Stretching the payments can thus, result in affecting the credit position in
the market.
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term financing, however, the extent to which the trade credit is used as a source varies
widely among firms. In general, manufacturers, retailers and wholesalers make extensive
use of trade credit. There is considerable variation also with respect to firm’s size and
smaller firms generally use trade credit more extensively than large firms. Particularly,
when the monetary policy is tight and credit is difficult to obtain, small firms tend to
increase their reliance on trade credit. Further, large firms are willing to finance their
smaller customers in terms of trade credits, in order to preserve their markets and therefore,
As the trade credit is readily acquired, the buying firm must exercise continuing
care to avoid falling into the habit of using trade credits beyond a particular level. Supplier
firms usually regard the extension of trade credit as a part of overall sales promotion
policy and therefore it is quite easy to get into debts through the use of trade credit. No
doubt, the trade credit is exceedingly useful and valuable for any firm because it can be
obtained, generally, at a time and to the extent it is needed. If the inventory level is to be
increased in order to meet the expected surge in sales volume, the trade credit will
is the accrued expenses or the outstanding expense liabilities. The accrued expenses refer
to the services availed by the firm, but the payment for which has not yet been made. It is
a built-in and an automatic source of finance as most of the services i.e., labor etc., are
paid only at the end of a period. Similarly, taxes are also paid at the end of a particular
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period only. Sales tax is collected by the firm on daily sales but is deposited with the
Government only at the end of a period. The accrued expenses represent an interest free
source of finance. There is no explicit or implicit cost associated with the accrued expenses
Employees, in any firm, provide services through out a month at the end of which
they are paid the accumulated wages for the month. The. liability for these expenses accrue
between two pay-days and becomes zero as soon as the payment is made. The longer the
payment period, greater will be the fund availability to the firm during that period. For
example, a firm having a policy of paying to temporary wagers on a weekly basis can
change the payment period to ten days or a fortnight and thereby can increase the funds
available to it and that too for a longer period. Similarly, the sales commission or target
incentives etc., are always payable with a time lag. These provide funds to the firm at no
with the general philosophy of paying the creditors as late as possible, as long as the firm
does not damage its credit rating. However, in case of setting or changing the payment
period of accrued expenses, the legal provisions must be taken care of. For example,
payment of tax i.e., on 15th September, 15th December and 15th March.
Likewise deferring payments for the services availed, the firm may also receive
advance payment for the goods and services which it has to provide / supply to the customer
in future. In some businesses, customers are often required to maintain a security deposit
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with the supplier, or to pay full or a part of total value with the order. These advance
payment also become a source of finance to a supplier firm, which may pay some nominal
funds for a short period, generally, varying from a few days to a few months. For example,
in India, the maturity period of CP can vary between 90 days to 180 days while in some
other countries, the maturity period may go even up to 270 clays. It is a money market
instrument and generally purchased by commercial banks, money market mutual funds
and other financial institutions desirous to invest their funds for a short period. As the CP
is unsecured, the finns having good credit rating can only issue the CP. The amount raised
the short term funds, however, as compared to customer loan market where the borrowers
The firm or the dealers in CP sell these to the short term lenders who use it as
interest earning investment of temporary surplus of operating funds. The nature of these
surpluses and motives for buying the CP suggest that all the holders of the CP expect to
be paid in full at maturity. The maturity term of CP is not generally extended. This
expectation on the part of short term lenders requires that the borrowing firm must be (i)
an established and profitable firm, (ii) consistently maintaining a good reputation in the
market, and (iii) having good credit rating. The firm issuing the CP generally has an open
line of credit with a commercial bank to provide a security against the CP. This is to
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provide protection to the lenders in case of borrower firm faces difficulty in redeeming
the CP on the maturity date. Particularly, when the conditions in the money market gets
The commercial papers are issued with a face value but the issue price may be
less than the face value. The difference i.e., the discount on the issue price works as a
return to the lender at the time of maturity, when he gets the refund. In other words, the
borrowing firm gets less at the time of issue but repays the full face value of the CP on
maturity. The discount on issue of CP depends upon the amount involved, maturity period
and the prime lending rates of commercial banks. The main advantage of CP is that the
cost involved is lower than the prime lending rates. In addition to this cost, the borrowing
firm has to bear another cost in the form of placement fees payable to the dealer of CP
regulation of CP comes under the purview of the Reserve Bank of India which has issued
guidelines in 1990 on the basis of the recommendations of the Vaghul Working Group.
i) Enabling the highly rated corporate borrowers to diversify their sources of short
These guidelines have stipulated certain conditions meant primarily to ensure that
only financially strong companies come forward to issue the CP. Subsequently, these
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guidelines have been modified to encourage the issuance of CP. The main features of the
and delivery. It can be issued at such discount to the face value as may be decided
2 The aggregate amount that can be raised by commercial papers is not restricted any
longer to the company’s cash credit component of the Maximum Permissible Bank
Finance.
3. CP is issued in the denomination of Rs. 5,00,000, but the maximum lot or investment
is Rs. 25,00,000 per investor. The secondary market transactions can be Rs.
raised within two weeks from the date on which the proposal is taken on record
by the bank.
4. CP should be issued for a minimum period of 30 days (with effect from April 15,
1997 when the monetary policy for 1997 was announced by the RBI) and a
maximum of 6 months. No grace period is allowed for repayment and if the maturity
date falls on a holiday, then it should be paid on the previous working day. Each
5. Commercial papers can be issued by a company whose (i) tangible net worth is not
less than Rs. 5 crores, (ii) funds based working capital limit is not less than 4
crores, (iii) shares are listed on a stock exchange, (iv) specified credit rating of P2
is obtained from CRISIL or A2 from ICRA, and (v) the current ratio is 1.33:1:
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The issue expenses consisting of dealers fees, credit rating agency fees and other
CP maybe issued to any person, banks, companies. The issue of CP to NRIs can
8. CP can be issued up to 100% of the fund based working capital loan limit. The
Deposits by the issue of CP have been exempted from the provisions of section
which provides working capital limit to it, along with the credit rating of the firm. The
issue has to be privately placed within two weeks by the company or through a merchant
banker. The initial investor pays the discounted value of the CP to the firm. Thus, CP is
issued only through the bank who has sanctioned the working capital limit to the company.
It is counted as a part of the total working capital limit and it does not increase the
From the point of the issuing company, CP provides the following benefits :
a) CP is sold on an unsecured basis and does not contain any restrictive conditions.
b) Maturing CP can be repaid by selling new CP and thus can provide a continuous
source of funds.
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e) Generally, the cost of CP to the issuing firm is lower than the cost of commercial
i) Only highly credit rating firms can use it. New and moderately rated firm generally
ii) CP can neither be redeemed before maturity nor can be extended beyond maturity.
CP as a source of short term finance for SSIs is unthinkable for the time being for
requirement has been an important source of short term funds to business firms. In India,
bank credit has been the main institutional source of short term financing requirement.
While the trade credit and accrued expenses are the automatic and spontaneous sources
of finance, the bank credit is a deliberate, negotiated and external source. The bank credit,
in general, is a short term financing say for a year or so. This short term financing to
business firm is regarded as self-liquidating in the sense that the uses to which the borrowing
firm is expected to put the funds are ordinarily expected to generate cash flows adequate
to repay the loan within a year. Further, these loans are called self-liquidating because the
bank’s motive to provide finance is to meet the seasonal demand e.g., to cover the seasonal
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the firm through seasonal peaks in financing need. The amount of credit extended by a
bank may be referred to as a credit limit which denotes the maximum limit of loan which
the firm can avail from the bank. Sometimes, the bank may approve separate limits for
Types of Bank Credit: In India, banks may give financial assistance in different
shapes and forms. The usual form of bank credit are as follows:
1. Overdraft: It is the simplest of different forms of bank credit. In this case, the
borrowing firm which already has a current account with the bank is allowed to withdraw
more (up to a specified limit) over and above the balance in the current account. The
amount so over drawn (i.e., borrowed) may be repaid by depositing back in the current
account as and when the firm wants. The firm is not required to seek approval of the bank
authority every time it is overdrawing, but a one time approval may work for a particular
period, say a year. The bank, however, can review and modify the overdraft limit at any
time. The firm has to pay interest at a specified rate only for the period during which the
amount was overdrawn. The bank may also charge a minimum amount per period for
maintaining the over draft limit even if no amount has been over drawn.
2. Cash Credit: The credit facility under the cash credit is similar to the overdraft.
Under the cash credit, a loan limit is sanctioned by the bank and the borrowing firm can
withdraw any amount at any time, within that limit. The interest is charged at the specified
rate on the amount withdrawn and for the relevant period. The bank may or may not
charge any minimum commitment fee. Under the cash credit also, the borrower has the
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option to withdraw or not the amount of loan sanctioned. The amount withdrawn can be
repaid by depositing in the bank account. This will enable the borrowing firm to reduce
Recently, the Reserve bank of India has issued guidelines which provide that a
firm has to maintain a margin of 25% and cash credit limit may be sanctioned only up to
75% of the cash-purchased inventories and book debts. The over draft limit and the cash
credit limit are considered simultaneously. However, the financing is called cash credit if
it is given against the hypothecation of goods or security of the book debts. The term
over draft may be used when the loan is given against the security of assets other than
inventories and book debts. In both the cases, however, the bank has some or the other
security.
3. Bills Purchased and Bills Discounting : Commercial banks also provide short
term credit by discounting the bill of exchange emerging out of commercial transactions
of sale and purchase. In the normal course of credit sales, the seller of the goods may
draw a bill on the buyer of the goods who accepts the bill and thereby promises to pay
the bill as per terms and conditions mentioned in the bill. However, if the seller wants the
money before the maturity date of the bill, he can get the bill discounted by a bank which
will pay the amount of the bill to the seller after charging some discount. The discount
depends upon the amount of the bill, the maturity period and the prime lending rate
prevailing at that time. The bank represents that bill to the buyer on the due date and gets
the payment. The difference between the amount so received and the amount paid by the
The bill may be payable on demand or on maturity. When the bill payable on
demand is discounted, it is called bills purchased; and when the bill payable at maturity is
discounted by a bank, it is called bills discounting. In order to popularize and regulate the
bill operations in India, the Reserve Bank of India announced the New Bill Market Scheme
in 1970. The Scheme envisaged the bill discounting as a means of providing short term
financing to various firms as against the cash credit system. The bill discounting is common
only among small size business firm. One of the short coming of the bill discounting system
is that the bank, which discounts that bill, must establish and verify the creditworthiness
of the buyer, which at times, maybe difficult, complicated and time consuming process.
banker to the seller that in case default or failure of the buyer, the bank shall make the
payment to the seller. The responsibility of the buyer is assumed by the bank in case the
latter fails to honour his obligations. The letter of credit issued by the bank may be given
by the buyer to the seller along with the bill of exchange. So, in fact, the letter of credit
becomes a security of the bill and any bank (or the bank or the seller) will have no problem
The letter of credit provides a non-fund based financing as the funds are not
involved in the issue of the letter of credit. It is a contingent liability of the bank and shall
arise only if the buyer fails to pay. However, whenever a letter of credit is issued, the
amount is adjusted against the fund based cash credit limit of the buyer. It may be noted
that in case of letter of credit, the bank provides only a security and undertakes the risk
for the bill period, but the financing is in fact, made by the seller. So, it is an indirect form
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of financing as against the over draft, cash credit and bill discounting where the bank
5. Working Capital Term Loan : Generally, the bank while granting working capital
by the customer and hence the bank borrowing remains only limited to 75% of the security
offered. In other words, against a security of Rs. 100, the bank gives a loan of up to Rs.
75. The shortfall is generally treated as Working Capital Term Loan (WCTL). This WCTL
may not be able to pay the interest charge on its working capital cash credit facility
obtained from a commercial bank. Such accumulation of unserviced interest makes the
cash credit account irregular and in excess of the sanctioned limit. It also prevents the
firm to make further operations in the account. Such unserviced accumulated interest may
be transferred by the bank from cash credit account to Funded Interest Term Loan (FITL).
This will enable the firm to operate its cash credit account. The FITL is considered
Security for Bank Credit: The bank credit is generally provided against the security of
one type or the other. Since the bank credit is on a short term basis, the security may be
primarily in the form of liquid assets such as stock, book debts, fixed deposit or other
generally stock, is given as a security against the loan. The ownership as well as the
physical possession of the goods remain with the borrower. He maybe allowed to even
deal in them. However, in case of default by the borrower, the bank will have the right to
take custody as per the terms and conditions agreed. As per the current practice, the
bank may allow a loan up to 75% of the value of goods, which is taken as the cash
purchased component of the total goods. So, the credit is not allowed against the goods
purchased on credit. For example, a borrower has a total stock of Rs. 9,00,000 in the
godown, and his debtors and creditors are estimated at Rs. 5,00,000 and Rs. 6,00,000
respectively. The value of the stock is taken at Rs. 8,00,000 (i.e., Rs. 9,00,000-Rs.
6,00,000+Rs. 5,00,000) and a loan up to 75% of this value i.e., Rs. 6,00,000 maybe
being provided as security is to be deposited (physically) with the bank. So, the bank
gets the physical possession of the security under the agreement of loan. This is generally
adopted in case of security provided in the form of investment certificates etc. In case of
repayment of loan, the security is returned to the borrower and, in case of default, the
security may be realized by the bank to recover the loan. During the period of custody,
the bank is supposed to take reasonable care of the goods/security as a pledgee (Pawnee).
or plant and machinery etc., is provided as a security. In this case, the title to the property,
under an agreement called Mortgage Deed, is transferred to the lender, however, the
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physical possession remains with the borrowers. The borrower who transfers this right is
called the mortgagor while the lender bank is called the mortgagee. In case of repayment
of loan, the title to property reverts to the borrower. However, in case of default, the
lending bank will have the right to sell or otherwise dispose off the asset. For this purpose,
the lender will have to procure the order of the Court of Law. The loan granted against
the mortgage is not self liquidating. The basic shortcoming of the mortgage is the valuation
4. Lien : The lien refers to a situation when a property or a beneficial right belonging
to another person is retained by a party who is having physical possession of the property,
unless the loan or any other amount due to the latter is paid. The lien may be general,
when the property may be retained for all amounts due or may be particular when the
property is retained for failure to repay a particular debt. The banks like to have a general
Bank credit has been an important and inevitable source of short term financing
or working capital finance for most of the business firms. Traditionally, bank credit has
been an easily accessible source of meeting the working capital needs of the borrowing
firms. Convenience in getting the bank credit has been an important factor for the growth
of bank credit in fulfilling the requirement of the industries. However, it also resulted in
credit has been subject to various rules, regulations and controls. The Reserve Bank of
India has appointed different study groups from time to time to suggest ways and means
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equitable distribution of bank resources. The present section discusses the important
findings and recommendations of the following committees, which in fact have shaped the
flow of bank credit in last three decades in India: i) Dehejia Committee, ii) Tandon
Committee, iii) Chore Committee, iv) Marathe Committee, v) Nayak Committee, vi)
Kannan Committee
Dehejia was constituted in 1968 by the National Credit Council to examine the extent to
which credit needs of industry and trade were inflated and to suggest ways and means of
curbing this phenomenon. The Dehejia Committee, inter alia, analyzed (i) the relative
growth rates of short term trade credit and the value of industrial production, (ii) the
relative growth rates of short-term trade credit and inventories with industry and trade,
(iii) the diversion of short-term credit for fixed asset acquisition and for loans and
investments, (iv) the incidence of multiple financing, and (v) the elongation of the credit
period. The major findings of the Dehejia Committee were : (i) Bank credit to industry
grew at a higher rate than the rise in industrial output, (ii) Banks in general, related credit
limits to the security provided by the borrowers without properly assessing their needs
based on projected financial statements, (iii) Short term bank credit was diverted to some
extent for acquiring fixed assets and for other purposes, (iv) The prevailing lending system
facilitated industrial units to rely on short term bank credit to finance non-current assets.
Out the basis of these findings, the principal suggestions made by Dehejia
current and projected, as reflected in the cash flow analysis and forecasts provided
by the borrowers. Cash credit accounts should be segregated into two components
: (i) the hard core component representing the minimum level of current assets
required for maintaining a given level of production and (ii) the strictly short-term
b) To eliminate multiple financing, a customer should be required to deal with only one
should be adopted.
d) The Committee recommended that commercial banks, industry and trade should
initiate and develop the practice of issuing usance bills as this would not only impose
financial discipline but also help the borrower to plan his financial commitments.
An adequate growth in the business of bills will facilitate the development of bill
market in India.
held by various industry and to minimize the stocks needed by industry. This will
Dehejia Committee pointed out the weaknesses of the system of bank credit as
well as gave recommendations to channelize it. However, the recommendations could not
222 •
be implemented and during 1974, the demand for bank credit rose sharply because of
unprecedented inflation. Most of the banks had to freeze the credit limits and a need was
felt to give a closure look at the entire bank credit system. In 1974, the RBI constituted,
the Tandon Committee to frame guidelines for the regulation and provision of bank credit.
TANDON COMMITTEE : A study group under the Chairmanship of Sh. P.L. Tandon
was constituted in 1974 by the Reserve Bank of India to frame the guidelines for the
effective regulation of bank credit and other related aspects. The basic terms of reference
a) To suggest guidelines for commercial banks to follow-up and supervise credit from
the point of view of ensuring proper end-use of funds and keeping a watch on the
d) To suggest criteria regarding satisfactory capital structure and sound financial basis
in relation to borrowings.
On the basis of the findings, the Tandon Committee noted various shortcomings
of the then prevailing cash credit system such as (i) the cash credit system which allows
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the withdrawal of any amount up to a given limit hinders credit planning, (ii) the security
based approach to lending has led to diversion of funds to purchase of fixed assets, and
(iii) the working capital finance should be made available only for a short period, as it has
otherwise, led to accumulation of inventories with the industry. The Tandon Committee
studied the entire system of bank credit and observed that banks should finance only the
genuine production needs of the borrowers who should indicate the likely demand for
credit based on operating plans for the coming period. The borrowers should maintain
only reasonable level of inventory and receivables and that the entire working capital
needs of the industry cannot be met by banks. The Tandon Committee made comprehensive
recommendations regarding the bank lending practices, which can be broadly classified
only a reasonable level of current assets, particularly inventory and receivables. Only the
normal inventory, based on a production plan, lead time of supplies, economic ordering
levels and reasonable factor of safety, should be financed by the banker, profit-making or
excessive inventory should not be permitted under any circumstances. Similarly, the banker
should finance only those receivables which are in line with the practices of the borrower’s
industry. The norms for reasonable level of inventory and receivables are needed to avoid
the undesirable holding and financing of current assets. The norms should also be specified
to bring uniformity in the bank’s approach in assessing the working capital requirements.
The Tandon Committee, in its final report, suggested norms for fifteen industries. Although
the Committee defined norms in the case of fifteen industries only, yet it emphasized, and
rightly so that industries not covered should not be exempt from the discipline of norms.
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It should be noted that the suggestions by the Tandon Committee are not merely meant
for banks to follows in financing the borrower’s working capital needs, rather they represent
the mavimnm limit which should not be exceeded in the normal circumstances.
The Tandon Committee has suggested norms for raw materials, work-in-progress,
finished goods, receivables and bills purchased for different industries. These norms have
been fixed after taking into account (i) company finance studies by the RBI, (ii) process
period in different industries, (iii) discussion with industry and (iv) need for ensuring smooth
production etc. Initially, the norms were intended to be applied to those borrowers with
aggregate credit limit of Rs. 10 lacs or more from the banking system, but were to be
The Tandon Committee introduced the concept of MPBF and suggested that bank should
attempt to supplement the borrowers resources in financing the current assets. It has
recommended that a part of current assets should be financed by trade credit and other
current liabilities. The remaining part of the current assets, which is termed by the group
as ‘working capital gap’, should be partly financed by the owner’s funds and long term
borrowings and partly by the short term bank credit. The Tandon Committee has suggested
three alternative methods for working out the MPBF, each successive method reducing
In the first method, the borrower will contribute 25% of the working capital
gap; the remaining 75% can be financed from bank borrowings. This method will give a
In the second method, borrower will contribute 25% of the total current assets.
The remaining of the working capital gap (i.e., the working capital gap/less the borrower’s
contribution) can be bridged from the bank borrowings. This method will give a current
ratio 1.3:1.
In the third method, borrower will contribute 100% of core assets, and 25% of
the balance of current assets. The remaining of the working capital gap can be met from
the borrowings. This method will further strengthen the current ratio.
The Committee recommended the 1st method mainly as a stop-gap method till
borrowers got used to the new approach of lending. The borrowers who are already in
the 2nd stage would not be allowed to revert to the 1st stage. The aim should be to move
forward. The methods for determining the MPBF maybe described as follows :
Liabilities
all borrowers on the first method within a year and then moving to the second and third
methods in stages in the light of the assessment of the prevailing circumstances. It also
expressed the view that the third method is ideal as it will provide the largest multiplier of
bank finance. The borrowings in excess of what is permissible under the first method
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should be converted into a working capital term loan and should be repaid over a period
of time. The borrowers should be gradually moved to the third method of calculation of
MPBF. The following example illustrates the three methods of maximum possible bank
finance (MPBF).
Total 850
The total Core Current Assets (CCA) are Rs. 300 lacs.
The maximum permissible bank finance in the above case under three methods
Method I: = .75(CA-CL)
= .75(850-300)
= Rs. 412.50 lacs
Method II: = .75(CA)-CL
= .75(850)-300
= Rs. 337.50 lacs
Method III: = .75(CA-CCA)-CL
= .75(850-300)-300
= Rs. 112.50 lacs
So, it may be noted that the MPBF decreases gradually from the first method to
second method and then to third method. As the firm has already availed the bank loan of
300 lacs, it can still avail a loan of Rs. 112.50 lacs as per the first method; or Rs. 37.50
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lacs as per second method. However, as per the third method, it is eligible to get finance
of Rs. 112.50 lacs only, whereas its present bank borrowings are Rs. 300 lacs.
At the time the new system of lending is introduced, in some cases the net working
capital may be negative while in others it may not be equal to 25% of working capital
gap. The Committee has allowed this deficiency to be financed, in addition to the
time depending upon the funds generating capacity and ability of the borrower. This kind
of credit facility has been called working capital term loan. The working capital term loan
iii) Style of Credit: The Tandon Committee also suggested the form of bank financing.
The total MPBF should be bifurcated into the fixed portion and the fluctuating portion.
The fixed portion refers to loan component and represents the minimum level of borrowing
throughout the year. The fluctuating component refers to demand cash credit component
which would take care of the fluctuating needs and required to be reviewed periodically.
Apart from the loan and the cash credit, a part of the total financing requirement should
also be provided byway of bills limit to finance the seller’s receivables. The demand cash
credit component should be charged a slightly higher interest rate than the loan component.
This would provide the borrower an incentive for better planning. The term loan
representing the excess borrowing to be amortized over a period of time, should also
iv) Information and Reporting System: Another suggestion of the Tandon Committee
was that there should be a regular flow of information from borrower to the bank. The
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working group under the Chairmanship of Shri K.B. Chore in April 1979, with the terms
of reference to review the cash credit system to promote greater credit discipline and to
make the cash credit system more amenable to rational management of funds by commercial
a combination of the three types of lending, viz., cash credit, loan, and bill should
be retained.
2. Bifurcation of Credit Limit: Bifurcation of cash credit limit into a demand loan
portion and a fluctuating cash credit component has not found acceptance either
on the part of the banks or the borrowers. Such bifurcation may not serve the
purpose of better credit planning by narrowing the gap between sanctioned limits
over-dependence of the medium and large borrowers on bank finance for their
established industrial unit should be utilized partly at least for reducing borrowing
enhance their contributions to working capital and to improve their current ratio, it
the Tandon Committee which would give a minimum current ratio of 1.33:1. To
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include the borrowers to repay this loan, it should be charged a higher rate of
interest. The Committee recommended that the additional interest may be fixed at
2% per annum over the rate applicable on the relative cash credit limits.
While assessing the credit requirement, the bank should appraise and fix separate
limits for the ‘normal non-peak level’ as also for the ‘peak level’ credit
requirements.
operable’ cash credit account. There should be a stiff penalty for such demand
loan or ‘non-operable’ cash credit portion, at least 2% above the normal rate.
7. Penal Interest: The borrower should be asked to give his quarterly requirement
of funds before the commencement of the quarter on the basis of his budget.
hoc increases in limits should be subjected by banks to close scrutiny and agreed
9. Bill system : As one of the reasons for the slow growth of the bill system is the
stamp duty on usance bills and difficulty in obtaining the required denominations
of stamps, these questions may have to be taken up with the state governments.
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November 1982, another study group known as Marathe Committee to review the Credit
Authorization Scheme (CAS) which was in operation since 1965. The CAS was introduced
in 1965 by the RBI to regulate the end use of credit. Under the CAS, all banks were
required to obtain the prior authorization of the RBI for sanctioning credit limits (including
bill discounting) of Rs. 6 crores or more. The Marathe Committee was required to take
an independent view of the CAS. The Committee was of the view that the CAS should
not be looked upon as a mere regulatory measure which is confined to large borrowers.
The basic purpose of the CAS is to ensure orderly credit managements and improve
quality of bank lending so that all borrowings, whether large or small, are in conformity
with the policies and priorities laid down by the central banking authority. If the CAS
Committee was to provide incentive to the borrowers to comply with all the requirement
of the CAS and to improve the quality of credit appraisal in the banks. It also
recommended that commercial banks be given discretion to deploy credit in CAS cases
On the basis of the recommendations of the Marathe Committee, the CAS was
withdrawn with effect from October 10,1988 and was replaced by the Credit Monitoring
Arrangement (CMA), under which the RBI is required to do the post-sanction scrutiny of
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the term loan and working capital loan provided by commercial banks beyond the
prescribed cut-off levels. The banks, under the CMA, have to submit to the RBI, sanctions/
renewals of credit limit beyond Rs. 5 crores for post-sanction scrutiny. In every case, the
banks should indicate whether the minimum level prescribed by the RBI with respect to
financing of credit sales through bills or credit purchases have been attained and if not,
steps taken to fulfill the RBI norms. The banks may also sanction ad hoc limits to
borrowers on merit, for a period not exceeding three months and all such ad hoc sanctions
enjoying working capital limits beyond Rs. 5 crores are to be reported to the RBI within
15 days.
Nayak, Deputy Governor, Reserve Bank of India was constituted to examine the adequacy
of institutional credit to Small Scale Industry (SSI) sector and other related aspects.
Considering the contribution of SSI sector to overall industrial production, exports and
employment and also recognizing the need to give a fillip to this sector, a special package
by the RBI in 1983 to ensure adequate and timely credit to this sector. The salient features
i) The banks should step up the credit flow to meet the legitimate requirements of the
SSI sector. For this purpose, the banks should draw up annual credit budget for
the SSI sector. Each branch of the bank should prepare an annual budget in respect
of working capital requirements of all SSI before the commencement of the year.
Such budgeting should cover (a) functioning (healthy) units which already have
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the term loan and working capital loan provided by commercial banks beyond the
prescribed cut-off levels. The banks, under the CMA, have to submit to the RBI, sanctions/
renewals of credit limit beyond Rs. 5 crores for post-sanction scrutiny. In every case, the
banks should indicate whether the minimum level prescribed by the RBI with respect to
financing of credit sales through bills or credit purchases have been attained and if not,
steps taken to fulfill the RBI norms. The banks may also sanction ad hoc limits to
borrowers on merit, for a period not exceeding three months and all such ad hoc sanctions
enjoying working capital limits beyond Rs. 5 crores are to be reported to the RBI within
15 days.
Nayak, Deputy Governor, Reserve Bank of India was constituted to examine the adequacy
of institutional credit to Small Scale Industry (SSI) sector and other related aspects.
Considering the contribution of SSI sector to overall industrial production, exports and
employment and also recognizing the need to give a fillip to this sector, a special package
by the RBI in 1983 to ensure adequate and timely credit to this sector. The salient features
i) The banks should step up the credit flow to meet the legitimate requirements of the
SSI sector. For this purpose, the banks should draw up annual credit budget for
the SSI sector. Each branch of the bank should prepare an annual budget in respect
of working capital requirements of all SSI before the commencement of the year.
Such budgeting should cover (a) functioning (healthy) units which already have
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borrowing limits with the branch (b) new units and units whose proposals are under
appraisal, and (c) sick units under nursing and also sick units found viable and for
ii) It is desirable that a single financing agency meets both the requirement of the
working capital and term credit for small scale units. The Single Window Scheme
(SWS) of SIDBI enables the same agency— State Financial Corporation (SFC)
or commercial bank — as the case may be, to provide term loans and working
capital requirement up to Rs. 10 lacs. The banks are advised to adopt this
approach.
iii) It has been decided by the RBI that for requirements of SSI units having aggregate
fond-based working capital credit limits up to Rs. 100 lacs from the banking system,
the norms for inventory and receivables and the first method of lending will not
apply. Instead such units maybe provided working capital limits computed on the
basis of a minimum of 20% of their projected annual turn-over for new as well as
Permissible Bank Finance (MPBF) on the basis of annual projected turn-over was
extended to “All Borrowers " enjoying fund based working capital of less than
100 lacs from the banking system. Thus, all the borrowers whether covered under
the definition of SSI or not, availing fund based working capital limits of less than
Rs. 100 lacs, from the banking system are covered under the Nayak Committee
recommendations.
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iv) These units would be required to bring in 5% of their annual projected turnover as
bank, the balance one-fifth representing the borrower’s contribution towards margin
for the working capital. The Reserve Bank of India issued from time to time various
per projected turnover basis and the traditional operating cycle method.
25% of the projected turnover to be shared between the borrower and bank viz,
providing finance at a minimum of 20% of the turnover. The above guidelines were
capital would be turned over four times in a year). It is possible that certain industries
may have a production cycle shorter/longer than 3 months. While in the case of a
shorter cycle, the same principles could be applied as it is the intention to make
available at least 20% of turnover by way of bank finance. In case the cycle is
longer, it is expected that the borrower should bring in proportionately higher stake
least l/5th of the working capital requirement should be brought in by way of Net
borrower; if the available Net Working Capital is more than 5% of the turnover,
the former should be reckoned for assessing the extent of bank finance.
d) Drawls of the limit is to be regulated to the extent of paid up stock. While bank
finance could be assessed at 20% of the annual projected turnover, the actual
e) In case of seasonal industries, the peak season and off season turnover, instead
levels.
have suggested that the prescribed uniform formula for MPBF (as suggested by the Tandon
Committee) should go and the banks should have the sole discretion to determine borrowing
limits of corporates. However, the change from the MPBF system should keep in view
the size of various banks, their delegation system, exposure limit etc. Banks and the
borrowers should be left free to decide the system they adopt for financing working capital.
(i) The Modelities for working capital assessment of the borrower may be left to the
bank who may draw a flexible system under the guidelines of RBI. The following
— For borrowers upto Rs. 25 lacs, assessment may be made on the basis of overall
— For loans between Rs. 25 lacs and Rs. 500 lacs, the turnover method as suggested
— For loans more than Rs. 500 lacs, the cash budget system should be followed.
— Loans limits by various types of facilities may be decided by the bank, (ii) The
system of cash credit should be replaced by a system of loans for working capital.
(iii) The uniform formula for MPBF should be abolished and banks should be given
(iv) The corporate borrowers may be allowed to issue short term debentures for
meeting short term requirements and the banks may subscribe to these debentures.
(v) Borrowers with requirements from Rs. 10 crores to Rs. 20 crores may have a
working capital by way of demand loans may be allowed to the extent of 100%.
(vi) Margins and holding levels of stocks and receivables as security may be left to the
(vii) Bench mark current ratio of 1.33:1 should be left to the discretion of the banks.
(x) Banks should be allowed to decide policy norms for issue of commercial papers.
(xi) Borrowers will have to obtain prior approval for investment of funds outside the
(xii) Banks should also try out the syndicate form of lending.
In section 7.3 of this Chapter, conceptual analysis of various short term sources
of finance was made. The important sources identified were trade credit, accrued
expenses, commercial papers, and banks. Financing through commercial paper is done in
India by large corporate houses only. Therefore, this source of short term finance is
In this section an attempt has been made to find out the source of finance used by the
selected units. Table 7.1 gives a break-up of current liabilities of selected SSIs of Orissa
TABLE 7.1
Table 7.1 reveals that on an average bank borrowings constitute 62.93 of total
current liabilities over the five year period of study. It also reveals that bank borrowings
are the major sources of finance for the selected SSIs. Further, the table also reveals that
the share of bank borrowings is having a rising trend starting from 60.46% in 2001-02,
they went up to 66.42%. The rise in bank borrowings (cash credit and overdrafts) is
primarily due to two reasons viz. raising of additional loan and due to accumulation of
Trade credits constitute the second important source of short term finance. On an
average trade credits are 16.09% of current liabilities. Except for the year 2002-03, the
trade credits are showing a declining trend. In 2001-02, the trade credits were 17.17%
on the higher side and 14.61% on the lower side in 2004-05. Though the decline is
marginal, it may indicate a lack of confidence by the suppliers. To analyse the extent of
trade credit financing vis-a-vis trade debtors (accounts receivable), Table 7.2 is prepared.
liabilities. These are fixed liabilities. The increase in absolute terms is primarily due to
The selected units have also made private borrowings (grouped under the head of
have remained between 10 to 11% for all the years of study except 2005-06 which has
shown a huge decline i.e. almost one half of the previous years. The other creditors also
Table 7.2 depicts the relationship between trade creditors and trade debtors of
the selected units for the entire five year period of study. The trade creditors have been
TABLE 7.2
From the above table 7.2, it can be observed that on an average for the period
under study the trade creditors are 44.12% of trade debtors. The percentage at a high
was 46.58% in 2001-02 and at a low was 40.94% in 2005-06. It is a matter of great
concern that the small scale units under study are forced to set apart a portion of their
scarce resources to finance their credit sales as the quantum of credit granted to them
stands much smaller in comparison to the quantum of credit allowed by them to their
customers. The gravity of this problem in different industries is highlighted in Table 7.3.
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TABLE 7.3
The table indicates that in all the 12 industry groups, the quantum of credit received
by small scale sector stands much lower to the quantum of credit allowed by it to its
taken together, works out at 40.94%. If the component of creditors for other liabilities is
included, than creditors as a percentage of debtors would have been slightly higher.
Analysing the position in separate industry groups, the “food and Allied based” group has
been the largest beneficiary, having availed credit facilities to the extent of 66.67% of the
debts allowed by it, followed by Electrical & Electronics’ group (58.33%). In Forest &
Wood’ group as well as ‘Glass & Chemicals’ group it is 50% and 53.85% respectively.
For 4 groups it is between 40-42%, for two groups 34 to 39%. The position is worst in
case of‘Repairing and Servicing’ group (16.67%) and ‘Miscellaneous manufacture’ group
(28.57%)
Concomitant with the problem of credit sales to customers, the problem of delayed
payment to small scale industry particularly by the government departments, public sector
undertaking and large scale undertakings in private sector is most pertinent. It has been
revealed by Ramanujam Committee that out of the total receipts on account of credit
sales by SSI units, to medium and large units, about two thirds of the amount has been
A large number of SSI units is managed by their promoters or persons with technical
orientation, who are not adequately equipped to pay attention to areas of accounting and
working capital management. By and large, they donot have organizational set up or
243
expertise in the area of credit management to attend to follow up and recovery of dues
from customers. It is only when they experience liquidity crunch by reasons of delayed
payments or other causes, that those managing such units direct their attention to working
The Reserve Bank of India had constituted a study group in January, 1988 to
examine the need and scope of for the introduction of ‘Factoring’ services in India to
help the small scale industries in realizing payments for supply of goods and services.
Fresh guidelines were issued by the RBI in July 1988 for credit assistance to small scale
sector, covering important aspects like timely and adequate sanction of working capital,
coordination between commercial banks and State Financial Corporation for adequate
The group opined, that factoring for SSI units could prove to be mutually beneficial
to both factors and SSI units. Introduction of export factoring will provide an additional
window of facility to the exporters. Even if some extra cost will be involved, exporters
In India, factoring services are now being permitted to be operated by State Bank
of India in the Western Region, Punjab National Bank in Northern Region, Allahabad
Bank in the Eastern Region and Canara Bank in the Southern Region. The result of the
7.6. CONCLUSION
From the foregoing analysis of the patterns of working capital finance to the SSIs,
remained almost constant over the period, on an assessment of the optimal level
of bank borrowings as per the Tandon Committee norms, it was found with regard
to the selected units that the existing borrowings were much in excess of what the
Financing through trade credit has proved itself a potential source of finance for
the SSI units. But the units could not utilize the opportunities to their advantage.
Trade creditors were constant and in some years showed a declining trend. The
amount of trade creditors both in absolute terms and percentage was less than
one-half of their receivables. Hence, the units were extending twice the credit to
their customers, then what they themselves were getting from their suppliers.
The use of long term funds for meeting working capital requirements was on the
REFERENCES :
2. Ibid.,pA51
4. Ibid.,p. 65
5. Vijaya Saradhi, S.P. and Rajeswara Rao, K., 'Working Capital Investment and
1966 p.27.
9. Weston, Fred J. and Brigham, Eugene, F., Managerial Finance, (Hinsdale : The
10. Supra p. Also See Dr Braj Kishore, 'Working Capital Policy - A General Frame
work of analysis : Lok Udyog, Vol XI, No. 11, February 1978, pp. 9-16.