Decoding Working Capital Assessment Methods (2024)

Working capital is the sum of funds invested in various current assets used in the operating cycle of industrial and trading establishments. It represents the amount of money required to fund day-to-day operations and ensure smooth business functioning.

The operating cycle refers to the time it takes to convert non-cash current assets (such as raw materials, work in progress, finished goods, and receivables) into cash. It involves the entire process of production, sale, and collection of cash from customers.

Various methods of working capital appraisal are used by banks in India to assess the working capital limits for borrowers. Some of these methods include:

1. Tandon's First Method: Under this method, the borrower must arrange 25% of the Working Capital Gap (the difference between total current assets and other current liabilities) as margin. The maximum permissible bank finance (MPBF) is calculated by subtracting the margin from the working capital gap.
2. Tandon's Second Method: In this method, the borrower must arrange 25% of the total current assets as margin. The MPBF is calculated by subtracting the margin from the total current assets.
3. Turnover Method (Nayak Committee Norms): The aggregate fund-based working capital limits are computed based on a minimum of 20% of the projected annual turnover. The borrower must provide a margin of 5% of the annual turnover.
4. Cash Budget Method: This method is used for industries with seasonal cash flow patterns. The bank finance is sanctioned based on the projected monthly cash flows estimated by the borrower. The peak cash deficit determines the working capital limit.

It's important to note that banks have the flexibility to choose the appropriate method based on the borrower's requirements. The methods mentioned above are commonly used guidelines, but the specific assessment may vary depending on the nature of the business and the bank's policies.

When assessing working capital, bankers consider factors such as the time period for holding raw materials, work-in-process, finished goods, and the collection of receivables. They also evaluate the borrower's ability to achieve projected sales and production targets, past trends in production/sales, availability of resources, competitive strength, pricing policies, economic factors, and profitability ratios.

Overall, the assessment of working capital aims to ensure that the borrower has adequate funds to support their operating cycle and meet their short-term obligations. The specific method chosen depends on the borrower's circ*mstances and the bank's lending policies.

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