An Insight of Corporate Banking – Working Capital Finance
In my first article i introduced and explained the term corporate banking and how it differ from retail as well as investment banking, I also gave the glimpse of some of the corporate banking products/services; here in this article i will elaborate one of the most important products of corporate banking – Working capital finance.
In financial management, two important decisions are very vital and crucial. They are decision regarding fixed assets/fixed capital and decision regarding working capital/current assets. Both are important and a firm always analyzes their effect to final impact upon profitability and risk. Fixed capital refers to the funds invested in such fixed or permanent assets as land, building, and machinery etc. Whereas working capital refers to the funds locked up in materials, work in progress, finished goods, receivables, and cash etc , Working Capital is the life-blood and nerve centre of the business, it is a measure of both a company's efficiency and its short-term financial health Working capital is calculated as: Working Capital = Current Assets - Current Liabilitiesn my first article I introduced and explained the term corporate banking and how it is differ from retail as well as investment banking, I also gave the glimpse of some of the corporate banking products/services; here I will elaborate one of the most important products of corporate banking – Working capital finance.
The object of working capital management is to manage firm’s current assets and liabilities in such a way that a satisfactory level of working capital is maintained. If the firm cannot maintain a satisfactory level of working capital, it is likely to become insolvent and may even be forced into bankruptcy. Thus, need for working capital to run day-to-day business activities smoothly can’t be overemphasized. The working capital ratio (Current Assets/Current Liabilities) indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
Any Business unit needs to purchase raw material, labor and other overheads in the production process, the portion of current assets which are not financed by the current liabilities is known as the working capital gap. The working capital gap is financed ether by own funds or from borrowings. Working capital finance is a loan that has the purpose of financing the everyday operations of a company. Working capital loans are not used to buy long-term assets or investments and are instead used to cover accounts payable, stock, wages, etc.
The facilities provided by the banks for financing the working capital gap are broadly categorized into two segments:
- Funded Facilities: Banks provides funding & assistance to actually purchase current assets or to meet business expenses.
- Non Funded Facilities: Banks can issue letter of credit or can give guarantee on behalf of the customer to the suppliers, Government departments for the procurement of goods/services on credit.
Some of the loans and advances which are considered as working capital finances:
- Cash Credit / Overdraft against inventories and book debts:
This is a running account facility that is extended for a short period, not more than 12 months and reviewed yearly. Banks normally lend money against the primary security of stock and debt. In addition to the collateral security, the borrower only has to pay interest on the amount actually utilized by it. And also required to submit monthly stock & book debt statements so that the bank can calculate his/her drawing power (The maximum limit the borrower can utilize during that month subject to the sanction limit) In order to repay and close the account simply deposit the outstanding dues into the account. Whereas overdraft facility is to get access to cash immediately as and when required, means the act of overdrawing from a Bank account. In addition, the borrower has to pay only the interest on the amount actually utilized by it. In order to close, simply deposit the outstanding dues into the account. This is the most common facility used by the corporates to finance their working capital gap, the level of finance depends upon the nature of current assets less desired margin, within the overall permissible bank finance, RBI, from time to time, prescribes norms for working capital to be financed by banks. The most important step was taken by the RBI IN July, 1974 when a committee was being formed under the chairmanship of Mr.P.L Tandon and the committee was named Tandon Committee, the practices of almost all the Indian banks are influenced by the tandon committee recommendations. The term MPBF (maximum permissible bank finance) was given by this committee only, MPBF calculation is being used to calculate the maximum level of working capital which a bank can finance.
Three methods for determining MPBF
- MPBF = .75(CA – CL)
- MPBF = .75 (CA) – CL
- MPBF = .75 (CA – CCA) – CL
CA = Current Assets, CL = Current Liabilities, CCA = Core Current Assets A borrower using cash credit limit or overdraft facility is required to submit the following statements on periodical basis:
- Stock & Book Debt statement – Monthly
- Quarterly Information system I (QISI) – Quarterly
- Quarterly Information system II (QISII) – Quarterly
- Half yearly operating statement – Half Yearly
- Balance sheet an P&L – Yearly
- Stock Audit Report – Yearly
2. Packing Credit Limit against Export orders / inventories
Packing credit financing enables exporters to procure raw materials for the manufacture of finished goods for export. The facility is available both in Indian Rupee and in major foreign currencies to Exporters, enabling the exporters to compete in global market against others. This limit is financed by the banks against a confirmed purchase order received by the Indian exporter from overseas buyer, this limit is generally granted for very shorter period varies from 90 days to 120 days and has to be liquidated by the export funds only. Apart from the confirmed purchase order the exporter is required to submit insurance policy from ECGC (Export credit Guarantee commission) for each buyer to cover the anticipatory risk involved in international trade and to secure the financing by the banks.
3. Buyers Credit:
As an importer, one can avail of Buyers Credit facility at very competitive rates. One can make the import payment to its overseas supplier by availing the buyers credit and can repay the lender at a later date. The funding is arranged from the overseas network branches and one can avail this product in major currencies. Availing Buyers credit would be subject to compliance with the bank’s internal process and policy requirements.
CA Kapil Khandelwal
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