Working capital


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Working capital

  1. 1. Working Capital <ul><li>What is working capital? </li></ul><ul><li>What are it’s components? </li></ul><ul><li>What factors influence working capital? </li></ul><ul><li>How is working capital projected? </li></ul><ul><li>What are the strategies as regards it’s financing? What is aggressive/moderate and conservative policy as regards working capital? Double edge characteristic. </li></ul><ul><li>What is operating cycle? How it is calculated? </li></ul><ul><li>Why is working capital important? </li></ul><ul><li>Working capital financing in India-various committees. </li></ul><ul><li>Receivables management-credit period decision evaluation-reports-control-credit policy. </li></ul><ul><li>Creditors management-report-payment terms-prompt payment discount evaluation. </li></ul><ul><li>Inventory management (EOQs, ABC analysis, slow moving-non moving, slump sale etc) </li></ul><ul><li>Cash /liquid resources management ( transactive /precautionary/speculative motive) </li></ul><ul><li>Different ways of financing working capital </li></ul><ul><li>Some practical hints classification of current assets . </li></ul>
  2. 2. What is working capital? <ul><li>Once the project is set up and goes on stream, the portion of capital which gets blocked in current assets and which is essentially required to keep the business going on. </li></ul><ul><li>Capital that is needed to keep business entity working round the clock! </li></ul><ul><li>Simply it is current assets less current liabilities including bank borrowings. </li></ul>
  3. 3. Working capital cycle Suppliers Raw materials WIP Finished goods overheads cash Accounts receivables
  4. 4. What factors influence working capital? <ul><li>Nature of business. ( services-manufacturing ) </li></ul><ul><li>Seasonality of operations. (ceiling fans?) </li></ul><ul><li>Production policy. (ceiling fans?) </li></ul><ul><li>Market conditions. (competitors) </li></ul><ul><li>Conditions of supply. (smooth supply/erratic supply) </li></ul>
  5. 5. Proportion of current assets and fixed assets Trading/construction 10-20 80-90 Edible oils/tobacco 20-30 70-80 Cotton textile/sugar 30-40 60-70 Tea plantation 40-50 50-60 Steel/chemicals 50-60 40-50 Aluminium/shipping 60-70 30-40 Electricity generation 70-80 20-30 Hotels/Restaurants 80-90 10-20 Industries Fixed assets (%) Current assets (%)
  6. 6. How is working capital projected? <ul><li>Flexible policy or conservative policy . </li></ul><ul><li>( fewer stoppages, quick delivery, stimulates sales due to liberal credit but this may result in higher carrying costs) </li></ul><ul><li>Restrictive / aggressive policy </li></ul><ul><li>( opposite to above policy) </li></ul><ul><li>Optimal Policy. </li></ul><ul><li>( trade off between carrying costs and shortages costs </li></ul>
  7. 7. Carrying costs / shortage cost (trade off) <ul><li>Carrying /shortage cost </li></ul>Level of current assets Carrying cost Shortage cost Total cost CA
  8. 8. Strategies for financing time Capital requirement Peak requirement Minimum requirement median
  9. 9. What is operating cycle? How it is calculated? <ul><li>Operating cycle begins with procurement of raw materials and ends with collection of receivables. It can be broadly divided into four stages (RM-WIP-FG-Receivables-Collections) </li></ul><ul><li>Duration of operating cycle is equal to the sum of the durations of each of these stages less the credit period allowed by the suppliers. </li></ul><ul><li>O=R+W+F+D-C </li></ul><ul><li>R=average stock of raw materials & stores/average daily consumption </li></ul><ul><li>W=average WIP/average daily cost of production </li></ul><ul><li>F=average FG stock/average daily cost of sales </li></ul><ul><li>D=average receivables/average daily sales </li></ul><ul><li>C=average creditors/average daily credit purchases. </li></ul>
  10. 10. Why is working capital important? <ul><li>Two characteristics make it special: </li></ul><ul><li>Short life span </li></ul><ul><li>Swift transformation in other assets. </li></ul><ul><li>Decisions relating to working capital management are repetitive and frequent. </li></ul><ul><li>The difference between profit and present value is insignificant. </li></ul><ul><li>Close interaction among working capital components implies that efficient management of one component can not be undertaken without simultaneous consideration of another component. (cash crunch-discount-accumulation of FG-liberal credit) </li></ul><ul><li>Investment in current assets involves substantial portion of total investment. </li></ul><ul><li>Investments in current assets and the level of current liabilities have to be geared quickly to changes in sales. </li></ul><ul><li>Although fixed asset investments and long term financing are also responsive to variation in sales however the relationship is not as close and direct as it is in the case of working capital components. </li></ul>
  11. 11. Working capital financing in India-various committees. <ul><li>Dahejia Committee ( 1968-69) Reference:the extent to which credit needs are likely to be inflated and how such trends could be checked. Concluded that short term banking funds diverted for long term needs. Weak corelation between bank credit and growth of industrial output. Need for separating permanent portion of working capital to be financed by long term funds. </li></ul><ul><li>Tandon Committee ( 1974) Reference: optimum utilization of bank credit. First major attempt to regulate bank credit. Even today although RBI has given freedom in assesing and financing working capital to individual banks most of the banks still use norms/methodology laid down by this committee. Bank credit viewed as tool of resource allocation. It suggested inventory norms for major 15 industries setting maximum levels. Norms were made applicable to all including SSI with aggregate limits of more than Rs 10 lakhs. It also suggested deviation from nborms in case of abnormal circumstances. </li></ul>
  12. 12. Tandon Committee (example) 400 Core Current assets A1 2.22 1.33 1.25 Current Ratio H 450 750 800 Current liabilities ( including bank finance) G 1000 1000 1000 Current Assets F 550 A1+(25%(A-A1)) 250 (25% of A) 200 (25% of gap) Net working Capital / Margin Money (long term) E 250 (gap-margin) 550 (gap-25%of A) 600 (75% of Gap) Bank Finance D 800 800 800 Working Capital Gap C 200 200 200 Creditors & payables B 600 1000 1000 Current Assets A 3 rd Method 2 nd Method 1 st Method
  13. 13. Academic significance <ul><li>Current ratio gradually improves. </li></ul><ul><li>Margin money / net working capital improves by way of long term portion. </li></ul><ul><li>Although RBI has now given freedom to banks in assessing and financing working capital, these norms and methodology is still followed by many banks. </li></ul>
  14. 14. Reporting system <ul><li>Chore Committee(1979) Reference: improvements in cash credit system for better management. Improving inter relationship between credit and production. Committee’s recommendation of applying 2 nd method of Tandon committee for all borrowers having credit limits of more than 10 lakhs not accepted by RBI and instead applied to borrowers having limits of more than Rs 50 lakhs. Shortfall in working capital can be given as WC term loan repayable in 5 years carrying 2% extra interest. Extra interest suggestion not accepted by RBI. Separate limits for peak level and normal requirements. Introduced QIS Form 1 quarterly projection of sales/production etc, Form 2 actual and projection comparison, form 3 half yearly P7L and fund flow. </li></ul>
  15. 15. Special facility-SSI Units ( investment up to Rs1cr in P&M –SSI and from 1-10 cr is SME) <ul><li>Nayak Committee ( 1991) reference: difficulties faced by small scale industries in securing finance. </li></ul><ul><li>SSI units are entitled for working capital at minimum 20% of projected sales (applicable for units having requirements up to Rs 500 lakhs) quantum of working capital bank financing to be 20% of projected sales subject to promoters’ contribution of 5% of projected sales i.e 20% of total fund requirement that has been estimated at 25% of projected sales. Collateral security and third party guarantee can be dispensed with. Two separate categories were made up to Rs 500 lakhs and above Rs 500 lakhs. </li></ul>
  16. 16. Overview-WC management <ul><li>Working capital is synonymous with current assets. Gross WC is current assets net working capital is current assets less current liabilities. </li></ul><ul><li>WC management concerns administration of firm’s current assets along with financing (especially current liabilities) needed to support current assets. </li></ul><ul><li>In determining optimum level of current assets management has to consider trade off between profitability and risk. Higher level will lead to liquidity but will lead to the risk of lower profitability. Profitability varies inversely with liquidity but moves together with risk. </li></ul><ul><li>WC has different components but it can be also classified by time permanent or temporary. </li></ul><ul><li>Permanent WC is the amount of current assets required to meet a firm’s long term minimum need. Temporary on the other hand is the amount that varies with seasonal needs. </li></ul><ul><li>When we adopt hedging approach to financing, each asset would be offset with financing instrument of approx same maturity. Short term seasonal variations would be financed with short term debts whereas permanent portion with long term debt or equity. </li></ul><ul><li>Longer the composite maturity schedule of financing, less risky is the financing but longer the maturity schedule financing is likely to be costly and hence less profitable. </li></ul><ul><li>The two key facets of WC management are-what level to maintain and how to finance them. These both facets are interdependent. </li></ul>
  17. 17. Inventory Management <ul><li>Object: to maintain quantities of stocks at a level which optimises some predetermined management criteria which could be- </li></ul><ul><li>a) minimising costs incurred as whole, as the result of holding stocks. </li></ul><ul><li>b) maximising profit. </li></ul><ul><li>c) maintain certain level of customer service. </li></ul><ul><li>d) guard against likely abnormal situations, if any. </li></ul>
  18. 18. Disadvantages of low stocks <ul><li>Unable to meet delivery schedules thereby causing loss of existing customers as well as future business. </li></ul><ul><li>In order to fulfil commitments to important customers costly emergency purchases ( special production runs) may become necessary to maintain goodwill. </li></ul><ul><li>Lower reordering level may result into higher reorder costs. </li></ul>
  19. 19. Disadvantages of high stock <ul><li>High storage & holding costs-chances of deterioration. </li></ul><ul><li>Loss due to capital tied up. </li></ul><ul><li>Locking of capital may result in to losing it’s alternative better uses. </li></ul><ul><li>Losses due to market price fluctuations on lower side. </li></ul>
  20. 20. Cost of holding stocks <ul><li>Purchase price </li></ul><ul><li>Cost of capital tied up. </li></ul><ul><li>Insurance </li></ul><ul><li>Deterioration </li></ul><ul><li>Obsolescence </li></ul><ul><li>Damage / pilferage </li></ul><ul><li>Store up keep </li></ul><ul><li>Labour & administrative costs. </li></ul><ul><li>Reorder cost </li></ul><ul><li>Shortage cost </li></ul><ul><li>Systems cost </li></ul>
  21. 21. Some of the best practices <ul><li>Reordering levels. </li></ul><ul><li>EOQ. </li></ul><ul><li>Standardisation. </li></ul><ul><li>Insurance spares. </li></ul><ul><li>ABC analysis. </li></ul><ul><li>Reports generation- actual-norms. </li></ul><ul><li>Corrective actions. </li></ul><ul><li>Responsibility fixing. </li></ul><ul><li>Preventive maintenance schedule. </li></ul><ul><li>Vendor development / sourcing. </li></ul><ul><li>Supply chain management. </li></ul><ul><li>Market feedback. </li></ul><ul><li>Effective coordination amongst departments. </li></ul><ul><li>Logistics services. </li></ul><ul><li>Outsourcing some of the activities. </li></ul><ul><li>Sub contracting. </li></ul><ul><li>Reengineering aimed at reducing the production process time / lead time. </li></ul><ul><li>Control over slow moving / non moving stocks. </li></ul><ul><li>Production planning. </li></ul><ul><li>Method of inventory valuation. </li></ul><ul><li>Removing bottlenecks in production, </li></ul><ul><li>Reducing change over time. </li></ul><ul><li>Adequate down stream facilities / balancing facilities. </li></ul>
  22. 22. Credit management <ul><li>Always remember, as creditors provide you the source of working capital your credit to customers is also partially funding his working capital. </li></ul>
  23. 23. Aspects of credit management <ul><li>Terms of payment. </li></ul><ul><li>Credit policy variables . (conflict-cross functional teams involving marketing & finance) </li></ul><ul><li>Credit evaluation. </li></ul><ul><li>Credit granting decision. </li></ul><ul><li>Review of credit. </li></ul><ul><li>Customer weightages. </li></ul><ul><li>Control of accounts receivables. </li></ul><ul><li>Latest trends in credit management (outsourcing). </li></ul>
  24. 24. Extremes in terms of payment <ul><li>Liberal credit till buyer converts goods into cash and then pays. </li></ul><ul><li>Buyer pays 100% advance and finances the entire trade cycle. </li></ul><ul><li>Actual practice the scene is in between the above two. </li></ul>
  25. 25. Payment terms <ul><li>Cash. </li></ul><ul><li>Open credit. (max outstanding at any point of time) </li></ul><ul><li>Line of credit ( upper ceiling) </li></ul><ul><li>Revolving credit. </li></ul><ul><li>Open / revolving credit with prompt payment discount. </li></ul><ul><li>Documentary credit.-demand bills - usance bills </li></ul><ul><li>Letter of credit </li></ul>
  26. 26. Credit policy variables. <ul><li>Credit standards ( customer category) </li></ul><ul><li>Credit period-fixed / variable to category. </li></ul><ul><li>Cash discount </li></ul><ul><li>Collection efforts </li></ul><ul><li>- monitoring state of receivables </li></ul><ul><li>- follow up for payment </li></ul><ul><li>- legal action </li></ul><ul><li>Nature of business </li></ul>
  27. 27. Credit evaluation <ul><li>Willingness of customer to honour obligation. ( character) </li></ul><ul><li>Ability to meet obligation based on operating cash flow. ( capacity) </li></ul><ul><li>Financial reserves ( capital) </li></ul><ul><li>Security offered ( collaterals) </li></ul><ul><li>General economic condition ( condition) </li></ul><ul><li>Sources to get above-bank references, financial statements, experience, stock prices , DGs& D registration etc </li></ul>
  28. 28. Should credit be granted? Credit Risk analysis character capacity capacity weak strong capital capital weak strong Dangerous risk Doubtful risk weak strong weak Fair risk strong Excellent risk capital capital weak strong strong weak weak strong Credit Period?
  29. 29. Credit granting decision <ul><li>Evaluate business potential. </li></ul><ul><li>Chances of repeat order. </li></ul><ul><li>Chances of approved supplier. </li></ul><ul><li>Chances of continuous annual open order. </li></ul>
  30. 30. Control of receivables <ul><li>Periodic reports </li></ul><ul><li>Review & follow up. </li></ul><ul><li>Ageing of receivables-flags </li></ul><ul><li>Collection matrix-to study trend. </li></ul><ul><li>Expert agencies ( credit rating) </li></ul><ul><li>Collection agents? Pit falls </li></ul><ul><li>Incentives. </li></ul><ul><li>Clear cut responsibility fixing. </li></ul>
  31. 31. Payables management <ul><li>It is the source of capital for business. </li></ul><ul><li>Should be given equal importance as receivables. </li></ul><ul><li>Involves: </li></ul><ul><li>Negotiations </li></ul><ul><li>Volumes </li></ul><ul><li>Price revisions </li></ul><ul><li>Escalations </li></ul><ul><li>Annual review. </li></ul><ul><li>Prompt payment discounts. </li></ul><ul><li>Deferred credit </li></ul>
  32. 32. Cash management <ul><li>Cash budgeting </li></ul><ul><li>Long term cash forecasting </li></ul><ul><li>Reports for control </li></ul><ul><li>Cash collections & disbursements </li></ul><ul><li>Optimal cash balance </li></ul><ul><li>Investment of surplus cash </li></ul><ul><li>Cash management models </li></ul>
  33. 33. Cash budgeting <ul><li>Estimating cash requirements </li></ul><ul><li>Planning short term financing </li></ul><ul><li>Scheduling capex </li></ul><ul><li>Developing credit policies </li></ul><ul><li>Checking accuracy of long term forecast </li></ul>
  34. 34. Investment portfolio <ul><li>Segments: ready cash – controllable cash- free cash. </li></ul><ul><li>Criteria: safety-liquidity-yield-maturity. </li></ul><ul><li>Options: term deposits with banks-treasury bills-mutual funds-commercial paper-ICD </li></ul>
  35. 35. Cash & short term investment <ul><li>Corporates hold cash to meet transactions, as well as for speculative and precautionary motives. </li></ul><ul><li>Cash management involves efficient collection and payments and investments out of temporary surpluses. </li></ul><ul><li>Efficient cash management consists of speedy collections and slowing down of payments. </li></ul><ul><li>Collections can be accelerated with the help of computerised billing, automatic debits, lockboxes, electronic transfers, electronic commerce etc. </li></ul><ul><li>Disbursements can be controlled through separate disbursement accounts, zero balance accounts, </li></ul><ul><li>Use of outsourcing wherever practical and feasible especially billing, collections, disbursements, short term investments etc. </li></ul><ul><li>Optimum cash balance will be based on transactions balances or minimum balance requirements of the bank whichever is higher. </li></ul><ul><li>Short term investments can be based on ready cash segment, controllable cash segments (taxes ,dividends etc) and free cash segments. </li></ul><ul><li>Principles of safety, marketability, yield and maturity will be deciding factors for portfolio. ( trade off between risk & returns). </li></ul>
  36. 36. Cash management cycle cash collections disbursements Short term investments Control by reporting Funds flow Information flow With timely information reporting it is possible to generate significant Income by properly managing collections, disbursements & investments.
  37. 37. Collection float Customer Mails check Receipt of check Check deposit Actual credit Mail float Processing float Clearing float Total float
  38. 38. Reducing collection float <ul><li>Collection float is important because we have to wait until a check mailed by the customer finally clears the banking system before cash becomes available. To turn mailed checks into cash more quickly collection float need to be reduced as much as possible. </li></ul><ul><li>What are the different ways to do this? </li></ul>
  39. 39. Reducing collection float <ul><li>Quicker invoicing : either send with shipment , by fax, by e-mail,should be computerised, or claim payment based on proforma. </li></ul><ul><li>Eliminate billing : preauthorised debits (ECS) </li></ul><ul><li>Lockbox system : post box maintained by bank to receive checks. This can be single location or multiple location. Evaluate financial implications. </li></ul><ul><li>Take benefit of multiple city checks at par. </li></ul><ul><li>Insist on payments by drafts or wire transfer . </li></ul><ul><li>Cash concentration through concentration banking. (Air India) </li></ul><ul><li>Prepare for paperless payments over a period of last 10 years paper based payment options such as checks have fallen from 81% of consumer spending to just 60%. </li></ul><ul><li>Stored value or prepaid cards. </li></ul><ul><li>Credit cards / debit cards. </li></ul>
  40. 40. Slowing down payments <ul><li>Playing the float: checks in transit, difference in book balance and bank balance. </li></ul><ul><li>Zero balance account linked to master account ( Ashok Leyland) </li></ul><ul><li>Policy to issue checks only on weekends. </li></ul><ul><li>Standing instructions to the bank to encash deposits kept in multiples internally. </li></ul><ul><li>Remote bank branch disbursements. </li></ul><ul><li>Renegotiate quick payment discount such to beat the cost of borrowing. </li></ul><ul><li>Outsourcing certain operations. </li></ul>
  41. 41. Integrated Financial Management System <ul><li>Essentials of an effective IFMS </li></ul><ul><li>-integration of budgeting-accounting-receivables-payables-inventory-cash management modules. </li></ul><ul><li>- timely reports. </li></ul><ul><li>- analysing reports </li></ul><ul><li>-corrective actions </li></ul><ul><li>-follow up. </li></ul>
  42. 42. Financing working capital <ul><li>Spontaneous financing ( creditors / accrued expenses) </li></ul><ul><li>Bank overdraft </li></ul><ul><li>Cash credit. </li></ul><ul><li>Bill discounting </li></ul><ul><li>Letters of credit </li></ul><ul><li>Factoring </li></ul><ul><li>Packing credit </li></ul><ul><li>Commercial paper </li></ul><ul><li>Advance against book debts. </li></ul>
  43. 43. Credit Rating system & Credit Risk Assessment. <ul><li>Earlier banks were scoring only two financial parameters depicting operating efficiency / strength of borrowing unit and few subjective aspects of the functioning of the unit. The total score used to be graded against scale and the pricing was decided on that basis. </li></ul><ul><li>CRS has now been replaced by CRA </li></ul>
  44. 44. Credit Rating system & Credit Risk Assessment. <ul><li>The earlier system relied on only two parameters Current ratio and debt equity ratio and other factors to depict adherence to financial discipline. Certain other areas used to be commented upon like extent of irregularity ( drawing in excess, default in payment etc) submission of QIS etc </li></ul><ul><li>Stress was more on compliance aspect and not on inherent risk in the proposal / venture. </li></ul><ul><li>CRS was more a loan classification system. </li></ul><ul><li>In today’s deregulated financial regime performance as well as risk perception in respect of borrowing unit is considerably influenced by external factors like industry scenario, Govt regulations, national / global economic scenario etc. </li></ul><ul><li>Risk factors need to be factored to arrive at </li></ul><ul><li>credit sanction </li></ul><ul><li>pricing thereof. </li></ul>
  45. 45. Credit Rating system & Credit Risk Assessment <ul><li>Risk elements ( financial, industrial, management) </li></ul><ul><li>Financial Risk </li></ul><ul><li>a) latest financials of the unit </li></ul><ul><li>b) average financials over a period of time (better, at par, worse) </li></ul><ul><li>c) comparison of latest financial with industry average. (better, at par, worse) </li></ul><ul><li>d) other risks-off balance sheet items ( contingent liabilities, disputes, guarantees, tax claims, accounting policies, auditor’s remarks etc) impact on profitability, interest coverage is done with sensitivity / probability approach. Qualifying remarks of auditors like non provisioning, recognising of income are also impacted. </li></ul><ul><li>Financial ratios will include </li></ul><ul><li>Current ratio, Debt equity, PBDIT/Interest, PAT/sales, ROCE or ROA, Inventory+Receivable/ net sales in days. Weightages- 25%, 25%, 10%,10%, 10% 20%. </li></ul>
  46. 46. Credit Rating system & Credit Risk Assessment <ul><li>Industry Risk: study current trends ( specific activity in particular) and translate perception into quantifiable terms. </li></ul><ul><li>This is generally done by value statement of various aspects of the industry risk parameters. </li></ul><ul><li>These are: </li></ul><ul><li>a) competition / market </li></ul><ul><li>b) industry cyclicality.( long term propects, stable outlook, stable industry cycle) </li></ul><ul><li>c) Regulatory (regulatory framework, availability of skilled labour, environment pollution, labour unrest) </li></ul><ul><li>d) Technology( kind of technology, state of maintenance,capacity utilisation) </li></ul><ul><li>e) Input profile ( rm availability, its price stability, alternate users, substitutes available) </li></ul><ul><li>f) User profile ( distinctive product, substitutes available, large buyers, no complaints) </li></ul>
  47. 47. Value statement example <ul><li>Competition & market risk: ( score of 4 for following) </li></ul><ul><li>a) company is one of the lead players or has an exclusive niche market or brand equity, ancillaries tie up with well known major domestic / multinational company. </li></ul><ul><li>b) has a market share growing faster than the industry. </li></ul><ul><li>c) does not depend on one or few buyers. </li></ul><ul><li>d) has a large area of operations. </li></ul><ul><li>e) has a range of products. </li></ul>
  48. 48. Value statement example <ul><li>Score of 3 for following: </li></ul><ul><li>Few significant players in the market. There are some barriers to entry. Company is one of the top three players. </li></ul><ul><li>Sufficient orders on hand. </li></ul><ul><li>Has a established brand which is well received. </li></ul><ul><li>Has a share which is steadily growing. </li></ul><ul><li>Has fairly large area of operations. </li></ul>
  49. 49. Value statement example <ul><li>Score of 2 could be for: </li></ul><ul><li>a) Competition heating up but by and large demand still exceeds supply. </li></ul><ul><li>b)Adequate orders on hand. </li></ul><ul><li>c)Is one of the average players. </li></ul><ul><li>Score of 1 could be for: </li></ul><ul><li>Market share is declining </li></ul><ul><li>Depends on few buyers. </li></ul><ul><li>Recession in market. </li></ul><ul><li>Does not have range of products. </li></ul><ul><li>Score of 0 could be for: </li></ul><ul><li>Industry has problem of over supply. </li></ul><ul><li>Company is insignificant player with no distinguished product line. </li></ul><ul><li>Depends on one or very few buyers. </li></ul>
  50. 50. Credit Rating system & Credit Risk Assessment <ul><li>Management Risk: perhaps the most important area of risk assessment especially when the management has not been time tested. </li></ul><ul><li>These include </li></ul><ul><li>a) integrity </li></ul><ul><li>b) track record </li></ul><ul><li>c) structure & systems </li></ul><ul><li>d) Expertise </li></ul><ul><li>e) Capital market perceptions ( may not be in case of agri, SSi etc) </li></ul>
  51. 51. CRA models <ul><li>Depending upon market segment and exposure proposed every bank has different models. </li></ul><ul><li>For example ABank has following: </li></ul><ul><li>Regular Model: (based on all risk parameters) </li></ul><ul><li>applicable for WC limits of Rs 5 cr and above in C&I, SSI and Agriculture segments, Rs 2 cr and above in trade segment. </li></ul><ul><li>Simplified (regular)model: ( based on only financial risk parameters) applicable for WC limits below Rs 5 cr in C&I, WC limits in the range of 2-5 cr for SSI & Agri and limits below 2 cr for trade. </li></ul><ul><li>Simplified liberal model (taking simplified model and again liberalizing it further) applicable to WC limits of Rs 25 lakhs and above and up to Rs 2 cr in SSI & Agri </li></ul><ul><li>for this model NFB is excluded to compute the limits </li></ul><ul><li>Some delegations and powers given to CGMs for interpretation </li></ul>
  52. 52. Models-applications Regular Simplified regular Simplified regular Simplified liberal CRA Model 520 470 230 230 Total 120 70 20 50 NFBWC 400 400 210 180 FBWC IV III II I situations ( Rs lakhs)
  53. 53. Risk & pricing <ul><li>Banks generally make a Risk Range Table </li></ul><ul><li>All the risks are scored according to the laid down formulae. </li></ul><ul><li>If some items could not be scored the score is proportionately reduced. </li></ul><ul><li>Total score is found out. </li></ul><ul><li>The relevant gradation is found out. </li></ul><ul><li>According to the gradation pricing is done </li></ul><ul><li>For example for a total risk score of 68 risk gradation could be AB3 and the corresponding pricing could be 3% above it’s PLR or such other rate fixed. </li></ul>
  54. 54. Risk & pricing <ul><li>Some time banks fix the exposure to a particular borrower based of initial assessment. For example no fresh / additional exposure will be allowed in respect of proposals which have been assessed at a grade worse than say AB5. </li></ul><ul><li>Some exceptional authorities could be given at a level. </li></ul><ul><li>Some time review of WC limits is done at half yearly or annual intervals. </li></ul><ul><li>Some times for deviations for say more than 20% in ratios or default in payment may attract penal interest. </li></ul><ul><li>Sometimes additional collaterals will be called for. </li></ul><ul><li>Sometimes pricing is done on account value based pricing model which considers volume of business, share of ancillary business to bank, value of account, price/earning ratio, length of relationship with the bank. These are quantitative parameters. The qualitative parameters will include threat of loss of business due to competition, overall image or reputation of the company, perception of long term benefit to company, perception of group potential for growth and business to bank. </li></ul>