The document discusses different methods used in India to assess working capital financing needs for MSMEs. It outlines recommendations from the Tandon Committee from 1974 and the Chore Committee from 1979 that established three methods and guidelines for calculating credit limits. Currently, common methods used include the FOIR method based on income, the operating cycle method based on business cycles, and the drawing power method based on stock levels and debtors.

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Working Capital Financing Underwriting Methods
To assess the financingneed of MSME sector in India,GOI has setup committees from time to time to reviseand improve the cr edit
assessment process. Following committees have setup in India-
 Tandon Committee- Commissioned in July’74 under chairmanship of Mr. P.L. Tandon
 Chore Committee- Commissioned in 1979 under chairmanship of Mr. Chore
Tandon Committee- RBI commissioned this committee to study the entire ecosystem of working capital finance and recommend ways
to optimize utilization of bank credit. Most of the bank still use the recommendations of Tandon committee. It proposed three
methods to calculate the working capital gap.
Method Calculation Suitability
First Method
Credit limit-Max[0.75*(CA1-CL)]
CL does not include bank borrowing*
Suitable for small borrowers where
credit requirement is up to INR 10 lakhs
Second Method
Borrower to provide 25% of total current assets out of long-term
funds hence following formula is used to cal.-
Credit limit- Max[0.75*(CA)-CL]
Workingcapital need of those borrower
enjoying fund based credit facilities
more than INR 10 lakhs
Third Method
Borrower contribution from long term funds will be the extent of
entire core current asset2 as defined by study group.
Credit limit- Max[0.75(CA-CCA)-CL]
Mostly for academic purpose
Chore Committee- RBI commissioned this committee to review cash credit system of banks to streamline the system. Major
recommendations of committee were-
 Abolished the previous practice of bifurcation of account into demand loan and cash credit account to charge differential interest
rate
 Banks to set separate credit limit for borrower according to the business session (peak/non-peak)
 Before commencement of every quarter borrower must indicate/share his expected requirement of credit amount known as
operating limit. A tolerance level of 10% is allowed in operating limit either direction
 Temporary limit should be dealt carefully and marked as demand loan with additional interest of 1% over normal interest rate
 Banks to use second method of lending proposed by Tandon committee to maintain current ratio of 1.33:1
Currently, Organizations uses below mentioned methods to assess credit limit for working capital financing apart from methods
prescribed by Tandon and Chore committee-
 FOIR- It is one of the most popular method used for assessing eligibility and setting credit limit by financial institutions. Following
steps to be undertake to calculate the credit limit-
oEligible income of applicant
oFOIR ratio set by the organization
oCurrently monthly loan obligation
oEligible loan amount- [((eligible income*applicable FOIR)/12-Currently monthly loan obligation)]
 Operating cycle method- Estimatingworkingcapital requirementbased on the operatingcycleof organization i.e.fromprocurement
of raw material to sales realization using following formula-
Working capital- [Estimated cost of goods sold * (Operating cycle/365)]+[Desired cash & bank balance]
 Drawing power method- Majorly used in CC facility availed from banks, DP is calculated from stock less creditors plus book debt-
Dealer Statement Drawing Power Calculation
Particulars $ Mn Particulars $ Mn Particulars $Mn
Stock 100 Stock 100 Debtors 80
Creditors 20 Less: Creditor 20 Less: Debtors < 90 days 20
Total Debtors 80 Paid Stock 80 Debtors allowed for DP 60
Debtor < 90 20 Less: Margin 25% 32 Less: Margin 40% 24
Stock Margin 0.25 Allowed DP cal 48 Allowed DP cal 36
Debtor Margin 0.40 Total DP 84
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CA-Current Asset, CL- Current Liabilities, CCA- Current Core Assets
2
Absolute minimum level of raw materials, process stock, finished goods and stores which are in the pipeline to ensure continuity of production