Working capital refers to the funds required to operate a business on a day-to-day basis. It is used to acquire current assets such as inventory and accounts receivable. There are various methods to assess working capital requirements, including the operating cycle method, turnover method, and projected balance sheet method. The operating cycle method calculates needs based on the time required to complete the operating cycle from acquiring raw materials to collecting payment from customers. The turnover method, recommended by the Nayak Committee, sets the requirement at 25% of projected annual turnover. Proper validation of projections is important when using the projected balance sheet method for larger businesses.

1. Working Capital
By
P. Venkat Rao
1

2. Funds required to acquire current
assets to enable business/industry
to operate at the expected levels.
What is Working Capital ?

3. Working Capital
• Business needs long term and short term funds
• Long term funds needed for fixed assets,
permanent assets
• Met through Fixed or Permanent Capital or
Long term Debt
• Short term funds needed for acquiring short term
assets, meet day to day business expenditure
• Met through Temporary capital, circulating capital
or Working Capital
• Banker meets both long term and short term needs

4. CONCEPTS OF WORKING CAPITAL
 GROSS WORKING CAPITAL = CA
These are in the system used/ consumed on a day to
day basis.
 NET WORKING CAPITAL = CA – CL
OR
(NW + TL) – (FA + MA + IA)
NWC (Liquid Surplus) is the entrepreneur's margin
available in the system from Long term Funds.
WCR = ST Application of Funds
Sources of WC Funds are Short Term as well as Long Term

5. WC Limits
• Cash Credit & OD facilities
• Drawing Power
• ‘Interest only’ facility
• Interest charged on the capital used
• Validity of 12 months; Renewal at existing level or
with enhancement or reduction of limit
• Short term, but practically speaking, WC finance
is long term !
• Requires closer & greater monitoring
• Project Cost : Margin for Working Capital
• Self-liquidating
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6. What are Working Capital Sources?
 Own funds sundry debtors falls under
current assets
sundry creditors under current
liabilities
 Bank borrowings
 Sundry Creditors
 Advances from customers
 Deposits due in a year

7. Current Assets for Bankers
• Any Asset that gets converted into cash within
the “Operating Cycle” or which forms part of
the operating cycle is current Asset for
bankers
• Logic- Bank finance to be used only for creation
of assets which will be sold and reconverted
into cash
• Investments in subsidiaries, deposits with
customs, electricity boards, municipal
authorities, advances to staff etc would not be
current assets to bankers

8. OPERATING CYCLE
Stages:
1) Raw materials (RM/RM consumption)
2) Work-in-process (WIP/COP)cost of production
3) Finished Goods (FG/COS)cost of sales
4) Receivables (Debtors/Credit sales)
Less:
Creditors (creditors/purchases)
…...begins with acquisition of raw materials and
ends with collection of receivables.

9. Operating Cycle for Bankers
• Only those assets which are involved in completing the
“Operating Cycle or Cash Cycle” or part of it.
Cash
Raw
materials
Stock in
process
Finished
Goods
Sales
Debtors

10. Service
Length of Operating Cycle
Receivables
Cash
Trade Industry
CashCash
Stocks
Receivables Receivables
Finished Goods
Semi Finished Goods
Raw
Material

11. WC Assessment Methods
• Operating Cycle Method
• Drawing Power Method
• Turnover Method
• Traditional Method
• Projected B/S Method
• Cash Budget Method
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12. Operating Cycle Method
Working capital requirement =
Operating expenses p.a.
------------------------------------------
No. of operating cycles in a year

13. Operating Cycle Method
A. Length of operating Cycle
a. Procurement of Raw Material 30 days
b. Conversion / Process time 15 days
c. Average time of holding of FG 15 days
d. Average Collection Period 31 days
e. Length of Operating Cycle (a+b+c+d) ….. days
f. No. of Operating Cycles in a year
(365days/e)
.…. cycles

14. …..Operating Cycle Method
•
B. Total Operating Expenses per
Annum
Rs 60 lakhs
C. Total Turnover per Annum Rs 70 lakhs
D. Working Capital Requirement Rs. … lakhs

15. Drawing Power Method
(for units with small limits)
Particulars Stock value Margin DP
Paid stocks (RM -- Creditors) 4 25% …
Semi Finished goods 4 50% …
Finished goods 4 25% …
Book debts 4 50% …
Total … …
(Rs.in lacs)

16. Drawing Power Method
(for units with small limits)
Particulars Stock value Margin DP
Paid stocks (RM -- Creditors) 4 25% 3
Semi Finished goods 4 50% 2
Finished goods 4 25% 3
Book debts 4 50% 2
Total 16 10
(Rs.in lacs)

17. Nayak Committee
• Report of the Committee to Examine the Adequacy of
Institutional Credit to SSI Sector(now MSE) and
Related Aspects
• MSMED Act 2006
• Enterprises engaged in the manufacture or
production, processing or preservation of goods &
• Whose Investment in P & M is:
Micro E: upto Rs. 25 L
Small E: > Rs. 25 L & upto Rs. 5 Cr.
Medium E: > 5 Cr. & upto Rs. 10 Cr.
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18. Recommendations
• (i) give pref. to village industries, tiny industries
and other small scale units in that order, while
meeting the credit requirements of the SSI;
• (ii) grant working capital credit limits to SSI (now
MSE) units computed on the basis of minimum
20% of their est. annual turnover whose credit
limit in individual cases is upto Rs.2 Cr.[since
raised, Rs.5 Cr.]
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19. DANGERS OF INADEQUATE WORKING CAPITAL
1.It Stagnates Growth
2.Fixed Assets Underutilised
3.Operating Inefficiency Creeps In
4.Difficult To Achieve Targets Of Business For
Production And Profit
5.Business Reputation At Stake
6.Situation Of Tight Credit Terms
7.Difficult To Meet Payment Commitments
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20. DANGERS OF EXCESSIVE WORKING CAPITAL
1.Accumulation Of Unnecessary Inventory
2.Risk Of Loss By Theft, And Wastage
3.Makes Management Complacent And Ineffective.
4.Results In Speculative Trend
5.Scope For Diversion Of Funds
6.Indication Of Defective Credit Policy
7.Slack Collection Of Receivable
8.Leads To Higher Incidence Of Bad Debts
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21. FACTORS INFULENCING WORKING
CAPITAL REQUIREMENT
Nature of business – service/trade/manufacturing.
Seasonality of operations – peak/non peak
Production Policy – Constant/seasonal
Market conditions- competition/credit terms
Conditions of supply of RM/stores/spares etc.
Quantum of production/Turnover(level of activity)
Operating Cycle
Current Assets to be maintained

22. Projections having direct relevance to Bank Finance
a. Sales
b. Production
c. Cost of production
d. Cost of sales
e. Current assets
f. Current liabilities
g. Net working capital.
The most important area to be looked into is Sales. All other aspects
are directly related to the projected level of sales.
Therefore, determining the projected level of sales is first step in
assessing the working capital needs of a borrower.
Once the level of sales has been determined, the other data can be
easily determined in relation to sales. 22

23. Projected Turnover depends on
• What is the installed and licensed CAPACITY? Does it have
any idle capacity which can now be utilised?
• Is the unit undertaking any expansion, modernisation or
diversification program? Have any funds been earmarked
for the same in the projections? Are they going to affect
the quantum of production for the following year and to
what extent? This will be very relevant where the borrower
is projecting more than normal rate of growth in respect of
production and sales.
• Are essential inputs available to take care of projected
production figure?
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24. Projected Turnover depends on
• What are the present market conditions and terms of
sales? What plans are there to boost sales. Will the sales in
future be on more favorable terms to the buyers? If the
period of credit is going to be extended is holding of
increased levels of receivables proposed to be financed?
Will it be within the lower of past trends or norms?
• Is the unit proposing to launch an export drive to capture
international markets?
• Are there any pending orders in hand? What has been the
position in the previous years? Was the unit forced to
launch any distress sales in the past?
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25. W
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C
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Turnover Method – Nayak Committee
1. Working capital requirement / Gap = 25% of the projected Turnover
2. Promoter’s Contribution (Margin) = 5% of the Turnover
3. Bank Finance = 20% of the Turnover
4. Margin available in system = NWC i.e. CA less CL
5. Higher of NWC or 5% of turnover = Margin
6. Limit permissible = WCG less Margin
7. This method is usually used to assess requirement of small mfg companies(SME) and
no financial documents are taken. Only annual sales considered
8. Projected Sales as per customer is considered, but accept/ validate sales from past
data. Use only audited balance sheet.
• Past performance of 3 years
• Sales growth trend
• Estimation
• Realistic sales
Minimum of above is taken (margin of safety)
NOTE : IF MARGIN AVAILABLE IN SYSTEM IS LOWER THAN 5 % OF TURNOVER, LIMITS IS TO
BE FIXED AT 20% OF TURNOVER. HOWEVER, OPERATIONS BE ALLOWED AS PER DRAWING
POWER AVAILABLE BASING ON PAID UP STOCK. IN OTHER WORDS DP IS RISTRICTED TO 4

26. Particulars Rupees Particulars Rupees
To Purchase
To Wages
To Gross Profit c/d
20000
5000
5000
Sales 30000
30000 30000
To Salaries
To Rent
To Depreciation on Plant
To Loss on Sale of Furniture
To Goodwill Written off
To Net Profit
1000
1000
1000
500
1000
5500
By Gross Profit b/d
By Profit on Sale of Building
Book Value 10000
Sale Value 15000
5000
5000
10000 10000
31-Mar-16 31-Mar-17
Stock 10000 12000
Debtors less than 6 months 10000 12000
Debtors greater than 6 months 5000 8000
Creditors 5000 7500
Bills Receivable 5000 8000
Outstanding Expenses 3000 5000
Bills Payable 4000 2000
Projected Turnover for FY16-17: 20% growth 26

27. Turnover Method
• Projected Turnover : 30,000 * 1.2 = 36,000
• Turnover Method:
• Working Capital Requirement:
• 25% of Projected Turnover : 36000 * 25% = 9,000
• Max Bank Funding = 20% of 36000 = 7,200
• Own Contribution = 5% of 36000 = 1,800
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28. Projected Balance Sheet Method ( for > Rs. 5 Cr.)
Proper examination of performance
• Profitability
• Financial Position
• Financial Management
Scrutiny & Validation of Projections
• Income & Expenses
• Changes in Financial Position
Acceptability of Liquidity, Overall gearing,
efficiency of operations

29. The MPBF Methods (Tandon Committee)
METHOD I METHOD II METHOD III
C.A 200 C.A 200 C.A 200
OCL 40 25% of CA 50 Non core CA 56
WCG 160 GAP 150 Core CA 144
25% of WCG 40 OCL 40 25% of Real CA 36
GAP 108
OCL 40
MPBF 120 MPBF 110 MPBF 68
NWC 40 NWC 50 NWC 92
C.A 200 C.A 200 C.A 200
C.L 160 C.L 150 C.L 108
CURRENT
RATIO
1.25
CURRENT
RATIO 1.33 CURRENT RATIO 1.85

30. Cash Budget Method
• Peak deficit is financed and drawings regulated by
monthly budgets.
• Advantages:
 Suitable for seasonal industries, contractors,
software exporters etc.
 Limitations:
 Will not reflect changes in various current assets and
liabilities.
 Will not give a clue whether a company is earning
 profit or not.

Funds flow statement is required to detect any
diversion of funds. 30

31. •Thank You !
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