BMS IV SS Industries 6

8/12/2019 BMS IV SS Industries 6

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Small Scale Industries 6

Working Capital Management

The management of working capital is an integral part of overall corporate management. Working capitalis the amount of funds which small scale industry must have to finance its day to day operations. It also

includes that portion of an industrys total capital which is employed in short!term operations. Such items

include stocks of raw material and supplies need for manufacture" stocks of finished goods awaiting sale"semi processed items" sundry de#tors for pending collections against credit sales" short term investments"etc.

Definition:The $ccounting %rinciples &oard of the $merican Institute of Certified %u#lic $ccountants" 'S$" has

defined working as follows(

Working capital, sometimes called net working capital, is represented by the excess of current assets

over current liabilities and identified the relatively liquid portion of total enterprise capital which

constitutes a margin of buffer for maturing obligations within the ordinary cycle of the business.

!b"ectives of Working #apital:

$ successful financial management is essential for sound and consistent asset management policies

covering fi)ed and current assets. $n effective utili*ation of working capital results in the ma)imi*ationof productivity and profits.

%rofita#ility and solvency are the twin o#+ectives of working capital management. These can #e achieved#y striving to maintain a correct ratio #etween working capital fi)ed capital. Such ratio will ensure a

smooth and rapid flow of funds and enhance the efficiency and profita#ility of the enterprises. $ proper

management of working capital synchroni*es the cash receipts and cash outlay" and a unit may functionwith minimum cash reserve.

#redit $equirement of small scale industries % Draw figure no. & page no. '(&.

)ross and *et Working #apital +tructure:

The concept of working capital is #roadly understood in ,gross and ,net concept. The financial is thegross concept. The gross working capital is represented #y the sum total of all the current assets of the

enterprises" while the net working capital is the difference #etween the current assets and current

lia#ilities. In short" the gross and the net working capital concepts represent two distinct and importantfacets -aspects of working capital management.

*et Working #apital:/et working capital represents the e)cess of total current assets over total current lia#ilities and ismeasured #y the current ratio indicates that current assets has an edge over current lia#ilities vi*. current

assets 0 current lia#ilities. 'nit has the current ratio of a large ratio 1(2 indicates greater solvency -in

sound financial position where as a very low ratio indicates insolvency.

)ross Working #apital:

It is e3ual to the total sum of current assets and may represent #oth owned capital and loan capital. Theconcept of gross capital is a financial concept" while that of net capital is an accounting concept.


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actors determining the -mount of Working #apital:

The working capital re3uirements of small scale industries vary from one unit to another and from one

type of unit to another type. Small scale units" which are located in rented premises and are engaged in

processing works" need a larger amount of working capital than other units. The other important factorsdetermining the amount of working capital are(

& +i/e of the +mall +cale 0nit( The amount of working capital depends directly upon the volume of#usiness. The #igger the si*e of a unit" the larger the amount of the working capital.

1 2rocess of 2roduction( Simple short period processes of production re3uire a smaller amount of

working capital and vice versa.

' 2roportion of $aw 3aterials to 4otal #ost( The price of raw materials and the 3uantity re3uired

determine the amount of working capital.

5 4erms of 2urchase and +ales( The amount of working capital varies directly with the use of credit

facilities offered to customers and Credit facilities o#tained while purchase of raw materials.

6 4urnover of 7nventories( If inventories are large and their turnover is slow" a small scale industry will

need a #igger amount of working capital. If the inventories are small and their turnover is 3uick" the unit

will re3uire a smaller amount of working capital.

8 7mportance of 9abour( Small scale and cottage industries are la#our intensive units and therefore

re3uire a larger amount of working capital.

#ash requirements( the amount of working capital re3uired varies directly with the cash re3uirement of

a unit.

; +easonal


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$gainst this #ackground" the eserve &ank constituted in 7uly 2489" a Study :roup to frame guidelines

for follow!up of #ank credit. The :roup functioned under the chairmanship of Shri %rakash Tandon.

4erms of $eference: The following tasks were spelt out for the Study :roup(

Suggest guidelines for commercial #anks to follow up and supervise credit dis#ursement. It will see

that the funds are utili*ed properly and keep a watch on the safety of the advances. It also suggests the

type of operational data and other information that may #e o#tained # #y #anks periodically from such#orrowers and #y the &I.

Make recommendations for o#taining periodical forecasts from #orrowers of -2 #usiness;production

plans -and -# credit needsn some special cases" when the #orrower is not a#le to raise there3uisite funds immediately towards his own contri#ution" the #anks may consider giving a term loan to a

reasona#le e)tent" provided that the cash raising capacity of the #orrower is good and that the proposed

term loan within a short period is accepta#le to the #ank.

When the additional fund needed is for a short period and cannot #e met from the e)isting credit

arrangement" it should #e possi#le to consider additional credit for such need without necessarily insistingon a matching contri#ution to ena#le the #orrower to complete the specific transactions. Moreover" itshould #e on the clear understanding that the #orrower would return the loan in the relevant method of

lending within the stipulated period.

2roposed style of credit:

>nce the 3uantum of #ank funds to finance a reasona#le level of current assets is agreed to" the style ofe)tending #ank credit should #e changed. The draw#ack of the cash credit system of lending are well

known" #ut may #e reiterated here(

$ #ank has no control over the level of advances in cash credit accounts. /o notice is re3uired fordrawing under limits that may remain unutili*ed for long periods.

$ #ank is in no position to foresee demand for credit. This hampers its credit planning.

The cost of the operation of the system to the #anker on account of attendant uncertainties is high #ecause

whatever chances he may take in overselling credit" there will always #e a limit to how far he willoversell.

It is practical that the level of #orrowings #y industrial units during the course of a year fluctuates frommonth to month. This depends upon the schedules of purchases of raw materials" dispatch of finished

goods" wage structure" etc. ?owever" the non!seasonal industries do maintain their level of outstanding ina cash credit account and their fund re3uirement will #e sta#le during the year. The Tandon Committee

suggested that instead of making availa#le the entire credit limit as a cash credit for a year" it may #e#ifurcated into a loan and a demand credit and the same shall #e reviewed annually.

/on!seasonal industries and most agro #ased industries with some degree of seasonality can agree to thesuggested system without difficulty. In case of high seasonal industries" the overall credit limit may have

to make on the #asis of monthly re3uirements. The main intention is to introduce discipline in the lending

system with higher rate of interest than the loan component. This approach will give the #orrower anincentive for good planning.


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>ill inance:

&ill 5inance is a way of shortening the transaction cycle through a movement of cash and carry system.

Sometimes it is necessary for the manufacturing unit to e)tent credit to maintain sales. >n such

conditions" apart from loan and demand cash credit" a part of the total credit re3uirement" within theoverall eligi#ility" may #e provided #y way of #ill limits to finance receiva#les.

It is desira#le that receiva#le should #e financed #y way of #ills rather than #y cash credit against #ookde#ts. These #ills may #e on a demand #asis or on a usance #asis" depending on the marketing practice inthe industry. There is more advantage as mentioned hereunder" on a #ill arising out of the sale of goods

over the cash credit against #ook de#ts(

The transaction is easily identifia#le.

There is a definite date of repayment

The #ill will carry more than one signature if it is on a usance #asis.

It represents an easily shifta#le asset.

When goods are sold on credit to a wholesaler instead of to a user industry" #ank finance for the

transaction would in effect #e credit trading purposes.

The Tandon Committee suggests that the #anking system should move towards financing the purchaser.The seller should #e paid off after the sale and the purchaser in fact should avail the credit facility from

the #ank. The purchases should #e for the #enefit of #oth the parties" should #e on the #asis of #ills. This

is #ecause

2. The amount should #e drawn only at the time of actual need. The end!use of credit is automatically

taken care of.

1. Credit to the purchaser is directly related to his actual need which is not in the case with the sellers

#ills" where credit is e)tended as a measure of sales promotion" irrespective of the purchasers a#ilityto pay of his need for credit.

@. $ #ill imposes discipline in respect of payments for purchases it ensures timely payment to suppliers

and also a sense of monthly installment on repayment of loan to #ank.

There were few limitations on the a#ove suggestions. It was argued that the cash credit mode of financing

is superior to #ill financing in respect of the #orrowers purchase operations on the following reasons(

Withdrawals for non!approved purposes will #e detected #y the new information system proposed and

also #y scrutiny of che3ues. The end use of credit will #e effectively taken care of #y the proposed

information system.

The cost of operations to the #orrower and the #ank will #e high. The #orrower will have to pay e)tra on

stamp duty and the #anker has meet the administrative cost #ecause of additional work due to non!availa#ility of mechani*ation or computeri*ation.

The advantages of centrali*ed #orrowing #y way of control over aggregate outstanding" de#it and credit

summaries and the #orrowing trends would #e lost.


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In view of the a#ove" the Tandon Committee suggested that each #ank might take its own in consultation

with the #orrower. It will take into consideration the si*e of his operations" his individual transactions" theadministrative set up and other re3uired norms.

The Mechanics of Lending:

The #anker will o#serve the following guidelines while lending financial assistance through &ills" to the

small scale industries

2. The #anker is concerned with the #orrowers operating systems and not #y the stocks of inventories or

receiva#les. The #orrowers operational plan for the ne)t few years re3uires special attention. The

#orrower will plan his operations and satisfy the #anker a#out his profita#ility plans to get theassurance #y the #anker of ade3uate credit to meet his genuine production needs.

1. The #orrower should prepare a plan of operating statement" pro+ected #alance sheet and an applicationfor advance for loan facility. The 5inancial $nalysis should cover an e)amination of the #orrowers

past and current financial position" profita#ility" production operations for the ne)t year and pro+ected

financial position at the end of the ne)t year.

@. The current asset position should #e e)amined to ensure conformity with inventory and receiva#les

norms in relation to the pro+ected production.

9. The financial assistance limit or the overall credit limit should #e fi)ed on the #asis of the a#ove

pro+ected #alance sheet and the said limit shall #e furnished to the egistrar of Companies and Credit

$uthorisation from the eserve &ank" at the time of the registration of the charge.

A. In respect of e)isting advances" the re3uirement of additional finance over and a#ove the permissi#le

level should #e identified and suggested on a repayment #asis. The repayment schedule shall #ead+usted over a period of time" taking into account the customers cash accruals" payment o#ligations

and capacity to raise additional e3uity.

6. $ new separate account shall #e made availa#le for the agreed 3uantum of #ank finance. Theminimum fund re3uired for 21 months shall #e released on fi)ed loan #asis and the #alance #y way of

cash credit or #ills.

8. The #anker should #e fle)i#le in the matter of #ifurcation of the limit #etween loan and cash credit"

which depends upon the customers past plans" actual pattern of drawings and the e)pectation for the

ne)t year.

B. The 3uarterly operating statement" funds flow statement and the performance data should #e furnished

to the #ank on regular #asis in the prescri#ed format. The #anker should satisfy that the 3uarterly plansdrawn out #y the #orrower shall #e more or less in line with the earlier e)pectations and pro+ectionsdrawn.

4. The actual drawings within the sanctioned limit should #e determined #y the customers inflow andoutflow of funds as reflected in the 3uarterly funds flow statement. $ny deficit in cash during the

3uarter calls for additional demand for cash credit re3uirement for that 3uarter. The 3uarterly

withdrawal limit should #e maintained e3ual to the previous 3uarter. $dditional re3uirement of fundsshould #e specifically mentioned his need to that e)tent.


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2=. Within the overall permissi#le limit of drawing" the day to day operations in the account #e regulated

on the #asis of drawing power restricted for a month. The drawing power is assessed on the #asis ofmargins stipulated against the different components of inventory and receiva#les" as per the monthly

stock statements.

22. $ny #udgeting or planning may not #e always 2== accurate and it is #ound to #e fluctuating.

Therefore" the #anker should #e fle)i#le in restricting the withdrawal limit to the e)tent of plus of

minus 2= on the overall sanctioned limit.

4erm 9oans to +mall +cale 7ndustries:

5or several years" the comprehensive criteria applied to the Term Doan $pplications from medium andlarge scale industries cannot #e used in respect of term proposals from small scale industries. Small units

were finding it difficult to secure ade3uate finance from Institutional sources even for their working

capital re3uirements.

It may #e due to their!own inherent limitations on the one hand

The generally high standards applied #y the lending institutions to #orrowers on the other.

>rganised credit institutions feel that small units are generally poor risk takers.

Small units have a low capital to turnover ratio.

The availa#le #lock capital security is inade3uate in relation to a given level of production

Small units markets are somewhat narrow

%rospects for #usiness fre3uently uncertain.

Therefore" the #anks find it difficult to assess their credit worthiness and re3uire special treatment #ecauseof their relatively high employment potential.

Difficulties in Procuring Institutional Finance:

Small Scale industries are generally not regarded as sufficiently credit worthy #ecause they are not a#le to

satisfy the criteria of financial institutions.

2. It involves assessment of credit worthiness of the #orrowers

1. Euantum of securities offered #y the #orrower@. Fifficult to o#serve the rules and regulations governing the advances.

9. The financial position of #orrower should #e fairly sound and show profit.

A. ?e should have the prospect of improving its earning capacity.

6. The e3uipment and technical processes employed in the production of goods and services should #eefficient.

8. The unit concerned should have an assured market and there should #e demand for its product #y a#ig industry.

B. The #orrowing concern should #e owned #y men of integrity and #usiness standing.

4. The lending institutions are very rigid in their approach while dealing with #orrowers.

2=. The complicated nature of information re3uired from the #orrowers22. Strict re3uirements of security and rigid prescription of accepta#le collateral

21. Felay involved in the sanction of loans.

2@. The assessment of risk factor in advancing to small industries natural poses a pro#lem for the

lending financial institutions.


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6. The interest charges should #e reasona#le. epayment period should #e determined according to

earning capacity of the unit. The first installment may #e called for after a year or two to ena#le the#orrower to sta#ili*e his position and strengthen his repaying capacity. The margin of security should

also #e li#eral.

8. :overnment of India has li#erali*ed the lending criteria through Credit :uarantee Scheme. This isoperated through eserve &ank of India which ena#les the financial institutions a#out the guarantee

facilities to cover some portion of the risk. Such guaranteed loans are refinanced in case of any risk on

non!repayment" #y the efinance Corporation.B. The different agencies may supplement one anothers resources and share the risks collectively #y

participating in the loans of other agencies.

4. Dending institutions should #e practical and fle)i#le in their attitude" rather than strictly legal" looking

at the temporary difficulties of the #orrowing units. Frastic step should not #e taken immediately ondefault cases. Timely advice and guidance and even the provision of additional financial assistance

wherever so warranted" would ena#le them to tide over the crises.

+3-99 +#-9= 7*D0+4$7=+:

2. It may not #e usually possi#le for small industries to provide financial and other data in a thorough

and detailed manner. In such cases" as much information as is availa#le on the following aspects of the

concern may #e given(! Fetails of the nature of the industry and its products.

! Fata regarding performance" estimated cost of production and selling price.

! Hstimates regarding market prospects" invested capital" proportion of #orrowed capital.! %urpose of the loan" result e)pected from the investment" etc.

1. Try to maintain audited accounts to facilitate the assessment of loan proposals #y the lending

institution and also in the interest of small units.@. The units must #e a#le to produce accepta#le evidence for verification of the value of assets offered

for security.

9. Doans sanctioned should not #e used for purposes other than those for which they have #een re3uestedfor.

A. Where the loan is granted on an individual capacity" or the loan is given on a personal guarantee orpersonal security" such individual should insure on him ade3uately to the e)tent of loan availed and

protect the interest of the lender.

#onclusion:

The working capital management is an internal part of overall management of small scale industries and itre3uires greater coordination #etween small scale industries and financial institutions. Towards this

direction" Small Industries Fevelopment &ank of India -SIF&I is shaped to provide a strong support to

small scale industries.

It is important that financial institutions should protect their interest with ade3uate security. Meanwhile"

small industries should not deny the assistance for financial re3uirements. Small scale industries alsore3uires non financial assistances on marketing" technical guidance and training in management" etc.Special institutions like the Small Industries Services Institutes" the /ational small Industries Corporation"

etc. provides necessary services on this matters.

%lanning and control of working capital centres facilitates the unit to control over the cash and credit

policies.

Documents

BMS IV SS Industries 6