what are the different methods of working capital assessment?

Working Capital Assessment Methods:

• Operating Cycle Method.
• Traditional method.
• Projected Balance Sheet method.
• Cash Budget method.
• Projected Annual Turnover method (Nayak Committee)

 Sources of working capital can be spontaneous, short term and long term. Spontaneous working capital includes mainly trade credit such as the sundry creditor, bills payable, and notes payable. Short term sources are tax provisions, dividend provisions, bank overdraft, cash credit, trade deposits, public deposits, bills discounting, shortterm loans, inter-corporate loans, and commercial paper. Long term sources are retained profits, provision for depreciation, share capital, long-term loans, and debentures.

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Hie Methods of Working capital assessment • Operating Cycle Method • Drawing Power Method. • Turnover Method. • MPBF method (II method of lending) for limits of Rs 6.00 crores and above • Cash Budget method - Based on procurement and cash inflow) . It is mainly used for Seasonal Industries (Sugar/ Rice Mills/Textiles/Tea/Tobacco/Fertilizers) Contractors & Real Estate Developers , Educational Institutions, etc. Operating Cycle Method Meaning of operating cycle: It begins with acquisition of raw materials and ends with collection of receivables. Stages: • 1)Raw materials (RM/RM consumption) 2)Work-in-process (WIP/COP) 3)Finished Goods (FG/COS) 4)Receivables (Debtors/Credit sales) Less: • Creditors (creditors/purchases) Example of Operating Cycle: Length of operating Cycle: a. Procurement of raw material : 30 days b. Conversion/process time : 15 days c. Average time of holding of finished goods: 15 days d. Average collection period : 30 days e. Total operating cycle : 90 days f. Operating cycle in a year : 4 g. Total operating expenses per annum : Rs.60 lacs h. Total turnover per annum : Rs.70 lacs i. Working capital requirement : 60/4= 15 lacs Drawing Power (DP) Method : (for units with small limits) Drawing power is arrived at on the basis of valuation of current assets charged to the bank in the shape of hypothecation and assignment , after deducting the stipulated margin Illustration: Paid stock – 4 Margin 25% - DP = 3 Semi-finished goods – 4 Margin 50% - DP=2 Finished goods -4 Margin 25% - DP = 3 Book Debts – 4 Margin 50% - DP = 2 Total DP= 10 Turnover Method : (originally suggested by Nayak Committee for SSI units) The WC requirements may be worked out on the basis of Naik Committee recommendations for working capital limit upto Rs.6 crores from the banking system, on the basis of minimum of 20% of their projected annual turnover for new as well as existing units, beyond which WC be computed on the basis of WC cycle, after fixing stipulated margins , on each component of the WC. In case of borrowers desiring facilities under Naik Committee recommendations and having a WC cycle of more than 3 months in a year, the WC requirements will be funded after assessing his requirements on the basis of his WC cycle, after fixing proper margins. Example: Applicable for limits upto Rs.6 crores : (a) Projected sales = Rs. 10,00,000 (b) Working capital requirements: 25% of projected sales i.e. Rs.2,50,000 (c) Margin (contribution of Owner) : 5% of projected sales i.e. Rs.50,000 (d) Working capital to be funded by bank : Rs.2,00,000 MPBF Method (Tandon’s II method of lending) • Working capital gap : Current assets – current liabilities (other than bank borrowings) • Minimum stipulated net working capital= 25% of current assets (excluding exports receivables) • Actual projected NWC

Working Capital Sources --Own funds --Bank borrowings --Sundry Creditors --Advances from customers --Deposits due in a year --Other current liabilities

Methods of Working capital assessment • Operating Cycle Method • Drawing Power Method. • Turnover Method. • MPBF method (II method of lending) for limits of Rs 6.00 crores and above • Cash Budget method - Based on procurement and cash inflow) . It is mainly used for Seasonal Industries (Sugar/ Rice Mills/Textiles/Tea/Tobacco/Fertilizers) Contractors & Real Estate Developers , Educational Institutions, etc. Operating Cycle Method Meaning of operating cycle: It begins with acquisition of raw materials and ends with collection of receivables. Stages: • 1)Raw materials (RM/RM consumption) 2)Work-in-process (WIP/COP) 3)Finished Goods (FG/COS) 4)Receivables (Debtors/Credit sales) Less: • Creditors (creditors/purchases) Example of Operating Cycle: Length of operating Cycle: a. Procurement of raw material : 30 days b. Conversion/process time : 15 days c. Average time of holding of finished goods: 15 days d. Average collection period : 30 days e. Total operating cycle : 90 days f. Operating cycle in a year : 4 g. Total operating expenses per annum : Rs.60 lacs h. Total turnover per annum : Rs.70 lacs i. Working capital requirement : 60/4= 15 lacs Drawing Power (DP) Method : (for units with small limits) Drawing power is arrived at on the basis of valuation of current assets charged to the bank in the shape of hypothecation and assignment , after deducting the stipulated margin Illustration: Paid stock – 4 Margin 25% - DP = 3 Semi-finished goods – 4 Margin 50% - DP=2 Finished goods -4 Margin 25% - DP = 3 Book Debts – 4 Margin 50% - DP = 2 Total DP= 10 Turnover Method : (originally suggested by Nayak Committee for SSI units) The WC requirements may be worked out on the basis of Naik Committee recommendations for working capital limit upto Rs.6 crores from the banking system, on the basis of minimum of 20% of their projected annual turnover for new as well as existing units, beyond which WC be computed on the basis of WC cycle, after fixing stipulated margins , on each component of the WC. In case of borrowers desiring facilities under Naik Committee recommendations and having a WC cycle of more than 3 months in a year, the WC requirements will be funded after assessing his requirements on the basis of his WC cycle, after fixing proper margins. Example: Applicable for limits upto Rs.6 crores : (a) Projected sales = Rs. 10,00,000 (b) Working capital requirements: 25% of projected sales i.e. Rs.2,50,000 (c) Margin (contribution of Owner) : 5% of projected sales i.e. Rs.50,000 (d) Working capital to be funded by bank : Rs.2,00,000 MPBF Method (Tandon’s II method of lending) • Working capital gap : Current assets – current liabilities (other than bank borrowings) • Minimum stipulated net working capital= 25% of current assets (excluding exports receivables) • Actual projected NWC

Methods 1.Operating Cycle Method 2.Traditional method 3.Projected Balance Sheet method 4.Cash Budget method 5.Projected Annual Turnover method (Nayak Committee) Sources 1.Own funds 2.Bank borrowings 3.Sundry Creditors 4.Advances from customers 5.Deposits due in a year 6.Other current liabilities

Dear Friend Working Capital Sources --Own funds --Bank borrowings --Sundry Creditors --Advances from customers --Deposits due in a year --Other current liabilities Working Capital Assessment Methods --Operating Cycle Method --Traditional method --Projected Balance Sheet method --Cash Budget method --Projected Annual Turnover method (Nayak Committee) OPERATING CYCLE METHOD Time taken between cash outlay and cash realisation through sale of finished goods & realisation of receivables is known as length of operating cycle. Consists of: --Time taken to acquire and average storage period of raw material --Conversion process time --Average period for which finished goods are in store --Average collection period of receivables (Sundry Debtors) Projected Balance Sheet Method --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 Cash Budget Method --Applicable to seasonal industry (such as tea, sugar) --Specific industry (such as Information Technology and software) --Based on Peak Deficit projected as per cash flow statement Thanks

Methods of Working capital assessment * Operating Cycle Method * Drawing Power Method. * Turnover Method. * MPBF method (II method of lending) for limits of Rs 6.00 crores and above * Cash Budget method - Based on procurement and cash inflow) . It is mainly used for Seasonal Industries (Sugar/ Rice Mills/Textiles/Tea/Tobacco/Fertilizers) Contractors & Real Estate Developers , Educational Institutions, etc.