Methods of Working Capital Assessment

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:

1. Procurement of raw material : 30 days
2. Conversion/process time : 15 days
3. Average time of holding of finished goods: 15 days
4. Average collection period : 30 days
5. Total operating cycle : 90 days
6. Operating cycle in a year : 4
7. Total operating expenses per annum : Rs.60 lacs
8. Total turnover per annum : Rs.70 lacs
9. 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.