SAHU & ASSOCIATES: MEANING OF WORKING CAPITAL

Working Capital is an integral and inherent component for running all kinds of business. In this competitive era of startups, it is very important to understand and determine the needs of working capital for running a business effectively.In order to run day to day business operations smoothly, working capital finance plays an important role. Insufficient working capital finance may result in nonpayment of certain due on time making the creditworthiness of the entity questionable.There are various types of working capital finance being offered by the banks. We will discuss here the most popular kind which is called cash credit limit.

Cash Credit/Bank Overdraft:- Cash credit Limit is one of the most popular kind of working capital finance. This limit is sanctioned in order to fill the gap between the working capital required to run a business and working capital already available in the business.It is a facility offered by commercial banks whereby the borrower is sanctioned a particular amount which can be utilized for making his business payments. The borrower has to make sure that he does not cross the sanctioned limit. The best part is that the interest is charged to the extent the money is used and not on the sanctioned amount which motivates him to keep depositing the amount as soon as possible to save on interest cost. Without a doubt, this is a cost effective working capital financing.

To assess the working capital finance required by a particular business, banks have to follow various methods as per their prescribed guidelines.

Here we have discussed in brief about aspects to be considered while applying for cash credit limit to banks.

Documents Required:-As per banking norms,

1. Business Registration Certificate
2. MOA,AOA in case of companies and partnership deed in case of partnership firms.
3. KYC of partners and directors.
4. Last three audited financial statements.
5. VATreturns or service tax returns of last one year.
6. Credit monitoring arrangement data as per banks’ format (CMA Data) in case of loan requirement is more than 2 crores.
7. Details of loan facilities availed from other banks.

Method of assessment: -

1. In case of cash credit limit upto 2crs, maximum permissible bank finance will be assessed as per Nayak Committee. In this method sales projections of next two financial years are taken into consideration for determining the requirement of loan. Generally,20% of sales projections is being considered as eligible working capital loan subject to other bank guidelines.
2. In case of cash credit limit more than 2crs,loan eligibility will be calculated as per TandonCommittee which is based on total working capital available in the business subject to 25% margin on total current assets.

Security:- Working capital finance is being done on the basis of availability of stock and book debts(not more than 90 days old) in a business. Banks will have a charge on book debts and stocks after the working capital loan is sanctioned to the entity. So, the entity is also required to submit a statement of stock and book debts to the Banks periodically usually monthly/quarterly.

Financial Aspects:

In order to apply for cash credit limit,entities are required to pay attention to the following ratios that these should be above the benchmark level as per bank guidelines:-

1. Current Ratio should be more than 1.33
2. Debt Equity Ratio should be less than 2 :1
3. DSCR should be more than 2.

These are the basic ratios which are to be taken care of while applying for a bank finance. However, there are other financial ratios too that banks take into account for considering working capital finance like debtors holding period, stock holding period, creditors holding period.etc.

To sum upcash credit limit is one of the best products being offered by the banks to cater the working capital needs of all kinds of businesses whether it is a service manufacturing or trading industry. It suits all kinds of industries as the limit once sanctioned can be utilized as per their business requirement and if not required the entities can keep the limit as it is without drawing any funds from the bank and are not required to pay interest also.

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