final rport summer.pdf

7/21/2019 final rport summer.pdf

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Summer Internship 2014 Page | 1

WELINGKAR INSTITUTE OF MANAGEMENT DEVELOPMENT AND RESEARCH

SUMMER PROJECT

ON

PROBLEMS IN ASSESSING

WORKING CAPITAL

FOR MSE

BY

NAME : SRUTHY GOPAN

COURSE : MMS-2013-15

SEMESTER : III

SPECIALIZATION : FINANCE

ROLL NO. : 90


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PROBLEMS IN ASSESSING

WORKING CAPITAL

FOR MSE


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ACKNOWLEDGEMENT

Experience is the best teacher and my summer internship period had been enriched by the

experiences of the people I got to work with in IDBI,MSE.

With a sense of great pleasure and satisfaction, I present this project report entitled

PROBLEMS IN ASSESSING WORKING CAPITAL FOR MSE. Completing a task

successfully is never an individual effort; similarly completion of this report is the result of

invaluable support and contribution of many people in direct and indirect manner. In the light of

foregoing, first of all my heartfelt great fullness and thanks goes to Mr. M C SUNIL KUMAR as

the DEPUTY GENERAL MANAGER of IDBI , for giving me an opportunity to work for this

highly esteemed organization and for being a constant source of inspiration and guidance

throughout the project. Without their able support the project would not have seen the light of the

day.

At this juncture, I would also like to thank the entire staff of IDBI. Without their indispensable

cooperation, the project wouldnt have been completed within the stipulated time period.

I would like to thank my mentor Mr SAIRAM SUBRAMANIAN for his earnest advices that

helped make my project more inclusive and exhaustive.

Finally,I would like to thank Professors of Welingkar Institute of Management Development

and Research, who provided guidance in this project.

SRUTHY GOPAN


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EXECUTIVE SUMMARY

In this report the problem we are trying to analyse is the loopholes in assessing the working

capital requirement for the MSE.

MSE s ,previously SSI (small scale industries) are the growth engines of economy.

The prevalent methods of assessments practiced in the banks are discussed .The project is

executed by jointly analyzing both those methods and the inherent features of MSEs. The sector

chosen being MSE hence envisages the discussion of PSL norms prevailing in the banking

industry . The Priority sector lending (PSL),it is the sector which gets directly affected by a lot

of government decisions and those by RBI. Hence the lending policies followed by the banks

will be aligned with those.That angle also forms a part of our project.

The evolution of priority sector lending in india over the years forms the bedrock for the existent

assessment policies in Banking sector.The project brings into purview the flaws addressed

through frequent revisions in the PSL norms and those flaws that remain unaddressed in the

present norms.


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TABLE OF CONTENTS

Sr. No. Topic Page

1 Banking Industry in India

1.1 Introduction 6

1.2 Industrial development Bank of India(IDBI) 8

2 RESEARCH METHODOLOGY 10

2.1 Objective of Study 10

2.2 Limitations of the study 10

2.3 Sources of data 10

3 IMPORTANCE OF PRIORITY SECTOR LENDING AND ITS

EVOLUTION

11

3.1 INTRODUCTION 11

4 IMPORTANCE OF MICRO AND SMALL ENTERPRISES(MSEs)4.1 INTRODUCTION 11

4.2 MSEs IN INDIA 13

4.3 ROLE OF BANKS IN MSE FINANCING 15

5 WHY WORKING CAPITAL NEEDS MANAGEMENT ?- WCM 17

5.1 IMPORTANCE 17

5.2 METHODS OF ASSESSMENT 21

6 PROBLEMS FACED BY IDBI AND OTHER BANKS ON ASSESSMENT

OF WORKING CAPITAL FOR MSEs

28

RECOMMENDATIONS/SUGGESTIONS 30

10.1 MODIFICATIONS REQUIRED IN THE SYSTEM 30

7 CONCLUSION 32

8 BIBLIOGRAPHY & REFERENCES 33

9 ANNEXURE I: 34

10 ANNEXURE II: 36


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1.BANKING INDUSTRY IN INDIA

1.1 INTRODUCTION

Banks play a critical role in the economic development of emerging economies such as India.

Banks today are important not just from the point of view of economic growth, but also financial

stability.

In emerging economies, banks are special for three important reasons:

1. They take a leading role in developing other financial intermediaries and markets.

2. Due to the absence of well-developed equity and bond markets, the corporate sector

depends heavily on banks to meet its financing needs.

3. In emerging markets such as India, banks cater to the needs of a vast number of savers

from the household sector, that prefer assured income, liquidity and safety of funds,

because of their inadequate capacity to manage financial risks.

Forms of banking have changed over the years and evolved with the needs of the economy. The

transformation of the banking system has been brought about by deregulation, technological

innovation and globalization. The focus on customers has been changing based on the changing

customer needs and increasing competition. The perspective of Banks towards customers in

various decades can be summarized as below:

Decade Focus on Customer

1950-1960 Serving the customer

1960-1980 Satisfying the customer

1980-1990 Pleasing the customer

1990-2000 Delighting the customer

2000 and beyond Retaining the customer


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PORTERS 5 FORCE MODEL FOR BANKING SECTOR

Threat of New Entrants (HIGH):

o Many financial, even non-financial organizations can easily enter into the banking

industry. For example, an insurance company can easily start offering mortgage

and loan services. Also, when analyzing a regional bank, the possibility of a mega

bank entering into the market poses a real threat. The switching cost in the current

market scenario has become smaller and the returns higher, which is why the

threat of new entrants is high in this industry.

Availability of Substitutes (HIGH):

o There are plenty of substitutes in the banking industry. Banks offer a suite of

services over and above taking deposits and lending money, but whether it is

insurance, mutual funds or fixed income securities, chances are there is a non-banking financial services company that can offer similar services. On the lending

side of the business, banks are seeing competition rise from unconventional

companies. For example, if car companies are offering 0% financing, customers

will not be approaching banks for Auto loans.

Bargaining Power of Buyers (HIGH):

o Bank industry is a high buyer concentration industry. Millions of people use bank

services, such as deposit money, mortgage, loan, investment, insurance and

currency exchange. Also, with the wide penetration of Internet and technology,the customer has access to extensive information. One click and the information

about the interest rates offered by all banks on various loans and deposits, is

easily available. Hence, the customers can compare the products and services

offered by Banks and choose the best among them. The customer generally


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compares various banking products and services on the basis of interest rates, be it

taking loans or for term deposits. Even a 0.5% difference in interest rates can

divert customer attention.

Bargaining power of Supplier (LOW):

o Depositors are one of the main capital suppliers of bank, they compare with other

financial products to see whether to draw out capital or not.

Competitive Rivalry (HIGH):

o The financial services industry has been around for hundreds of years and just

about everyone who needs banking services already has them. Because of this,

banks must attempt to lure clients away from competitor banks. They do this by

offering lower financing, preferred rates and investment services. The banking

sector is in a race to see who can offer both the best and fastest services, but this

also causes banks to experience a lower ROA. They then have an incentive to take

on high-risk projects.

1.2 I.D.B.I

Industrial Development Bank of India

Industrial Development bank of India (IDBI) was constituted under Industrial Development bank

of India Act, 1964 as a Development Financial Institution and came into being as on July 01,

1964 vide GoI notification dated June 22, 1964. It was regarded as a Public Financial Institution

in terms of the provisions of Section 4A of the Companies Act, 1956. It continued to serve as a

DFI for 40 years till the year 2004 when it was transformed into a Bank.

Industrial Development Bank of India Limited

In response to the felt need and on commercial prudence, it was decided to transform IDBI into a

Bank. For the purpose, Industrial Development bank (transfer of undertaking and Repeal) Act,

2003 [Repeal Act] was passed repealing the Industrial Development Bank of India Act, 1964. In

terms of the provisions of the Repeal Act, a new company under the name of Industrial

Development Bank of India Limited (IDBI Ltd.) was incorporated as a Govt. Company under the

Companies Act, 1956 on September 27, 2004. Thereafter, the undertaking of IDBI wastransferred to and vested in IDBI Ltd. with effect from the effective date of October 01, 2004. In

terms of the provisions of the Repeal Act, IDBI Ltd. has been functioning as a Bank in addition

to its earlier role of a Financial Institution.


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Merger of IDBI Bank Ltd. with IDBI Ltd.

Towards achieving the faster inorganic growth of the Bank, IDBI Bank Ltd., a wholly owned

subsidiary of IDBI Ltd. was amalgamated with IDBI Ltd. in terms of the provisions of Section

44A of the Banking Regulation Act, 1949 providing for voluntary amalgamation of two banking

companies. The merger became effective from April 02, 2005.

Merger of United Western bank with IDBI Ltd.

The United Western bank Ltd. (UWB), a Satara based private sector bank was placed under

moratorium by RBI. Upon IDBI Ltd. showing interest to take over the said bank towards its

further inorganic growth, RBI and Govt. of India amalgamated UWB with IDBI Ltd. in terms of

the provisions of Section 45 of the Banking Regulation Act, 1949. The merger came into effect

on October 03, 2006.

Change of name of IDBI Ltd. to IDBI Bank Ltd.

In order that the name of the Bank truly reflects the functions it is carrying on, the name of the

Bank was changed to IDBI Bank Limited and the new name became effective from May 07,

2008 upon issue of the Fresh Certificate of Incorporation by Registrar of Companies,

Maharashtra. The Bank has been accordingly functioning in its present name of IDBI Bank

Limited.


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2. RESEARCH METHODOLOGY

2.1 OBJECTIVE OF STUDY

The objective of the project is to analyse in depth the problems in assessing the working capital

requirement for MSEs.It was quite clear from the beginning that the problems are faced by the

entire banking industry .But the depth and facets of the problems was quite inevitable to be

brought into the picture.Also the inherent flaws prevailing in the system(not only in india butoutside ) is also studied along with to get a more clear picture.

2.2 LIMITATIONS OF THE STUDY

The substantiation of the facts which I got through the files which I came across during my

stint at the bank is impossible because of the extant guidelines of the bank.Because of what I

had to recreate a sample case with hypothetical numbers.Also I had to rely mostly on the oral

interview reports for my primary research.

In performing the comparative study among different banks ,the obstacle faced was their

reluctance to disclose.So the numbers were limited.The banks covered were

CANARA BANK

INDIAN OVERSEAS BANK

BANK OF BARODA

KARUR VYSYA BANK

SYNDICATE BANK

2.3 SOURCES OF DATA

The method adopted is primarily collecting the anecdotes from the managers in IDBI.The nature

of the problems that I have to analyse regarding the assessment is very relevant not only to

IDBI, but also to the entire banking and hence experiences by respective officials of some more

banks were also taken.The modes opted were both questionnaire and oral interview.

The secondary data was collected through Books & magazines, and Websites.


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3.IMPORTANCE OF PRIORITY SECTOR LENDING AND ITS EVOLUTION

3.1 INTRODUCTION

At a meeting of the National Credit Council held in July 1968, it was emphasised that

commercial banks should increase their involvement in the financing of priority sectors, viz.,agriculture and small scale industries. The description of the priority sectors was later formalised

in 1972 on the basis of the report submitted by the Informal Study Group on Statistics relating to

advances to the Priority Sectors constituted by the Reserve Bank in May 1971. On the basis ofthis report, the Reserve Bank prescribed a modified return for reporting priority sector advances

and certain guidelines were issued in this connection indicating the scope of the items to be

included under the various categories of priority sector. Although initially there was no specifictarget fixed in respect of priority sector lending, in November 1974 the banks were advised to

raise the share of these sectors in their aggregate advances to the level of 33 1/3 percent by

March 1979.At a meeting of the Union Finance Minister with the Chief Executive Officers of

public sector banks held in March 1980, it was agreed that banks should aim at raising theproportion of their advances to priority sector to 40 percent by March 1985. Subsequently, on the

basis of the recommendations of the Working Group on the Modalities of Implementation of

Priority Sector Lending and the Twenty Point Economic Programme by Banks (Chairman: Dr.

K. S. Krishnaswamy), all commercial banks were advised to achieve the target of priority sectorlending at 40 percent of aggregate bank advances by 1985..The guidelines were last revised in

the year 2007 based on the recommendations made in September 2005 by the Internal Working

Group of the RBI (Chairman: Shri C. S. Murthy). The Sub-Committee of the Central Board ofthe Reserve Bank (Chairman: Shri Y. H. Malegam) constituted to study issues and concerns in

the Micro Finance institutions (MFI) sector, inter alia, had recommended review of the

guidelines on priority sector lending. Accordingly, Reserve Bank of India in August 2011 set upa Committee to re-examine the existing classification and suggest revised guidelines with regard

to Priority Sector lending classification and related issues (Chairman: M V Nair).

I. Categories under priority sector

(i) Agriculture

(ii) Micro and Small Enterprises

(iii) Education

(iv) Housing

(v) Export Credit & (vi) Others


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I I . Targets /Sub-targets for Pri ori ty sector

Categories Domestic commercial banks / Foreign banks Foreign banks with less thanwith 20 and above branches 20 branches

Total Priority 40 percent of Adjusted Net Bank Credit [ANBC 32 percent of ANBC or creditSector defined in sub paragraph (iii) below] or credit equivalent amount of Off-

equivalent amount of Off-Balance Sheet Balance Sheet Exposure,Exposure, whichever is higher. whichever is higher.

Total agricultur e

18 percent of ANBC or credit equivalent

No specific target. Forms part of

amount of Off-Balance Sheet Exposure, total priority sector target.whichever is higher.Of this, indirect lending in excess of 4.5% of

ANBC or credit equivalent amount of Off-

Balance Sheet Exposure, whichever is higher,

will not be reckoned for computing achievement

under 18 percent target. However, all

agricultural loans under the categories 'direct'

and 'indirect' will be reckoned in computing

achievement under the overall priority sector

target of 40 percent of ANBC or credit

equivalent amount of Off-Balance Sheet

Exposure, whichever is higher.

Micro & Small (i) Advances to micro and small enterprises No specific target. Forms part ofEnterprises sector will be reckoned in computing total priority sector target.(MSE) achievement under the overall priority sector

target of 40 percent of ANBC or creditequivalent amount of Off-Balance SheetExposure, whichever is higher.

40 percent of total advances to micro andsmall enterprises sector should go to Micro(manufacturing) enterprises having investmentin plant and machinery up to Rs.10 lakh andmicro (service) enterprises having investment inequipment up to Rs. 4 lakh;

(iii) 20 percent of total advances to micro andsmall enterprises sector should go to Micro(manufacturing) enterprises with investment inplant and machinery above Rs.10 lakh and up toRs.25 lakh, and micro (service) enterprises withinvestment in equipment above Rs.4 lakh andup to Rs.10 lakh

Export Credit Export credit is not a separate category. Export No specific target. Forms part ofcredit to eligible activities under agriculture and total priority sector target.MSE will be reckoned for priority sectorlending under respective categories.

Advances to 10 percent of ANBC or credit equivalent No specific target in the totalWeaker Sections amount of Off-Balance Sheet Exposure, priority sector target.

whichever is higher.


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Performance of Indian MSME Sector

Indian MSMEs, which constitute more than 95% of the enterprises in India, have grown

significantly, with their gross output growing from 11.5% in FY03 to 15.8% in FY06; from `

3,148.5 bn in FY03 to ` 4978.42 bn in FY06.The gross output of MSME sector is projected to

grow from 6.2% in FY08 to 6.3% in FY11, slightly less than Indias GDP growth during the

same period. During FY12, the gross output of MSME sector is projected to grow at 6.6%,

slightly higher than Indias GDP growth of the same period.The sudden spike in gross output and

market value of fixed assets in FY07 was due to the passing of MSMED Act, 2006,thereby,

changing SSI definition incorporating medium enterprises and enterprises providing services

under the definition. the gross products of the MSMEs is projected to grow at a consistent pace

of over 6% from ` 14,351.79 bn in FY08 to ` 18,434.32 bn in FY12. The market value of fixed

assets of the MSMEs has grown from 4.9% in FY03 to 5.3% in FY06 and is projected to grow

over 6% from FY08 to FY11 and by 7.5% in FY12. Similarly, employment growth rate in

MSMEs projected to grow at an average rate of over 6%. These figures clearly highlight

importance of the MSME sector towards the development of Indian economy.

4.2ROLE OF BANKS IN MSE FINANCING

Availability of timely and adequate credit is a prerequisite to enable Indian MSEs to expand andscale their operations.In recent years, while the Indian economy has been growing at over 6%,

the production from micro, small and medium enterprises has been growing at over 11%

between 2002 - 2003 and 2007- 2008 (Ministry of Micro, Small and Medium Enterprises, 2008-

Source:Ministr o micro ,small and medium enter rises


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2009). In India, banks are the dominant channel for providing funds to industry. However their

importance in funding smaller firms is even more pronounced since most small and medium

enterprises (MSEs) are not able to access the capital markets for funds. In recent years, govern-

ments and policy makers have been giving considerable attention to facilitate the development of

the MSE sector, as a strong and vibrant MSE sector provides a good foundation for

entrepreneurship and innovation in the economy.


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and transformation of finished goods into book debts / cash.In respect of trading concerns,

operating cycle represents the period involved from the time the goods and services are procured

and the same are sold and realized. The working capital cycle is illustrated as follows:

Trade Cycle for Working Capital

Fixed Portion of Trade Cycle

There is always a minimum level of current assets or working capital which is continuouslyrequired by the firm to carry on its business operations. This minimum level of current assets is

known as permanent or fixed working capital or core current assets. It is permanent in the same

way as the firms fixed assets are. This portion of working capital has to be fi nanced by

permanent sources of funds such as; share capital, reserves, debentures and other forms of long

term borrowings. The extra working capital needed to support the changing production and sales

is called fluctuating or variable or temporary working capital. This has to be financed on short

term basis. The main sources for financing this portion are trade credit, bank credit, factoring and

commercial paper. It is in this context that bank financing assumes significance in the working

capital financing of industrial concerns.

Investment is needed at each stage to finance current assets. The total working capital

requirements for Industrial Units will depend upon the holding period of assets and the operation

of the trade cycle. Thus, the stocking of raw materials may be equivalent to one to three months


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raw materials consumption for most industries.As regards the operating cycle, the duration of

each stage of process cycle is first decided upon having regard to the function it is supposed to

perform. The conversion of raw materials into finished goods depends upon the technical

requirements and manufacturing facilities available. Similarly, the turnover of finished products

and their transformation into book debts, bills or cash could be related to factors like delivery

schedule, business customs and competition. Thus, the working capital cycle of a manufacturing

activity starts with the acquisition of raw materials in cash or credit basis and ends withrealization of finished goods in cash/ book debts.

The cycle is long in some cases and short in others, depending upon the nature of business.

Cycle is fast in consumer goods industries and slow in capital goods industries. Cycle is short in

case of perishables such as food articles, beverages, fruits, fish, eggs, etc. Cycle is long in the

case of tobacco, distilling, timber, steel, etc. Seasonal industries like manufacturers of umbrella,

woollen fabrics, fans, refrigerators, etc., require higher stocks in some months and bare minimum

in remaining months.Companies that have high inventory turnover and do business on a cash

basis (such as a trader) need very little working capital. These types of businesses raise money

quickly, then turn around and plough back that money back into inventory to increase sales.

Since cash is generated so quickly, managements can simply stockpile the proceeds from their

daily sales for a short period of time if a financial crisis arises. Since cash can be raised so

quickly, there is no need to have a large amount of working capital available.

A company that makes heavy machinery is a completely different story. Because these types of

businesses are selling expensive items on a long-term payment basis, they can't raise cash as

quickly. Since the inventory on their balance sheet is normally ordered months in advance, it can

rarely be sold fast enough to raise money for short-term financial crises (by the time it is sold, it

may be too late). It's easy to see why companies such as this must keep enough working capitalon hand to get through any unforeseen difficulties. During the cycle, funds are blocked in various

stages of current assets, viz., , inventory (consisting of raw materials, stock in process, finished

goods) and receivables.

These require finance, finance involves costs. Quicker the cycle more is the turnover normally

and longer the cycle, the less is the turnover. Stagnation in any area effects turnover and

profitability. Working capital cycle vary from industry to industry depending upon its nature of

business. Factors which affect working capital cycle are:

Policy of the management on production and sales Inventory management/ Receivables management

Nature of manufacturing activity/process

Policy of extending credit for purchases as well as sales

Government policy


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Type of product

Demand for the products/services and level of competition.


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5.2 METHODS OF ASSESSMENT

Consistent with the policy of liberalization, in April 1997, RBI withdrew the prescription in

regard to assessment of working capital needs, based on MPBF, enunciated by Tandon

Committee. Thus banks are given greater operational freedom for dispensation of credit. Banks

are also free to evolve their own method of assessing working capital requirements of the

borrowers within the prudential guidelines and exposure norms already prescribed.

The level of investment in an operating cycle depends upon changes in:

1) Terms of production and sales other factors remaining constant

2) The price of raw materials

3) Lead time for producing raw materials

4) The pattern of manufacturing expenses

5)

The process time

6) Policy of extending credit (both on purchase as well as sales) etc.

Assessment of working capital shall normally based on the following:

1) Production / Processing cycle of the industry

2) Size of the business and quantum of working capital requirements

3) Financial and managerial capability of the borrower and the various parameters relating to

the borrower.

4) Prevailing mandatory instructions of RBI

5) The trade and industry practice prevailing and other objective factors

This chapter explains the framework for assessing working capital requirement. AssesMSEnt of

the Working Capital requirement of a borrower shall generally be made under any one of the

following three methods:

1) Turnover method (P R Nayak Committee recommendation)

2)

Maximum Permissible Bank Finance (MPBF) Method (Tandon/Chore Committee

recommendation)

3) Cash flow budget method


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Turnover method

This method has been introduced in 1993 by RBI with a view to improve overall credit flow to

the SSI sector. MSE units having working capital limits of up to Rupees 500 lakh from the

banking system are to be provided working capital finance computed on the basis of 20 percent

of their projected annual turnover. The turnover method shall be applicable on MSE units (new

as well as existing).

Applicability of turnover method:

Particular Working capital limit upto Applicable to

MSEs Upto 5 crs Manufacturing sector & services sector

Non MSEs Upto 2 crs Traders, Merchants, exporters etc.

This system is normally applicable to traders, merchants, exporters who are not having a predetermined manufacturing / trading cycle. Under the turnover method bank should ensure that

maintenance of minimum margin on the projected annual sales turnover. Normally 25% of the

estimated gross sales turnover value shall be computed as working capital requirements, of

which 20% shall be provided by the bank and the balance 5% by way of promoter contribution

towards margin money. In case of a traders, while bank finance could be assessed at 20% of the

projected turnover, the actual drawals should be allowed on the basis of drawing power

determined after deducting unpaid stocks. Under this method current ratio would be min. 1.25.

Illustration

working capital requirement under the turnover method:

a) Projected accepted annual Gross Sales Turnover Rs.10.00 lakh

b) Working capital required 25% of the sales Rs. 2.50 lakh

c) Minimum margin to be provided by the borrower Rs. 0.50 lakh

d) Working capital finance (b-c) Rs. 2.00 lakh

Monitoring of the working capital finance


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As the working capital requirement are linked to projected turnover, reasonableness of the

projected annual turnover of the applicant company should be analysed by keeping in view of

past performance of the unit, the orders on hand, installed capacity of the units, power,

availability of raw materials and other infrastructural facilities . In respect of a new unit projected

turnover should be analysed with regard to installed capacity, marketability of the products,

performance of the similar unit in the industry, background of the promoters etc.

The projected turnover / output value is the gross sales which include excise duty. The

assessment of working capital credit limits should be done both as per projected turnover basis

and traditional methods based on production/processing cycle (MPBF). If the credit requirement

based on MPBF method is higher than the one assessed on projected turnover basis, the same

may be sanctioned. On the other hand, if the assessed credit requirement is lower than the one

assessed on projected turnover basis, while the credit limit can be sanctioned at 20% of the

projected turnover, drawals may be allowed basing on actual drawing power after excluding

unpaid stocks after obtaining monthly stock statement.

MPBF Method

Before going through the MPBF method of working capital assesMSEnt, we need to understand

two very important concepts of working capital finance as under;

Working Capital Gap

This represents excess of current assets over current liabilities excluding bank borrowings. A

part of the Current Assets are financed by Current Liabilities (other than bank borrowings). The

remaining portion of current assets which requires financing is called as working capital gap.

Banks do not grant advance to the full extent of working capital gap. It is always desirable rule

that the borrower has to finance a part of working capital gap out of either capital or long term

sources called as net working capital (NWC) which reflects his continued commitment to the

business that is necessary for the survival of the unit.

Net Working Capital

NWC indicates the margin or long term sources provided by the borrower for financing a part of

the current assets. Rest part of current assets gets funded by current liabilities (including Bank

Borrowings). For successful operation of a business, Current Assets should be more than the

Current Liabilities. It ensures continuous liquidity (current assets are prone to price fluctuations

and should, therefore, have an in-built margin to absorb changes) and owner's stake in the current

business operations. In other terms, NWC is excess of long term sources available for WC needs

after long term uses. As such, actual NWC is equal to Long Term Sources (LTS) minus Long


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Term Uses (LTU). Net Working Capital changes with the change in level of Long Term Sources

(including profits earned during the year) or Long Term Uses.

Three methods for assessing working capital requirement as per Tandon Committee Norms are:-

Method Quantum of bank finance for working capital

First 75% of working capital gap (Current Assets Current Liabilities). Balance 25% hasto be funded out of long term sources.This part is also called Net Working Capital (NWC)

Second NWC should be at least 25% of the total Current assets. Remaining 75% to be firstfinanced by other current liabilities and the bank may finance the balancerequirement.

Third Borrower should provide for entire core current assets and 25% of the balancecurrent assets.

Before the MPBF Method is explained, it is necessary to understand the erstwhile Second

Method of Lending under Tandon Committee Recommendations. Method 2 is the most

commonly adopted tool to assess working capital finance. Under Method II, the borrower should

bring in a minimum margin of 25% of all current assets from owned funds and long term

liabilities, and the balance i.e 75% be financed by the Bank.

The example given below will illustrate this:-


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Current Liabilities Current Assets

Credit for purchase 30 Raw materials 100

Other current liabilities 10 Stock-in-process 10

40 Finished goods 50

Bank borrowings including bill

discounted

140 Receivables including bill

discounted

80

180 Other current assets 10

Method II 250

a. Current Assets 250

Less:

b. Current Liabilities other than BankBorrowings

40

c. Working Capital Gap 210

d. Minimum stipulated net working

capital i.e 25% of Current Assets

62.50

e. Actual / projected net working capital

(total current assets 250 minus

total current liabilities 180 incl.

Bank Borrowings 140)

70

f. Item c minus d 147.50

g. Item c minus e 140

h. Max. Permissible Bank Finance (Item

f or g whichever is lower)

140

i. Excess borrowings

(representing shortfall in net working

capital item d minus e)

0

Cash Flow Budget Method


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In the case of specific industries / seasonal activities such as software export, construction

activity, tea and sugar, normally, the system of assesMSEnt based on the cash budget may be

adopted. Further, in the case of specific industries like tea, wherever for specific reasons, the

borrower opts to avail the Working Capital facility under MPBF system, the same may be

permitted by the respective sanctioning authority after necessary evaluation and justification.

Structure of Cash Flow Statement

The cash flow statement shows the movement of cash and bank balances during a certain period,

the reasons for increase (+) or decrease (-) in the bank borrowings, the level of cash holding

between 2 intervals of time. The cash flow statement is a historical statement that depicts the

flow of cash in the system. A cash budget statement depicts the projected movement of cash and

bank balances at a future period. It shows the expected inflow and outflow of cash and deficit

and surplus in generation of cash. The statement covers most of the details needed for assessment

of the financial needs of the borrower.

Needless to mention that this method of assessment needs to be supplemented with the

following:

1. Need for the projected levels of production (can be justified on the basis of orders on hand /

seasonal availability of the raw material / seasonal demand etc)

2. The projected levels of production should commensurate with the operating capacities of the

unit.

3. Verification of actual level of inventories, creditors and receivables so as to establish the

veracity of projections.

The statement of cash flow is made more meaningful and useful for assessment of working

capital by grouping the cash flows under three heads viz., Operating, Investing and Financing.

The principal cash flows arising out of the above three main groups are described below:

i) Operating Activities

These activities involve producing and delivering goods and providing services. Cash inflows

from operating activities include receipts from customers for sale of goods and services,

including receipts from collection of debtors. Cash outflows from operating activities include

payments to employees for services, payment to suppliers of goods, payments to Governmentsfor taxes and duties and services etc.

ii) Investing Activities


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These activities involve extending and recovering loans and acquiring and disposing of debt and

equity instruments and fixed assets. Cash inflow from investing activities include receipts from

loan collections, receipts from sales of debt and equity instruments of other enterprises and

receipts from sale of fixed assets. Cash outflows from investing activities include disbursements

of loans, payments to acquire debt and equity instruments of other enterprises and payments

(including advances or down payments) to acquire fixed assets.

iii) Financing Activities

These activities involve obtaining resources from owners and providing them with a return on

and return of their investment, borrowing and repaying amounts borrowed, and obtaining and

paying for other resources obtained from creditors on long term credit. Cash inflows from

financing activities include proceeds from issuing equity instruments, debentures, mortgages,

bills and from other long and short term borrowings. Cash outflows from financing activities are

payments of dividends, repayments of amounts borrowed and principal payments to creditors

who have extended long term credit.

Assessment of the limit under the cash budget system is done by arriving at the deficit between

cash inflow and cash outflow during a period of time. In this method, quantum of finance is

determined by the extent of negative cumulative cash flow position during a particular month.

The indicative format for cash budgeting is in ANNEXURE II.

In the case of seasonal industries / industries having peak/non peak level operations, cash budget

indicating the peak level/non peak level cash flows shall be obtained separately. Based on such

peak level/non peak level cash deficit, peak level limits shall be arrived at.The quantum of bank

finance for working capital to the borrower shall be the peak level of the annual cash deficit

projected as per the projected cash flow statement. However, the working capital limits shall bein tune with the quarterly cash deficit of the borrower as revealed in the quarterly cash budget.

To ensure sufficient liquidity, the projected balance sheet should reveal the minimum current

ratio acceptable to the bank. It should be ensured that working capital availed by way of cash

deficit is supported by adequate drawing power. Though cash budgeting is adopted, it is still

essential to analyse the liquidity, working capital management, overall leverage and debt

repayment capacity.


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6. PROBLEMS FACED BY IDBI AND OTHER BANKS ON ASSESSMENT OF

WORKING CAPITAL FOR MSEs

Diversion of funds is occasionally noted among many small and medium enterprises:

This may be due to sheer ignorance or due to lack of financial discipline.If such an event is

noted in the past, the natural tendency is to curtail credit exposure to the party irrespective of the

present state of the enterprise or the actual requirements noted.Possibility of diversion of

working capital finance to long term uses ie the Working capital finance which is meant for short

term uses and day to day operations of the firm due to lack of knowledge and financial expertise

,firms use short term capital to purchase long term assets. It will create an asset liability

mismatch and in turn can lead to cash flow crunch. This type of practices can lead to liquidity

crunch in the system.

Information asymmetry:

Difficulty in determining accuracy

a)There are instances when parties under report figures with a view to evade taxes or inflate

certain figures to make the ratios look good. Under such circumstances it is difficult to arrive at a

reasonably accurate credit profile of the party and can result in under financing or rejection of the

proposal.

b)Acceptability of Projected sales and profits

We use Nayak Committe Method for assessing working capital of Small Scale Industries, in

which the eligible working capital limit is calculated as a percentage of total projected sales. So,in order to avail more working capital finance firms project higher sales and they fall short of

estimates when the actual results come out

Inherent loopholes in the bureaucratic system cause inadvertent delays

Working capital methods existing do not have the scope of include the delays caused due to

pending sanctions from local bodies for instances environmental clearances,power connection

etc.


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Rising pressure of NPAs

Mounting npa levels of many branches have increased the risk averse nature of credit officials.

This results in sanctioning lesser than ideal limits for w.c . Leading to cash strapped enterprises

unable to kick start growth and eventually threatening their very sustainability. Lack of owned

funds in the business, and complete dependency on borrowed funds also add to the conservative

nature of assessing officer


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6. RECOMMENDATIONS/SUGGESTIONS

6.1 Modifications required in the System

Bureaucratic hurdles:The major revamp is required in the Indian way of redressal of

problems.Despite earning the status of priority sector MSEs struggle for the relevant

sanctions for speedy execution of their project.This in turn causes diversion of the funds

allocated for working capital into other uses .

Solution : A single window clearing system for MSEs in every state can be a solution. States like

Gujarat have already implemented .This ensure ri ght inf usion of funds at ri ght time so that

working capital cycle is not affected. The lending technologies employed to lend to the SME

sector in India would thus be influenced by the government policies and the lending

infrastructure prevalent in the country. Lending technology is categorised into two

types:transactions lending that is based on hard quantitative data and relationship lending

which is based on softqualitative information.

Lack of action for increasing awareness: Realizing the importance of the MSME

sector to the Indian economy, both the central and state governments have taken various

initiatives to strengthen and enhance the competitiveness of MSME sector. This is

evident from the subsequent passing of the MSME Development (MSMED) Act in 2006.

Few of the key initiatives include:

National Manufacturing Competitiveness Program (NMCP)

Rajiv Gandhi Udyami Mitra

Credit Guarantee Trust Fund Scheme for Micro and Small Enterprises

Credit Linked Capital Subsidy Scheme (CLCSS)

Solution:But from the interaction I had with the managers of the banks I had surveyed ,I could

discern that the borrowers who are the beneficiary of these plans are many a times unaware of

these steps taken by government.So only through awareness those funds reach the right hands.

Bridging the information asymmetry:

MSEs are more vulnerable to information availability as they lack from large sources of finance

and hence largely in need of bank assistance.

Solution:credit scoring helps to reduce the information asymmetry, particularly with respect to

small firms and hence geographic proximity of the borrower and lender is not crucial to loan


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decisions.Recognising that better credit information can directly increase the amount of

financing for SMEs by reducing the risk and costs arising from information asymmetries, the

Credit Information Bureau of India Limited (CIBIL) has been established as a publice private

partnership to enhance the availability of credit information to member financial institutions.

Also tis estimated that in India, family businesses account for 70% of the total sales and net

profits of the biggest 250 private-sector companies (The Economist, 1996), and almost all

MSME would be family firms. Inter-family relationships and family succession play an important

role in the performance of family firms, and banks would need to take this into account in their

credit decisions. It was also found that family businesses in India where succession takes place

without fights and splits show higher profitability. This would suggest that a credit officer should

also be aware of inter-family relationships as the souring of these relationships could

significantly change the credit risk of the family firm.Hence soft information inclusive ranking

should be introduced in some way.


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7.CONCLUSION

The MSE sector in India, which includes the micro, small and medium enterprises, constitutes an

important part of the economy. However, a major concern for the MSEs is the availability of an

adequate amount of finances. The government has recognised the key role that the MSE segment

plays in creating new enterprises and in providing employment to a large segment of the

population and has adopted several public policy measures to enhance flow of credit to the

sector. One of the prominent measures used to ensure adequate flow of funds to the MSE sector

is through regulation requiring banks to provide at least 40% of loans to targeted areas which

include the micro, small and medium enterprises. Although directed lending would increase the

flow of funds to the MSE sector, studies suggest that MSE firms are credit constrained. One of

the significant issues in lending to MSEs is the use of both hard data such as financial

information, as well as soft data such as feedback from vendors and other family members,

which become important inputs towards understanding the credit risk of the business. The

challenge for banks is to bridge the information asymmetry so as to take the appropriate lending

decision so that the good firms are not financially constrained, and at the same time, cut down on

exposures to bad credit risks.Also the bureaucratic delays adversely affects the working capital

cycle and there is no magical solution to it.So that problem remain out of bound in assesMSEnt.

Measures such as credit scoring for MSEs should improve the quality of financial information

and enable greater funding for the sector. While it may be too early to conclude that MSE firms

in India are not financially constrained, the reforms in the financial sector and the improvement

in the lending infrastructure has certainly improved access to finance for small firms.The banks

as such should keep a balanced view regarding NPAs and should collaboratively deal the risk

averse nature arising out of it.MSE s are indeed the growth engines of our economy and perhaps

our only hope for bridging the CAD in the long term.So it is quite inevitable the sector continue

to be our priority.


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8.BIBLIOGRAPHY & REFERENCES

1. http://www.idbi.co.in/

2. ebsco

I.

Impact of basel ii on lending to MSEs:a regulatory policy assesMSEnt of

Spanish credit register data

II. Real-time financing: Extending e-invoicing to real-time MSE financing,

Jaap Jan Nienhuis, Mounaim Cortet and Douwe Lycklama

III. The Reasons and Symptoms of Failure in MSE, Jaroslaw Ropega

IV.

Financing of SME firms in India Interview with Ranjana Kumar,

Former CMD, Indian Bank;Vigilance Commissioner, CVC

3. science direct


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ANNEXURE I


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ANNEXURE II

FORMAT FOR CASH BUDGETING

Particulars / month 1 2 3

Activity Details

Production (quantity)

Sales ( quantity)

Purchases

Cash Flows

(A) Total Cash Inflow ( Sum of 1 to 8)

Cash Sales

Realisation from Debtors

Receipt by way of trade advances

Receipt of interest, dividend, other income

Long term loans raised

Short term loans raised

Sale of assets

Others (Specify)

(B) Total Cash Outflow ( sum of 1 to 16)

Cash purchases

Payment to sundry creditors

Advances to suuppliers

Wages and salaries

Lease rentals


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Manufacturing expenses

Selling and distribution expenses

General administrative expenses

Interest payment

Dividend payment

Capital expenditure

Repayment of Long term loan

Repayment of short term loan

Taxes

Deposits and investments

Others (specify)

(C ) Cash Budget

Total Cash Inflow (A)

Total Cash Outflow (B)

Net cash flow (1-2)

Add Opening cash balance

Cumulative net cash flow Amount to be

financed

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