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WORKING CAPITAL
MANAGEMENT
By
CA SANJAY MAJMUDAR
RAJKOT BRANCH-WIRC OF ICAI
30TH MAY, 2015
7/6/2017
SANJAY MAJMUDAR & ASSOCIATES
1. PRELIMINARY
• Working Capital is – literally “Life Blood” of Business.
• Analysis of Business failures indicate inadequate
/non availability of working capital as a major reason
for downfall.
• Proper
understanding
of
working
capital
management nuances is therefore, of paramount
importance, particularly for finance professionals..
SANJAY MAJMUDAR & ASSOCIATES
2. METHODS OF DETERMINING
WORKING CAPITAL
• The generally prevalent methods for working capital
assessment are –
• CMA Method – Widely popular for most of the working
capital assessments involving turnover in excess of
threshold limit usually applicable for manufacturing
concerns, trading concerns, contracting business, etc.
• Turnover Method – Typically applied for simple
business with turnover up to Rs.6-10 crores (this limit
may vary) with thumb rule of the working capital limits
required being at the rate of 20% of the turnover.
SANJAY MAJMUDAR & ASSOCIATES
METHODS OF DETERMINING WORKING CAPITAL Contd…
• Cash Flow Method – Applied where the primary
objective is to fund the cash flow deficit for a given
business model – for e.g. real estate development
projects or short term specific purpose working capital
loans, etc.
SANJAY MAJMUDAR & ASSOCIATES
3. ASCERTAINING WORKING CAPITAL NEEDS
: CMA METHOD : BASIC PROCESS
• Understanding the Basic Industry in which the unit
operates;
• Understanding the Business Model and strategy of the
Enterprise.
• Understanding the basic philosophy of the Enterprise
w.r.t. Working Capital Management.
• Analyzing the past performance trends, historical
working capital cycles & movements identifying any
abnormal factors or “One-Offs”; and normalizing the
historical trends.
SANJAY MAJMUDAR & ASSOCIATES
ASCERTAINING WORKING CAPITAL NEEDS : BASIC PROCESS
contd..
• Based on historical trends, as suitably modified
by changing business dynamics/parameters,
working out realistic and acceptable estimates
for the current fiscal year and projections for the
next fiscal year.
• Timing of the exercise is very crucial, and can
impact the process materially – eg:. Instead of
initiating the same in Feb/March; it will be more
meaningful if it is initiated in April end, based on
latest historical provisional/Audited financials.
SANJAY MAJMUDAR & ASSOCIATES
4. DETAILED WORKING CAPITAL ASSESSMENT : KEY
PARAMETERS – CMA METHOD
• Analysis of working capital movement trends :
 Last 12 Months Domestic/Export Sales
 Last 12 months Inventory & Receivable levels.
(RM/WIP/FG/Domestic receivables/Export
Receivables)
• Analysis of the key findings of the latest stock –audit
reports/internal inspection reports.
• Perusal of minutes of consortium meetings, so as to
determine the mind-set/concerns of the member Banks.
SANJAY MAJMUDAR & ASSOCIATES
Detailed Working Capital Assessment : Key Parameters contd…
• Perusal of Statutory Audit/Internal Audit/MIS Reports so
as to have an idea about inventory movement,
identification of slow moving/non-moving/obsolete
inventory & sticky receivables not provided for.
• Ageing Analysis of Debtors, - in line with the Business
Cycle, and identifying debts which are not recovered and
have become disputed /sticky.
• Perusal of last 12 months Bank statements (CC/EPC
accounts) to determine the stress areas reflected by
frequent overdrawing, ad-hoc limits taken, servicing of
interest/repayment obligations, etc.
SANJAY MAJMUDAR & ASSOCIATES
Detailed Working Capital Assessment : Key Parameters contd…
• Perusal of the external rating of the company together
with rating rationale which will give a fairly reasonable
overview of the affairs and the concern areas as well as
strengths and opportunities available with the enterprise.
• Perusal of existing Terms of sanction, if available, and
identifying critical terms with regard to DP eligibility,
Margins, pricing, fees & expenses, Commissions &
charges, Guarantees & Securities, etc.
SANJAY MAJMUDAR & ASSOCIATES
5. CERTAIN KEY RATIOS:
Current ratio: Classically computed as current assts
divided by current liabilities. Although conventionally,
deal level of current ratio is regarded as 1.33, now this
is fairly flexible and is basically required to be over 1
with the minimum entry level CR stipulated by RBI at
1.17 for takeover of an account from another bank and
CR above 1.25 is generally eligible for good marks for
internal/external rating purposes.
CR can be generally lower in export oriented
undertakings since export finance is with NIL/lower
margins.
SANJAY MAJMUDAR & ASSOCIATES
CERTAIN KEY RATIOS – contd.
Net working capital: This typically is the difference
between total current assets and total current liabilities,
representing core working capital which has to be
funded by the borrowing entity from long term sources.
Typical sources for NWC would be internal cash
generation, equity, long term secured/unsecured loans,
long term debentures and preference share capital. A
higher NWC denotes strong financial position and vice
versa. CR less than one would result into negative
NWC – an undesirable situation.
SANJAY MAJMUDAR & ASSOCIATES
CERTAIN KEY RATIOS – contd.
Tangible Net Worth: In ordinary parlance tangible net
worth is share capital + reserves less intangibles.
However, from a working capital perspective
investment outside business made by an enterprise is
also deducted from TNW so as to arrive at adjusted
TNW.
TOL/TNW: This is the ratio of total outside liabilities to
tangible net worth. Total outside liabilities include
secured and unsecured loans, trade creditors, creditors
for expenses, provisions, etc. If preference share
capital is redeemable before a period of 12 years then
the same will also be included in TOL. DTL also
normally forms part of TOL, however, some banks (very
few) are also treating the same as a part of TNW.
SANJAY MAJMUDAR & ASSOCIATES
CERTAIN KEY RATIOS – contd.
Generally the acceptable level of this ratio is that it
should be less than 3. It is possible to argue that
unsecured loans given by the promoters being
subordinate to bank loans should be regarded as quasi
equity and accordingly work out the adjusted ratio of
TOL/TNW so as to bring it down below the normally
accepted benchmark level.
TTL/TNW: This is the ratio of total term liabilities to
TNW. It is normally accepted to be in the region of
maximum 2 times.
SANJAY MAJMUDAR & ASSOCIATES
CERTAIN KEY RATIOS – contd.
Impact: If the ratios are favourable it has a positive
bearing on the internal and external rating. It is again
having a direct bearing on the pricing of the loan.
Highly unfavourable ratios would push the rating below
the investment grade and it would not be normally
feasible to fund such units.
SANJAY MAJMUDAR & ASSOCIATES
(6) W-CAP COMPONENTS
A.
INVENTORIES
 Seasonality, identification of peak levels
 Commercial usability of slow moving/non-moving
inventories.
 Goods-in-Transit/with third parties.
 Sufficiency of insurance coverage, whether insurance
can be avoided?
 Uniform margins preferred
 In case of imports, terms to be ascertained, i.e.
minimum shipment load, L/C requirements, cycle
time, etc.
 Imports /local purchases against firm export orders
are
eligible
for
concessional
rates/interest
subvention/lower margins.
SANJAY MAJMUDAR & ASSOCIATES
W-CAP COMPONENTS
B) RECEIVABLES (DOMESTIC)
 Debts due in excess of 6 months : Schedule
III vis-à-vis Bank’s treatment.
 Linkage with Business Cycles Margins to be in sync. With Quality of
Receivables.
 Factor of year end lumpiness to be judged in
line with quarterly sales trends.
SANJAY MAJMUDAR & ASSOCIATES
W-CAP COMPONENTS : contd…
C) EXPORT RECEIVABLES
•
Holding levels to be properly determined
•
Countries of exports –special dispensation for
certain countries like Iran, Pakistan & certain
African countries.
•
In case of exports against L/Cs special treatment
is possible.
•
Ranking of Banks opening L/Cs, and L/C terms
are critical, otherwise can impact transaction
costs/L/C Discounting charges, (eg.: confirmation
costs), acceptance conditions, etc.
SANJAY MAJMUDAR & ASSOCIATES
W-CAP COMPONENTS : contd…
C)
EXPORT RECEIVABLES
•
ECGC cover charges & costs are relevant-ECGC
Cover may not be needed in case of exports
through WOs/Marketing JVs; and will not be
needed in case of exports against L/Cs.
•
Export receivables can be funded at lower
rates/Nil Margins- and have a direct impact on the
C.R.
SANJAY MAJMUDAR & ASSOCIATES
W-CAP COMPONENTS : : contd…
D) (OCA) OTHER CURRENT ASSETS
•
•
•
•
•
E)
L/C & B/G Margins (inclusion/exclusion)
Balances with Govt. Authorities (inclusion/exclusion)
DEPB/Export Incentives Receivable- whether qualify for
DP?
Adv. Tax (vis-à-vis Tax Provision)
Advances to Suppliers.
(OCL) OTHER CURRENT LIABILITIES
•
•
•
•
•
•
Current Maturities of LTLs.
Advances from Customers
Trade Creditors/payables for expenses
Short Term unsecured loans
Tax Provisions (vis-à-vis Advance Tax)
Statutory Liabilities
SANJAY MAJMUDAR & ASSOCIATES
7. STRUCTURING
A. ABF : FBL
•
C/C
(Hypothecation
of
inventories/debtors)
earmarking against FCNR-B deposits possible.
•
WCDL (a portion of C/C at a lower rate)
•
EPC/FBP/FBD (standalone or sub-limit of CC)
•
PC FC possible.
•
Domestic BD (standalone or sub-limit of CC)
SANJAY MAJMUDAR & ASSOCIATES
STRUCTURING contd..
B. NFB
a) L/C (Site /Usance)
 Usance period depends upon trade cycle-normally
upto 90-120 days in case of Domestic purchases &
180-270 days in case of import purchases.
 Buyer’s credit-BC(sub-limit of L/C to be considered).
 Master
circular
of
RBI
allows
RM/components upto 365 days max.
BC
for
 Has to be in line with Business cycle.
 An increasing Trend to assess a combined C/C /
L/C limit as C/C limit, and then give L/C sub-limit, so
as to reduce risks of devolvement & consequent
stress.
SANJAY MAJMUDAR & ASSOCIATES
STRUCTURING contd..
b) B.G.

ABG, for enabling to take advance monies as per contractual
terms

PBG, for performance guarantees, typically relating to export
obligations against duty free imports, performance under
contractual terms, EPCG guarantees, Retention Money
guarantees, etc.

Guarantees against security deposits like tender deposits,
deposits with utility companies for power connection, etc.

Tenor depends upon cycle time and contractual terms.
c) CEL

It is a notional limit, covering margin required to be taken for
currency exposures like forward contracts, etc.

It is usually @ 2% of the likely exposure.
STRUCTURING contd.
(d) SBLC/Letter of Comfort

Used generally for securing the limits to be granted to overseas
subsidiary/JV companies.
(C) Irregularity/NWC Deficit Funding

Devolved portion of L/Cs and DP shortfall can be carved out into
WCTL; however this may tantamount to Restructuring.

DP shortfall (resulting into NWC deficit) can be funded through a
medium /long term corporate loan, provided sufficient F.A. cover is
available.
SANJAY MAJMUDAR & ASSOCIATES
8. SHARING PATTERN
• Funding upto certain exposure levels (now generally
upto Rs.50 crores) is on stand-alone basis.
• For larger exposure, banks insist for either Consortium
lending or in some cases, Multiple Banking based
lending.
• Typically Consortium Banking preferred, as it ensures
better control & Monitoring, higher discipline, sharing of
common pool of securities, joint documentation etc.
•
A Bank with higher exposure/initial exposure usually
acts as a leader of the consortium, and other banks
follow the lead bank.
SANJAY MAJMUDAR & ASSOCIATES
SHARING PATTERN
• However, the flip side of consortium banking is longer
time in proposal processing, documentation, problem of
managing many banks, higher costs & charges, etc.
• Multiple Banking possible generally in case of distinctly
different verticals/ Divisions of an Enterprise, with
clearly identifiable income streams, securities & cash
flows.
SANJAY MAJMUDAR & ASSOCIATES
9. Security Structure
a)
Primary





b)
First pari passu/exclusive charge on inventories & receivables.
Customers’ acceptances of Bills
Cash Margins in case of NFB limits.
Escrow of specific cash flows
First charge on fixed assets in case of corporate loans/SBLCs
Collateral




Second charge on fixed assets.
Charge on other immovable properties of the
enterprise/promoters
Personal /corporate guarantees.
Pledge of shares.
SANJAY MAJMUDAR & ASSOCIATES
10. PRICING
• Linked to External & Internal Rating
• External rating compulsory as per Basel II Guidelines
• Increasing trend for Banks not to take new exposure if
external rating is below BBB.
• Equally important is internal rating – most of the
models are designed by CRISIL/Mckinsey; and place
heavy reliance on achievement of past performance,
financial Benchmark ratios; industry, corporate status,
promoters & management quality; market information
& reports; conduct of account, etc.
• FBL priced at Base rates plus applicable spreads, as
per rating. Concessional pricing applicable for
EPC/FBP/FBD limits; discounting of sales bills under
L/Cs, WCDL limits, etc.
SANJAY MAJMUDAR & ASSOCIATES
PRICING Contd.
• L/C & B/G opening charges & Commissions depend
upon rating, quantum, security, past-performance, etc.
• Banks also charge separately lead Bank fees,
proposal processing charges, legal documentation
charges, TEV charges, inspection charges, etc.
• Intelligent & careful negotiation is required for
ensuring an overall fair & reasonable pricing.
• Concessional pricing possible for MSME/SME
sectors.
SANJAY MAJMUDAR & ASSOCIATES
11. Documentation
• Legal documentation could be a cumbersome,
expensive & Time consuming exercise, particularly in
consortium accounts.
• As per prevalent stamp duty law in Gujarat, graded
duty is levied for Hypothecation & Equitable
Mortgages.
• However, for larger advances (in excess of Rs. 10
crores), maximum stamp duty is payable Bank-wise
at around Rs. 11.00 lacs for hypo & Rs. 4.00 lacs for
E.M.
• Separate fees are to be paid to lawyers for TCR,
Documentation etc.
SANJAY MAJMUDAR & ASSOCIATES
Documentation contd.
• Separate fees are also to be paid to panel valuers for
valuation.
• If Terms of sanction are not carefully proposed,
multiple duties /costs will be applicable, which can be
prohibitively expensive.
• To avoid steep stamp duties in case of large
consortiums, there is a trend to have a common
security trustee of all Banks for security creation &
holding of title documents.
SANJAY MAJMUDAR & ASSOCIATES
12. Cash Flow Method:
• This method is applicable generally in case of
situation where specific cash flow deficit financing
requirement exists.
• This is widely used in case of real estate developers –
i.e. those developing
commercial/ residential
projects, townships, etc. For a developer the entire
project funding has mainly working capital element
but the time period for the project can be much longer
say 2 to 5 years depending upon the size and type of
the project.
SANJAY MAJMUDAR & ASSOCIATES
Cash Flow Method cntd.
• The developer will make sales bookings and get
periodic advances from the customers as per the
terms of allotment.
• At the same time the developer will have to continue
constructing the scheme and typically in the initial
phases the cost of construction would be higher than
the inflows in the form of equity infusion/booking
advances from members, thereby creating cash flow
deficit.
SANJAY MAJMUDAR & ASSOCIATES
Cash Flow Method:
• Construction term loan (which is in the nature of working
capital loan) is required to be estimated for this deficit
funding. It is typically of longer tenor – over one year up
to even 5 years and will be repaid as and when the cash
surplus arises.
• Cash flow method is also used for certain specific “one
off” abnormal items of costs required to be incurred (for
e.g. abnormally high purchases or heavy payment of
custom duty etc.) which is not envisioned as a part of
normal cycle which specifically requires a STL which will
be repaid over certain designated period from future
cash flows.
SANJAY MAJMUDAR & ASSOCIATES
CASE STUDY -1.
• ABC Engineering Limited is manufacturing certain
engineering products. Its estimated turnover for fiscal
2014-15 is around Rs.500 crores. The main raw material
is in the form of special steel sheets and the estimated
consumption for FY : 2014-15 is around Rs.350 crores.
70% of the raw material is imported mainly from
Japan/China/Korea. Imports are against usance LC with
usance period ranging from 180-270 days. Time taken
by the suppliers to ship the material is around 30 days
after receipt of LC and it takes about 45 days for the
material to reach Indian Port. After receipt of the goods
at the factory the company takes about 45 days for
production. The average holding level of imported
inventory is around 1 month. The normal credit offered to
the customers is around 2 months.
SANJAY MAJMUDAR & ASSOCIATES
CASE STUDIES -1 contd..
• What will be the LC limit required by the company? The
suppliers can offer a discount of 5 to 7% if the company
makes payment against delivery/site LC. Will this be
beneficial to the company? How can the company fund
the same in a cost effective manner?
SANJAY MAJMUDAR & ASSOCIATES
CASE STUDY - 2
•Pipeline Limited are acting as turnkey/EPC contractors in the field
of water treatment plants, pipeline laying jobs, etc. As of
01.04.2014 they have unexecuted order book of around Rs.1200
crores. Their target completion and billing for FY 21014-15 is
Rs.500 crores. They are also targeting a fresh intake of new
orders of around Rs.500 crores in FY 2014-15.
•On an average they take about 2 years for execution of the
project. The normal terms of the contract is that around 10% of
the contract value is held back as retention money which is
released after about 12 months of successful running of the
project. Again in general as per the past trend their bid success
ratio is about 20%. The bid bond deposit requirement is at the rate
of around 2% of the bid amount and it takes about 4 months for
the bidding process to be complete
SANJAY MAJMUDAR & ASSOCIATES
CASE STUDIES-2 contd..
• On an average they get about 10% of the
contract value as advance and the performance
guarantee is also around 10%.
• The opening balance of outstanding bank
guarantee is Rs. 60 crores. What would be the
fresh bank guarantee limit required for FY 201415?.
SANJAY MAJMUDAR & ASSOCIATES
CASE STUDY-3
• XYZ Cotspin Limited is a major exporter of cotton out of
India. Its estimated cotton exports in FY 2014-15 is around
Rs.2,000 crores. Almost 90% of these exports take place
during the cotton season – which is generally from October
till March every year. All exports are against L/Cs from
reputed banks. Almost 70% exports are on 90 days’ usance
basis and balance 30% exports are on at site basis. The
normal documentation/negotiation period is about 15 days. It
takes about 10 days for the customers to accept the bills
under LCs.
• As per the business cycle, once the LC is received, it takes
about 10 days for the company to procure the material, get
the quality certification and make it ready for shipment.
Please determine the requirement of EPC limit as well as
FBP/FBD limit for FY : 2014-15.
SANJAY MAJMUDAR & ASSOCIATES
THANK YOU
SANJAY MAJMUDAR & ASSOCIATES