13 April 2009
By its nature working capital assets get transformed with time. Raw material changes into goods in process, then in finished goods, then in receivables and finally in cash. This cash to cash cycle is called working capital cycle. Tandon Committee (incidentally Mr Tandon, a CA, was the first Indian CEO of Hindustan Lever, now Hindustan Unilever) was appointed by RBI in early seventies to devise a mechanism for allocating bank’s lendable resources equitably among various industries. (Those days bank finance was a scarce commodity) The essence of TC’s recommendations was that a certain part of the working capital needs must come from long term sources. As most borrowers were lax, relying overly on bank finance TC made graded recommendations giving three methods of lending.
In first method the borrower was to fund 25% of working capital gap (this was defined as total current assets less current liabilities less short term loans from banks) from long term sources. In the second method the borrower was to fund 25% of all current assets from long term sources and in the third method the borrower was to fund “core” working capital assets plus 25% of non-core working capital assets from long term sources. The concept of core working capital assets can be understood with reference to the working capital cycle (cash to cash cycle referred to earlier). Though the non-cash components of working capital will fluctuate with the manufacturing process, to avoid stoppage of work all firms will maintain certain minimum stocks of raw material etc all the time. The logic was that if these assets are to be maintained all the time they become akin to fixed assets and should, therefore, be funded with long term sources.
Permanent working capital is the working capital funding core working capital assets.
First, banks are no longer to rigidly follow the TC norms. Second if the working capital norms of your industry have not been described in TC report (and in the subsequent circulars of RBI) banks usually accept reasonable scenarios.
For estimating MPBF I will suggest you try to avoid core working capital assets concept. Most of the banks are no longer very rigid about it. You go for the 2nd method.
All projections: Build up of current assets Less 25% long term resources Less projected current liabilities = Maximum Permissible bank Finance
Please note that MPBF is never made available by bank / RBI only the formula for arriving at is given. The one I have cited above is for second method of lending recommended by TC. I am not sure banks are still following TC.
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