Working Capital Loan Requirement:
An entity engaged in commercial activities requires finance of various types over and above the promoters /owners fund & therefore plan to enhance working capital loan. The requirement of finance may be of short term/medium term /long term /revolving term etc.
Working capital loan is required to finance the day to day operational expenditure which is also called revenue expenditure or repetitive expenditure for running operation of the company either for production of goods or rendering services.
Working capital Loan Enhancement:
Working Capital Loan enhancement is necessitated when the following situation arise in the company/Firm.
- Augmentation of production line & adding new product variants
- Adding new services & enlarging area of service
- Increase in volume of sales & consequent hike in sales related expenditure
- Capacity expansion after acquisition or takeover of new unit for inorganic growth
- Spurt in input cost of material, labor & highly skilled person & other expenses like transportation, rental etc.
Now, that considering the satisfactory conduct of Cash Credit account where Working capital loan is sanctioned & utilization of existing working capital limit by any entity, process to enhance working capital loan can be initiated by the borrower as well as by the bank.
The need to enhance working capital loan should be justified by the borrower on any the above mentioned reasons or combination thereof to the satisfaction of the Banker.
The Firm /Company must demonstrate that that they are on the growth trajectory YOY, and there is increase in Current assets in the form of Stock, work in progress, debtors, cash, bank balance & cash equivalent liquid assets commensurate with the higher volume of business to apply for Working Capital Loan enhancement.
Working Capital Loan enhancement letter to Bank:
The Company /Firm contemplates to enhance the Working capital Loan need to submit formal application letter to Bank by applying in the company’s letter Head along with the presentation of the prescribed format of the Bank( Most Bank have their unique application format) along with the documents as desired by the Bank.
What are the Documents Required :
Bank require documents to understand as to why the borrower wants to enhance working capital loan over the existing cash credit limit (mode of working capital finance).
Generally the following documents are required from the loan account holder when they approach to enhance the working capital loan.
- a)All audited financials for the last 2 yrs
- b) Provisional & Projected P& L /Balance sheet for the current & at least 3 years respectively
- b) Age wise debtors/Creditors list
- c) Current stock Statement (wherever applicable)
- d) New production plan/ DPR (in case of modernization / increase in production volume)
- e)Cash/Fund Flow statement.)
- Cost escalation matrix schedule certified by C.A
- Latest IT return & Up to date GST Return (3B etc.). Net worth statement in the Balance format of the Promoters /directors of the company.
- Valuation /revaluation of security as desired by the Bank
- Documents /Contracts establishing new work orders in domestic or overseas market if any.
Process of working capital loan enhancement:
Once the working capital loan application along with all these papers are submitted to the Branch Manager of the Bank, requesting to enhance working capital loan.
Banks Credit Officer / respective credit department start assessing the documents to arrive at the actual quantum of enhancement of working capital that can be sanctioned to the constituent.
 While processing any such application to  enhance working capital loan Bank uses different financial ratios to assess the growth of the business , new business prospect , interest servicing capacity , past performance records & promoters outlook .
Bank generally uses any of the following ratios on receipt of request to enhance working capital loan.
Debt Service coverage Ratio
Current Ratio
Quick/Acid test ratio
Turnover ratio
Profitability ratio
Capital gearing ratio
Bank may use any other financial /mathematical tool /in-house rating system while approving to enhance working capital loan.
Besides Bank undertake physical inspection & verification of the Business unit production facility/plant /service set ups as the case may be where the requirement to enhance working capital loan is acknowledged.
How long time is required for the enhancement of the loan:
There is no fixed time frame for approval of the application to enhance the working capital loan. In this context borrower & bank both have their role to expedite the time of sanction.
In the part of Borrower , all the documents as desired by the Bank to be submitted without any lapses and incorrect /inflated figure and the credentials & conduct of the borrower is the pre requisite for in principal acceptance of application to enhance the working capital loan.
On the part of the bank the Understanding of the processing officer and the approving Authority to realize the timely requirement of enhanced cash credit limit by their customer subject to fulfilment of proper documentary compliance there by is of paramount importance.
Avoidable delay in financing is tantamount to cost overrun & derailment of the project/venture etc. needs Banks attention.
However we may say for small & medium size project it may take up to 45 days & for larger cases it may take up to 3 months & above from the day of submission of the application to enhance working capital loan.
How is working capital loan amount determined?
Estimation of Working Capital Requirements to Enhance the Working Capital Loan.
| I | Current Assets : | Amount | Amount | Amount |
| Minimum Cash Balance | 3,50,000 | |||
| Inventories : | ||||
| Raw Materials | 12,00,000 | |||
| Work-in-progress | 7,30,000 | |||
| Finished Goods | 9,50,000 | 28,80,000 | ||
| Receivables : | ||||
| Debtors | 4,50,000 | |||
| Bills | 3,75,000 | 8,25,000 | ||
| NET Working Capital (CA) Excluding depreciation. | 40,55,000 | **** | ||
| II. | Current Liabilities : | |||
| Creditors for Purchases | 7,65,000 | |||
| Creditors for Wages | 3,37,000 | |||
| Creditors for Overheads | 9,25,000 | |||
| Total Current Liabilities (CL) | 20,27,000 | **** | ||
| Excess of CA over CL | 20,28,000 | **** | ||
| + Safety Margin 20%of net CA (40,55,000) = | 8,11,000 | **** | ||
| Net Working Capital | 28,39,000 | **** |
The following points are also worth noting while estimating the working capital requirement:
- Depreciation: It is considered as non-cash item & therefore not added while arriving the Working Capital or Net Working Capital.
- A margin of safety as % to total Current Assets are desired by the firms while estimating the requirement to enhance working capital loan.
Other Important Notes:
To enhance working capital loan, capital estimates may be made on the basis of (i) As a % of net sales, (ii) As a % of total assets or fixed assets and (iii) operating cycle of the firm.
The need for cash is estimated for all the components of working capital I.e. Raw material, work in progress, finished goods& debtors following Operating Cycle Method. However to enhance the working capital loan creditors or others receipt amount are deducted to find out the net working capital requirement.
Raw material is considered to be introduced in total in the production process in the beginning, but wages and expenses are assumed proportionately to accrue throughout the production process cycle.
The debtors (receivables), finished goods & work in progress to be taken at cash cost because that shows the funds required for financing of working capital. Depreciation should not be included as per Accounting Standard of India.
While approaching to enhance working capital loan the working capital the firm may also include a safety margin to take care of the contingencies.
Working capital loan Balance Transfer & Enhancement:
Company /firm using the Working capital loan by availing Cash Credit sometimes find it difficult that the existing Bank may not show interest in enhancing the Limit and or not reducing the rate of interest in spite of years of credit relation with them.
In such cases the borrowers opt for transfer of their Debit balance outstanding in their cash credit account to another Bank to enhance working capital loan amount with better rate of interest.
For such transfer the Company /Entity must approach a bank to enhance the Working capital loan and fulfill their criteria including security coverage etc. & get the proposal accepted.
Once the new Bank gives their sanction to enhance the working capital loan, they pay the bank where the cash credit account is running by the amount of outstanding plus interest and open the cash credit account in the new bank giving such enhanced limit.
After payment of the dues to other bank, all the securities are released and mortgaged to the bank which enhance the working capital loan to their new customer.
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