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Classification of Current Assets

Jan. 27, 2021, 11:19 p.m.

It is customary for banks to adjudge levels of working capital limits of borrowers by arriving at the Working Capital Gap after reclassifying the current assets and current liabilities as per accepted norms/ guidelines of RBI/individual bank.

 

While seeking the WC limits , borrowers try to justify their levels of current assets . During this process , normally there is tendency of the borrowers to inflate their current assets and project their current liabilities low so that higher WC gap is shown, thereby to derive Maximum Permissible bank Finance. However bankers has to assess the justified level of limits wherever the levels be. Normally there exists a Mutual mistrust between the bankers and borrowers leading to conflict of projections . Pity is that both fail in this process leading to either over finance or under finance which jeopardizes both of them.

 

In this post today , we shall discuss what should be a banker’s approach in classifying the current assets and current liabilities simultaneously not undermining the needs from borrower’s point of view. If a borrower or his consultant happens to be a financial experts , they play with bankers by using the projected level of CA at such a level that they can get max finance. Here an unscrupulous borrower plays the game entirely at the risk of banker, and profit generated is happily taken and all losses if any are left with the bankers.

 

Assessment of borrowers , the 3 Cs ( Character, capital and capacity ) play a major role in credit appraisal more than tools like ratios- cash flows etc. If a banker is successful in judging the borrower’s character/ integrity correctly a major part of assessment over. If he faults here he will enter into a black hole to be lost forever. Unfortunately there is no precise scale of measurement of these factors and the banker is left with no other alternative but to resort to the tools.

 

Bankers has to classify the current assets and current liabilities from last actual balance sheet, estimates for the ensuing year, projections for the next year and can confirm voraciousness of data, based on which limits are to be sanctioned.

 

What is current assets : Current assets are those assets which are transformed from cash to cash within 12 months period. But bankers feel under certain circumstances there is no need for extending finance for all current assets . Hence they classify and divide CA into actual current assets which need to be financed and non current assets which do not need finance and shift the same to a block below the fixed assets .

 

The normal current assets , which are included in the purview of finance are : cash / bank balances , stocks of inventory , receivables , advances to suppliers , genuine short term deposit/investments , normal prepaid expenses and other current assets ( specific).

 

The following paragraphs give in detail what is to be included and what should be excluded for assessment of WC limits:

 

Cash and Bank Balances : Cash balances in bank / on hand / FDs( even more than 12 months if justified), are accepted by bankers as normal current assets. Some bankers do agree , for classification of FDs kept under lien as margin under LCs and BGs opening for acquiring raw materials or bidding purpose or security deposits as current assets. On examination , it it is found that nature of deposits is long term , the same may be classified as NCA and borrower be advised to meet the same from long term source. However , if the borrower is required to place it on short term basis , the same may be accepted as current assets. Situational exigencies are to be examined to include or exclude the FDs in the current asset category.

 

Inventory : All stocks of raw materials / stock in process/consumable stores/ finished goods are accepted as CA. However, dead /obsolete / slow moving/ unrelated inventory etc. are to be classified as NCA. Further it is to be ensured that the quantum and levels of actual/ projected inventory are not above the acceptable level though there are no mandatory norms as on date. Banks and borrowers to mutually decided depending on the operating cycle , the levels which are justifiable /practicable and fall in line with past trends. The levels of inventory management also depend on the terms of supply and whether the product is in a buyers market or in a sellers market. Proximity of raw materials availability also figure while assessing the levels of inventory. What is significant here is that a borrower knows and calculate all these before he takes a business decision. Any inconsistency in these parameters needs explanation from borrower.

 

Receivables : Receivables which are normal and emerging out of genuine trade transactions are to be included. Receivables which are not related to normal business transactions/ older than six months ( depending on the working capital cycle or sanction terms age of receivables may be more) are to be treated as NCA. To know , old and dead unrecoverable receivables banker has to study the previous BS, auditors comments if any and look for repeated items and call for explanation.

 

Care should be taken for receivables from group/ associated/subsidiary companies. Genuine trade/ business related receivables will definitely count for real CA. However at times , just to boost the figure some accommodation entries may be shown which should be studied thoroughly .

 

Advance to Suppliers : Bifurcation is to be made for advances made to supplier of capital goods and for raw materials . Items appearing for capital goods should come from long term sources and shall not be  accounted as CA. Amount paid to suppliers , which are shown on a running account basis be cross checked for regular supplies made , and bills / invoices raised to be treated as CA. If the borrower makes a security deposit on long term basis for supply of RMs , the same will not rank as CA. Wherever possible , borrower is to be advised to substitute the cash deposit with BG or LCs , which can also be sanctioned as a part of non fund based WC facility ( contingent liability) by bank provided the supplier is willing for the same.

 

Short term investments: As a thumb rule bankers do not appreciate any investments other than bank deposit and investment is supposed to be made to the extent of surpluses available in the system . Inter corporate deposits ( ICDs) placed by borrower is generally are not considered by banks as a CA. But ICDs placed with the borrower are to be treated as Current liability. However quoted investments are considered as current assets.

 

At times borrower do have surplus funds at his disposal and he may invest it in his associates for working capital purpose ( short term need) . At the same time since , he is having available limit under DP , he may draw the funds for his own concern for its normal requirement. The associates returns the fund to the main concern after their fund position eases. Under such circumstances , it is justified by bank to consider such ICDs as CA. However many bankers do not accept this and question as to why the surplus monies are not deposited into the advance accounts to bring down the interest cost . However the significant aspect is that when the borrower makes any investment on a short term basis the need and period should be acceptable to the bank. In any case unjustified investment is not to be considered as CA.

 

Prepaid Expenses : All prepaid expenses are reflected in the CA by the borrower . Normally prepaid expenses include the taxes/excise /customs duty paid. Care to be exercised that the prepaid expenses comprise those of current year only and items which pertain to past years and not settled yet are to be excluded from current category. Hence a study of those items in detail required.

 

Other Current Assets ( OCA): Borrower has to explain and justify all other entries in this category with suitable explanatory notes and remarks. Bank has also to judge the same depending upon the level and period and decide whether to accept the same or not. Any large amount without justification needs to be classified as NCA.

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