Maximum Permissible Bank Finance (MPBF) is arrived at by deducting the stipulated Net Working Capital (NWC)  or available NWC in the system ( whichever is higher) from the working capital Gap. This concept is brought by Tandon Committee recommendations where minimum NWC is stipulated to be maintained under the following three methods of lending :

Tandon Committee – 1974 stipulates minimum Net Working Capital (NWC) as below:-

First Method - -  25% of the working capital Gap

Second Method - - 25% of the accepted Current Assets

Third Method - - Core Current Assets ( CCA) + 25% of the Real Current Assets ( RCA)

Core Current Assets - are those current assets which are required to be maintained in the system irrespective of having any activity or not.

Real Current Assets- are total current assets less core current assets.

It is important to remember here that the NWC stipulated or available whichever is higher, should be considered by bankers as NWC for deciding the quantum of limits.

Bankers have to assess the real NWC by correct classification of current assets and current liabilities as per their norms/standards. But one thing should always keep in mind that borrowers, after learning that their WC limits are decided by bankers based on the level of current assets, try to inflate or project the current assets at the highest level and maintain the current liabilities at lowest level. This concludes that the projected balance sheet, based on which limits are finalized, as given by the borrower is to be studied carefully and bankers to reclassify the current assets and current liabilities as per certain norms/ prudence. Any current assets which are not felt by bankers as genuine and not justified, is to be reclassified as a Non-Current Assets and to exclude it from the purview of extending finance.  

Bankers and borrowers have to work with mutual trust in arriving at the correct level of current assets and current liabilities.

It is dangerous either to have inadequate or excessive working capital in the system both for banker and borrower for following reasons:

Danger of inadequate Working Capital:

1. It stagnates growth.

2. Fixed assets and manpower underutilized.

3. Difficult to achieve targets of business and profit and ultimately default may occur.

Danger of excessive Working Capital:

1. Accumulation of unnecessary inventory.

2. Results in speculation/ Diversion.

3. Makes Management complacent and ineffective.

4. Leads to higher incidence of bad debts.

5. Adversely affects profitability.

It is essential that banker to assess critically the requirement of projections which depend on the followings:

1. Nature and size of business

2. Manufacturing / operating cycle

3. Growth and expansion proposals.

4. Seasonality of  raw materials availability.

5. Bank/ RBI credit policy guidelines.

In the MPBF method, Banks are assessing the requirement of WC considering the above factors and the exact amount of facility is determined by analyzing the operating cycle, which emphasizes on the period and amount blocked at each stage in the operating cycle.

In each business, there is always a time lag between investment and realization of the investment i.e, time taken for cash to convert into cash. This is called the Operating Cycle.

For Service Sector or professionals, the cycle is very small.

For a Trader, say cloth shop, the cycle is little bit increased to the extent of realization of receivables into cash.

For a Manufacturing Unit like a steel mill, the length is further extended to the extent of time taken for the raw materials to be converted into finished goods and ultimately sold.

1. Service Sector ——- Cash ——debtor—-cash

2. Trader ——cash——-stock ———debtor —-cash

3. Manufacturing Unit ——-cash——RM—-Stock in process——-Finished goods - cash

However, the bankers were finding it difficult to arrive at the correct holding period of each item in the operating cycle, though mathematically it is possible to arrive at the holding period by obtaining the opening stock, closing stock, consumption during the year (Raw material / stock purchase), average consumption and average holdings etc. However the holding period so worked out may not give a correct picture all the time since any dressing on the last day of the balance sheet,  based on which the working is done, shall alter the holding period. Hence the following method is generally worked out:-

1. Actual holding period as per two years audited/actual financial statements.

2. Average for industry type of product/commodity.

3. Actual requirements based on discussions with the borrower about the holding period of each item of both current assets and current liabilities depending upon the size of business , seasonality of raw materials, terms of supply, availability of funds etc.

Now bankers and borrowers have to agree mutually for one of the methods above  (for normal business and industrial activity the second method is generally applied), whichever is suitable and justified but not what is lower.

After the holding period is worked out, banks can work out the requirement by using traditional format ( CMA data) which we will discuss separately.  

The theory of arriving at the working capital requirement as per MPBF method revolves around the assumption that the borrowers, at all times keep the records and accounts updated/ accurate showing the levels of current assets and current liabilities. This is difficult to comprehend in any normal business practice. What is needed is mutual trust between the borrower and banker when the data is called for and scrutinized. Bankers have to arrive at an  opinion about the levels of NWC which are available and which are expected to be achieved with certain assumptions of business levels.