Working Capital Assessment Methods
Three methods, three kinds of borrower. Here is what each one computes, with the numbers worked.
A business needs working capital to buy raw material, carry stock and wait for customers to pay. A bank's job is to work out how much of that need it should fund, and how much the borrower must bring from its own long-term money. That split is what every assessment method decides.
The CCP syllabus names three methods for banks: the turnover method, the MPBF method and the cash budget system. Each fits a different kind of borrower. This page shows what each one computes, with a worked number, and when a bank uses it.
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Terms You Need First
- Gross working capital
- Total current assets: raw material, work in progress, finished goods, receivables, cash and other current assets.
- Net working capital (NWC)
- Current assets minus current liabilities. This is the part funded by long-term sources, such as capital and term loans.
- Working capital gap
- Current assets minus current liabilities other than bank borrowings. It is the hole the borrower and the bank must fill together.
- Operating cycle
- The days cash stays locked in the business: inventory holding days plus debtor collection days, minus the days suppliers give to pay.
Operating Cycle: A Worked Example
A trader has annual operating costs of ₹1,82,50,000, so a daily cost of ₹50,000 (₹1,82,50,000 ÷ 365).
Inventory holding
Working
Stock held for 45 days
Result
45 days
Debtor collection
Working
Customers pay in 60 days
Result
+ 60 days
Creditor payment
Working
Suppliers allow 30 days
Result
− 30 days
Operating cycle
Working
45 + 60 − 30
Result
75 days
Working capital needed
Working
₹50,000 × 75 days
Result
₹37.5 lakh
| Step | Working | Result |
|---|---|---|
| Inventory holding | Stock held for 45 days | 45 days |
| Debtor collection | Customers pay in 60 days | + 60 days |
| Creditor payment | Suppliers allow 30 days | − 30 days |
| Operating cycle | 45 + 60 − 30 | 75 days |
| Working capital needed | ₹50,000 × 75 days | ₹37.5 lakh |
Method 1: The Turnover Method (Nayak Committee)
RBI brought in the turnover method in 1991 on the Nayak Committee's advice, for small borrowers who often lack detailed financial records. It assumes the working capital need is 25% of projected annual turnover. The bank funds 20% of turnover and the borrower brings 5% as margin. Put another way, the bank funds 80% of the need and the borrower funds 20%.
It applies to MSE borrowers up to ₹5 crore. Banks set their own cut-offs within that. Corporation Bank's 2019 credit policy, for example, used the turnover method for fund-based limits up to ₹2 crore, and up to ₹5 crore for medium enterprises.
Turnover Method: Worked Example
A wholesaler projects annual sales of ₹4 crore.
Working capital requirement
Formula
25% of ₹4 crore
Amount
₹1 crore
Borrower's margin (minimum)
Formula
5% of ₹4 crore
Amount
₹20 lakh
Bank finance (maximum)
Formula
20% of ₹4 crore
Amount
₹80 lakh
| Item | Formula | Amount |
|---|---|---|
| Working capital requirement | 25% of ₹4 crore | ₹1 crore |
| Borrower's margin (minimum) | 5% of ₹4 crore | ₹20 lakh |
| Bank finance (maximum) | 20% of ₹4 crore | ₹80 lakh |
Method 2: The MPBF Method (Tandon Committee)
Maximum Permissible Bank Finance (MPBF) comes from the Tandon Committee of 1974. It starts from the working capital gap and makes the borrower fund a set share from long-term sources. Under its second method, the one banks use most, the borrower funds 25% of total current assets.
Example: current assets ₹100 lakh, current liabilities other than bank borrowings ₹30 lakh. The gap is ₹70 lakh. The borrower funds 25% of ₹100 lakh, or ₹25 lakh. MPBF is ₹70 lakh − ₹25 lakh = ₹45 lakh.
RBI withdrew MPBF as a mandatory rule in 1997, but banks still use it, often in a modified form, for larger limits. The three methods are worked side by side on the MPBF page.
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Method 3: The Cash Budget System
Some businesses have uneven cash flows: contractors, builders, sugar mills, educational institutions. A balance sheet on one date says little about their real need. For them the borrower prepares a month-by-month cash budget, usually for 12 months, and the bank funds the peak monthly deficit.
Corporation Bank's policy credits the cash budget method to the Kannan Committee. For construction borrowers of any size it allowed either this method or its modified MPBF, and it offered the cash budget as an option for borrowers with fund-based limits above ₹10 crore.
Cash Budget: Finding the Peak Deficit
A contractor's projected cumulative position over one quarter, in ₹ lakh.
April
Inflows
40
Outflows
70
Net for month
−30
Cumulative position
−30
May
Inflows
35
Outflows
60
Net for month
−25
Cumulative position
−55
June
Inflows
90
Outflows
50
Net for month
+40
Cumulative position
−15
| Month | Inflows | Outflows | Net for month | Cumulative position |
|---|---|---|---|---|
| April | 40 | 70 | −30 | −30 |
| May | 35 | 60 | −25 | −55 |
| June | 90 | 50 | +40 | −15 |
Reading the Cash Budget
The peak cumulative deficit is ₹55 lakh, in May. That is the most the business is short at any point in the year, so the limit is set around that figure, not around the April or June number. A question that asks for the limit under the cash budget method wants the peak deficit, not the average and not the year-end figure.
Which Method for Which Borrower
MSE borrower, small limits
Usual method
Turnover method
Why
Simple; needs only projected sales
Manufacturer or trader, larger limits
Usual method
MPBF (or a bank's modified version)
Why
Uses the full balance sheet and holding levels
Seasonal or contract business
Usual method
Cash budget
Why
Need peaks in some months and falls in others
IT and software firm, limits up to ₹2 crore
Usual method
20% of projected turnover
Why
RBI's guidelines for the sector
IT and software firm, larger limits
Usual method
MPBF on a monthly cash budget
Why
No stock to lend against; cash flow drives the need
Member of a consortium
Usual method
Method used by the lead bank
Why
Members generally follow the leader
| Borrower | Usual method | Why |
|---|---|---|
| MSE borrower, small limits | Turnover method | Simple; needs only projected sales |
| Manufacturer or trader, larger limits | MPBF (or a bank's modified version) | Uses the full balance sheet and holding levels |
| Seasonal or contract business | Cash budget | Need peaks in some months and falls in others |
| IT and software firm, limits up to ₹2 crore | 20% of projected turnover | RBI's guidelines for the sector |
| IT and software firm, larger limits | MPBF on a monthly cash budget | No stock to lend against; cash flow drives the need |
| Member of a consortium | Method used by the lead bank | Members generally follow the leader |
The Loan Delivery System
Assessment fixes how much. The loan delivery system fixes the form the money takes.
- check_circleRBI introduced the loan system in April 1995 to bring discipline to large borrowers' use of cash credit.
- check_circleFor working capital limits of ₹10 crore and above, the loan component should normally be 80% and the cash credit component 20% (RBI circular of 25 October 2001).
- check_circleBanks are free to raise either component beyond those levels and must price the two separately.
- check_circleExport credit limits are taken out before the loan and cash credit split. Inland bills limits come out of the loan component.
- check_circleBanks may, with Board approval, exempt cyclical, seasonal or volatile activities from the loan system.
How the CCP Exam Tests This
Expect a projected turnover figure with a question on bank finance or margin under the Nayak norms (20% and 5% of turnover), a balance sheet with a question on MPBF under the second method, and a scenario asking which method fits a seasonal borrower. The common trap is mixing up the two Nayak ratios: 20% of turnover is the bank's share, while 20% of the requirement is the borrower's.
FAQs
What are the methods of working capital assessment for banks?expand_more
The CCP syllabus covers three: the turnover method (Nayak Committee), the MPBF method (Tandon Committee) and the cash budget system. Banks pick by borrower size and the kind of business.
What is the formula under the turnover method?expand_more
Working capital requirement is 25% of projected annual turnover. The bank funds 20% of turnover and the borrower brings at least 5% as margin.
Is MPBF still used after 1997?expand_more
RBI withdrew it as a mandatory rule in 1997, but banks still use it, often in a modified form, to assess larger working capital limits.
When is the cash budget method used?expand_more
For businesses with uneven cash flows, such as contractors, builders and seasonal industries. The bank funds the peak monthly deficit shown in a 12-month cash budget.
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