Working Capital Assessment by Banks: Methods, Norms, and What Borrowers Must Know

How Banks Assess Working Capital Requirements

When a business applies for a working capital loan (Cash Credit, Overdraft, or Bill Discounting), the bank doesn't simply take the borrower's word for the amount needed. It conducts a structured working capital assessment to determine the genuine requirement and the permissible bank finance.

This assessment is the backbone of CMA data analysis and directly impacts how much credit a business receives.

The Three Assessment Methods

1. Tandon Committee Method (MPBF-Based)

The Tandon Committee (1975) introduced the concept of MPBF using three methods. Method II is most prevalent:

• 25% of current assets must come from long-term sources (promoter's contribution)
• Bank finances the balance after deducting current liabilities
• Requires detailed CMA data with current asset and liability break-up

This method is used for borrowers with fund-based working capital limits above Rs 5 crores in most banks.

2. Nayak Committee Method (Turnover-Based)

The Nayak Committee (1992) simplified the process for smaller borrowers:

• Working capital requirement = 25% of projected annual turnover
• Bank finances 80% of the requirement (i.e., 20% of turnover)
• Borrower's margin = 5% of turnover

Example:

• Projected annual turnover: Rs 2 crores
• Working capital requirement: Rs 50 lakhs (25% of Rs 2 crores)
• Bank finance: Rs 40 lakhs (80% of Rs 50 lakhs)
• Promoter's margin: Rs 10 lakhs

Applicable for MSMEs with fund-based limits up to Rs 5 crores.

3. Cash Budget Method

Used for seasonal industries (sugar, tea, rice mills) and project-based businesses:

• Month-wise cash inflow and outflow projections
• Peak deficit month determines the maximum limit
• Provides more granular assessment than annual methods

The Operating Cycle Approach

Underlying every assessment method is the operating cycle concept:

Operating Cycle = Raw Material Holding Period + WIP Conversion Period + Finished Goods Holding Period + Debtor Collection Period - Creditor Payment Period

A longer operating cycle means higher working capital requirement. Banks benchmark your operating cycle against industry norms.

Industry	Typical Operating Cycle
FMCG / Consumer Goods	30-60 days
Manufacturing (Engineering)	90-120 days
Construction / Infrastructure	120-180 days
Software / IT Services	45-90 days
Trading	30-45 days
Textiles	90-150 days

What Banks Scrutinise in Your Assessment

Inventory Norms

Banks don't accept your actual inventory at face value. They apply holding period norms:

• If you hold raw material for 90 days but the industry norm is 60, the bank will assess raw material inventory at 60 days' consumption
• Slow-moving and obsolete inventory is excluded
• WIP is assessed based on the production cycle, not book value

Debtor Norms

• Debtors beyond the sanctioned credit period (usually 60-90 days) are treated as sticky and excluded from the assessment
• Export debtors may get a longer period (90-120 days)
• Related-party debtors attract higher scrutiny

Creditor Stretch

Banks check whether the creditor payment period is realistic:

• Stretching creditors beyond industry norms suggests liquidity stress
• Conversely, very short creditor periods may inflate the working capital requirement

The Current Ratio Requirement

Regardless of the assessment method, banks require a minimum current ratio of 1.33:1 (i.e., current assets must be at least 1.33 times current liabilities including bank borrowings).

This ensures a 25% margin of safety. If the projected current ratio falls below 1.33, the bank will either:

• Reduce the sanctioned limit
• Ask for additional long-term funds (promoter contribution or term loan)
• Reject the proposal

Working Capital Assessment for Different Borrower Categories

Category	Method	Typical Limit
Micro enterprises	Nayak	Up to Rs 25 lakhs
Small enterprises	Nayak	Rs 25 lakhs - Rs 5 crores
Medium enterprises	Tandon Method II	Rs 5 - 25 crores
Large corporates	Tandon Method II + detailed CMA	Rs 25 crores and above
Seasonal industries	Cash Budget	Varies

Common Reasons for Under-Assessment

1. Not projecting turnover growth realistically — if sales grow 30% but you project flat working capital, the bank knows your operations will be starved
2. Ignoring GST impact on working capital — GST paid on inputs before claiming credit creates a timing gap that needs financing
3. Not factoring in term loan repayment — term loan instalments paid from operations reduce the cash available for working capital
4. Seasonal fluctuations — using average inventory instead of peak season inventory understates the requirement

Drawing Power vs Sanctioned Limit

The sanctioned limit is the maximum. The drawing power determines what you can actually use each month:

• Drawing Power = Value of eligible stock + eligible debtors - margin
• Submitted monthly via stock and debtor statements
• If your actual inventory or debtors are below the projected levels, your drawing power will be lower than the sanctioned limit

How CMA Report Streamlines This

CMA Report generates a complete working capital assessment using both Tandon Method II and Nayak Committee norms based on your financial data. It computes the operating cycle, applies standard holding period norms, projects the current ratio, and presents the assessment in the exact format credit officers expect.