Working Capital Management Interview Questions And Answers

Norms : The committee suggested 15 industries excluding engineering industries. These norms were suggested in following forms:

a. For Raw materials: Consumption in months
b. For Work in Progress: Cost of production in months
c. For Finished Goods: Cost of Sales in months
d. For Receivables: Sales in months

It introduced the concept of working capital gap which the excess of current assets over current liabilities other than bank borrowing. They also suggested three progressive methods to decide the maximum limits according to which banks should provide the finance.

Is suggested that the cash credit limit should be bifurcated into two components i.e. Minimum level of borrowing required throughout the year should be financed by way of a term loan and the demand cash credit to take care for fluctuating requirements.

Credit Information Systems : The committee recommended the submission of a quarterly reporting system based on actual ass well as estimations, so that the requirements of working capital may be estimated on the basis of production needs.

The committee suggested that there should be a proper system of supervision and control.

The committee did not suggest any right norm for debt equity ratio, the committee opined that if the trend of debt equity ratio is worse than the medians, the banker should persuade the borrowers to strengthen the equity base as early as possible.

According to the notification of RBI dated on 21st Aug 1975 accepted the following recommendations of Tandon committee:

1) Norms for Inventories and Receivables

2) Coverage

3) Methods of Borrowing

4) Style of Credit

5) Information System

Hypothecation is a mode of security in which bank extends the assistance to the company against the security of movable property. Neither the property nor the possession of the goods hypothecated is transferred to the bank. If the company fails to repay the amount of assistance, in such case the bank has the right to sell the goods hypothecated to realize the outstanding amount of assistance granted by it to the company. A consumer entering into a mortgage agreement is an example of Hypothecation.

Pledge is a mode of security in which bank extends the assistance to the company against the security of movable property. But the possession of the goods is with the bank and the goods pledged are in the custody of the bank. Thus, it becomes the duty of the bank to take care of the goods in the custody. In case the company is unable to repay the amount of assistance, the bank has the right to sell the goods pledged to realize the outstanding amount.

Lien is a mode of security in which the bank retains the goods belonging to the company until the debt due to the bank is paid. Lien is of two types: Particular Lien and General Lien. Normally, Bank enjoys general Lien.

Mortgage is a mode of security in which the legal interest in a specific immovable property is transferred as security for the payment of debt. The party who transfers the interest is called mortgager and party in whose favour the interest is so transferred is called mortgagee. The borrower possesses the property while the bank gets full legal title, subject to borrower’s right, to repay to debt.

The observation and recommendations made by Tandon committee were:

1) Norms : The committee suggested 15 industries excluding engineering industries. These norms were suggested in following forms:

a. For Raw materials: Consumption in months
b. For Work in Progress: Cost of production in months
c. For Finished Goods: Cost of Sales in months
d. For Receivables: Sales in months

2) Methods of Borrowings : It introduced the concept of working capital gap which the excess of current assets over current liabilities other than bank borrowing. They also suggested three progressive methods to decide the maximum limits according to which banks should provide the finance.

3) Style of Lending : Is suggested that the cash credit limit should be bifurcated into two components i.e. Minimum level of borrowing required throughout the year should be financed by way of a term loan and the demand cash credit to take care for fluctuating requirements.

4) Credit Information Systems : The committee recommended the submission of a quarterly reporting system based on actual ass well as estimations, so that the requirements of working capital may be estimated on the basis of production needs.

5) Follow up, Supervision and Control : The committee suggested that there should be a proper system of supervision and control.

6) Norms for Capital Structure: The committee did not suggest any right norm for debt equity ratio, the committee opined that if the trend of debt equity ratio is worse than the medians, the banker should persuade the borrowers to strengthen the equity base as early as possible.

A bank needs following forms of security to provide security to a company:
1) Hypothecation
2) Pledge
3) Lien
4) Mortgage

a.) Hypothecation is a mode of security in which bank extends the assistance to the company against the security of movable property. Neither the property nor the possession of the goods hypothecated is transferred to the bank. If the company fails to repay the amount of assistance, in such case the bank has the right to sell the goods hypothecated to realize the outstanding amount of assistance granted by it to the company. A consumer entering into a mortgage agreement is an example of Hypothecation.

b.) Pledge is a mode of security in which bank extends the assistance to the company against the security of movable property. But the possession of the goods is with the bank and the goods pledged are in the custody of the bank. Thus, it becomes the duty of the bank to take care of the goods in the custody. In case the company is unable to repay the amount of assistance, the bank has the right to sell the goods pledged to realize the outstanding amount.

c.) Lien is a mode of security in which the bank retains the goods belonging to the company until the debt due to the bank is paid. Lien is of two types: Particular Lien and General Lien. Normally, Bank enjoys general Lien.

d.) Mortgage is a mode of security in which the legal interest in a specific immovable property is transferred as security for the payment of debt. The party who transfers the interest is called mortgager and party in whose favour the interest is so transferred is called mortgagee. The borrower possesses the property while the bank gets full legal title, subject to borrower’s right, to repay to debt.

The main issues studied by Tandon committee to exercise control over working capital were:

1) Can the norms be evolved for current assets and for debt equity ratio to ensure minimum dependence on bank finance?
2) How the quantum of bank advances may be determined?
3) Can the present manner and style of lending be improved?
4) Can an adequate planning, assessment and information system by evolved to ensure a disciplined flow of credit to meet genuine production needs and its proper supervision?

Advantages of Letter of Credit to an Importer:

1) Importer is guaranteed to receive timely delivery of goods.

2) It makes structuring an advantageous payment schedule easy.

3) Expediting customs clearance and ultimate delivery as the documents are received quickly.

4) It gives an assurance to the importer that the payment will only be made to the exporter upon presentation of documents
evidencing the shipment of goods.

5) It reduces the risk of non-performance of the exporter.

Fund based lending, where the lending bank commits the physical outflow of funds. The various forms in which fund based lending may be made by banks:

1) Loan

2) Overdraft

3) Cash Credit

4) Bills Purchased/Discounted

5) Working Capital Term Loans

6) Packing Credit

Different types of Letter of Credit:

1) Revocable Letter of Credit

2) Irrevocable Letter of Credit

3) Confirmed Irrevocable Letter of Credit

4) Transferable Letter of Credit

5) Revolving Letter of Credit

6) Credit available by installments

7) Back to Back Letter of Credit

8) Anticipatory Credit or Red Clause

9) Green Clause Letter of Credit

10) Deferred Payment Letter of Credit

11) Standby Letter of Credit

Advantages of Letter of Credit to an Exporter:

1) Exporter is guaranteed payment upon presentation of specified documents.

2) It eliminates the risk of dealing with an unknown importer in a different country.

3) It becomes easier for the exporter to secure pre order financing.

4) Importer cannot refuse payment by raising a complaint about the goods.

Bank Guarantee is a non fund based lending given by the bank to ensure that the liabilities of a debtor will be met. This facility enables the customer to acquire goods, buy equipment and thereby expand business activity. This process can be explained with the help of an example. Suppose X and Y are two companies both unknown to each other, in which X wants to purchase some material from Y Company. As the company Y does not know the company X and is concerned whether company Y will make the payment or not. Bank Z of Company X opens the bank guarantee in favour of company Y Bank Z in which it undertakes to make the payment to Company Y, if the company fails to make payment to company Y. In this way, interests of company Y are protected as it is assured to get the payment either from company X or from its Bank Z. As such, it becomes non fund based lending for Bank Z as it does not commit any outflow of funds. Bank Guarantee transactions will be applicable in case of credit transactions.

Following are the parties involved in a letter of credit :

1) Importer

2) Issuing Bank, Bank of Importer

3) Advising Bank, which is in Exporter’s country, which notifies the exporter about opening of letter of credit.

4) Confirming Bank, confirms the letter of credit in case the exporter is not satisfied about the security offered by the importer.

5) Exporter, who is the beneficiary

6) Negotiating Bank, whom the exporter submits the documents.

Letter of Credit is a non fund based lending which is very regularly found in international trade. This facility is given when the exporter and importer are unknown to each other. In this case, the importer applies to his bank (Issuing Bank) in his country to open a letter of credit in favour of exporter whereby the importers’ bank undertakes to pay the exporter on fulfilling the terms and conditions specified in the letter of credit.

A bank can disburse the amount of assistance in any of the following forms:

1) Non-fund based lending
a. Bank Guarantee
b. Letter of Credit

2) Fund based lending
a. Loan
b. Overdraft
c. Cash Credit
d. Bills purchased/Discounted
e. Working Capital term loans
f. Packing Credit

Non fund based lending, where the lending bank does not commit any physical outflow of funds. The funds position of the lending bank remains intact. The non-funding based lending can be maid in two forms:

1) Bank Guarantees
2) Letter of Credit

Advantages of commercial papers:

1) It is quick and cost effective way of raising working capital.

2) Best way to the company to take the advantage of short term interest fluctuations in the market

3) It provides the exit option to the investors to quit the investment.

4) They are cheaper than a bank loan.

5) As commercial papers are required to be rated, good rating reduces the cost of capital for the company.

6) It is unsecured and thus does not create any liens on assets of the company.

7) It has a wide range of maturity

8) It is exempt from federal SEC and State securities registration requirements.

Disadvantages of commercial papers:

1) It is available only to a few selected blue chip and profitable companies.

2) By issuing commercial paper, the credit available from the banks may get reduced.

3) Issue of commercial paper is very closely regulated by the RBI guidelines.