Running a business requires continuous funds for inventory, receivables, salaries, and operational expenses. Banks provide Working Capital Limits to ensure businesses have sufficient liquidity to manage day-to-day operations.
But a common question from business owners is:
“How do banks actually decide how much working capital limit to sanction?”
Let us understand the key methods used by banks in India.
1️⃣ Turnover Method (Nayak Committee Method)
This method is generally used for MSMEs with working capital limits up to ₹5 Crore.
Principle
Banks estimate working capital requirement as 25% of projected annual turnover.
Out of this:
20% is financed by the bank
5% must be brought by the borrower
Example
Projected Turnover = ₹10 Crore
| Particulars | Amount |
|---|---|
| Working capital requirement (25%) | ₹2.5 Cr |
| Borrower contribution (5%) | ₹0.5 Cr |
| Bank finance (20%) | ₹2 Cr |
So the bank may sanction a working capital limit of around ₹2 Crore.
This method simplifies credit assessment for MSME borrowers.
2️⃣ MPBF Method (Maximum Permissible Bank Finance)
For larger businesses, banks usually follow the Tandon Committee recommendations.
Step 1 – Calculate Working Capital Gap
Working Capital Gap =
Current Assets – Current Liabilities (excluding bank borrowings)
Step 2 – Determine Bank Finance
Example:
| Particulars | Amount |
|---|---|
| Current Assets | ₹10 Cr |
| Current Liabilities | ₹4 Cr |
| Working Capital Gap | ₹6 Cr |
Bank normally finances 75% of this gap.
Working Capital Limit = ₹4.5 Cr
The remaining portion must be funded by the business owner.
3️⃣ Drawing Power (DP) Concept
Even after sanctioning a limit, banks allow withdrawal only based on available stock and receivables.
Formula
Drawing Power = Eligible Stock + Debtors – Margin
Example:
| Particulars | Amount |
|---|---|
| Stock | ₹1 Cr |
| Debtors | ₹80 Lakhs |
| Total | ₹1.8 Cr |
| Bank margin (25%) | ₹45 Lakhs |
| Drawing Power | ₹1.35 Cr |
If sanctioned limit is ₹2 Cr but drawing power is ₹1.35 Cr, the borrower can use only ₹1.35 Cr.
4️⃣ Operating Cycle Analysis
Banks also analyse the business operating cycle, which includes:
Raw material holding period
Production cycle
Finished goods holding
Debtor collection period
Creditor payment period
Operating Cycle =
Inventory Days + Debtor Days – Creditor Days
The longer the cycle, the higher the working capital requirement.
Key Factors Banks Evaluate
Before sanctioning limits, banks review:
✔ Financial statements
✔ GST returns and turnover trends
✔ Inventory and receivable levels
✔ Profit margins
✔ Current ratio (usually expected above 1.33 : 1)
✔ Industry benchmarks
✔ Cash flow stability
This helps banks ensure that the borrowing is sustainable and aligned with business operations.
How We Assist Businesses
Proper working capital planning is crucial for smooth business operations. Many businesses either underestimate or overestimate their funding needs, which can impact growth.
Our professional support includes:
✔ Preparation of CMA Data and financial projections
✔ Structuring working capital loan proposals
✔ Assistance in bank documentation and compliance
✔ Analysis of operating cycle and working capital gap
✔ Advisory on optimal funding structure for business growth
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