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Tandon Committee Method 1 & Method 2 | IIBF | JAIIB PPB 2022

IIBF | JAIIB PRINCIPLES & PRACTICES OF BANKING 2022 NOTES

Tandon Committee Method 1 & Method 2 

In this article, as the title suggests we will be talking about the Tandon Committees’ method 1 & method 2 for the calculation of maximum amounts that the banks can lend for capital purposes as given in the prescribed Syllabus of Junior Associate of the Indian Institute of Bankers for Exams 2022.

So, if you are preparing for the Principles & Practices of Banking i.e. Paper No.1 of JAIIB 2022 Examinations, then you can read all about the methods & save the same for future reference.

 

 

Let us first understand the meaning of:

  1. Working capital: Working capital means the sum of the funds invested in different current assets that are used in the operating cycle, by industrial & trading corporations.
  2. Operating cycle: Operating cycle means the length of time which is required to convert ‘Non-Cash current assets into cash. Example: Raw Materials, Work-in-process, Finished Goods, and Bills receivables.

 

Tandon Committee

A study group, which was headed by Shri. P.L. Tandon, framed guidelines for fast working capital loans in July 1974 which are known as Tandon Committee recommendations.

These methods are used for working out the maximum amount that a unit may expect from the bank, which is termed as ’maximum permissible bank finance (MPBF)’.

Out of three methods proposed by the Tandon Committee, method I (also called as ‘first method’) and method II (also called as ‘second method’) were accepted for appraisal of working capital limits, which are explained below.

METHOD – I

As per Tandon’s -I method (also called as ‘first method’) of lending the borrower has to arrange 25% of Working Capital Gap (WCG) as margin.

MPBF = 75% of (Current assets – Current liabilities other than bank borrowings)

The minimum current ratio under this method works out to 1: 1.

FOR EXAMPLE :

A company has Total Current Assets (TCA) of Rs. 4,000 and Other Current Liabilities (OCL), i.e. (without working capital facilities from the bank) is Rs. 800. Now we will compute the Maximum Permissible Bank Finance (MPBF) under method-I.

TCA=4000 and OCL=800,

WCG (Working capital gap)  is (TCA-OCL)) = 4000 – 800 = 3200   ….. (A)

25% of WCG = 25/100 * 3200 = 640 …….. (B)

Here, Maximum permissible bank finance = A – B = 3200 – 640 = 2,560

Therefore, MPBF from Bank under the first method is Rs. 2,560 if Total Current Asset is Rs. 4000.

 

METHOD – II

In Tandon’s Second method of lending the borrower has to arrange 25% of Total Current Assets (TCA) as margin.

MPBF = (75% of Current assets) – (Current liabilities other than bank borrowings)

The minimum current ratio under this method works out to 1.33: 1.

FOR EXAMPLE :

A company has Total current liabilities (TCA) of Rs 4,000 & its Other Current Liabilities (OCL) is Rs 800. Here, MPBF under 2nd method will be calculated as follow:-

(WCG) Working capital gap = CA – CL = 4000 – 800 = Rs 3200 ……..(A)

25% of (TCA) Total current assets = 25/100 * 4,000 = Rs 1,000……..(B)

The MPBF under this method = A – B = Rs 3,200 – Rs 1,000 = Rs 2,200

Therefore, MPBF from Bank under the second method, is Rs. 2200 when Total Current Asset is Rs. 4000 and the working capital gap is Rs. 3200. 

The current Ratio will be calculated as :

Total Current Assets =Rs 4,000 & Total Current Liabilities = Rs 3000

CURRENT RATIO = 1.33 : 1

*** The Chore committee which was appointed in April 1979 suggested that all borrowers apart from sick units which have working capital of Rs.50 lakhs and over from the bank system should be positioned under method-II which will give a current ratio of 1.33:1.

As per RBI guidelines, the lower cut-off limit for method II is changed from time to time, but the current benchmark ratio of 1.33:1 should remain unchanged.

To summarise, as per Tandon Committees’ suggested methods for determining the maximum permissible bank finance(MPBF) can be calculated using:

Method 1 i.e. MPBF=0.75(CA-CL)

Method 2 i.e. MPBF=0.75(CA)-CL

 

So, let us solve 1 Question using both of the above methods.

Q. You are given the below data of Pendu Company Limited

Current Liabilities Rs. (in lacs)
Trade Creditors 120
Other Current Liabilities 30
Bank Borrowings (including Bills discounted) 250
Total Current Liabilities 400
   
Current Assets  
Raw Material 180
Work in progress 50
Finished Goods 100
Receivable (including bills discounted) 150
Other Current Assets 20
Total Current Assets 500

 

Solution: MPBF for Pendu Company Limited using the above methods will be:

Method 1:

Maximum Permissible Bank Finance =

= 0.75 (CA – CL) = 0.75 (500 – 150)

= Rs.262.50 lacs

Method 2:

Maximum Permissible Bank Finance =

= 0.75 * CA – (CL) = 0.75 * 500 – (150)

= Rs.225.00 lacs

 

So, this way banks can’t provide credit facilities to Pendu Company Limited for more than the calculated amounts.

 

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