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, the method I and method II 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.