Cash credit enhancement for a job-work unit: computing drawing power
Sri Kamakshi Textiles is a proprietorship doing job work on cotton fabric for two wholesale buyers in Erode. Its cash credit limit is ₹1.20 crore, secured by hypothecation of stock and book debts and a second charge on the proprietor's house; no first charge on immovable property is available. FY2024 sales were ₹6.20 crore against ₹5.10 crore in FY2023, but GSTR-1 for FY2024 reports turnover of only ₹4.90 crore. The latest stock and book-debt statement, filed 40 days late, shows inventory of ₹95 lakh, including ₹18 lakh of slow-moving goods older than one year, and receivables of ₹1.10 crore, of which ₹35 lakh are over 90 days and ₹22 lakh are due from the proprietor's brother's firm. The current ratio is 1.06. The proprietor has asked for an enhancement to ₹2.00 crore to execute an order from a large buyer, and the branch has forwarded the proposal with a favourable recommendation, noting that the unit has never defaulted.
1. Compute the drawing power on the basis of the stock and book-debt statement, and state whether the enhancement to ₹2.00 crore is justified.
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Apply the usual margins after excluding ineligible items, because drawing power is computed on realisable security, not on gross figures.
Inventory ₹95 lakh less ₹18 lakh slow-moving stock older than a year = ₹77 lakh. Less margin 25% = ₹57.75 lakh.
Receivables ₹1.10 crore less ₹35 lakh overdue beyond 90 days less ₹22 lakh due from the proprietor's related firm = ₹53 lakh. Less margin 40% = ₹31.80 lakh.
Drawing power = ₹57.75 + ₹31.80 = ₹89.55 lakh.
Against this, the existing limit is ₹1.20 crore, so the account is already over-financed by about ₹30.45 lakh. An enhancement to ₹2.00 crore would create an excess of about ₹1.10 crore over drawing power - that is, roughly 55% of the proposed limit would be unsecured by current assets. The length of the relationship and the absence of default are not substitutes for drawing power. Enhancement is therefore not justified. The immediate task is to bring the account back within the computed drawing power, obtain a fresh stock statement on the first of every month, and set a hard cap of ₹89.55 lakh (revised monthly) until the security position improves.
2. Apart from drawing power, what appraisal concerns does this proposal raise, and what conditions would you attach if the case is to be supported in any form?
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Three concerns stand out.
Turnover mismatch. Books show ₹6.20 crore of sales but GSTR-1 shows ₹4.90 crore - a gap of ₹1.30 crore, about 21% of reported sales. This can indicate unrecorded sales, inflated debtors, or purchases/sales routed outside the books. Either way the debtor book used for drawing power is questionable.
Related-party receivables and stale stock. ₹22 lakh due from the brother's firm and ₹18 lakh of stock older than a year suggest weak quality of current assets and possible circular transactions within the family group.
Liquidity and security cover. A current ratio of 1.06 is below the accepted 1.33 norm, and the bank holds only a second charge on the house, so there is no first-charge immovable collateral to fall back on.
Conditions to attach: reconciliation of the GST gap supported by a chartered accountant's certificate and GST returns before any limit revision; drawing power strictly linked to monthly statements with stock audits each quarter; exclusion of related-party debtors permanently; personal guarantee of the proprietor and his wife; a covenant that the new buyer's receivables be routed through the bank with a tripartite arrangement; and a phased 10% reduction in the existing excess each quarter rather than fresh limits.
3. The proprietor offers to bring in ₹25 lakh of additional capital and to offer a first charge on a godown worth ₹60 lakh. Does this change your recommendation on the ₹2.00 crore limit?
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It changes the risk profile, not the drawing power. Drawing power is determined by the value of current assets net of margin; collateral supports recovery, it does not create eligibility for working capital. So the ₹2.00 crore request still fails the drawing power test: the eligible current assets would have to roughly double before ₹2.00 crore could be supported.
What the offer does achieve is a better current ratio (the ₹25 lakh of capital reduces dependence on bank funds and improves net working capital), a first-charge fallback, and demonstrable promoter skin in the game - which matter if the unit later needs a term loan or restructuring.
The practical response is to regularise the existing limit at the computed drawing power of about ₹89.55 lakh, park the excess in a repayment schedule over three to four quarters sourced from the additional capital, and record the godown as additional security. An enhancement may be considered later, but only on evidence of a sustained rise in eligible stock and receivables and removal of the GST turnover gap. Recommend to the branch that the proposal be returned with the drawing power working, since a favourable recommendation with no computation invites criticism at inspection.