Drawing Power Against a Sanctioned Limit
M/s Sharma Traders (proprietor Rakesh Sharma), a hardware and sanitaryware dealer in Kota, holds a Cash Credit limit of ₹25,00,000 sanctioned eight months ago against hypothecation of stock and book debts, with a second charge on the proprietor's residential flat. The sanction states: drawing power = 75% of paid stock plus 50% of book debts not older than 90 days, and a monthly stock statement by the 10th. The statement dated 31 January, received on 18 February, shows closing stock at cost ₹22,00,000, of which goods worth ₹6,00,000 were bought on credit and remain unpaid; sundry debtors ₹9,00,000, of which ₹2,00,000 are outstanding for more than 120 days. The debit balance on 20 February is ₹21,40,000. The stock insurance policy, valued at ₹15,00,000, expired on 31 December and has not been renewed. The proprietor argues that his limit is ₹25 lakh and therefore he is 'within limit'.
1. Compute the drawing power and state the true position of the account. Is the proprietor right that he is within limit?
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Drawing power is a computed figure, not the sanctioned limit, and the proprietor is confusing the two.
Step 1 - paid stock. Closing stock ₹22,00,000 less creditors ₹6,00,000 = ₹16,00,000. Unpaid stock was financed by the supplier, not by the borrower; counting it would let the same goods support two sets of credit. 75% of ₹16,00,000 = ₹12,00,000.
Step 2 - eligible book debts. ₹9,00,000 less ₹2,00,000 older than 120 days (already past the 90-day covenant) = ₹7,00,000; 50% = ₹3,50,000.
Step 3 - drawing power = ₹12,00,000 + ₹3,50,000 = ₹15,50,000. This is below the limit of ₹25,00,000, so the limit is not the binding constraint.
Step 4 - position. Debit balance ₹21,40,000 against DP ₹15,50,000 = excess of ₹5,90,000. Roughly 27% of the balance has no cover under the sanctioned formula.
Step 5 - two aggravating facts. The stock statement arrived on 18 February for 31 January, eight days after the due date of the 10th; most sanctions allow drawings to be frozen until a fresh statement is received. And the insurance lapsed on 31 December, so the hypothecated security is presently uninsured - a breach of covenant independent of the excess.
Answer: he is not 'within limit'. The account is irregular on three counts (excess, stale statement, uninsured security) and must be reported under the bank's irregularity policy, not argued at the counter.
2. Why are debtors over 120 days excluded from drawing power, and how would you treat a debtor who says he paid after the statement date? Also explain why creditors are deducted.
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The 90-day cut-off is the sanction's way of saying that drawing power should rest only on assets that will turn into cash quickly enough to repay the drawing. A debtor ageing beyond 120 days has already failed that test once (the 90-day covenant) and is still unrealised; it is drifting towards becoming a doubtful asset.
Later realisation. DP is drawn from the statement, and the branch may recognise a subsequent realisation only if it is evidenced - the money has actually come into the account, or a receipt and bank statement are produced and verified against the ledger. An oral claim ('the party paid me on 5 February') is not evidence and must not be added back. If the branch does accept a verified realisation, record it on the statement with the date of verification, and reconcile it in the next statement.
Related parties. If a large debtor is a firm of the proprietor, a relative, or a concern sharing the premises, exclude it altogether - it is not an independent realisation.
Creditors. Keep deducting them. Drawing power measures how much of the stock the bank is really financing; stock bought on supplier credit is financed by the supplier. Including it would double-count the same goods.
Why the detail matters. Excluding ₹2,00,000 of debtors removed ₹1,00,000 of DP at 50%. Verifying debtors is not a formality - it changes the borrowing limit by real money.
3. The proprietor promises to renew the insurance tomorrow and asks to keep operating the account. As the officer handling the file, set out your response and the conditions you would impose.
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Do not give a verbal yes. Put the reply in writing, with conditions and deadlines, and copy the controlling office.
The reply, in substance: 'The account is irregular to the extent of ₹5,90,000 as on 20 February. You are requested to (i) renew the stock insurance for at least the DP value with the bank's hypothecation clause and deposit the policy by 5 March; (ii) submit the stock statement for February by 10 March; (iii) bring the balance within DP by 31 March, or submit a written repayment plan for the excess, which the bank will consider for conversion into a term loan; (iv) route all sale proceeds through this account.'
Why each condition: insurance without the bank clause does not protect the bank's interest in the goods; a fresh statement is needed to compute a current DP; converting the excess into a term loan is often the honest answer where long-term funds have been parked in a working-capital limit; routing proceeds raises credits and reduces dependence on the limit.
What else: charge penal interest on the excess as per the sanction letter, report the irregularity in the monthly returns, consider a stock audit, and permit no further drawings until the conditions are met.
Escalation is not disloyalty - the branch manager is personally accountable for irregular accounts, and a written file is the only protection for both of you.