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Documente Profesional
Documente Cultură
SUMMER PROJECT
ON
PROBLEMS IN ASSESSING
WORKING CAPITAL
FOR MSE
BY
NAME
: SRUTHY GOPAN
COURSE
: MMS-2013-15
SEMESTER
: III
SPECIALIZATION : FINANCE
ROLL NO.
: 90
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PROBLEMS IN ASSESSING
WORKING CAPITAL
FOR MSE
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ACKNOWLEDGEMENT
Experience is the best teacher and my summer internship period had been enriched by the
experiences of the people I got to work with in IDBI,MSE.
With a sense of great pleasure and satisfaction, I present this project report entitled
PROBLEMS IN ASSESSING WORKING CAPITAL FOR MSE. Completing a task
successfully is never an individual effort; similarly completion of this report is the result of
invaluable support and contribution of many people in direct and indirect manner. In the light of
foregoing, first of all my heartfelt great fullness and thanks goes to Mr. M C SUNIL KUMAR as
the DEPUTY GENERAL MANAGER of IDBI , for giving me an opportunity to work for this
highly esteemed organization and for being a constant source of inspiration and guidance
throughout the project. Without their able support the project would not have seen the light of the
day.
At this juncture, I would also like to thank the entire staff of IDBI. Without their indispensable
cooperation, the project wouldnt have been completed within the stipulated time period.
I would like to thank my mentor Mr SAIRAM SUBRAMANIAN for his earnest advices that
helped make my project more inclusive and exhaustive.
Finally,I would like to thank Professors of Welingkar Institute of Management Development
and Research, who provided guidance in this project.
SRUTHY GOPAN
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EXECUTIVE SUMMARY
In this report the problem we are trying to analyse is the loopholes in assessing the working
capital requirement for the MSE.
MSE s ,previously SSI (small scale industries) are the growth engines of economy.
The prevalent methods of assessments practiced in the banks are discussed .The project is
executed by jointly analyzing both those methods and the inherent features of MSEs. The sector
chosen being MSE hence envisages the discussion of PSL norms prevailing in the banking
industry . The Priority sector lending (PSL),it is the sector which gets directly affected by a lot
of government decisions and those by RBI. Hence the lending policies followed by the banks
will be aligned with those.That angle also forms a part of our project.
The evolution of priority sector lending in india over the years forms the bedrock for the existent
assessment policies in Banking sector.The project brings into purview the flaws addressed
through frequent revisions in the PSL norms and those flaws that remain unaddressed in the
present norms.
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TABLE OF CONTENTS
Sr. No.
1
1.1
1.2
2
Page
6
8
RESEARCH METHODOLOGY
2.1 Objective of Study
2.2 Limitations of the study
2.3 Sources of data
3
3.1
4
Topic
Banking Industry in India
Introduction
Industrial development Bank of India(IDBI)
IMPORTANCE OF
EVOLUTION
INTRODUCTION
PRIORITY
10
10
10
10
SECTOR
LENDING
AND
5
5.1
5.2
6
ITS 11
11
11
13
15
17
17
21
30
30
CONCLUSION
32
33
ANNEXURE I:
34
10
ANNEXURE II:
36
10.1
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Forms of banking have changed over the years and evolved with the needs of the economy. The
transformation of the banking system has been brought about by deregulation, technological
innovation and globalization. The focus on customers has been changing based on the changing
customer needs and increasing competition. The perspective of Banks towards customers in
various decades can be summarized as below:
Decade
1950-1960
1960-1980
1980-1990
1990-2000
2000 and beyond
Focus on Customer
Serving the customer
Satisfying the customer
Pleasing the customer
Delighting the customer
Retaining the customer
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compares various banking products and services on the basis of interest rates, be it
taking loans or for term deposits. Even a 0.5% difference in interest rates can
divert customer attention.
1.2
I.D.B.I
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2.
RESEARCH METHODOLOGY
2.1
OBJECTIVE OF STUDY
The objective of the project is to analyse in depth the problems in assessing the working capital
requirement for MSEs.It was quite clear from the beginning that the problems are faced by the
entire banking industry .But the depth and facets of the problems was quite inevitable to be
brought into the picture.Also the inherent flaws prevailing in the system(not only in india but
outside ) is also studied along with to get a more clear picture.
2.2
LIMITATIONS OF THE STUDY
The substantiation of the facts which I got through the files which I came across during my
stint at the bank is impossible because of the extant guidelines of the bank.Because of what I
had to recreate a sample case with hypothetical numbers.Also I had to rely mostly on the oral
interview reports for my primary research.
In performing the comparative study among different banks ,the obstacle faced was their
reluctance to disclose.So the numbers were limited.The banks covered were
2.3
CANARA BANK
BANK OF BARODA
SYNDICATE BANK
SOURCES OF DATA
The method adopted is primarily collecting the anecdotes from the managers in IDBI.The nature
of the problems that I have to analyse regarding the assessment is very relevant not only to
IDBI, but also to the entire banking and hence experiences by respective officials of some more
banks were also taken.The modes opted were both questionnaire and oral interview.
The secondary data was collected through Books & magazines, and Websites.
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Priority
Total agriculture
Micro &
Small
Enterprises
(MSE)
Advances to
Weaker Sections
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MSEs play a crucial role of a catalyst in driving growth of the Indian economy by providing vital
linkages to large local and international value chains. As per the Fourth All India Census of
MSE, 2006, there are more than 36 million MSEs in India contributing 45% of industrial output,
40% to Indias exports, and approximately 8% to Indias GDP. MSEs employ more than 80
million people and generate gross output of ` 13,513.8.
The Fourth All India Census of MSME indicates that, of the overall Indian MSME sector,
31.79% of the enterprises are engaged in manufacturing activities, while the remaining 68.21%
are engaged in services.
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2009). In India, banks are the dominant channel for providing funds to industry. However their
importance in funding smaller rms is even more pronounced since most small and medium
enterprises (MSEs) are not able to access the capital markets for funds. In recent years, governments and policy makers have been giving considerable attention to facilitate the development of
the MSE sector, as a strong and vibrant MSE sector provides a good foundation for
entrepreneurship and innovation in the economy.
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Financing the gap between the supply of goods and the receipt of payment thereafter
(trade credit).
In other words, Working Capital Finance is the fund required to meet the cost involved
during the working capital cycle or operating cycle.
Operating Cycle or Working Capital Cycle
Operating cycle is the period involved from the time raw materials are purchased to the time they
are converted into finished goods and the same are finally sold and realized. The need for current
assets arises because of operating cycle. The operating cycle is a continuous process and
therefore the need for current assets is felt constantly. Each and every current asset is nothing but
blockage of funds. Therefore, these current assets need to be financed which is done through
Working Capital Financing.
In manufacturing units, Working capital cycle comprises of purchase of raw materials either in
cash or credit basis, converting raw materials into work in process and then into finished goods
Summer Internship 2014
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and transformation of finished goods into book debts / cash.In respect of trading concerns,
operating cycle represents the period involved from the time the goods and services are procured
and the same are sold and realized. The working capital cycle is illustrated as follows:
Trade Cycle for Working Capital
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raw materials consumption for most industries.As regards the operating cycle, the duration of
each stage of process cycle is first decided upon having regard to the function it is supposed to
perform. The conversion of raw materials into finished goods depends upon the technical
requirements and manufacturing facilities available. Similarly, the turnover of finished products
and their transformation into book debts, bills or cash could be related to factors like delivery
schedule, business customs and competition. Thus, the working capital cycle of a manufacturing
activity starts with the acquisition of raw materials in cash or credit basis and ends with
realization of finished goods in cash/ book debts.
The cycle is long in some cases and short in others, depending upon the nature of business.
Cycle is fast in consumer goods industries and slow in capital goods industries. Cycle is short in
case of perishables such as food articles, beverages, fruits, fish, eggs, etc. Cycle is long in the
case of tobacco, distilling, timber, steel, etc. Seasonal industries like manufacturers of umbrella,
woollen fabrics, fans, refrigerators, etc., require higher stocks in some months and bare minimum
in remaining months.Companies that have high inventory turnover and do business on a cash
basis (such as a trader) need very little working capital. These types of businesses raise money
quickly, then turn around and plough back that money back into inventory to increase sales.
Since cash is generated so quickly, managements can simply stockpile the proceeds from their
daily sales for a short period of time if a financial crisis arises. Since cash can be raised so
quickly, there is no need to have a large amount of working capital available.
A company that makes heavy machinery is a completely different story. Because these types of
businesses are selling expensive items on a long-term payment basis, they can't raise cash as
quickly. Since the inventory on their balance sheet is normally ordered months in advance, it can
rarely be sold fast enough to raise money for short-term financial crises (by the time it is sold, it
may be too late). It's easy to see why companies such as this must keep enough working capital
on hand to get through any unforeseen difficulties. During the cycle, funds are blocked in various
stages of current assets, viz., , inventory (consisting of raw materials, stock in process, finished
goods) and receivables.
These require finance, finance involves costs. Quicker the cycle more is the turnover normally
and longer the cycle, the less is the turnover. Stagnation in any area effects turnover and
profitability. Working capital cycle vary from industry to industry depending upon its nature of
business. Factors which affect working capital cycle are:
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Type of product
Demand for the products/services and level of competition.
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Turnover method
This method has been introduced in 1993 by RBI with a view to improve overall credit flow to
the SSI sector. MSE units having working capital limits of up to Rupees 500 lakh from the
banking system are to be provided working capital finance computed on the basis of 20 percent
of their projected annual turnover. The turnover method shall be applicable on MSE units (new
as well as existing).
Applicability of turnover method:
Particular
Applicable to
MSEs
Upto 5 crs
Non MSEs
Upto 2 crs
This system is normally applicable to traders, merchants, exporters who are not having a pre
determined manufacturing / trading cycle. Under the turnover method bank should ensure that
maintenance of minimum margin on the projected annual sales turnover. Normally 25% of the
estimated gross sales turnover value shall be computed as working capital requirements, of
which 20% shall be provided by the bank and the balance 5% by way of promoter contribution
towards margin money. In case of a traders, while bank finance could be assessed at 20% of the
projected turnover, the actual drawals should be allowed on the basis of drawing power
determined after deducting unpaid stocks. Under this method current ratio would be min. 1.25.
Illustration
working capital requirement under the turnover method:
a) Projected accepted annual Gross Sales Turnover
Rs.10.00 lakh
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As the working capital requirement are linked to projected turnover, reasonableness of the
projected annual turnover of the applicant company should be analysed by keeping in view of
past performance of the unit, the orders on hand, installed capacity of the units, power,
availability of raw materials and other infrastructural facilities . In respect of a new unit projected
turnover should be analysed with regard to installed capacity, marketability of the products,
performance of the similar unit in the industry, background of the promoters etc.
The projected turnover / output value is the gross sales which include excise duty. The
assessment of working capital credit limits should be done both as per projected turnover basis
and traditional methods based on production/processing cycle (MPBF). If the credit requirement
based on MPBF method is higher than the one assessed on projected turnover basis, the same
may be sanctioned. On the other hand, if the assessed credit requirement is lower than the one
assessed on projected turnover basis, while the credit limit can be sanctioned at 20% of the
projected turnover, drawals may be allowed basing on actual drawing power after excluding
unpaid stocks after obtaining monthly stock statement.
MPBF Method
Before going through the MPBF method of working capital assesMSEnt, we need to understand
two very important concepts of working capital finance as under;
Working Capital Gap
This represents excess of current assets over current liabilities excluding bank borrowings. A
part of the Current Assets are financed by Current Liabilities (other than bank borrowings). The
remaining portion of current assets which requires financing is called as working capital gap.
Banks do not grant advance to the full extent of working capital gap. It is always desirable rule
that the borrower has to finance a part of working capital gap out of either capital or long term
sources called as net working capital (NWC) which reflects his continued commitment to the
business that is necessary for the survival of the unit.
Net Working Capital
NWC indicates the margin or long term sources provided by the borrower for financing a part of
the current assets. Rest part of current assets gets funded by current liabilities (including Bank
Borrowings). For successful operation of a business, Current Assets should be more than the
Current Liabilities. It ensures continuous liquidity (current assets are prone to price fluctuations
and should, therefore, have an in-built margin to absorb changes) and owner's stake in the current
business operations. In other terms, NWC is excess of long term sources available for WC needs
after long term uses. As such, actual NWC is equal to Long Term Sources (LTS) minus Long
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Term Uses (LTU). Net Working Capital changes with the change in level of Long Term Sources
(including profits earned during the year) or Long Term Uses.
Three methods for assessing working capital requirement as per Tandon Committee Norms are:-
75% of working capital gap (Current Assets Current Liabilities). Balance 25% has
to be funded out of long term sources.
This part is also called Net Working Capital (NWC)
Second
NWC should be at least 25% of the total Current assets. Remaining 75% to be first
financed by other current liabilities and the bank may finance the balance
requirement.
Borrower should provide for entire core current assets and 25% of the balance
current assets.
Third
Before the MPBF Method is explained, it is necessary to understand the erstwhile Second
Method of Lending under Tandon Committee Recommendations. Method 2 is the most
commonly adopted tool to assess working capital finance. Under Method II, the borrower should
bring in a minimum margin of 25% of all current assets from owned funds and long term
liabilities, and the balance i.e 75% be financed by the Bank.
The example given below will illustrate this:-
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Current Liabilities
Current Assets
30
10
40
Bank
borrowings
discounted
including
bill 140
180
Method II
a. Current Assets
Raw materials
100
Stock-in-process
10
Finished goods
50
Receivables
discounted
including
bill 80
10
250
250
Less:
b. Current Liabilities other
Borrowings
c. Working Capital Gap
than Bank 40
210
147.50
g. Item c minus e
140
Excess
borrowings 0
(representing shortfall in net working
capital item d minus e)
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In the case of specific industries / seasonal activities such as software export, construction
activity, tea and sugar, normally, the system of assesMSEnt based on the cash budget may be
adopted. Further, in the case of specific industries like tea, wherever for specific reasons, the
borrower opts to avail the Working Capital facility under MPBF system, the same may be
permitted by the respective sanctioning authority after necessary evaluation and justification.
Structure of Cash Flow Statement
The cash flow statement shows the movement of cash and bank balances during a certain period,
the reasons for increase (+) or decrease (-) in the bank borrowings, the level of cash holding
between 2 intervals of time. The cash flow statement is a historical statement that depicts the
flow of cash in the system. A cash budget statement depicts the projected movement of cash and
bank balances at a future period. It shows the expected inflow and outflow of cash and deficit
and surplus in generation of cash. The statement covers most of the details needed for assessment
of the financial needs of the borrower.
Needless to mention that this method of assessment needs to be supplemented with the
following:
1. Need for the projected levels of production (can be justified on the basis of orders on hand /
seasonal availability of the raw material / seasonal demand etc)
2. The projected levels of production should commensurate with the operating capacities of the
unit.
3. Verification of actual level of inventories, creditors and receivables so as to establish the
veracity of projections.
The statement of cash flow is made more meaningful and useful for assessment of working
capital by grouping the cash flows under three heads viz., Operating, Investing and Financing.
The principal cash flows arising out of the above three main groups are described below:
i)
Operating Activities
These activities involve producing and delivering goods and providing services. Cash inflows
from operating activities include receipts from customers for sale of goods and services,
including receipts from collection of debtors. Cash outflows from operating activities include
payments to employees for services, payment to suppliers of goods, payments to Governments
for taxes and duties and services etc.
ii)
Investing Activities
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These activities involve extending and recovering loans and acquiring and disposing of debt and
equity instruments and fixed assets. Cash inflow from investing activities include receipts from
loan collections, receipts from sales of debt and equity instruments of other enterprises and
receipts from sale of fixed assets. Cash outflows from investing activities include disbursements
of loans, payments to acquire debt and equity instruments of other enterprises and payments
(including advances or down payments) to acquire fixed assets.
iii)
Financing Activities
These activities involve obtaining resources from owners and providing them with a return on
and return of their investment, borrowing and repaying amounts borrowed, and obtaining and
paying for other resources obtained from creditors on long term credit. Cash inflows from
financing activities include proceeds from issuing equity instruments, debentures, mortgages,
bills and from other long and short term borrowings. Cash outflows from financing activities are
payments of dividends, repayments of amounts borrowed and principal payments to creditors
who have extended long term credit.
Assessment of the limit under the cash budget system is done by arriving at the deficit between
cash inflow and cash outflow during a period of time. In this method, quantum of finance is
determined by the extent of negative cumulative cash flow position during a particular month.
The indicative format for cash budgeting is in ANNEXURE II.
In the case of seasonal industries / industries having peak/non peak level operations, cash budget
indicating the peak level/non peak level cash flows shall be obtained separately. Based on such
peak level/non peak level cash deficit, peak level limits shall be arrived at.The quantum of bank
finance for working capital to the borrower shall be the peak level of the annual cash deficit
projected as per the projected cash flow statement. However, the working capital limits shall be
in tune with the quarterly cash deficit of the borrower as revealed in the quarterly cash budget.
To ensure sufficient liquidity, the projected balance sheet should reveal the minimum current
ratio acceptable to the bank. It should be ensured that working capital availed by way of cash
deficit is supported by adequate drawing power. Though cash budgeting is adopted, it is still
essential to analyse the liquidity, working capital management, overall leverage and debt
repayment capacity.
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Diversion of funds is occasionally noted among many small and medium enterprises:
This may be due to sheer ignorance or due to lack of financial discipline.If such an event is
noted in the past, the natural tendency is to curtail credit exposure to the party irrespective of the
present state of the enterprise or the actual requirements noted.Possibility of diversion of
working capital finance to long term uses ie the Working capital finance which is meant for short
term uses and day to day operations of the firm due to lack of knowledge and financial expertise
,firms use short term capital to purchase long term assets. It will create an asset liability
mismatch and in turn can lead to cash flow crunch. This type of practices can lead to liquidity
crunch in the system.
Information asymmetry:
Working capital methods existing do not have the scope of include the delays caused due to
pending sanctions from local bodies for instances environmental clearances,power connection
etc.
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Mounting npa levels of many branches have increased the risk averse nature of credit officials.
This results in sanctioning lesser than ideal limits for w.c . Leading to cash strapped enterprises
unable to kick start growth and eventually threatening their very sustainability. Lack of owned
funds in the business, and complete dependency on borrowed funds also add to the conservative
nature of assessing officer
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6.
6.1
RECOMMENDATIONS/SUGGESTIONS
Bureaucratic hurdles: The major revamp is required in the Indian way of redressal of
problems.Despite earning the status of priority sector MSEs struggle for the relevant
sanctions for speedy execution of their project.This in turn causes diversion of the funds
allocated for working capital into other uses .
Solution : A single window clearing system for MSEs in every state can be a solution. States like
Gujarat have already implemented .This ensure right infusion of funds at right time so that
working capital cycle is not affected. The lending technologies employed to lend to the SME
sector in India would thus be influenced by the government policies and the lending
infrastructure prevalent in the country. Lending technology is categorised into two
types:transactions lending that is based on hard quantitative data and relationship lending
which is based on softqualitative information.
Lack of action for increasing awareness: Realizing the importance of the MSME
sector to the Indian economy, both the central and state governments have taken various
initiatives to strengthen and enhance the competitiveness of MSME sector. This is
evident from the subsequent passing of the MSME Development (MSMED) Act in 2006.
Few of the key initiatives include:
National Manufacturing Competitiveness Program (NMCP)
Rajiv Gandhi Udyami Mitra
Credit Guarantee Trust Fund Scheme for Micro and Small Enterprises
Credit Linked Capital Subsidy Scheme (CLCSS)
Solution:But from the interaction I had with the managers of the banks I had surveyed ,I could
discern that the borrowers who are the beneficiary of these plans are many a times unaware of
these steps taken by government.So only through awareness those funds reach the right hands.
MSEs are more vulnerable to information availability as they lack from large sources of finance
and hence largely in need of bank assistance.
Solution: credit scoring helps to reduce the information asymmetry, particularly with respect to
small firms and hence geographic proximity of the borrower and lender is not crucial to loan
Summer Internship 2014
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decisions. Recognising that better credit information can directly increase the amount of
financing for SMEs by reducing the risk and costs arising from information asymmetries, the
Credit Information Bureau of India Limited (CIBIL) has been established as a publice private
partnership to enhance the availability of credit information to member financial institutions.
Also tis estimated that in India, family businesses account for 70% of the total sales and net
profits of the biggest 250 private-sector companies (The Economist, 1996), and almost all
MSME would be family firms. Inter-family relationships and family succession play an important
role in the performance of family firms, and banks would need to take this into account in their
credit decisions. It was also found that family businesses in India where succession takes place
without fights and splits show higher profitability. This would suggest that a credit officer should
also be aware of inter-family relationships as the souring of these relationships could
significantly change the credit risk of the family firm.Hence soft information inclusive ranking
should be introduced in some way.
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7.CONCLUSION
The MSE sector in India, which includes the micro, small and medium enterprises, constitutes an
important part of the economy. However, a major concern for the MSEs is the availability of an
adequate amount of nances. The government has recognised the key role that the MSE segment
plays in creating new enterprises and in providing employment to a large segment of the
population and has adopted several public policy measures to enhance ow of credit to the
sector. One of the prominent measures used to ensure adequate ow of funds to the MSE sector
is through regulation requiring banks to provide at least 40% of loans to targeted areas which
include the micro, small and medium enterprises. Although directed lending would increase the
ow of funds to the MSE sector, studies suggest that MSE rms are credit constrained. One of
the signicant issues in lending to MSEs is the use of both hard data such as nancial
information, as well as soft data such as feedback from vendors and other family members,
which become important inputs towards understanding the credit risk of the business. The
challenge for banks is to bridge the information asymmetry so as to take the appropriate lending
decision so that the good rms are not nancially constrained, and at the same time, cut down on
exposures to bad credit risks.Also the bureaucratic delays adversely affects the working capital
cycle and there is no magical solution to it.So that problem remain out of bound in assesMSEnt.
Measures such as credit scoring for MSEs should improve the quality of nancial information
and enable greater funding for the sector. While it may be too early to conclude that MSE rms
in India are not nancially constrained, the reforms in the nancial sector and the improvement
in the lending infrastructure has certainly improved access to nance for small rms.The banks
as such should keep a balanced view regarding NPAs and should collaboratively deal the risk
averse nature arising out of it.MSE s are indeed the growth engines of our economy and perhaps
our only hope for bridging the CAD in the long term.So it is quite inevitable the sector continue
to be our priority.
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1. http://www.idbi.co.in/
2. ebsco
I.
II.
III.
IV.
3. science direct
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ANNEXURE I
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ANNEXURE II
FORMAT FOR CASH BUDGETING
Particulars / month
Activity Details
Production (quantity)
Sales ( quantity)
Purchases
Cash Flows
(A) Total Cash Inflow ( Sum of 1 to 8)
Cash Sales
Realisation from Debtors
Receipt by way of trade advances
Receipt of interest, dividend, other income
Long term loans raised
Short term loans raised
Sale of assets
Others (Specify)
(B) Total Cash Outflow ( sum of 1 to 16)
Cash purchases
Payment to sundry creditors
Advances to suuppliers
Wages and salaries
Lease rentals
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Manufacturing expenses
Selling and distribution expenses
General administrative expenses
Interest payment
Dividend payment
Capital expenditure
Repayment of Long term loan
Repayment of short term loan
Taxes
Deposits and investments
Others (specify)
(C ) Cash Budget
Total Cash Inflow (A)
Total Cash Outflow (B)
Net cash flow (1-2)
Add Opening cash balance
Cumulative net cash flow Amount to be
financed
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