Working Capital Banking: Cash Credit (CC), LC & Bill Discounting

Even a highly profitable plastics manufacturing plant can fail if it runs out of cash. In India, plastics processors must purchase raw materials (polymer granules) on cash terms or tight schedules, while supplying finished products to large FMCG/retail clients on 30- to 90-day credit terms. This mismatch creates a gap that must be financed through bank working capital facilities. Understanding trade finance instruments (Cash Credit, Letters of Credit, Bill Discounting) is essential for entrepreneurs to maintain liquidity.

• Formulate working capital cycles and calculate the net operating cycle (in days).
• Contrast bank credit facilities: Cash Credit (CC), Letters of Credit (LC), and Bill Discounting.
• Size drawing power (DP) limits against paid stock and receivables.
• Solve interest cost and discounting charge calculations.
• Reference Indian banking guidelines on working capital financing (Tandon Committee rules).

3.1 The Net Operating Cycle

The net operating cycle measures the duration between cash paid for raw materials and cash received from sales:

3.2 Key Bank Trade Finance Instruments

• Cash Credit (CC): Running bank account facility where borrowers can withdraw up to a designated credit limit. The actual withdrawal limit is governed by the Drawing Power (DP), calculated monthly based on inventory value and debtors, minus creditors, applying margins (typically 25% on stock, 30–40% on debtors).
• Letter of Credit (LC): Payment guarantee issued by the buyer's bank to the seller, ensuring payment upon presentation of shipping documents. Essential for purchasing raw polymer batches from major suppliers like Reliance or IOCL.
• Bill Discounting: The bank purchases unpaid trade invoices (bills of exchange) from the manufacturer at a discount (minus interest fees), providing immediate cash flow.

Problem: A plastic processor submits their monthly stock statement to their bank to determine their Drawing Power (DP) under a Cash Credit limit of ₹1.50 Crore. The stock statement details are:

• Value of raw polymer stock + finished goods = ₹80,00,000.
• Sundry creditors (unpaid stock) = ₹20,00,000.
• Sundry debtors (receivables $< 90$ days old) = ₹60,00,000. The bank applies a margin of $25\%$ on inventory (net of creditors) and $40\%$ on debtors. Calculate the available Drawing Power.

Solution:

1. Calculate Net Eligible Inventory:

1. Apply margins to calculate Drawing Power (DP):

• DP from Stock: $\text{Net Stock} \times (1 - 0.25) = 60,00,000 \times 0.75 = \text{₹45,00,000}$
• DP from Debtors: $\text{Debtors} \times (1 - 0.40) = 60,00,000 \times 0.60 = \text{₹36,00,000}$
• Total Drawing Power = $\text{DP from Stock} + \text{DP from Debtors} = 45,00,000 + 36,00,000 = \mathbf{₹81,00,000}$

Interpretation: The bank will allow the processor to draw up to ₹81,00,000 from their Cash Credit account this month, despite their nominal sanction limit being ₹1.50 Crore. Managing paid inventory levels is critical to maximize drawing power.

Indian polymer distributors (e.g., selling Reliance PP grades) demand Letters of Credit (LC) from small processors before dispatching raw materials. Small processors negotiate LC-Usance (e.g., 90 days) with their banks to get raw materials, convert them to products, and collect payments before the LC matures.

• Drawing Power: The actual amount an entrepreneur can withdraw from their CC account based on current assets.
• Letter of Credit (LC): Financial instrument guaranteeing payment to a seller from the buyer's bank.
• Bill Discounting: Immediate funding secured by selling accounts receivable invoices to a bank.
• Creditor Days: Days of credit extended by suppliers for raw material purchases.
• Tandon Committee: Historical RBI committee establishing working capital lending norms.

1. Reserve Bank of India (RBI) master circular on working capital credit facilities
2. Uniform Customs and Practice for Document Credits (UCP 600) for international LCs

1. Explain the difference between Fund-Based (Cash Credit, Term Loans) and Non-Fund-Based (Letters of Credit, Bank Guarantees) credit facilities.
2. Why do banks exclude debtors older than 90 days from the Drawing Power calculation? Discuss debtor aging schedules.
3. A factory has 45 stock days, 60 debtor days, and 30 creditor days. Calculate the operating cycle and discuss working capital needs.