The Cash Credit limit (known as working capital limit) is sanctioned by banks and financial institutions to business organizations to run their day to day functions and achieve growth of business. This facility offers the borrowers to withdraw funds from the bank from time to time. The working capital facility is sanctioned for a period of one year and the same may be renewed by the bank (or financial institution) every year.
Drawing power is the limit upon which every borrower can withdraw the money within the cash credit limit.
Drawing Power can be calculated based on the specific margins and other terms and conditions contained in the Sanction letter. Here, margin is the owner’s contribution to the business. (In most of the cases, a margin on the stock is 25% and for book debts 40% of net debtors which may vary from bank to bank and industry to industry.)
The general formula for calculating Drawing Power (DP) is as under:
Drawing Power = Net Value of Stock + Net Value of Debtors
Where, Net Value of Stock = (Stock – Creditors)*(100% – % margin on stock) and Net Value of Debtors = (Debtors*(100% – % margin on debtors))
A limited company enjoying CC sanction limit of INR 14,00,000. The details of stock and book debts statement as at the end of May ’21 are as under.
Total stock INR 14,00,000, Creditors INR 3,00,000, Total book debtors INR 5,00,000, Debtors more than 90 days old is INR 1,00,000 (as per sanction 90 days old are considered for DP).
DP Power Calculation:
|A||Total Stock||Rs. 1400000|
|B||Less: Creditors||Rs. 300000|
|C||Net paid stock (A-B)||Rs. 11,00,000|
|D||Less: Margin on stock @25%||Rs. 2,75,000|
|E||Drawing Power (DP) on stock (C-D)||Rs. 8,25,000|
|F||Total Book Debtors||Rs. 500000|
|G||Less: Debtors > 90 days||Rs. 1,00,000|
|H||Net Debtors for DP (F-G)||Rs. 4,00,000|
|I||Less: Margin on Debtor @40%||Rs. 1,60,000|
|J||Drawing Power (DP) on Debtor (H-I)||Rs. 2,40,000|
|K||Total Drawing Power (E+J)||Rs. 10,65,000|
The final drawing power shall be lower of the sanctioned limit or the DP as calculated above.
In terms of the RBI guidelines, Drawing Power is required to be arrived at based on the stock statement. Further, stock statements relied upon by the banks for determining drawing power should not be older than three months. The outstanding in the account based on drawing power calculated from stock statements older than three months would be deemed as irregular.
As overdraft facilities are offered for a shorter duration of time. Therefore, it is also considered as a demand loan. The maximum repayment tenure of overdraft facilities is 12 months and it gets renewed after every year.