How to working capital drawing power from the balance sheet of the company
Answers
Drawing Power is usually applied on Cash Credit Accounts. It is usually calculated by taking a Margin of 25% on Stocks and 40% on Book Debts.
If the above explanation just went above your head, read further to get a better understanding.
A Cash Credit s a revolving line of Credit which is basically used for basic Working Capital needs. The Bank sets a limit of the Cash you can borrow and you will be charged interest based only on what you use. The Interest is calculated based on your balance at the end of the day.
The Limit of Credit that can be availed is determined by the bank mainly on ones Financials (differs from Bank to Bank lending Policy) and Drawing Power. This Drawing Power is reviewed on a quarterly basis and DP is set accordingly.
Let us understand by Considering 2 scenarios:
Scenario 1:
Sanctioned Limit: 10000000 units
Stocks: 100000 units
Book Debts: 2000000 units
Drawing Power: 25% Margin on Stocks + 40% Margin on Book Debts
which is (1–25%)*Stocks + (1–40%)*Book Debts= 1260000 units
Therefore DP is 1260000 units which is lesser than the Sanctioned Limit.
Scenario 2:
Sanctioned Limit: 10000000 units
Stocks: 1000000 units
Book Debts: 20000000 units
Drawing Power: 25% Margin on Stocks + 40% Margin on Book Debts
which is (1–25%)*Stocks + (1–40%)*Book Debts= 12600000 units
Therefore DP is 12600000 units which is greater than the Sanctioned Limit.
In Scenario 1, we can see that DP is less than Sanctioned Limit, in which case the customer can avail credit maximum up to the the DP even if the customer has higher Credit Limit Sanctioned.
In Scenario 2, we can see that DP is more than Sanctioned Limit, in which case the customer can avail credit maximum up to the the DP even if the customer has lower Credit Limit Sanctioned.
This is the Banks way of penalizing/rewarding the customer based on how the Customer is maintaining the Working Capital expenses (also a way of risk management for the Banks, so that one doesn’t use these Short Term funds for Long Term purposes)