Maximum Permissible Bank Finance

Maximum Permissible Bank Finance (MPBF) refers to the maximum amount a bank can extend as a working capital loan to a business based on the financial health, net working capital, and other financial metrics of the borrowing company. MPBF plays a crucial role in helping businesses manage their working capital efficiently. In this guide, we’ll explore the MPBF concept, its calculation methods, and how it impacts businesses seeking loans for their operations.

MPBF is primarily used to calculate the working capital finance that a business can avail of from a bank. It ensures that companies don’t over-borrow beyond their financial capacity and prevents banks from taking unnecessary risks.

1. Ensures Responsible Borrowing: MPBF helps businesses borrow only what they can manage without putting undue financial strain on their operations.
2. Optimal Fund Allocation: By limiting the maximum finance available, it encourages better fund utilization and prioritization of key business activities.
3. Risk Management: It aids banks in reducing their exposure to credit risk by evaluating the financial health of companies before lending.
4. Financial Discipline: The requirement to meet certain financial metrics promotes discipline in maintaining financial statements, ensuring businesses stay on track financially.

There are two main methods used to calculate MPBF:

1. Tandon Committee Method (First Method)

This method, proposed by the Tandon Committee, is one of the most commonly used approaches for calculating MPBF.

• Working Capital Requirement (WCR): WCR is the difference between current assets and current liabilities.
• Minimum Margin Requirement: A margin of 25% on current assets is required, which means the borrower must finance 25% of their current assets from long-term sources or internal accruals.
• Bank Finance: The remaining 75% is considered as eligible for bank finance.

Formula:MPBF=Current Assets−(Current Liabilities+Borrower’s Contribution)MPBF = \text{Current Assets} – (\text{Current Liabilities} + \text{Borrower’s Contribution})MPBF=Current Assets−(Current Liabilities+Borrower’s Contribution)

Example: Let’s assume a business has current assets worth ₹10,00,000 and current liabilities of ₹2,00,000. The borrower’s contribution is 25% of the current assets, i.e., ₹2,50,000. Hence, the MPBF will be:MPBF=₹10,00,000−(₹2,00,000+₹2,50,000)=₹5,50,000MPBF = ₹10,00,000 – (₹2,00,000 + ₹2,50,000) = ₹5,50,000MPBF=₹10,00,000−(₹2,00,000+₹2,50,000)=₹5,50,000

2. Tandon Committee Method (Second Method)

This method is more conservative compared to the first and limits the bank’s finance further.

• Working Capital Requirement: This method requires a margin of 25% on the total working capital requirement (not just on current assets).

Formula:MPBF=75%×(Current Assets−Current Liabilities)MPBF = 75\% \times (\text{Current Assets} – \text{Current Liabilities})MPBF=75%×(Current Assets−Current Liabilities)

Example: Using the same figures from the previous example, the MPBF will be:MPBF=75%×(₹10,00,000−₹2,00,000)=₹6,00,000MPBF = 75\% \times (₹10,00,000 – ₹2,00,000) = ₹6,00,000MPBF=75%×(₹10,00,000−₹2,00,000)=₹6,00,000

3. Nayak Committee Method

The Nayak Committee method is a simplified approach that is primarily used for small and medium-sized enterprises (SMEs). It suggests that businesses can avail 25% of their projected annual turnover as MPBF.

Formula:MPBF=25%×Projected Annual TurnoverMPBF = 25\% \times \text{Projected Annual Turnover}MPBF=25%×Projected Annual Turnover

Example: If a small business has a projected turnover of ₹40,00,000 for the year, the MPBF would be:MPBF=25%×₹40,00,000=₹10,00,000MPBF = 25\% \times ₹40,00,000 = ₹10,00,000MPBF=25%×₹40,00,000=₹10,00,000

The maximum permissible bank finance is determined by several factors that banks take into account when processing loan applications. These include:

1. Current Assets: The business’s current assets, such as inventory and accounts receivable, are a key factor in calculating MPBF.
2. Current Liabilities: These include short-term financial obligations like accounts payable, taxes payable, and other short-term debts.
3. Projected Turnover: For SMEs, banks often use projected turnover to calculate MPBF using the Nayak Committee method.
4. Borrower’s Contribution: The borrower is expected to contribute a portion of the working capital requirement from long-term funds or internal accruals.
5. Bank’s Risk Appetite: Banks may adjust MPBF based on their risk assessment of the borrower and industry factors.
6. Industry Norms: Some industries might have specific norms that banks follow when determining MPBF.
7. Cash Flow Management: Effective cash flow management by a business can also influence the amount of finance available.

Incorrectly calculating MPBF can lead to both over-borrowing and under-borrowing, both of which can harm a business. Here’s why:

• Over-borrowing: If a business borrows more than it needs, it incurs unnecessary interest costs, which can erode profits.
• Under-borrowing: If a business borrows less than required, it may struggle to meet working capital needs, leading to cash flow problems.

A carefully calculated MPBF ensures that the business has the right amount of working capital finance to maintain operations without taking on too much risk.

To apply for working capital finance, businesses need to submit certain documents, including:

1. Financial Statements: Profit and loss statements, balance sheets, and cash flow statements for the past three years.
2. Projected Turnover: A detailed projection of the business’s expected turnover for the next year.
3. Working Capital Requirement: A breakdown of the working capital requirements for the business.
4. Inventory and Receivables Details: Information on current inventory levels and receivables.
5. Income Tax Returns: The business’s income tax returns for the past three years.
6. Bank Statements: Bank statements for the past six months.

Businesses looking to maximize their MPBF can take certain steps to improve their financial metrics and creditworthiness:

1. Maintain Healthy Current Assets: Increasing inventory turnover and maintaining receivables at manageable levels can improve current assets.
2. Reduce Current Liabilities: Paying off short-term liabilities promptly can help improve the current ratio, which directly affects MPBF.
3. Improve Profit Margins: Higher profit margins can lead to higher projected turnovers, which can increase MPBF, especially under the Nayak Committee method.
4. Maintain Good Credit Score: A good credit score can influence a bank’s willingness to offer higher MPBF.

While MPBF is designed to ensure businesses get the appropriate amount of working capital, it comes with challenges:

1. Rigid Calculations: Some businesses may find the calculations too rigid and may not align with their real working capital needs.
2. Over-reliance on Projections: In methods like the Nayak Committee, the reliance on projected turnover can sometimes lead to inaccurate MPBF calculations if projections are off.

MPBF is a crucial tool for businesses seeking working capital loans. By understanding the different methods of calculation and the factors that influence MPBF, businesses can make informed decisions about how much working capital finance to seek from banks. With proper financial discipline and planning, businesses can optimize their MPBF and ensure they have the working capital needed to thrive.

1. What is Maximum Permissible Bank Finance (MPBF)? MPBF refers to the maximum working capital loan a bank can offer based on the financial health of the business.
2. How is MPBF calculated? MPBF is calculated using different methods, including the Tandon Committee and Nayak Committee methods.
3. What are the benefits of MPBF? MPBF helps businesses borrow responsibly, ensuring they don’t take on more debt than they can manage.
4. What documents are needed to apply for MPBF? Financial statements, projected turnover, working capital requirements, inventory details, and bank statements are needed.
5. What is the Tandon Committee method? The Tandon Committee method calculates MPBF by requiring businesses to maintain a minimum margin on current assets.
6. What is the Nayak Committee method? The Nayak Committee method is a simplified approach, allowing SMEs to borrow 25% of their projected annual turnover.
7. Can MPBF change over time? Yes, MPBF can change based on the financial health of the business and its working capital requirements.
8. How can businesses maximize their MPBF? Maintaining healthy current assets, reducing liabilities, and improving profit margins can help maximize MPBF.
9. What challenges do businesses face with MPBF? Rigid calculations and reliance on projected turnovers are common challenges with MPBF.
10. Is MPBF the same for all industries? No, industry norms and risk assessments can influence MPBF differently for various industries.