How to Calculate Drawing Power for a Cash Credit / Working Capital Facility with Examples 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 flexibility and comfort to withdraw funds from the bank as per their financial requirement from time to time. The working capital facility is sanctioned for a period of one year and same may be renewed by the bank (or financial institution) every year with the same limit or enhanced limit or reduced limit to the borrower firm / company which is assessed on the basis of firm’s financial result of the preceding (reporting) year as well as on projected balance sheet for the ensuing (subsequent) year. Drawing Power generally addressed as “DP” is an important concept for Cash Credit (CC) facility availed from banks and financial institutions. It is the limit up to which a borrower can withdraw funds within the Cash Credit limit. Updating drawing power for working capital by the bank is an important credit monitoring exercise. The borrower is allowed utilize the funds from the cash credit account within the sanctioned cash credit limit or drawing power arrived by the bank for the particular month whichever is less. The Drawing Power is arrived on the basis the stock, book debts and creditors statement submitted by the borrower based on the closing position of the earlier month. 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.) Banks have a practice of updating drawing power based on monthly / quarterly closing stock-book debt and trade creditors’ statements submitted by the firm/company. 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))
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