CAIIB ABM Module C UNIT 19 MCQ – Working Capital Finance

Correct Answer: C. The money blocked in current assets such as raw materials, finished goods, and receivables. Working capital refers to the funds required by a business to finance its day-to-day operations, primarily tied up in current assets necessary for the operational cycle.

Correct Answer: B. The sum total of all current assets required to run the enterprise smoothly. Gross Working Capital specifically refers to the total investment made in all current assets of the business, such as inventory, receivables, and cash.

Correct Answer: C. The amount arranged by the enterprise through long-term funds (capital or borrowings) to meet part of the working capital requirement. NWC represents the portion of current assets financed by long-term sources, indicating the company’s liquidity position.

Correct Answer: C. By a combination of short-term credit (including bank finance) and Net Working Capital arranged from long-term funds. Funding for gross working capital comes from both short-term sources (like supplier credit and bank loans) and long-term sources (NWC).

Correct Answer: B. Cash -> Raw Materials -> Work in Process -> Finished Goods -> Book Debts -> Cash. The operating cycle describes the flow of funds starting with cash used to buy raw materials, which are processed, sold (creating receivables/book debts), and finally converted back into cash.

Correct Answer: C. The time involved in the manufacturing or processing activities. The duration of the work-in-process stage depends entirely on how long it takes to convert raw materials into finished goods through the production process.

Correct Answer: B. Higher requirement for working capital finance. A longer cycle means funds are tied up in current assets for a longer duration, thus increasing the overall need for working capital.

Correct Answer: B. The amount of fixed assets acquired by the enterprise. The working capital cycle is concerned with the flow of current assets and liabilities in operations; fixed assets are long-term investments and do not directly impact the operating cycle’s length.

Correct Answer: B. They help assess the enterprise’s ability to meet its short-term obligations and monitor fund usage. The Current Ratio (Current Assets / Current Liabilities) is a key measure of short-term solvency, crucial for banks assessing the risk associated with working capital loans.

Correct Answer: C. It helps ensure the enterprise maintains a minimum Current Ratio (usually greater than one). Stipulating a minimum NWC (which is Long Term Sources – Long Term Uses, or essentially financing part of Current Assets with Long Term Funds) increases the numerator (Current Assets) relative to the denominator (Current Liabilities, excluding the NWC component funded long-term), thus supporting a minimum acceptable current ratio.

Correct Answer: B. Based on production capacity, proposed market share, and industry norms. For new enterprises without past performance data, projections rely on factors like potential output, market conditions, and comparable industry benchmarks.

Correct Answer: B. Inventory, Receivables/Bills, and Other Current Assets. Gross Working Capital represents the total investment in current assets, which primarily includes stocks (inventory), amounts due from customers (receivables), and miscellaneous current assets like cash or prepayments.

Correct Answer: C. The lead time for raw material procurement and the manufacturing process duration. Inventory assessment involves estimating the required stock levels of raw materials, work-in-progress, and finished goods, considering factors like supply lead times, production cycle time, and minimum order quantities.

Correct Answer: B. The market practice applicable to the specific business or location regarding credit terms. The level of receivables is mainly determined by the standard credit period offered to customers in that particular industry or market.

Correct Answer: C. Net Working Capital (Own Sources), Supplier’s Credit, Other Current Liabilities, and Bank Finance. The total need for current assets (Gross Working Capital) is financed through a mix of promoter’s long-term funds (NWC), credit from suppliers, other operational liabilities, and the remaining gap is typically covered by bank finance.

Correct Answer: C. As the gap between total working capital needed (Gross WC) and the funds available from NWC, supplier’s credit, and other current liabilities. Bank finance bridges the shortfall after accounting for the funds provided by the business’s own long-term sources and naturally available short-term credit.

Correct Answer: C. Net Working Capital equal to at least 25% of the working capital gap (Total Current Assets minus Current Liabilities other than bank finance). This method focused on the enterprise funding a portion of the gap between current assets and non-bank current liabilities from long-term sources.

Correct Answer: C. Total Current Assets. This method required a stronger contribution from long-term funds, mandating that at least a quarter of the total current assets be financed through NWC.

Correct Answer: C. The Current Ratio must be at least 1.33. If NWC (CA – CL) is at least 25% of CA, then (CA – CL) ≥ 0.25 × CA. This simplifies to 0.75 × CA ≥ CL, or CA ⁄ CL ≥ 1 ⁄ 0.75, which means Current Ratio ≥ 1.33.

Correct Answer: C. 100% of core current assets plus at least 25% of the remaining current assets. This method involved classifying current assets into ‘core’ (permanent) and ‘fluctuating’ components, requiring full funding of core assets and partial funding of the rest from long-term sources.

Correct Answer: B. Projecting cash inflows and outflows over a specific period to identify potential cash deficits. This method focuses on the timing of cash receipts and payments to determine the exact periods when external finance might be needed to cover shortfalls.

Correct Answer: C. When projected cash outflows exceed the sum of opening cash balance and projected cash inflows for a period. Bank finance under this method is intended to bridge the gap during periods where operational expenses and payments surpass available cash.

Correct Answer: C. Monthly or Quarterly. Projecting cash flows on a daily basis is often impractical, so banks typically work with estimates prepared for monthly or quarterly periods to assess financing needs.

Correct Answer: C. 25%. This simplified method estimates that a business typically needs funds equivalent to one-quarter of its annual sales turnover to manage its working capital cycle.

Correct Answer: B. 20%. The method suggests a bank limit equivalent to 20% of turnover, with the remaining 5% of turnover (which is 20% of the 25% total requirement) being contributed by the enterprise as margin.

Correct Answer: C. 20%. The guideline mandates that banks should provide working capital limits of at least 20% of the estimated annual turnover for eligible MSE units.

Correct Answer: D. 37.50%. To encourage digital transactions, such units may have their working capital requirement assessed at a higher rate of 37.50% of turnover, potentially leading to a higher credit limit (30% of turnover).

Correct Answer: C. Sanction the highest amount assessed, unless the borrower applies for a lesser amount. To avoid under-financing, banks should ideally sanction the maximum eligible amount derived from different appropriate assessment methods, provided the borrower needs it.

Correct Answer: B. Businesses with relatively uniform operations and stable market conditions. Since the holding method relies on average levels over a year, it works best when operations and market factors do not fluctuate drastically.

Correct Answer: B. Businesses executing project contracts or having seasonal variations in activity levels. The Cash Budget method’s ability to capture month-to-month fluctuations makes it better suited for businesses with uneven cash flow patterns.

Correct Answer: C. Projected Turnover Method. Its simplicity makes it suitable for smaller units, and RBI guidelines mandate its use for assessing limits up to Rs. 5 crores for MSMEs, subject to certain conditions.

Correct Answer: C. Based on 20 per cent of the projected turnover. For smaller limits in this sector, a simplified turnover-based assessment is suggested by the guidelines.

Correct Answer: C. Monthly cash budget system. For larger limits where complexities increase, the cash budget method provides a more detailed assessment of fund requirements, and loan system guidelines also become applicable above Rs. 10 crores.

Correct Answer: C. Obtaining quarterly statements of cash flows or other suitable reporting systems. Given the nature of the industry, monitoring cash flows through periodic statements is considered an appropriate follow-up mechanism.

Correct Answer: C. As Book Debts or Sundry Debtors. These terms represent amounts owed by customers for goods or services sold on credit, documented simply by invoices rather than formal bills of exchange.

Correct Answer: B. By deducting an applicable margin from the value of eligible book debts submitted. Banks provide finance against receivables but maintain a margin as security, so the drawing power is less than the total value of the debts.

Correct Answer: B. To indicate that payment is due immediately upon presentation, usually against delivery of transport documents. A demand bill signifies that no credit period is offered, and payment is expected on demand.

Correct Answer: B. A specific credit period is granted, and payment is due after that period. A usance bill specifies a future date or a period after which the payment must be made by the drawee (purchaser).

Correct Answer: C. Discounting the bill. Banks provide finance against usance bills by ‘discounting’ them, which means paying the drawer upfront after deducting interest for the usance period and other charges.

Correct Answer: C. Financing bills (demand or usance) drawn under Letters of Credit (LCs). Negotiation specifically relates to the examination of documents and providing finance under the terms of a Letter of Credit.

Correct Answer: C. No, banks should generally avoid financing non-constituents, with limited exceptions (like restricted LCs). The guidelines emphasize dealing with regular borrowers who have sanctioned credit facilities with the bank.

Correct Answer: C. As an exposure on the LC issuing bank, attracting inter-bank exposure risk weight. Since the primary obligation rests with the LC issuing bank, the risk is considered akin to lending to that bank.

Correct Answer: C. It is prohibited; the restriction remains in force. While banks have discretion for ‘without recourse’ negotiation under LCs, the prohibition on purchasing/discounting other bills ‘without recourse’ continues.

Correct Answer: D. Accommodation bills. These are bills drawn without any underlying trade transaction, merely to facilitate raising finance, and banks are instructed not to finance them.

Correct Answer: C. They do not appear directly in the assets or liabilities but as contingent liabilities for both. These represent potential future obligations contingent upon certain events, hence disclosed separately rather than as direct assets or liabilities.

Correct Answer: B. To reimburse the beneficiary for monetary loss if the bank’s customer fails to perform a contract as specified. Performance guarantees cover obligations related to the execution of a contract, such as meeting deadlines, quality standards, or equipment functionality.

Correct Answer: C. Meeting financial obligations or dues of the customer, such as security deposits or payments in case of default. Financial guarantees assure the beneficiary that specific monetary commitments of the applicant will be met.

Correct Answer: B. It acts as a guarantee to the supplier, potentially enabling the customer to receive more favourable credit terms or credit itself. The bank’s co-acceptance enhances the purchaser’s creditworthiness in the eyes of the supplier, facilitating smoother trade credit.

Correct Answer: C. 10 years. While longer durations are possible, banks are advised that guarantees should normally not exceed 10 years and to consider Asset Liability Management implications for longer periods.

Correct Answer: B. Banks should generally avoid issuing such guarantees. The guidelines caution against issuing unsecured guarantees, especially for significant amounts and longer durations, due to the inherent risks involved.

Correct Answer: B. Limit the amount to a reasonable proportion of the bank’s total unsecured guarantees and the constituent’s equity. This measure aims to prevent excessive concentration of unsecured risk with a single customer or group.

Correct Answer: C. The customer’s ability to reimburse the bank if the guarantee is invoked and payment is made. Since the bank has to pay the beneficiary if the guarantee is invoked, it must assess the customer’s capacity to repay the bank.

Correct Answer: B. The customer’s experience, capacity, and means to perform the obligations under the contract successfully. For performance guarantees, the bank needs to be confident that the customer can fulfill the contractual obligations, reducing the likelihood of the guarantee being invoked due to non-performance.

Correct Answer: C. Banks should generally refrain from doing so. The general guideline discourages providing non-fund facilities to entities that do not have a borrowing relationship (fund-based) with the bank.

Correct Answer: C. If the bank has a comprehensive Board-approved policy and adheres to all prudential norms, including KYC and credit appraisal. An exception exists, allowing banks to provide non-fund facilities to such customers, provided stringent conditions including policy approval, due diligence, and adherence to regulatory norms are met.

Correct Answer: B. The customer has not availed any fund-based facility from any bank operating in India. A key condition for this exception is that the customer should not have any existing fund-based borrowing relationship with any bank in India.

Correct Answer: B. The bank may negotiate such an LC, provided the proceeds are remitted to the beneficiary’s regular banker. An exception allows negotiation of restricted LCs for non-constituents, ensuring the funds flow back to the beneficiary’s primary bank.

Correct Answer: B. To speed up the process of verifying the genuineness of the bank guarantee. Including these details facilitates quicker confirmation by the beneficiary (DGS&D) regarding the authenticity of the guarantee document.

Correct Answer: B. A period of six months beyond the original delivery period. The guideline specifies an initial validity extending six months past the contractual delivery date.

Correct Answer: C. A clause providing for automatic extension of the validity period by 6 months. To streamline the process, especially when delivery periods are extended, banks are advised to include an automatic extension clause, mirroring the terms in DGS&D tenders.

Correct Answer: C. 50%. Banks are required to obtain a margin of at least 50% of the guarantee amount when issuing guarantees for stock brokers related to exchange requirements.

Correct Answer: D. 25% cash margin. The guidelines specify that at least half of the total minimum margin (i.e., 25% of the guarantee amount) must be maintained in the form of cash.

Correct Answer: B. Yes, the same minimum margin requirements apply. The guidelines explicitly extend the margin rules for stock brokers to guarantees issued on behalf of commodity brokers favouring the specified national exchanges.

Correct Answer: B. The agreement must give the bank an inalienable right over the securities to be received as payout. This clause secures the bank’s position by giving it rights over the assets resulting from the settlement for which it provided the commitment.

Correct Answer: C. When the transaction is pre-funded (clear funds available before IPC issuance). If the bank already holds the funds (INR) or has received the foreign exchange in its nostro account before issuing the IPC, the risk is mitigated, and the specific agreement clause is not mandatory.

Correct Answer: B. They form part of the bank’s Capital Market Exposure (CME). IPCs represent commitments related to capital market transactions and are included within the bank’s overall exposure to this sector.

Correct Answer: C. Genuine trade bills representing actual movement of goods. The primary safeguard is to ensure co-acceptance facilities are used only for legitimate commercial transactions involving the purchase and receipt of goods.

Correct Answer: C. Banks should not extend their co-acceptance to such bills. Co-acceptance should be restricted to genuine trade transactions, and financing accommodation bills between related parties is discouraged.

Correct Answer: C. It is likely to reduce the fund-based requirement. Receiving an advance payment provides the customer with funds, thereby reducing their need to borrow funds from the bank for working capital purposes. The guarantee merely facilitates this advance.

Correct Answer: B. Because co-acceptance helps the borrower get more credit from suppliers, reducing the need for direct bank funds (assuming this credit wasn’t already factored in). The co-acceptance facilitates supplier credit, which is another source of funding working capital, thus potentially reducing the amount needed directly from the bank’s fund-based limit.

Correct Answer: B. The seller’s worry about receiving payment and the buyer’s worry about receiving goods. An LC acts as a bridge, assuring the seller of payment upon meeting conditions and the buyer of not paying until conditions (like proof of shipment) are met.

Correct Answer: C. An undertaking by a bank, at the buyer’s request, to pay the seller upon submission of specified documents. The bank substitutes its creditworthiness for the buyer’s, promising payment if the seller complies with the LC terms.

Correct Answer: C. The Uniform Customs and Practice for Documentary Credits (UCPDC 600) published by the ICC. UCP 600 provides a standardized set of rules for LCs used globally.

Correct Answer: C. The average amount or value for each individual LC to be opened. EOQ helps determine the optimal quantity to order each time, which dictates the value of each LC required for purchases.

Correct Answer: B. 6 LCs per year. The number of LCs is calculated by dividing the total annual consumption by the amount per LC (EOQ): ₹12 crores / ₹2 crores/LC = 6 LCs.

Correct Answer: B. The sum of lead time (opening LC to shipment), transit time, and any usance period. The LC needs to be valid and outstanding covering the entire duration from initiation until the end of the payment term after goods receipt.

Correct Answer: C. By multiplying the average amount of each LC by the estimated number of LCs outstanding at any point in time. The total limit needs to cover the aggregate value of all LCs that are likely to be active simultaneously.

Correct Answer: C. It is usually ‘carved out’ of the total sanctioned fund-based working capital limit. Since LCs facilitate purchases and potentially provide credit, the need for direct fund-based borrowing for those purchases decreases, allowing the LC limit to be accommodated within the overall working capital assessment.

Correct Answer: B. An unsecured money market instrument issued in the form of a promissory note. CP is a form of short-term, unsecured debt issued by eligible entities to raise funds from the money market.

Correct Answer: B. ₹4 crores. A company must have a tangible net worth of not less than ₹4 crores, among other conditions, to be eligible for issuing CP.

Correct Answer: C. A3. The minimum acceptable credit rating for CP issuance is ‘A3’ according to SEBI’s prescribed symbols and definitions.

Correct Answer: B. Minimum 7 days, Maximum up to one year. CP is a short-term instrument with maturity ranging from 7 days to a maximum of 365 days from the date of issue.

Correct Answer: B. The maturity date cannot go beyond the date up to which the credit rating is valid. The CP’s validity is linked to the validity of the credit rating that supports its issuance.

Correct Answer: D. Individuals, banks, corporates, unincorporated bodies, NRIs, and FIIs. Investment in CP is open to a wide range of domestic and certain international investors.

Correct Answer: B. The cost of borrowing is typically lower compared to other short-term bank finance. CP allows top-rated borrowers to access funds directly from the market, often at finer rates than traditional bank loans.

Correct Answer: B. A method of financing the receivables (book debts) of a business enterprise. Factoring involves a financial institution (Factor) purchasing or financing a company’s accounts receivable.

Correct Answer: B. ‘Without recourse’ means the Factor bears the risk of non-payment by the buyer, while ‘with recourse’ means the client remains liable. The allocation of credit risk associated with the buyer’s default distinguishes the two types.

Correct Answer: B. At least 75% of its income must come from factoring, and at least 75% of its assets must be receivables purchased/financed. RBI guidelines stipulate these concentration norms for factoring companies to be eligible for bank finance for their factoring activities.

Correct Answer: C. To improve their cash flow and meet working capital requirements by receiving funds upfront without default risk. Non-recourse factoring provides exporters with immediate funds and protection against buyer default, aiding liquidity management.

Correct Answer: C. The Export Factor must have an arrangement with the Import Factor for credit evaluation and payment collection. The Import Factor, being in the buyer’s country, usually handles credit assessment and collection activities.

Correct Answer: B. A method of financing export receivables, supported by bills of exchange/promissory notes, typically without recourse. Forfaiting specifically deals with medium-to-long term export receivables evidenced by negotiable instruments.

Correct Answer: C. It is always ‘without recourse’ to the exporter (client). The forfaiter purchases the receivables and assumes the full risk of non-payment by the buyer, providing the exporter with complete risk protection.

Correct Answer: C. EXIM Bank and AD Category – I banks. The guidelines permit the Export-Import Bank of India and authorized dealer banks to offer forfaiting services.

Correct Answer: C. Rupee (INR) Denominated Trade Credit. This specific framework allows importers to obtain credit for imports denominated in INR from overseas sources.

Correct Answer: C. Up to one year from the date of shipment or up to the operating cycle, whichever is lower. The credit period for non-capital goods is linked to the operating cycle or a maximum of one year.

Correct Answer: C. Up to five years from the date of shipment. A longer credit period is permitted for capital goods imports under this scheme.

Correct Answer: C. USD 20 million equivalent. There is a per-transaction cap on the amount of INR trade credit that can be permitted by authorized banks.

Correct Answer: B. Maximum three years from the date of shipment. The tenure for bank guarantees supporting such trade credits is capped at three years.

Correct Answer: B. The cycle starting from purchase of raw material to the final receipt of sales proceeds from customers. It represents the time taken for funds invested in operations to convert back into cash.

Correct Answer: D. Advance payments made to suppliers for future goods. While dealing with suppliers is part of operations, making advance payments uses working capital rather than providing it as a source like supplier credit does.