Understanding Maximum Permissible Bank Finance (MPBF)
Maximum Permissible Bank Finance (MPBF) is a key concept for businesses wanting working capital loans from banks. It represents the maximum amount a bank is willing to lend to a business, based on its working capital cycle and financial health. A thorough understanding of MPBF helps businesses to:
- Assess their borrowing eligibility: Before approaching a bank, calculate your MPBF to understand the potential loan amount.
- Improve loan applications: Present a well-prepared MPBF calculation to improve credibility and increase the chances of loan approval.
- Manage working capital works well: The MPBF calculation provides understanding into your working capital cycle, enabling better management of current assets and liabilities.
Step-by-Step Guide to Calculating MPBF
So, The MPBF calculation involves a structured way, considering different components of your working capital. Here's a detailed step-by-step guide:
Step 1: Find out Current Assets
Current assets are assets that can be converted into cash within one year. Common examples include:
- Cash and Bank Balances: The readily available cash balance in your accounts.
- Inventory: Raw materials, work-in-progress. Also, finished goods.
- Accounts Receivable (Debtors): Money owed to you by customers for goods or services sold on credit.
- Prepaid Expenses: Expenses paid in advance, such as insurance premiums or rent.
- Short-Term Investments: Investments that mature within one year.
You see, Formula: Total Current Assets = Cash + Inventory + Accounts Receivable + Prepaid Expenses + Short-Term Investments
Step 2: Decide Current Liabilities
So, In fact, Current liabilities are obligations that are due within one year. Common examples include:
- Accounts Payable (Creditors): Money owed to suppliers for goods or services purchased on credit.
- Short-Term Loans: Loans that are due within one year.
- Outstanding Expenses: Expenses that have been incurred but not yet paid.
- Bank Overdraft: The amount by which your bank balance is overdrawn.
- Current Maturities of Long-Term Debt: The portion of long-term debt that is due within one year.
Formula: Total Current Liabilities = Accounts Payable + Short-Term Loans + Outstanding Expenses + Bank Overdraft + Current Maturities of Long-Term Debt
Step 3: Calculate Net Working Capital (NWC)
Net working capital represents the difference between current assets and current liabilities. It indicates the liquidity position of the business.
You see, Formula: Net Working Capital (NWC) = Total Current Assets - Total Current Liabilities
Step 4: Apply the MPBF Method (Either Method I or Method II)
Banks usually use one of two methods to calculate MPBF:
Method I: 75% of (Current Assets - Current Liabilities)
In fact, Under this method, the bank finances 75% of the net working capital.
Formula: MPBF = 0.75 * (Total Current Assets - Total Current Liabilities)
Method II: Current Assets - Current Liabilities (excluding Bank Borrowings) - 25% of Current Assets
This method is slightly more conservative. First, you calculate the working capital gap (Current Assets - Current Liabilities excluding bank borrowings). Then, the bank finances the gap minus 25% of Current Assets. This ensures that the company contributes at least 25% of its current assets from its own sources.
Formula: MPBF = Total Current Assets - Total Current Liabilities (excluding Bank Borrowings) - 0.25 * Total Current Assets
So, Important Note: Always clarify with your bank which method they use for MPBF calculation.
Step 5: Look at Permissible Level of Current Assets
Banks also assess the permissible level of current assets, considering the operating cycle of the business. They might impose limits on certain components of current assets, such as:
- Inventory Holding Period: The maximum period for which inventory can be held.
- Receivables Collection Period: The maximum period allowed for collecting receivables from customers.
If the actual inventory holding period or receivables collection period exceeds the permissible limits, the bank may reduce the MPBF accordingly. This is because excessive inventory or delayed receivables collection can indicate inefficiencies in working capital management.
Step 6: Adjust for Margin Requirements
Banks often require a margin on certain current assets, particularly inventory and receivables. This means that the bank will only finance a portion of the value of these assets.
Like, if the bank requires a 25% margin on inventory, it will only finance 75% of the inventory value. Similarly, a margin may be applied to accounts receivable.
The MPBF calculation should be adjusted to reflect these margin requirements. This can be done by reducing the value of the relevant current assets by the margin percentage before applying the MPBF formula.
Step 7: Think about Other Factors
In addition to the above steps, banks may think about other factors when determining MPBF, such as:
- Credit Rating: A higher credit rating most of the time results in a higher MPBF.
- Financial Performance: Profitability, solvency. Also, cash flow are all important indicators of financial health.
- Industry Outlook: The bank will assess the all in all health and prospects of the industry in which the business operates.
- Management Expertise: The bank will evaluate the experience and competence of the management team.
- Security Offered: The value and liquidity of the collateral offered as security for the loan.
Sample Calculation
Let's assume the following data for a hypothetical company:
- Cash: $50,000
- Inventory: $200,000
- Accounts Receivable: $150,000
- Accounts Payable: $100,000
- Short-Term Loans: $50,000
Step 1: Calculate Current Assets
Total Current Assets = $50,000 + $200,000 + $150,000 = $400,000
Here's the thing: Step 2: Calculate Current Liabilities
Total Current Liabilities = $100,000 + $50,000 = $150,000
In fact, Step 3: Calculate Net Working Capital
Net Working Capital = $400,000 - $150,000 = $250,000
Step 4: Calculate MPBF using Method I
MPBF = 0.75 * $250,000 = $187,500
Step 4: Calculate MPBF using Method II (Assuming no bank borrowings are included in Current Liabilities)
MPBF = $400,000 - $150,000 - (0.25 * $400,000) = $250,000 - $100,000 = $150,000
In this sample, the MPBF would be $187,500 using Method I and $150,000 using Method II. The bank would likely think about additional factors and margin requirements before approving the final loan amount.
Tips for Improving Your MPBF
- Improve Inventory Management: Reduce inventory holding periods by putting into place efficient inventory control techniques.
- Speed up Receivables Collection: Offer early payment discounts to encourage customers to pay invoices promptly.
- Negotiate Favorable Payment Terms with Suppliers: Extend payment terms with suppliers to improve cash flow.
- Continue Accurate Financial Records: Make sure that your financial records are accurate and up-to-date.
- Build a Strong Relationship with Your Bank: Communicate regularly with your bank and provide them with timely and accurate information.
Conclusion
You see, Calculating MPBF is a vital step in securing working capital finance. By understanding the different components of the calculation and using strategies to improve your working capital management, you can increase your chances of obtaining the funding you need to grow your business. Remember to consult with your bank and a financial advisor for personalized guidance.