CMA Report Accuracy: Turnover Method vs. MPBF Demystified

Understanding CMA Reports: Choosing the Right Method

Creating accurate and insightful Credit Monitoring Arrangement (CMA) reports is important for businesses looking for financing. Two common methods used in CMA report preparation are the Turnover Method and the Maximum Permissible Bank Finance (MPBF) method. While both aim to find out the eligible bank finance, they differ a lot in their method and application. This article dives deep into both methods, highlighting their strengths, weaknesses. Also, when to use each one to make sure your CMA report is not only compliant but also presents your financial position in the best possible light.

What is a CMA Report?

Before we dig into the specifics, let's briefly define a CMA report. It's a thorough financial document prepared by businesses to project their future financial performance and assess their working capital requirements. Banks use CMA reports to evaluate the creditworthiness of loan applicants and find out the appropriate level of financing.

The Turnover Method: A Closer Look

The Turnover Method, also known as the Operating Cycle Method, focuses on the efficiency of a company's operations. It calculates the working capital requirement based on the company's sales turnover and the length of its operating cycle. The operating cycle represents the time it takes to convert raw materials into cash from sales.

How the Turnover Method Works:

1. Calculate Projected Sales: The starting point is an accurate projection of your company's sales for the upcoming period. This should be based on historical data, market trends. Also, realistic growth expectations.
2. Decide the Operating Cycle: This involves calculating the average number of days it takes to:
   • Hold raw materials (Raw Material Holding Period)
   • Convert raw materials into finished goods (Work-in-Progress Holding Period)
   • Sell finished goods (Finished Goods Holding Period)
   • Collect receivables from customers (Debtors Collection Period)
   The operating cycle is the sum of these periods.
3. Calculate Working Capital Requirement: The working capital requirement is calculated as: (Projected Sales / 365) * Operating Cycle.
4. Decide Permissible Bank Finance: This is usually a percentage of the working capital requirement, often ranging from 75% to 80%, depending on the bank's policy and the company's creditworthiness.

Advantages of the Turnover Method:

• Simple and easy to understand: The calculations are kind of straightforward, making it easier for businesses to prepare and for banks to assess.
• Focuses on operational efficiency: It highlights the importance of managing the operating cycle in a way that works to reduce working capital requirements.
• Suitable for businesses with stable sales: It works well for companies with predictable sales patterns and consistent operating cycles.

Disadvantages of the Turnover Method:

• Ignores specific payment terms: It assumes a uniform collection period for all debtors, which may not be accurate in reality.
• May not be suitable for seasonal businesses: Fluctuations in sales and operating cycles can distort the results.
• Can be overly simplistic: It may not capture the complexities of some businesses, especially those with complex supply chains or diverse product lines.

The MPBF Method: A Detailed Examination

So, The Maximum Permissible Bank Finance (MPBF) method is a more conservative method to determining the eligible bank finance. It focuses on the current assets and current liabilities of the business and establishes a maximum limit on the amount of working capital that can be financed by the bank.

How the MPBF Method Works:

1. Calculate Current Assets: This includes all assets that can be converted into cash within one year, such as:
   • Cash and Bank Balances
   • Accounts Receivable (Debtors)
   • Inventory (Raw Materials, Work-in-Progress, Finished Goods)
   • Prepaid Expenses
2. Calculate Current Liabilities: This includes all liabilities that are due within one year, such as:
   • Accounts Payable (Creditors)
   • Short-Term Loans
   • Outstanding Expenses
   • Current Maturities of Long-Term Debt
3. Calculate Net Working Capital (NWC): NWC = Current Assets - Current Liabilities
4. Decide MPBF: The MPBF is calculated using one of two methods:
   • MPBF I: 75% of (Current Assets - Current Liabilities)
   • MPBF II: Current Assets - Current Liabilities - (25% of Current Assets)
   The lower of MPBF I and MPBF II is usually taken as the permissible bank finance.

Advantages of the MPBF Method:

• More conservative way: It provides a safety cushion for the bank by limiting the amount of financing based on readily realizable assets.
• Considers specific payment terms: It directly incorporates the actual levels of current assets and current liabilities.
• Suitable for businesses with volatile cash flows: It provides a more stable and reliable measure of working capital requirements.

Disadvantages of the MPBF Method:

• Can be restrictive: It may limit the amount of financing available to businesses, even if they have strong sales growth potential.
• May not fully reflect operational efficiency: It doesn't directly look at the operating cycle or the efficiency of inventory management.
• Requires accurate data: The accuracy of the calculation depends heavily on the accuracy of the current asset and current liability data.

Turnover Method vs. MPBF: Key Differences and When to Use Each

You see, The following table summarizes the key differences between the Turnover Method and the MPBF method:

Feature	Turnover Method	MPBF Method
Focus	Operational Efficiency (Operating Cycle)	Liquidity and Solvency (Current Assets & Liabilities)
Calculation Basis	Projected Sales and Operating Cycle	Current Assets and Current Liabilities
Conservatism	Less Conservative	More Conservative
Suitability	Businesses with stable sales and predictable operating cycles	Businesses with volatile cash flows or complex financial structures

When to Use the Turnover Method:

• Your business has a consistent sales history and a predictable operating cycle.
• You want to highlight the efficiency of your operations to the bank.
• You need a simple and easy-to-understand method for calculating your working capital requirement.

When to Use the MPBF Method:

• Your business experiences significant fluctuations in sales or cash flows.
• You have a complex financial structure with all kinds of current assets and liabilities.
• The bank requires a more conservative method to assessing your creditworthiness.

Conclusion: Choosing the Right Way for Your CMA Report

You see, Selecting the appropriate method for your CMA report depends on the specific characteristics of your business and the requirements of the lending bank. The Turnover Method offers simplicity and highlights operational efficiency, while the MPBF method provides a more conservative assessment based on current assets and liabilities. Understanding the strengths and weaknesses of each method will enable you to prepare a CMA report that accurately reflects your financial position and maximizes your chances of securing the financing you need. Always consult with a financial professional to figure out the best method for your specific situation.