Raw materials: Every unit likes to keep the minimum level of raw material which ensures that a steady supply of the same is available for production requirements without having to face the prospect of idle machine and loss of man hours due to "stock-out" or non availability of raw material. This minimum level is dependent on factors such as lead time of supplies, minimum order quantity, budgeted production etc. In case the unit has well defined seasonal or peak level fluctuations of business, the peak season build up would also have to be worked out.
Stock-in-process: The levelof stocks-in-process would normally correspond to production or process time.
Finished goods: The level of stocks-in-process would normally correspond to production or process time;
Finished goods: The level of finished goods is determined both by market trends and to a larger extent through a conscious corporate policy;
Receivables: Market terms would normally dictate the extent of credit extended;
Apart from the above, the other major items of current assets are:
Cash: The minimum cash balance to be held can be determined by multiplying the predetermined number of days of cash holding required by the average of the highest daily cash holding;
Based on the above criteria, the banker arrives at the peak level of current assets holding required by a business entity and then arrives at its valuation as per the undernoted traditionally accepted methods of valuation;
Raw material: At cost/invoice value or market value whichever is lower;
Stock in process: At cost of production (including depreciation)
Finished goods: At cost of production/cost of goods sold;
Book debts: At gross sales or credit sales if this figure is available.
Once the banker is in a position to arrive at the peak investment that the unit has to make in current assets, the banker would then like to keep a margin on the assets to be financed i.e. that part of current assets to be financed by the unit from its own resources; the balance to be financed by the banker and other short term sources. The need for maintenance of margins arises for such reasons as
1) To ensure the owners' stake in the business;
2) To insulate the banker from price fluctuations of his security (i.e. current assets) and 3) in the event of enforcement of security, the banker would need to realize in full the principal amount lent as well as interest and other charges due.