Chapter 19: Working Capital Finance (CAIIB – Paper 1)
1. What does ‘Working Capital’ primarily represent for a business?
A. Total assets minus fixed assets
B. Cash balance of the company
C. Current assets minus current liabilities
D. Long-term liabilities plus equity
Working Capital = Current Assets – Current Liabilities. It indicates short-term liquidity and operational efficiency of a business.
2. Which of the following best describes the ‘Working Capital Cycle’?
A. Period between purchase of fixed assets and recovery of cash
B. Time taken to convert raw materials into cash from sales
C. Period between raising long-term funds and repayment
D. Cycle of fixed asset depreciation
The Working Capital Cycle is the duration between the purchase of raw materials and the collection of cash from debtors after sales.
3. A shorter Working Capital Cycle indicates:
A. Higher inventory levels
B. Longer credit terms to customers
C. Poor liquidity position
D. Faster conversion of resources into cash
A shorter working capital cycle means cash is recovered faster, improving liquidity and reducing financing costs.
4. Which of the following is NOT a component of the Working Capital Cycle?
A. Depreciation of fixed assets
B. Accounts receivable days
C. Inventory holding days
D. Accounts payable days
Working Capital Cycle includes Inventory Days, Receivable Days, and Payable Days. Depreciation is a non-cash expense and not part of WCC.
5. If a company reduces its receivable collection period while keeping other factors constant, what will happen to its Working Capital Cycle?
A. It will increase
B. It will decrease
C. It will remain unchanged
D. It will become negative
A reduction in receivable days leads to faster cash recovery, thereby shortening the Working Capital Cycle.
6. Why are liquidity ratios important in credit assessment?
A. They measure long-term solvency of the borrower
B. They indicate profitability of the business
C. They reflect the borrower’s ability to meet short-term obligations
D. They help in valuation of fixed assets
Liquidity ratios (like Current Ratio and Quick Ratio) assess the borrower’s ability to meet short-term obligations, which is crucial for banks before sanctioning working capital finance.
7. The Current Ratio is calculated as:
A. Current Assets ÷ Current Liabilities
B. Current Liabilities ÷ Current Assets
C. Net Worth ÷ Total Assets
D. Fixed Assets ÷ Long-term Liabilities
Current Ratio = Current Assets ÷ Current Liabilities. A ratio of 1.33:1 is generally considered acceptable by banks for working capital appraisal.
8. In bank finance assessment, which of the following is NOT a commonly used method?
A. Turnover Method
B. Maximum Permissible Bank Finance (MPBF) Method
C. Cash Budget Method
D. Dividend Discount Method
Turnover, MPBF, and Cash Budget are standard methods of working capital assessment. Dividend Discount is a valuation model, not a working capital assessment method.
9. The Turnover Method (Nayak Committee) is mainly applicable to:
A. Large corporates with turnover above ₹500 crore
B. Small and medium enterprises with working capital up to ₹5 crore
C. Housing finance companies
D. Banks themselves for internal liquidity management
As per Nayak Committee, the Turnover Method applies to MSMEs with working capital limits up to ₹5 crore, where 25% of projected annual turnover is considered as working capital requirement.
10. In the MPBF method (Tandon Committee), which of the following is true under the Second Method of Lending?
A. Borrower finances 25% of Working Capital Gap from long-term sources
B. Bank finances 100% of Working Capital Gap
C. Borrower brings in 10% of current assets as margin
D. Bank finances only against receivables
In the Second Method of Lending under Tandon Committee, the borrower must finance at least 25% of the Working Capital Gap (Current Assets – Current Liabilities other than bank borrowings) from long-term sources.
11. What is the key characteristic of working capital finance requirement in the IT and Software industry?
A. High inventory holding cost
B. Heavy investment in plant and machinery
C. Low receivable cycle and quick cash conversion
D. Predominantly service-oriented, hence focus on receivables financing
In the IT and software industry, there is negligible inventory and minimal fixed assets. The working capital finance is mainly required for receivables, as billing cycles are long due to export contracts and credit terms.
12. Which method is generally preferred for assessing working capital finance to software companies?
A. Turnover method (Nayak Committee)
B. Cash Budget method
C. Maximum Permissible Bank Finance (MPBF) method
D. Asset-based financing method
For IT and service-based companies, the Cash Budget method is preferred since cash inflows and outflows depend on billing cycles and project milestones rather than inventory.
13. Which of the following is NOT generally considered while assessing working capital for IT/software industry?
A. Debtors and receivables cycle
B. Project milestones and billing schedule
C. Inventory holding period
D. Export receivables
IT/software companies are service-based and generally do not maintain physical inventory. Hence, inventory holding period is not relevant.
14. Bills/Receivables finance provided by banks is primarily meant to:
A. Provide liquidity against trade receivables
B. Finance acquisition of fixed assets
C. Provide margin for term loans
D. Fund long-term infrastructure projects
Bills/Receivables finance helps businesses convert credit sales into immediate cash, thus improving liquidity and shortening the working capital cycle.
15. In case of Bills Finance, when a bank discounts a bill of exchange, what risk is the bank primarily taking?
A. Risk of depreciation of fixed assets
B. Foreign exchange risk
C. Interest rate risk
D. Credit risk of the drawee (buyer)
In bill discounting, the bank takes on the credit risk of the drawee (buyer). If the buyer defaults, the bank may not recover the discounted amount.
16. As per RBI guidelines, bills eligible for discounting by banks must arise from:
A. Transactions in the secondary market
B. Genuine commercial or trade transactions
C. Speculative derivative contracts
D. Interbank treasury operations
RBI requires that only bills arising out of genuine commercial or trade transactions (such as sale of goods/services) are eligible for discounting/rediscounting by banks.
17. Which type of bill is not permitted for discounting under RBI guidelines?
A. Usance bills
B. Demand bills
C. Bills accompanied by documents of title to goods
D. Accommodation bills without genuine trade transaction
RBI prohibits banks from discounting accommodation bills or bills not backed by genuine trade transactions, as these involve high risk of misuse.
18. As per RBI guidelines, bills drawn for period exceeding how many months are generally not eligible for bank financing?
A. 90 days (in most cases)
B. 180 days (in most cases)
C. 270 days
D. 365 days
RBI guidelines generally restrict bill finance to usance bills of up to 90 days, extendable to 180 days in specific cases (like export bills).
19. Under RBI guidelines, banks can rediscount eligible bills with:
A. Insurance companies only
B. Public sector undertakings
C. All India Financial Institutions and other banks
D. Foreign institutional investors
RBI allows rediscounting of genuine trade bills with approved institutions like SIDBI, NABARD, EXIM Bank, and other scheduled commercial banks.
20. Which of the following is a key safeguard prescribed by RBI for discounting/rediscounting of bills?
A. Bills must not represent accommodation transactions
B. Bills must be accompanied by invoice or transport documents
C. Banks must verify the genuineness of underlying transactions
D. All of the above
RBI mandates multiple safeguards: bills must be genuine trade bills, backed by invoices/shipping documents, and banks must ensure they are not accommodation bills.
21. What is the primary objective of the Trade Receivables Discounting System (TReDS)?
A. To regulate foreign exchange transactions
B. To facilitate financing of trade receivables of MSMEs
C. To provide venture capital to startups
D. To refinance infrastructure projects
TReDS was introduced to provide a platform for financing trade receivables of MSMEs from corporate buyers through multiple financiers.
22. Who regulates the Trade Receivables Discounting System (TReDS) in India?
A. SEBI
B. Ministry of MSME
C. Reserve Bank of India
D. SIDBI
RBI regulates TReDS under the Payment and Settlement Systems Act, 2007. Entities operating TReDS require authorization from RBI.
23. Which of the following participants are part of the TReDS platform?
A. MSME suppliers
B. Corporate and Government buyers
C. Financiers such as banks and NBFC-Factors
D. All of the above
The three main participants in TReDS are MSME sellers, corporate/government buyers, and financiers (banks/NBFC-factors).
24. Which of the following is a unique benefit of TReDS compared to traditional bill discounting?
A. Multiple financiers can bid to discount the same receivable
B. Only one bank is allowed to discount
C. No KYC norms are applicable
D. Settlement happens only after 180 days
A major advantage of TReDS is competitive bidding by multiple financiers, which reduces the financing cost for MSMEs.
25. What is the maximum tenor of receivables that can be financed on the TReDS platform as per RBI guidelines?
A. 90 days
B. 180 days
C. 270 days
D. 365 days
RBI permits financing of trade receivables with a maximum tenor of 180 days on TReDS.
26. Which of the following is an example of a non-fund based working capital facility?
A. Cash Credit
B. Overdraft
C. Bank Guarantee
D. Term Loan
Non-fund based limits do not involve direct outflow of funds. Bank Guarantees (BG) and Letters of Credit (LC) are examples, unlike CC/OD which are fund-based.
27. In a Letter of Credit (LC) issued by a bank, which party bears the primary payment responsibility?
A. Beneficiary
B. Issuing Bank
C. Applicant
D. Negotiating Bank
The issuing bank provides the guarantee of payment under an LC once the terms and conditions are met, even though the applicant (buyer) requests the LC.
28. Which type of Bank Guarantee assures performance of a contract rather than payment?
A. Financial Guarantee
B. Deferred Payment Guarantee
C. Advance Payment Guarantee
D. Performance Guarantee
A Performance Guarantee ensures that the contractual obligations (like project completion, quality, or timelines) will be met by the applicant.
29. For non-fund based limits like LC and BG, banks usually require:
A. Margin money and security
B. Only cash margin without security
C. No margin or security
D. Only personal guarantee
Banks take cash margin (part of the limit) and collateral/security to safeguard themselves against default, since non-fund based limits can convert into fund-based exposure on invocation.
30. What happens when a Bank Guarantee issued by a bank is invoked?
A. The applicant makes direct payment to the beneficiary
B. The guarantee is automatically cancelled
C. The bank makes payment to the beneficiary and recovers it from the applicant
D. The bank refuses payment unless approved by the applicant
On invocation of a BG, the bank is obligated to honor the payment to the beneficiary, regardless of disputes. The bank then recovers the amount from the applicant.
31. What is the consequence of over-financing working capital by banks?
A. Improves liquidity and profitability
B. Leads to diversion of funds and higher NPAs
C. Reduces borrower’s debt burden
D. Encourages efficient inventory management
Over-financing often results in misuse or diversion of funds, increasing the bank’s credit risk and probability of turning into NPAs.
32. Under RBI guidelines, banks should primarily assess working capital finance for MSMEs based on:
A. Net Present Value of projects
B. Capital budgeting techniques
C. Turnover method
D. Discounted Cash Flow method
RBI suggests that for MSMEs with credit limits up to ₹5 crore, banks should use the Turnover method, where working capital is assessed as 25% of projected annual turnover.
33. What is a common misuse of working capital finance by borrowers?
A. Maintaining stock levels
B. Meeting operational expenses
C. Paying trade creditors
D. Using funds for long-term capital expenditure
Working capital finance is meant for short-term needs. Using it for long-term fixed assets or capital expenditure is a misuse and increases default risk.
34. Which regulatory guideline ensures that banks monitor the end-use of working capital finance?
A. Loan Review Mechanism (LRM)
B. Basel III norms
C. FEMA regulations
D. Insolvency and Bankruptcy Code
The Loan Review Mechanism (LRM) requires banks to periodically check end-use of funds and detect any irregularities or diversion in working capital usage.
35. Which of the following practices improves the efficient use of working capital finance?
A. Excessive dependence on bank borrowings
B. Ignoring inventory and receivable turnover
C. Regular monitoring of current assets and liabilities
D. Funding fixed assets from working capital loans
Effective monitoring of current assets, current liabilities, stock turnover, and receivable collection ensures that working capital is efficiently utilized.
36. A firm has Current Assets of ₹500 lakh and Current Liabilities of ₹300 lakh. What is its Working Capital?
A. ₹200 lakh
B. ₹800 lakh
C. ₹300 lakh
D. ₹500 lakh
Working Capital = Current Assets – Current Liabilities = 500 – 300 = ₹200 lakh.
37. As per the Turnover Method (Nayak Committee), what is the minimum working capital requirement for an MSME with projected annual turnover of ₹1,200 lakh?
A. ₹100 lakh
B. ₹200 lakh
C. ₹300 lakh
D. ₹400 lakh
Under Turnover Method, working capital = 25% of projected turnover.
25% of ₹1,200 lakh = ₹300 lakh.
38. If Current Assets are ₹600 lakh, Current Liabilities (excluding bank borrowings) are ₹150 lakh, and Bank Borrowings are ₹200 lakh, what is the Working Capital Gap?
A. ₹250 lakh
B. ₹400 lakh
C. ₹450 lakh
D. ₹600 lakh
Working Capital Gap = Current Assets – Current Liabilities (other than bank borrowings).
= 600 – 150 = ₹450 lakh.
39. A company has Current Assets of ₹1,000 lakh, Current Liabilities (other than bank borrowings) of ₹200 lakh. As per Tandon Committee’s 2nd Method, what is the Maximum Permissible Bank Finance (MPBF)?
A. ₹600 lakh
B. ₹533 lakh
C. ₹800 lakh
D. ₹667 lakh
As per Tandon Committee’s 2nd Method:
Borrower to bring 25% of Working Capital Gap.
WCG = CA – CL = 1000 – 200 = 800.
Borrower share = 25% of 800 = 200.
MPBF = 800 – 200 = ₹600 lakh.
(Answer choice closest is ₹600 lakh.)
40. A firm’s Current Ratio is 1.5, with Current Assets of ₹900 lakh. What are the Current Liabilities?
A. ₹600 lakh
B. ₹450 lakh
C. ₹300 lakh
D. ₹750 lakh
Current Ratio = Current Assets ÷ Current Liabilities.
1.5 = 900 ÷ CL → CL = 900 ÷ 1.5 = ₹600 lakh.
41. A company has Raw Material Holding Period of 60 days, WIP Period of 15 days, Finished Goods Holding of 30 days, and Debtors Collection Period of 45 days. The Creditors Payment Period is 40 days. What is the Operating Cycle?
45. A firm has Current Assets of ₹1,200 lakh and Current Liabilities of ₹800 lakh. If its Annual Sales are ₹3,600 lakh, what is its Working Capital Turnover Ratio?
A. 2 times
B. 4 times
C. 9 times
D. 12 times
Working Capital = CA – CL = 1200 – 800 = ₹400 lakh.
Working Capital Turnover = Sales ÷ WC = 3600 ÷ 400 = 9 times.
