Understanding the Maximum Permissible Bank Finance (MPBF): Factors and Calculation

The Maximum Permissible Bank Finance (MPBF) is a key concept in corporate finance that defines the amount of long-term funds that can be borrowed by a company to ensure a current ratio of 1.33. It is particularly important for businesses managing their short-term and long-term liabilities. In this article, we will explore the factors that affect MPBF and the detailed steps for calculating it.

Factors Affecting MPBF

There are several factors that can impact the Maximum Permissible Bank Finance (MPBF). The primary factors include:

Current Ratio Requirements: A current ratio of 1.33 is typically a benchmark that ensures the company has enough liquidity to meet its short-term obligations. Current and Non-Current Assets: The specific mix of current and non-current assets held by the company can affect MPBF calculations. Short-Term and Long-Term Liabilities: The proportion of short-term versus long-term liabilities can influence the amount of finance a company can secure without endangering its liquidity. Usage of Short-Term Liabilities: If short-term liabilities are used to finance non-current assets, this can result in an excess borrowing situation, which is undesirable. Banker-Assessed Operational Plans: The accuracy and feasibility of a company's operational plans are crucial, as banks will assess these plans to determine the appropriate finance.

MPBF for Excessive Borrowing

When short-term liabilities are used to finance non-current assets, this scenario leads to excess borrowing under the MPBF. To mitigate this, it is recommended to use long-term funds to pay off short-term liabilities, except for current maturities such as loan installments. This ensures that current assets remain appropriately managed and that long-term stability is maintained.

Calculation of MPBF

The Reserve Bank of India, through its committee led by Mr. P.L. Tandon in 1974, provided detailed guidelines for calculating the Maximum Permissible Bank Finance. These guidelines have been summarized and explained below:

Method 1: Total Current Assets Required

Determine total current assets required by the company. Subtract current liabilities from the total current assets to find the working capital gap. Subtract 25% from the long-term sources to ensure a reasonable mix of long-term and short-term financing. The result from step 3 is the maximum permissible bank borrowing.

Example: Total current assets: 1,000,000
Current liabilities: 600,000
Long-term sources: 300,000
Working capital gap (1,000,000 - 600,000) - 25% of 300,000 425,000

Method 2: Current Assets Required

Determine current assets required by the company. Subtract 25% from long-term sources to be provided. Subtract current liabilities from the result of step 2. The result from step 3 is the maximum permissible bank borrowing.

Example: Current assets required: 800,000
Long-term sources to be provided: 250,000
Current liabilities: 600,000
800,000 - 250,000 - 600,000 150,000

Method 3: Core Current Assets

Determine core current assets which are essential for operating the business. Subtract core current assets from total current assets. Subtract 25% from long-term sources to be provided. Subtract current liabilities from the result of step 3. The result from step 4 is the maximum permissible bank borrowing.

Example: Core current assets: 300,000
Total current assets: 800,000
Long-term sources to be provided: 150,000
Current liabilities: 600,000
(800,000 - 300,000) - 37.5% of 150,000 - 600,000 137,500

Conclusion and Recommendations

The calculation of the Maximum Permissible Bank Finance is a critical component of effective corporate finance management. By adhering to the guidelines set by the Reserve Bank of India, companies can ensure that they are using their long-term resources appropriately and maintaining liquidity. Regular assessments and updates to the MPBF are recommended to keep pace with changing market conditions and the company's needs.

For more detailed guidance, teachers like CA Aaditya Jain provide comprehensive resources. If you have any further questions, feel free to ask.