How Banks Calculate Your Working Capital Limit: Turnover Method, MPBF and Drawing Power
For micro and small enterprises with limits up to ₹5 crore, banks are advised to use the Nayak Committee turnover method: need is 25% of projected turnover, with at least 20% financed by the bank. Larger limits are usually assessed on MPBF or a cash budget. Drawing power then sets what you can draw each month.
Why does the method matter?
Two businesses with the same turnover can get very different limits, depending on how the bank assesses them. Knowing the method lets you estimate your limit before you apply, prepare the right data, and spot when a sanction is undersized.
There are three layers:
- Assessment: how big the limit should be.
- Sanction: the limit the bank approves, with margins and security.
- Drawing power: how much of that limit you can use each month.
What is the turnover method?
The turnover method comes from the Nayak Committee, set up by RBI in 1991. Its recommendation, accepted by RBI, is that working capital limits for micro and small enterprises be computed on the basis of a minimum of 20% of estimated annual turnover, for limits up to ₹5 crore. The ₹5 crore threshold was originally ₹2 crore and was later raised.
The arithmetic in practice:
- Working capital requirement = 25% of projected annual turnover.
- Borrower contribution (margin) = at least 5% of turnover.
- Bank finance = at least 20% of turnover.
Worked example: turnover method
Illustrative numbers only.
| Item | Amount |
|---|---|
| Projected annual turnover | ₹8 crore |
| Working capital requirement (25%) | ₹2 crore |
| Borrower margin (5%) | ₹40 lakh |
| Bank finance (20%) | ₹1.6 crore |
If your available net working capital is higher than 5% of turnover, the bank may finance less than 20%. The bank will also test whether the projected turnover is reasonable against past GST returns, bank credits and financial statements. Inflated projections are the most common reason the computed limit gets cut.
What is MPBF and how is it calculated?
MPBF means Maximum Permissible Bank Finance. It comes from the Tandon Committee methods of the 1970s. RBI withdrew mandatory MPBF in 1997, and banks are now free to choose an assessment method under their board-approved credit policy. Many still use MPBF logic for larger limits.
Key terms:
- Current assets (CA): stock, receivables, advances to suppliers, other current assets.
- Current liabilities (CL): creditors and other short-term liabilities, excluding bank borrowings.
- Working capital gap (WCG): CA − CL.
The two common methods:
| Method | Formula | Borrower's contribution |
|---|---|---|
| Method I | MPBF = 75% × (CA − CL) | 25% of the working capital gap |
| Method II | MPBF = 75% × CA − CL | 25% of total current assets |
Method II produces a lower limit and is the more conservative approach.
Worked example: MPBF Method II
Illustrative numbers only.
| Item | Amount |
|---|---|
| Projected current assets | ₹6 crore |
| Current liabilities excluding bank borrowings | ₹2 crore |
| Working capital gap | ₹4 crore |
| 75% of current assets | ₹4.5 crore |
| MPBF under Method II (₹4.5 crore − ₹2 crore) | ₹2.5 crore |
| MPBF under Method I (75% × ₹4 crore) | ₹3 crore |
The borrower funds the rest of the gap from net working capital, meaning long-term funds such as equity and term debt.
What is the cash budget method?
For seasonal or project-led businesses, banks may assess the need month by month from a cash budget: projected inflows and outflows, with the peak deficit determining the limit. This often suits contractors, developers and seasonal manufacturers better than a turnover ratio.
What is drawing power and how is it calculated?
The sanctioned limit is a ceiling. Drawing power (DP) decides how much of it you can actually use in a given month. A simplified version:
DP = (Stock − margin) + (Eligible receivables − margin) − Creditors for goods
Worked example: drawing power
Illustrative numbers. Sanctioned CC limit ₹1.6 crore. Stock margin 25%, receivables margin 40%, receivables eligible up to 90 days old.
| Item | Amount |
|---|---|
| Stock at cost | ₹1.2 crore |
| Less 25% margin | ₹30 lakh |
| Stock eligible | ₹90 lakh |
| Receivables up to 90 days | ₹1 crore |
| Less 40% margin | ₹40 lakh |
| Receivables eligible | ₹60 lakh |
| Less creditors for goods | ₹20 lakh |
| Drawing power | ₹1.3 crore |
Here you can draw only ₹1.3 crore, even though the limit is ₹1.6 crore. Improving collections or reducing old debtors raises DP. Margins and age cut-offs vary by lender and are set in the sanction.
What data should you prepare?
- Audited financial statements for the last two to three years.
- Provisional financials for the current year.
- Projected turnover and balance sheet, often in CMA format for larger limits.
- GST returns and bank statements that support the turnover figures.
- An ageing schedule of receivables and a stock statement.
- Details of existing limits and term loans.
See documents required for a business loan for a complete checklist.
How can you get a better limit?
- Use realistic projections that reconcile with GST and bank data.
- Clean up old receivables. They reduce DP and signal collection risk.
- Strengthen net working capital by funding long-term needs with term debt or equity, not the CC.
- Match the method to your business. Seasonal and project businesses may get a better outcome with a cash budget.
- Compare lenders. Margin and eligibility rules vary, and they change your usable limit.
What mistakes reduce your limit?
- Mixing term needs with working capital. Using the CC to buy machinery or pay for a property drains net working capital and reduces your borrowing capacity under gap methods.
- Stock statements that do not match the books. If the stock statement differs from audited stock, banks may cut DP or ask for a stock audit.
- Ignoring creditors. Under MPBF and DP, high trade creditors reduce the limit or DP. A growing supplier credit line may mean a smaller bank limit, not a larger one.
- Uneven turnover. If turnover swings across the year, a cash budget approach may give a better result than a fixed ratio.
How MoneyKarma helps
MoneyKarma is a loan distribution platform, not a lender. We help you prepare your assessment data and compare working capital structures across 90+ lender partners, then coordinate with the lender you choose. The lender makes the credit decision. See working capital, compare cash credit vs overdraft, or share your requirement.