Importance of Stock Audit for Working Capital Lender

The working capital finance is extended to a company/corporate borrower based on various projections about the operations/business performance. The fund based and non fund based limits are provided to the borrower for procuring raw materials required in the production process. The fund based limits are released to the borrower depending upon the Drawing Power (DP) arrived based on

Stock Statement. The non fund based limits are utilized by the borrower in the form of Letter of Credit(LC)/Buyer’s Credit (BC) for procurement of stocks. The banker understands the financial performance of the corporate borrower based on financial reports and various other statements submitted by borrower. However, since monitoring is the most critical part of working capital lending management, the bank needs to undertake assessment of the position of operations at the factories of the borrower to know about the position of stocks and receivables which are primary security to the working capital lender and appropriate safety measures and valuation of the same is of prime importance for the WC lender.

The Stock Audit report is prepared by a Chartered Account (CA) firm empanelled with the lender, and at the cost of borrower. It is preferred to conduct at least two stock audits in a financial year. The periodicity may depend upon the size of operations of the company/borrower as well their financial health/reputation deciding the criticalness of the stock audit. Sometimes, when the factories of the borrower are spread across several locations, it becomes tedious to conduct multiple stock audits. Similarly, for small companies also multiple stock audits may put burden on their budget as well as time & resources.

Stock Audit report of company is like an X-Ray Report for a Working Capital lender. It provides details of important inside information about the stocks and operations at the factories of the borrower which are generally situated at far-away locations and it is not possible for the banker to undertake regular and exhaustive inspections. The stock audit supports in fulfilling this requirement. The report covers many important details viz installed capacities, major stock items, method of inventory management/control at factory, no. of days for which stock is stored, proper preservation/handling of stocks, identification of movement of stocks, age-wise examination of receivables,  stock valuation methods adopted by borrower, adequacy of insurance coverage, job work received/outsourced, details of slow moving stocks, obsolete stocks, auditors views on marketability of stock, ownership of stock with borrower, demand/supply conditions, stock being commensurate with production or not, no. of workers, any abnormal consequence occurred at factory, data/record management, receivable collection system, quality of stock and receivables, auditors suggestion on any improvement required etc.

The fund based limits are released to the borrower based on drawing power(DP) worked out and DP depends on the stock and receivable statement. Under the stock audit, the auditor physically checks the stock position of raw materials, work in progress and sales registers at the factories. The auditor checks the production and despatch of goods through Excise Register, Purchase Invoices, Sales Bills etc. The stock auditor compares his calculations of drawing power based on his physical verification of stock & receivable position at the factory, with the calculation submitted by the borrower to the lender. Any difference in calculation is reported in the audit report, based on which the borrower is required to submit clarifications to the lender or take corrective measures.

From the above, it can be understood that stock audit is a critical tool which helps the working capital banker to understand the actual positions of the raw materials and production funded by the limits released by the lender. The audit helps to ensure that the bank funds are properly utilized without diversion. Considering, the working capital lending relationships to be long term in nature, and for the growing companies whose working capital need increase year on year, the stock audit helps in understanding the growing requirements. Stock Audit ensures proper valuation of stocks and receivables and measures for safety of stocks. In light of the above, it is of utmost importance for the banker to timely get the stock audits conducted, thoroughly analyze the stock audit report, and also take up any issue mentioned in the report with the borrower.