What is Drawing Power? How do banks calculate it?

Drawing Power
Drawing Power: Image Source- Banking School

Drawing Power (DP) is an important concept for fund-based working capital financing facilities. It is the limit up to which a borrower can withdraw funds within the Cash Credit limit. Drawing power arrives based on the stock, book debts, and creditors’ statement submitted by the borrower based on the closing position of the earlier month. The borrower may use the funds from the cash credit account within the sanctioned cash credit limit or drawing power arrived by the bank for the particular month, whichever is less. The purpose of arriving at DP every month is to keep a tab on performing the firm or company to whom the limits are sanctioned. The calculation of DP every month also reveals the health of the concerned firm/company month after month. If they don’t pay the bills on time and become sticky or the amounts of creditors are increasing because of unpaid stock, it gives an early warning to the bank about the unit. In such an event, the concerned Bank has to take a timely step towards safeguarding its exposure. Calculation of Drawing Power is done as follows –

Drawing Power = (Fully insured Total Stock – Unpaid Stock (Creditors) – Margin) + (Book Debts – Margin)

Usually, book debts not over 90 days old are taken into consideration for DP calculation. However, if the business has a longer credit cycle, over 90 days debtors might be per sanction terms. Margin is the owner’s contribution to the business. In most cases, a margin on the stock is 25% and for book debts 40% of net debtors may vary from bank to bank and industry to industry.

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