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Short-Term (Working Capital) Financing of Information Technology (IT) and Software Industry

Short-Term (Working Capital) Financing of Information Technology (IT) and Software Industry

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The software industry has always been the driving force in the Information Technology (IT) industry, especially

so in India. It has, therefore, been rightly termed as the ‘growth sector of the millennium’. This sector requires

highly skilled manpower, and it is heartening to note that in India, the sector has grown almost 50 per cent

during the short span of just five years, i.e. from the year 1992 to 1997.

The government and the Reserve Bank of India are, therefore, earnestly endeavouring to encourage and

facilitate easy and adequate financing of the software activities, as this sector inter alia will make a major

contribution in the export earnings of the country, both in the short and medium terms.


(i) Manpower Intensive

As has been stated earlier, the software industry is highly manpower intensive, and that too, requiring proficient

and skilled professionals. Thus, the availability and cost of such manpower, and the productivity and turnover

of the unit, are most critical for the success of a software venture.

Further, the following are the most sought after personnel for the sector:


(ii)Data-based analysts

(iii)MIS professionals

(65 per cent to 70 per cent);

(25 per cent to 30 per cent);

(15 per cent to 20 per cent); and


(around 15 per cent).

The productivity and performance of these professionals require high intensity and immense concentration,

coupled with continued long hours of work, with flexible work schedules.

Also, the scarcity of competent and skilled professionals seems to be the main impediment to the growth

and success of the software units. Thus, as the supply is far short of the demand, it is no wonder that the

price (market value) of software engineers and experts has, of late, rocketed sky high. But then, the terrorists’

attack on the Twin Towers of the World Trade Centre, and other landmarks in the US on the 11 September,

2001, seems to have had a great dampening effect on this sector, in particular. This downward trend, however,

proved to be shortlived and soon picked up the usual pace of progress and prosperity. In fact, the uptrend has

now started showing up.

(ii) High Capital Output Ratio

Besides being a highly skilled manpower intensive sector, the critical inputs and assets of the software industry

are highly intangible in nature. Consequently, the assessment of their creditworthiness, chances of success and

prosperity, and even the credit needs, becomes rather subjective and judgemental, instead of being objective

and analytical, as is the case in respect of the conventional industries. Further, as the units, engage in the

business of assembly of hardware, or consultancy assignments, or even rendering programming services, require

a relatively smaller quantum of capital investment and outlay, it has resulted in an uninterrupted growth

of such units. But then, only the innovative and dynamic units, like Infosys, Wipro, TCS, HCL-HP, to name

only a few, could flourish and generate high cash inflows and cash surpluses, in relatively much lesser span of

time. Such cases are rarer than the rule. Thus, it is, in fact, in these special areas that lies the real skill and

acumen, experience, and expertise of financial risk assessment and management on the part of the bankers

and the other financial institutions.

(iii) Fast Changing Technology and Shorter Lifespan of Products

In the modern age and era of rapidly-changing technology like DOS, Windows, and so on, most of the software

products become obsolete and outdated fast enough. Thus, the market share of a product may be gained and

lost overnight. This sector has, therefore, been rightly termed as the ‘high-risk-high-reward’ sector.



(iv) Project Appraisal

The assessment and appraisal of the technical feasibility and economic viability of a software project is very

tough and tricky, as it involves more intuitional and judgemental skills (the sixth sense, rather than the usual

business sense) on the part of the (traditional and conventional) bankers and other creditors.


The Indian Advantages

1.A World Bank Study of the US companies pertaining to country preferences for outsourcing softwares

has ranked India as the first choice.

2.In the year 1997 alone, 131 of the Fortune 500 companies outsourced their software requirements from

India, and by now, the credibility and capability of the Indian software has been well established the

world over. Besides, as many as 25 of the Fortune 500 companies comprise the regular client list of

Infosys alone.

3.These figures are rather natural, as on a cost-quality coordinates grid, India occupies a unique position

in the ‘High Quality, Low Cost’ quadrant (as against Ireland, Singapore, and Israel in the ‘High Quality,

High Cost’ quadrant, and the countries like China, Philippines and Hungary in the ‘Low Quality, Low

Cost’ quadrant).

4.The major Indian companies have started successfully executing large projects, involving more than

200-300 man years.

5.Over sixty Indian companies have ISO 9000 series certification, out of which as many as forty-one

companies export to the tune of US $3 million annually.

6.India can rightly boast of the availability of large manpower resources of English-speaking and technically

proficient personnel, recognized globally as having high mathematical and logical expertise and, above

all, at a rather competitive salary.

7.The twelve-hour time zone difference between India and the US (US being the largest software market in

the world today and a net importer to the tune of over US $40 billion per annum) has been successfully

leveraged by the bigger Indian companies into offshore software project work. The work is carried out from

India through high speed data communication satellite links on US client mainframes on US downtime

(night-time), thereby creating extended ‘virtual’ software arms for the client companies, equipped to even

troubleshoot overnight and deliver solutions without loss of daytime working hours for the US company.

The Indian Disadvantages


The rising manpower cost/wage structure, coupled with stiff competition from countries like Ireland and

Israel, Singapore and China, Taiwan and Philippines, have, of late, been creating some problems for the



Besides, the low market share at the higher ends of the value addition chain has given rise to a greater

vulnerability and lower level of consolidation in the industry.


Lower rate of technology/enterprise return to the home country by the expatriate entrepreneurs, as

compared to Taiwan, Korea and Singapore (i.e. lower ‘re-export’ of talent and capital) is yet another

disadvantage that India is faced with.


The CEO and the Team of Professionals

The team of software engineers and professionals, in general, and the Chief Executive Officer (CEO) in particular,

are very critical and crucial factors for the success, progress and prosperity of the rapidly-changing, highlycompetitive, and manpower-intensive software industry.



Most of the Chief Executive Officers (CEOs) of the software companies have generally been found to be

technopreneurs and/or highly empowered persons, inspiring team leaders as also all the other persons, with

vision and mission, drive and urge, to prove, progress and prosper. Above all, all the professionals in the

organization keep working as a well-knit team, complementing and supplementing the efforts and achievements

of each other, as they fully realize that in the software industry, in particular, they all are destined to sail or

sink together, sell or fail en block. The organizational structure of the units in this sector is relatively flat (and

not hierarchical) and is conspicuously characterized by a youthful workforce of 30s and 40s, with an egalitarian

approach, attitude, and work culture.

Recruitment and Retention of the Human Resources

The success, especially of a software company, to a large extent, depends on its ability to recruit, enable, empower

and, above all, retain its employees. Work demands in the industry are uniquely creative and stressful, too,

requiring round-the-clock work schedules, so as to meet the deadlines and time-bound programmes. Successful

companies, therefore, have to always resort to some innovative and attractive retention strategies, all the time.

Of late, the Employee Stock Option Plans (ESOPs), initially introduced by Microsoft et al. have become

popular enough, and have given rise to several variations like stock option build up over time, with additional

options extended after additional years of service, and so on. Finally, as is well known, many of the Infosys

employees have, by now, become millionaires, mainly through their Employee Stock Option Plans (ESOPs).

What is the Employee Stock Option Plan (ESOP)

Under the Employee Stock Option Plan (ESOP), a company grants option to its employees to apply for and

obtain a certain number of its own shares at a price, usually lower than the prevailing market price in the stock

exchanges. Recently, the State Bank of India (SBI), National Thermal Power Corporation (NTPC), to name

only a few, had given such options to their employees at the time of their Initial Public Offer (IPO). Further,

the company also specifies the lock-in-period for such shares. Moreover, the employee does not have any right

as a shareholder of the company till the shares are issued to him on his exercising the option. Such shares,

however, are issued in accordance with the SEBI guidelines.


The software industry is characterized by higher-than-average financial risks. The key components of financial

risks are given as follows:

(i) Intangible Current Assets

There is, in fact, no tangible current assets like inventories (raw materials, work-in-process, and finished goods)

in this sector. The current assets of software companies, instead, comprise mostly intangibles, as their raw

materials, workin- process and finished goods comprise nothing but the intellectual capital or property. The

other current assets (OCAs) are also those that are not generally considered as very significant components of

the operating cycle, viz. prepaid expenses, rent advances and employee-related advances.

(ii) Obsolescence

Besides, the most important fixed assets of software companies, viz. the computer hardware, depreciate fast

enough, a fact which tends to make the financial institutions both wary and worried. The fixed assets, other

than land and buildings, comprise the auxiliary equipments, like the generators; uninterrupted power system

(UPS); furniture and fixtures.

Further, as the risk of obsolescence of software techniques is rather too high, it calls for the scarce virtue of

very quick adaptability, as also the zeal and preparedness to learn, and remain most up-to-date, all the time.

(iii) Low Initial Capital Investment

Low initial capital requirements of the software sector is more a vice than virtue, as it gives rise to a low entry

barrier, leading to a mushroom growth of small and medium units, which, in turn, makes it difficult to assess

the risks and predict the success. The uncomfortably high rate of mortality of the software firms says it all.



(iv) Long Gestation Period

Besides, the jobs at the higher end of the value chain (i.e. software products) have rather long gestation periods,

carrying very high developmental costs (and that, too, mostly intangible in nature). So, the risk and threat, that

the end-product being developed, may itself become a non-marketable product at the end of the long gestation

period, is very real and repetitive. The stiff and cut-throat competition in this sector is an added disadvantage,

filled with high financial risks.

(v) Marketing

It has been observed, over a period of time, that though some companies had developed high quality products,

their marketing had called for a higher degree of dexterity of product commercialization, especially in the overseas

markets, full of fierce competition. The lack of a well-developed domestic market is yet another constraint for

the industry to attain the required depth, even on the home front.

(vi) Some Other Risk/Threat Factors

(a)Fierce competition, resulting in erosion of margins, may, in turn, inhibit the ability of the Indian

softwarecompanies to invest for growth and upgradation.

(b)Ever-rising cost of manpower (comprising highly qualified, skilled professionals).

(c)Ever-increasing preference of the users, in the Western markets, for packaged, standard software products,

rather than for the customised software development.




Some facilitating factors which have encouraged the banks and the other financial institutions to go in for fresh

financing and exposure to the software sector, may be summarized as follows:

(i)The software industry in India has, by now, become well stabilized and strengthened.

(ii)Threats of failure of software industries in India have shown a marked decline since the early 1990s.

(iii)The skill and expertise of the Indian software engineers and professionals have gained high recognition

the world over, as being both of high quality and cost competitive.

(iv)The STPs have dramatically facilitated and improved satellite-based telecommunication facilities in

India, enabling online work-access to the clients and thereby expanding the business opportunities.

(v)Besides, the rapid growth and development of foreign markets have given rise to outsourcing, wherein

India has emerged as the country of the very first choice. It is evident from the fact that way back in

1997, 131 Fortune 500 companies had outsourced softwares from India.

(vi)Moreover, with the improvements in the client profiles, the financial risks like delayed payments, or

even non-payments of bills, have since substantially reduced.

(vii)The Indian software industry has attained perfection and quality, whereby the risk of rejection is rather


(viii)Further, the continued exposure to the global markets has given several Indian software units a rigorous

commercial education and expertise, relevant for the international marketplace. Accordingly, their

business perspective has broadened and their goals and strategies have stabilized.

(ix)Distinct hierarchies have since emerged among the Indian software units, which have facilitated the

benchmarking, as also a much better credit risk appraisal and assessment.

(x)Besides, the margin of profit of the Indian software industry has also increased, which has given added

financial strengths to the units and has brightened up their prospects and profitability.





Financing of the Four Segments of the Information Technology (IT) and Software Industries

The various segments of the information technology and software industries can broadly be classified under

the following four categories.

(i) Software Service

(That is, staffing services and programming services).

These software services, also known as the manpower exports, involve deputation of professionals for

delivering programming services at the customers’ locations within the country, as also abroad, under different

types of contracts.

The working capital requirements for these services would, therefore, be in the form of initial travel costs and

living expenses of the personnel deputed for executing the orders. The party may, in some cases, receive some

amount by way of advance payment from the clients, which is usually specifically mentioned in the contract.

The contract would also indicate the mode of payment, i.e. whether by way of monthly/periodical payments, or

payment in lumpsum, after the execution of the contract.

Thus, the working capital requirements of the company would inter alia depend upon the gap in the inflows

of cash.

(ii) Project Services

Project services may usually have the following three categories:

(a)Customized Software Development: Customized software development services provide solutions to

the specific problems of a customer, to be utilized by the corporate mainframe and the mini-computer

users. These services could be rendered either at the customer’s location or may be delivered on physical

magnetic media (like floppies and diskettes) or even through satellite communication network. This

service is normally offered under special contracts, which provide for ‘milestone’ payments.

In these cases, as well, the working capital requirements would be for meeting the gaps, as would be

revealed by the company’s cash flow statements.

(b)Systems Solution and Integration: Systems solution and integration involve providing a complete business

solution, using information technology. Here, the integrator addresses a business problem of the client

and offers an IT-based business solution. The work involves programming, testing, and documenting

customized software solution for clients, and integration of this programme with the client’s existing IT

system, as also with the systems of the client’s parties and associates.

Working capital requirements in such cases, however, would arise mainly on account of the expenditure

on professionals, and purchase of software packages and tools.

(c)Maintenance of Software: In the category of maintenance of software, the party takes up the assignment

for maintenance of the client’s software. Typically, it takes on the complete responsibility for maintaining

a suit of software of the client. These contracts cover troubleshooting operations and, at times, even

updating of the software.

Working capital for this activity would be needed mainly for meeting the expenditure on the professionals.

(iii) Software Products and Packages

These products and packages comprise the following:

(a)Systems software, viz. operating system software, conversion of programmes and utilities, which enhance

the computer’s capabilities; and

(b)Application software, which lets the computer perform specific functions. The packages, like the word

processing, graphic design, financial analysis, and so on, come under this category.

These software products are prepared to meet the standard requirements of the end-users, and are sold as

packaged units, comprising software manual and other user aids (tutorials). The development of these products



involves fairly large-scale investment, the return on which can be realized only after the product is fully

developed and sufficient demand is generated. By and large, no payments (by the buyers) would be involved at

any stage of the development, and the developer would be receiving payments only when the interested buyers

purchase the products.

In such a case, working capital requirements would be mainly to meet the expenditure like salaries and

expenses of the professionals associated with the development of the products. The period required for the

development would, of course, vary and, in some cases, it may extend even upto twenty-four months (or even


As regards the financing of the working capital requirements of this category, it would have to be funded as

a venture financing, which naturally involves considerable financial risks.

(iv) Information Technology Related Services (IT-Services)

IT services, such as call centres, monitoring, tele-conferencing, tele-medicine, and so on, result from the use of

any IT software, over a system of IT products, for realizing the value additions.

Working capital requirements, under this segment, may arise for meeting the expenditure incurred in respect

of providing these services. However, these may not be of a significant scale.




Banks may consider the sanction of the working capital finance, irrespective of the business age of the borrower

unit, and/or the quantum of turnover achieved by it, in the previous year(s), in respect of its business activities.

While considering the applications for credit facilities, they may be guided by the track record of the promoters,

their group affiliations, the management team, academic/professional qualifications and work experience,

particularly in the software writing/development/marketing, besides the infrastructure available with the unit.

Methodology for Assessment of Working Capital Requirements

The monthly cash budget system has been considered by the banks to be ideal for arriving at the permissible

bank finance. A specimen of the pro forma statement has been circulated by the Reserve Bank of India (RBI) to

the banks, for obtaining the cash budget from the borrowing units. The financing banks may, however, adopt

the pro forma, with suitable changes, to suit their specific requirements.

The working capital needs of the borrowers may be assessed on the basis of 20 per cent of the projected turnover

for those units, which may be having working capital limits of up to ` 2 crore. The assessment of Permissible

Bank Finance (PBF) on cash budget basis may be followed in regard to the borrowers having working capital

requirement of over ` 2 crore. Further, while the peak deficit in the cash budget would determine the PBF,

credit would be made available on the basis of the deficits shown at the relevant points in time. Cash budgets

may, however, be reviewed, if the underlying presumptions undergo some significant change(s), and accordingly,

the credit limits may also have to be modified/revised.

Working capital credit needs of the borrowers, with credit limits up to ` 2 crore, may as well be assessed

on cash budget system, if they would so desire. Further, software products and packages, which are normally

financed out of equity, seed money and venture capital may be considered for finance, on a case to case basis.

Documents to be Submitted for Credit Appraisal Purposes

To enable the banks to appraise the credit requirements of the units, the following documents are obtained by

them, from the borrowers:

(a)(i) Operating Statement, and the

(ii) Note on the assumptions, underlying the operating statement.



(b)Balance Sheet

(c)Cash Budget

This form, however, is required only in the cases where the working capital gap is to be financed on the

basis of the cash budget

(d)Statement of Economics

Every proposal for financial assistance must be accompanied by a detailed project report and a business plan.

Besides, the documents must clearly and specifically describe the short-term and long-term goals of the unit,

the strategies proposed to develop and market the softwares, the stage-wise financial outlays and the revenue/

cost projections. The basis for seeking the proposed limits from the bank also needs to be clearly spelt out.

As the activity involved in such cases is different from the conventional activities (which a banker is quite

familiar with), a detailed plan needs to be drawn up for evaluation of the progress made by the unit. The plan

may provide for the milestones to be delineated, which could then be appraised.

Nature of Credit Facilities

In respect of credit facilities of below ` 10 crore, the banks have the freedom to sanction the credit facilities by

way of cash credit facility or overdraft. However, in respect of credit facilities of ` 10 crore and above, the banks

would be required to restrict the Cash Credit Component (CCC) to 20 per cent of the aggregate credit limit after,

of course, excluding the export credit component. The balance 80 per cent, however, will be disbursed by way

of a Working Capital Demand Loan (WCDL) component. The borrower could as well be sanctioned appropriate

credit facility by way of bills purchased/discounted and the invoices drawn.

In the case of specific orders received from abroad, the credit provided will amount to export finance;

preshipment or post-shipment finance, as the case may be.


It is open to the banks to stipulate a reasonable promoter’s contribution, which would serve as the margin.


The process of development of software does not generate tangible goods, as is the case in respect of the other

manufacturing activities. Also, the value of the end-product depends upon its acceptability to the client users.

Further, as the success of the activity depends largely upon the skills of the professionals/promoters, the banks

will have to carefully evaluate the promotors’ track record, their competence, their stake in the business,

marketing strategies, etc. It is also open to the banks to obtain some collateral (additional) security, wherever

available. The first or second charge on the current assets, if available, may as well be obtained.

Rate of Interest


In respect of pre-shipment and post-shipment credits, extended for the financing of the exports, the

concessional rate(s), as applicable for such credits, could be charged, provided all the conditions stipulated

for such concessional credit are complied with.


For all other types of advance, the rate will be as prescribed by the Reserve Bank of India (RBI), for the

general category of borrowers, and, accordingly, no concession will be available.

Periodical Reporting System

In order to verify whether the actual cash flows are in conformity with the projected ones, the banks may

periodically, say, once in a quarter, obtain from the borrowers, the statement of actual cash flows, so that the

mid-course corrections can be made in respect of the further cash budgets, if necessary. However, in respect of

the borrowers, where cash budget is not the basis for the sanction of the limit, the banks may devise a suitable

reporting system, as considered necessary.




Considering the risks associated with this activity, and the fact that the banks would, naturally, take some

more time to gain the necessary insights into the intricacies involved in financing the same, additional attention

has to be paid to these advances, and tailor-made followup systems may have to be evolved by the banks for

this purpose.

Administrative Arrangements

As the banks are already aware, the Indian software industry is essentially export-oriented, and, accordingly,

these contribute substantially to the country’s foreign exchange earnings. It is, therefore, necessary that the

efforts of the industry are supplemented by providing timely and adequate quantum of credit. The banks may,

therefore, have to streamline their administrative arrangements accordingly. They must identify the centres

where the IT software and services units are sufficiently large in number, and create IT-financing cells in the

identified branches at these centres. Banks may also consider constituting appropriate screening committees

for appraisal of the credit proposals as also for monitoring the progress/performance of the units.

As regards the training (of the bank executives) as an input, the banks may arrange for a requisite in-house

training programmes on the IT and software industries. It may augur well to depute the bank staff and officers

to the seminars/workshops conducted by the Industry Associations and/or such other agencies.


There has been a tremendous growth in the Information Technology (IT) sector in India, especially during

the last few years. This sector, being a large foreign exchange earner, enjoys some special concessional

credit facilities from the banks. The terrorist attack in the US on 11 September, 2001, however, had proved

to be a major jolt for the industry. The position has gradually become normal.

The software industry requires highly skilled manpower like the Programmers, Data base Analysts, MIS

Professionals and Coders. Further, the capital output ratio in this sector is rather too high, and most of

the inputs and assets are in the nature of intangibles, like the human capital, which comprises highly

skilled and high-value professionals.

Accordingly, the assessment of the credit needs, as also the prospects, potentials and profitability of an IT

unit, becomes rather too technical and mostly judgmental. Besides, the phenomena of the mushroom growth

in this sector, (as it involves quite low capital investments), and the episode of massive failures attached

therewith, make the problem still worse. Further, the fast changing technology in this sector makes the

task of Project Appraisal of IT Units highly risk-prone. But then, despite the aforesaid fluid situation and

risk factors, Indian professionals have been having a marked edge on the other suppliers of softwares,

because of its unique position in the ‘High Quality, Low Cost’ quadrant. However, the unique features of

long gestation period, stiff competition, and ever-changing technology, pose their own special problems.

Reserve Bank of India has, accordingly, issued some guidelines to the banks for granting working capital

loans to the IT and Software Industries, especially for,

(i)Software Services or Manpower exports,

(ii)Project Services, comprising:

(a) Customized Software Development

(b) System Solution and Integration

(c) Maintenance of software.

(iii)Software products and packages comprising:

(a) System Software and

(b) Application Software

(iv)IT-related Services.

The eligibility criteria, the methodology for assessment of working capital loans and the documents/statements

and some further details required for credit appraisal have also been incorporated in the RBI guidelines.




1. Bring out the salient features of software industries.

2. What are the main advantageous and disadvantageous features attached with the progress and growth of the

software industries in India?

3. What are the various critical success factors and the main risk factors connected with the bank advances to

the software industries in India?

4. What are the various facilitating factors, which have encouraged the banks and other financial institutions

to venture into fresh financial exposure to the software industries in India?

5. Discuss the various guiding principles stipulated by the Reserve Bank of India in regard to the financing of

the software industry in India.

Part VI



22.Contribution Analysis and Break-Even Point (BEP) or Cost-Volume-Profit (CVP)


23.Cost Management and Control – Steps and Strategies

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Short-Term (Working Capital) Financing of Information Technology (IT) and Software Industry

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