What is Stock Audit for Banks?
A stock audit is an independent verification of the inventory and receivables that a borrower has pledged or hypothecated to a bank as security for working-capital finance. The auditor compares physical stock with the stock statements submitted, tests valuation and ageing, verifies book debts, and reports on the drawing power available in the account.
Who needs it
- Banks and non-banking financial companies that have lent against stock and book debts and want the security verified independently.
- Borrowers with cash-credit or overdraft limits where the sanction letter makes a periodic stock audit a condition.
- Accounts where the limit crosses the threshold at which the bank's policy requires a stock audit.
- Accounts showing warning signs: static stock, stretched debtors, or stock statements that are late or inconsistent.
- Companies that want an independent inventory count for their own financial reporting, insurance or internal control purposes.
Benefits
- Independent confirmation that the stock and debtors shown as security actually exist and are valued reasonably.
- A drawing power calculation the lender can rely on, with the margin and ineligible items applied correctly.
- Identification of slow-moving, obsolete or third-party stock that should not count towards security.
- Ageing of book debts, separating those within the sanctioned period from overdue balances.
- Observations on the borrower's stock records and controls, which the borrower can act on directly.
Key facts
| Item | Position |
|---|---|
| What is verified | Stock and book debts charged to the bank as security for working-capital finance |
| Who appoints | The lending bank or non-banking financial company |
| Who the report goes to | The lender, with a copy to the borrower where the appointment allows |
| What governs the frequency | The sanction letter and the bank's own policy, not statute |
| Main output | Reconciliation, drawing power computation and observations on records and controls |
| Usual deductions | Ineligible and obsolete stock, overdue debtors, creditors for stock, and the prescribed margin |
How is drawing power calculated?
Drawing power is the amount the borrower may actually draw at a point in time, and it is recalculated from each stock statement rather than fixed at sanction. The calculation starts from the current assets charged to the bank and takes out everything that should not support borrowing.
| Step | Illustrative amount |
|---|---|
| Stock as per statement | ₹1,80,00,000 |
| Less: obsolete and slow-moving stock | (₹15,00,000) |
| Less: stock not owned by the borrower or held at an undisclosed location | (₹5,00,000) |
| Eligible stock | ₹1,60,00,000 |
| Less: creditors for stock | (₹40,00,000) |
| Paid stock | ₹1,20,00,000 |
| Less: margin at 25% | (₹30,00,000) |
| Drawing power from stock | ₹90,00,000 |
| Book debts within the sanctioned period | ₹60,00,000 |
| Less: margin at 40% | (₹24,00,000) |
| Drawing power from book debts | ₹36,00,000 |
| Total drawing power | ₹1,26,00,000 |
These figures are an illustration only. The margin percentages, the treatment of creditors and the debtor period that qualifies are all fixed by the sanction letter for the particular account, and they differ between lenders and between facilities. In this illustration the account has a sanctioned limit of ₹1.5 crore but a drawing power of ₹1.26 crore, so the borrower may not draw the full limit until the eligible security position improves.
Stock statements and physical stock: why they differ
A difference between the statement and the physical count is the most common finding in a stock audit, and it is not always a sign of anything wrong. The usual reasons are worth separating, because they lead to different conclusions.
- Timing: the statement is as at the month end and the count happens later, so purchases and sales in between explain part of the gap
- Estimation: the statement was prepared from a rough figure rather than from the stock records, which is a records weakness rather than a shortfall
- Valuation: the quantity is right but the rate used is not the basis the sanction requires, for example selling price instead of cost
- Ownership: the statement includes consignment stock, customer-supplied material or goods already sold but not despatched
- Location: stock is held at a branch, warehouse or job worker's premises that the bank was not told about
- Condition: damaged or obsolete stock is still carried at full value
How are book debts verified?
Book debts usually carry a higher margin than stock because they are harder to realise, and only debts within the period the sanction allows are eligible at all. The auditor obtains a party-wise ageing, traces a sample of balances to invoices and to the ledger, and checks it against the sales records and the GST returns for the period. Balances outside the eligible period, amounts due from group or related concerns, disputed balances and debts already provided for are identified separately, because each is normally excluded from drawing power. Credit balances in debtor accounts, which represent advances from customers rather than amounts receivable, are also separated out.
Inventory audits for companies
Not every inventory verification is done for a lender. A company may commission one for its own reasons, and the scope then follows the company's purpose rather than a sanction letter.
- Year-end verification to support the figure in the financial statements, often coordinated with the statutory auditor's attendance at the count
- Periodic cycle counts across locations, so that differences are found during the year rather than at the year end
- Verification before or after a change in management, a transaction or a change of warehouse
- Insurance purposes, where the sum insured needs to reflect the stock actually held
- Investigation of recurring differences between the physical stock and the records, where the question is why the control is failing
The deliverable differs too. A bank stock audit ends in a drawing power computation; an inventory audit for a company more often ends in a reconciliation and a set of recommendations on stock records, custody and cut-off procedures.
What a borrower should prepare
The audit is shorter and the report shorter still when the records are ready before the visit. In practice that means the stock records reconciled to the books and to the statements already submitted, a party-wise debtor ageing, creditor balances for stock, the valuation workings including costing for work in progress and finished goods, current insurance policies recording the bank's interest, and a written note of any stock held at another location, in transit, or belonging to someone else.
Related reading
- Bank statutory audit — where drawing power is tested from the lender's side
- Project report and CMA data for bank loans — the working-capital assessment behind the limit
- Statutory audit — inventory as part of the financial statements audit
Official sources
- Reserve Bank of India – master circulars — loans and advances, and working-capital assessment
- The Institute of Chartered Accountants of India — guidance on inventory verification and auditing standards
Documents required
- 01Sanction letter with the limit, margin and stock audit conditions
- 02Stock statements submitted to the bank for the period under review
- 03Stock registers, bin cards or the inventory module reports from the accounting system
- 04Purchase and sales registers and the GST returns for the period
- 05Debtor ageing statement with party-wise balances
- 06Creditor balances, since stock funded by creditors is usually deducted from drawing power
- 07Valuation basis and workings, with costing records for work in progress and finished goods
- 08Insurance policies covering the stock, with their sums insured and validity
- 09Details of stock held at third-party locations, in transit, or on consignment
Due dates and penalties
| Item | Due date | If missed |
|---|---|---|
| Stock statement to the bank | At the frequency the sanction requires, commonly monthly | Drawing power is usually restricted, and penal charges may apply under the sanction |
| Stock audit | At the interval fixed in the sanction, commonly annually or half-yearly | Non-compliance with a sanction condition, which can affect renewal |
| Insurance cover on hypothecated stock | Kept current throughout, with the bank's interest noted | Uninsured security and a breach of the sanction terms |
The frequency of stock statements and stock audits is set by the sanction letter and the bank's own policy, not by statute, so it varies between lenders and between accounts. We work to the dates in the appointment letter.
Mistakes to avoid
- Stock statements prepared from an estimate rather than from the stock records, so they never reconcile with the books.
- Including stock that is not the borrower's security: goods held on consignment, customer-supplied material, or stock at an undisclosed location.
- Showing stock at selling price or at an inflated valuation instead of the basis the sanction requires.
- Leaving slow-moving and obsolete stock in the statement at full value for years.
- Reporting gross debtors without ageing, so overdue balances outside the sanctioned period still attract drawing power.
- Not deducting creditors for stock, which overstates the drawing power the borrower is entitled to.
- Insurance that has lapsed, is for less than the stock held, or does not record the bank's interest.
Why PHMG
- Partner-led: a chartered accountant reviews your work, not only a junior team.
- Clear fee and scope in writing before we start.
- Deadlines tracked for you, with reminders well before the due date.
- Your documents and data are handled confidentially.
- Online service across India, with a single point of contact.
Fees depend on your case. Request a quote for a clear scope and fee.