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TRANSCRIPT
Annexure A
Credit appraisal for working capital finance
A PROJECT REPORT
Under the guidance of
Sri Debabrata Chakraborty, Manager
Indian overseas Bank, Chowringhee Branch
Submitted by
Mitali Bagchi Roll No 520933922
A REPORT SUBMITTED IN PARTIAL FULFILLMENT FOR THE AWARD OF THE DEGREE OF MBA
PROGRAMME IN FINANCE
November 2010
1
Annexure B
I hereby declare that the project report entitled Credit appraisal for
working capital finance is submitted in partial fulfillment of the
requirement for the degree of Master of Business Administration in Finance
under Sikkim Manipal University, India, is my original work and not submitted
for the award of any other degree, diploma, fellowship, or any other similar title
or prizes.
Place: Kolkata (Mitali Bagchi)Date: Roll No 520933922
2
Annexure C
A PROJECT REPORT ON
Credit appraisal for working capital financeSUBMITTED BY MITALI BAGCHI ROLL NO 520933922
Is approved and is acceptable in quality and form.
Internal Examiner External Examiners (Name, Qualification and Designation) (Name, Qualification)
3
Chapter No.
Particulars Page No
4
AcknowledgementBonafide Certificate Executive SummaryMethodology and sources of data
6.7.8.9.
1. Introduction1.1 Banking Sector in India1.2 An Overview of Indian Overseas Bank1.3 Rationale for Study1.4 Objective
13-1415-17.18.19.
2. Bank’s Loans and Advances 20-28.3. Working Capital Management
3.1 Introduction3.2 Need of Working Capital Management3.3 Gross Working Capital and Net Working Capital3.4 Concepts3.5 Types of Working Capital3.6 Determinants of Working Capital3.7 Working Capital Cycle3.8 Working Capital financing3.9 Working Capital Products3.10 Various methods of Working Capital Assessment
29.30.31.32-38.39.40-43.44.45.46.47-49.
4. Credit Appraisal and Monitoring: Common Issues4.1 What is Credit Appraisal4.2 Data to be obtained for Credit Appraisal4.3 Credit Monitoring: Common Issues 4.3.1 Additional requirements in case of Loan is granted to Company 4.3.2 Additional requirements in case of Loan is granted to Firm4.4 Principles of Lending4.5 Principles of BASEL II Accord 4.5.1 Basel II consists of three pillars 4.5.2 PD Dynamics4.6 Financial Analysis of Lending 4.6.1 Steps involved in Financial Analysis of Lending4.7 Clarification with regard to Classification of Working Capital limits
50.51.52-53.54
55.56.57.57-59.60-61.626366-68
5. Case Study 69 -93
6. Conclusion and Recommendation6.1 Comments on financial performance of the company 94-95
Chapter No.
Particulars Page no
5
6. 6.2 Gist of Recommendations 96-98
AppendicesBibliography
99
Acknowledgement6
The project report submitted in partial fulfillment of MBA Programme in Finance is a golden
opportunity for learning and self-development. I consider myself very lucky and honored to have
many distinguished personalities to lead and guide me in completion of this project.
My grateful thanks to Mr. DEBABRATA CHAKRABARTY, CREDIT MANAGER, INDIAN
OVERSEAS BANK, CHOWRINGHEE branch who in spite of being immensely busy with his
duties, provided me the essential information and extended his best support providing me an
insight into various issues pertaining to the case mentioned in the report. His sincere support and
consistent guidance led to the completion of the project.
My humble gratitude to Mr. K PARTHASARATHY, CHIEF MANAGER, INDIAN
OVERSEAS BANK, CHOWRINGHEE branch for giving me ample scope to continue my
project work inside the branch.
Mr. PRABIR KUMAR ROY, CHIEF MANAGER, IOB, REGIONAL OFFICE, KOLKATA (1)
arranged all the facilities to make the process very easier to me. I choose this moment to
acknowledge his contribution gratefully.
I am highly indebted to Prof. SUJIT DUTTA and Prof. RANJAN DAS GUPTA for their
mentorship and valuable suggestions that gave an entirely new dimension to the project under
consideration. Their guidance gave immense confidence and encouragement that helped me to
put in my best.
In this opportunity I would like to thank my brother who has helped and encouraged me to
complete the Project work smoothly.
Last but not the least I am very grateful to my parents, husband and son for providing me all
sorts of cooperation, encouragement and inspiration.
Bonafide Certificate:
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BONAFIDE CERTIFICATE
Certified that this project report titled Credit appraisal for Working Capital
Finance is the bonafide work of Smt Mitali Bagchi Roll No 520933922, a student
of MBA Finance of Sikkim Manipal University who carried out the project work
under my supervision during the period 21/06/2010 to 20/08/2010. I wish her all
round success in her professional career.
(P K Roy) (Debabrata Chakraborty)
Chief Manager ManagerIndian Overseas Bank Indian Overseas BankRegional Office Chowringhee BranchKolkata I
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EXECUTIVE SUMMARY
Almost all of the industrial enterprises whether they are into manufacturing trading or service
sector need bank finance in order to run the businesses. So everyone approaches the bank at the
same point of time for business loan whether it is for running day to day business or for setting
up a new project. A banker approaches the proposal and then decides whether to lend the money
or not. This report gives a clear understanding with what goes behind the credit appraisal of the
proposal.
Chennai based Indian Overseas Bank is one of the nationalized banks in India, that has a
substantive history since 1937. The bank not only deals in retail banking providing utility
services to its customers but has also expanded its area of operation in multidimensional services
like merchant banking, agribusiness consultancy and e-banking. It recently registered a core
profit of Rs.1325 crores in the financial year March‟08-March‟09.
The report deals with the lending procedures followed by Indian Overseas Bank. It explains
different types of loans and advances offered by banks. It gives an insight of the steps involved
in lending process. Working capital financing is discussed in the report. Calculation of maximum
permissible bank finance is shown with example. Common issues related to credit appraisal is
discussed in detail. This report also deals with principles of lending and principles of BASEL II
ACCORD.
The most important part of the study includes case analysis of Working Capital
Assessment/Appraisal of a partnership firm M/s XXX Co. ( Name of the firm changed )
which is a trading concern dealing in Indian manufactured foreign liquor (IMFL).
This explains the significance of study of key financial indicators, study of debt service coverage
ratio, in a precise manner. The present status of the project shown by the study of balance sheets
sand other financial details furnished by the borrower and the bank. Financial ratios, past
performance and projected future performance, study of cash flow statement and collateral
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security are helpful to the bank while taking lending decision. Finally, conclusion and
recommendation as per the analysis during the training period winds up the report.
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METHODOLOGY AND SOURCES OF DATA
The proposed methodology for fulfilling the objectives of the project is as follows:
The study of guidelines laid by the Reserve Bank of India and the governing authorities
of Indian Overseas Bank to be adhered to (pertaining to advances) as published in the
journals issued by these authorities from time to time.
The secondary data is deduced from the books of accounts maintained by the bank
(without disclosure of any personal details of the borrower).
The data from the official books as maintained by the bank, reference books, newsletters
published by financial institutions and websites have been utilized for the analytical study
of advances made by bank.
The methodology includes a detailed study of the data collected from the bank, pre and
post requisites of lending, calculation of interest on loans and equated monthly
installments and documentation of the same.
The observation of advances sanctioned by the bank in the past few years that resulted
successful lending constitutes the most substantial part of the project work.
It also involves active participation in banking transactions and internal functioning of the
Advances Department of the branch. An elaborate study of loans and advances granted
by the branch and analysis of the same has been the most significant component of the
project.
Information mentioned in the cases are deduced from the books of accounts as maintained by the
bank branch, the figures and facts given being realistic in nature. Finally, identification of the
problems associated with advances by bank and the solution of the same with certain
recommendations is to be provided after analyzing certain loans (stated as illustrations in the
project) to help the advances department of the bank.
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Serial No. Abbreviation Narration1. CBS Core Banking Solution2. ISO Indian Standard Organization3. IMFL Indian Manufactured Foreign Liquor4. SCB Scheduled Commercial Banks5. ICRA International Credit Rating Agency6. FOREX Foreign Exchange7. IPO Initial Public Offer8. VISA Visa International Service Association9. NRI Non Resident Indian10. ROE Return on Equity11. WIP Work in Process12. NFS National Financial Switch13. FDR Fixed Deposit Receipt14. EPS Earnings per share15. DSCR Debt Service Coverage Ratio16. AR Accounts Receivable17. SME Small Medium Enterprise18. MPBF Maximum Permission Banks Finance19. CMA Credit Monitoring Analysis20. NWC Net Working Capital21. NSC National savings Certificate22. LIC Life Insurance Corporation23. KVP Kishan Vikas Patra24. IBA Indian Bank Association25. CIBIL Credit Information Burea India Limited26. CC Cash Credit27. ROC Registrars of Companies28. HO Head Office29. LGD Loss Given default30. EAD Exposure at Default31. MCR Minimum Capital Requirement32. RWA Risk Weighted Assets33. PD Probability of Default34. EL Expected Loss35. SWOT Strength,Weakness,Opportunity & Threat36. CLB Company Law Board37. DPG Deferred Payment Guarantee38. WCG Working Capital Gap39. TNW Tangible Net Worth40. TOL Total of Liabilities
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Figure No Narration Page No
Fig 1 IOB 14
Fig 2 Working Capital 38
Fig 3 Working Capital Cycle 43
Fig 4 Cash Operating Cycle 44
Fig 5 Credit Appraisal 49
Fig 6 BASEL II 56
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Table No. Narration Page No:1. Key Ratio levels 642. Nature of Facilities 693. Guarantors and their Networth 704. Collateral Securities details 705. Securities 716. FORM I 737. FORM II 74 -768. FORM III(P & L A/C) 77 -799. FORM III(B/S) 79 - 8110. FORM IV(B/S) 82 - 8311. Comparison 84 - 8512. FORM V(B/S) 86 - 8713. FORM VI(B/S) 88 - 8914. Financial Indicators 9015. Financial Position 9116. Sanction of enhancement cum renewal of limits 93
Chapter 1.
INTRODUCTION
1.1BANKING SECTOR IN INDIA
Banking in India originated in the last decades of the 18th century. The first bank in India,
though conservative, was established in 1786. From 1786 till today, the journey of Indian
Banking System can be segregated into three distinct phases. They are as mentioned below:
Early phase from 1786 to 1969 of Indian Banks
Phase from Nationalization of Indian Banks and up to 1991, prior to Indian banking
sector Reforms.
New phase of Indian Banking System with the advent of Indian Financial & Banking
Sector Reform after 1991.
Currently, India has 88 scheduled commercial banks (SCBs) - 27 public sector banks (that is
with the government of India holding a stake), 31 private banks (these do not have government
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stake; they may be publicly listed and traded on stock exchanges) and 38 foreign banks. They
have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by
ICRA Limited, a rating agency, public sector bank holds over 75% of the total asset of the
banking industry, with the private and foreign bank holding 18.2% and 6.5% respectively.
Currently (2007) banking in India is generally fairly mature in terms of supply, product,range
and reach even though reach in rural India still remains a challenge for private sector .In terms of
capital adequacy and quality of assets, Indian banks are considered to have clean, strong and
transparent balance sheet relative to other banks in comparable economies in its region. The
Reserve Bank of India is an autonomous body, with minimal pressure from the government. The
stated policy of the bank on the Indian rupee is to manage volatility but without any fixed
exchange rate and this has mostly been true.
With the growth in the Indian economy expected to be strong for quite some time, especially in
its services sector -the demand for banking services, especially retail banking mortgages and
investment services are expected to be strong.
Without a sound and effective banking system in India it cannot have a healthy economy. The
banking system of India should not only be hassle free but it should be able to meet new
challenges posed by the technology and any other external and internal factor.
Indian Banking market is growing at an astonishing rate, with assets expected to reach US$1
trillion by 2010. An expanding economy, middle class and technological innovations are all
contributing to this growth. The country’s middle class accounts for over 330 million people. In
correlation with the growth of the economy, rising income levels, increased standard of living
and affordability of banking products are promising factors of continued expansion.
For the past three decades India's banking system has several outstanding achievements to its
credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or
cosmopolitans in India.
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1.2 AN OVERVIEW OF INDIAN OVERSEAS BANK
Fig 1.IOBVISION
Their vision is to emerge as one of the most competitive banks in the industry.
INDIAN OVERSEAS BANK (IOB) enjoys pride of place as the premier institution among the
public sector banks in the country. Indian Overseas Bank was rated as one of Fortune 2000
companies last year with gross profits of nearly $295 million. Headquartered in Chennai – Tamil
Nadu, Indian Overseas Bank has nearly 1500 branches and 250 extension counters with more
than 24,000 employees all across India and overseas. IOB was founded in 1937 before World
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War II. Shri M Ct M Chidambaram Chettiar, the founder, was a man of remarkable foresight and
vision who focussed on overseas banking and foreign exchange business as the primary activities
that the bank would concern itself with. IOB commenced operations on Feb 10, 1937. IOB
started up simultaneously at three branches, one each in Karaikudi, Chennai and Rangoon. It
then quickly opened a branch in Penang and another in Singapore. Indian Overseas Bank (IOB or
the Bank) provides various banking services, including saving bank, current accounts, credit
facilities and other services. The Bank's services also include personal banking services, non-
residential Indian (NRI) accounts, corporate banking services, foreign exchange reserves
(FOREX) collections services, agri business consultancy and e-banking services. IOB was the
first bank to venture into consumer credit, as it introduced the popular Personal Loan scheme.
In 1964, the Bank started computerization in the areas of inter-branch reconciliation and
provident fund accounts. Indian Overseas Bank was one of the 14 major banks which were
nationalized in 1969. After nationalization, the Bank emphasized on opening its branches in rural
parts of India. In 1979, IOB opened a Foreign Currency Banking Unit in the free trade zone in
Colombo. It offers internet banking and is one of the banks that the Government Of India has
approved for online payment of taxes. In the year 2000, Indian Overseas Band undertook an
initial public offering (IPO) that brought the government's share in the bank's equity down to
75%. The equity shares of IOB are listed in the Madras Stock Exchange (Regional), Bombay
Stock Exchange, and National Stock Exchange of India Ltd., Mumbai. Since its inception, IOB
has absorbed various banks including the latest — Bharat Overseas Bank — in 2007. Indian
Overseas Bank offers investment options like Mutual Funds and Shares. It provides a wide range
of consumer and commercial banking services, including Savings Account, Current Account,
Depositary Services, VISA Cards, Credit Cards, Debit Cards, Online Banking, Any Branch
Banking, Home Loans, NRI Account, Agricultural Loans, Payment of Bills / Taxes, Provident
Fund Scheme, Forex Collection Services, Retail Loans, etc. Indian Overseas Bank has an ISO
certified in-house Information Technology department, which has developed the software that
2018 branches use to provide online banking to customers; the bank has achieved 100%
networking status as well as 100% CBS status of branches with a total number of 2018 CBS
branchs and Extension Counters. IOB also has a network of about 771 ATMs all over India and
IOB's International VISA Debit Card is accepted at all ATMs belonging to the Cash Tree and
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NFS networks During fiscal 2009, the Bank launched an rural development project aiming at
total village development called IOB-Sampoorna in Kuthambakkam and Padur villages in
Tiruvallur District, Kameshwaram village in Nagapattinam District, Dhaliyur village in
Coimbotore District and Innambur village in Thanjavur, Tamil Nadu. In 2009, IOB took over
Shree Suvarna Sahakari Bank, which was founded in 1969 and had its head office in Pune. In
2001 it acquired the Mumbai-based Adarsha Janata Sahakari Bank, which gave it a branch in
Mumbai. Shree Suvarna Sahakari Bank has been in administration since 2006.
It has nine branches in Pune, two in Mumbai and one in Shirpur. The total employee strength is
estimated to be little over 100. During the fiscal year ended March 31, 2010 (fiscal 2010), IOB
had 13 establishments abroad, consisting of six branches (two branches in Hong Kong and one
each in Singapore, South Korea, Sri Lanka and Bangkok), four representative offices, two
remittance centers and one extension counter.
1.3 RATIONALE FOR THE STUDY
Offering credit is an operation fraught with risk. Before offering credit to an organization, its
financial health must be analyzed. Credit should be disbursed only after ascertaining satisfactory
financial performance. Based on the financial health of an organization, banks assign credit
ratings. These credit ratings are used to fix the interest rate and quantum of installment.
This study aims to analyze steps involved in credit appraisal .After analyzing credit health, the
credit rating is determined. On the basis of credit rating, the interest rate guidelines circular is
consulted to fix a price for the credit facilities i.e. determine the interest rate.
This study aims to analyze the credit health of organizations that approach Indian overseas bank
for credit facilities. After analyzing credit health, the credit rating is determined. On the basis of
credit rating, the interest rate guidelines circular is consulted to fix a price for the credit facilities
i.e. determine the interest rate.
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Companies present audited balance sheets of the current and previous years. These are used to
determine the financial health, turnover trends and rise and fall of profitability. Then credit rating
is done.
The financial health and credit rating are theoretical methods for determining the right interest
rate. However, in practice, banks consider other factors such as history with client, market
reputation and future benefits with clients. Thus, a difference exists between theory and practice.
1.4 OBJECTIVE
1. Understand the principles of good lending, including relevant law and codes of practice such
as Treating Customers Fairly, Responsible Lending and The Banking Code. Provide an outline
of the principles of credit scoring.
2. Understand the nature of different types of borrowers (personal customers, sole traders,
partnerships and, limited companies and the lending services that may be of benefit to them.
3. Analyse the borrowing requirements of personal and commercial customers (including the
interpretation of financial statements).
4. Understand and apply the features and benefits of the whole range of lending products and
services to each customer type and lending situation.
5. Understand the implications and application of the lending cycle, from the lending decision,
through lending and control, management of early warning signals to the recovery of debts.
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6. Apply the principles of security including land and property, life policies, stocks and shares,
guarantees and debentures incorporating fixed and floating charges.
Chapter 2.
BANK LOANS AND ADVANCES
Bank is a lawful organization, which accepts deposits that can be withdrawn on demand. It also
lends money to individuals and business houses that need it. Banks also render many other useful
services – like collection of bills, payment of foreign bills, safe-keeping of jewellery and other
valuable items, certifying the credit-worthiness of business, and so on.
Commercial banks accept deposits and also lend money to the people who require it for various
purposes.
Lending of funds to traders, businessmen and industrial enterprises is one of the important
activities of commercial banks. The major part of the deposits received by banks is lent out, and
a large part of their income is earned from interest on such lending. There is a considerable
difference between the rate of interest which the commercial bank grants on deposits, and the
rate they charge on loans and advances. It is this difference which constitutes the main source of
bank earnings. Operation and expansion of business and commercial activities depend a great
deal on the availability of loans/advances from commercial banks.
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2. a. Meaning of Loans and Advances
The term ‘loan’ refers to the amount borrowed by one person from another. The amount is in the
nature of loan and refers to the sum paid to the borrower. Thus from the view point of borrower,
it is ‘borrowing’ and from the view point of bank, it is ‘lending’. Loan may be regarded as
‘credit’ granted where the money is disbursed and its recovery is made on a later date. It is a debt
for the borrower. While granting loans, credit is given for a definite purpose and for a
predetermined period. Interest is charged on the loan at agreed rate and intervals of payment.
‘Advance’ on the other hand, is a ‘credit facility’ granted by the bank. Banks grant advances
largely for short-term purposes, such as purchase of goods traded in and meeting other short-
term trading liabilities. There is a sense of debt in loan, whereas an advance is a facility being
availed of by the borrower. However, like loans, advances are also to be repaid. Thus a credit
facility- repayable in instalments over a period is termed as loan while a credit facility repayable
within one year may be known as advances. However, in the present lesson these two terms are
used interchangeably.
2.b. Utility of Loans and Advances
Loans and advances granted by commercial banks are highly beneficial to individuals, firms,
companies and industrial concerns. The growth and diversification of business activities are
effected to a large extent through bank financing. Loans and advances granted by banks help in
meeting short-term and long term financial needs of business enterprises. We can discuss the role
played by banks in the business world by way of loans and advances as follows:
1. Loans and advances can be arranged from banks in keeping with the flexibility in
business operations. Traders may borrow money for day to day financial needs availing
of the facility of cash credit, bank overdraft and discounting of bills. The amount raised
as loan may be repaid within a short period to suit the convenience of the borrower. Thus
business may be run efficiently with borrowed funds from banks for financing its
working capital requirements.
2. Loans and advances are utilized for making payment of current liabilities, wage and
salaries of employees, and also the tax liability of business.
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3. Loans and advances from banks are found to be ‘economical’ for traders and
businessmen, because banks charge a reasonable rate of interest on such loans/advances.
For loans from money lenders, the rate of interest charged is very high. The interest
charged by commercial banks is regulated by the Reserve Bank of India.
4. Banks generally do not interfere with the use, management and control of the borrowed
money. But it takes care to ensure that the money lent is used only for business purposes.
5. Bank loans and advances are found to be convenient as far as its repayment is concerned.
This facilitates planning for future and timely repayment of loans. Otherwise business
activities would have come to a halt.
6. Loans and advances by banks generally carry element of secrecy with it. Banks are duty-
bound to maintain secrecy of their transactions with the customers. This enhances
people’s faith in the banking system.
2. c. Borrowing Rate and Lending Rate
People make their funds available to the banks by depositing their ‘savings’ in various types of
accounts. In other words, bank funds mainly consist of deposits from the public, though banks
may also borrow money from other institutions and the Reserve Bank of India.
Banks, thus mobilizes funds through its deposits. On public deposits the banks pay interest at and
the rate of interest vary according to the type of deposit. The borrowing rate refers to the rate of
interest paid by a bank on its deposits. The rates which the banks allow depend upon the nature
of deposit account and the period for which the deposit is made with the bank. No interest is
generally paid on current account deposits. The rate is relatively lower on savings account
deposits. Higher rates ranging from 6% to 12% per annum are paid on fixed deposit accounts
according to the period of deposit.
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Banks also borrow from other institutions as well as from the Reserve Bank of India. When the
Reserve Bank of India lends money to commercial banks, the rate of interest it charges for
lending is known as ‘Bank Rate’.
The rate at which commercial banks make funds available to people is known as ‘Lending-rate’.
The lending rates also vary depending upon the nature of loans and advances. The rates also vary
according to the purpose in view. For example if the loan is sanctioned for the purpose of
activities for the development of backward areas, the rate of interest is relatively lower as against
loans and advances for commercial/business purposes. Similarly for smaller amounts of loan the
rate of interest is higher as compared to larger amounts. Again lending rates for consumer
durables, e.g. loans for purchase of two-wheelers, cars, refrigerators, etc. are relatively higher
than for commercial borrowings.
However, the Reserve Bank of India from time to time announces changes in the interest-rate
structure to regulate the lending of fund by banks. Different rates of interest are prescribed for
various categories of advances, such as advances to agriculture, small scale industries, road
transport, etc. Graded rates of interest are prescribed for backward areas. Lower rate is normally
charged from agencies selling food-grains at fixed price through Govt. approved outlets.
Lastly, lower rate of interest is charged for loans granted to persons belonging to ‘weaker
sections of the society’.
2. d.Lending of Money
Commercial banks lend money in four different ways: (a) direct loans, (b) cash credit, (c)
overdraft, and (d) discounting of bills. These are briefly discussed below:
(a) Loans
Loan is the amount borrowed from bank. The nature of borrowing is that the money is disbursed
and recovery is made in installments. While lending money by way of loan, credit is given for a
definite purpose and for a pre-determined period. Depending upon the purpose and period of
loan, each bank has its own procedure for granting loan. However the bank is at liberty to grant
the loan requested or refuse it depending upon its own cash position and lending policy.
There are two types of loan available from banks:
Demand loan
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Term loan
(a) A Demand Loan is a loan which is repayable on demand by the bank. In other words, it is
repayable at short-notice. The entire amount of demand loan is disbursed at one time and the
borrower has to pay interest on it. The borrower can repay the loan either in lump sum (one time)
or as agreed with the bank. For example, if it is so agreed the amount of loan may be repaid in
suitable installments.
Such loans are normally granted by banks against security. The security may include materials or
goods in stock, shares of companies or any other asset. Demand loans are raised normally for
working capital purposes, like purchase of raw materials, making payment of short-term
liabilities.
(b) Term Loans: Medium and long-term loans are called term loans. Term loans are granted for
more than a year and repayment of such loans is spread over a longer period. The repayment is
generally made in suitable installments of a fixed amount. Term loan is required for the purpose
of starting a new business activity, renovation, modernization, expansion/ extension of existing
units, purchase of plant and machinery, purchase of land for setting up of a factory, construction
of factory building or purchase of other immovable assets.
These loans are generally secured against the mortgage of land, plant and machinery, building
and the like.
(b) Cash credit
Cash credit is a flexible system of lending under which the borrower has the option to withdraw
the funds as and when required and to the extent of his needs. Under this arrangement the banker
specifies a limit of loan for the customer (known as cash credit limit) up to which the customer is
allowed to draw. The cash credit limit is based on the borrower’s need and as agreed with the
bank. Against the limit of cash credit, the borrower is permitted to withdraw as and when he
needs money subject to the limit sanctioned. It is normally sanctioned for a period of one year
and secured by the security of some tangible assets or personal guarantee. If the account is
running satisfactorily, the limit of cash credit may be renewed by the bank at the end of year. The
interest is calculated and charged to the customer’s account. Cash credit, is one of the types of
bank lending against security by way of pledge or / hypothetifcation of goods. ‘Pledge’ means
24
bailment of goods as security for payment of debt. Its primary purpose is to put the goods
pledged in the possession of the lender. It ensures recovery of loan in case of failure of the
borrower to repay the borrowed amount. In ‘Hypothetication’, goods remain in the possession
of the borrower, who binds himself under the agreement to give possession of goods to the
banker whenever the banker requires him to do so. So Hypothetication is a device to create a
charge over the asset under circumstances in which transfer of possession is either inconvenient
or impracticable.
(c) Overdraft
Overdraft facility is more or less similar to ‘cash credit’ facility. Overdraft facility is the result of
an agreement with the bank by which a current account holder is allowed to draw over and above
the credit balance in his/her account. It is a short-period facility. This facility is made available to
current account holders who operate their account through cheque. The customer is permitted to
withdraw the amount of overdraft allowed as and when he/she needs it and to repay it through
deposits in the account as and when it is convenient to him/her.
Overdraft facility is generally granted by a bank on the basis of a written request by the
customer. Sometimes the bank also insists on either a promissory note from the borrower or
personal security of the borrower to ensure safety of amount withdrawn by the customer. The
interest rate on overdraft is higher than is charged on loan. The following are some of the
benefits of cash credits and overdraft :-
(i) Cash credit and overdraft allow flexibility of borrowing, which depends upon the need of the
borrower.
(ii) There is no necessity of providing security and documentation again and again for
borrowing funds.
(iii) This mode of borrowing is simple and elastic and meets the short term financial needs of the
business.
(d) Discounting of Bills
Apart from sanctioning loans and advances, discounting of bills of exchange by bank is another
way of making funds available to the customers. Bills of exchange are negotiable instruments,
25
which enable debtors to discharge their obligations to the creditors. Such Bills of exchange arise
out of commercial transactions both in inland trade and foreign trade. When the seller of goods
has to realize his dues from the buyer at a distant place immediately or after the lapse of the
agreed period of time, the bill of exchange facilitates this task with the help of the banking
institution. Banks invest a good percentage of their funds in discounting bills of exchange. These
bills may be payable on demand or after a stated period.
In discounting a bill, the bank pays the amount to the customer in advance, i.e. before the due
date. For this purpose, the bank charges discount on the bill at a specified rate. The bill so
discounted , is retained by the bank till its due date and is presented to the drawee on the date of
maturity. In case the bill is dishonoured on due date the amount due on bill together with interest
and other charges is debited by the bank to the customer’s account.
Term Loans
Medium and long-term loans are generally known as ‘term loans’. These loans are granted for
more than 15 months. In case of medium term loan, the period ranges from 15 months to less
than 5 years. Medium term loans are generally granted for heavy repairs, expansion of existing
units, modernization /renovation etc. Such loans are sanctioned against the security of
immovable assets. The normal rate of interest ranges between 12% to 18% depending upon the
period, purpose, nature and amount of the loan. Though banks may grant long-term loans, they
avoid granting loan for more than 5 years.
2.e. Nature and Security of Loans
To ensure the safety of funds lent, the first and most important factor considered by a bank is the
capacity of borrowers to repay the amount of loan , The bank therefore, relies primarily on the
character, capacity and financial soundness of the borrower. But the bank can hardly afford to
take any risk in this regard and hence it also has the security of tangible assets owned by the
26
borrower. In case the borrower fails to repay the loan, the bank can recover the amount by
attaching the assets.
It can sell the assets offered as security and realize the amount. Thus from the viewpoint of
security of loans, we can divide the loans into two categories: (a) secured, and (b) unsecured.
Unsecured loans are those loans, which are not covered by the security of tangible assets.
Such loans are granted to firms/institutions against the personal security of the owner, manager
or director.
On the other hand Secured loans are those which are granted against the security of tangible
assets, like stock in trade and immovable property. Thus, while granting loan against the security
of some assets, a charge is created over the assets of the borrower in favour of the bank. This
enables the bank to recover the dues from the customer out of the sale proceeds of the assets in
case the borrower fails to repay the loan.
There are various types of securities which may be offered against loans granted, but all of those
are not acceptable to the banks. The types of securities generally accepted by the bank are the
following:
Tangible assets such as plant and machinery, motor-van, etc.
Documents of title to goods, like Railway Receipt (R/R), Bills of exchange, etc.
a) Financial Securities (Shares and Debentures)
b) Life-Insurance Policy
c) Real estates (Land, building, etc).
d) Fixed Deposit Receipt (FDR)
e )Gold ornaments, Jewellery etc.
2.f. Procedure of granting Cash Credit, Overdraft and Discounting Bills
We have studied in this lesson that banks provide financial assistance to its customers in the form
of loans, advances, cash credit, overdraft and through the discounting of bills. The procedure of
applying for and sanction of loans and advances differs from bank to bank. However, the steps
which are generally to be taken in all cases are as follows:
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(I) Filling up of loan application form
Each bank has separate loan application forms for different categories of borrowers. When you
want to borrow money from a bank, you will have to fill up a loan application form available
with the bank free of cost.
The loan application form contains different columns to be filled in by the applicant. It includes
all information required about the borrower, purpose of loan, nature of facility (cash-credit,
overdraft etc) required, period of repayment, nature of security offered, and the financial status
of the borrower.
A running business limit may be required to furnish additional information in respect of :
— Assets and liabilities
— Profit and loss for the last 2 to 3 years.
— The names and addresses of three persons (which may include borrowers, suppliers,
customers and bankers) for reference purposes.
(ii) Submission of form along with relevant documents
The loan application form duly filled in should be submitted to the bank along with the relevant
documents.
(iii) Sanctioning of loan
The bank scrutinizes the documents submitted and determines the credit worthiness of the
applicant. If it is found to be feasible, the loan is sanctioned. If the loan is for Rs 5000 or less,
normally the Branch Manager himself can take the decision and sanction the loan. In case the
amount of loan is more than Rs 5000, the application is considered at regional, zonal or head
office level, depending on the amount of loan.
(iv) Executing the Agreement
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When the loan is sanctioned by the bank and the borrower is informed about it, he will have to
execute an agreement with the bank regarding terms and condition for the amount of loan raised.
(v) Arrangement of Security for Loan
The borrower will now arrange for security against the loan. These securities may be immovable
properties, shares, debentures, fixed deposit receipts, and other documents, like, Kisan Vikas
Patra, National Savings Certificate, as per agreement. When the borrower completes all the
formalities, he is allowed to get the amount of loan/advance/ over draft as sanctioned by the
bank. In case of ‘discounting of bills’, the bank credits the amount of bill to the customer’s
account before the realization of the bill and thus, makes available the fund. In case, the bill is
dishonored on due date, the amount due on the bill together with interest and other charges are
payable by the party whose bill is discounted.
Chapter 3.
WORKING CAPITAL MANAGEMENT
3.1.Introduction
Working capital management is concerned with the problems arise in attempting to manage the
current assets, the current liabilities and the inter relationship that exist between them. The term
current assets refers to those assets which in ordinary course of business can be, or, will be,
turned in to cash within one year without undergoing a diminution in value and without
disrupting the operation of the firm. The major current assets are cash, marketable securities,
account receivable and inventory. Current liabilities ware those liabilities which intended at their
inception to be paid in ordinary course of business, within a year, out of the current assets or
earnings of the concern.
The basic current liabilities are account payable, bill payable, bank over-draft, and outstanding
expenses.
The goal of working capital management is to manage the firm’s current assets and current
liabilities in such way that the satisfactory level of working capital is mentioned. The current
29
should be large enough to cover its current liabilities in order to ensure a reasonable margin of
the safety.
Definition:-
1. According to Guttmann & Dougall
“Excess of current assets over current liabilities”.
1. According to Park & Gladson
“The excess of current assets of a business (i.e. cash, accounts receivables, inventories) over
current items owned to employees and others (such as salaries & wages payable, accounts
payable, taxes owned to government)”.
3.2) Need of working capital management
The need for working capital gross or current assets cannot be over emphasized. As already
observed, the objective of financial decision-making is to maximize the shareholders wealth. To
achieve this, it is necessary to generate sufficient profits can be earned will naturally depend
upon the magnitude of the sales among other things but sales cannot convert into cash. There is a
need for working capital in the form of current assets to deal with the problem arising out of lack
of immediate realization of cash against goods sold. Therefore sufficient working capital is
necessary to sustain sales activity. Technically this refers to operating or cash cycle. If the
company has certain amount of cash, it will be required for purchasing the raw material may be
available on credit basis. Then the company has to spend some amount for labour and factory
overhead to convert the raw material in work in progress, and ultimately finished goods. These
finished goods convert in to sales on credit basis in the form of sundry debtors. Sundry debtors
are converting into cash after expiry of credit period. Thus some amount of cash is blocked in
raw materials, WIP, finished goods, and sundry debtors and day to day cash requirements.
However some part of current assets may be financed by the current liabilities also. The amount
30
required to be invested in this current assets is always higher than the funds available from
current liabilities. This is the precise reason why the needs for working capital arise.
3.3. Gross working capital and Net working capital
There are two concepts of working capital management
1. Gross working capital
Gross working capital refers to the firm’s investment in current assets. Current assets are the
assets which can be convert in to cash within year includes cash, short-term securities, debtors,
bills receivable and inventory.
2. Net working capital
Net working capital refers to the difference between current assets and current liabilities. Current
liabilities are those claims of outsiders which are expected to mature for payment within an
accounting year and include creditors, bills payable and outstanding expenses.
Net working capital can be positive or negative. Efficient working capital management requires
that firms should operate with some amount of net working capital, the exact amount varying
from firm to firm and depending, among other things; on the nature of industries net working
capital is necessary because the cash outflows and inflows do not coincide. The cash outflows
resulting from payment of current liabilities are relatively predictable. The cash inflow are
31
however difficult to predict. The more predictable the cash inflows are, the less net working
capital will be required. The concept of working capital was, first evolved by Karl Marx. Marx
used the term ‘variable capital’ means outlays for payrolls advanced to workers before the
completion of work. He compared this with ‘constant capital’ which according to him is nothing
but ‘dead labour’. This ‘variable capital’ is nothing This ‘variable capital’ is nothing but wage
fund which remains blocked in terms of financial management, in work-in-process along with
other operating expenses until it is released through sale of finished goods. Although Marx did
not mentioned that workers also gave credit to the firm by accepting periodical payment of
wages which funded a portioned of W.I.P, the concept of working capital, as we understand
today was embedded in his ‘variable capital’.
3.4.CONCEPTS
Gross working capital referred to as working capital, means the total current assets.
Net working capital can be explained in two ways :
The difference between the current assets and current liabilities.
The portion of current assets which is financed with long term funds.
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CALCULATION OF FINANCIAL RATIOS Ratio analysis is a powerful tool of financial
analysis. In financial analysis, a ratio is used as a benchmark for evaluating the financial position
and performance of the firm. A ratio in itself has no meaning. It should be compared with some
standard. Standards of comparison may consist of:
A)Past ratios
B)Competitors ratios
C)Industry ratios
D)Projected ratios
The most frequently used ratios by bank and financial analysts are:
A)Liquidity Ratio
B)Degree of financial leverage of debt
C)Profitability
C)Efficiency
D)Value
The task of financial manager in managing working capital efficiently is to ensure requisite
liquidity in the operations of the enterprise. The liquidity of a business firm is measured by its
ability to satisfy short-term obligations as they become due. The two basic measures of a frrm’s
overall liquidity are –
Current Ratio
Liquid ratio
CURRENT RATIO
The current ratio is the ratio of total current assets to total liabilities. It is calculated by dividing
current assets by current liabilities.
CURRENT ASSETS
CURRENT RATIO = ----------------------------------
CURRENT LIABILITIES
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Current assets include –
cash and bank balances
marketable securities
Inventory of raw materials
Semi-finished goods or work-in-progress
Finished goods
Debtors net of provision for bad and doubtful debts
Bills receivables
Prepaid expenses
The current liabilities are defined as liabilities which are short-term maturing obligations to be
met, as originally contemplated, within a tear, consist of –
Trade creditors
Bills payable
Working capital credit by banks
Provision for taxation
Dividends payable
Outstanding expenses
The current ratio of a measures its short term liquidity, that is, its ability to meet short-term
obligations. The higher the current ratio, the larger is the amount of rupees available per rupee of
current liability, the more is the firm’s ability to meet current obligations and the greater is the
safety of funds of short-term creditors. The firm should maintain sufficient/ requisite amount of
current assets which should be larger than current liabilities so that the firm would be assured of
being able to pay its current maturing debts as and when it becomes due. The current ratio
measures the size of the short-term liquidity ‘buffer’. A satisfactory current ratio would enable a
firm to meet its obligations. Ideal current ratio should be 1.33.
LIQUID RATIO:
The acid test ratio provides a check on the liquidity position of a firm. The quick ratio or the acid
test ratio is a more rigorous and penetrating test of the liquidity position of a position. The acid-
test ratio is a measure of liquidity designed to overcome the shortcomings of the current ratio.
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It is often referred to as quick ratio because it is a measurement of a firm’s ability to convert its
liabilities. Thus, it is a measure of quick or acid liquidity. The acid test ratio is the ratio between
quick current assets and current liabilities and is calculated by dividing the quick assets and
current liabilities.
QUICK ASSETS
LIQUID RATIO= ----------------------------------------
CURRENT LIABILITIES
The term quick assets refers to current assets which can be converted into cash immediately or at
a short notice without diminution of value.
Quick asset includes
Cash and Bank balances
Short-term marketable securities
Debtors/ receivables
And it excludes
Prepaid Expenses
Inventory.
The reason of excluding inventory is that it is not easily and readily convertible into cash.
Prepaid expenses by their very nature are not available to pay off current debts.
Current liabilities exclude the bank borrowings.
So, the ratio can be written as
QUICK ASSET — PREPAID EXPENSES — INVENTORIES
LIQUID RATIO= -------------------------------------------------------------------------------------------
CURRENT LIABILITIES — BANK BORROWINGS
Generally, an acid-test ratio of 1:1 is considered satisfactory as a firm can easily meet all
current claims.
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ANALYZING DEBT: Debt ratios show the extent to which a firm is relying on debt to finance
its investments and operations, and how well it can manage the debt obligation, i.e. repayment of
principal and periodic interest. If the company is unable to pay its debt, it will be forced into
bankruptcy. On the positive side, use of debt is beneficial as it provides tax benefits to the firm,
and allows it to exploit business opportunities and grow.
Note that total debt includes short-term debt (bank advances + the current portion of long-term
debt) and long-term debt (bonds, leases, notes payable)
1. Leverage Ratios
Debt to Equity Ratio = Total Debt / Total Equity
This shows the firm’s degree of leverage or its reliance on external debt for financing.
Debt to Assets Ratio = Total Debt / Total assets
In general, with either of the above ratios, the lower the ratio, the more conservative (and
probably safer) the company is. However, if a company is not using debt, it may be foregoing
investment and growth opportunities. This is a question that can be answered only by further
company and industry research.
Interest Coverage (or Times Interest Earned) Ratio = Earnings before Interest and Taxes /
Annual Interest Expense
This shows the firm’s ability to cover fixed interest charges (on both short-term and long-term
debt) with current earnings. The margin of safety that is acceptable varies within and across
industries, and also depends on the revenue generation history of a firm (especially the
consistency of earnings from period to period and year to year).
Cash Flow Coverage = Net Cash Flow / Annual Interest Expense
Net cash flow = Net Income is either subtracted from or added to non-cash items, as applicable
(e.g. -equity income + minority interest in earnings of subsidiary + deferred income taxes +
depreciation + depletion + amortization expenses)
Since depreciation is usually the largest non-cash item in most companies, analysts often
approximate Net cash flow as being equivalent to Net Income + Depreciation.
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Cash flow is a “critical variable” in assessing a company. If a company is showing high profits
but has poor cash flow, one should investigate further before passing a favorable opinion on the
company. Analysts prefer ratio #3 to ratio #2.
ANALYZING PROFITABILITY: Profitability is a relative term. It is hard to say what
percentage of profits represents a profitable firm, as profits depend on factors such as the
position of the company and its products on the competitive life cycle (for example profits will
be lower in the initial years when investment is high), on competitive conditions in the industry,
and on borrowing costs. For decision-making, bank is mainly concerned with the present value
of expected future profits. Past or current profits are important only as they help us to ascertain
future profits, by identifying historical and forecasted trends of profits and sales.
Net Profit Margin = Profit after taxes / Sales
Return on Assets (ROA) = Profit after taxes / Total Assets
Return on Equity (ROE) =Profit after taxes / Shareholders‟ Equity (book value)
Earnings per Common share (EPS) = (Profits after taxes - Preferred Dividend) / (# of
common shares outstanding)
Payout Ratio = Cash Dividends / Net Income.
ANALYZING EFFECIENY: These ratios reflect how well the firm’s assets are being
managed.
The inventory ratio shows how fast the inventory is being produced and sold.
Inventory Turnover = Cost of Goods Sold / Average Inventory
This ratio shows how quickly the inventory is being turned over (or sold) to generate sales. A
higher ratio implies the firm is more efficient in managing inventories by minimizing the
investment in inventories. Thus a ratio of 12 would mean that the inventory turns over 12 times,
or the average inventory is sold in a month.
Total Assets Turnover = Sales / Average Total Assets
This ratio shows how much sales the firm is generating for every dollar of investment in assets.
The higher the ratio, the better is the performance of the bank.
Accounts Receivable Turnover = Annual Credit Sales / Average Receivables
Average Collection period = Average Accounts Receivable / (Total Sales / 365)
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The last two ratios show the firm’s efficiency in collecting cash from its credit sales. While a low
ratio is good, it could also mean that the firm is being very strict in its credit policy, which may
not attract customers.
Days in Inventory = Days in a year / Inventory turnover
This is referred to as the “shelf-life” i.e. how quickly the manufactured product is sold off the
shelf. Thus days in Inventory and inventory turnover ratios are related.
VALUE RATIOS: Value ratios show the “embedded value” in stocks, and are used by investors
as a screening device before making investments.
1. Price to Earnings Ratio (P/E) = Current Market Price per Share / After-tax Earnings
per Share
2. Dividend Yield = Annual Dividends per Share / Current Market Price per Share
DEBT SERVICE COVERAGE RATIO:
The debt service coverage ratio (DSCR) is the ratio of cash available for debt servicing to
interest, principal and lease payments. It is a popular benchmark used in the measurement of an
entity's (person or corporation) ability to produce enough cash to cover its debt (including lease)
payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in
commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it
may be a loan condition or covenant. Breaching a DSCR covenant can, in some circumstances,
be an act of default.
In general, it is calculated by:
Net Operating Income/Total Debt Services
A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1 say 0.95 would
mean that there is only enough net operating income to cover 95% of annual debt payments. For
example, in the context of personal finance, this would mean that the borrower would have to
delve into his or her personal funds every month to keep the project afloat. Generally, lenders
frown on a negative cash flow, but some allow it if the borrower has strong outside income.
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3.5) Type of working capital
The operating cycle creates the need for current assets (working capital).However the need does
not come to an end after the cycle is completed to explain this continuing need of current assets a
destination should be drawn between permanent and temporary working capital.
1) Permanent working capital
The need for current assets arises, as already observed, because of the cash cycle. To carry on
business certain minimum level of working capital is necessary on continues and uninterrupted
basis. For all practical purpose, this requirement will have to be met permanent as with other
fixed assets. This requirement refers to as permanent or fixed working capital
2) Temporary working capital
Any amount over and above the permanent level of working capital is temporary, fluctuating or
variable, working capital. This portion of the required working capital is needed to meet
fluctuation in demand consequent upon changes in production and sales as result of seasonal
changes
Fig 2. Working Capital
Graph shows that the permanent level is fairly castanet; while temporary working capital is
fluctuating in the case of an expanding firm the permanent working capital line may not be
horizontal. This may be because of changes in demand for permanent current assets might be
increasing to support a rising level of activity.
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3.6 Determinants of working capital
The amount of working capital is depends upon a following factors
1. Nature of business
Some businesses are such, due to their very nature, that their requirement of fixed capital is more
rather than working capital. These businesses sell services and not the commodities and that too
on cash basis. As such, no founds are blocked in piling inventories and also no funds are blocked
in receivables. E.g.public utility services like railways, infrastructure oriented project etc. there
requirement of working capital is less. On the other hand, there are some businesses like trading
activity, where requirement of fixed capital is less but more money is blocked in inventories and
debtors.
2. Length of production cycle
In some business like machine tools industry, the time gap between the acquisition of raw
material till the end of final production of finished products itself is quite high. As such amount
may be blocked either in raw material or work in progress or finished goods or even in debtors.
Naturally there need of working capital is high.
3. Size and growth of business
In very small company the working capital requirement is quit high due to high overhead, higher
buying and selling cost etc. as such medium size business positively has edge over the small
companies. But if the business start growing after certain limit, the working capital requirements
may adversely affect by the increasing size.
4. Business/ Trade cycle
If the company is the operating in the time of boom, the working capital requirement may be
more as the company may like to buy more raw material, may increase the production and sales
to take the benefit of favorable market, due to increase in the sales, there may more and more
amount of funds blocked in stock and debtors etc. similarly in the case of depressions also,
working capital may be high as the sales terms of value and quantity may be reducing, there may
be unnecessary piling up of stack without getting sold, the receivable may not be recovered in
time etc.
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5. Terms of purchase and sales
Some time due to competition or custom, it may be necessary for the company to extend more
and more credit to customers, as result which more and more amount is locked up in debtors or
bills receivables which increase the working capital requirement. On the other hand, in the case
of purchase, if the credit is offered by suppliers of goods and services, a part of working capital
requirement may be financed by them, but it is necessary to purchase on cash basis, the working
capital requirement will be higher.
6. Profitability
The profitability of the business may be vary in each and every individual case, which is in turn
its depend on numerous factors, but high profitability will positively reduce the strain on
working capital requirement of the company, because the profits to the extent that they earned in
cash may be used to meet the working capital requirement of the company.
7) Operating efficiency
If the business is carried on more efficiently, it can operate in profits which may reduce the strain
on working capital; it may ensure proper utilization of existing resources by eliminating the
waste and improved coordination etc.
8)Production policy – The quantum of working capital is also determined by production policy.
In the case of certain lines of business, the demand for products is seasonal, that is, they are
purchased during the certain months of the year.
9) Credit policy— The credit policy relating to sales and purchases also affects the working
capital. The credit policy influences the requirement of working capital in two ways:
Through credit terms granted by the firm to its customers/ buyers of goods
Credit terms available to the firm from its creditors.
The credit terms granted to customers have a bearing on the magnitude of working capital by
determining the level of book debts. The credit sales result in higher book debts (receivables).
Higher book debts mean more working capital. On the other hand, if liberal credit terms are
available from the suppliers of goods (trade creditors), the need for working capital is less.
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10) Growth and Expansion— As a company grows, it is logical to expect that a larger amount
of working capital is required. It is, of course, difficult to determine precisely the relationship
between the growth in the volume of business of a company and the increase in its working
capital. But it is true that growth industries require more working capital than those that are
static.
11) Vagaries in the availability of Raw Material – The availability of certain raw materials on
a continuous basis without interruption would sometimes affect the requirement of working
capital. There may be some materials which cannot be procured easily either because of their
sources are few or they are irregular. To sustain smooth production, therefore, the firm might be
compelled to purchase and stock them far in excess of genuine production needs. This will result
in an excessive inventory of such materials. This will lead to a relatively high level of working
capital.
12) Profit level – The level of profits earned differ from enterprise to enterprise. In general, the
nature of the product, hold on the market, quality of management and monopoly power would
determine the profit earned by a firm. Higher profit margin would improve the prospects of
generating more internal funds thereby contributing to the working capital pool. The net profit is
a source of working capital to the extent that it has been earned in cash. The cash profit can be
found by adjusting non-cash items such as depreciation, outstanding expenses and losses written
off, in the net profit. But in practice, cash is used for augmenting stock, book debts, and fixed
assets. The availability of internal funds for working capital requirements is determined not
merely by the profit margin but also by the manner of appropriating profits.
13) Level of taxes – The first appropriation out of profits is payment or provision for tax. The
amount of taxes to be paid is determined by the prevailing tax regulations. Tax liability is, in a
sense, short-term liability payable in cash. An adequate provision for tax payment is, therefore,
an important aspect of working capital planning. If tax liability increases, it leads to an increase
in the requirement of working capital and vice versa.
14) Dividend policy – Another appropriation of profits which has a bearing on working capital
is dividend payment. The payment of dividend consumes cash resources and, thereby, affects the
working capital to that extent. If any firm does not pay dividend but retains the profits, working
42
capital increases. In planning working capital requirements, therefore, a basic question to be
decided is whether profits will be retained or paid out to shareholders.
15) Depreciation policy— Depreciation policy also exerts an influence on the quantum of
working capital. Depreciation charges do not involve any cash outflows. The effect of
depreciation policy on working capital is indirect.
16) Price level changes – Changes in the price level also affect the requirements of working
capital. Rising prices necessitate the use of more funds for maintaining an existing level of
activity. For the same level of current assets, higher cash layouts are required. The effect of
rising prices is that a higher amount of working capital is required. In the case of companies
which can raise their prices proportionately, there is no serious problem regarding working
capital.
To conclude, the level of working capital is determined by a wide variety of factors which
are partly internal to the firm and partly external (environmental) to it. Efficient working
capital management requires efficient planning and a constant review of the needs of an
appropriate working capita strategy.
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3.7. WORKING CAPITAL CYCLE
AR converted to cash
Cash to inventory
Goods/services
converted to
accounts receivable
Fig 3. Working Capital Cycle
44
Cash
Sales Order
Produces goods/services
Deliver goods/services
Collect Account
receivable
3.8. WORKING CAPITAL FINANCING
Working Capital is financed by following sources:
•OWNED FUNDS
A portion of long term funds, equity share capital and reserves & surplus is utilized to fund
working capital
•BANK BORROWINGS
Various bank products like cash credit, packing credit, bills discounting etc.
•CREDITORS
FUNDING THE CASH OPERATING CYCLE
Raw Materials W-I-P Finished Good Debtors
Trade Payables Bank Borrowings + LongTermfunds
Fig 4. Cash operating Cycle
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3.9. WORKING CPITAL PRODUCTS
Working Capital Products are broadly classified under three categories:
FUND BASED
NON FUND BASED
STRUCTURED PRODUCT
1)FUND BASED
A)Domestic
Cash Credit
Over Draft Facility
Bill finance
Documentary
Clean
B) Export
Pre-shipment
Postshipment
2) NON FUND BASED
Letter of Credit
Bank guarantee
3) STRUCTURED PRODUCT
Commercial Papers
Buyers’and Suppliers’ Credit
Corporate Loan
Securitisation
Factoring
Forfeiting
3.10.VARIOUS METHODS OF WORKING CAPITAL ASSESSMENT: 46
Like many other activities of the banks, method and quantum of short-term finance that can be
granted to a corporate was mandated by the Reserve Bank of India till 1994.
NAYAK COMMITTEE METHOD—
With freedom given to the banks in evolving their own method of lending, generally the banks
evolved their lending policy accordingly to which borrowers with working capital limits upto Rs.
2crores (Rs. 7.5 crore for SME borrowers) which will be assessed as per Nayak Commiittee
Recommendations ( TURNOVER METHOD).
The calculation of bank finance under this method is as follows:
1. Estimated Sales Turnover as on current year XXXX Lacs
2. 25% of the Estimated Turnover as on current year XXX Lacs
3. 5% of the Estimated Turnover as on current year XXX Lacs
4. Available net working capital in the past financial year XXX Lacs
5. 2 – 3 XXX Lacs
6. 2 – 4 XXX Lacs
7. Maximum Permissible Bank Finance
(5 or 6 whichever is lower) XXX Lacs
MPBF-II METHOD—
Borrowers enjoying working capital limits of Rs. 2 crore and above (Rs. 7.5 crore and above for
SME borrowers) and upto Rs. 10 crores, will be assessed as per the entirely traditional method of
arriving at Maximum Permissible Bank Finance (MPBF) calling for the CMA data.
1. Total Current Assets XXXX Lacs
2. Current Liabilities (other than bank borrowings) XXX Lacs
3. Working Capital Gap XXX Lacs
4. Min. stipulated net working capital- 25% of total current assets
other than export receivables XXX Lacs
5. Actual / projected net Working capital XXX Lacs
6. Item 3 minus item 4 XXX Lacs
7. Item 3 minus item 5 XXX Lacs
8. Maximum permissible by bank finance
47
(item 6 or 7 whichever is lower) XXX Lacs
9. Excess borrowings, if any representing short fall in NWC (4-5) XXX Lacs
Excess borrowing (short fall in NWC) shall be ensured by additional funds to be brought in by
the applicant or by additional bank finance over MPBF.
Under this method, it was thought that the borrower should provide for a minimum of 25% of
total current assets out of long-term funds i.e., owned funds plus term borrowings. A certain
level of credit for purchases and other current liabilities will be available to fund the buildup of
current assets and the bank will provide the balance (MPBF). Consequently, total current
liabilities inclusive of bank borrowings could not exceed 75% of current assets specially
inventory. Generally, bankers are stipulating 50% margin on book debts and in case of valued
debtors they are lowering the margin to the tune of 40% to 30% on case to case basis.
Important Aspects of MPBF method
Production/Sales estimates
Profitability estimates
Inventory/receivables norms
Build up of Net Working Capital
CMA data is a tool used by the bankers to assess the requirement of working capital. It is divided
into six parts as follows:
Form-I Particulars of Existing & Proposed Limits
Form-II Operating Statement
Form-III Analysis of Balance Sheet
Form-IV Comparative Statement of Current Assets & Current Liabilities
Form-V Computation of Maximum Permissible Bank Finance (MPBF)
Form-VI Funds Flow Statement
Limitations:
48
Represents position on a particular date
Not tuned to Peak Time Assessment
Not applicable for service industries
In practice may differ with Drawing Power
CASH-BUDGET METHOD
In this method credit appraisal is entirely done by total inflows and outflows of the firm/
company during peak season and slack season throughout the year. This method is applicable
for:
Seasonal industries (sugar/ rice/ mills/ textiles/ tea/ tobacco/ fertilizers)
Contractors
Real Estate Developers
Software Exporters
Borrowers enjoying working capital limits of Rs. 10 crores and above option has been given to
the borrower to be assessed as per the Cash Budget Method. For industries like the mentioned
above where in the pattern of financing the peak cash deficit(s) is followed all along, the existing
system of assessment under the Cash Budget Method is followed.
Limitations:
Will not reflect changes in various current assets and current liabilities.
It does not give any clue whether a company is earning profit or not.
Funds flow statement is required to detect any diversion of funds. But this method
does not include Funds flow statement.
Chapter 4
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CREDIT APPRAISAL AND MONITORING: COMMON ISSUES
4.1. WHAT IS CREDIT APPRAISAL?
Credit appraisal is a process to ascertain the risks associated with the extension of the credit
facility. It is generally carried by the financial institutions which are involved in providing
financial funding to its customer. Credit risk is a risk related to non-payment of the credit
obtained by the customers of a bank. Thus, it is necessary to appraise the credibility of the
customer in order to mitigate the credit risk. Proper evaluation of the customers is performed
which measures the financial condition and the ability of the customer to repay back the loan in
future. Generally, the credit facilities are extended against the security for which the credit limit
is being sanctioned, known as PRIME SECURITY. Apart from that, financial institutions take
some other securities like fixed deposits, NSCs, LICs, KVPs, immovable properties, to be
considered as COLLATERAL SECURITY for the credit limits sanctioned by them. But even
though the loans are backed by collateral, financial institutions are normally interested in the
actual loan amount to be repaid along with the interest.
Fig 5. Credit Appraisal
50
4.2. DATA TO BE OBTAINED FOR CREDIT ASSESSMENT:
Loan application of the credit facilities. A profile of the firm/ company. Financial Statements of previous years. Estimates/ projections (with quantitative details) Asset liability statement of the borrowers/ guarantors. Supporting details of the financials including income tax return, stock/ book debt
statements etc.
Apart from that bankers are to obtain the market reports of the proposed borrower as also credit opinion from other banks/ financial institutions, if any, as per INDIAN BANKS ASSOCIATION (IBA) approved format. In spite of that due to latest technological improvements bankers are viewing any default of payments towards credit obligations from other financial institutions through online CIBIL System.
51
4.3. CREDIT MONITORING: Common Issues
Caution needs to be exercised when loan is to be sanctioned to a party who operates in rented
premises and leave & license agreement period is less than repayment period of the loan.
Specific enquiry should be made for approaching IOB and whether loan application has been
simultaneously submitted to other banks.
Apart from obtaining usual credit report from existing bankers, it is also necessary to find out
from other sources about the borrower’s operation with that banker as it is quite likely for any
banker to give normal report if they do not wish to retain account.
Bank should prepare S (Strength) W (Weakness) O (Opportunity) T (Threat) analysis in case of
advances of say Rs. 15 Lacs & above.
Whenever borrower submits IT Return then it should be ensured that it has been filed every year
rather all a time or in a short span of few months. It is obvious from such so-called compliance
that IT Return has been filed just to meet the stipulation for processing of loan application.
Loan should not be granted on the basis of income affidavit submitted by borrower. Reasons for
not filing IT Return should be enquired.
Net worth of secureties should be ascertained to confirm that he has the capacity to pay the loan
in case of default by borrower.
Bank should stipulate the condition that unsecured loans should not be withdrawn till currency of
Bank Loan.
Bank should stipulate the condition that expansion plans would be executed only after consulting
bank.
Bank should stipulate the condition that Key personnel appointment will be approved /
confirmed by Bank.
Collateral security should be taken to the extent possible. e.g. Residential flat, LIC, Shares, NSC,
KVP etc. More so when effective/economical life of the asset hypothecated is less than
repayment period of loan.
Bank’s nameplate should be given to borrower and his acknowledgement should be taken,
followed by his letter confirming the affixing the nameplate.
Bank should stipulate that borrower should submit Monthly Information as per the format
52
stipulated by Bank.
Undertaking to deal exclusively with our bank is obtained and borrower blindly executes the
same. In fact we are aware that borrower is operating with other banks. In such case, in case he
cannot close the account with other banks as the same may be required for ST, Excise etc. then
we should specifically give permission & bank statements should be obtained monthly of such
accounts .Otherwise account closure certificate should be obtained
Disbursement should be directly made to Builder, Vendor etc. depending on type of loan. In case
the same is to be reimbursed to borrower, then stamped receipt, bills, installation report,
inspection report, insurance policy, valuation report etc. should be available on record.
Post dated cheques (payable fortnightly) should be taken from large borrowers (New) as well as
from existing borrowers not repaying the loan regularly
Insurance policy of adequate sum should be taken covering the appropriate risks such as Fire,
Burglary etc.
Security documents should be verified periodically to confirm with entries in Security Register.
Valuation report should be obtained say once in three years of security offered such as Land,
Machinery, Gala, Flat, and Vehicle etc.
Accounts, Audit report, I.T.Return etc. of Borrower, Directors, Partners and Guarantors should
be obtained in November every year.
Assets & Liabilities statement of Borrower, Directors, Partners and Guarantors should be
obtained every year.
Term Loans should be reviewed every year.
Caution is called for whenever lump sum payment is arranged by borrower to regularize the loan
account.
Bank should avoid the temptation of ever greening / window dressing the CC / Loan
account
Recovery notice should be sent whenever overdue is noticed.
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4.3.1 Additional requirements in case of Loan is granted to Company:
Search Report of ROC records should be obtained in case loan is proposed to be given / given to
Pvt. Or Public ltd. Company.
Company Secretarial Compliance Report should also be obtained in case loan has been
given to Pvt. Or Public ltd. Company.
Board resolution for making loan application to a Bank should also be obtained along with Loan
application.
Board resolution for acceptance of terms & conditions of sanctions and for execution of
documents should be kept on record. The said resolution should be typed on Company’s
letterhead and authenticated by chairman of the meeting and not by any director.
Common seal of the company should be affixed on all documents executed by the company.
Form 8 & Form 13 should be filed with ROC within 30 days of loan documentation.
Bank should stipulate the condition that dividend should not be declared without approval
of Bank.
Promoter’s contribution should be brought in the form of Capital.
If Authorized capital is not adequate to accommodate promoter’s capital
Contribution, then borrower should be requested to enhance authorized Capital clause
immediately.
List of shareholders & their relationship with the promoters /management of the company should
be ascertained.
Details of Shareholding should be obtained.
Copies of various forms filed with ROC should be obtained such Annual Audited Accounts,
Annual Return, Allotment of Shares, Agreements, Resolutions etc. should be obtained.
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4.3.2 Additional requirements in case of Loan is granted to Firm:
Certified true copy of Partnership Deed should be obtained. Original deed should also be referred
to confirm the Xerox copy.
Partnership deed should be referred to confirm as to whether firm could do banking
operations with Co-operative bank and how bank account will be operated?
Partnership should be registered with Registrar of Firms. Relevant registration certificate
and other papers filed should be kept on record.
Bank should stipulate condition that says 25 % profit & Salary due to partner should be
retained in the business
REGISTERS
HO should prescribe the format of various loan registers to be maintained by branches.
HO should arrange to print these registers or procure them on behalf of branches to ensure
uniformity.
Security register (computer) should be up dated regularly.
4.4. PRINCIPLES OF LENDING
55
According to general principles of lending, all mortgage originators should act in "good faith and
with fair dealings" in any transaction. A reliable customer forms the basis of a successful
lending. The following principles act as the foundation of a judicious lending:
Safety of funds ensures that the bank, although being a profit generating unit, continues
to build and retain the trust of the public at large.
Security accepted from the borrower as an alternative for recovery of advances in case of
default must be of significant value.
Purpose or the objective of advances should remain in favor of nation‟s security. It
should not be anti- social or illegal.
Profitability and yield on advances should be in line with the banks objective, so the
advances made must be successful.
Liquidity of advances made by the bank indicates its ability to meet its deposit liabilities,
so the advances made should be adequately liquid.
Integrity of borrower is very vital to consider the loan proposal envisaged by him for
further sanction.
Adequacy of bank finance is of prime importance for a borrower to accomplish his
project so both under and over financing should be avoided by the bank.
Timely availability of funds to the borrowers helps the bank grow in the current scenario.
These principles strengthen the bank finance eventually leading to safe advances.
4.5 PRINCIPLES OF BASEL II ACCORD
56
4.5.1 Basel II consists of three pillars
Fig 6. Basel II
PILLAR 1
It sets principles for minimum capital requirements to cover both credit and operational risks.
Capital requirement is a guarantee amount against unexpected losses. It is taken as equity in
banks accounts. To determine minimum capital requirements, a bank can either use external
sources or an internal rating base approach. There are three fundamental components to calculate
the minimum capital requirement according to Basel II.
a) Probability of Default (PD): It is the likelihood that an applicant will default in one year time
period.
b) Loss Given Default (LGD): It is the proportion of the exposure that will be lost if the applicant
defaults.
c)Exposure at Default (EAD): The nominal value of loan granted. The minimum capital
requirement (MCR) estimation is shown in with respect to Basel II:
57
MCR = 0.08*RW*EAD = 0.08 RWA
Here
RW is the risk weight calculated by using PD, LGD and remaining maturity of exposure. It has
specific formulas for each asset type. RWA is the risk weighted asset.
EL = PD*EAD*LGD
MCL=EAD*LGD*PD-b*EL
Where
EL is the expected loss and b is the proportion of expected loss of loan covered by minimum
capital requirement.
PILLAR 2
It defines principles for supervisors to review assessments to ensure adequate capital. The rating
system and risk management activities are checked by supervisors. Supervisors review process,
to be sure that banks have adequate and valid techniques for capital requirements. Accurate and
valid techniques lead to better credit risk management for the banks. Banks are expected to
manage their internal capital assessments.
According to Basel Committee, there is a relation between capital required and banks risk. Banks
should have a process for assessing overall capital adequacy in relation to their risk profile.
Supervisors are responsible for the review and evaluation of the assessment procedure. When
supervisors think the validity of the rating process is not adequate, they can take appropriate
actions. They can take early stage actions to prevent capitals from falling below the minimum
levels required to support the risk characteristic.
PILLAR 3
It sets principles about banks disclosure of information concerning their risk. Its purpose is to
maintain the market discipline by completing pillar 1 and pillar 2. The Basel Committee
encourages market discipline by developing sets of disclosure requirements.
According to the new accord, banks should have a disclosure policy and implement a process to
evaluate the appropriateness of the disclosure. For each separate risk areas banks must describe
their risk management objectives and policies.
58
4.5.2 PD Dynamics
59
Probability of default is one of the challenging factors that should be estimated while
determining the minimum capital requirement. New Accord has sets principles in estimating PD.
According to Basel II, there are two definitions of default:
a) The bank considers that the obligor is unlikely to pay its credit. There are four main indicators
that bank considers the obligor is unlikely to pat the obligation:
• The bank puts the obligation on an non-accrued stratus
• The bank sells the credit obligation at a material credit related economic Loss.
• The bank consents to a distressed restriction of credit obligation.
• The obligor sought or has been placed in bankruptcy.
b) The obligor past due more than 90 days on credit obligation to the bank.
Banks should have a rating system of its obligor with at least 7 grades having meaningful
distribution of exposure. One of the grades should be for no defaulted obligor and one for
defaulted only. For each grade there should be one PD estimate common for all individuals in
that grade. It is called as pooled PD.
There are three approaches to estimate pooled PD.
a) Historical experience approach:
In this approach, PD for the grade is estimated by using the historical observed data default
frequencies. In other words, the proportion of defaulted obligers in a specific grade is taken as
pooled PD.
b)Statistical Model Approach
In that approach, firstly predictive statistical models are used to estimate default probabilities of
obligor’s. Then, for each grade the mean or median of PDs are taken as pooled PD.
c)External Mapping Approach
In this approach, firstly a mapping procedure is established to link internal ratings to external
ratings. The pooled PD of external rating is assigned to internal rating by means the mapping
established before.
Basel II allows the banks to use simple averages of one year default rates while estimating
pooled PD.
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While establishing the internal rating process, the historical data should be at least 5 years, and
the data used to build the model should be representative of the population. Where only limiting
data are available or there are limitations of assumptions of the techniques, banks should add the
margins of conservatism in their PD estimates to avoid over optimism. The margin of
conservatism is determined according to the error rates of estimates depending on the
satisfactory of the models. There should be only one primary technique used to estimate PD, the
other methods can be used just for comparison. Therefore, the best model should be taken as the
primary model representing the data.
After the estimation of PDs, the rating classes are needed to be built. The banks are allowed to
use the scale of external institutions.
In the PD estimation process, just building the model is not enough supervisors need to know not
only the application also the validity of the estimates. Banks should guarantee to the supervisor
that the estimates are accurate and robust and the model has good predictive power. For this
purpose, a validation process should be built.
The scoring models are built by using a subset of available information. While determining the
variables relevant for the estimation of PD, banks should use human judgment. Human judgment
is also needed when evaluating and combining the results.
4.6 FINANCIAL ANALYSIS OF LENDING
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Financial analysis is the systematic examination and interpretation of financial data to evaluate
the past performance of a business, its present conditions and its future prospects. It refers to an
assessment of the viability, stability and profitability of a business, sub-business or a project.
Essentially, financial analysis moves from a preliminary investigation of the client to an in depth
examination of operating performance, as interpreted from historical and projected financial
statements. With financial analysis, the advances manager assesses the financial performance of
the company to arrive at a conclusion about the future prospects of the loan repayment.
4.6.1 FINANCIAL ANALYSIS ASSESSES THE FIRM’S:
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1. Profitability - its ability to earn income and sustain growth in both short-term and long-term.
A company's degree of profitability is usually based on the income statement, which reports on
the company's results of operations;
2. Solvency - its ability to pay its obligation to creditors and other third parties in the long-term;
3. Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations;
4. Stability- the firm's ability to remain in business in the long run, without having to sustain
significant losses in the conduct of its business. Assessing a company's stability requires the use
of income statement and balance sheet, as well as other financial and non-financial indicators.
4.6.2 STEPS INVOLVED IN FINANCIAL ANALYSIS OF LENDING
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Step1: Company’s financial statement for at least 3 to 5 years is acquired. The financial
statement must include the following:
Balance sheets
Income statements
Shareholders equity statement
Cash flow statements
Step 2: A quick scanning of all the statements is done to look for large movements in specific
terms from one year to the next. If there is something suspicious, relevant research about the
company is done from the information available to find out the reason. Notes accompanying the
financial statements are also reviewed for additional information that may be significant to
analysis.
Step 3: This stage calls for an exhaustive scrutiny of the balance sheet. While examining, the
advances manager looks for the large changes in overall components of company‟s assets and
liabilities of equity. For example, have fixed assets grown rapidly in one or two years, due to
acquisitions or new facilities? Has the portion of debt grown rapidly, to reflect a new financial
strategy?
Step 4: This level relates to an assessment of the income statement as furnished by the client.
The advances manager looks for the trends overtime. Graphs and growth of the following entries
over the past several years are calculated.
1. Revenue (sales)
2. Net income (profit, earnings)
For each key expense components on the income statement, percentage of sales of each year is
calculated. For example, percentage of cost of goods sold over sales, general and administrative
expenses over sales and development over sales are computed. Favorable and unfavorable trends
are highlighted. Manager determines whether the spending trends support the company‟s
strategies.
Step 5: The very phase pertains to an evaluation of the cash flow statement. It gives information
about the cash inflows and outflows from operations, financing and investing. While the income
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statement provides information about both cash and non-cash items, the cash flow statement
attempts to reconstruct that information to make it clear how cash is obtained and used by the
business, since that is what investors really care about.
Step 6: Calculation of financial ratios- Discussed in Chapter 3.
KEY RATIO LEVELS
PARTICULARS
LOW RISK MEDIUMRISK HIGH RISK
Current Ratio > 1.40 1.20-1.40 <1.20
TOL/TNW <2.00 2.00-3.50 <3.50
Interest Coverage >3.50 2.00-3.50 <2.00
PAT/SALES% >10.00 4.00-10.00 <4.00
Inventory (No. of
days
<60 60-90 >90.00
Debtors (No. of days <45 45-90 >90.00
Debt –Equity Ratio <1.25 1.25-1.75 >1.75
DSCR (For TL) >2.00 1.25-2.00 <1.25
Table 1: Key ratio levels
4.7 CLARIFICATION WITH REGARD TO ASSESSMENT OF WORKING CAPITAL LIMITS
65
Issues raised by banks Clarification
1 2
A Whether banks should sanction working capital
limits on the basis of a minimum of 20 percent of
the projected annual turn over /output value or
whether it is intended that banks should also
arrive at the requirement based on the traditional
approach of production /processing cycle and
there after decide the quantum of need based
finance.If the traditional approach is
followed ,the working capital finance arrived at
could be either more than or less than .In case it is
less than 20%,whether bank should still give 20%
?
The assessment of working capital credit limits
should be done both as per projected turnover
method and traditional method . If credit
requirement based on production/processing
cycle is higher than the one assessed on project
turn over basis ,the same may be sanctioned as
RBI guidelines stipulate bank finance at
minimum of 20% of the projected turnover.On
the other hand of it the assessed credit
requirement is lower than the one assessed on
projected turn over basis,while the credit limit
can be sanctioned at 20% of the projected turn
over ,actual drawals may be allowed on the
basis of drawing power to be determined by the
banks after excluding unpaid stocks. In case of
selective credit control commodities the
drawing power should be determined as
indicated in the RBI directives.
B Whether projected turnover/output value basis
‘gross sale’
The projected turnover/output value ,may be
interpreted as ‘gross sale’ which will include
excise duty also.
C Whether 5% promoter’s stake (Net Working
Capital) should be reckoned with reference to the
projected turnover with reference to working
capital arrived at based on production and process
cycle ?
In terms of extant guidelines the working
capital requirement is to be assessed at 25% of
projeted turnover to be shared between the
borrower and bank viz. borrower contributing
5% of the turnover as NWC and bank providing
finance at a minimum of 20% of the turn
over .The above guideline were framed
66
assuming the average production cycle of 3
months .It is possible that certain industries may
have production cycle of shorter/longer 3
months.While in the case of shorter cycle ,the
same principal could be applied as it the
intention to make available atleast 20% of
turnover by way of bank finance. In case the
cycle is longer ,it is expected that the borrower
should bring in proportionately higher stake in
relation to his requirement of bank
finance.Going by the above principal ,at least
1\5 of working capital requirement should be
brought in by way of NWC.
D Whether 5% NWC should be reckoned with
reference to turnover or with reference to
available long term source; in other words is the
prescribed NWC the minimum amount?
Since the bank finance is only intended to
support need- based requirement of a borrower
if the available NWC(net long term surplus
funds)is more than 5% of the turnover the
former should be reckoned for assessing the
extent of the bank finance.
E Whether drawing power should continue to be
regulated through stocks and whether unpaid
stocks deducted for arriving at drawing power?
It is left to the discretion of the banks.However
in arriving at drawing power,unpaid stocks are
not financed as it would result in double
financing.The drawing power should conform
to RBIdirectives in the case of selective credit
control commodities.
F Since the present instruction cover traders as
well, and most trade is done at market credit,
whether the credit limits should be assessed as
20% of the turnover per se and actual drawing
In case of traders ,while bank finance could be
assessed at 20% of the projected turnover, the
actual drawals should be allowed on the basis of
drawing power to be determined by banks after
67
regulated through stocks ? ensuring that unpaid stocks are excluded. In
case of SCC commodities the RBI directive
should be scrupulously followed.
68
Chapter 5.
A CASE STUDY
While undergoing my project work under the guidance of Indian Overseas Bank authority,
I have been assigned to do the Working Capital Assessment/Appraisal of a partnership
firm M/s XXX Co. ( Name of the firm changed ) which is a trading concern dealing in
Indian manufactured foreign liquor (IMFL).
BACKGROUND OF THE FIRM
XXX Co. is a partnership firm promoted by Mrs. A, Mr. B and Mr. C. They belong to the same
family. Mrs. A is the mother of Mr. B and Mr. C. The unit being established on 09/09/2001
started wholesale dealership trading in Indian manufactured foreign liquor and beer since 2003.
XXX Co., opened their account with INDIAN OVERSEAS BANK since 09-01-2003. At first
they availed a cash credit facility of Rs. 35 Lacs on 08-04-2003, after then it had enhanced to the
tune of Rs. 95 Lacs on 20-09-2004. So long they used to avail the same credit facility without
further enhancement. This limit expired on 31-07-2009. Earlier in this nature of business a
sizeable quantum of credit could be obtained from the manufacturers/ stockists, but as per recent
trend almost all the payments are to be made in advance to get the stocks due to shortage of
supply and huge demand of the product resulting in stiff competition amongst the wholesale
dealers. Sales are going on increasing over the years. In this year, they got an offer of
stockistship of BEER under the brand name of KINGFISHER STRONG and KINGFISHER
PREMIUM product of eminent UB GROUP which has already gain a lions share in the field of
BEER market. It is expected that with the intervention of this lucrative branded BEER market,
their sales turnover would increase by leaps and bounds. For this, they need further Working
Capital. In this year they appealed the bank to enhance the existing credit limit of Rs. 95 Lacs to
the tune of Rs. 200 Lacs. The business is sound and progressing. Partners are creditworthy, well
experienced and enjoying goodwill in the market.
In this trade, the manufacturer fix the price of the product and allow a certain percentage of
discount to the wholesaler. The wholesaler keep a portion of the discount with them and pass the
remaining discount to the retailer. The retailer sells the product at the predetermined price. The
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discount allowed by the manufacturer to them as Stockiest/ Dealers/ Wholesalers is a lump sum
profit, but the same is shown as other income in the balance sheet.
Conduct of the account for full financial year from 01-04-2008 to 31-03-2009
(Rs. In crores)
Nature of facility Limit Max. O/s
Min.O/s
Turn over
Average Utilization
Income Earned
Interest serviced Upto
Cash Credit 0.95 0.97 0.84 6.58 97.26% 0.14 31-03-2009
From 01-04-2009 to 14-08-2009 0.95 0.97 0.88 2.19 96.23% 0.04 31-07-2009
Table 2: Nature of Facility
SWOT ANALYSIS OF THE FIRM:
STRENGTH: Good Entrepreneurship, Knowledge and Experience
WEAKNESS: Advance payment to the stockists for getting the stock, on the contrary sizeable receivables from the retailers.
OPPORTUNITY: Good location of the shop establishment and possibility of getting stockistship of renowned beer of UB group.
THREAT: Competitors.
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SUBJECT’S PRESENT REQUEST
XXX Co. requested for Renewal cum Enhancement of cash credit limit of Rs. 95.00 Lacs to the
tune of Rs. 200.00 Lacs. They submitted all the required data which is very much necessary for
the approval of the request. The details are as follows:
Table 3: Guarantors and their net worth
NAME AGE ADDRESS WORTH (in crores)
AS ON
Mrs. A 59 1.78 10/08/2009
Mr. B 38 1.16 -do-
Mr. C 37 1.13 -do-
Mr. D 62 0.10 -do-
Table 4:COLLATERAL SECURITY DETAILS
(in crores)
Nature of Security Market Value
Forced Sale Value Proposed
Valuation Other details/percentage of security cover
Existing Proposed
Date & Name of Approved Valuer
F.D.-0.10
LIC-0.03
NSC-0.02
F.D-0.11
LIC-0.04
NSC-0.02
F.D-0.11
LIC-0.04
NSC-0.02
AAA & Consultants
Collateral security coverage is 76.50% with the total exposure
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Cash Credit Flat-0.42
Shop cum Godown-0.85
Flat-0.56
Shop cum
Godown-1.03
Flat-0.48
Shop cum
Godown-0.88
Dated
20/08/2009.
of the cash credit limit of 200 lacs
Total-1.42 Total-1.76 Total-1.53
INSURANCE
Table 5: Securities (in crore)
Prime Securities
Value of the Securities
Insured Value Valid Upto
Stocks 1.30 1.50 23/11/2010
Collateral Securities
Building 0.92 1.13 22/11/2010
** As per stock statement submitted by the firm to the bank, it has been observed
that on an average they are keeping stocks to the tune of Rs. 1.20 – Rs. 1.30 crores in
their godown. Hence, keeping some margin they have made insurance on stock
valued at Rs. 1.50 crores.
** Though the value of the Flat and godown kept with the bank as collateral security
stands at Rs. 0.92 crores but the valuation has been done two years ago. Keeping in
view towards the escalation of immovable properties valuation, they have made
insurance on building to the extent of Rs. 1.13 crores.
They have done so because if the securities are being insured at undervalue, the
insurance company will not compensate the actual value of the securities in case of
any untoward incidence would take place.
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VALUE OF THE CUSTOMER
In the year 2008-2009, average balance stands @97.26% of the existing limit and the same
stands @96.63% on & from 01.04.2009 to 14.08.2009. fixed deposits are being held at card rates
i.e., the normal rate of interest on deposits to various types of customers approved by the
competent bank authority. We are hopeful for bringing few other low cost and no cost accounts
through the subject(s).
CMA FORMAT
The basic foundation of all banks' appraisal of the needs of creditors is the level of current assets.
The classification of assets and balance sheet analysis, therefore, assumes a lot of importance.
RBI has mandated a certain way of analyzing the balance sheets. The requirements of this break-
up of assets and liabilities differs slightly from that mandated by the Company Law Board
(CLB). The analysis of balance sheet in CMA data is said to give a more detailed and accurate
picture of the affairs of a corporate. The corporates are required by all banks to analyse their
balance sheet in this specific format called CMA data format and submit to banks. While most
qualified accountants working with the firms are aware of the method of classification in this
format, professional help is also available in the form of Chartered Accountants, Financial
Analysts for this analysis.
All the data available in the Balance Sheet give by the XXX Co. are extracted and put it in the
CMA format for the required analysis.
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ASSESSMENT OF WORKING CAPITAL REQUIREMENTSFORM-I
Particulars of the existing/proposed limits from the banking system.
(Limits from all Banks and Financial Institutions s on the date of application)
Table 6: FORM1
(AMOUNT- Rs. IN LACS)
SL
NO.
NAME OF THE BANK/ FINANCIAL INSTITUTION
NATURE
OF THE
FACILITY
EXISTING
LIMITS
EXTENT TO WHICH LIMITS WERE UTILIZED
DURING THE LAST 12 MONTHS
BALANCE O/S AS ON 20-08-2009
LIMITS NOW QUESTED
MAX. MIN.
Indian Overseas Bank,
Chow
ringhee branch
Cash
credit95 97 84 93 200
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ASSESSMENT OF WORKING CAPITALFORM- II
Table 7:FORM II As per Profit and Loss accounts /estimates for the year ended /ending
LAST THREE YEARS ACCOUNT (AS PER AUDITED ACCOUNTS)
CURRENT YEAR ESTIMATES31-03-2009
FOLLOWING YEAR PROJECTION31-03-2010
31-03-2006 31-03-2007 31-03-2008
1.GROSS INCOMEi. SALES
(NET OR RETURNS)a) Domestic sales 692.56 483.96 540.34 622.60 1134.00b) Export salesc) Sub-total [a +b] 692.56 483.96 540.34 622.60 1134.00d) Percentage rise [+] or
fall [-]in sales turnover as compared to previous year (%)
-30.12 11.65 15.22 82.14
ii. OTHER INCOMEa) Duty drawbackb) Cash assistant/
discount 29.74 21.26 11.03 13.49 24.78
c) Other assistanced) Sub-total [a +b +c]iii. Total [i]+[ii] 722.30 505.22 551.37 636.09 1158.78
2.COST OF SALESi. Purchases 401.91 470.75 518.18 586.20 1167.44
75
ii. Other trading expenses
[ carriage onward. Commn & brokerage on purchase]
3.69 0.00 0.00 0.00 0.00
iii. Sub-total [ i + ii] 405.60 470.75 518.18 586.20 1167.44
iv. Add: opening stock 171.62 44.05 53.41 74.34 73.86
v. Sub-total [ iii + iv] 577.22 514.80 571.49 660.54 1241.30
vi. Less : closing stock 44.05 53.41 74.34 73.86 164.00
vii. Sub-total [v-vi] 533.17 461.39 497.25 586.68 1077.30
3. SELLING GENERAL & ADMINISTRATIVE EXPENSES (including Bonus payments)
175.66 21.11 24.85 23.23 32.76
4. OPERATING PROFIT [interest & depreciation] [1 (iii) – 2 (vii) - 3]
13.47 22.72 29.27 26.18 48.72
5. INTEREST 12.45 11.80 13.36 13.46 26.00
6. DEPRECIATION 1.64 1.64 1.40 1.19 1.04
7.OPERATING PROFIT [after interest / depreciation] [ 4- 5- 6]
-0.62 9.28 14.51 11.53 21.68
8. i] Add: Other non operating-income
a) Interest on FRD
b) Interest on loan/ Income Tax Refund 0.00 0.84 0.00 0.00 0.00
c) Others (lifting charges) 5.94 0.44 0.39 0.00 0.00
d) Sub-total (income) 5.94 1.28 0.39 0.00 0.00
ii] less: Other non-operating expenses.
a) Preliminary expenses
b) Interest on
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Partners’ Capital A/C
1.90 1.61 5.24 4.71 4.92
c) Partners’ Remuneration 1.56 3.50 3.54 3.50
9.00
d) Sub-total (expenses) 3.46 5.11 8.78 8.21 13.92
iii] Net of other non-operating income / expenses [ net of 8 (i) & 8 ( ii )]
2.48 -3.83 -8.39 -8.21 -13.92
9. PROFIT BEFORE TAX / LOSS [ 7+8( iii )]
1.86 5.45 6.12 3.32 7.76
10. PROVISION FOR TAXES 1.83 5.44
6.08 4.38 8.24
11.NET PROFIT / LOSS (9- 10) 0.03 0.01 0.04 -1.06 -0.48
12. a) Equity dividend paid**
b) Dividend rate
13. RETAINED PROFIT (11-12) 0.03 0.01 0.04
14. RETAINED PROFIT / NET POFIT (%) (13-11) 100% 100% 100%
** In case of firms, drawings made during the year by projectors / partners.
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ASSESSMENT OF CAPITALTable 8:FORM- III(P& L A/C)
LIABILITIES As per Profit and loss accounts actual / estimates for the year ended / ending
LAST THREE YEARS ACCOUNT ( as per audited accounts)
CURRENT YEAR ESTIMATES31-03-2009
FOLLOWING YEAR PROJECTION31-03-2010
31-03-2006 31-03-2007 31-03-2008
1. Short term borrowings from banks
( including Bill purchased, discounted & excess borrowings placed on repayment basis)
a) From applicant bank 93.10 95.71 97.93 94.60 200.00
b) From other bank
c) ( of which BP & BD )
SUB-TOTAL ( A ) 93.10 95.71 97.93 94.60 200.00
2. Short term borrowing from others
3. Sundry creditors ( trade ) ( months purchases) 49.76 61.46 89.02 66.16 60.37
4. Advance payments from customers / deposits from dealers
0.43 0.12 0.02 0.00 0.00
5. Provisions for taxation
6. Dividend payable
7. Other statutory Liabilities ( due within one year)
0.07 0.07 0.13 0.00 0.00
8. Deposits / debentures / installments under term
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loans / DPGs, etc. (due within one year)
9. Other current liabilities & provisions
(due within one year) ( specially major terms) (sundry Expenses + other Finance) 5.92 5.69 7.06 7.90 8.65 SUB-TOTAL ( B ) 56.18 67.34 96.23 74.06 69.02
10. TOTAL CURRENT LIABILITIES
149.28 163.05 194.16 168.66 269.0211. Debentures ( not
maturing within one year )
12. Preference shares (redeemable after one year )
13. Term Loans from HDFC
3.85 1.97 0.11 0.00 0.00
14. Deferred Payment Credits
15. Term Deposits ( repayable after one year)
16. Other term liabilities( Unsecured loan from friends and relatives)
17. TOTAL TERM LIABILITIES
( TOTAL OF 11 TO 16)3.85
1.97 0.11 0.00 0.00
18. TOTAL OUTSIDE LIABILITIES
(10 + 17)153.13 165.02 194.27 168.66 269.02
NET WORTH19. Share Capital 13.43 43.69 47.68 57.97 98.91
20. General reserve
21. Revaluation Reserve
22. Other Reserves (excluding provisions)
23. Surplus (+) or Deficit (-) in profit & loss account
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24. NET WORTH13.43 43.69 47.68 57.97 98.91
25. TOTAL LIABILITIES( 18 + 24) 166.56 208.71 241.95 226.63 367.93
ASSESSMENT OF CAPITALTable 9:FORM-III(B/S)
As per balance sheet as at
CURRENT ASSETS
LAST THREE YEARS ACCOUNT (AS PER AUDITED ACCOUNTS)
CURRENT YEAR ESTIMATES31-03-2009
FOLLOWING YEAR PROJECTION31-03-201031-03-2006 31-03-2007 31-03-2008
26. Cash and bank balances22.21 19.83 13.96 7.40 8.00
27. Investments [ other than long term investments]
i. Government & other Trustee Securities
ii. Fixed Deposits with banks including Interest accrued
28. i. Receivables other than deferred 7 exports
[ including bills purchased & discounted by bankers] [Month’s export sales]
60.4698.99 119.48 112.32 159.84
ii. Export receivables
[ including bills purchased / discounted by bankers]
[ month’s export sales]29. Installments of deferred
receivables (due within one year)
30. Stocks-in trade ( month’s cost of sales)
31. Advances to suppliers of merchandise & deposits
32. Advance payment of taxes
80
33. Other current assets
[ specify major items]
Loan and Advances
29.67 27.55 26.10 24.83 28.03
34. TOTAL CURRENT ASSETS[ TOTAL OF 26 TO 33]
35. Fixed Assets
156.39
11.73
199.78
10.48
233.88
9.39
218.41
8.27
359.87
7.4836. Depreciation 1.64 1.64 1.40 1.19 1.04
37. NET BLOCK [ 35 – 36 ]
10.09 8.84 7.99 7.08 6.44
38. Investments / book debts/ advances/ deposits , which are not current assets
i. a) investments in subsidiary companies / at liabilities
b) Others
ii. advances to suppliers of capital Goods & contractors.
iii. deferred receivables [ maturity exceeding one year]
iv. security deposits / tender deposits
0.08 0.08 0.08 1.14 1.62
v. others / Debtor over 6 months
39. Obsolete stocks
40. Other non-current assets
41. TOTAL OTHER
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NON CURRENT ASSETS ( total of 38 to 40)
0.08 0.08 0.08 1.14 1.62
42. Assets ( patents, goodwill, preliminary expenses, bad/doubtful debts not provided for ,etc)
43. TOTAL ASSETS( total of 34, 37, 41 & 42 ) 166.56 208.71 241.95 226.63 367.93
44. TANGIBLE NET WORTH ( 24-42 ) 13.43 43.69 47.68 57.97 98.91
45. NET WORKING CAPITAL
{[ 17+24] – [37+41+42]} TO TALLY WITH [ 34 - 10]
8.74 36.74 39.72 49.75 90.85
46. CURRENT RATIO [ 34/10]
1.05 1.23 1.20 1.29 1.34
47. TOTAL OUTSIDE LIABILITIES/ TANGIBLE NW WORTH [ 18/44 ]
11.40 3.78 4.07 2.91 2.72
ASSESSMENT OF WORKING CAPITALTable 10:FORM-IV(B/S)
As per balance sheet as atLAST THREE YEARS ACTUALS( AS PER AUDITED ACCOUNTS)
CURRENT YEAR ESTIMATES31-03-2009
FOLLOWING YEAR PROJECTION31-03-2010
31-03-2006 31-03-2007 31-03-2008
A. CURRENT ASSETS1. Stocks- in-trade
[ months cost of sales ]44.05 53.41 74.34 73.86 164.00
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2. Receivables other than export and deferred receivables
( including bills purchased and discounted by bankers)
( months domestic sales)
60.46 98.99 119.48 112.32 159.84
3. Export receivables
( including bills purchased and discounted by bankers)
( months domestic sales)4. Advances to suppliers
of merchandise
5. Other current assets
( including cash and bank balances & deferred receivables due within one year) ( specially major items)
(Loan and Advances)
51.88 47.38 40.06 32.23 36.03
6. TOTAL CURRENT ASSETS
( to agree with item 34 in Form-III )
156.39 199.78 233.88 218.41 359.87
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COMPARATIVE STATEMENT OF CURRENT ASSETS AND CURRENT LIABILITIES
As per balance sheet as at
Table 11:ComparisionLAST THREE YEARS ACTUALS( AS PER AUDITED ACCOUNTS)
CURRENT YEAR ESTIMATES31-03-2009
FOLLOWING YEAR PROJECTION31-03-2010
31-03-2006 31-03-2007 31-03-2008
B. CURRENT LIABILITIES
( other than bank borrowings for working capital)
7. Sundry Creditors ( Trade) ( Months Purchases)
49.76 61.46 89.02 66.16 60.37
8. Advance payments from 84
customer / deposits from dealers
0.43 0.12 0.02 0.00 0.00
9. Statutory Liabilities 0.07 0.07 0.13 0.00 0.00
10. Other current liabilities( specially major items such as short time borrowings, unsecured loans dividend payable , installments of TL, DPG , public deposits, debentures , etc.)
5.92 5.69 7.06 7.90 8.65
11. TOTAL( To agree with sub-total B- Form-III)
56.18 67.34 96.23 74.06 69.02
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COMPUTATION OF MAXIMUM PERMISSIBLE BY BANK [FINANCE FOR WORKING CAPITAL]
Table 12:FORM-V(B/S)As per balance sheet as at
LAST THREE YEARS ACTUALS( AS PER AUDITED ACCOUNTS)
CURRENT YEAR ESTIMATES31-03-2009
FOLLOWING YEAR PROJECION31-03-2010
31-03-2006 31-03-2007 31-03-2008
1. Total current assets (34 Form III)
156.39 199.78 233.88 218.41 359.87
2. Current liabilities
( 2 to 9 Form III)
( other than bank borrowings)
56.18 67.34 96.23 74.06 69.02
3. Working capital gap
( WCG) ( 1-2 )100.21 132.44 137.65 144.35 290.85
4. Min. stipulated net
working capital- 25% of total current
assets other than export receivables
39.10 49.95 58.47 54.60 89.97
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( as at 28(ii) of form III )5. Actual / projected
net Working capital
(45 in form III)
8.74 36.74 39.72 49.75 90.85
6. Item 3 minus item 4
61.11 82.49 79.18 89.75 200.88
7. Item 3 minus item 5
91.47 95.70 97.92 94.60 200.00
8. Maximum permissible
by bank finance ( item 6 or 7 whichever is lower)
61.11 82.49 79.18 89.75 200.88
9. Excess borrowings, if
any representing short fall in NWC (4-5)
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Table 13: FORM – VI (B/S)
FUNDS FLOW STATEMENTAs per balance sheet as at
LAST TWO YEARS ACTUALS ( as per audited balance sheet)
CURRENT YEAR ESTIMATES31-03-2009
FOLLOWING YEAR PROJECTI
ON31-03-2010
31-03-2007 31-03-2008
1. SOURCESa) Net profit ( after tax)
0.01 0.04
b) Depreciation 1.64 1.40 1.19 1.04
c) Increase in capital 30.26 3.99 10.29 40.94
d) Increase in term liabilities ( including Public Deposits)
e) Decrease in I. Fixed assets
II. Other Non-Current assets
f) Others
g) TOTAL 31.91 5.43 11.48 41.98
2. USESa) Net Loss 1.06 0.48b) Decrease in term
liabilities ( including Public deposits)
1.88 1.86 0.11 0.00
c) Increase in I. Fixed assets
II. Other Non-Current assets
0.39 0.55 0.28 0.40
d) Dividend payments
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e) Others
f) TOTAL 2.27 2.41 1.45 0.88
3. Long term Surplus (+)/ deficit (-)( 1-2)
29.64 3.02 10.03 41.10
4. Increase / Decrease in current assets
43.39 34.10 -15.47 141.46
5. Increase / Decrease in current Liabilities other than bank borrowings
11.16 28.89 -22.17 -5.04
6. Increase / decrease in working capital gap
32.23 5.21 6.70 146.50
7. Net surplus (+) / deficit (-)(Difference of 3 & 6)
-2.59 -2.19 3.33 -105.4
8. Increase / decrease in bank borrowings
2.59 2.19 -3.33 105.4
INCREASE / DEFICIT IN NET SALES -208.6 56.38 82.26 511.4
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BRIEF FINANCIAL INDICATORS OF SUBJECT COMPANY:
(Rs. In crores)
Table 14: Financial Indicators
Year Ending 2006-2007 2007-2008 2008-2009 2009-2010
Audit Status Audited Audited Provisional Estimated
Net Sales 4.84 5.40 6.23 11.34
Operating Profit
0.23 0.29 0.26 0.49
Net Profit After Tax
0.0001 0.0004 -0.0106 -0.0048
Cash Generation
0.04 0.05 0.08 0.14
Net Working Capital
0.37 0.40 0.50 0.91
Current Ratio 1.23 1.20 1.29 1.34
TNW 0.44 0.48 0.60 0.99
TOL/TNW 3.78 4.07 2.91 2.72
Term Liability/TNW
0.05 0.00 0.00 0.00
Gross Fixed Assets
0.10 0.09 0.08 0.07
Term Loan 0.02 0.00 0.00 0.00
N.B. : Net Profit After Tax in each year have been depicted very less as per the above charge. This is so that the subjects have debited the items like Interest in Partners’ Capital, Partners’ Remuneration etc. in their Profit and Loss account.
A BRIDGED FINANCIAL POSITION:(Rs. In crores)
90
Table 15: Financial Position
Year ending 2006-2007 2007-2008 2008-2009 2009-2010
Audit Status Audited Audited Provisional Estimated
LIABILITIES- Capital and Reserves
0.44 0.48 0.58 0.99
Long Term Liabilities
002 0.00 0.00 0.00
TOTAL LIABILITIES 2.09 2.42 2.27 3.68ASSETS-Fixed Assets 0.09 0.08 0.07 0.06Non-Current Assets 0.00 0.00 0.00 0.00
Current Assets 2.00 2.34 2.20 3.62
Intangible Assets 0.00 0.00 0.00 0.00
TOTAL ASSETS 2.09 2.42 2.27 3.68
Chapter 6.CONCLUSION AND RECOMMENDATION
6.1 COMMENTS ON FIANCIALS/PERFORMANCE OF THE COMPANY (conclusion)
SALES: Comments on achievements of sales vis-à-vis estimates given in the past, current year sales achieved till previous month, feasibility of achieving sales estimated/ projected.
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PROFITS: comments on trend in profitability and feasibility of achieving estimates/ projections
TANGIBLE NET WORTH (TNW): comments of trend and feasibility of achieving the estimates / projections.
TOL/TNW: comments on acceptability of key ratios and other negative features.
CR/ NWC: comments on large amounts held under “Non-Current Assets”, “other Current Assets”, “other Current Liabilities” with break up details must be furnished with justification thereof.
Sales are going on increasing over the years. In this year they got an offer of stockistship of BEER under the brand name KINGFISHER STRONG and KINGFISHER PREMIUM product of eminent UB GROUP which has already gain a lions share in the field of BEER market. It is expected that with the intervention of this lucrative branded BEER market, their sales turnover would increase by leaps and bounds. So far in this financial year, their turnover as per financial year 2009 stands at Rs. 218.69 lacs upto JULY 2009 with induction of further Working Capital and ensuing festive season and winter season, we can presume that estimated sales target of Rs. 1134.00 lacs in the financial year 2009-2010 would be achieved within rest period of 8months.
Operating Profit of the firm are going on increasing over the years. Net Profit After Tax in each year have been depicted very less as per the above charge. This is so that the subjects have debited the items like Interest in Partners’ Capital, Partners’ Remuneration etc. in their Profit and Loss account.
TNW is also going on increasing over the years due to fresh induction of capital as also retained profit which includes partners remuneration, interest on capital and capital and share of profit.
TOL/TNW IS 2.91 & 2.72 in the financial year 2008-09 & 2009-10 respective acceptable especially in this time of business where much working capital is needed to run the show.
Current Ratio is gradually improving over the years and stands well within the benchmark level ie 1.32 in the estimated in the increasing order over the years.
In a word, sales, Net profit, TNW and NWC are in the increasing order.
6.2GIST OF RECOMMENDATIONS:
Based on the aforementioned facts and figure, Partners’ Goodwill, creditworthiness and good
entrepreneurship, financials of the company, progressing trend of the business, working capital
92
need, overall security aspects and guarantee offered, we may consider favorably to enhance the
existing cash credit limit of Rs. 95 Lacs to the tune of Rs. 200 Lacs.
We recommend sanction of the same.
Table 16: SANCTION OF FOLLOWING ENHANCEMENT cum RENEWAL OF LIMITS
( IN CRORES)
Nature of
limit/
facility
purpose Existing
limit
Revised
limit
(+)/
(-)
Margin Interest%
applicable
rate
Interest %
proposed
Cash
Credit
Working
Capital
0.95 2.00 +1.05 25% on
stock
and 40%
on book-
debts
BLPR
+2.25% i.e.
at present
@14.75%
BLPR
+2.25% i.e.
at present
@14.25%
TERMS AND CONDITIONS OF SANCTION
1. A processing charge of Rs 33,600/- only is to be paid to the bank.
2. All sale transactions must be rooted through the cash credit account with the bank.
3. The firm is to deal exclusively with the bank for departmental stores with the bank.
4. Hypothecation board must be displayed in the shop/ godown.
5. Stocks and land & Buildings are to ensured in full value with the respective bank clause
6. Bank officials must have an access in the shop/ godown and all immovable properties for
the purpose of inspection as on when required.
7. Stock statements as on last date of each month must be submitted to the bank with the
10th day f the following month filing which 2% penal interest will be levied.
8. All the other norms/guidelines as applicable for finance as per bank’s book of
instructions, manual of documentation and circulars issued by RBI/Central Office from
time to time should be complied with.
** The entire working capital credit assessment of the aforementioned appraisal has been done
from one of the files of Indian Overseas Bank, Chowringhee branch and the name of the firm
93
being changed where the sanction has been based on the then current year estimates as on 2009-
2010.
After study and analysis of working capital I would like to recommend the following:
1. Company should raise funds through short term sources for short term requirement of
funds, which comparatively economical as compare to long term funds.
2. Company should take control on debtor’s collection period which is major part of
current assets.
94
3. Company has to take control on cash balance because cash is non earning assets and
increasing cost of funds.
4. Company should reduce the inventory holding period with use of zero inventory
concepts.
APPENDICES
Bibliography
Books Referred
1. I. M. Pandey - Financial Management - Vikas Publishing House Pvt. Ltd. - Ninth Edition
95
2. M.Y. Khan and P.K. Jain-Financial management – Vikas Publishing house ltd., New
Delhi.
3. K.V. Smith- management of Working Capital- Mc-Grow-Hill New York
4. Satish Imandar- Principles of Financial Management-Everest Publishing House
Websites References
1. www.jains.com
2. www.google.co.in
3. www.workingcapitalmanagement.com
4. www.wikipedia.com
All the data regarding the subject of the case study are supplied by the bank.
Images are collected from google images.
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