A PROJECT REPORT ON

CREDIT APPRAISAL PROCESS

OF A BANK
WORKING CAPITAL ASSESSMENT

Name – HIMANSHU SHARMA

Reg. No. – 201126804

SYMBIOSIS CENTRE FOR DISTANCE LEARNING

ACADEMIC YEAR- 2011

 INDEX
S.No. TOPIC PAGE No.

1 DECLARATION BY LEARNER 1

2 CERTIFICATE OF SUPERVISOR (GUIDE) 2

3 CHAPTER 1- INTRODUCTION 3

4 CHAPTER 2- MSME 10
5 CHAPTER 3- BASIC PRINCIPLE OF LENDING 15
CHAPTER 4- FINANCIAL INSTRUMENTS PROVIDED BY
6 17
BANK
7 CHAPTER 5- TYPES OF LENDING 20

8 CHAPTER 6- CREDIT APPRAISAL PROCRESS 23

9 CHAPTER 7- CASE STUDY 44
10 CONCLUSION 57
11 SUMMARY 58
12 ANNEXURES 59
NO OBJECTION CERTIFICATE
This is to certify that HIMANSHU SHARMA is permitted to use relevant
data/information of this organization for his project in fulfillment of the POST
GRADUATE DIPLOMA IN BANKING AND FINANCE Program.
We wish him all the success.

Place: KOTA
Date: 20-06-2015
DECLARATION BY THE LEARNER
This is to declare that I have carried out this project work myself in part fulfillment of
the
POST GRADUATE DIPLOMA IN BANKING AND FINANCE Program of SCDL.
The work is original, has not been copied from anywhere else and has not been
submitted
to any other University/Institute for an award of any degree/diploma.

Date: 20-06-2015 Signature:

Place: KOTA Name: HIMANSHU
SHARMA
CERTIFICATE OF SUPERVISOR (GUIDE)

Certified that the work incorporated in this Project Report submitted CREDIT
APPRAISAL PROCESS OF A BANK (WORKING CAPITAL ASSESSMENT) by
HIMANSHU SHARMA is his original work and completed under my supervision.

Material obtained from other sources has been duly acknowledged in the Project
Report.

Date: 20-06-2015 Signature of Guide:

Place: KOTA
 CHAPTER 1

INTRODUCTION
WORKING CAPITAL

What is Working Capital?

According to Lawrence. J. Gitmen

“The most common definition of working capital is the difference of the firm’s current
assets and current liabilities.”

Need for Working Capital:

Apart from financing for investing in fixed assets, every business also requires funds on
a continual basis for carrying on its operations. These include expenses incurred for
purchase of raw material, manufacturing, selling, and administration; until such goods
are sold and the sales realized. Business transactions are generally carried on credit with
a number of days elapsing subsequent to the sale being affected for realization of
proceeds. While part of the raw material may be purchased by credit, the business
would still need to pay its employees, meet manufacturing & selling expenses (wages,
power, supplies, transportation and communication) and the balance of its raw material
purchases. Working capital refers to the source of financing required to by businesses
on a continual basis for meeting these needs.

The advantages of working capital or adequate working capital may be enumerated as

below-

1. Cash Discount:
If a proper cash balance is maintained, the business can avail the advantage of
cash discount by paying cash for the purchase of raw materials and merchandise.
It will result in reducing the cost of production.

2. It creates a Feeling of Security and Confidence:

The proprietor or officials or management of a concern are quite carefree, if they
have proper working capital arrangements because they need not worry for the
payment of business expenditure or creditors. Adequate working capital creates
 a sense of security, confidence and loyalty, not only throughout the business
itself, but also among its customers, creditors and business associates.

3. ‘Must’ for Maintaining Solvency and Continuing Production:

In order to maintain the solvency of the business, it is but essential that the
sufficient amount of fund is available to make all the payments in time as and
when they are due. Without ample working capital, production will suffer,
particularly in the era of cut throat competition, and a business can never
flourish in the absence of adequate working capital.

4. Sound Goodwill and Debt Capacity:

It is common experience of all prudent businessmen that promptness of payment
in business creates goodwill and increases the debt bearing capacity of the
business. A firm can raise funds from the market, purchase goods on credit and
borrow short-term funds from bank etc., if the investors and borrowers are
confident that they will get their due interest and payment of principal in time.

5. Easy Loans from the Banks:

An adequate working capital i.e. excess of current assets over current liabilities
helps the company to borrow unsecured loans from the bank because the excess
provides a good security to the unsecured loans, Banks favour in granting
seasonal loans, if business has a good credit standing and trade reputation.

6. Distribution of Dividend:
If company is short of working capital, it cannot distribute a good dividend to its
shareholders in spite of sufficient profits. Profits are to be retained in the
business to make up the deficiency of working capital. On the other contrary, if
working capital is sufficient, ample dividend can be declared and distributed. It
increases the market value of shares.

7. Exploitation of Good Opportunity:

In case of adequacy of capital in a concern, good opportunities can be exploited
e.g., company may make off-season purchases resulting in substantial savings or
it can fetch big supply orders resulting in good profits.
8. Meeting Unseen Contingency:
Depression shoots the demand of working capital because stock piling of
finished goods becomes necessary. Certain other unseen contingencies e.g.,
financial crisis due to heavy losses, business oscillations, etc. can easily be
overcome, if company maintains adequate working capital.

9. High Morale:
The provision of adequate working capital improves the morale of the executive
because they have an environment of certainty, security and confidence, which
is a great psychological, factor in improving the overall efficiency of the
business and of the person who is at the helm of fairs in the company.

10. Increased Production Efficiency:

A continuous supply of raw material, research programme, innovations and
technical development and expansion programmes can successfully be carried
out if adequate working capital is maintained in the business. It will increase the
production efficiency, which will, in turn increase the efficiency and morale of
the employees and lower costs and create an image in the community.

Factors affecting Working Capital:

1. Nature of Business:
Working capital requirement of a firm basically influenced by the nature of its
business trading and financial firms have a very small investment in fixed assets,
but require a large sum of money to be invested in working capital. Retails
stores, for example must carry large stock of a verity of good to satisfy varied
and continuous demand of their customer.

2. Seasonality of operations:
 Firms which have marked seasonality in their operations usually have highly
fluctuating working capital requirements. Consider a firm selling air
conditioners, its sale reaches a peak during the summer months and drops
sharply during the winter period. The working capital requirements of such a
firm are likely to increase considerably in summer months and decrease
significantly during the winter period. On the other hand, a firm manufacturing
product like lamps, which have fairly even sales round the year, tends to have
stable working capital requirements.

3. Production policy:
If the production is evenly spread over the entire year, working capital
requirements are greater, because the inventories will be unnecessarily
accumulated during off season period. But if the production schedule favours a
varying production plan as per the seasonal requirements, working capital is
required to a greater extent during a specified season only. The production
policies are affected by so many factors availability of raw materials, labour,
stocking facility etc & therefore, whatever the productions policies are, the firm
has to arrange its working capital requirements accordingly.

4. Market and demand conditions:

The degree of competition prevailing in the market place has an important
bearing on working capital needs. When competition is keen, a larger inventory
of finished goods is required to promptly serve customers who may not be
inclined to be waiting because other manufacturers are ready to meet their
needs. Further, generous credit terms may have to be offered to attract customers
in highly competitive market. Thus, working capital requirements tend to be
high because of greater investment in finished goods inventory and accounts
receivable.

5. Market Situation:
If the market is strong and competition weak a, firm can manage with a smaller
inventory of finished goods because customers can be served with some delay.
Further, in such a situation the firm can insist on cash payment and avoid lock
 up of funds in accounts receivable- it can ask for advance payment, partial or
total.

6. Conditions of supply:
The inventory of raw materials, spares, and stores depends on the condition of
supply. If the supply is prompt and adequate, the firm can manage with small
inventory. However, if supply is unpredictable and scant, the firm, to ensure
continuity of production, would have to acquire stocks as and when they are
available and carry larger inventory, on an average. A similar policy may have
to be followed when the raw material is available only seasonally and production
operations are carried out round the year.

7. Proportion of the cost of raw materials to total cost:

In those industries where cost of raw materials is a large proportion of total cost
of the goods produced, requirements of working capital will be comparatively
large.

8. Length of period of manufacturing:

The time which elapses between the commencement and end of the
manufacturing process has an important bearing upon the requirements of
working capital. The manufacturing cycle may be shorter for certain concerns &
longer for others- it depends on the type of the product to be manufactured, work
to be done through machine labor & hand labor, degree of rationalization of
manufacturing procedures through times, motion & fatigue studies etc.

9. Business cycles:
Requirement of working capital also varies with the business. When the price
level is up due to boom conditions, the inflationary conditions create demand for
more working capital. During depression also a heavy amount of working capital
is needed due to the inventories being locked unsold and book debts uncollected.

10. Requirement of cash:

 The working capital requirements of a company are also influenced by the
amount of cash required by it for various purposes. The greater the requirement
of cash, the higher will be the working capital needs of the company.
11. Dividend policy of concern:
If the management follows a conservative dividend policy the needs of working
capital can be met with the retained earnings. The relationship between dividend
policy and working capital is well established and mostly companies declare
dividend after a careful study of their cash requirements.

12. Other Factors:

Other factors, which affect the requirement of working capital, are lack of co-
operation in production and distribution policies, transport and communication
facilities, the fiscal and tariff policies of the government etc.
 CHAPTER 2

MICRO SMALL AND MEDIUM

ENTERPRISES (MSME)
MSME (MICRO SMALL AND MEDIUM ENTERPRISES)

Definition and Overview:

The SME Sector includes Micro Enterprises, Small Enterprises, Artisans & Village
Industries, Medium Enterprises, Service Sector units & individual sub-sector units.

Micro Enterprises
Micro Enterprises are those engaged in manufacturing, processing, preservation of
goods, mining, quarrying, servicing & repairing of specified type of machinery &
equipment, agro service units whose investment in Plant and Machineries does not
exceed Rs. 25.00 lacs irrespective of location of the unit in respect of manufacturing
units and investment in equipments not exceeding Rs 10.00 lacs in respect of Service
Sector units.

Small Enterprises
A Small Enterprise industrial is one which is engaged in the manufacture, processing or
preservation of goods or is a servicing and repair workshop undertaking repairs of
machinery used for production, mining or quarrying or custom service unit (except
water service units), having investment in Plant and Machineries (original cost) above
Rs 25.00 lacs but not exceeding Rs. 5.00 Cr in respect of manufacturing unit and above
Ra 10.00 lacs but not exceeding Rs 2.00 Cr in respect of Service Sector unit.

Medium Enterprises
A Unit which is engaged in the manufacture, processing or preservation of goods or is a
servicing and repair workshop undertaking repairs of machinery used for production,
mining or quarrying or custom service unit (except water service units), with investment
in Plant & Machinery in excess of Rs 5.00 crores and upto Rs.10.00 crores in respect of
manufacturing units and investment in equipments in excess of Rs 2.00 crores and up to
Rs 5.00 crores in respect of Service Sector units may be treated as Medium Enterprises
(MEs).
 The MSMED Act 2006

Enterprise Engaged in Manufacturing / Preservation Engaged In Providing/ Rendering

of Goods(incl. Processing Units) of Services

Micro Enterprise Not to Exceed Rs. 25 Lakhs in Plants & Not to Exceed Rs. 10 Lakhs in
Machinery. Equipments.

Small Enterprise More than Rs.25 Lakhs but does not exceed More than Rs.10 Lakhs but does not
Rs. 5 Crore Plants & Machinery. exceed Rs. 2 Crore in Equipments.

Medium Enterprise More than Rs.5 Crore Rupees but does not More than Rs. 2 Crore Rupees but
exceed Rs. 10 Crore Plants & Machinery. does not exceed Rs. 5 Crore
Equipments.

Problems faced by SME’s:

The SME sector, particularly the tiny segment of the small enterprises, faces huge
challenges as under:

1. Competition from both domestic and multi-national companies:

2. Inadequate access to finance due to lack of financial information and non-formal

business practices;

3. Lack of access to private equity and venture capital;

4. Lack of access to inter-state and international markets;

5. Limited access to secondary market instruments;

6. Fragmented markets in respect of their inputs as well as products;

7. Vulnerability to market fluctuations;

8. Limited access to technology and product innovations;

9. Lack of awareness of global best practices and

10. Considerable delays in the settlement of dues/payment of bills by the large scale
buyers.

Taking a look at the role of SMEs in India’s economy and their future growth potential
and the problems they face especially with respect of finance, banks have a greater role
to play in addressing their needs.

Credit Risk faced by a Bank:

Credit risk or default risk involves inability or unwillingness of a customer or

counterparty to meet commitments in relation to lending, trading, hedging, settlement
and other financial transactions. The Credit Risk is generally made up of transaction
risk or default risk and portfolio risk. The portfolio risk in turn comprises intrinsic and
concentration risk. The credit risk of a bank’s portfolio depends on both external and
internal factors. The external factors are the state of the economy, wide swings in
commodity/equity prices, foreign exchange rates and interest rates, trade restrictions,
economic sanctions, Government policies, etc. The internal factors are deficiencies in
loan policies/administration, absence of prudential credit concentration limits,
inadequately defined lending limits for Loan Officers/Credit Committees, deficiencies
in appraisal of borrowers’ financial position, excessive dependence on collaterals and
inadequate risk pricing, absence of loan review mechanism and post sanction
surveillance etc.

Another variant of credit risk is counterparty risk. The counterparty risk arises from
non-performance of the trading partners. The non-performance may arise from
counterparty’s refusal/inability to perform due to adverse price movements or from
external constraints that were not anticipated by the principal. The counterparty risk is
generally viewed as a transient financial risk associated with trading rather than
standard credit risk.

SOURCES OF CREDIT RISK

Direct Lending Risk:

It lies in the products like loans and advances, overdrafts, bills discounted, etc. It is the
risk that the dues will not be paid on time.

Contingent Lending Risk:

It lies in products like letters of credit, guarantees, etc. It is the risk that contingent
exposures get converted into actual obligations and that these obligations may not be
repaid on time.

Issuer Risk:

It is the risk of financial loss due to the degradation in the credit rating of the issuer of
the debt instrument. It is also the risk that the bank may not be able to sell the
instrument within a predetermined holding period.

Pre-Settlement Risk:

It is the risk that the counter-party with whom the bank has a reciprocal agreement may
fail before settlement of the contract e.g. in forwards, futures and options. As a result
the bank faces the risk of default on the settlement date and hence may have to
undertake fresh transactions, leading to replacement cost.

Settlement Risk:

It is the risk where the bank delivers its part of the contract but the other bank does not
fulfill its obligation. This risk arises out of time lags in settlement of another currency in
another time zone.

The bank needs to identify all sources of credit risk and monitor aggregated exposures
to a borrower or counter-party on a bank-wide basis.
 CHAPTER 3

BASIC PRINCIPLES OF
LENDING
BASIC PRINCIPLES OF LENDING
Banks are in business to maximize value for its shareholders. Consequently, when a
bank lends money, it attempts to lend money to those applicants that are deemed as the
best from the applicant pool. The process by which a lender appraises the
creditworthiness of the prospective borrower is called credit appraisal. This normally
involves appraising the borrower’s payment history and establishing the quality and
sustainability of his income. A bank assesses the credit risk of any borrower based on
the following 5 "C's" of Credit:

1. Capacity to repay is the most significant of the five factors. The lender will
have to determine the sources of income that the applicant possesses to repay the
loan. The main consideration will be cash flow generated from the business.
2. Capital is the money that has been invested by the business owner into his/her
business. The amount of invested capital by the owner is indicative of the
owner's stake and confidence in the viability of his/her business.
3. Collateral is pledged assets to guarantee the security of a loan. Collateral is
deemed as a second source of income in the event that the borrower cannot
repay the loan. Assets that are typically accepted as collateral are fixed assets of
a business i.e., equipment, plant etc. Banks also consider working capital like
accounts receivable and inventory, to be feasible sources of collateral. But,
typically banks will usually discount the value of working capital (being that the
market value is neither fixed nor certain) at a certain percentage of estimated
market value.
4. Conditions focus on the intended purpose of the loan. How will the proceeds
from the loan be utilized i.e. to purchase equipment, working capital? Also
banks consider the local market and economic conditions both within your
industry and other industries that affect your business e.g., your suppliers and
customers.
5. Character is the personal impression that a prospective borrower makes to a
potential lender or investor. A person's educational background, industrial
experience and credit history with other creditors will be considered.
 CHAPTER 4

FINANCIAL INSTRUMENTS
PROVIDED BY BANK
FINANCIAL INSTRUMENTS PROVIDED BY BANK
SME Finance is the funding of small and medium sized enterprises and represents a
major function of the general business finance market – in which capital for firms of
different types is supplied, acquired, and priced. Capital is supplied through the
business finance market in the form of bank loans and overdrafts; leasing and hire-
purchase arrangements; equity/corporate bond issues; venture capital or private equity;
and asset-based finance such as factoring and invoice discounting.

However, not all business finance is external/commercially supplied through the

market. Much finance is internally generated by businesses out of their own earnings
and/or supplied informally as trade credit (i.e., delays in paying for purchases of goods
and services).

The Bank has provided wide range of financial facilities to this fast growing MSME
sector for fulfilling their credit requirement. The credit facilities that normally banks
offer to MSMEs can be divided into fund based and non-fund based is;

Fund Facilities:

1. Term Loan:
It is given for acquisition of capital goods (including second hand), fixed assets,
vehicles, plant & machinery, purchase of land, construction of buildings etc.
2. Cash Credit:
It is given for meeting working capital requirements
 Purchase of raw material, components, stores, spares and maintenance of stock
of these items at minimum level and stock in process and finished goods.
 Finance against receivables including receipted challans / invoices.
 For meeting marketing expenses where the units have to incur large scale
expenditure towards marketing of their products.
3. Bills Purchase/Discounting:
 It is another form of financing in which cash is given against bills of purchases
made by company or bills of sales to customer to whom credit is granted by
company.

Non-Funded Facilities:

1. Letter of Credit:
On sight/usance basis letter of credit is given to the companies for purchase of
raw material/capital goods. In this actual disbursement of cash does not take
place. This is just banks assurance that his customer will pay the specified
amount within specified date else bank will pay it. A Letter of Credit (LC) is a
document issued by the importer’s bank in favour of the exporter giving him the
authority to draw bills up to a particular amount (as per the contract price)
covering a specified shipment of goods and assuring him of payment against the
delivery of shipping documents as mentioned in LC.
2. Letter of Guarantee:
It is given for Performance, Advance Payment, Tender Money Security Deposit,
Guarantees for getting orders, for procurement of raw materials etc.
 CHAPTER 5

TYPES OF LENDING
TYPES OF LENDING
Sole –Financing:
Where all the credit needs of borrowing unit are met by single bank. A single bank
carries disproportionate risk when it finances huge amount. Smaller banks cannot
finance huge sums. It may not have appraising skills. ‘AAA’ & ‘AA’ Borrowers’
accounts can be taken over subject to exposure ceiling; ‘A’ Rated borrower in normal
course.

Multiple Lending:
Where the credit needs of different divisions of a borrowing company are met
independently by different banks without any formal agreement/ arrangements amongst
them. This system has certain drawbacks. Their credit discipline is in jeopardy, good
accounts are snatched away, and recovery becomes difficult. While presently both the
arrangements are there in the market, multiple banking arrangements are beset with
many pitfalls as observed below.

Consortium Financing:
The entire credit need of a borrowing unit is financed by a group of banks by forming a
consortium. It is concept to promote collective application of banking resources.
Consortium helps to spread risk amongst bank consortium members. There is better
credit appraisal. Smaller banks can join consortium and finance to improve their
profitability. It also stops unhealthy practice of snatching accounts. Borrowers get their
credit requirements even if single bank has credit squeeze. Consortium would meet all
their genuine needs. Syndicate lending: A syndicated loan is an arrangement whereby a
number of banks, known as the syndicate, agree to make a loan to a borrower on
uniform terms and conditions, usually through the signature of one document or a set of
documents. This form of lending existed primarily to provide large sums of lending on
international level. Large projects, corporate acquisitions and debt to developing
countries are maintained at economical level purely because of this syndication
mechanism. Though similar to consortium, it provides freedom to borrower to choose
and at competitive pricing. In syndication, one bank, generally called lead manager/
syndicator, arranges a group of banks to form a syndicate and this syndicate provides
credit facilities to a borrower, using common loan documentation.

CHAPTER 6

CREDIT APPRAISAL PROCESS

CREDIT APPRAISAL PROCESS
Credit risk is a risk related to non repayment of the credit obtained by the customer 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 customer is performed this measures the
financial condition and the ability of the customer to repay back the loan in future.
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 customers.

A. DETAILS OBTAINED FROM BORROWER

1. Financial Data of the Company:

 Audited balance sheets and Profit & Loss Account of the proponent concern for
past 2 years.
 Equity / capital details
 Credit facility sanctioned/availed by/from other banks/Financial institutions.
 Projected profitability and balance sheet details (min for the next 2* years)
 Projected cash flows & fund flow i.e. CMA data

2. Non-Financial Details:
 Copies of Memorandum of Association and Articles of Association (for limited
companies)
 List of shareholders holding 5% or more in equity
 Note on Company’s tax payment status
 Copies of clearance from Government/Local Bodies a may be relevant to the
type of proponent e.g. NOC from Population Control authorities, approvals for
construction of factory/office building from Municipal Corporation/Local Body
etc.
 Copies of letters of sanction from Banks/Financial Institutions participating in
financing the project and working capital requirements
 Details on Associates and their nature of association if applicable
  Photocopies of lease deeds /title deeds of all the properties being offered as
primary and collateral securities
3. Company’s Promoters and Management Details:
 Bio-data of promoter/s and guarantor/s
 Details of Managerial Personnel: Names of Directors /Partners, their addresses
and their PAN, Customer-IDs, if any. (Minimum of ten directors/partners)
 Statement of Assets and Liabilities, certified by a Chartered Accountant, for past
3 years in respect of promoter/s and guarantor/s

4. Additional Details:
 Constitution
 Date of commencement of business / project
 Size
B. PRE-SANCTION INSPECTION

1. Visits
Along with the collection of information and documents from the borrower, the bank
official conducts a pre-sanction inspection at the borrower’s factory and office site. The
purpose of this inspection is to view the operations and to verify the accuracy of the
details provided by the borrower. The observations during the visit may include the
following.
 General working of factory / tempo of activity.
 Power / fuel supply.
 Idle machinery.
 No. of shift worked.
 Labour / Employee situation.
 Pollution Control Certificate.
 Details provided by the borrower during the discussion.
 Other observations during the visit

2. CIBIL Report
Another Important thing in Pre-sanction Inspection is the CIBIL Report which is been
issued by the Credit Investigating Bureau. The aim of CIBIL's Commercial Credit
Bureau is to minimize instances of concurrent and serial defaults by providing credit
information pertaining to non-individual borrowers such as public limited companies,
private limited companies, partnership firms, proprietorships, etc. CIBIL will maintain a
central database of information as received from its Members. CIBIL will then collate
and disseminate this information on demand to Members, in the form of Commercial
Credit Information Reports (CIR) to assist them in their loan appraisal process.
CIBIL primarily gets information from its Members only and at a subsequent stage will
supplement it with public domain information in order to create a truly comprehensive
snapshot of an entity’s financial track record.
The CIBIL Report contains the following information-
 Basic borrower information
 Records of all the credit facilities availed by the borrower
 Past payment history
 Amount overdue
 Number of inquiries made on that borrower, by different Members
 Suit-filed status
3. Verification of Documents:
It Involves
 Title clearance reports of the properties to be obtained from empanelled
advocates.
 Valuation reports of the properties to be obtained from empanelled
valuer/engineers.
In this report all the documents are verified and thoroughly checked and authenticated.
It is important to see that all the necessary documents submitted are true. The Bank
officer checks with the respective authorities that the document submitted initially are
true and okay. Also the validity and dates of the document are to be noted.
C. APPRAISAL NOTE
The proposal is prepared by the bank officials on the basis of the data provided by the
client. Information gathered during meetings with the client and from other sources. The
sanctioning of credit facility is done on the basis of the proposal. The components of the
proposal as mentioned below explain the factors considered for sanction of credit.

1. Borrower Profile:
This comprises
 Name of the Borrower
 Date of establishment
 Year since advance provided by the bank
 Business activity
 Name of the Group to which the company belongs
 Chief Executive / Promoter
 Banking Arrangement – sole banking, multiple banking or consortium.
 Type of Facility
 Types of Borrower: Individual, Joint Accounts, Partnership Firms, Limited
Companies
 Industry Experience
 CIBIL Score
 Present Industry Scenario
2. Financial Analysis:

The assessment of financial risks is made on the basis of the analysis of the
performance of the borrowers as obtained from the last audited balance sheet / profit &
loss account. Additionally the trends for the past 2-3 years may be considered to give a
dynamic character to the variables selected.
 Balance sheet analysis
 P&L Statement Analysis
 Fund Flow Analysis
All the above data can be easily obtained with the help of CMA data provided by the
company/borrower.

CMA DATA
Credit Monitoring Arrangement (CMA) data is a very important area to understand by a
person dealing with finance in an organization. It is a critical analysis of current &
projected financial statements of a loan applicant by the banker. CMA data is a
systematic analysis of working capital management of a borrower and objective of this
statement is to ensure the usage of long term and short term fund have been used for the
given purpose. In this article I want to discuss about the basic contents of the CMA
data. Basically CMA data contains the 7 statements which as follows.

1. Particular of Existing & Proposed Limits:

It is the first statement in the CMA Data which contains the present fund & non fund
based credit limits of the borrower and their usage limits and history. Along with
present fund limits what is the proposed or applied limit of the borrower will be
mentioned in this statement, this is a basic information document which provided by the
borrower the banker.
2. Operating Statement:
This is the second statement which provided by the borrower, it indicates the business
plan of the borrower which gives the Current Sales, Direct & indirect expenses, Profit
before & after tax along with the projections of sales, expenses and profit position for
the 3 to 5 years based on the borrower working capital request. This statement is a
scientific analysis of current & projected financial and profit generating capacity of the
borrower.
3. Analysis of Balance Sheet:
Balance sheet analysis for the current & projected financial years is the third statement
in CMA data. This statement gives the detailed analysis of Current & noncurrent assets,
fixed assets, cash & bank position, current & noncurrent liabilities of the borrower. Also
this statement indicates the net worth position of the borrower for the projected years.
Balance sheet analysis gives a complete financial position of the borrower and cash
generating capacity during the projected years.
4. Comparative Statement of Current Asset & Liabilities:
Fourth statement which gives the comparative analysis of current assets & current
liabilities movement of the borrower. This basically decides the actual working capital
cycle for the projected period and the capacity of the borrower to meet their working
capital requirements.
5. Calculation of MPBF:
This is a very important statement and calculation which indicates
the Maximum Permissible Bank Finance. This statement which calculates the borrower
working capital GAP and permissible finance in two lending methods, first method of
lending will allow the MPBF 75% of the net working capital GAP which is Current
assets less current liabilities, Second method of lending will allow the MPBF 75 % the
current assets less current liabilities. So only the MPBF limit is the cash credit
component of the borrower which generally known Drawing power (DP Limit). So this
is very important statement which decide the borrower`s borrowing limit from the bank.
6. Fund flow statement:
Fund flow statement analysis for the current & projected period is one of the statements
in CMA data. This statement analysis borrower fund position with reference to the
working capital analysis given in MPBF calculations & projected balance sheets. Basic
objective of this statement capture the funds movement of the borrower for the given
period.
7. Ratio Analysis:
This is the last statement which gives the key ratios to the banker based on the CMA
data prepared and submitted to the bank for finance. Basic key ratios are Gross profit
ratio, net profit ratio, current ratio, MPBF, Net worth, ratio of net worth with Liabilities,
quick ratio, stock turnover, asset turnover, fixed asset turnover, current asset turnover,
working capital turnover, Debt Equity ratio etc.

CREDIT RISK RATING (CRR):

Basic Indicator Approach (BIA) for Operational Risk & Standardised Approach for
Market & Credit Risk for the purpose of Capital Adequacy computation as per the
guidelines of Reserve Bank of India. The Bank has a credit risk rating framework for
risk rating of various categories of borrowers.
The various parameters on which CRR is calculated is as follows-
External risk /Govt Policy Risk/ Environmental Risk:
 Regulator's Risk Borrowers Business is subject to Government Policies and is
exposed to external / environment risks including pollution control risks
o No restrictions
o Some restrictions
o Stringent Restrictions
 Intensiveness of Competition
 Presence of substitute etc.
 Barriers to entry for new players
 Business returns: Profit before interest depreciation & Tax & Total Tangible
Asset
 Cyclicality in earnings, subject to vagaries of nature technological obsolescence
 Technology adopted by Borrower
 Dependence on a few suppliers for raw material
 Borrower’s dependence on a few customers
 Foreign exchange component of total business
 Whether borrower dealing in perishable commodity
 Demand/supply gap in the business
Management Risk:
 Ownership pattern
 Past track record of the Management
o Sales
o Financial Discipline
o Furnishing Information
 Quality of the management personnel
 Experience of the Management
 Payment record with banks
 Financial conservatism
 Market standing / credibility
 Support from Group Companies
  Succession risk/plan
 Security (Collateral) Value of collateral security covering the bank's total
exposure to the extent of credit given.
 Income value to the Bank: Income/interest, commission exchange etc from the
account as %age of total fund based limit
Conduct of the Account:
 Timely submission of stock and/or Book debts statement
 Compliance with terms and conditions of sanction
 Timely renewal/review of the account
 Regularity / irregularity of the working capital facilities
Financial Analysis:
 Net Sales
 Net PAT/% Sales
 Cash Accruals
 Tangible Net Worth
 TOL/TNW
 Net Working Capital: CA-CL

Key Financial Indicators:

Net Sales:
Gives a picture as to how have the business been performing, with over the years and
also based on the projections made will it be under or over performing.

Net PAT/% Sales:

It gives an Idea how much profit the company is making on YOY basis and with respect
to sales it tells us about the profit generating capacity of the company the bank is
appraising.
Also on comparison of the above two ratios the bank officer can assess whether there
has been a decrease or increase in profits in comparison to sales and the probable reason
for it e.g. Increase in taxes, increase or decrease in operating efficiency.
Cash Accruals:
It is obtained from the cash flow statement submitted by the borrower, the cash accruals
indicate the amount that is to be received or expensed but not yet accrued. It gives a
composite picture on credit and debit policy of the borrower.

Tangible Net Worth:

In terms of a consumer, tangible net worth is the sum of all your tangible assets (cash,
home, cars, etc) less any liabilities you may have. In the financial markets, tangible net
worth represents the amount of physical assets a company has net of its liabilities. Thus,
it represents the supposed liquidation proceeds a company would fetch if its operations
were to cease immediately and the firm was sold off.
TNW = Ordinary Share Capital + General Reserve + balance in P&L + securities
premium + Capital Reserve (–) Intangible Assets (–) Misc Exp. not written off.

TOL/TNW:
TOL = Current Liabilities + long term Liabilities
It indicates what proportion of equity and debt the company is using to finance its
assets.

Net Working Capital:

CA-CL, the amount of working capital that will be needed by the borrower for the
company and its probable reasons for increase or decrease.

The Current Ratio:

A simple measure that estimates whether the business can pay debts due within one year
from assets that it expects to turn into cash within that year. A ratio of less than one is
often a cause for concern, particularly if it persists for any length of time.
Current Ratio = Current Assets
Current Liabilities

DSCR :
The Debt Service Coverage Ratio is a financial ratio that measures a company's ability
to service its current debts by comparing its net operating income with its total debt
service obligations. In other words, this ratio compares a company's available cash with
its current interest, principle, and sinking fund obligations.

The debt service coverage ratio is important to both creditors and investors, but
creditors most often analyze it. Since this ratio measures a firm's ability to make its
current debt obligations, current and future creditors are particularly interest in it.

Benchmark Ratio for Credit Proposals: (For Working Capital Method)

Current Ratio Minimum – 1.25:1

TOL/TNW Maximum – 4:1 (5:1 for Export credit facilities)
DSCR Minimum – 1.5:1 for Term Loans

Relaxations in the above benchmark ratios may be considered by sanctioning authority

deserving cases after recording justification for the same and shall be reported to the
next higher authority through noting.
If the bank is providing a working capital loan to existing firm efficiency ratios are also
included in the report.

Debtors Turnover:
An accounting measure used to quantify a firm's effectiveness in extending credit as
well as collecting debts. The receivables turnover ratio is an activity ratio, measuring
how efficiently a firm uses its assets.

Inventory Turnover:
A ratio showing how many times a company's inventory is sold and replaced over a
period. The days in the period can then be divided by the inventory turnover formula to
calculate the days it takes to sell the inventory on hand or "inventory turnover days."

Asset Turnover:
The amount of sales or revenues generated per dollar of assets. The Asset Turnover
ratio is an indicator of the efficiency with which a company is deploying its assets.

Asset Turnover = Sales or Revenues/Total Assets

Generally speaking, the higher the ratio, the better it is, since it implies the company is
generating more revenues per dollar of assets. But since this ratio varies widely from
one industry to the next, comparisons are only meaningful when they are made for
different companies in the same sector.

Creditors Turnover:
A short-term liquidity measure used to quantify the rate at which a company pays off its
suppliers. Accounts payable turnover ratio is calculated by taking the total purchases
made from suppliers and dividing it by the average accounts payable amount during the
same period.

The benchmark ratio for these differs from sector to sector and hence is dependent upon
the borrowers’ sector.
3. Assessment of Credit Requirement:
After the implementation of a phased liberation programme since 1991, the RBI
decided to allow full operational freedom to the banks in assessing the working capital
requirements of the borrowers. All the instructions relating to Maximum Permissible
Bank Finance (MPBF) have been withdrawn. The following two methods are employed
by Bank-
A. Turnover Method (Nayak Committee)

B. Traditional Method (Tondon Committee)

As per RBI guidelines credit requirement should be assessed by both the above methods
and higher of the PBF computed by these two methods should be sanctioned.
The following category of borrowers shall be considered on the basis of turnover
method
1. SSI borrowers shall be availing fund based facilities up to Rs. 5 Cr.
2. Other category of borrowers availing fund based facilities up to Rs. 2 Cr.
4. Cash Budget System:
An estimation of the cash inflows and outflows for a business or individual for a
specific period of time-
Cash budgets are used by banks to assess whether the entity has sufficient cash to fulfill
regular operations and/or whether too much cash is being left in unproductive
capacities.
For Seasonal industries such as sugar, tea etc; Software industry; Sick Units;
construction/Contractors/Developers cash budget method shall be used for assessment
of Working capital requirements. Separate Peak and Non-Peak level credit limits shall
be given consideration while working on the credit appraisal where the borrowers’
activities are of seasonal nature.
5. Operating Cycle:
The operating cycle is also useful for estimating the amount of working capital that a
company will need in order to maintain or grow its business. A company with an
extremely short operating cycle requires less cash to maintain its operations, and so can
still grow while selling at relatively small margins. Conversely, a business may have fat
margins and yet still require additional financing to grow at even a modest pace, if its
operating cycle is unusually long.

The operating cycle is the average period of time required for a business to make an
initial outlay of cash to produce goods, sell the goods, and receive cash
from customers in exchange for the goods. If a company is a reseller, then the operating
cycle does not include any time for production - it is simply the date from the initial
cash outlay to the date of cash receipt from the customer.

Operating Cycle = Days Inventory Outstanding + Days Sales Outstanding + Days

Payables Outstanding

For example, let's say Company XYZ makes widgets, which typically sit in the
warehouse for 10 days. Let's also assume that it typically takes 15 days to collect on
the sale of each widget, and that it takes 14 days to pay invoices to Company
XYZ's vendors. Using the formula above, Company XYZ's net operating cycle is:

Net Operating Cycle = 10 + 15 + -14 = 11 days

This means that Company XYZ generates cash from its assets within 11 days.

The operating cycle is thus a measure of how long an investment is locked up in

production before turning into cash. In turn, the net operating cycle is a measure of
managerial competency as well as operational efficiency.
6. Security
The bank would prefer to have its credit exposures backed by tangible security, either
primary or collateral, to the full extent of the liability. The bank may consider obtaining
the collateral security where the primary security is inadequate or for any other valid
reasons like weak financials, risky ventures, untested projects / products, sunrise
industries etc. where the primary security has limited market etc
There are two types of security one is principal & another one is collateral security.
Usually, the principal security considered by the bank is the hypothecation of the
stocks and the book debts in case of working capital requirements.
Collateral security is extra security provided by a borrower to back up his/her intention
to repay a loan. Such security is likely to be documentation (deeds) giving right of title
to property, which the lender may take over and sell to repay the loan if the borrower
does not keep up the mortgage payments.
Different types of Security:
Hypothecation: under this mode of security, the banks provide credit to borrowers
against the security of movable property, usually inventory of goods. The goods
Hypothecated, however, continue to be in possession of the owner of the goods i.e. the
borrower. The rights of the banks depend upon the terms of the contract between
borrowers and the lender. Although the bank does not have the physical possession of
the goods, it has the legal right to sell the goods to realize the outstanding loans.
Hypothecation facility is normally not available to new borrowers.
Mortgage: It is the transfer of a legal / equitable interest in specific immovable
property for securing the payment of debt. It is the conveyance of interest in the
mortgaged property. This interest terminated as soon as the debt is paid. Mortgages are
taken as an additional security for working capital credit by banks.

Pledge: The goods which are offered as security are transferred to the physical
possession of the lender. An essential prerequisite of pledge is that the goods are in the
custody of the bank. Pledge creates some kind of liability for the bank in the sense that
‘Reasonable care’ means care, which a prudent person would take to protect his
property. In case of non-payment by the borrower, the bank has the right to sell the
goods.

Lien: The term lien refers to the right of a party to retain goods belonging to other party
until a debt due to him is paid. Lien can be of two types viz. Particular lien i.e. A right
to retain goods until a claim pertaining to these goods are fully paid, and General lien,
Which is applied till all dues of the claimant are paid. Banks usually enjoyed general
lien.

In case of SSI units the bank does not demand any collateral security for accounts with
limits up to Rs 5 lakhs. In case of accounts with limits above Rs5 lakhs but not
exceeding Rs25 Lakhs , the bank may not insist on collateral security provided the
financial position is good and the unit’s track record is good. In case of certain
categories of advances such as the diamond exports, software etc. where the tangible
primary security is not available and the advance is granted more on trust and the track
record of the performance and conduct of the account .

When the bank is considering security cover, the following points are to be taken into
consideration:
 Facility
 Nature of security
  Value of the security
 Date of valuation
 Date of creation of first/second charge
 In case of pari-passu /second charge over
7. Deviation
Deviations from RBI guidelines or Bank policy regarding the proposal must be
mentioned and the justification/Mitigates for the same must be provided.
8. SWOT Analysis
A tool that identifies the Strengths, Weaknesses, Opportunities and Threats of an
organization. Specifically, SWOT is a basic, straightforward model that assesses what
an organization can and cannot do as well as its potential opportunities and threats. The
method of SWOT analysis is to take the information from an environmental analysis
and separate it into internal (strengths and weaknesses) and external issues
(opportunities and threats). Once this is completed, SWOT analysis determines what
may assist the firm in accomplishing its objectives, and what obstacles must be
overcome or minimized to achieve desired results.
It consists of various parameters; the broad categories are as follows

This assessment gives the credit analyst an insight into the macro environment and the
potential risk for the company. As the economic and business environment in which a
company is working is constantly changing it becomes all the more important for the
bank to assess the industry.
The industry is assessed in four parameters-
a. Demand – Supply Gap
b. Government policies
c. Input related risks
d. Extent of competition
Nature of the product, demand, existing and perceived competition in the segment,
ability of the proponents to withstand the same, government policies governing the
industry need to be taken into account.
9. Recommendations:
After considering the entire proposal the bank officer makes recommendations about
whether the proposal can be approved or not, any changes in terms or conditions is
required and should be notified to the Chief Manager and Borrower.
Also a small summary of the proposal is provided containing the details as follows-
 Limit
 Purpose
 Security
 Margin
 ROI
 Review
 Collateral
 Guarantees
D. SANCTION OF LOAN

1. Delegation of Authority
The bank officer prepares the documents and the Appraisal Proposal which is then
scrutinized by the senior manager or a higher authority which is then given for approval
to the Branch Manager for approval if limit is within 2cr and then to Zonal officer.
Also Deviations from the bank policy or Guidelines from RBI needs to be
communicated to the higher authorities.

2. GENERAL ‘Terms and conditions’

After the competent authority sanctions the loan; a letter of sanction is issued to the
borrower. This communicates to the borrower the assistance sanctioned and also it
contains the letter of sanction contains the general terms and conditions which the
borrower is required to fulfil it before the disbursement of the loan.
Following are general ‘Terms and conditions’-
i. Bank has a liberty to recall the finance without any reasons and the entity is liable to
pay the amount on demand within given period of time.
ii. Bank’s officer can come for inspection at any moment. He should be provided with
free access for inspection of the factory, books of accounts, etc.
iii. All the securities offered should be fully insured.
iv. Accounts of the business firm shall be fully operated from the lending bank.
v. If there is major change in constitution, like,
vi. Change of business.
vii. Additional product line introduced
viii. Change in business plan
xi. Change in debt-equity composition
x. Change in management.

 Then, the bank should be within the knowledge of these matters and in case of
important decision affecting business banks concern should also be taken.
 Disallowing large cash withdrawals - Large cash withdrawal will be allowed
only if the branch manager is satisfied with the purpose.
 Bank will not allow operations in a NPA account and may seek legal remedies
to recover its dues.
 On receiving the letter of sanction from the financial institution, the borrowing
unit convenes its board meeting at which the terms and conditions associated
with the letter of sanction are accepted and an appropriate resolution is passed to
that effect. The acceptance of terms and condition has to be conveyed to the
financial institution within a stipulated period.
 The financial institution, after receiving the letter of acceptance from borrower,
sends the draft of the agreement to the borrower to be executed by the
authorized persons and properly stamped as per Indian Stamp Act, 1899. Once
the financial institution also signs the agreement, it becomes effective.

E. DISBURSEMENT
Working capital loan is disbursed to the borrower with help of a Cash Credit Account
and Issuing a Cheque book for the same, initial amount that can be accessed by the
borrower is as follows

1. Drawing Power
Sanction of the limits does not entitle the borrower to draw the limit to the fullest extent
disregarding the “drawing power” worked out in terms of security cover available to the
bank. Bank considers permissible bank finance (PBF) or DP, whichever is less. Thus, if
DP works out in the excess of sanction limit, the withdrawals is restricted to the extent
of sanctioned limit. And wherein the sanction limit is in excess of DP then withdrawal
is restricted to the extent of DP.

The drawing power is calculated with the help of monthly stock statements submitted
by the borrower to the bank. It is as follows-

Stock Current
(+) Debtors
(-)Creditors O/S
Net Drawing Power
(-25%) Margin to the bank
Drawing Power (DP)
Registration under CERSAI is mandatory for all eligible cases.

2. Repayments Calculation

The interest rate is decided on the basis of circular provided by the bank taking into
account the Internal Credit Risk Rating of the borrower, base rate, coverage under
CGTMSE, percentage of Collateral security offered, whether the company falls under
priority sector lending or not and the limit of the loan sanctioned.

The rates are easily available on the banks website.

3. Controlling and Monitoring

Supervision and follow-up of assisted project is during and after disbursement is indeed
a crucial exercise to be performed periodically with meticulous care, not only to
safeguard the interest of the term lending institution but also to ensure optimization of
returns on investments in the project. Follow-up is necessary as even a well convinced
project at appraisal stage could come to grief due to lack of adequate care, supervision
and control.
4. Tools Used
 Monthly Stock Statements/6 months of Auditing done by the bank.
 Analysing of annual financial statements.
 Visits and Inspection.
 Discussion with the management.

Executing of loan agreement and other necessary legal documents is not sufficient for
disbursing the loan. The term lending institution should ensure that the amount
disbursed would be utilized for the purpose for which it has been sanctioned.
 CHAPTER 7

CASE STUDY
CASE STUDY

Consider the following proposal; to increase the cash credit limit from 1250 lacs INR
to Rs.2000 lacs INR. The increase in cash credit limit is needed to complete the existing
sales order and achieve the sales target.

Company Profile

XYZ Engineering Industries Private Limited is a SME promoted by technocrat

entrepreneur Mr. Ram Sharma From the modest beginning in 1987 as a supplier of
small capital goods equipments to the Central and State Electrical Utilities and BHEL,
the company has over the past 20 years, emerged as an accredited supplier of capital
goods equipments to many Central and State Electrical Utilities in India.

The core competences of the company are thermal & mechanical design, fabrication,
machining & assembly and erection & commissioning of capital goods equipments. The
company product range covers all type of small capital goods equipments in power
generation and other process plant like refineries, fertilizer, chemical, smelting etc. Now
the company is equipped to fabricate large components and assemblies for all types of
power plants like Thermal, Hydro and Wind.

EXECUTIVE SUMMARY

Name of the Company XYZ Engineering Industries Pvt. Ltd.

Constitution Private Limited Company

Registered Office India

Year of Incorporation 2007

Promoters The company is promoted by Mr. Ram Sharma

Company Business Manufacture of small capital goods equipments

Key Financials(2012) Rs. in Lacs

Particulars Sales EBIDTA PAT NCA(1)

2013(A) 1916.56 268.06 76.72 965.82

2014(A) 2446.92 326.43 96.26 1181.57

2015(P) 3330.95 434.31 126.99 1435.61

2016(E) 4800.00 732.48 291.53 2550.33

2017(E) 6000.00 802.97 295.91 3355.95

Note 1: Net Current Assets

Project Details The company has registered a steady growth in the business
operations in the current year. The company expects a
turnover of Rs. 4800 Lacs in the current year 2015-16 as
compared to the existing turnover for FY 2014-15 of Rs.
3300 Lacs. Due to this increased turnover the company has
asked for a Cash credit facility of Rs. 1700 Lacs and Bank
Guarantees of Rs. 150 Lacs and L/C of Rs. 150 Lacs.
(Existing CC Limit of ` 1000 Lacs and Bank Guarantee
limit of Rs. 150 Lacs and LC Limit of Rs. 100 Lacs with
existing Bank)

Amount of loan Rs.1700 Lacs as Cash Credit Limit

Rs. 150 Lacs as Bank Guarantee Limit

Rs.150 Lacs as L/C Limit

Purpose of loan For Funding working Capital Operations.

Security Primary: First charge on all the Current Assets of the

Company.
Collateral: Mortgage of the factory land and Assets.
Mortgage of Residential Houses and land.
Total market value of the collateral assets (approximately Rs
1000 Lacs)
XYZ ENGINEERING INDUSTRIES PVT. LTD.

About the Company

XYZ Engineering Industries Private Limited is a SME promoted by technocrat
entrepreneur Mr. Ram Sharma From the modest beginning in 1987 as a supplier of
small capital goods equipments to the Central and State Electrical Utilities and BHEL,
the company has over the past 20 years, emerged as an accredited supplier of capital
goods equipments to many Central and State Electrical Utilities in India.

The core competences of the company are thermal & mechanical design, fabrication,
machining & assembly and erection & commissioning of capital goods equipments. The
company product range covers all type of small capital goods equipments in power
generation and other process plant like refineries, fertilizer, chemical, smelting etc. Now
the company is equipped to fabricate large components and assemblies for all types of
power plants like Thermal, Hydro and Wind.

Product Portfolio

XYZ Engineering Industries Pvt. Ltd. having its registered office in India and is a
private limited company incorporated under companies Act, 1956 in the year 2007. The
core competences of the company are thermal & mechanical design, fabrication,
machining & assembly and erection & commissioning of heat transfer equipments. The
company product range covers all types of heat transfer solutions in power generation
and other process plant like refineries, fertilizer, chemical, smelting etc. Now the
company is equipped to fabricate large components and assemblies for all types of
power plants like Thermal, Hydro and Wind.

Some of the equipments manufactured by the company are-

1. Surface Condenser.
2. LP Heater.
3. HP Heater.
4. Exhaust Diffuser.
5. Other Heat Exchanger Equipment.
Shareholding Pattern
The share capital as on March 31, 2012 was Rs. 26624000 consisting 2662400 shares of
Rs 10 each. The shareholding pattern is as under-

Sr. No. Name of the Shareholder % of Shareholding

1. Mr. Ram Sharma 30.00%

2. Mr. Akash Banasha 30.00%

3. Mr. Ankit Mathur 20.00%

4. Mr. Bikas Nath 20.00%

SWOT Analysis of Company

Strength

 Highly experienced Promoters and skilled management with extensive

reputation in the respective fields will enable the company to move ahead.
 The company has highly skilled labour force and over the years company
suitably trained its labour force for specific skills required in the industry that
enable the company to produce qualitative products.
 The company has A Grade Customer.
 Wide and well spread base of well known customer.
 Offering competitive prices.
Weakness

 Lack of subcontracting arrangements.

 Focus largely on domestic market.
Opportunities

 Opportunities in the renewable sector, bio mass generation, waste heat recovery
and other sector.
  A rise in the cogeneration power projects which is our niche market segment.

Threats

 Rapid change in technology.

 A worldwide slow down in thermal power sector due to coal shortages.

PROJECT DETAILS
XYZ Engineering Industries Pvt. Ltd. is currently having a Cash Credit Limits of Rs.
1000 Lacs and Bank Guarantee limit & LC of Rs. 250 Lacs with Bank.

The company has registered a steady growth in the business operations in the current
year. The company expects a turnover of Rs.4800 Lacs in the current year 2015-16 as
compared to the existing turnover for FY 2014-15 of Rs. 3300 Lacs. Due to this
increased turnover the company has asked for a Cash credit facility/WCDL of ` 1700
Lacs and Bank Guarantees of Rs. 150 Lacs and LC of Rs. 150 Lacs.

The company is looking for a Cash credit Limits, Bank Guarantee and LC Limits.

The Loan Structure is requested as follows-

Rs. In
Lacs

Nature of Loan Amount

Cash Credit Facility 1700.00

L/C 150.00

Bank Guarantee 150.00

Total 2000.00
The MPBF Calculation for Cash Credit Limits is as under-

Rs. In
Lacs

Particulars Period(in 2014-15 2015-16 2016-17

days) (Provisional) (Projected) (Projected)

Current Assets

Inventory

Raw Materials 53 287.74 441.00 551.25

Consumables 90 0.00 65.36 81.71

WIP 131 903.02 1,314.22 1,707.36

Finished Goods 18 40.80 172.59 297.13

Receivables 70 638.28 920.55 1,150.68

Total 1,869.84 2,913.72 3,788.12

Less: Current
Liabilities

Creditors 51 537.07 452.65 554.23

Other liabilities 25 26.54 32.88 41.10

Net Current Assets 1,306.23 2,428.19 3,192.80

Margin(25% on CA) 467.46 728.43 947.03

MPBF 838.77 1,699.76 2,245.77

Loan Required - 1,700.00 2,200.00

Justifications for the Assumptions used for Working Capital

1. Raw Material
The product of the company is custom built items with long production cycle.
The raw materials which are used are steel plates ( mild steel, Carbon steel or
boiler quality steel) of various thicknesses, brass plates, stainless steel plates,
ERW steel tubes , stainless steel tubes, copper tubes, admiralty brass tubes ,
cupro nickel tubes, aluminum strips, copper strips, copper wires, solder wires et.
Due to a variety of material and each custom built product requiring specific
dimension material accumulation is rather large. The Company generally buys
whole plates. Tubes of specific size are bought as per the order requirement.
The actual raw material stocking were therefore around 2 months and as such it
has been assumed a raw material stocking of 2 months (53 days).(For FY 2014-
15 the actual days were 53 days)

2. Consumables
The Company till last year was not holding consumables stock but due to the
increase in the number of orders and the configuration of orders increasing in
the nature of custom built orders it has decided to keep stock of consumables
also. Hence the stock of consumables has been assumed at reasonable 90 days (3
months).

3. WIP
The production cycle is long which is further aggravated by the requirement of
in-stage inspection in many of the orders and the processing of orders may take
upto 5 months. While there may be some variation in small jobs a minimum
period of three months is nevertheless required and it has been assumed an SIP
stocking of 131 days (3 months).(For FY 2014-15 the actual days were 131
days).

4. Finished Goods
Once the job is ready it is invariably subjected to ultimate customer’s inspection
in addition to the inspection by the purchaser who is normally an EPC contractor
 or OEM manufacturer. It has been the company’s experience that generally
about a month is passed between the job’s readiness and its ultimate dispatch
from the factory. This fact does not reflect in the balance sheet since there is a
universal tendency to expediency towards the financial year end. So 18 days
(half month) of stocking of finished goods has therefore been assumed. (For FY
2014-15 the actual days were 6 days).

5. Receivables
The payment terms from the majority buyers is 45 to 85 days averaging about
60-65 days. Accordingly the receivables have been assumed at 70 days for FY
2015-16(2.30 months). (For FY 2014-15 the actual days were 69 days).

6. Creditors
The credit on major material is available only against the LC. It varies from 30
to 60 days. Consumables and other spares are available on 30 days credit. Any
longer credit is usually at a higher price. Our average creditors have been around
1.75 to 2 months which the company is desirous of reducing to 51 days (1.7
months) for better pricing and faster deliveries. While the credit is available
LCs are required for availing the credit. (For FY 2014-15 the creditors days
were 96 days, however the average creditors days during the FY 2014-2015
were 45 days)

7. Other Liabilities
The other liabilities have been assumed as per FY 2014-15 for FY 2015-16 also.
i.e 25 days(0.83 months).

8. Calculation of Bank Guarantee

Particulars Rs. in Lacs

Sales 4800.00

Hit rate 40%

Tenders Expected 1920.00

 EMD BG's @ 2% - A 48.00

Existing BG for existing contracts – B 25.00

Future orders 500.00

PBG required @10% for 18 months - C 75.00

Total BG required 148.00

Say 150.00

9. Calculation of LC

Particulars Rs. in Lacs

Raw Material Consumed 3024.00

Purchase under LC 30%

Average Credit period 60.00

Average Lead time 15.00

LC required 186.41

Say 150.00
PAST & PROJECTED FINANCIALS

Profit & Loss A/c-

Rs. In Lacs

Particulars FY 14 FY 15 FY16 FY17

Income from Operations 2,446.92 3,330.95 4,800.00 6,000.00

Other Income 3.79 4.98 - -

TOTAL INCOME 2,450.71 3,335.93 4,800.00 6,000.00

Less: Cost of Sales 2,124.51 2,901.86 4,067.52 5,197.03

EBIDTA 326.20 434.07 732.48 802.97

Depreciation 23.09 27.92 34.46 34.46

EBIT 303.11 406.15 698.01 768.51

Interest 167.91 238.10 261.46 325.39

EBT 135.20 168.05 436.55 443.12

Tax Provision 38.93 41.06 145.03 147.20

PAT 96.27 126.99 291.53 295.91

Balance Sheet -

Rs. In
Lacs

Particulars FY 14 FY 15 FY16 FY17

Paid-up Equity Capital 233.50 266.24 300.00 300.00

Share Application
Money 66.01 31.40 0.00 0.00

Reserves and Surplus 324.68 468.03 776.44 1072.36

Unsecured Loan 146.03 139.34 250.00 250.00

Misc. Expenses -4.84 -11.24 -11.00 -10.76

Net worth 765.38 893.77 1315.44 1611.60

Secured Loan 923.54 1161.93 1820.51 2295.51

Capital Employed 1688.92 2055.70 3135.95 3907.11

Net Block 507.41 620.09 585.62 551.16

Non Current Assets - 147.58 - -

Current Assets 1561.40 2064.19 3325.88 4182.48

Less: Current Liability 379.89 776.16 775.55 826.53

Net Current Asset 1181.51 1288.03 2550.33 3355.95

Capital Utilized 1688.92 2055.70 3135.95 3907.11

Ratios-

Particulars FY 14 FY 15 FY16 FY17

Profitability Ratios (In

%)

EBIDTA Ratio 13.31% 13.01% 15.26% 13.38%

EBIT Ratio 12.37% 12.18% 14.54% 12.81%

EBT Ratio 5.52% 5.04% 9.09% 7.39%

Net Profit Ratio 3.93% 3.81% 6.07% 4.93%

Sales/Total Asset
(Times) 1.18 1.24 1.23 1.27

Return Ratios (In %)

ROCE 6% 6% 9% 8%

RONW 13% 14% 22% 18%

Return on Total Asset 5% 5% 7% 6%

Liquidity Ratios (In

Times)

Debt Equity 1.21 1.30 1.38 1.42

Current Ratio 4.11 2.66 4.29 5.06

TOL/TNW 1.70 2.17 1.97 1.94

Investor Ratios( In `)

Cash EPS 5.11 5.82 10.87 11.01

BV per share 32.78 33.57 43.85 53.72

CONCLUSION
Credit provided by the banks is an important source of finance for the corporate. But the
bank has to check the acceptability of the corporate before they can sanction the loan to
it. Along with this, the assessment of the credit needs of the corporate also has to be
done by the bank. This entire process is called the credit appraisal process of the bank.
Before sanctioning a loan to the corporate, in general, these following things are taken
into consideration- the track record of the corporate, the risk profile of the corporate,
and the ability of the corporate to repay the loan disbursed.

Generally, while performing the credit appraisal process, the bank takes into
consideration the borrower’s profile , the facilities of credit delivery required by the
corporate, the security cover which the corporate can provide, the conduct/value of the
account of the corporate, the favorable conditions and the mitigants to the project for
which loan is required, the financial position of the corporate, the credit rating of the
corporate, the RBI and the bank’s norms relating to the exposure to the industry, region,
the margin norms etc.

Taking these factors into consideration, the bank decides whether to sanction the loan to
the corporate or not. If the loan is to be sanctioned then what rate of interest is to be
provided to the corporate is decided based on the risk rating of the corporate and a host
of other subjective factors.
SUMMARY

Banking sector plays a very crucial role in development of an economy. They provide
financial assistance to different kind of projects – to entrepreneurs for establishment of
new ventures, to existing firms – for expansion, diversification and modernization; thus
encouraging industrial development.
This project is undertaken to understand the procedure followed by a bank when it
extends working capital financing to a borrower. The detailed analysis is carried out by
the bank in the form of a proposal that is assessing the parties’ financial position and its
capacity to repay the debt which it has asked from the bank.
The banks need to appraise or evaluate the corporate before lending them any credit.
This process is called the credit appraisal of the corporate. The process of credit
appraisal would begin with the selection of the proponent. It would involve appraising
the background of the proponent/management, commercial, technical and financial
appraisal. Appraisal of credit facilities would comprise two distinct segments – (I)
Appraising the acceptability of the customer and (II) Assessment of the customer’s
credit needs.
It involves studying the different information, which the bank requires to appraise the
credit to the corporate. This project includes the study of the different types of facilities
of credit delivery that the bank gives to the corporate. It also includes the study of the
method of assessment of the working capital limits. This project will also consider the
study of the various parameters that the bank takes into consideration while deciding the
credit rating of the corporate.