Short Term Finance---Working Capital Finance Through Bank

CREDIT MANAGEMENT IN THE CHANGING SCENERIO

- Global Economic slowdown

- High inflation and low rate of growth of GDP
- Slackness in industrial growth
- High interest rate
- Slackness in demand for credit ,esp. quality credit
- Stiff competition
- Declining & thinner spread
- Stiff income recognition , provisioning &capital adequacy norms
- Increased operational costs
BASIC REQUIREMENTS FOR LENDING

-Capital
-Borrowers’ Constitution
-Documentation
-Credit monitoring-financial follow-up, Physical follow-up &Legal follow-up
PRINCIPLES OF LENDING
Activity
1 .Ensuring Safety
2 . Providing Liquidity
3. Generate Profit
4.Purpose
5.Adequate Security
6. Risk Management through Diversification
EVALUATION OF BORROWERS-THE 6C’s
1.Character,
2.Capacity
3.Capital
4.Conditions-Social,Technological,Economic&Political (STEP)
5.Collateral
6.Compliance

OBJECTIVES OF CREDIT MANAGEMENT

Comprise of following Activities:

i.Credit Allocation-15per cent of capital funds for individual exposure,40 per cent
for Group Exposure,Advances to Priority Sectors, Advances under DRI Scheme,
Export Credit and Financing of Infrastructure Projects etc.
ii. CREDIT EVALUATION:
a. Credit Appraisal Standards-qualitative &quantitative
b. Credit Rating of Borrower
c. Risk Management-management risk, business risk, financial risk, &project risk
d.Credit Discipline-Asset-Liability matching
e.Loan pricing-Risk based pricing
f.Review /Renewal of advances.
CREDIT EVALUATION -WORKING CAPITAL Finance
I. Concept of working capital &Net working capital-CA-CL
II. Dangerof inadequate working capital
III. Danger of excess working capital
IV. Factors Determining Working Capital
a. Production Policies
b. Nature of business
c. Length of the period of process
d. Working capital cycle
e. Seasonal fluctuations
f. Fluctuations of supply
V. METHODS OF LENDING
1.Operating cycle method
Step by step calculation of different segments of operating cycle:
a.Raw Material Storage Period
b.Conversion period
c.Finished goods Storage Period
d.Average collection period of credit sales
e.Average payment period of credit purchases
Operating cycle period=a+b+c+d-e
. 2.Turn Over Method ( Nayak Com Recommendations)
Fixing a limit of working capital of minimum of 20 per cent of assessed turnover
with a minimum margin of 5 per cent tobe brought by the borrower.This
method can be adopted for fund based working capital liability of Rs.5 crore.
3.Cash Budget Method
It is based on cash flow estimation . It has to show sources of funds including
due to profits & depreciation on ,l one side and application of funds which
reveals interest payment &payment of istalment of long term debts.Concept
of debt coverage ratio =cash accruals+ net profit divided by interest
charges+loan instalments.
This method asseses the requirement of funds by the firm at various periods
and then decide on the MPBF.This method suits the seasonal industries. Based
on the seasonality .banks can decide peak and – peaklimits for bank finance.
4.Tandon Committee Methods
Three Methods of assessing the MPBF which are as follows
Method I -0.75 (CA-CL)

Method II -- 0.75(CA)-CL

Method III 0.75(CA-CCA i.e.Core Current Assets)-CL

Banks can use any of the above methods depending on the nature of the
business and size of the firms and decide MPBF.
Whatever method is followed for assessing the requirement financing of
working capital will be through Cash Credit working loan(WCDL)and/or bill
financingmechanism. For borrowers with working limit of Rs.10 crore &
above.WCDL is a short term loan with a minimum repayment period of
15days.The CC AND WCDL component will be in the ratio of 80:20.
The other details of of this loan system will be as follows:
The WCDL can be rolled over.
There should be annual renewal of working capital limits. To ensure need
based credit facility ,the disbursement of the WCDL should be based on the
projected cash budget statements and the Quarterly Information/ Quarterly
Operating System(QIS/QOS).
The Model normally followed by the banks today are as follows:
1.Fund -based Working Capital Limits (FBWC) up to Rs.5crore –Turn Over
Method
 2. FBWC RS.5to Rs.25 crore: .The modified MPBF Method. i.e.the second
method of lending of Tandon Committee. However, it departs in the approach
by removing all rigidities associated with the original recommendations .It also
provides a great deal of flexibility.
3.FBWC above Rs.25 crore—The Cash Budget Method .It is a very flexible
Method and takes into consideration the cash flows for the ensuingfinancial
year. limits are arrived at based on the peak level cash deficit projected by
the borrower.
Super vision & followup
a. Financial supervision and
b. Physical supervision
Credit Monitoring
This is done through:
a. Credit Audit System
b. Quarterly Loan Migration Analysis and
c. Credit rating of Borrowers by external credit rating agency
As per RBI Guide lines borrowers enjoying credit limits of Rs.10 cr0re and
above should get them rated every year any of the rating agencies viz.
CRISIL,CARE,ICRA and FITCH.

References:
I Industrial Finance (Second &Revised Edition) by R.Vishwanathan
2.Credit Management by THE ICFAI UNIVERSITY,HYDERABAD.