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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

2 .

3. Generate Profit

4.Purpose

5.Adequate Security

6. Risk Management through Diversification

Safety

Providing

Liquidity

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

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

Rating of Borrower

I. Concept of working capital &Net working capital-CA-CL

II. Dangerof inadequate 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

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

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:

depending on the nature of the

loan(WCDL)and/or bill

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.