A Project Report On Study of assessment methods of working capital requirement For Bank of Maharashtra By Vaibhav N Jagat Under the

guidance of Mrs. Sovani

Submitted to

University of pune In partial fulfillment of the requirement for the award of the degree of master of business administration (MBA)

Through Vishwakarma institute of management Pune- 48

EXECUTIVE SUMMERY

It gives me great pleasure to present this project report on working capital finance at bank of Maharashtra, credit department, head office, Pune. The project was carried out from 1st June 2007 to 31st July 2007.

The main objective of the project was to study various types of working capital finance provided by banks. To know details the procedure of assessment of working capital finance extended by banks.

Wheels of business cannot move without money. Availability of money is being limited and wants being unlimited. So procurement of fund is one of the important functions in commercial & non-commercial enterprises and utilizes it for maximization of business profits.

Business enterprises need funds to meet their different types of requirements, i. ii. iii. Long-term requirement Medium-term requirement Short-term requirement Working capital requirement is the short-term requirement. Working capital is the investment needed for carrying out day-to-day operations of the business smoothly. Bank is one of the important sources of working capital requirement. Bank gives various facilities to the borrowers.

In this project I have considered various banking facilities for the working capital finance to the industries. It covers almost important aspect relating to assessment & follow up of working capital finance. After discussing the procedure followed by bank, For assessing working capital requirement case studies have been given with necessary data in the prescribed forms demonstrate the calculable done by bank to arrive at maximum permissible bank finance. An inventory & receivables constitute the major portion of the total working capital requirement.

Company Profile

The Birth

Registered on 16th Sept 1935 with an authorized capital of Rs 10.00 lakh and commenced business on 8th Feb 1936.

The Childhood

Known as a common man's bank since inception, its initial help to small units has given birth too many of today's industrial houses. After nationalization in 1969, the bank expanded rapidly. It now has 1292 branches (as of 30th September 2005) all over India. The Bank has the largest network of branches by any Public sector bank in the state of Maharashtra.

The Adult

The bank has fine tuned its services to cater to the needs of the common man and incorporated the latest technology in banking offering a variety of services.

Our Philosophy

o Technology with personal touch.

Our Emblem

The Deepmal

o With its many lights rising to greater heights.

The Pillar

o Our institution- Symbolizing strength.

The 3 M's

Symbolising

Mobilisation of Money Modernisation of Methods and Motivation of Staff.

Our Aims

The bank wishes to cater to all types of needs of the entire family, in the whole country. Its dream is "One Family, One Bank, Maharashtra Bank".

The Autonomy

The Bank attained autonomous status in 1998. It helps in giving more and more services with simplified procedures without intervention of Government.

Our Social Aspect

The bank excels in Social Banking, overlooking the profit aspect; it has a good share of Priority sector lending having 46% of its branches in rural areas.

Other Attributes

Bank

is

the

convener

of

State

level

Bankers

committee

Bank has signed a MoU with EXIM bank for co-financing of project exports Bank offers Depository services and Demat facilities in Mumbai.

Bank has captured 97.68% of its total business through computerization.

OBJECTIVES

To know the various types of working capital finance provided by banks. To analyze in detail the procedure of assessment of working capital finance extended by bank. To apply these procedure at a practical level with the help of case studies.

RESEARCH METHODOLOGY This is analytical research area where we analyses information with cause and its effects relationship. This analysis leads to the simple conclusions of whether to lend money to the institution for business. Also if the money is lend then there is reality the norms are not always perfect and hence it is essential to priorities stringent parameters and secondary parameters. Research Type Source of Data Sample Unit Sample Sample Technique Analysis Tool used Analytical Primary and Secondary Industries applying for loan Case studies Allocation of Case Financial Analysis

Primary Data: Observation, Discussion with the manager. The company profile, annual reports have been obtained from BOM. Secondary Data:

Secondary data relating to the procedure of assessment of working capital finance, old sanction proposals, RBI guidelines etc. have been sourced from reference books.

INTRODUCTION TO WORKING CAPITAL

In accounting, Working capital is the difference between the inflow and outflow of funds. In other words, it is the net cash inflow. It is defined as the excess of current assets over current liabilities and provisions. In other words, it is net current assets or net working capital.

A study of working capital is of major importance to internal and external analysis because of its close relationship with the day-to-day operations of a business. Working Capital is the portion of the assets of a business which are used on or related to current operations, and represented at any one time by the operating cycle of such items as against receivables, inventories of raw materials, stores, work in process and finished goods, merchandise, notes or bill receivables and cash.

Working capital comprises current assets which are distinct from other assets. In the first instance, current assets consist of these assets which are of short duration. Working capital may be regarded as the life blood of a business. Its effective provision can do much to ensure the success of a business while its inefficient management can lead not only to loss of profits but also to the ultimate downfall of what otherwise might be considered as a promising concern.

The funds required and acquired by a business may be invested to two types of assets: 1. Fixed Assets.

2. Current Assets

Fixed assets are those which yield the returns in the due course of time. The various decisions like in which fixed assets funds should be invested and how much should be invested in the fixed assets etc. are in the form of capital budgeting decisions. This can be said to be fixed capital management.

Other types of assets are equally important i.e. Current Assets.

These types of assets are required to ensure smooth and fluent business operations and can be said to be life blood of the business. There are two concepts of working capital Gross and Net. Gross working capital refers to gross current assets. Net working capital refers to the difference between current assets and current liabilities. The term current assets refers to those assets held by the business which can be converted into cash within a short period of time of say one year, without reduction in value. The main types of current assets are stock, receivables and cash. The term current liabilities refer to those liabilities, which are to be paid off during the course of business, within a short period of time say one year. They are expected to be paid out of current assets or earnings of the business. The current liabilities mainly consist of sundry creditors, bill payable, bank overdraft or cash credit, outstanding expenses etc.

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NEED FOR WORKING CAPITAL

The need of gross working capital or current assets cannot be overemphasized. The object of any business is to earn profits. The main factor affecting the profits is the magnitude of sales of the business. But the sales cannot be converted into cash immediately. There is a time lag between the sale of goods and realization of cash. There is a need of working capital in the form of current assets to fill up this time lag. Technically, this is called as operating cycle or working capital cycle, which is the heart of need for working capital. This working capital cycle can be described in the following words.

If the company has a certain amount of cash, it will be required for purchasing the raw material though some raw material may be available on credit basis. Then the company has to spend some amount for labour and factory overheads to convert the raw material in work in progress, and ultimately finished goods. These finished goods when sold on credit basis get converted in the form of sundry debtors. Sundry debtors are converted in cash only after the expiry of credit period. Thus, there is a cycle in which the originally available cash is converted in the form of cash again but only after following the stages of raw material, work in progress, finished goods and sundry debtors. Thus, there is a time gap for the original cash to get converted in form of cash again. Working Capital needs of company arise to cover the requirement of funds during this time gap, and the quantum of working capital needs varies as per the length of this time gap.

Thus, some amount of funds is blocked in raw materials, work in progress, finished goods, sundry debtors and day-to-day requirements. However some part of these current assets may be financed by the current liabilities also. E.g. some raw material may be

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available on credit basis, all the expenses need not be paid immediately, workers are also to be paid periodically etc. But still the amounts required to be invested in these current assets is always higher than the funds available from current liabilities. This is precise reason why the needs for working capital arise. From the Financial management point of view, the nature of fixed assets and current assets differ from each other 1. The fixed assets are required to be retained in the business over a period of time and they yield the returns over their life, whereas the current assets loose their identity over a short period of time, say one year.

2. In the case of current assets, it is always necessary to strike a proper balance between the liquidity and profitability principles, which is not the case with fixed assets. E.g. If the size of current assets is large, it is always beneficial from the liquidity point of view as it ensures smooth and fluent business operations. Sufficient raw material is always available to cater to the production needs, sufficient finished goods are available to cater to any kind of demand of customers, liberal credit period can be offered to the customers to improve the sales and sufficient cash is available to pay off the creditors and so on.

However, if the investment in current assets is more than what is ideally required, it affects the profitability, as it may not be able to yield sufficient rate of return on investment. On the other hand, if the size of current assets is too small, it always involves the risk of frequent stock out, inability of the company to pay its dues in time etc. As such, the investment in current assets should be optimum. Hence, it is necessary to manage the individual components of current assets in a proper way. Thus, working capital management refers to proper administration of all aspects of current assets and

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current liabilities. Working Capital Management is concerned with the problems arising out of the attempts to manage current assets, current liabilities and inter-relationship between them. The intention is not to maximize the investment in working capital nor is it to minimize the same. The intention is to have optimum investment in working capital. In other words, it can be said that the aim of working capital management is to have minimum investment in working capital without affecting the regular and smooth flow of operations. The level of current assets to be maintained should be sufficient enough to cover its current liabilities with a reasonable margin of safety. Moreover, the various sources available for financing working capital requirements should be properly managed to ensure that they are obtained and utilized in the best possible manner.

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FACTORS AFFECTING WORKING CAPITAL MANAGEMENT

The amount of working capital required depends upon a number of factors which can be stated as below

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 not the commodities and that too on cash basis. As such, no funds are blocked in piling inventories and also no funds are blocked in receivables. E.g. Public utility services like railways, electricity boards, infrastructure oriented projects etc. Their requirement of working capital is less. On the other hand, there are some business like trading activity, where the requirement of fixed capital is less but more money is blocked in inventories and debtors. Their requirement of the working capital is more.

Length of Production Cycle:

In some business like machine tool industry, the time gap between the acquisitions of raw material till the end of final production of finished product itself is quite high. As such more amounts may be blocked either in raw materials, or work in progress or finished goods or even in debtors. Naturally, their needs of working capital are higher. On the other hand, if the production cycle is shorter, the requirement of working capital is also less.

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Size and Growth of Business:

In very small companies the working capital requirements are quite high overheads, higher buying and selling costs etc. As such, the medium sized companies positively have an edge over the small companies. But if the business starts growing after a certain limit, the working capital requirements may be adversely affected by the increasing size.

Business I Trade Cycles:

If the company is operating in the period of boom, the working capital requirements may be more as the company may like to buy more raw material, may increase the production and sales to take the benefits of favourable markets, due to the increased sales, there may be more and more amount of funds blocked in stock and debtors etc. Similarly, in case of depression also, the working capital requirements may be high as the sales in terms of value and quantity may be reducing, there may be unnecessary piling up of stocks without getting sold, the receivables may not be recovered in time etc.

Terms of Purchase and Sales:

Sometimes, due to competition or custom, it may be necessary for the company to extend more and more credit to the customers, as a result of which more and more amounts is locked up in debtors or bills receivables which increase working capital requirements. On the other hand, in case of purchases, if credit is offered by the suppliers of goods and services, a part of working capital requirement may be financed by them, but if it is necessary to purchase these goods or services on cash basis, the working capital requirement will be higher.

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Profitability:

The profitability of the business may vary in each and every individual case, which in its turn may depend upon numerous factors. But high profitability will positively reduce the strain on working capital requirements of the company, because the profits to the extent that they are earned in cash may be used to meet the working capital requirements of the company. However, profitability has to be considered from one more angles so that it can be considered as one of the ways in which strain on working capital requirements of the company may be relieved. And these angles are:

Taxation Policy:

How much is required to be paid by the company towards its tax liability? Dividend Policy:

How much of the profits earned by the company are distributed by way of dividend?

Effect of Inflation on Working Capital Requirement:

The phase of inflation can be identified with the situation of increasing price levels, increasing demand and increasing supply. As such, the working capital requirements multiply during the phase of inflation due to increasing cost of production and increasing level of sales turnover. However, in order to control the increasing demand for working capital during the period of inflation, the following measures may be applied. Possibility of using cheaper substitute raw material, without affecting the quality, should be explored. For this purpose, research activities may be conducted. Attempts should be

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made to reduce the production costs to maximum possible extent. For this purpose, the techniques like time and motion study, incentive schemes, cost reduction programmes etc. may be implemented. Attempts should be made to reduce the operating cycle to the maximum possible extent. Aiming at greater turnover at short intervals will go a long way to reduce the stress on working capital requirements. Attempts should be made to reduce the locked up working capital in non-moving or obsolete inventories. A clear-cut policy should be formulated and followed for timely disposal of non- moving and obsolete inventories. Similarly, efficient management information system should be developed to reflect the position of inventory from the various angles. Attempts should be made to reduce the amount looked up in receivables. Quicker realization of debts will go a long way to reduce the stress on working capital requirements. Attempts should be made to make the payments of to creditors in time. This helps the business to build up good reputation and increases its bargaining power with respect to period of credit of credit for payment and other conditions.

Attempts should be made to match the projected cash inflows and projected cash outflows. If they do not match, some of the payments should be postponed or purchases of certain avoidable items should be deferred. Estimation of Working Capital Requirements: First of all estimates of all current assets should be made. These current assets may include stock, debtors. Cash/Bank balance prepaid expenses etc.

Difference between the estimated current assets and current liabilities will represent the working capital requirements. To this sometime a standard percentage may be added to take care of the contingencies. This technique is known as Cash Cost technique of

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estimating of working capital requirements. There is another technique available for estimating working capital requirements also and that is in the form of Balance Sheet Method. In this the forecast is made of various assets and liabilities, the difference between assets and liabilities indicating either the surplus or deficiency of cash. There are various methods available for financing the working capital requirements:

Flied or Permanent or Core Working Capital:

This indicates the amount of minimum working capital, which is required to be maintained by every business at any point of time, in order to carry on the business on permanent and uninterrupted basis.

Variable or Temporary Working Capital:

This indicates that amount of working capital required by the business which is over and above fixed or permanent or core working capital. This need of the working capital may vary depending upon the fluctuations in demand as a result of changes in production or sales. As far as financing of the fixed or permanent needs of working capital are concerned, these needs should be met out of the long term sources of funds, Own generation of funds, out of the profits earned, shares or debentures.

As far as financing of the variable or temporary needs of working capital are concerned, these needs can be met from the various sources:

1. A part of these needs may be financed by way of the credits available from the suppliers of material or services and of delayed payment of expenses.

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2. A part of these needs may be financed by way of long term sources of funds in the form of own generation of funds, out of profits earned shares, debentures and other long term borrowings, public deposits etc.

3. A part of these needs may be financed by way of long term sources of funds in the form of own generation of funds, out of profits earned, shares, debentures and other long term borrowing.

4. A major portion of these working capital needs are financed by the Banks. In financing the working capital needs of the business, the credit obtained from Banks plays a very important role.

Bank Credit as a Source of Meeting Working Capital Requirements:

While bank credit is considered as a major source of meeting the working capital requirement of the industry, the banks have to consider the following factors before meeting their requirements.

A].What should be the amount of working capital assistance?

B].What should be the form in which working capital assistance may be extended?

C].What should be the security that should be obtained for extending the working capital assistance?

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Amount of Assistance:

To obtain the bank credit for meeting the working capital requirements, the company will be required to estimate the working capital requirements and will be required to approach the banks along with the necessary supporting data. On the basis of the estimates submitted by the company, the bank may decide the amount of assistance which may be extended, after considering the margin requirements. This margin is to provide the cushion against the reduction in the value of security. If the company fails to fulfill its obligations, the bank may be required to realize the security for recovering the dues. Margin money is meant to take care of the possible reduction in the value of security. The percentage of margin money may depend upon the credit standing of the company, fluctuations in the price of security or the directives of Reserve Bank of India from time to time.

Form of Assistance:

After deciding the amount of overall assistance to be extended to the company, the bank can disburse the amount in any of the following forms

Non-Fund Based Lending

Fund Based Lending

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Non-Fund Based Lending

In case of Non-Fund Based Lending, the lending bank does not commit any physical outflow of funds. As such, the funds position of the lending bank remains intact. The Non-Fund Based Lending can be made by the banks in two forms-

a. Bank Guarantee:

Suppose Company A is the selling company and Company B is the purchasing company. Company A does not know Company B and as such is concerned whether Company B will make the payment or not. In such circumstances, D who is the Bank of Company B, opens the Bank Guarantee in favour of Company A in which it undertakes to make the payment to Company A if Company B fails to honour its commitment to make the payment in future. As such, interests of Company A are protected as it is assured to get the payment, either from Company B or from its Bank D. As such, Bank Guarantee is the mode which will be found typically in the sellers market. As far as Bank D is concerned, while issuing the guarantee in favour of Company A, it does not commit any outflow of funds. As such, it is a Non-Fund Based Lending for Bank D. If on due date, Bank D is required to make the payment to Company A due to failure on account of Company B to make the payment, this Non-Fund Based Lending becomes the Fund Based Lending for Bank D which can be recovered by Bank D from Company B. For issuing the Bank Guarantee, Bank D charges the Bank Guarantee Commission from Company B which gets decided on the basis of two factors-what is the amount of Bank Guarantee and what is the period of validity of Bank Guarantee. In case of this conventional for of Bank Guarantee, both company A as well as Company B get benefited as it is able to make the

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credit purchases from Company A without knowing Company A. As such, Bank Guarantee transactions will be applicable in case of credit transactions.

In some cases, interests of purchasing company are also to be protected. Suppose that Company A which manufactures capital goods takes some advance from the purchasing Company B. If Company A fails to fulfill its part of contract to supply the capital goods to Company B, their needs to be to be some protection available to Company B. In such circumstances, Bank C which is the banker of Company A opens a Bank Guarantee in

Favour of Company B in which it undertakes that if Company A fails to fulfill its part of the contract, it will reimburse any losses incurred by Company B due to this non fulfillment of contractual obligations. Such Bank Guarantee is technically referred to as performance Bank Guarantee and it ideally found in the buyers market.

b. Letter of Credit:

The non-fund based lending in the form of letter of credit is very regularly found in the international trade. In case the exporter and the importer are unknown to each other. Under these circumstances, exporter is worried about getting the payment from the importer and importer is worried as to whether he will get the goods or not. In this case, the importer applies to his bank in his country to open a letter of credit in favour of the exporter whereby the importers bank undertakes to pay the exporter or accept the bills or drafts drawn by the exporter on the exporter fulfilling the terms and conditions specified in the letter of credit.

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Fund Based Lending

In case of Fund Based Lending, the lending bank commits the physical outflow of funds. As such, the funds position of the lending bank gets affected. The Fund Based Lending can be made by the banks in the following forms-

Loan: -

In this case, the entire amount of assistance is disbursed at one time only, either in cash or by transfer to the companys account. It is a single advance. The loan may be repaid in instalments, the interests will be charged on outstanding balance.

Overdraft: - In this case, the company is allowed to withdraw in excess of the balance standing in its Bank account. However, a fixed limit is stipulated by the Bank beyond which the company will not be able to overdraw the account. Legally, overdraft is a demand assistance given by the bank i.e. bank can ask for the repayment at any point of time. However in practice, it is in the form of continuous types of assistance due to annual renewal of the limit. Interest is payable on the actual amount drawn and is calculated on daily product basis.

Cash Credit: -

In practice, the operations in cash credit facility are similar to those of overdraft facility except the fact that the company need not have a formal current account. Here also a fixed limit is stipulated beyond which the company is not able to withdraw the amount. Legally, cash credit is a demand facility, but in practice, it is on continuous basis. The interests is payable on actual amount drawn and is calculated on daily product basis.

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Bills purchased or discounted: -

This form of assistance is comparatively of recent origin. This facility enables the company to get the immediate payment against the credit bills raised by the company. The bank holds the bill as a security till the payment is made by the customer. The entire amount of bill is not paid to the company. The Company gets only the present worth of the amount of bill, the difference between the face value of the bill and the amount of assistance being in the form of discount charges. On maturity, bank collects the full amount of bill from the customer. While granting this facility to the company, the bank inevitably satisfies itself about the credit worthiness of the customer. A fixed limit is stipulated in case of the company, beyond which the bills are not purchased or discounted by the bank.

Working Capital Term Loans: -

To meet the working capital needs of the company, banks may grant the working capital term loans for a period of 3 to 7 years, payable in yearly or half yearly installments.

Packing Credit: -

This type of assistance may be considered by the bank to take care of specific needs of the company when it receives some export order. Packing credit is a facility given by the bank to enable the company to buy the goods to be exported. If the company holds a confirmed export order placed by the overseas buyer or a letter of credit in its favour, it can approach the bank for packing credit facility.

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Operating cycle: The time between purchase of inventory items (raw material or merchandise) and their conversion into cash is known as operating cycle or working capital cycle. The longer the period of conversion the longer will be the period of operating cycle. A standard operating cycle may be for any time period but does not generally exceed a financial year. Obviously, the shorter the operating cycle larger will be the turnover of the fund invested for various purposes. The channels of investment are called current assets.

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OPERATING CYCLE

Cash

Receipt from debtors

Purchase of raw material, components

Creation of receivables (Debtors)

Creation of A/c payable (Creditors)

Sales of Finished Goods

Payments to creditors

Warehousing of Finished Goods

Manufacturing operation: wages & salaries, fuel, power, etc

Office, selling, distribution and other expenses

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WORKING CAPITAL FINANCE

A manufacturing concern needs finance not only for acquisition of fixed assets but also for its day-to-day operations. It has to obtain raw materials for processing, pay wage bills & other manufacturing expenses, store finished goods for marketing & grant credit to the customers. It may have to pass through the following stages to complete its operating cycle-

i.

Conversion of cash into raw materials raw material procured on credit, cash may have to be paid after a certain period.

ii. iii. iv. v.

Conversion of raw materials into stock in process. Conversion of stock in process into finished goods. Conversion of finished goods into receivables/debtors or cash. Conversion of receivables/debtors into cash.

A non-manufacturing trading concern may not require raw material for their processing, but it also needs finance for storing goods & providing credit to its customers. Similarly a concern engaged in providing services, it may not have to keep inventories but it may have to provide credit facility to its customers. Thus all enterprises engaged in manufacturing or trading or providing services require finance for their day-to-day operations, the amount required to finance day-to-day operation is called working capital & the assets & liabilities are created during the operating cycle are called current assets & current liabilities. The total of all the current assets is called gross working capital & the excess of current assets over current liabilities is called net working capital.

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When entrepreneurs for financing working capital requirements approach the banks, the bank has to examine the viability of the project before agreeing to provide working capital for it. Financial institutions & bank while providing term loan finance to unit for acquisition of fixed assets does a detailed viability study. They have to ensure that the project will generate sufficient return on the resources invested in it. The viability of a project depends on technical feasibility, marketability of the products, at a profitable price, availability of financial resources in time & proper management of the unit. In brief the project should satisfy the tests of technical, commercial, financial & managerial feasibility. Proper co-ordination amongst banks & financial institution is necessary to judge the viability of a project & to provide working capital at appropriate time without any delay. If a unit approaches banks only for working capital requirement & no viability study has been done earlier which is done at the time of providing term loans, a detailed viability study is necessary before agreeing to provide working capital finance. In the view of scarcity of bank credit, its increasing demand from various sectors of economy & its importance in the development of economy, bank should provide working capital finance according to production requirements. Therefore it is necessary to make a proper assessment of total requirement of the working capital, which depends on the nature of the activities of an enterprise & the duration of its operating cycle. It has to be ensured that the unit will have regular supply of raw material to facilitate uninterrupted production. The unit should be able to maintain adequate stock of finished goods for smooth sales operation. The requirement of trade credit, facilities to be given by the unit to its customers should also be assessed on the basis of practice prevailing in

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the particular industry/trade which assessing above requirements, it should also be ensured that carrying cost of inventories & duration of credit to customers are minimized. After assessing the total requirement of working capital, a part of working capital requirement should be financed for the long term & partly by determining maximum permissible bank finance.

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ASSESSMENT OF WORKING CAPITAL

A unit needs working capital funds mainly to carry current assets required for its operations. Proper assessment of funds required for working capital is essential not only in the interest of the concerned unit but also in the national interest to use the scare credit according to production requirements. Inadequate levels of working capital may result in under-utilization of capacity and serious financial difficulties. Similarly excessive levels may lead to unproductive use of credit and unnecessary interest Burdon on the unit. Proper assessment of working capital requirement may be done as under-

I. Norms for inventory and receivables: If the bank credit is to be linked with production requirements, it is necessary to assess the requirements on the basis of certain norms. The study group to frame guidelines to follow-up of bank credit (Tandon Study Group) appointed by Reserve Bank of India had suggested the norms for inventory and receivables regarding 1: major industries on the basis of company finance studies made by Reserve Bank process periods in the different industries, discussions with the industry experts and feed-back received on the interim report. The norms suggested by Tandon Study Group are being reviewed from time to time by the Committee of Direction constituted by the Reserve Bank to keep a constant view on working capital requirements. The committee has representatives from a few banks and it generally once in a quarter. It also consults the representatives from industry and trade. It keeps a watch on the various issues relating to working

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capital requirements and gives various suggestions to suit the changing requirements of the industry and trade. Banks make their own assessment of credit requirements of borrowers based on a total study of borrowers business operations and they can also decide the levels of holding each item of inventory as also of receivables which in their view would represent a reasonable built up of current assets for being supported by banks finance. Banks may also consider suitable internal guidelines for accepting the projections made by the borrowers regarding sundry creditors as sundry creditors are taken as a source of financing current assets (inventories, receivables, etc.), it is necessary to project them correctly while calculating need of bank finance for working capital requirements.

II. Computation of Maximum Permissible Bank Finance (MPBF):

The Tandon Study group had suggested the following alternatives for working out the maximum permissible bank finance:a. Bank can work out the working capital gap. i. e. total current assets less current liabilities other than bank borrowings and finance a maximum of 75 per cent of the gap; the balance to come out of long-term funds, i.e. owned funds and term borrowings b. Borrower should provide for a minimum of 25 per cent of total current assets out of long-term funds, i.e. owned funds and long term borrowings. A certain level of credit for purchases and other current liabilities inclusive of bank borrowings will not exceed 75 per cent of current assets.

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It may be observed from the above that borrowers contribution from long term funds would be 25 per cent of the working capital gap under the first method of lending and 25 per cent of total current assets under the second method of lending. The above minimum contribution of long-term funds is called minimum stipulated Net Working Capital (NWC) which comes from owned funds and term borrowings.

Above two method of lending may be illustrated by taking the following example of a borrowers financial position, projected as at the end of next year.

Current Liabilities Creditors for purchase Other current liabilities

Amt

Current Assets

Amt 380 40 180

200 Raw materials 100 Stock in process 300 Finished goods

Bank borrowing, including bills discounted with bankers

400 Receivables,

including

bills

110

discounted with bankers Other current assets 700 30 740

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First method Total current assets Less: current liabilities Other than bank borrowings 300 740

Second method total current assets 25% of above from long term sources 185 740

Working capital gap 25% of above from long term Sources

440 less: current liabilities 110

555

Other than bank borrowings 300 Maximum permissible bank 255 finance

Maximum permissible bank 330 Finance Excess Bank borrowings Current ratio 70 1.17:1

Excess Bank borrowings Current ratio

145 1.33:1

It may be observed from the above that in the first method, the borrower has to provide a minimum of 25 per cent of working capital gap from ling-term funds and it gives a minimum current ratio 1.17:1. In the second method, the borrower has to provide a minimum of 25 per cent of total current assets from long-term funds and gives a minimum current ratio of 1.33:1. While estimating the total requirement of long-term funds for new projects, financial institutions/banks should calculate for working capital on the basis of norms prescribed for inventory and receivables and by applying the second method of lending. A project may suffer from shortage of working capital funds if sufficient margin for working capital is not provided as per the second method of lending while funding new projects. Proper co-ordination between banks & financial institutions is necessary to ensure availability of sufficient working capital finance to meet the production requirement.

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III. Classification of current assets & Current liabilities: In order to calculate net working capital & maximum permissible bank finance, it is necessary to have proper classification of various items of current assets & current liabilities. All illustrative lists of current assets & current liabilities for the purpose of assessment of working capital are furnished below; Current assets: a. Cash and bank balances b. Investments c. Receivables arising out of sales other than deferred receivables (including bills purchased & discounted by bankers) d. Installments by deferred receivables due within one year e. Raw materials & components used in the process of manufactured including those in transit f. Stock in process including semi finished goods g. Finished goods including goods in transit h. Other consumable spares i. Advance payment for tax j. Prepaid expenses k. Advances for purchases of raw materials, components & consumable stores l. Payment to be received from contracted sale of fixed assets during the next 12 months

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Current Liabilities: a. Short-term borrowings (including bills purchased & discounted) from Banks and b. Unsecured loans c. Public deposits maturing within one year d. Sundry creditors (trade) for raw material & consumer stores & spares e. Interest & other charges accrued but no due for payments f. Advances/progress payments from customers g. Deposits from dealers selling agents, etc. h. Statutory liabilities Provident fund dues Provision for taxation Sales-tax, excise, etc. Obligation towards workers considered as statutory i. Miscellaneous current liabilities Dividends Liabilities for expenses Gratuity payable within one year Any other payments due within one year ii. Others

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Notes on classification of Current Assets & Current Liabilities: 1. Investment in shares, debenture, etc. and advances to other firms/companies, not connected with the business of the borrowing firm, should be excluded from current assets. Similarly investment made in units of Unit Trust of India & other mutual funds & in associate companies/subsidiaries, as well as investment made and/or loans extended as inter-corporate deposits should not be included in the build-up of current assets while assessing maximum permissible bank finance. 2. The borrowers are not expected to make the required contribution of 25 per cent from long-term sources in respect of export receivables. Therefore, export receivables may be included in the total current assets for arriving at the maximum permissible bank finance but the minimum stipulated net working capital may be reckoned after excluding the quantum of export receivables from the total current assets. 3. Dead inventory i.e. slow moving or obsolete items should not be classified as current assets. 4. Security deposits/tender deposits given by borrower should be classified as noncurrent assets irrespective of whether they mature within the normal operating cycle of one year or not. 5. Advances/progress payments from customer should be classified as current liabilities. However, where a part of advances received is required by government regulations to be invested in certain approved securities, the benefit of netting may be allowed to the extent of such investment and the balance may be classified as current liability.

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6. Deposits from dealers, selling agents, etc. received by the borrower may treated as term liabilities irrespective of their tenure if such deposits are accepted to be repayable only when the dealership/agency is terminated. The deposits, which do not fulfill the above condition, should be classified as current liabilities. 7. Disputed liabilities in respect of income tax, excise, custom duty and electricity charges need not be treated as current liabilities except to the extent of provided for in the books of the borrower. Where such disputed liabilities are treated as contingent liabilities for period beyond one year, the borrower should be advised to make adequate provision so that he may be in a position to meet the liabilities as & when they accrue. 8. If disputed excise liability has been shown as contingent liability or by way of notes to the balance sheet, it need not be treated as current liability for calculating the permissible bank finance unless it has been collected or provided for in the accounts of borrowers. A certificate from the Statutory Auditors of the borrowers may be obtained regarding the amount collected from the customers in respect of disputed excise liability or provision made in the borrowers accounts. The amount of excise duty payable should be treated as current liability for the purpose of working out the permissible limit of the bank finance strictly on the basis of the certificate from the borrowers Statutory Auditors. The same principle may also be applied for disputed sales tax dues. 9. In case of other statutory dues, dividends, etc., estimated amount payable within one year should be shown as current liabilities even if specific provisions have not been made for their payment.

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10. As per the instructions issued by the Reserve Bank in October, 1993, the entire term loan investment falling due for payment in the next twelve months need not be treated as an item of current liabilities for the purpose of arriving at MPBF. However all overdue term loan should be treated as current liabilities unless the loan has been rescheduled by the financial institutions/banks. It may be added that the entire amount of term loan installments payable within the next twelve months which is kept outside the current liabilities while calculating MPBF. Need not be taken into account while computing net working capital (NWC). However the entire amount of term loan installments due within the next twelve months should continue to be treated as current liability for the purpose of calculating the current ratio.

IV. Information/Data required for assessment of working capital:

In order to assess the requirements of working capital on the basis of production needs, it is necessary to get the data from the borrowers regarding their past/projected production, sales, cost of production, cost of sales, operating profit, etc. in order to ascertain the financial position of the borrowers & the amount of working capital needs to be financed by banks, it is necessary to call for the data from the borrowers regarding their net worth, long term liabilities, current liabilities, fixed assets, current assets, etc. the Reserve Bank prescribed the forms in 1975 to submit the necessary details regarding the assessment of working capital under its credit authorization scheme. The scheme of credit authorization was changed into credit monitoring arrangement in

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1988. The forms used under the credit authorization scheme for submitting necessary information have also been simplified in 1991 for reporting the credit sanctioned by banks above the cut-off point to reserve bank under its scheme of credit monitoring arrangement. As the traders and merchant exporters who do not have manufacturing activities are not required to submit the data regarding raw materials, consumable stores, goodsin-process, power and fuel, etc., a separate set of forms has been designed for traders and merchant exporters. In view of the peculiar nature of leasing and the hire purchase concerns, a separate set of forms has also designed for them. In addition to the information/data in the prescribed forms, bank may also call for additional information required by them depending on the nature of the borrowers activities & their financial position. The data is collected from the borrowers in the following six forms: -

1. Particulars of the existing/proposed limits from the banking system (form I) Particulars of the existing credit from the entire banking system as also the term loan facilities availed of from the term lending institutions/banks are furnished in this form. Maximum & minimum utilization of the limits during the last 12 months outstanding balances as on a recent date are also given so that a comparison can be made with the limits now requested & the limits actually utilized during the last 12 months.

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2. Operating Statement (Form II) The data relating to last sales, net sales, cost of raw material, power & fuel, direct labour, depreciation, selling, general expenses, interest, etc. are furnished in this form. It also covers information on operating profit & net profit after deducting total expenditure from total sale proceeds.

3. Analysis of Balance Sheet (Form III) A complete analysis various items of last years balance sheet, current years estimate & following years projections is given, in this form. The details of current liabilities, term liabilities, net worth, current assets, other non-current assets, etc. are given in this form as per the classification accepted by banks.

4. Comparative statement of current assets & current liabilities (Form IV) This form gives the details of various items of current assets and current liabilities as per classification accepted by banks. The figures given in this form should tally with the figures given in the form III where details of all the liabilities & assets are given. In case of inventory, receivables and sundry creditors; the holding/levels are given not only in absolute amount but also in terms of number of month so that a comparative study may be done with prescribed norms/past trends. They are indicated in terms of numbers of months in bracket below their amounts.

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5. Computation of Maximum Permissible Bank Finance (Form V) On the basis of details of current assets & liabilities given in form IV, Maximum Permissible Bank Finance is calculated in this form to find out credit limits to be allowed to the borrowers.

6. Fund Flow Statement (Form VI) In this form, fund flow of long term sources & uses is given to indicate whether long term funds are sufficient for meeting the long term requirements. In addition to long term sources and uses, increase/decrease in current assets is also indicated in this form.

V. Check list for verification of the information/data: Bank should verify not only the arithmetical accuracy of the data furnished by the borrowers but also the logic behind various assumptions based on which the projections have been made. For this purpose, bank officials should hold discussions with the borrowers on projected sales, level of operations, level of inventory, receivables, etc. if necessary, a visit to the factory may also be made to have a clear idea of products and processes.

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ASSESSEMENT OF OTHER LIMITS

LETTER OF CREDIT

The banker examines the proposal of the letter of credit from two angles:

o The cases where letter of credit is required once only o The cases where letter of credit is required once regularly.

In the second category it is convenient for the banker to fix the separate limit of the letter of credit.

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ASSESSEMENT OF THE LIMITS UNDER LETTER OF CREDIT-WITH LEAD TIME

The buyer does not receive the goods immediately on the placement of the order on the seller. There is always long time log between the order placement and the receipt of the material. This period is also referred to as the lead-time.

Example: -

If it is assumed that the total raw material requirement is Rs.240lacs per annum and the normal lead time is 2 months, the buyer will be required to place order so that he has at least 2 months stock (ignoring safely level). Thus, the total number of order placed would be 6 per year and the value of per order would be Rs.40 Lacs. This is shown below

Assessment of the limits under LC- with lead-time

Annual requirement of raw material

240 Lacs

Normal lead time

2 months

Value per order (A)

240/6=Rs.40 Lacs

Margin for customer @20%(B)

Rs 8 Lacs

Limits under letter of credit (A-B)

Rs 32 Lacs

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Assessment of the limits under letter of credit-without lead-time

Annual requirement of raw material

240 lacs

Monthly requirement of raw material

240/12 months =20 lacs

Normal inventory level (1 month)

Rs 20 lacs

Value per order (A)

Rs 20 lacs

Margin for customer @ 20% (B)

Rs 4 lacs

Limits under letter of credit (A-B)

Rs 16 lacs

BANK GUARANTEES

There is no standard formula for assessment of bank guarantee limit. The details pertaining to nature of guarantees, particulars of the contract, period for which the guarantee is sought and the amount of guarantee to be obtained, this information along with the view on the creditworthiness of the borrower and relationship with the bank comprise the major input towards deciding the sanction of limits required by borrower. Appropriate conditions regarding cash margin and securities have to be laid down to protect the interest of the bank..

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PROCEDURE FOR WORKING CAPITAL FINANCE

CREDIT SANCTION PROCESS

The revised credit process is introduced with a view of reducing the time lag in the sanction of credit besides clearly delineating the areas of responsibilities of various functionaries. As per this the revised process is divide into two components that is Pre sanctioning and Post sanctioning

In the pre sanctioning it is the only time that the bank can take due assessment and precautions to make sure that the investments are done for the benefit of the bank. The post sanctioning is the follow of the payment. Incase the payment defaults then the account will go into NPA in stages and the bank is then said to scrutinize the said account.

PRE SANCTION PROCESS: -

Obtain loan application

When a customer required loan he is required to complete application form and submit the same to the bank also the borrower has to be submit the required information along with the application form.

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PRE SANCTION PROCESS

APPRAISAL & RECOMMANDATION

SANCTIONING

ASSESSMENT

The information, which is generally required to be submitted by the borrower along with the loan application, is under:

Audited balance sheets and profit and loss accounts for the previous three year(in case borrower already in the business)

Estimated balance sheet for current year. Projected balance sheet for next year. Profile for promoters/directors, senior management personnel of the company. In case the amount of loan required by borrower is 50 lacs and above he should be submit the CMA Report

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Examine for preliminary appraisal RBI guidelines. Policies Prudential exposure norms and bank lending policy Industry exposure restriction and related risk factors. Compliance regarding transfer of borrowers accounts from one bank to another bank Government regulation / legislation impact on the industry Acceptability of the promoter and applicant status with regards to other unit to industries. Arrive at the preliminary decision. Examine/analysis /assessment Financial statement (in the prescribed forms) refers figure WC cycle & BS assessment thumb rules. Financial ratio & Dividend policy. Depreciation method Revaluation of fixed assets. Records of defaults (Tax, dues etc.) Pending suits having financial implication (Customs, excise etc.) Qualifications to balance sheet auditors remarks etc. Trend in sales and profitability and estimates /projection of sales. Production capacities and utilization: past & projected production efficiency and cost.

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Estimated

working

capital

gap

W.R.T

acceptable

buildup

of

inventory/receivables/other current assets and bank borrowing patterns. Assess MPBF determine facilities required Assess requirement of off balance sheet facilities viz.L/cs,B/gs etc. Management quality, competence, track records Companys structure and system Market shares of the units under comparison. Unique feature Profitability factors Inventory/Receivable level Capacity utilization Capital market perception.

POST SANCTION PROCESS

Supervision and follow up: -

Sanction credit limit of working capital requirement after proper assessment of proposal is alone not sufficient. Close supervision and follow up are equally essential for safety of bank credit and to ensure utilization of fund lend. A timely action is possible only close supervision and followed up by using following techniques.

o Monthly stock statement o Inspection of stock o Scrutiny of operation in the account

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o Quarterly/half quarterly statements. o Under information system o Annual audited report

POST SANCTION PROCESS

FOLLOW UP

MONITORING & CONTROL

SUPERVISION

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CREDIT MONITORING ARRANGEMENT

Consequent upon the withdrawal of requirement of prior authorization under the erstwhile credit authorization scheme (CAS) and introduction of a system of post sanction scrutiny under credit monitoring arrangement (CMA) the database forms have been recognized as CMA database. The revised forms for CMA database as drawn up by the sub-committee of committee of directions have come into use from 1st April 1991.

The existing forms prescribed for specified industries continue to remain in force. With a view to imparting uniformity to the appraisal system, database from all borrowers including SSI units enjoying working capital limits of Rs. 50 lacs and more from the banking system should be obtained.

The revised sets of forms have been separately prescribed for industrial borrowers and traders/merchant exporters. The details of forms are as under: -

Form 1: - particulars of the existing/proposed limit from the banking system.

Form 2: -Operating statement.

It contains data relating to gross sales, net sales, cost of raw material, power and fuel, etc. It gives the operating profit and the net profit figures.

Form 3 : - Analysis of balance sheet.

It is complete analysis of various items of last years balance sheet; current years estimate and following years projection are given in this form.

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Form 4 : - Comparative statement of current asset and liabilities.

Details of various items of current asset and current liabilities are given.

The figures in this form must tally with those in form III.

Form 5: - Computation of maximum permissible bank finance for working capital.

The calculation of MPBF is done in this form to obtain the fund based credit limits to be granted to the borrower.

Form 6: - Fund flow statement

It provides the details of fund flow from long term sources and uses to indicate weather they are sufficient to meet the borrowers long term requirements.

CREDIT RATING MODEL

The various risk faced by any company may be broadly classified as follows:

Industry Risk: It covers the industry characteristic, compensation, financial data etc.

Company/ business risk: It considers the market position, operating efficiency of the company etc.

Project risk: It includes the project cost, project implementation risk, post project implementation etc.

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Management risk: It covers the track record of the company, their attitude towards risk, propensity for group transaction, corporate governance etc.

Financial risk: financial risk includes the quality of financial statements, ability of the company to raise capital, cash flow adequacy etc.

DRAWING POWER OF THE BORROWER

The drawing power that a borrower enjoys at any one point depends on each components of working capital. The bank for each component, which the borrower must hold as his contribution to finance working capital, prescribes margins. The drawing power of the borrower can be best explained with the following illustration

Illustration:

Suppose a borrower has Rs 100.00 lacs as working capital limit sanctioned to him by a bank.

The security provided by the borrower to the bank is the hypothecation of inventory. Suppose, the borrower needs to hold an inventory level of say 130 lacs in order to enjoy Rs 100 lacs as his working capital limit.

The actual level of inventory with the borrower at a point is say 110 lacs.

The inventory margin prescribed by the bank is say 25 %

Therefore with this inventory level, the borrower enjoys only Rs 82.5 lacs as his working capital limit as against Rs 100 lacs.

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Inventory level (Required)

Rs 130 lacs

Drawing power of borrower

Rs 100 lacs

Inventory level (Actual)

Rs 110 lacs

Margin prescribed by bank 25 %

Drawing power of borrower

110-(0.25 110) = Rs 82.5 lacs

Suppose, the borrower holds Rs 150 lacs of inventory,

Inventory level (required)

Rs 150 lacs

Drawing power of borrower

Rs 100 lacs

Inventory level (actual)

Rs 150 lacs

Margin prescribed by bank 25 %

Drawing power of borrower

150 (0.25 150) = Rs. 112.2 lacs

Therefore, in this case the borrower would still enjoy Rs 100 lacs as his working capital limits as against Rs 112.5 lacs.

Therefore, the lower of the two is always considered as the working capital limit or the drawing power of the borrower sanctioned by the bank.

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SECURITY

Banks need some security from the borrowers against the credit facilities extended to them to avoid any kind of losses. securities can be created in various ways. Banks provide credit on the basis of the following modes of security from the borrowers.

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 f 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.

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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 retained 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.

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BANKING ARRANGEMENTS

Working capital is made available to the borrower under the following arrangements;

CONSORTIUM BANKING ARRANGEMENT:

RBI till 1997 made it obligatory for availing working capital facilities beyond a limit (Rs 500 million in 1997), through the consortium arrangement. The objective of the arrangement was to jointly meet the financial requirement of big projects by banks and also share the risks involved in it.

While it consortium arrangement is no longer obligatory, some borrowers continue to avail working capital finance under this arrangement. The main features of this arrangement are as follows;

Bank with maximum share of the working capital limits usually takes the role of lead bank.

Lead bank, independently or in consultation with other banks, appraise the working capital requirements of the company.

Banks at the consortium meeting agree on the ratio of sharing the assessed limits.

Lead bank undertakes the joint documentation on behalf of all member banks.

Lead bank organizes collection and dissemination of information regarding conduct of account by borrower.

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MULTIPLE BANKING ARRANGEMENT

Multiple banking is an open arrangement in which no banks will take the lead role. Most borrowers are shifting their banking arrangement to multiple banking arrangements. The major features are

Borrower needs to approach multiple banks to tie up entire requirement of working capital.

Banks independently assessed the working capital requirements of the borrower.

Banks, independent of each other, do documentation, monitoring and conduct of the account

Borrowers deals with all financing banks individually.

SYNDICATION

A syndicated credit is an agreement between two or more lenders to provide a borrower credit facility using common loan agreement. It is internationally practiced model for financing credit requirements, wherein banks are free to syndicate the credit limit irrespective of quantum involved. It is similar to a consortium arrangement in terms of dispersal of risk but consist of a fixed repayment period.

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REGULATION OF BANK FINANCE

INTRODUCTION

Bank follows certain norms in granting working capital finance to companies.

These norms have been greatly influenced by the reconditions of various committees appointed by the RBI from time to time. The norms of working capital finance followed by banks are mainly based on the recommendation of Tandon committee and chore committee.

These committees were appointed on the presumption that the existing system of bank lending of number of weakness industries in India have grown rapidly in the last three decades as result of which, the industrial system has become vary complex. The banks role has shifted from trade financing to industrial financing during this period.

However, the banks lending practices and styles have remained the same. Industries today fail to use bank finance efficiently. Their techniques of managing funds are unscientific and non-professional. The industries today lack optimizing the use of inputs, conserving resources etc. in reducing costs,

The weakness of the existing system highlighted by the Dehejia committee in 1968 and identified by the tondon committee in 1974, are as follows:

It is the borrower who decides how much he would borrow ;the bankers does not decide how much he would lend and is, therefore, not in a position to do credit planning. The

58

bank credit is treated as the first sources of finance and not as supplementary to other sources of finance.

The amount of credit is extended is based on the amount of security available and not on the level of operations of the borrower.

Security does not by itself ensure safety of bank. Funds since all bad sticky advances are secure advances. Safety essentially lies in the efficient follow up of the industrial operations of the borrower.

We discuss the following committees important finding and recommendations for bank finance:

TANDON COMMITTEE CHORE COMMITTEE.

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TANDON COMMITTEE

INTRODUCTION:

The Tandon committee was appointed by the RBI in July 1974 and headed by Shri. Prakash L. Tandon, the chairman of the Punjab national bank, to suggest guidelines for rational allocation and optimum use of bank credit taking into consideration the weakness of the leading system. Bank credit, which had become a scare commodity, strictly rationed to meet the credit requirement of all the sectors. The larger sector of the industry needed strict rationing becomes

It was over relying on bank finance and pre empted most of it while the other sectors were not getting even their due share. Therefore, the method and criterion adopted for fixing credit ration needed to be standardized so that there is minimum scope for miss-use or part of the credit uses. The Tandon committee was concern exactly with this problem. Its report laid down as to how the credit ratio of individual borrowers could be fixed at imposed certain obligation on them for the efficient use of the credit made available.

The recommendation of the Tandon committee based on the following notions:

The borrower should indicate the demand for credit for which he should draw operating plans for the ensuring year and supply them to the banker. This would facilitate credit planning at the banks level and help the banker in evaluating the borrowers credit needs in a more realistic manner.

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The banker should finance only the genuine production needs of the borrower. The borrower maintained reasonable levels inventories and receivables. Efficient management of resources should therefore be ensured to eliminate slow moving and flabby inventories.

The working capital needs of borrower cannot entirely finance by the banker. The banker will finance only a reasonable part of it for the remaining; the borrower should depend on his own fund. Recommendation of Tandon committee accordingly, the Tandon committee put forth in the following recommendations

Inventory and receivables norms

The borrower is allowed to hold only a reasonable level of current asset, particularly inventory and receivable. The committee suggested the maximum level of raw material, stock in process, finished goods, which corporate in an industry should be to hold.

Only the normal inventory based on a production plan, lead-time of supplies, economic ordering levels and reasonable factor safety should be financed by the banker.

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Lending norms:

The banker should finance only a part of the working capital gap; the other part should be financed by the borrower form long-term sources.

The current asset will be taken on the estimate values or values as per the Tandon committee norms, whichever is lower.

The current will consist of inventory and receivables, referred as chargeable current assets (CCA), and other current assets (OCA).

MAXIMUM PERMISSIBLE BANK FINANCE:

The Tandon committee suggested the following three methods of determining the permissible level of bank borrowings-

The borrower will contribute 25 % of the working capital gap from long term fund i.e owned fund and term borrowings; the remaining 75 % can be financed from bank borrowings. This method gives a minimum current ratio of 1:1. This method was considered suitable only for very small borrowers where the requirement 0 credit was less than Rs 10 lacs

The borrower will contribute 25 % of the total current assets from long-term funds i.e. owned funds and term borrowings. A certain level of credit for purchases and other current liabilities will be available to fund the building up of current assets and the bank will provide the balance. Consequently, the current liabilities inclusive of bank borrowing could not exceed 75 % of current assets. This method gives a current ratio of 1.3:1. This

62

method was considered for all borrowers whose credit requirements were more than Rs 10 lacs.

The borrower will contribute 100 % of core current assets, defined at the absolute minimum level of raw material, processed stock, finished goods and stores, which are in the pipeline. A minimum level of the 25 % of the balance of the current assets should be finance from the long term funds and term borrowings. This method covers straightness the current ratio. The third is the ideal method. Borrowers in the second stage are not allowed to revert to the first stage. This method applies to all borrowers having credit limit in excess of Rs.20 lacs from the bank. However this method was not accepted for implementation.

In some cases, the net working capital was negative or 25 % of the working capital gap. The new systems allowed this deficiency to be financed in addition to the permissible bank finance by the bank. This kind of credit facility is called working capital demand loan, which was to be regulated over a period of time depending on the funds generating capacity and ability of the borrower.

The working capital demand loan is not allowed to be raised in the subsequent year. For additional credit in subsequent year, the borrowers long-term sources were required to provide 25 % of the additional working capital gap.

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4. Style of credit:

The committee recommended the bifurcation of total credit limit into fixed and fluctuating parts.

The fixed component is then treated as demand loan for the year representing minimum level of borrowing, which the borrower expected to use through out the year.

The fluctuating component is taken care of by a demand cash credit. It could be partly used by way of bills.

The new CC limit should be placed on a quarterly budgeting reporting system.

The interest rate on the loan components should be charged lower than the cash credit amount. The RBI has stipulated the interest differentiate at 1 %.

The cash credit limits sanctioned (fluctuating) are currently 205 and the loan components (fixed) are 80 %.

5) INFORMATION SYSTEM:

The committee advocated for grater flow of information from borrower to the bank for operational purpose and for the purpose of supervision and flow of up credit.

Information should be provided in the following forms:

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QUARTERLY INFORMATION SYSTEM: FORM:

It should contain the production and sales estimates for the current and next quarter. also, the current asset current liabilities estimates for the next quarter should be mentioned.

Quarterly information system: Form II:

It should contain the actual production and sales finger during the current year and the latest completed year. Also, actual current asset and current liabilities for the latest completed quarter should be mention.

Half year operating statement form IIIA:

Actual operating performance for the half year ended against the estimate should be mentioned.

Half year fund flow statement: Form IIIB:

It should contain the estimate as well as the actual sources and use of fund for the half year ended.

Borrowers with a credit limit of more than1 crore are required to supply the quarterly information.

The bank to follow up and supervise the use of credit should properly use the information supplied by the borrower.

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The bank must ensure that the bank credit was used for the purposes for which it is granted, keeping in view the borrowers operation and environment.

The bank should confirm whether the actual result is in conformity with the expected results. A+/- 10% variation is considered normal.

The banker should be treated as a partner in the business with whom information should be shared freely and frankly.

The recommendations of the Tandon committee have been widely debated and criticized. The bankers have found a difficult to implement the committees recommendations.

However, the Tandon committee has brought about a perceptible change in the outlook and attitude of both the banker and their customers. They have become quite aware in the matter of making the best use of a scare resource like bank credit. The committee has help in bringing the financial discipline through a balanced and integrated scheme of bank lending. Most of banks in India, even today continue to look at the needs of the corporate in the light of recommendation of the Tandon committee

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CHORE COMMITTEE

INTRODUCTION

In April 1979, the RBI constituted a working group to review the system of cash credit under the chairmanship of Mr. K. B. Chore, Chief Officer, DBCOD, RBI. The main terms of reference for the group were to review the cash credit discipline and relate credit limit to production.

RECOMMENDATION OF CHORE COMMITTEE: -

Bank credit: -

Borrower should contribute more funds to finance their working capital requirement and reduce their dependence on bank credit. The committee suggested placing the second method of lending as explain in the Tandon committee report.

In case the borrower is unable to comply with this requirement immediately, he would be granted excess borrowing in the form of working capital loan (WCTL).

The WCTL should be paid in seamy annual installments for a period not exceeding 5 years and a higher rate of interest than under the cash credit system would be charged.

This procedure should apply to those borrowers, having working capital requirements of more than Rs 10 lacs.

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LEVEL OF CREDIT LIMIT

Bank should appraise and fix separate limits for the peak level and normal non pick level credit requirements for all borrowers in excess of Rs. 10 lacs indicating the relevant periods.

With the sanctioned limits for these two periods, the borrower should indicate in advance his need for funds during the quarter. Any deviation in utilization of funds Beyond 10% should be considered irregular and is subject to penalty fix by the RBI (2% p.a. over the normal rate)

Bank should discourage ad hoc or temporary credit limits. If sanction under exceptional circumstances the same should be given in the form of a separate demand loan and additional interest of at least 1% should charged.

Lending system:

The system of three types of lending should continue i.e. cash credit loan and bills wherever possible; the bank should replace cash credit system by loan and bills.

Bank should scrutinize the cash credit accounts of large borrowers ones a year.

Bifurcation of cash credit account into demand loan fluctuating cash credit component, as recommended by the Tandon committee should discontinue.

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Advances against books debts should be converted to bills wherever possible and at least 50% of cash credit limit utilize for financing purchases of raw material inventory should also be charged to the bill system.

Information System

The discipline relating to the submission of Quarterly Statements to be obtained from the borrower should be strictly adhered to in respects of all borrowers having working capital limits of more than Rs.50 lacs.

If the borrower does not submit report within the prescribed time, he should be penalized by charging a penal rate of interest, which is 2% p. a. more than the contracted rate.

Banks should insists the public sector undertakings and large borrower to maintained control accounts in their books to give precise data regarding their dues to the small units and furnish such data in their quarterly reports.

Other recommendations:

Request for relaxation of inventory norms and for ad hoc increases in limits should be subjected by banks to close scrutiny and agreed only in exceptional circumstances.

Delays on the part of the banks in sanctioning credit limits should be reduced in cases where the borrowers cooperate in giving the necessary information about their past performance and future projection in time.

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Autonomous institutions on the lines of the discount houses in U.K may be set up to encourage the bill system of financing and to facilitate all money operations.

There should be a cell attached to the chairmens office at the central office of each bank to attend to matters like immediate communication of credit control measures at the operational level.

The central offices of bank should take a second look at the credit budget as soon as changes in the credit policy are announced by the RBI and they should revised their plan of action in the right of new policy and communicate the corrective measures at the operational levels at the earliest.

Bank should give particular attention to monitor the key branches and critical accounts.

The communication channels and system and procedures with in the banking system should be toned up so as to ensure that minimum time is taken for collection of instruments.

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FINANCIAL RATIOS

CURRENT RATIO=CURRENT ASSET/ CURRENT LIABITIES

Help to measure liquidity and financial strength, indication of availability of current assets to pay current liabilities. The higher the ratio betters the liquidity position. Generally it should be at least 1.33.

TOL/TNW=TOL/TANGIABLE NET WORTH

Indicate size of stakes, stability and degree of solvency. Indicates how high the stake of the creditors is. Indicate what proportion of the company finance is represented by the tangible net worth. The lower the ratio, greater the solvency. Anything over 5 should be viewed with concern.

The ratio should be studied at the peak level of operations.

OPERATING PROFIT RATIO=OPERATING PROFIT/NET SALES100

This ratio indicates operating efficiency. Indication of net margin of profit available on Rs. 100 sales. Trend for company over a period should be encouraging.

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DSCR(DEBT SERVICE COVERAGE RATIO)=DEPRICIATION+INTREST ON TERM LOAN/ INTREST ON TERM LOAN+INSTALLMENT OF TERM LOAN

It indicates the number of times total debt service obligation consisting of interest and repayment of the principal in installment is covered by the total fund available after taxes. With the help of this ratio (popularly known as DSCR), we can find out whether the loan taken for acquisition of fixed assets can be rapid conveniently.

This ratio of 1.5 to 2 considered adequate.

We have already touched upon depreciation as non cash expenditure and since the funds are available with the enterprise to that extent. It is in order to ask for this sum in reduction of loan.

INTEREST COVERAGE RATIO=EARNINGS BEFORE TERM LOAN AND TAXATION / INTEREST ON TERM LOAN

The ratio indicates adequacy of profit to cover interest. Higher the ratio more is the security to the lender.

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Analysis & Interpretation of the data

Case studies

Case study 1: Comparative Balance Sheet and Performance / Financial Indicators: Abridged Balance sheet (Rs in lacs) 31.03.04 31.03.05 Audited Audited 23.15 26.64 5.85 6.38 17.30 20.26 1.47 0.84

Liabilities 31.03.04 Audited Capital 17.53 Reserves NW 17.53 TL 12.43 Unsec Ln TL from BOM TL(car) Scred Bk Borr OCL TCL

31.03.05 31.03.06 Assets Audited Prov. 18.41 84.84 FA Depr. Net Block 18.41 84.84 15.98 2.98 Cash & Bank RM 2.46 81.46 WIP 1.88 13.08 0.15 13.23 0.38 15.00 15.00 FG Rec- Dom Export OCA TCA Inv Tot NCA Acc Loss Tot.Intang Ass. Tot Ass

31.03.06 Prov. 150.73 21.42 129.31 2.51

1.76 9.11 0.09 9.20

12.77 8.18 1.19 23.61

16.53 12.01 2.32 31.70

15.00 35.13 2.71 55.35

Tot Liab

40.91

51.96

184.66

40.91

51.96

184.66

* Net Worth Less: Revaluation Reserves Less: Intangible Assets Tangible Net Worth

31.03.2004 17.53 17.53

31.03.05 18.41 18.41

31.03.06 84.84 84.84

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PERFORMANCE / KEY FINANCIAL INDICATORS: (Rs in Lacs) Particulars Net Sales % Increase / Decrease Net Profit After Tax % to Net Sales Cash Accruals TNW excl Revaluation Reserve TOL / TNW Ratio NWC Current Ratio 31.03.04 56.11 71.1% 0.57 1.01% 6.42 17.53 1.33 14.41 2.57 31.03.05 95.70 70.55% 0.89 0.93% 7.28 18.41 1.82 18.47 2.40 31.03.06 180.00 88% 8.62 4.79% 30.04 84.84 1.18 40.35 3.69

1. Sales: As partners have been engaged in marketing the new technology to various users for the initial 2/3 years vigorously and their efforts are started yielding results. During the year 2005 the firm has obtained approval from BHEL, NTPC, and HAL for use of its products DSC & ESC. Agreement with NTPC through BHEL (Haridwar) is exclusive supply (not to any other companies) for annual turnover of Rs. 250.00 Lacs. The orders are of repetitive nature. Besides BHEL (Hyd) have also started placing sample orders. The firm has also been able to secure orders from HAL (Koraptut) for DSC & ESC. During the year up to Nov05 the firm has already done sale of Rs. 100.00 lacs besides the job work. Orders worth Rs. 150.00 lacs from BHEL (Haridwar) are on hand scheduled to be completed before March06. Completion of this of these orders will enable the firm to achieve a sale of Rs. 250.00 lacs by this year end. This is acceptable.

2. Profit: Hitherto the net profit in terms of sales has been about 1.00%. Against this backdrop the estimated profitability of 4.79% in the current appears unreasonable. During discussion it is clarified that as the firm has shifted its focus from mare job work to direct

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selling the margin will be high. In fact it has set up its own machining plant and has secured approval from BHEL for the Quality of its own materials. It used to pay for job works to other companies/firms for the machining purpose. This payment was to the tune of 25% (appx) of the job work revenue. For the year 2005 as the job work is being done in-house the expenses are estimated to be hardly 5%. Besides, margin of direct selling of its materials is better. Moreover with increased sales the marginal revenue would be proportionately high adding to the increased yield. In view of the above factors we may accept the profitability estimates made by the firm. In the coming 7 years the firm has estimated profitability ranging from 8.5% to 12.5%. This appears to be on the higher side. As the sales are estimated to stabilize at Rs. 312.00 lacs we may accept the profitability of 4.79% as acceptable for the year 2005. Accordingly the net profit for the 2nd year would be Rs. 13.70 lacs and then Rs. 14.95 lacs p. a. 3. Cash Accrual: With addition to fixed assets the depreciation shall be high. Thus with accepted profitability the accrual would be Rs. 30.00 lacs for the year 2005 followed by Rs. 32.03 lacs, Rs. 30.62 lacs respectively. The position is acceptable. 4. TNW: Up to 2004-05 the TNW has been increasing with retention of profits. In the year 2005 for the expansion plan the partner have agreed in bring in additional capital of Rs. 46.00 lacs, Remaining Rs 20.00 lacs from internal accrual. We have discussed the issue of infusion of capital by partners. It is informed that depending upon the advice of their auditors they would be either increasing the amount of individual capital and/or brings in unsecured loans from friends/relatives to be converted to capital over a period of time. Since the existing work is being carried out from their own sources the branch is advised to obtain a CAs certificate certifying the amount investing that will be

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considered as their contribution. Since the cash accrual for the year 2005 is accepted at Rs. 30.00 lacs the remaining contribution of Rs. 20.00 lacs from partners appears reasonable. 5. TOL/TNW: The ratio has been below 2.00 up to 31.03.05 and with proposed capital infusion the same is estimated to be about 1.18 which is acceptable being well within benchmark level. 6. NWC & C. R.: Both the parameters have been well above their respective benchmark levels and are estimated to improve further over the existing levels. It may be mentioned that even though the firm is increasing its production capacity and consequently sales it has not requested any additional working capital. During discussion it is gathered that with direct selling the payment term would be 90 % against supply of materials which would improve its cash flow and hence there will not be additional requirement of working capital. However the partners have informed that after the expansion is completed in March 06 they may approach us for additional working if required at that point of time. Thus the overall financial position of the firm is satisfactory. Assessment of present proposal: A. Working capital assessment: A. Comments on: i. ii. Sales projections: Already discussed. Inventory & receivables: Except the receivables the firm has estimated other current asset as per past trend and hence acceptable. The holding level of receivables has been 1.5 month to 1.75 months sales. For the current year it has estimated the same to

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be 2.33 months. It is clarified that as the firm would be executing Rs 150.00 lacs worth of orders from BHEL in next 4 months ( At least Rs 80.00 lacs as accepted by us) there will be concentration of debtors at the year end. Hence the estimates appear reasonable. Creditors have been nil and are estimated to be nil too. Against this background PBF is calculated as under. B. Working of MPBF: WORKING OF MAXIMUM PERMISSIBLE BANK FINANCE: (Rs in lacs). Particulars 31.03.04 31.03.05 31.03.06 Audited a. Total current assets b. OCL Excl. short term BB c. Working Capital Gap(a-b) d. Min. Stipulated NWC (25% of TCA) e. Actual/Projected NWC f. Item c-d g. Item c-e h. MPBF i. excess borrowings if any 14.41 17.62 9.11 9.11 18.47 23.62 13.08 13.08 40.35 41.51 15.00 15.00 23.61 0.09 23.52 5.90 Audited 31.70 0.15 31.55 7.93 Projected 55.35 55.35 13.84

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Case Study 2:

Comparative Balance Sheet and Performance / Financial Indicators: Bridged Balance Sheet: (Rs in lacs) 31.03.04 31.03.05 31.03.04 31.03.05 31.03.06 Assets (Audit) (Audit) (Estm) (Audit) (Audit) 27.77 36.30 41.42 Net Block 3.10 2.45 1.00 1.00 5.00 Advance/Deposits 0.34 0.34 (NCA) 1.18 0.68 Sundry Debtors 24.17 28.59 1.15 29.75 6.20 1.63 13.87 45.80 4.24 11.71 100.00 3.86 Stock Recurring Dep Cash OCA Chits Total 34.52 0.75 2.74 3.06 68.68 59.92 1.53 2.30 4.14 2.62 101.89

Liabilities Capital Unsec Ln Term Loan Sundry Creditors Bank Borrowing Chits Other liabilities Total

31.03.06 (Estm) 1.71 1.09 58.69 70.36 1.60 3.21 25.33 161.99

68.68

101.89

161.99

Net Worth Less: Revaluation Reserves Less: Intangible Assets Tangible Net Worth

31.03.2004 27.77 27.77

31.03.05 36.30 36.30

31.03.06 41.42 41.42

31.03.07 48.04 48.04

PERFORMANCE / KEY FINANCIAL INDICATORS: (Rs in Lacs) Particulars Net Sales % Increase / Decrease Net Profit After Tax Cash Accruals TNW excl Revaluation Reserve TOL / TNW Ratio 31.03.04 (audited) 720.26 0.41 3.87 27.77 1.47 78 31.03.05 (audited) 1126.16 56% 0.25 3.51 36.30 1.81 31.03.06 (estimated) 1749.64 55% 0.23 4.81 41.42 2.91 31.03.07 (projected) 1866.08 6.63% 0.23 4.74 48.04 2.49

NWC Current Ratio

26.51 1.68

35.19 1.55

43.62 1.38

50.79 1.44

Net Sales: The firm deals in the products of Hindustan Lever Ltd and Bharti Tele Ltd (Airtel). The estimated sale for 2004-05, as per last review, was Rs. 1405 lacs, with a growth of 95% over previous year. However the actual sales were Rs. 1126 lacs, with a growth of 56%. Achievement is 80%. In this connection, the firm has informed that the estimated growth of 20% in Hindustan Lever products could not be achieved and hence the variation. This is due to policy changes contemplated by HLL to reduce the no. of dealers as well as product consolidation. For the year 01.04.05 to 31.01.06, the firm has estimated a sale of Rs. 1749.64 lacs and for the next year, projected a sale of Rs. 1866.08 lacs. Till September 05, the firm was dealing in detergents, Lakme products of Hindustan Ltd and the products of Airtel. From October 05, the firm added the business of personal of Hindustan Lever Ltd. The performance of the firm during the year 01.04.05 to 31.01.06 is as under:

Detergent of Hindustan Lever Ltd Lakme of Hindustan Lever Ltd Personal products of HLL Airtel Total

: Rs. 536 lacs : Rs. 135 lacs : Rs. 121 lacs (Oct 05 to Jan 06) : Rs. 642 lacs : Rs. 1434 lacs

Considering the actual sale of Rs. 1434 lacs in the first ten months the estimated sales of Rs. 1750.00 lacs during the current year appears reasonable. As per the estimate, the

79

growth in sales during the year 05-06 is 55% compared to 04-05. in this connection, the firm has informed that they were allotted more areas/jurisdiction by Hindustan Lever Ltd. For the next year, the firm has projected a sale of Rs. 1866 lacs, with the break up of sales as under:

Detergent of Hindustan Lever Ltd Lakme of Hindustan Lever Ltd Personal products of HLL Airtel Total

: Rs. 602 lacs (12.3% growth) : Rs. 168 lacs (24%) : Rs. 388 lacs (7% annualized) : Rs. 708 lacs (10.28%) : Rs. 1866 lacs

The growth of the sale projected for the next year is around 7%. The estimated/projected sales, appears achievable in view of the performance of the firm in the past and during the year till Jan 06. Net Profit: The firm has been earning profits consistently, but the margin is very thin. During 2004-05 the profitability further dropped as compared to its previous year mainly due to competitive pricing in the consume/personal goods segments offered by various companies. The profitability has been between 0.25% in 2004-05 and is estimated to be 0.23% in the year 2005-06 followed by similar trend in the next year. The trend is estimated/projected to continue. Hence it is acceptable. Tangible Net Worth: The firm has been maintaining the TNW at a satisfactory level. Major portion of the profits are retained in the business. During the year 2005-06 the firm has proposed to infuse additional capital of Rs. 2.00 lacs followed by Rs. 4.00 lacs in the next year. The position is acceptable.

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TOL/TNW: The ratio has been consistently below the bench mark level. However compared to the previous years, the present level estimated/projected is higher in view of view of the additional borrowings for the increased turnover. However the same is still below the bench mark. Net Working Capital: The firm has been maintaining NWC at more than 25% of TCA level which is above the stipulated bench mark and is estimated to well within the bench mark too. The firm has proposed infusion of addition unsecured loan of Rs. 4.00 lacs to improve the NWC position. A suitable certificate from the CA is to be obtained to this effect. An undertaking is to be obtained not to repay this unsecured loan during current of our credit facilities. Current Ratio: The firm has been maintaining current ratio at a satisfactory level. Through the estimated level for the year 2005-06, is slightly lower compared to year 2004-05 it is still above the bench mark level. Thus overall financial position is satisfactory. Assessment of Proposal: A. Working capital assessment Comments on: i. Inventory: As per past trend, the level of stocks held by the firm is between 18 days to 20 days during last tow years and the same is estimated to be 15 days in this year 2005-06. This being an improvement over the past years is acceptable. ii. Receivables:

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As per past trend, the level of credit allowed by the firm is between 0.30 to 0.40 months sales. However the firm estimated/projected a higher level of 0.54 months sale this level appears on the higher side and therefore bank recast the figures of receivables with a 0.40 months sales. Accordingly the acceptable level of debtors would be Rs. 58.50 lacs. iii. Other Current Assets: The current assets include cash and bank deposits (RD). The estimated/projected level of these assets is in conformity with the earlier levels. Other than the above, the firm has another current asset in the form of Claims Receivable. These are amount receivables from M/s Hindustan Lever Ltd for any breakage in stock supplied. Till year 2004-05 the level was quite on lower side oaround Rs. 3 to 4 lacs. However during the year 2005-06 and 2006-07, the firm has estimated/projected a higher level of Rs. 25 lacs and Rs. 30 lacs respectively. In this connection the firm has informed that present outstanding claims receivable from Hindustan Lever Ltd is around 25 lacs and the level is likely to continue. The branch is to obtain a CAs certificate in this regard. iv. Sundry Creditors: The firm is reportedly not getting any credit from either Hindustan Lever Ltd of Airtel. However the firm has estimated/projected a level of Rs. 11 lacs for miscellaneous credits. The level is in conformity with the past trend. v. Other Current Liability:

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The other current liabilities include provisions for expenses and taxation. The estimated/projected level is in conformity with the past trend. vi. Method Lending: The method of lending is based on build up of current assets and liabilities, with second method of lending. vii. Comments on NWC: The estimated/projected NWC is adequate to meet the margin requirement of working capital. B. Working of MPBF:

Particulars A B C D E F G H I

31.03.04 (audited) Total Current Assets 65.24 TCL (except bank borrowings) 8.98 Working Capital Gap 56.26 Minimum stipulated margin (25% 16.31 of TCA) Actual/ estimated NWC 26.51 Item (c-d) 39.95 Item (c-e) 29.75 MPBF (lower of above two) 29.75 Excess borrowings, if any -

31.03.05 (audited) 99.10 18.11 80.99 24.78 35.19 56.21 45.80 45.80 -

31.03.06 (Estimated) 159.19 15.57 143.62 39.80 43.62 103.82 100.00 100.00 -

31.03.07 (Projected) 165.60 14.81 150.79 41.40 50.79 109.39 100.00 100.00 -

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Case Study 3:

Comparative Balance Sheet and Performance / Financial Indicators: (Rs in lacs) Liabilities Capital Reserves Def tax NW TL 31.03.04 Audited 16.20 4.70 0.27 21.17 1.92 31.03.05 Aud 17.20 4.82 2.15 24.17 8.99 31.03.06 Estm 17.20 15.10 2.10 34.40 10.66 Assets FA Depr. Net Block Cash & Bank RM WIP FG RecDom Export OCA TCA Inv Oth NCA Tot NCA Acc Loss Oth Intang Ass. Tot Ass 31.03.04 Audited 30.59 6.63 23.97 5.34 31.03.05 Aud 46.97 12.26 34.71 6.02 31.03.06 Estm 64.37 21.25 43.12 6.77

Unsec Ln OTL TTL Scred Bk Borr OCL TCL

14.16 16.08 3.49

18.17 27.16 6.06

16.71 27.37

10.64 7.23

11.33 12.70

24.50 40.80

9.36 12.85

12.80 18.86

25.00 36.00 61.00

2.82 26.03 -

2.49 32.54 2.86

4.64 76.71 2.86

0.10

0.08

0.08

Tot Liab

50.10

70.19

122.77

50.10

70.19

122.77

* Net Worth Less: Revaluation Reserves Less: Intangible Assets Tangible Net Worth

31.03.2004 21.17 0.10 21.07

31.03.05 24.17 0.08 24.09

31.03.06 34.40 0.08 34.32

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PERFORMANCE / KEY FINANCIAL INDICATORS: (Rs in Lacs) Particulars Net Sales % Increase / Decrease Net Profit After Tax % to Net Sales Cash Accruals TNW excl Revaluation Reserve TOL / TNW Ratio NWC Current Ratio Comments: 31.03.04 75.35 69.36% 3.15 4.18% 6.03 21.07 1.37 13.18 2.02 31.03.05 61.21 -ve 2.00 3.28% 7.63 24.09 1.91 13.68 1.73 31.03.06 204.00 10.29 5.04% 19.29 34.32 2.57 15.71 1.26

1. Sales: Sales mean service charges/ consultancy fees received for the NDT inspection and course fees received for its various training programs on NDT. As mentioned earlier the company is mainly doing NDT inspection of oil refineries of Reliance Industries, ONGC, and NTPC. The consultancy fees depend upon the volume of machineries put under NDT inspection. During 2004-05 the sales have declined due to this factor only. It may be mentioned here that during the year the course fees have grown by 200% whereas consultancy fees have declined by 65% (appx). In the year 2005-06 the company has received contracts worth Rs 87.00 lacs from RIL for its Jamnagar Plant. The company has estimated a sale of Rs 204.00 lacs comprising consultancy fee & component sale of Rs 180.00 lacs and training fees of Rs 24.00 lacs. The training fee is slightly less than the last years fees. As on 30.11.05 the company has already booked a sale of Rs129.00lacs. Besides it has orders from small & medium companies. As such we are of the view that the company would be in a position to achieve a sale of Rs150.00lacs. We may accept the said level.

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2. Net Profit: Profit margins in consultancy works are comparatively more. Therefore with decline in consultancy fees the profitability has declined during 2004-05. During 2005-06 the company has estimated a net profit of Rs 10.29 lacs with profitability of 5.04%. The company officials have clarified that with increased sales and without any additional cost the marginal revenue will be more. Moreover net profit as of 30.11.05 as declared by the company has been Rs. 10.10 lacs. Accordingly the estimates appear reasonable.

3. TNW: With 100% retention of net profit the TNW acceptable as on 31.03.06 would be Rs. 34.40 lacs.

4. TOL/TNW: The ratio for the last three years has been below the bench mark and is expected to be so in the current year too.

5. NWC & C.R: During 2002-03 sundry creditors mode of financing was resorted to by the company for its working funds and partly for its fixed assets resulting in C.R. below 1.00. This imbalance is rectified in 2003-04 by raising capital and infusing unsecured loans from directors and others. The position as at 31.03.05 is also above the respective bench mark. However during the current year the company proposes to add fixed assets from its internal accruals and partly out of its existing built up of NWC resulting in reduction in NWC level to 20% of the TCA. Consequently current ratio is estimated at 1.26. In fact as the minimum acceptable NWC is 20% and current ratio is 1.25 the

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proposed estimates can be acceptable as the purpose of utilization of NWC is for acquiring fixed assets required for business purposes only. Thus overall financial position is satisfactory.

Assessment of Present Proposal: A. Working Capital Assessment: A. Comments on: i. ii. Sales Projections: Already dealt with elsewhere in the note. Comments on NWC: Already discussed.

Assessment: The company had requested for project specific working capital (CC) facility of Rs 25.00 lacs for its contract worth Rs 87.00 lacs from RIL which will be completed within 4 months. This job is completed. But the company is able to obtain similar contracts from others like L&T, South Central railways etc in ensuing months for which it requires the working capital. In fact for the next year it has estimated a sale of more than Rs. 200.00 lacs.

As at 30.11.05 the TCA level is Rs. 62.57 lacs which is 49% of total sales as on that date. For the current year it has estimated a TCA level of Rs. 76.71 lacs which works out to 51% of accepted sales level. Since the estimated level is more or less equivalent to the actual level as on 30.11.05 we may accept the same. The company has estimated an OCL level of Rs. 36.00 lacs which as per the actual level prevailing as on 30.11.05. This is acceptable too. Accordingly PBF is arrived as under.

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i. ii. iii. iv. v. vi.

TCA level accepted OCL WCG Required NWC (20%) Estimated level MPBF

Rs76.71lacs Rs36.00lacs Rs40.71lacs Rs15.34lacs Rs15.71lacs Rs25.00lacs.

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Conclusions

The requirement of working capital finance is ever increasing. Loans and advances formed a major portion of the current assets of the firm because of which the working capital gap is large. The bank prefers to use the second method of lending working capital under the MPBF rather than evolving their own method. In most of the cases, hypothecation and/or mortgage are used to create securities for the banks. Bank has their own internal credit rating procedure to rate the clients (Borrowers). After doing the assessment of the financial indicators it is up to the judgment of the top management of the bank to sanction such loan. The very decision could be against the assessment result. If the company is with bank from inception stage then they are given preference, as credible and loyal party over their financial indicators. There is a stiff competition to the nationalized banks from the foreign investors as their lending rates are much lower than nationalized banks. Today the foreign investors are very big threat to business and its existence. Bank of Maharashtra has kept a conservative look to banking.

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Suggestions

Closely monitoring and inspecting the activities and stocks of the borrowers from time to time can avoid the misuse of working capital While working out the working capital limits, banks must exclude the loans and advances from the current assets. The assessment should be done mainly stock and the inventory level of borrower. Bank must extend working capital finance through non-fund based facilities. Another ideal method would be to use LC as the primary source of extending, working capital clubbed with bill discounting. This would ensure that the credit is put to the right use by the borrower and repayment is guaranteed to the bank. The bank must further secure themselves by holding a second charge on all the fixed assets of the borrower. The time period taken by the banks to sanction the limits should be significantly reduced to allow the borrowers to make use of the credit when the need is most felt.

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Bibliography Books: 1. HAND BOOK ONWORKING CAPITAL FINANCE D. P. SARDA, PUBLISHED BY S.J.D. IMPEX, MUMBAI, FOURTH EDITION 2. FINANCIAL MANAGEMENT R. P. RUSTAGI, GALGOTIA PUBLICATION, NEW DELHI, SECOND EDITION, 2000.

INTERNET SITES: http://www.banknetindia.com http://www.bankofmaharashtra.in http://www.indiamarkets.com http://www.businessfinance.com

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