SME- Non Schematic (Standard) For a business on the growth phase with a wide range of opportunities to explore, timely

availability of credit is an integral ingredient needed to scale new heights. Axis Bank understands this and endeavor to be not just a bank but also financing partner, so that focus on business needs becomes possible whereas Bank cater to meet financing needs. Their services ranging from Funded to Non-Funded, from Short Term to Long Term and from Credit to Trade Services ensures to get finance the way it is best suited for business. Services: Cash Credit Working Capital Demand Loan Export Finance Short Term Loan Term Loan Clean Bill Discounting LC Backed Bill Discounting Co-Acceptance of Bills Credit Facilities against Guarantee or Stand By Letter of Credit issued by Foreign Banks Letter of Credit Bank Guarantee Solvency Certificates

Cash Credit: Bank offer Cash Credit facilities to meet day-to-day working capital needs. Cash Credit is provided against the primary security of stock, debtors, other current assets, etc., and/or collateral security of movable fixed assets, immovable property, personal or corporate guarantee, etc. Interest is charged not on the sanctioned amount but on the utilized amount

Working Capital Demand Loan: Bank also provides working capital facilities in the form of Working Capital Demand Loan instead of cash credit facility. The primary or collateral security will be as mentioned in cash credit facility. Here also interest is levied on the amount drawn rather than on the amount utilized.

Export Finance: Bank provides finance for export activities in the form of Pre-Shipment Credit against firm order and or Letter of Credit and Post shipment credit. Credit is available for procuring raw materials, manufacturing the goods, processing and packaging the goods and shipping the goods. Finance is provided in Indian or foreign currency depending upon the need of the borrower.

Short Term Loan: Bank provides Working Capital facilities to meet day-to-day working capital needs and Term Loan for capex. However there may be occasions where there is need of ad hoc or short-Term finance for general corporate purposes, meeting temporary mismatches in working capital or for meeting contingent expenses. In such situations it provides Short Term Loans for tenure up to a year to ensure that business runs smoothly.

Term Loan: When there is need of long-Term funds for capex or capacity expansions or plant modernization and so on. Keeping these requirements in mind Bank provides Term Loans up to acceptable tenor with suitable moratorium, if required, and repayment options structured on the basis of customers estimated cash flows. These Loans are primarily secured by a first charge on the fixed assets acquired through the Loan amount. Suitable collateral security is also taken whenever required.

Clean Bill Discounting: Bank provides clean bill discounting facilities to fund receivables. Bank discount bills or receivables and provide credit against that. This facility is provided for a period of 3-6 months depending upon the tenor of the bill.

LC Backed Bill Discounting: Bank discount trade bills drawn under Letters of Credit issued by reputed banks to fund receivables. This facility is provided for a period of 3-6 months depending upon the tenor of the bill or Letter of Credit.

Co-Acceptance of Bills: Bank also provides co-acceptance of trade bills depending upon the need of the borrower.

Credit Facilities against Guarantee or Stand By Letter of Credit issued by Foreign Banks: Various foreign companies set up subsidiary in India. Bank provides funding to such companies against guarantees or SBLCs of acceptable foreign banks.

Letter of Credit: Apart from fund based working capital facilities Bank provides a range of Non-Fund Based facilities such as Letter of credit, Bank Guarantees, Solvency certificates, etc. Letter of Credit is provided to meet trade purchases. These are generally provided for 3-6 months depending upon Trade cycle. Apart from this it provides Import Letter of Credit for importing machinery or capital goods. Such LCs are for tenure ranging from 1-3 years depending upon the need of the borrower.

Bank Guarantee: Bank provides Bank Guarantee on behalf of its client to various other entities such as Government, quasi govt bodies, corporate and so on. it provides a range of guarantee such as Performance guarantee, financial guarantee, EPCG etc. The tenure of Bank

Guarantee range from 1 year to 10 years depending upon the purpose of the guarantee.

Solvency Certificates: Bank also provides solvency certificate depending upon the need of the borrower.

Sanctioning powers for schematic Loans under MSME and Mid Corporate
In order to have better control over the portfolio, it is felt that the budget for schematic advances should be allotted only to select branches, where the potential and manpower support exist for such business. Accordingly, the budget for FY 08 has been restricted to select branches, to be decided by Advances Cells. The Branch Heads of branches located at centers where Advances Cells have been set up will not have any sanctioning powers. Branch Heads of stand-alone branches where budgets have been allocated will have sanctioning powers as per delegation of powers given below. The Branch Heads of other stand-alone branches where budgets have not been allocated will not have any sanctioning powers. These branches would, however, continue to source business and such proposals would be processed / sanctioned at the respective Advances Cells. Review / renewal of existing Loans at such branches would also be done at the Advances Cells. Branches would continue to be responsible for all post sanction formalities, maintaining quality of assets held in their books, periodic updating of drawing power, obtention of stock statements and periodical inspection of borrowal units. The sanctioning powers, to be exercised by various officials would be as under.

Sanctioning Authority

Exposure Limits (in Rs. Lacs)

Interest rates Concessions NIL NIL Upto 100 bps Upto 100 bps

Reviewing Authority

Manager

50 250 1000 2000

AVP / VP-Advances at the Advances Cell VP-Advances SVP Advances Zonal Head

AVP VP SVP (Advances) at ZO

All requests for interest rate concessions are to be forwarded to the Advances Cells. The proposals sanctioned at Advances Cells / Zonal Offices during a particular month are to be submitted for review by the next higher authority through a monthly control return, latest by the 5th of the succeeding month, in the prescribed format and not on a case-by-case basis. Similarly, the proposals sanctioned by the Branch Heads /Advances Cells (headed by AVPs/Managers) during a particular month are to be submitted for review by the appropriate authority at Zonal Office or Advances Cells as the case may be through a monthly control return, latest by the 5th of the succeeding month, in the prescribed format and not on a case-by-case basis. The concessions in rates of interest / variations authorised by the VP (Advances) and SVP (Advances) during a particular month are to be submitted for review by the SVP(Advances)/ Zonal Head respectively through a monthly control return, in the prescribed format by the 5th of the succeeding month. If a combination of schematic Loan products is to be offered, the combined exposure should be the criterion while sanctioning the limits

Introduction to Credit Risk Management

Definition Of all different types of risks that a bank is subject to, credit risk can be defined as the risk of failure on the part of the borrower to meet obligations towards the bank in accordance with the Terms and conditions that have been agreed upon. Inability and/or unwillingness of the borrower to repay debts may be the cause of such default.

The bank aims at minimizing this risk that could arise from individual borrowers or the entire portfolio. The former can be addressed by having well-developed systems to appraise the borrowers; the latter, on the other hand, can be minimized by avoiding concentration of credit exposure with a few borrowers who have similar risk profiles. Credit risk management becomes even more relevant in the light of the changes that have been brought about in the economic environment, including increasing competition and thinning spreads on both the sides of Balance sheet

Determinants of Credit Risk Factors determining credit risk of a banks portfolio can be divided into external and internal factors. The banks do not have control on external factors. These include factors across a wide spectrum ranging from the state of the economy to the correlation among different segments of industry. The risk arising out of external factors can be mitigated via diversification of the credit portfolio across industries especially in light of any expectations of adverse developments in the existing portfolio.

Given that the banks have very little control over such external factors, the bank can minimize the credit risk that it faces mainly by managing the internal factors. These include the internal policies and processes of the bank like Loan policies, appraisal processes, monitoring systems etc. These internal factors can be taken care of, partly, via effective rating and monitoring systems, entry level criteria etc. These processes would enable improvement in the quality of credit decisions.

This would effectively improve the quality (and hence profitability) of the portfolio. While monitoring systems are useful tool at post-sanction stage, rating systems act as important aid at the pre-sanction stage.

Introduction to Credit Tools

The Bank has developed tools for better credit risk management. These focus on the areas of rating of corporate (pre-sanctioning of Loans) and monitoring of Loans (post-sanctioning). The focus of this manual is to familiarise the user with the credit rating tool. Credit Rating: Definition Credit rating is the process of assigning a letter rating to borrowers indicating the creditworthiness of the borrower. Rating is assigned based on the ability of the borrower (company) to repay the debt and his willingness to do so. The higher the rating of a company, the lower the probability of its default. The companies assigned with the same credit rating have similar probability of default. Use in decision-making Credit rating helps the bank in making several key decisions regarding credit including: Whether to lend to a particular borrower or not? What price to charge? What are the products to be offered to the borrower and for what tenure? At what level should sanctioning be done? What should be the frequency of renewal and monitoring?

It should, however, be noted that credit rating is one of the inputs used in taking credit decisions. There are various other factors that need to be considered in taking the decision (e.g., adequacy of borrowers cash flow, collateral provided, relationship with the borrower). The rating allows the bank to ascertain a probability of the borrowers default based on past data.

 Main features of the rating tool: i) Comprehensive coverage of parameters. ii) Extensive data requirement. iii) Mix of subjective and objective parameters. iv) Includes trend analysis. v) 13 parameters are benchmarked against other players in the segment. The tool contains the latest available audited data/ratios of other players in the segment. The data is updated at intervals. vi) Captures industry outlook. vii) Eight grade ratings broadly mapped with external credit rating agencys ratings prevalent in India. Special features of the web based credit rating tool i) Centralised data base. ii) Easy accessibility and faster computation of scores. iii) Selective access to users based on the area of operation. Branches have access to the data pertaining to their branch only, Zonal offices have access to the data pertaining to all the branches under their control and the Credit Department and Risk Department at Central Office have access to all accounts. iv) Adequate security system and provision of audit trails for confidentiality. v) Maintaining of past rating records in the system for collection of empirical data on rating migrations. This will enable the bank to arrive at PDs (Probability of Default) factor.

Rating Tool for Small and Medium Enterprises (SME)

The SME rating tool has been developed for the purpose of assigning a credit rating to the SME borrower of the Bank. The aim of the tool is to provide a standardised system for the bank to evaluate the credit risk of different borrowers. It should, however, be noted that this tool is not the standalone exercise for the purpose of sanctioning of Loan to a SME borrower. It should be supplemented with other inputs important in the sanctioning process.

The following broad areas have been considered for determining the rating of borrowers in the SME category:

Financial performance Business performance Industry outlook Quality of management Conduct of account (after roll out of the Monitoring tool)

Within each of these broad areas, various parameters have been used for obtaining an overall rating of the borrower. In the following sections, we shall discuss in greater detail the structure of the tool and the methodology of using it. Parameters used in credit rating of SME:

The rating tool for SME borrowers assigns the following weightages to each one of the four main categories i) Scenario (I) without monitoring

Parameter Financial performance Operating performance of business Quality of management Industry outlook

Weightage (%) 40 22.5 22.5 15

ii) Scenario (II) with monitoring tool: The weightages would be conveyed separately on roll out of the tool.

 Parameters used in the SME tool

Financial performance The tool in its current form uses various parameters for rating a borrower on its financial strength. These various sub-parameters give us an idea of the different sources of risk being faced by a company in different areas.

Operating performance of business Operational efficiency of a borrower is important in determining the generation of cash for repayment of its debt obligations. The parameters in this category assess the borrowers competence in its primary activities.

Quality of management Quality of the management of a borrowal unit has a direct impact on the performance of the unit. Also, it would have a direct impact on the integrity of the borrower especially in Terms of its willingness to repay its debt.

Industry In order to undertake the credit rating of any borrower, it is important to assess the riskiness of the industry to which that borrower belongs. Borrowers, which are similarly ranked in Terms of financial performance, operating performance of business and quality of management may have different credit ratings due to the risks inherent in their industry. The risk assessment in industry sectors is done at the Central Office level and appropriate score for each industry has been allocated in the tool. On selection of the relevant industry sector, the tool will automatically reckon the allocated score.

 Three types under SME tool

i) Manufacturing ii) Services and iii) Trading Various parameters under each of the above stated parameters for these three types of SME tool are as under:

Manufacturing

i) Financial performance

Sr. No. F1 F2 F3 F6 F7 F8 F9 F12*$ F13 F24 F27* F28*

Sub parameters Net Sales Growth Rate (%) PBDIT Growth Rate (%) PBDIT/Sales (%) TOL/TNW Current Ratio Operating Cash Flow DSCR Foreign exchange risk Expected values of D/E, if 50% of NFB credit devolves (corrected for margin) Realisability of Debtors State of export country economy Fund repatriation risk TOTAL

Weightage (%) 10 7 10 10 10 8 8 10 5 12 5 5 100

* Applicable for export units $Applicable for units having imports and or exports

ii) Operating performance of business

Sr. No. B7 B8 B9 B10 B13 B14 B15 B20 B21

Sub parameters Credit period allowed Credit Period Availed Working Capital Cycle Tax incentives Production Related Risk Product Related Risks Price Related Risk Client Risk Fixed Asset Turnover TOTAL

Weightage (%) 10 10 20 10 10 10 10 10 10 100

iii) Quality of management

Sr. No. M1 M2 M3 M4 M6 M9 M8

Sub parameters HR policy/track record of industrial unrest Track Record in Default of Statutory Dues Market Report of Management reputation History of FERA violation/ED enquiry Too Optimistic Projections of Sales and Other Financials Technical & Managerial Expertise Capability to raise money TOTAL

Weightage (%) 15 16 15 8 16 15 15 100

Services

i) Financial performance

Sr. No. F1 F2 F3 F6 F7 F8 F9 F12*$ F13 F24 F27* F28*

Sub parameters Net Sales Growth Rate (%) PBDIT Growth Rate (%) PBDIT/Sales (%) TOL/TNW Current Ratio Operating Cash Flow DSCR Foreign exchange risk Expected values of D/E, if 50% of NFB credit devolves (corrected for margin) Realisability of Debtors State of export country economy Fund repatriation risk TOTAL

Weightage (%) 10 7 10 10 10 8 8 10 5 12 5 5 100

* Applicable for export units $Applicable for units having imports and or exports

ii) Operating performance of business

Sr. No. M1 M3 M4 M6

Sub parameters HR Policy/Track Record in Industrial Unrest Market Report of Management Reputation History of FERA violation/ED enquiry Too Optimistic Projections of Sales and Other

Weightage (%) 15 20 10 20

Financials M8 M12 Capability to raise money Mix of Professional and Traditional Management TOTAL 100 15 20

iii) Quality of management

Sr. No. M1 M3 M4 M6

Sub parameters HR Policy/Track Record in Industrial Unrest Market Report of Management Reputation History of FERA violation/ED enquiry Too Optimistic Projections of Sales and Other Financials

Weightage (%) 15 20 10 20

M8 M12

Capability to raise money Mix of Professional and Traditional Management TOTAL

15 20

100

Trading

i) Financial performance

Sr. No. F1 F2

Sub parameters Net Sales Growth Rate (%) PBDIT Growth Rate (%)

Weightage (%) 10 7

F3 F6 F7 F8 F9 F12*$ F13 F24 F27* F28*

PBDIT/Sales (%) TOL/TNW Current Ratio Operating Cash Flow DSCR Foreign exchange risk Expected values of D/E, if 50% of NFB credit devolves (corrected for margin) Realisability of Debtors State of export country economy Fund repatriation risk TOTAL

10 10 10 8 8 10 5 12 5 5 100

* Applicable for export units $Applicable for units having imports and or exports

ii) Operating performance of business

Sr. No. B3 B7 B8 B9 B10 B14 B15 B24

Sub parameters Inventory Turnover Credit period allowed Credit Period Availed Working Capital Cycle Tax incentives Product Related Risks Price Related Risk Sustainability of Sales TOTAL

Weightage (%) 16 10 12 16 10 12 12 12 100

iii) Quality of management

Sr. No. M1 M2 M3 M4 M6 M8 M12

Sub parameters HR Policy/Track Record in Industrial Unrest Track Record in Default of Statutory Dues Market Report of Management Reputation History of FERA violation/ED enquiry Too Optimistic Projections of Sales and Other Financials Capability to raise money Mix of Professional and Traditional Management TOTAL

Weightage (%) 15 16 15 8 16 15 15 100

Definition of Parameters used in SME tool

F1 - Net Sales Growth Rate Importance of this indicator This ratio refers to the compounded annual growth rate of net sales over a period of three years. The companys growth ratio vis--vis other companies in the industry will be a good tool to assess its performance. If the growth rate is low compared to others in the industry, then it will enable us to analyse the problems unique to this company.

Formula The compounded annual growth rate over the past 3 years is calculated in percentage Terms. CAGR (Compounded annual growth rate) for three years = [{(Value of sales in current year)/(Value of sales in year 3)}(1/3) 1}]*100 Thus it is the third root of sales in current year divided by sales three years ago, minus 1, expressed as percent.

Notes Net sales = Gross sales Indirect taxes For banks, NBFCs, and other financial institutions: Net sales = net interest income + other income

F2 - PBDIT Growth Rate Importance of this indicator This ratio refers to the compounded annual growth rate of profits before depreciation (non cash), finance costs (interest) and tax over a period of three years. A consistent growth in this ratio indicates an improved performance of the company, reflected in increasing profitability (compared to its sales growth).

Formula The compounded annual growth rate over the past 3 years is calculated in percentage terms.

CAGR (Compounded average growth rate) for three years = [{(Value of PBDIT in current year)/(Value of PBDIT 3 years back)}(1/3) 1}]*100 Thus it is the third root of PBDIT in current year divided by PBDIT three years ago, minus 1, expressed as percent.

Notes PBDIT denotes profit before depreciation, interest and tax. For banks, NBFCs, and other financial institutions, use PBT instead of PBDIT

F3 - PBDIT/Sales Importance of this ratio This ratio indicates the profit before depreciation, interest and tax as a percentage of net sales. The profit before interest, depreciation and tax is an indicator of the operational efficiency. If this ratio as a percentage of sales is high, then it is a positive indication of the operating efficiency in Terms of raw material consumption, employee productivity and power consumption among other things. A high value indicates greater profitability and hence betters capability to repay the debt. The ratio is a measure of the margin available to a company from its operations.

Formula This ratio (in %) is computed by dividing the PBDIT with Net Sales. (PBDIT/Net Sales) x 100 PBDIT = Operating profit before depreciation, interest and tax For banks, NBFCs, and other financial institutions: o Net sales = net interest income + other income o Use PBT instead of PBDIT

F6 - TOL/TNW Importance of this ratio This ratio gives a holistic representation of total outside liabilities in relation to tangible net worth of company. It reflects the capacity of the business unit to assure the creditors of the

security they have for payment of both interest and installment. It indicates the extent to which the creditors are covered by asset. This ratio shows how much outside borrowings are resorted to in comparison with owners funds Formula The total outside liabilities are divided with the tangible net worth of the company.

Total Outside Liabilities Tangible Net Worth TOL = Total liabilities - TNW TNW as defined in Debt Equity ratio Also calculate this ratio for banks, NBFCs and other financial institutions, as it will give an indication of the capital adequacy of the company

F7 - Current Ratio Importance of this ratio Current assets of company are the assets that can be easily liquidated and converted into cash. The current ratio measures short-Term liquidity of the company and ability to meet its shortTerm financial obligations. A high ratio is good from the point of view of the bank but a very high ratio may affect profitability through a high inventory carrying cost. Formula The ratio is worked out by dividing the Current Assets with Current Liabilities Current Assets Current liabilities (including instalments due during the year) To get a meaningful current ratio, we should account for the vulnerability of a company to short Term insolvency. The current ratio could be high because of excess inventory or slow realisation of debtors. Therefore, current assets must not include inventory which is older than the normal working cycle of company (say 6-8 month), receivables over 6 months, dies, spares required for more than 9 months of production and disputed receivables. If such excess assets

exist then please make necessary notes in the remarks column. In such cases please indicate your assessment of the value of current ratio. Also calculate this ratio for banks, NBFCs and other financial institutions, as it will give an indication of the duration mismatch of the companys balance sheet

F8 - Operating Cash Flow Importance of this indicator This measure indicates the companys cash inflows and outflows arising from its operations. It is different from funds flow of business. It helps us to evaluate the companys ability to generate cash inflows from operations to pay debt, interest and dividends, and to explain the difference between net income and net cash flow for operating activities. The operating cash flow can indicate the companys need for external financing. While funds flow is good to match long Term and short Term use and source of funds, this indicator tries to capture the capability of the firm to be able to meet its business obligations . Calculation Operating cash flow (for the last financial year) is computed in the following manner

Head Net Sales Other income Total receipts Less: COGS Gross Profit Less: SGA/Operating expenses PBDIT - Increase / + decrease in non cash current assets + Increase / - decrease in current liabilities Operating cash

Amount

Less: Income tax paid Post tax operating cash Less: Interest paid on LT & ST Less: Dividend paid Cash from operations

Repayment due of long Term debt

How to rate Compare cash flow from operations to repayment due of long Term debt. The rating is done as explained in the table below.

Description The company is likely to default on repayment of its Loans and Interest The company is not in a position to meet its repayment obligations from its own resources and it faces difficulties to arrange outside funds The company is in a position to meet its repayment obligation from its own resources and Term funds that are already applied for (and expected to be sanctioned shortly) The company is in a position to meet its repayment obligation from its own resources and Term funds The company is in a comfortable position to meet its repayment obligation from its own resources (no need for outside funds)

Score 0

F9 - DSCR (Debt Service Coverage Ratio) Importance of this ratio This ratio measures the capacity of the company to service its debt i.e. repayment of principal and interest. DSCR measures the number of times a companys earnings cover its total long-

Term debt-servicing requirement, including interest and principal repayments in Term Loans, over a period of one year. This ratio will help us to evaluate if an adequate cash flow will be available to meet debt obligation and also for providing margin of safety to lenders. This ratio also helps to determine the time when repayment should commence and the pay-back period of the Loan. This ratio is a good indicator of the long-Term solvency of a company.

Formula The profit before depreciation and interest (PBDI) is divided by installments due during the year plus interest. P B D I__________ Installments for the year + interest Do not fill in this ratio for banks, NBFCs and other financial institutions

F12 - Foreign exchange risk Importance of this indicator Adverse movements in the foreign exchange rate can have a tremendous impact on the companys financial strength. Foreign exchange risk may be either transaction based or portfolio based. Transaction based risk is due to time lags between purchases being made and payment being made, or sales being made and payment being received against these sales. Portfolio based risk is on account of foreign exchange Loans where the repayment is made on future dates in foreign currency. The rater needs to know how the likely fluctuation in exchange rate will affect the profits of the company. Depending on composition of international trade, the adverse exchange rate movement could affect the profitability/cash flow. Prudent borrowers hedge their exposure to foreign exchange. Only the un-hedged part of the foreign exchange exposure should be taken into account.

How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception and knowledge of the foreign exchange risk. A potential model to allocate score can be the following:

Description The risk involved is > 10% of TNW The risk involved is between 8% and 10% of TNW The risk involved is between 5% and 8% of TNW The risk involved is less than 5% of TNW The entire portfolio is hedged

Score 0 1

2 3 4

Important notes The foreign exchange risk can be quantified by using the forward exchange rates prevailing in the currency market. The risk involved can be estimated by evaluating two measures: 1. Exports as % of TNW 2. Natural hedge involved, with a proxy measure being (1- imports divided by exports) (always divide the smaller number by the larger one). When this ratio is 1, foreign exchange risk from exports and imports cancels each other out (provided it is to/from similar currency zones)

Example: total sales = 100, exports = 20, imports = 10, TNW = 200 Risk involved = exports x (1- imports/exports) = 20 x (1- 10/20) = 10 = 5% of TNW Also calculate this ratio for banks, NBFCs and other financial institutions

F13 - Expected values of Debt Equity ratio if 50% NFB credit devolves Importance of this indicator This indicator gives us an idea about the future expected debt equity structure in an extreme situation. It recalculates the Debt/Equity ratio when 50% of non-fund based limits devolve. In doing so, it gives a sense of the long-Term financial stability in an extreme situation. This is quite a good comforting factor for the bank. Most companies have to put up a margin for their non-fund based credits. The new D/E ratio will have to be corrected for this when the limits devolve, since part of it will be covered by the margin

Calculation The calculation is the same as for F5 Debt/Equity ratio, with Debt = Long Term debt + 50% of the companys non-fund based limits Margin that the company put up for its non-fund based limits.

Do not calculate this ratio for banks, NBFCs and other financial institutions F24 - Realisability of Debtors Importance of this indicator This indicator should indicate the quality of the debtors of the company and if money can be recovered from them quickly and easily. A lot depends on how auditors have treated the receivables.

There are many ways in which the auditors can play around with the receivables viz. the receivables may be disputed. Receivables may be unrelated to business activity of the company or there could be high amount of bad debts in the receivable portfolio of the company. Any delay in receipt of payment from debtors/non-receipt of amount can hamper the production cycle of a company as well as increase collection costs and the probability of default on the part of the debtor of the company. Hence the realisability of the debtors of a company is a critical input for assessing the financial risk of a borrower.

F27 State of the export country economy Importance of this indicator The economy of the country to which is being exported, will have a significant impact on the exporters business. A slowdown in the economic growth might even have a more than linear impact on the exporters turnover and profitability, since importers will typically may have the reaction to cut costs by cutting relationships with overseas suppliers.

How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception and knowledge of the foreign exchange risk. The minimum score of 0 could be assigned to exporters who trade the bulk of their products/services with 1 single country, that is currently in a recession. The maximum score of 4 can be granted to parties who have a wide portfolio of export countries, with most (or all) of these countries showing strong economic growth. F28 Fund repatriation risk Importance of this indicator Exporters are often paid in the currency of the country to which they export.Some of these currencies may be difficult to exchange or to wire back to India. In that case, significant costs and risks are involved in the repatriation of funds, which could affect the overall risk profile of the exporter How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception and knowledge of the foreign exchange risk. The minimum score of 0 could be assigned to an exporter who trades the bulk of his products/services with a country that has very stringent foreign exchange and currency repatriation policies. The maximum score of 4 could be granted to exporters who only trade with countries, which have no restrictions on the flow or repatriation of funds.

B3 - Inventory Turnover (Trading) Importance of this ratio This ratio indicates the velocity (number of times) with which the inventory circulates in the business, during the relevant period.

A decrease in ratio could be a significant danger signal. Low ratio could indicate the presence of slow moving items in stock. A high ratio is good from the point of liquidity since inventory will be quickly converted into cash. This ratio also indicates the efficiency of the company in utilizing its inventory and maintaining it at an optimum level. Thus, the higher the ratio, the higher the sales per unit of investment in inventories. A lower ratio results in high carrying cost and blocking of funds, thus limiting the liquidity of the company.

Formula The ratio is worked out by dividing the net sales with average inventory maintained. Net sales Average inventories Average inventory = (opening stock of inventory + closing stock of inventory)/2 Inventory = raw materials + WIP + finished goods Do not calculate this ratio for banks, NBFCs and other financial institutions

B7 - Credit period allowed Importance of this indicator This indicates the period of realisation of sales proceeds. It is the average length of time that customers who buy on credit take to pay their dues. It indicates the efficiency of management in debt collection. A lower value of this ratio indicates a speedy realisation of sale proceeds. The industrys practice should be given due consideration. A high ratio could be indicative of disputed receivables or a high amount of bad debts. The appraisal officer should be careful when assessing this ratio, since it also reflects the bargaining power enjoyed by the company in the market with respect to the buyers.

Formula The period of collection (in days) is calculated by dividing the average debtors outstanding with average daily sales. Average debtors Average daily sales

Average debtors = (Sundry debtors in the beginning of the year + sundry debtors at the close of the year)/2 Do not calculate this ratio for banks, NBFCs and other financial institutions

B8 - Credit period availed Importance of this indicator It measures the average time taken by the company to pay its suppliers for purchases made on credit. This ratio relates credit availed to its total purchases. This indicator is a measure of the bargaining power that the company enjoys with its suppliers. A stronger company will avail a longer credit period from its suppliers than a weak company. A longer credit period offered by suppliers also indicates that the suppliers are confident of the ability of the company to pay them. A word of caution, a very high ratio could indicate short-Term liquidity problems also.

Formula The credit period availed (in days) is computed by dividing the average (non financial) creditors outstanding during the year with average daily cost of sales. Average creditors Average daily cost of sales

Average creditors = (Sundry creditors in the beginning of the year + sundry creditors at the close of the year)/2 Do not calculate this ratio for banks, NBFCs and other financial institutions

B9 Working capital cycle (Manufacturing, Trading) Importance of this indicator Working capital represents an important part of the employed capital of many companies. Therefore, a good performing company should carefully manage this part of its assets, since it represents an important invest Also, the way a company go about their working capital, says a lot about the management of the company. In a sense one could argue that good working capital management is an indicator of good management Factors to be considered Inventory turnover and credit period allowed

How to calculate Net sales Working capital

Working capital = Raw materials and spares+ Finished and semi finished goods+ Debtors Do not calculate this ratio for banks, NBFCs and other financial institutions

B10 - Tax Incentives Importance of this indicator Tax incentives can be a major driver of profitability for many companies. A unit located in backward area or in some of the states (like Goa or union territory of Daman & Diu etc.) enjoy special tax incentives. (Both states grant income tax and sales tax holidays for 3-5 yrs.) Such tax holiday period is helpful for company to take advantage especially in a commodity market and thus improve profitability. How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception and knowledge of the government policies and industry. The rater should also be aware of the management strengths and their ability to make best use of the existing government incentives. Score of 4 indicates a high probability of successfully getting tax incentives. Score of 0 means no or negative effect of taxes.

B13 - Production related risk (Manufacturing) Importance of this indicator This measures the risk of a company with respect to its production activities. It evaluates the ability of company to sustain the production activity at a diversified level. A company having little production related uncertainties in production would be better placed in the industry. Problems in production would lead to impact on overall performance of the company. Thus the efficiency, stability and consistency of quality of the production activities are a critical determinant of performance. The state of technology can be considered an overall driver of this risk

Factors to be considered Capacity Utilisation ; Availability of raw material, State of technology used; Flexibility in product manufacturing; Patents and proprietary technology; R&D Number of manufacturing plants.

How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception and knowledge of the production risk. A potential model to allocate score can be the following: Score =2, if company is upgrading but has old technology Score = 0,1 if company is not upgrading and has old technology Score = 4, if company is upgrading and technology is new Score = 3, if company is not upgrading but has new technology

Do not calculate this ratio for banks, NBFCs, other financial institutions or service Companies B14 Product/service related risk Importance of this indicator This indicator measures the risk relating to the products manufactured / services provided by the company.

The risks associated with the product can be those related to obsolescence, substitution, decrease in demand etc. A product should be of a consistent high quality; otherwise its market reputation will suffer. The companys ability to standardize product quality, getting ISI benchmarks or ISO certificates will add to its advantage. The expected product life cycle will also contribute to the overall product risk. The shorter the expected life of the product, the riskier the companys business performance . Factors to be considered Product range; Product/service quality; Brand value, highly customized product/service; Obsolescence, Demand supply position/gap. How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his perception and knowledge of the product risk. A potential model to allocate score can be the following:

Description High variability in product/service quality (e.g. frequent recalls) and short product life (<1 year) High variability in product/service quality and medium product life (1 to 3 years) Low variability in product/service quality and medium product life (1 to 3 years) No variability in product/service quality and long product life (> 3 years)

Score 0

No variability in product/service quality and very long product life (> 5 4 years)

B15 - Price Related Risk Importance of this indicator This indicator measures the ability of a company to dictate prices in the marketplace as well as to cut its prices in case of a price war. The price competitiveness of a company is an important indicator of the competitive position of a company. A company that is in a position to charge a premium over its competitors is better placed in the industry. Similarly, a company with lower costs is in a good position to withstand price competition in the market. If the companys products enjoy a high reputation, it can price the product to its advantage.

Factors to be considered Economies of scale/cost effective technology; Brand Equity; Pricing Flexibility; Financing edge over competitors; Bargaining power of buyers

How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his/her perception and knowledge of the price risk. A score of 4 means that the company is not at all subject to price risk i.e. can charge a sustainable price premium. A score of 0 indicates that the company has no control at all over its price, thus being subject to high price risks. B20 Client risk (Services, Manufacturing) Importance of this indicator Smaller to midsized companies can face considerable risks at the client side. This risk is twofold: number of clients and quality of clients. Medium-sized companies sometimes depend on a very small portfolio of clients, or have 1 predominant clients who makes or breaks the company. Also, medium sized companies are sometimes closely connected to clients with a shady or poor reputation. This might not only adversely impact their own reputation, but also represent a barrier to recruiting and retaining of talent, innovation. Factors to be considered Number of clients, quality/reputation of clients

How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his/her perception and knowledge of the client risk. A score of 4 means that the company has a well diversified portfolio of high quality clients. A score of 0 indicates that the company depends on a small set of clients, which can be perceived as 2nd or 3rd rank in their respective industry. B21 Fixed asset turnover (Manufacturing) Importance of this indicator Fixed assets represent an important part of the capital employed at manufacturing companies. A well performing company should therefore make sure that it gets the maximum out of its machine park. How to rate Net sales Fixed tangible assets With fixed tangible assets = replacement or acquisition value of fixed tangible assets (land, machines, buildings,..) B22 Quality of internal processes & systems (Services) Importance of this indicator The business performance of service companies is often determined by the quality of their internal processes and systems. It is therefore important to assess how the companies score on these dimensions, since they will be an important contributor to the potential success and / or risk of the company.

Factors to consider Consistency of delivered service, timeliness or response time, internal sharing of know-how, quality of internal training programs,

How to rate The rater has to subjectively rate this indicator on a score of 0 to 4 based on his/her perception and knowledge of the quality of internal processes and systems. A score of 4 means that the

companys processes and systems are considered top class in the industry. A score of 0 indicates that the company has a very poor service offering and resulting reputation. B23 Competence to innovate (Services) Importance of this indicator The success of a company can often be related to the overall performance of its service offering. Therefore, a companys capability to develop services which respond to its users needs (through efficiency, customization, effectiveness ) will influence its competitive position and hence its success

How to rate The rater has to subjectively rate this indicator, based on his understanding of the companys innovation capabilities. A rating scale from 0 to 4 will be used. A score of 2 means that the company can be seen as having average innovation skills. A score of 3 or 4 indicates a stronger or outstanding (respectively) innovational strength compared to its competitors. A score of 1 or 0 indicates a weaker or poor (respectively) innovation skill compared to competitors. B24 Sustainability of sales(Trading) Importance of this indicator An important driver of the success of a trading company, is the level of sales it is able to generate. Therefore, the risk associated with a trading company is very much linked to the sustainability of its sales. A company with sustainable sales will have a core portfolio of products, which will not switch quickly. Opportunistic trading companies do run the risk of making the wrong bet, resulting in impressive declines in sales.

How to rate The rater has to subjectively rate this indicator, based on his understanding of the companys sales sustainability. A rating scale from 0 to 4 will be used. The maximum score of 4 can be assigned to trading companies with a strong portfolio of core products, showing continuous growth as a result of a well laid out strategy. The minimum score of 0 could be given to

opportunistic trading companies, showing a very random path in performance, and without a clear-cut strategy.

Subjective Assessment of Quality of Management

How to rate: The rater should rate the ratios and indicators on the score of 0 to 4 depending on his understanding and comfort levels. A score of 4 means that the rater feels that promoters and their management will perform very well on the ratio/indicator. Adversely, the rater should assign a score of 0 if he/she thinks that management will perform poorly on the ratio/indicator.

The importance of each of the above ratios and indicators are now listed.

M1 - HR policy / Track record of industrial unrest Importance of this indicator This factor relates to labour unrest, lock out, and work slowdown, strike and strained management employee relation. Industrial harmony is a key factor for success of an industry/business. In short, this indicator reflects the quality of the companys HR policy. Factors to assess include: is the HR system fair and equitable, are promotions based on merits, does the company provide a supportive environment, and do employees feel appreciated?

M2 - Track record in default of statutory dues (e.g. Electricity bills, PF dues, etc.) (Manufacturing, Trading) Importance of this indicator This factor takes into account the seriousness of the company and its management towards contractual obligation. If management is not serious about the legal and statutory dues then there is a high probability of it not being committed to fulfill the Loans taken from the bank.

M3 - Market report of management reputation Importance of this indicator This market report assesses the reputation or general perception about integrity and fair dealing of the promoters. The reputation of promoters regarding their integrity, adhering to commitments, fair dealings has important bearing on quality of management. This incidentally becomes one of the most important ratios and indicators, as past behaviour is often a good proxy for their future behaviour. Adverse performance of associate concerns controlled by the corporate should also be considered. M4 - History of FERA violation /ED enquiry Importance of this indicator A company may have a track record of FERA violation or might have faced raids by the Enforcement Directorate. Companies also indulge in unhealthy practice of electricity thefts or evasion of ST, IT or Excise or indulge in Hawala transactions, under-invoicing or overinvoicing. Such instances speak about poor integrity of company and indicate about company working against national interest. M6 Too optimistic projections of sales and other financials Importance of this indicator There is sometimes a conscious attempt to over-estimate financial projections to secure excess borrowings. Recurrent non-achievement of targets could be indicative of such practice. Careful scrutiny of past track records help develop an idea of reliability of projections. M8 Capability to raise resources Importance of this indicator Managements capability of raising additional resources is an important factor in assessing the creditworthiness of the company. If management is likely to find additional outside funding (from capital market, partners, family, group company) whenever this is necessary, this should contribute to a reduced risk for the bank.

M9 - Technical & Managerial expertise (Manufacturing) Importance of this indicator This indicator relates to the technical knowledge and experience of the promoters in the relevant area of operation. Technical skills will contribute to a greater efficiency of operations and quality of products. Managerial know-how will enable management to avoid typical pitfalls and to put together a consistent and feasible strategy. M12 Mix of professional and traditional management (Services, Trading) Importance of this indicator This indicator tries to evaluate the professionalism of the companys management. It is important that the management consists of people who know the business, the industry and who have the necessary experience to make things work. However, a lot of companies are still family-owned, which is often reflected in the composition of the management team. Therefore, it is important to assess if the company maintains a good balance between traditional management (who often own the client relations) and professional management.