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Q.1. The Importance of Small and Medium Enterprises (SMEs) in Economic Development

One of the significant characteristics of a flourishing and growing economy is a booming and blooming small
and medium enterprises (SMEs) sector. Small and medium enterprises play an important role in the
development of a country. SMEs contribute to economic development in various ways by creating
employment for rural and urban growing labor force, providing desirable sustainability and innovation in the
economy as a whole .In addition to that, a large number of people rely on the small and medium enterprises
directly or indirectly.One of the significant characteristics of a flourishing and growing economy is a
booming and blooming small and medium enterprises (SMEs) sector. Small and medium enterprises play an
important role in the development of a country. SMEs contribute to economic development in various ways:
by creating employment for rural and urban growing labor force, providing desirable sustainability and
innovation in the economy as a whole .In addition to that, a large number of people rely on the small and
medium enterprises directly or indirectly.

Most of the current larger enterprises have their origin in small and medium enterprises. SMEs are different
from large scale enterprises in three main aspects; uncertainty, innovation and evolution. The SME sector
itself can be classified into micro enterprises, small enterprises and medium enterprises. SMEs are the starting
point of development in the economies towards industrialization. However, SMEs have their significant effect
on the income distribution, tax revenue, and employment, efficient utilization of resources and stability of
family income. According to the United Nations Industrial Development Organization UNIDO, for
developing countries, integration into the global economy through economic liberalization, deregulation, and
democratization is seen as the paramount way to triumph over poverty and inequality. Important to this
process, is the development of an animated private sector, in which small and medium enterprises can play a
central role. SMEs have a propensity to employ more labor-intensive production processes than large
enterprises. Consequently, they contribute significantly to the provision of productive employment
opportunities, the generation of income and, eventually, the reduction of poverty. According to the statistics,
in industrialized countries, SMEs are major contributors to private sector employment. Empirical studies have
shown that

SMEs contribute to over 55% of GDP and over 65% of total employment in high income countries .SMEs and
informal enterprises, account for over 60% of GDP and over 70% of total employment in low income
countries, while they contribute about 70% of GDP and 95% of total employment in middle income countries.
SMEs play significant contribution in the transition of agriculture-led economies to industrial ones furnishing
plain opportunities for processing activities which can generate sustainable source of revenue and enhance the
development process. SMEs shore up the expansion of systemic productive capability. They help to absorb
productive resources at all levels of the economy and add to the formation of flexible economic systems in
which small and large firms are interlinked. Such linkages are very crucial for the attraction of foreign
investment. Investing transnational corporations look for sound domestic suppliers for their supply chains.
SMEs are the major growing force behind the fastest growing economy of China, in terms of contribution to
the national GDP (accounting for 40%), scale of assets, diversification of products, and the creation of
employment. Similarly, the role of SMEs is well acknowledged in other countries such as Japan, Korea, and
all other industrialized economies in terms of creating employment, reducing poverty and increasing the
welfare of the society. Experts and economists are unanimous about the role and importance of small and
medium enterprises in the development of Pakistan economy. The statistical data and empirical studies about
SMEs highlight the bulk share of SMEs in the economy. According to the Small and Medium Enterprises
Development Authority (SMEDA), "SMEs constitute nearly 90% of all the enterprises in Pakistan; employ
80% of the non-agricultural labor force; and their share in the annual GDP is 40%, approximately?.
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Q. 2. SME Foundation

SMEs are recognized as engine of economic growth and employment generation for sustainable
industrialization in both developed and developing countries of the world. In context of Bangladesh, there is
no alternative of small and medium enterprises for rapid industrialization and national economic growth
through lower capital investment and employment generation. The SME Foundation is playing its role in
helping the SME entrepreneurs including the women entrepreneurs by conducting various programs with an
aim to develop the SMEs of Bangladesh. One of the major aims of SMEF is to bring the grassroots
entrepreneurs into the main stream of economic development through employment generation, reduction of
social discrimination and poverty alleviation.

Legal base of establishing SME Foundation

Small and Medium Enterprise Foundation got registration from the Ministry of Commerce on 12-11-2006 and
from the Registrar of Joint Stock Companies and Firms on 26-11-2006 under the Companies Act (Act
XXVIII), 1994 . A resolution (Gazette notification) was circulated on 30-05-2007 regarding the establishment
of SME Foundation. It is an independent and unique non-profit organization.

Vision
Fostering industrialization through SME promotion for employment generation, economic development
finally poverty alleviation of Bangladesh.

Mission
Undertake and implement multi sectoral action plan for proper growth of SMEs and make them competitive
in the free market economy.

Objective
1. Implementing SME Policy Strategy adopted by the Government of Bangladesh.

2. Recommending SME friendly policies to different government ministries and agencies.

3. Providing business support services to the SME entrepreneurs.

4. Providing information and proper guidance for establishing new SMEs.

5. Conducting sectoral study to ensure availability of latest information, identify challenges and recommend
preventing measures.

6. Operating credit wholesaling programs for the SMEs through different banking and non-banking financial
institutions.
7. Conducting training programs to create skilled labor for different SME sub-sector based on their demands.
8. Technology development, adopting new technology, conducting reverse engineering and supporting SMEs
to get quality certifications.

9. Supporting SMEs in marketing their products and promotion of services.

10. Bringing women entrepreneurs into the mainstream of development and helping them to achieve
economic self dependency.

11. Assisting SMEs in creating institutional bondage with foreign companies for capacity building,
technology transfer and improving productivity.

12. Training up and motivating SMEs in using ICT tools for more productivity and improving quality.
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Q. 3.Types Of Financial Institutions And Their Roles

A financial institution is an establishment that conducts financial transactions such as investments, loans and
deposits. Almost everyone deals with financial institutions on a regular basis. Everything from depositing
money to taking out loans and exchanging currencies must be done through financial institutions. Here is an
overview of some of the major categories of financial institutions and their roles in the financial system.

Commercial Banks
Commercial banks accept deposits and provide security and convenience to their customers. Part of the
original purpose of banks was to offer customers safe keeping for their money. By keeping physical cash at
home or in a wallet, there are risks of loss due to theft and accidents, not to mention the loss of possible
income from interest. With banks, consumers no longer need to keep large amounts of currency on hand;
transactions can be handled with checks, debit cards or credit cards, instead.
Commercial banks also make loans that individuals and businesses use to buy goods or expand business
operations, which in turn leads to more deposited funds that make their way to banks. If banks can lend
money at a higher interest rate than they have to pay for funds and operating costs, they make money.
Banks also serve often under-appreciated roles as payment agents within a country and between nations. Not
only do banks issue debit cards that allow account holders to pay for goods with the swipe of a card, they can
also arrange wire transfers with other institutions. Banks essentially underwrite financial transactions by
lending their reputation and credibility to the transaction; a check is basically just a promissory note between
two people, but without a bank's name and information on that note, no merchant would accept it. As payment
agents, banks make commercial transactions much more convenient; it is not necessary to carry around large
amounts of physical currency when merchants will accept the checks, debit cards or credit cards that banks
provide.

Investment Banks
The stock market crash of 1929 and ensuing Great Depression caused the United States government to
increase financial market regulation. The Glass-Steagall Act of 1933 resulted in the separation of investment
banking from commercial banking. While investment banks may be called "banks," their operations are far
different than deposit-gathering commercial banks. An investment bank is a financial intermediary that
performs a variety of services for businesses and some governments. These services include underwriting debt
and equity offerings, acting as an intermediary between an issuer of securities and the investing public,
making markets, facilitating mergers and other corporate reorganizations, and acting as a broker for
institutional clients. They may also provide research and financial advisory services to companies. As a
general rule, investment banks focus on initial public offerings (IPOs) and large public and private share
offerings. Traditionally, investment banks do not deal with the general public.

Insurance Companies
Insurance companies pool risk by collecting premiums from a large group of people who want to protect
themselves and/or their loved ones against a particular loss, such as a fire, car accident, illness, lawsuit,
disability or death. Insurance helps individuals and companies manage risk and preserve wealth. By insuring a
large number of people, insurance companies can operate profitably and at the same time pay for claims that
may arise. Insurance companies use statistical analysis to project what their actual losses will be within a
given class. They know that not all insured individuals will suffer losses at the same time or at all.

Brokerages
A brokerage acts as an intermediary between buyers and sellers to facilitate securities transactions. Brokerage
companies are compensated via commission after the transaction has been successfully completed. For
example, when a trade order for a stock is carried out, an individual often pays a transaction fee for the
brokerage company's efforts to execute the trade. A brokerage can be either full service or discount. A full
service brokerage provides investment advice, portfolio management and trade execution. In exchange for this
high level of service, customers pay significant commissions on each trade. Discount brokers allow investors
to perform their own investment research and make their own decisions. The brokerage still executes the
investor's trades, but since it doesn't provide the other services of a full-service brokerage, its trade
commissions are much smaller.
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Investment Companies
An investment company is a corporation or a trust through which individuals invest in diversified,
professionally managed portfolios of securities by pooling their funds with those of other investors. Rather
than purchasing combinations of individual stocks and bonds for a portfolio, an investor can purchase
securities indirectly through a package product like a mutual fund. There are three fundamental types of
investment companies: unit investment trusts (UITs), face amount certificate companies and managed
investment companies. All three types have the following things in common:
An undivided interest in the fund proportional to the number of shares held
Diversification in a large number of securities
Professional management
Specific investment objectives
Let's take a closer look at each type of investment company.

Unit Investment Trusts (UITs)

A unit investment trust, or UIT, is a company established under an indenture or similar agreement. It has the
following characteristics:
The management of the trust is supervised by a trustee.
Unit investment trusts sell a fixed number of shares to unit holders, who receive a proportionate share of net
income from the underlying trust.
The UIT security is redeemable and represents an undivided interest in a specific portfolio of securities.
The portfolio is merely supervised, not managed, as it remains fixed for the life of the trust. In other words,
there is no day-to-day management of the portfolio.

Face Amount Certificates

A face amount certificate company issues debt certificates at a predetermined rate of interest. Additional
characteristics include:
Certificate holders may redeem their certificates for a fixed amount on a specified date, or for a specific
surrender value, before maturity.
Certificates can be purchased either in periodic installments or all at once with a lump-sum payment.
Face amount certificate companies are almost nonexistent today.

Management Investment Companies

The most common type of Investment Company is the management investment company, which actively
manages a portfolio of securities to achieve its investment objective. There are two types of management
investment company: closed-end and open-end. The primary differences between the two come down to
where investors buy and sell their shares - in the primary or secondary markets - and the type of securities the
investment company sells.

Closed-End Investment Companies:

A closed-end investment company issues shares in a one-time public offering. It does not continually offer
new shares, nor does it redeem its shares like an open-end investment company. Once shares are issued, an
investor may purchase them on the open market and sell them in the same way. The market value of the
closed-end fund's shares will be based on supply and demand, much like other securities. Instead of selling at
net asset value, the shares can sell at a premium or at a discount to the net asset value.

Open-End Investment Companies:

Open-end investment companies, also known as mutual funds, continuously issue new shares. These shares
may only be purchased from the investment company and sold back to the investment company. Mutual funds
are discussed in more detail in the Variable Contracts section.
Read more: Series 26 Exam Guide: Investment Companies
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Nonbank Financial Institutions
The following institutions are not technically banks but provide some of the same services as banks.

Savings and Loans

Savings and loan associations, also known as S&Ls or thrifts, resemble banks in many respects. Most
consumers don't know the differences between commercial banks and S&Ls. By law, savings and loan
companies must have 65% or more of their lending in residential mortgages, though other types of lending is
allowed.

S&Ls emerged largely in response to the exclusivity of commercial banks. There was a time when banks
would only accept deposits from people of relatively high wealth, with references, and would not lend to
ordinary workers. Savings and loans typically offered lower borrowing rates than commercial banks and
higher interest rates on deposits; the narrower profit margin was a byproduct of the fact that such S&Ls were
privately or mutually owned.

Credit Unions
Credit unions are another alternative to regular commercial banks. Credit unions are almost always organized
as not-for-profit cooperatives. Like banks and S&Ls, credit unions can be chartered at the federal or state
level. Like S&Ls, credit unions typically offer higher rates on deposits and charge lower rates on loans in
comparison to commercial banks.

In exchange for a little added freedom, there is one particular restriction on credit unions; membership is not
open to the public, but rather restricted to a particular membership group. In the past, this has meant that
employees of certain companies, members of certain churches, and so on, were the only ones allowed to join a
credit union. In recent years, though, these restrictions have been eased considerably, very much over the
objections of banks
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Shadow Banks
The housing bubble and subsequent credit crisis brought attention to what is commonly called "the shadow
banking system." This is a collection of investment banks, hedge funds, insurers and other non-bank financial
institutions that replicate some of the activities of regulated banks, but do not operate in the same regulatory
environment.
The shadow banking system funneled a great deal of money into the U.S. residential mortgage market during
the bubble. Insurance companies would buy mortgage bonds from investment banks, which would then use
the proceeds to buy more mortgages, so that they could issue more mortgage bonds. The banks would use the
money obtained from selling mortgages to write still more mortgages.
Many estimates of the size of the shadow banking system suggest that it had grown to match the size of the
traditional U.S. banking system by 2008.
Apart from the absence of regulation and reporting requirements, the nature of the operations within the
shadow banking system created several problems. Specifically, many of these institutions "borrowed short" to
"lend long." In other words, they financed long-term commitments with short-term debt. This left these
institutions very vulnerable to increases in short-term rates and when those rates rose, it forced many
institutions to rush to liquidate investments and make margin calls. Moreover, as these institutions were not
part of the formal banking system, they did not have access to the same emergency funding facilities. (Learn
more in The Rise And Fall Of The Shadow Banking System.)

Money lending in one form or the other has evolved along with the history of the mankind. Even in the
ancient times there are references to the moneylenders. Shakespeare also referred to ‗Shylocks‘ who made
unreasonable demands in case the loans were not repaid in time along with interest. Indian history is also
replete with the instances referring to indigenous money lenders, Sahukars and Zamindars involved in the
business of money lending by mortgaging the landed property of the borrowers. Towards the beginning of the
twentieth century, with the onset of modern industry in the country, the need for government regulated
banking system was felt.
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Modern Day Role
Banking system and the Financial Institutions play very significant role in the economy. First and foremost is
in the form of catering to the need of credit for all the sections of society. The modern economies in the world
have developed primarily by making best use of the credit availability in their systems. An efficient banking
system must cater to the needs of high end investors by making available high amounts of capital for big
projects in the industrial, infrastructure and service sectors. At the same time, the medium and small ventures
must also have credit available to them for new investment and expansion of the existing units. Rural sector in
a country like India can grow only if cheaper credit is available to the farmers for their short and medium term
needs.

Future
Till a few years ago, the government largely patro-nized the small savings schemes in which not only the
interest rates were higher, but the income tax rebates and incentives were also in plenty. The bank deposits, on
the other hand, did not entail such benefits. As a result, the small savings were the first choice of the investors.
But for the last few years the trend has been reversed. The small savings, the bank deposits and the mutual
funds have been brought at par for the purpose of incentives under the income tax. Moreover, the interest rates
in the small savings schemes are no longer higher than those offered by the banks.

Q.4. Eligibility for equity support from the Equity and Entrepreneurship Fund Unit (EEF):
1. The project will have to be a new one and belong to either of the sectors viz., software industry or food
processing and agro-based industry.

2. The sponsors/entrepreneurs applying for EEF support will have to be a private limited company
registered under the Companies Act, 1994 and established old companies can also apply for EEF
support by setting-up a subsidiary new private limited company. But in case of a software company
registered on or after 01 January, 1997 will be treated as a new company.

3. The total project cost ( including net working capital ) of the proposed project will have to be of
minimum 0.50 (half) core for both IT and agro-based industries and that of the maximum is Taka 5.00
Crore for IT& Taka 10.00 Crore for agro –based industries . Project proposal with bank loan is not
allowed for agro –based industries but allowed for IT industries.

4. The project shall have to be viable technically & financially .It should be environment friendly.
Importance shall be given on the appraisal of the entrepreneurship such as educational qualification in
the relevant discipline, knowledge in the technology/ process operating such project, track records in
financial conduct specially with Banks/FI. In case of ratio analysis the project has to offer minimum
IRR (Internal Rate of Return) of 15%, Return on equity (ROE) of 15% Debt service coverage Ratio
1.50:1 Current ratio 1.50:1 and Fixed asset coverage ratio 1.50: 1 and SWOT analysis should have to
be acceptable.4. The project shall have to be viable technically & financially .It should be environment
friendly. Importance shall be given on the appraisal of the entrepreneurship such as educational
qualification in the relevant discipline, knowledge in the technology/ process operating such project,
track records in financial conduct specially with Banks/FI. In case of ratio analysis the project has to
offer minimum IRR (Internal Rate of Return) of 15%, Return on equity (ROE) of 15% Debt service
coverage Ratio 1.50:1 Current ratio 1.50:1 and Fixed asset coverage ratio 1.50: 1 and SWOT analysis
should have to be acceptable.

5. The non-resident Bangladeshis will be given preference subject to the fulfillment of the terms &
conditions mentioned in the above paragraphs.

6. Any defaulter (as defined by Bangladesh Bank) cannot apply for EEF.

7. Where a sponsor of a project needs term-loan and /or working capital loan from any Bank/FI and also
equity support form the EEF, he has to submit application to the Bank/FI concerned. The Bank/FI will
have to be satisfied that the project has fulfilled all the terms and conditions required. Where the
sponsors/entrepreneurs need only equity support from EEF without any bank loan a Bank/FI will be
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nominated as representative of EEF for appraisal of the project by Bangladesh Bank(EEF) . To
nominate such Bank/FI, previous business relationship of entrepreneur with the Bank/FI will be
considered. The concerned Bank (which will also act as monitoring bank) will make thorough
appraisal of the project in accordance with EEF rules and guidelines and if the bank is satisfied about
the viability of the project they shall send the project proposal with specific recommendation to
Bangladesh Bank. The Bank/FI may determine their project examination fee according to their existing
rules. Bangladesh Bank, EEF Unit will re-examine the project appraisal and perform pre-sanction visit
if necessary. Then EEF Unit will place it with specific recommendation before the Technical Advisory
Committee (TAC). TAC is a four member expert Committee under the chairmanship of the Governor
of the Bangladesh Bank. This Committee is the ultimate authority to approve the projects. When a
project is approved by the TAC, EEF Unit will issue a sanction letter to the concerned entrepreneur
instructing them to invest their portion of equity within a certain period of time.

Q. 5. Role of NGO

Non-governmental organizations (NGOs) have played a major role in pushing for sustainable development at
the international level. Campaigning groups have been key drivers of inter-governmental negotiations,
ranging from the regulation of hazardous wastes to a global ban on land mines and the elimination of
slavery.But NGOs are not only focusing their energies on governments and inter-governmental processes.
With the retreat of the state from a number of public functions and regulatory activities, NGOs have begun to
fix their sights on powerful corporations - many of which can rival entire nations in terms of their resources
and influence. Aided by advances in information and communications technology, NGOs have helped to
focus attention on the social and environmental externalities of business activity. Multinational brands have
been acutely susceptible to pressure from activists and from NGOs eager to challenge a company's labour,
environmental or human rights record. Even those businesses that do not specialize in highly visible branded
goods are feeling the pressure, as campaigners develop techniques to target downstream customers and
shareholders. In response to such pressures, many businesses are abandoning their narrow Milton Friedmanite
shareholder theory of value in favour of a broader, stakeholder approach which not only seeks increased share
value, but cares about how this increased value is to be attained. Such a stakeholder approach takes into
account the effects of business activity - not just on shareholders, but on customers, employees, communities
and other interested groups. There are many visible manifestations of this shift. One has been the devotion of
energy and resources by companies to environmental and social affairs. Companies are taking responsibility
for their externalities and reporting on the impact of their activities on a range of stakeholders. Nor are
companies merely reporting; many are striving to design new management structures which integrate
sustainable development concerns into the decision-making process. Much of the credit for creating these
trends can be taken by NGOs. But how should the business world react to NGOs in the future? Should
companies batten down the hatches and gird themselves against attacks from hostile critics? Or should they
hold out hope that NGOs can sometimes be helpful partners? For those businesses willing to engage with the
NGO community, how can they do so? The term NGO may be a ubiquitous term, but it is used to describe a
bewildering array of groups and organizations - from activist groups 'reclaiming the streets' to development
organizations delivering aid and providing essential public services. Other NGOs are research-driven policy
organizations, looking to engage with decision-makers. Still others see themselves as watchdogs, casting a
critical eye over current events. They hail from north and south and from all points in between - with the
contrasting levels of resources which such differences often imply. Some are highly sophisticated, media-
savvy organizations like Friends of the Earth and WWF; others are tiny, grassroots collectives, never destined
to be household names. Although it is often assumed that NGOs are charities or enjoy non-profit status, some
NGOs are profit-making organizations such as cooperatives or groups which lobby on behalf of profit-driven
interests. For example, the World Trade Organization's definition of NGOs is broad enough to include
industry lobby groups such as the Association of Swiss Bankers and the International Chamber of Commerce.
Such a broad definition has its critics. It is more common to define NGOs as those organizations which pursue
some sort of public interest or public good, rather than individual or commercial interests. Even then, the
NGO community remains a diverse constellation. Some groups may pursue a single policy objective - for
example access to AIDS drugs in developing countries or press freedom. Others will pursue more sweeping
policy goals such as poverty eradication or human rights protection.
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Q. 6. What are the assumption of of BEP analysis.
The Break-even Analysis depends on three key assumptions:

Average per-unit sales price (per-unit revenue):

This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get
this number from your Sales Forecast. For non-unit based businesses, make the per-unit revenue $1 and enter
your costs as a percent of a dollar.

Average per-unit cost:

This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what
you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per dollar of
revenue or unit of service delivered, to deliver that service.

Monthly fixed costs:

Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke.
Instead, we recommend that you use your regular running fixed costs, including payroll and normal expenses
(total monthly Operating Expenses). This will give you a better insight on financial realities. If averaging and
estimating is difficult, use your Profit and Loss table to calculate a working fixed cost estimate—it will be a
rough estimate, but it will provide a useful input for a conservative Break-even Analysis.

Q. 7. Methods of BEP

Equation Method:
The equation method centers on the contribution approach to the income statement. The format of this
statement can be expressed in equation form as follows:
Profit = (Sales − Variable expenses) − Fixed expenses

Rearranging this equation slightly yields the following equation, which is widely used in cost volume profit
(CVP) analysis:Sales = Variable expenses + Fixed expenses + Profit

According to the definition of break even point, break even point is the level of sales where profits are zero.
Therefore the break even point can be computed by finding that point where sales just equal the total of the
variable expenses plus fixed expenses and profit is zero.

Contribution Margin Method:

The contribution margin method is actually just a short cut conversion of the equation method already
described. The approach centers on the idea discussed earlier that each unit sold provides a certain amount of
contribution margin that goes toward covering fixed cost. To find out how many units must be sold to break
even, divide the total fixed cost by the unit contribution margin.
This approach is particularly suitable in situations where a company has multiple products lines and wishes to
compute a single break even point for the company as a whole.

Q. 8. Break Even point Analysis and its importance.

Break even point is the level of sales at which profit is zero. According to this definition, at break even point
sales are equal to fixed cost plus variable cost. This concept is further explained by the the following
equation:[Break even sales = fixed cost + variable cost]

The break even point can be calculated using either the equation method or contribution margin method.The
main advantages of break even point analysis is that it explains the relationship between cost, production,
volume and returns. It can be extended to show how changes in fixed cost, variable cost, commodity prices,
revenues will effect profit levels and break even points. Break even analysis is most useful when used with
partial budgeting, capital budgeting techniques. The major benefits to use break even analysis is that it
indicates the lowest amount of business activity necessary to prevent losses.
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Q.9. Capital budgeting techniques.
The Major Capital Budgeting Techniques
A variety of measures have evolved over time to analyze capital budgeting requests. The better methods use
time value of money concepts. Older methods, like the payback period, have the deficiency of not using time
value techniques and will eventually fall by the wayside and be replaced in companies by the newer, superior
methods of evaluation.

1. Payback Period : Alright, let's get this out of the way up front: the Payback Period isn't a very good
method. After all, it doesn't use the time value of money principle, making it the weakest of the methods that
we will discuss here. However, it is still used by a large number of companies, so we'll include it in our list of
popular methods. What is the payback period? By definition, it is the length of time that it takes to recover
your investment.

2. Net Present Value: Using a minimum rate of return known as the hurdle rate, the net present value of an
investment is the present value of the cash inflows minus the present value of the cash outflows. A more
common way of expressing this is to say that the net present value (NPV) is the present value of the benefits
(PVB) minus the present value of the costs (PVC) NPV = PVB - PVC

3. Internal Rate of Return: The Internal Rate of Return (IRR) is the rate of return that an investor can expect
to earn on the investment. Technically, it is the discount rate that causes the present value of the benefits to
equal the present value of the costs. According to surveys of businesses, the IRR method is actually the most
commonly used method for evaluating capital budgeting proposals.

4. Discounted Cash Flow : The discounted cash flow method takes into account the time value of money by
discounting an investment's future return to a present value. The premise of the time value of money is that a
dollar in-hand today is worth more than the same dollar in the future. In more sophisticated capital budgeting
valuations, this discount is taken into consideration when the present value of the future return is assessed
against the present value of the cash outflows on an investment.

Q. 10. What is the purpose of the cash flow statement?

The purpose of the cash flow statement or statement of cash flows is to provide information about a
company‘s gross receipts and gross payments for a specified period of time. The gross receipts and gross
payments will be reported in the cash flow statement according to one of the following classifications:
operating activities, investing activities, and financing activities. The net change from these three
classifications should equal the change in a company‘s cash and cash equivalents during the reporting period.
For instance, the cash flow statement for the calendar year 2010 will report the causes of the change in a
company‘s cash and cash equivalents between its balance sheets of December 31, 2009 and December 31,
2010. In addition to the cash amounts being reported as operating, investing, and financing activities, the cash
flow statement must disclose other information, including the amount of interest paid, the amount of income
taxes paid, and any significant investing and financing activities which did not require the use of cash. The
statement of cash flows is to be distributed along with a company‘s income statement and balance sheet.

Q.11. Define working capital and its significance for a firm.

Net liquid assets computed by deducting current liabilities from current assets. The amount of available
working capital is a measure of a firm's ability to meet its short-term obligations.Sources of working capital
are (1) net income, (2) long-term loans, (3) sale of capital assets, and (4) injection of funds by stockholders.
Ample working capital allows management to take advantage of unexpected opportunities, and to qualify for
bank loans and favorable trade credit terms. In the normal trade cycle of a company, working capital equals
working assets. Also called net current assets. A measure of both a company's efficiency and its short-term
financial health. The working capital ratio is calculated as:
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Positive working capital means that the company is able to pay off its short-term
liabilities. Negative working capital means that a company currently is unable to meet its short-term liabilities
with its current assets (cash, accounts receivable and inventory). Also known as "net working capital", or the
"working capital ratio". If a company's current assets do not exceed its current liabilities, then it may run into
trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working
capital ratio over a longer time period could also be a red flag that warrants further analysis. For example, it
could be that the company's sales volumes are decreasing and, as a result, its accounts receivables number
continues to get smaller and smaller.

Working capital also gives investors an idea of the company's underlying operational efficiency. Money that
is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the
company's obligations. So, if a company is not operating in the most efficient manner (slow collection), it will
show up as an increase in the working capital. This can be seen by comparing the working capital from one
period to another; slow collection may signal an underlying problem in the company's operations.

Importance of Working Capital: Working capital is very important concept in finance.

Working capital represents the funds available with the company for day to day operations. working capital
finances the cash conversion cycle. company cannot survive with negative working capital which represents
that the company has no funds for day to day operations Essentially working capital is the answer to the
question: "How much short term funding do you need to operate this business?". Short term funding is
important because, with long term funding already in place, the business still needs short term funding to
operate. Without the short term funding, the business will go bankrupt. Another concept is net working capital
which means surpuls of current assets over current liablities. a positive NWC is good for a company.

Q.12. Project appraisal

Meaning and definition

•Assessment of a project in terms of its economic, socialand financial viability•A lending financial institution
makes an independentand objective assessment of various aspects of aninvestment proposition

•It is defined as taking a second look critically andcarefully at a project by a person who is in no wayinvolved
or connected with its preparation. He is able totake independent, dispassionate and objective view of the
project in totality, along with its variouscomponents.
Steps for project appraisal/Aspectsof project appraisal

•Economic Aspects•Technical Aspects•Organisational Aspects•Managerial Aspects•Financial

Aspects•Market/Commercial Aspects

Economic Aspects
•Analyses if the benefits will justify the projectcost/investment done•A successful project gives following
benefits:
–Increased output–Enhanced services–Increased employment–Larger government revenue–Higher earnings–
Higher standard of living–Increased national income–Improved income distribution
Technical Aspects

•Site and Location: RM supply, proximity to markets,transportation facility, power supply, manpower,
water,government policies, labour laws, climate, taxes•Size of plant/scale of operations: Technological
capacityis standardised for achieving economies of scale, lowdemand or less resource availability result in
economiesof scale•Technical feasibility: Technology selected, availability of infrastructure, plant layout,
project implementationschedules etc

Organisational Aspects
•Organisation structure, recruitment and training aspectsare studies•Appraisal done to see if project is
adequately staffed,initial recruitment is done.
Managerial Aspects
 11
•Financial institutions check if promoters are competentand have business sense•They can appoint nominee
directors on board•The Companies Act and Industries Act empowergovernment to exercise control over
management•They can also take over the management in case it isneeded.
Financial Aspects
•Cost analysis: Finding out the cost of production•Pricing: Deciding price of the product after
consideringdemand, profit and competition•Financing: Raising funds and efficient use of the same•Income
and Expenditure: Concerned with predictingprofit and costs involved

Market/Commercial Aspects
•Analysis of market opportunities•Specification of marketing objectives•Planning and organising of
marketing process•Controlling of implementation of marketing plan.

Q.13. Essentials of Business Plans.

When you're about to embark on developing a business plan, remember this: Form follows function, so you
want a plan that fits your exact business needs. The emphasis should change depending on whether it's a plan
for starting a company, raising investment money, supporting a business loan or managing an existing
business. In most cases, your plan will be a 20- to 30-page document written in simple business language so
it's easy to read with the main points highlighted and lots of bullets, and some tables and charts to highlight
the most important financial projections. A standard plan includes seven sections:

1. The Executive Summary. Write this summary last, and make sure it contains the highlights of your plan.
Assume your most important readers will read only this section.

2. The Company. A plan for a startup describes your strategy for creating the legal entity and how the initial
ownership will be divided among the founders. It should also include a table that lists startup costs and initial
funding. A plan for an ongoing or already existing company should describe the legal form of the business,
the company history and the business's past performance.

3. What You Sell. Describe the products or services you offer. Emphasize why buyers purchase those things,
what benefits they get, and what pain points they have before they buy. Show how much it costs to deliver
what you're selling.

4. Your Market. Describe your target market, including market demographics, market growth and trends.
Include a table that shows a market forecast. Describe the nature of your industry and the competition you
have.

5. Strategy and Implementation. Strategy is all about focus. So focus on certain target market segments,
certain products or services, and specific distribution avenues. Forecast your sales and the cost of sales.
Define your milestones with dates, budgets and specific responsibilities.

6. Management Team. Name and describe the key members on your team. Include a table that shows
personnel costs. List the gaps in the management team--if any--and show how they're being addressed.

7. Financial Projections. Describe your financial strategy and how it supports your projected growth. Include
a break-even analysis that shows risk as a matter of fixed vs. variable costs. Include projected profit or loss,
cash flow and balance sheets.

1. Specific milestones, with deadline dates, spending budgets and a list of the people responsible for
them. I've seen this called "weaving a MAT," with MAT standing for "milestones, assumptions and tasks."
That normally goes into Section 5, Strategy and Implementation. Make the responsibilities specific for
specific people, and make sure every task gets assigned to a single person with a name and a face. This
section must describe how these different milestones are going to be tracked and measured.
 12
2. Real cash flow. Your plan should show cash flow--either projected or actual or both--month by month
for at least 12 months. Show where you're getting money and how much, and show what you're spending the
money on. This is cash flow, not just profit and loss, and you have to understand how different cash flow is
from profits. Profitable companies go under all the time, but companies with positive cash flow can pay their
bills.

3. Focus. A business plan should establish your company's priorities. Don't try to do everything, and don't try
to please everybody.

Q. 14. Asset based financing.

A specialized method of providing structured working capital and term loans that are secured by accounts
receivable, inventory, machinery, equipment and/or real estate. This type of funding is great for startup
companies, refinancing existing loans, financing growth, mergers and acquisitions, and management buy-outs
(MBOs) and buy-ins (MBIs). An example of asset-based finance would be purchase order financing; this
may be attractive to a company that has stretched its credit limits with vendors and has reached its lending
capacity at the bank. The inability to finance raw materials to fill all orders would leave a company operating
under capacity. The asset-based lender finances the purchase of the raw material, and the purchase orders are
then assigned to the lender. After the orders are filled, payment is made to the lender, and the lender then
deducts its cost and fees and remits the balance to the company. The disadvantage of this type of financing,
however, is the high interest typically charged - which can be as high as prime plus 10%. In the simplest
meaning, asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid,
the asset is taken. In this sense, a mortgage is an example of an asset-backed loan. More commonly however,
the phrase is used to describe lending to business and large corporations using assets not normally used in
other loans. Typically, these loans are tied to inventory, accounts receivable, machinery and equipment. This
type of lending is usually done when the normal routes of raising funds, such as the capital markets (selling
bonds to investors) or normal unsecured or mortgage secured bank lending is not possible. This is usually
because the company was unable to raise capital in the normal marketplace or needs more immediate capital
for project financing needs (such as inventory purchases, mergers, acquisitions and debt purchasing). It is
usually accompanied by higher interest rates, and can be very lucrative for the parent company. For example,
the bank Wells Fargo made more money from asset-based lending business than it did the rest of its corporate
business (both lending and fee based services). Many financial services companies now use asset-based
lending package of structured and leveraged financial services. Most banks, both national investment banks
(Goldman Sachs, RBC) and conglomerates (i.e. Citigroup, Wells Fargo), along with regional banks, offer
these services to corporate clients.

Q. 15. Factoring.

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third
party (called a factor) at a discount. In "advance" factoring, the factor provides financing to the seller of the
accounts in the form of a cash "advance," often 70-85% of the purchase price of the accounts, with the
balance of the purchase price being paid, net of the factor's discount fee (commission) and other charges, upon
collection from the account client. In "maturity" factoring, the factor makes no advance on the purchased
accounts; rather, the purchase price is paid on or about the average maturity date of the accounts being
purchased in the batch. Factoring differs from a bank loan in several ways. The emphasis is on the value of
the receivables (essentially a financial asset), whereas a bank focuses more on the value of the borrower's total
assets, and often also considers, in underwriting the loan, the value attributable to non-accounts collateral
owned by the borrower. Such collateral includes inventory, equipment, and real property,[1][2] That is, a bank
loan issuer looks beyond the credit-worthiness of the firm's accounts receivables and of the account debtors
(obligors) thereon. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable).
Third, a nonrecourse factor assumes the "credit risk", that a purchased account will not collect due solely to
the financial inability of account debtor to pay. In the United States, if the factor does not assume credit risk
on the purchased accounts, in most cases a court will recharacterize the transaction as a secured loan.
 13
Q.16. Leasing
Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series
of contractual, periodic, tax deductible payments. The lessee is the receiver of the services or the assets under
the lease contract and the lessor is the owner of the assets. The relationship between the tenant and the
landlord is called a tenancy, and can be for a fixed or an indefinite period of time (called the term of the
lease). The consideration for the lease is called rent. A gross lease is when the tenant pays a flat rental amount
and the landlord pays for all property charges regularly incurred by the ownership from lawnmowers and
washing machines to handbags and jewellry.[1]
Under normal circumstances, a freehold owner of property is at liberty to do what they want with their
property, including destroy it or hand over possession of the property to a tenant. However, if the owner has
surrendered possession to another (the tenant) then any interference with the quiet enjoyment of the property
by the tenant in lawful possession is unlawful.
Similar principles apply to real property as well as to personal property, though the terminology would be
different. Similar principles apply to sub-leasing, that is the leasing by a tenant in possession to a sub-tenant.
The right to sub-lease can be expressly prohibited by the main lease.

Q. 17. Documentation and creation of charges on securities.

CHARGING OF SECURITIES AND DOCUMENTATION

Security for bank advance has no doubt been reduced to secondary importance in the present context
particularly for priority sector advances but it is still very important to influence the decision of banks in
conventional advances. Reserve Bank of India has also stipulated certain quantitative restrictions on the
banks' power to grant clean advances. Banks have prescribed their own formats for documentation for various
types of advances and the borrowers in almost all the cases have to execute those documents without any
choice. It would never be advantageous to know the general characteristics of securities, methods of their
charging and documentation procedures adopted by the banks.
The securities may primarily be divided in two categories as under
 Primary security.

Collateral security.

The assets created by the borrower from the credit facilities granted by the bank form the primary security for
the bank advance as a matter of rule. The bank invariably obtains a charge over those assets. Similarly, other
assets on which the advance is primarily based even if it is not created from the credit facilities granted by the
bank will also be taken as primary security. In some cases where primary security is not considered adequate
or the charge on the security is open the bank may insist on an additional security to collaterally secure
advances granted by it. Such securities are termed as collateral securities. Collateral security may either be
tangible or third party guarantees may also be accepted. Bank now grant need based advance after proper
assessment and should not normally insist for collateral security in most of the cases.1bip matter needs to be
discussed at die time of sanctioning of limits. Reserve Bank, of India has advised the banks not to obtain any
collateral security in case of all priority sector advances upto Rs. 25,000. In other cases, it is left to the mutual
agreement of the borrower with the bank.

BASIC CHARACTERISTICS OF SECURITIES AND CONCEPT OF MARGIN

The securities acceptable to banks either as primary or collateral must have certain, basic characteristics as
under:

 Ascertainment of value. A security will be considered good and will be acceptable to the bank only if its
value can be ascertained with a definite degree of correctness. Certain articles may be valuable but may not be
accepted as security if the value cannot be ascertained such as paintings/antiques etc.

 Marketability. A good security must have a ready market. Raw materials, articles of necessity, other
primary commodities are easily marketable and are considered good security. Semi-finished goods may be
more valuable than raw material for the borrower but may not be marketable at all and will thus be considered
inferior to raw material in as much as its acceptance as a security is concerned.
 14
 Stability in value. A good security should have a stable value over along period. If the value of a
security fluctuates violently over a short period, it may not be considered a good security and may be accepted
by the bank only after keeping a very high margin.

 Ascertainment of title and transferability. An asset can be accepted as security by the bank only when
the title over that asset can be ascertained. Furthermore, the title should be easily transferable. The purpose of
obtaining a security is to apply the sale proceeds of the security if the customer fails to repay the advance. But
if the security is not easily transferable the very purpose of obtaining a security may be defeated. Immovable
property located at a prime location may be very stable in value has a ready market and the value can also be
ascertained but may still not be considered as a good security due to difficulty in ascertaining the title and
elaborate legal process involved for effecting its sale through a court of law.

 Durability. The security accepted by the Bank must be durable. No bank advance is granted against
perishable commodities.

 In case loan or advances to Muslims offering their property as primary or collateral security, it should be
ensured, before accepting property as security that such property has not been alienated under the Muslim
Law like 'waqf-ul-ulad' and/or 'Haq-rnehr' in favour of their wives or for the benefit of their heirs since it will
jeopardise the interest of the banker as lender.

TYPES OF CHARGES
Security is obtained by the bank as an additional cover against default by the borrower in repayment of bank's
dues. Charging of security means making such security available to the bank and involves certain formalities.
Charging should be legal and perfect so that it is possible to realise the security if such a need arises. There
are six different modes of charging a security as under:
 Pledge. Pledge is bailment of goods by the debtor to the creditor with an intention to create a charge
thereon as security for the debt. It has a legal backing as per the Indian Contract Act, 1872 wherein the
definition of pledge and bailment and also the rights and liabilities of all the parties to pledge have been
clearly spelt out. Important conditions to be complied with for constitution of a valid pledge are:

There should be bailment of goods which implies that goods should be delivered the debtor
(pledger) to the creditor (pledgee). The delivery may nevertheless be actual physical delivery or constructive
delivery as in case of documents of title to goods.

The bailment must be by the debtor or on behalf of the debtor.

The delivery of goods must be with an intention of the parties to create security for die debt or
performance of a promise.
In pledge the ownership of the goods remain with the borrower whereas physical control over these goods
will be exercised by the bank. The borrower has a right to get the goods returned to him after payment of debt
created here against. In case of default by die borrower the bank can sell the goods after giving a reasonable
notice of sale as required under Section 176 of the Indian Contract Act,1872. Notice must clearly indicate the
intention of the pledgee to sell the security and is compulsory before the sale can be effected. If the bank
realises more than its dues by such sale, the excess realised will have to be returned to the borrower. However,
if there is any shortfall, die bank can proceed against the borrower in a court of law for recovery of the
balance.

 Hypothecation. Pledge takes away control over the goods from the borrower which may not be
practicable as the borrower would require certain goods under his control to continue its manufacturing and/or
trading activities. An equitable charge in favour of the bank over the goods is created in such cases without
parting with the possession of the goods. A charge on a property for a debt where neither ownership nor
possession is passed on to the creditor is known as ‗hypothecation charge‘ Hypothecation agreements
obtained by banks generally have a clause under which hypothecation can be converted into a pledge at, a
later date.
 15
Assignment. Assignment means transfer of a right, property or debt by one person to another person.
The person transferring the right is known as assignor and the person to whom the right is transferred is
known as assignee. The assignment may be legal in which case the assignor must give a written notice of the
assignment stating the name and address of the assignee to the debtor or may he equitable where no such
notice is sent. This form of charge is generally adopted for charging of book debts, monies due from
Government (supply bills) and life insurance policies etc. Banks generally go in for legal assignment and
insist for obtaining an acknowledgement of assignment from the debtor.

 Mortgage. Mortgage is a mode of charge associated with immovable property. Immovable property has
been defined by Section 3(26) of General Clauses Act, 1887 as under:
Immovable property shall include land, benefits to arise out of land and things attached to the earth or
permanently fastened to anything attached to the earth".
Section 4 of General Clauses Act, 1887 further provides that the above definition of immovable property shall
hold good under the Transfer of Property Act, 1882 as well.
Section 3 of Transfer of Property Act, 1882 provides that immovable property does not include standing
timber, growing crops or grass. It also provides explanation to the term "attached to the earth" which means:

(a) rooted in the earth, as in case of trees and shrubs,

(b) imbedded in the earth, as in case of walls or buildings, or
(c) attached to what is so imbedded for the permanent enjoyment of that to which it is attached.
Immovable property' includes land, buildings, hereditary allowances, rights to ways, lights, ferries, fisheries
or any other benefit to arise out of land and things attached to the earth or permanently fastened to anything
which is attached to the earth but not standing timber, growing crops nor grass".

Mortgage by deposit of title deeds or equitable mortgage. Section 58(f) of the Transfer of Property Act,
1882 defines equitable mortgage as mortgage created by depositing title deeds of an immovable property to
secure a debt, existing or future. Three basic conditions to constitute a valid equitable mortgage are
(i) Delivery of title deeds (original) by the mortgagor to the bank.
(ii) Existence of a debt, existing or future.
(iii) Intention of the mortgagor to create a mortgage on that property to secure the debt.
No equitable mortgage can be created if any of the above three conditions' is not complied with.
This form of mortgage is very popular because it does not require finalisation of any mortgage deed and its
subsequent registration which requires payment of heavy stamp duty. Mortgage is created simply by
depositing the title deeds with the bank with an intention to create a security and no other agreement etc. is
strictly required. Equitable mortgage can, however, be created only at places as notified by government in this
regard.
Simple Mortgage. Section 58(b) of Transfer of Property Act, 1882 relates to simple mortgage in which the
mortgagor personally binds himself to pay the debt and agrees that in the event of non-payment by him, the
mortgager may cause the mortgaged property to be sold and the proceeds of sale be applied in repayment of
debt. The possession of mortgaged property, however, still remains with the mortgagor. The mortgagee does
not have an absolute right to sell the property in case of default but has to seek intervention of the court.
A formal mortgage deed will have to be executed for creation of a simple mortgage which will also be
required to be registered after payment of necessary stamp duty which is quite substantial and in all the cases
will have to be borne by the borrower. All efforts should, therefore, be made to convince the bank to accept
equitable mortgage. Simple mortgage may be resorted to only when equitable mortgage cannot be created as
in cases where title deeds are not available,
 Lien. Lien means the right of the creditor to retain the goods or securities of the debtor, which are in his
possession until the debt due from the debtor is paid. It does not require any specific agreement to support this
right. The lien may be general which confers the right to retain any goods for a general balance of account or
it may be particular lien where goods can be retained by the creditor for a particular debt only. The person
exercising general lien has only a right to retain the goods till the dues are paid and may not be able to sell
those goods.
The right of the banks to general lien is however, considered on a different footing and banks have a general
lien on all securities deposited with them as bankers by a customer, unless there be an express contract or
circumstances that show an implied contract, inconsistent with lien. A banker‘s lien is thus more than a
 16
general lien, it is an implied pledge. The bank, therefore, has a right to sell the goods in his possession after
giving a reasonable notice. The lien can be exercised on bills and cheque deposited for collection, dividend
warrants received by the banker as a mandatee from the customer, securities left with the banker after a
particular loan has been paid. The bankers lien however, does not extend to:
(i) Securities or valuables lying in the locker rented to the customer.
(ii) Securities deposited upon a particular trust.
(iii) Securities deposited to secure a specific loan.
(iv) Securities left with the banks after an advance against them has been adjusted.
(v) Securities left inadvertently with the bank.
No specific letter of lien agreement is necessary as the banks enjoy the right of lien under the Contract Act.
However, in some cases the bank may obtain a specific letter of lien so that the borrower is not able to
contend later that the securities were deposited by him for a specific purpose inconsistent with the lien.
Negative Lien
The borrower may sometime be having non-encumbered assets which are not charged to the bank as security.
The borrower is thus free to deal with these assets and may even sell them if he so desires. To restrict this
right of the borrower, bank may sometimes request him to give an undertaking to the effect that he will
neither create any encumbrance on these assets nor sell them without the previous permission of the bank so
long as the advance continues. This type of an undertaking obtained by the bank is known as 'Negative Lien'.
Negative lien is in the form of a personal assurance or undertaking which has binding effect but confers no
right on the bank to proceed against the property itself and thus creates no encumbrance or charge on the
property.
 Set Off. Set off is the right of combining of accounts between a debtor and a creditor so as to
arrive at a net balance payable to one or the other. Set off in relation to bank means his right to apply the
credit balance in customer's account towards liquidation of debit balance in another account of the customer
provided both the accounts are maintained by him in the same capacity. The right may not be considered as
absolute and the bank may be required to give a notice for exercising his right of set off. The right of set off
can be applied by the bank only if the following conditions are met:
(a) The liability of the borrower is for a sum which is certain,
(b) The repayment of debt is due, and
(c) Both the accounts are held by the customer in the same capacity.
The right of set off should, however, not be exercised arbitrarily and a notice for combining the accounts must
invariably be served by the bank on the customer.

DIFFERENT TYPES OF BORROWERS/EXECUTION OF DOCUMENTS

Banks generally grant advance to persons having legal capacity to enter into a contract.
Minors/lunatics/drunken persons etc. who cannot enter into a valid contract may not be favoured as borrowers
and no credit facilities may be sanctioned to such persons.
The borrowers may have different constitution conferring on themselves various legal rights and
responsibilities and banks as creditors will be interested to know the exact constitution of the borrower. Banks
may also require additional undertakings information in some cases. This information is very essential for the
banks while getting the documents executed from the borrowers. The documents can be executed only by the
persons who can validly bind the borrower. The position regarding obtaining of undertaking/information may
differ from bank to bank. Chart given on the next page gives details of various types of borrowers, the
additional undertakings required by banks and the persons who are authorised to execute the documents
which is based upon the common practice of most of the banks.
S.NO. Constitution of Additional papers required Persons authorised to execute
the document
Borrower
1. Individual ---- Individual in his personal capacity
2. Joint ---- All the borrowers in their personal
capacity binding themselves jointly
and severally.
3. Sole Declaration regarding his sole Sole proprietor in his capacity as sole
Proprietorship interest in the proprietor. He is, however, personally
 17
business. liable for all the dealings and
obligations in the name of business.
4. Joint Hindu 1. Letter of Joint Hindu Family All documents to be signed by Karta of
Family giving details of all the male HUF and all major coparceners in their
members including capacity as Karta & coparceners and
minors also in their individual capacity.
2. Declaration to the effect that
the advances will be utilised
only for the family business to be
signed
by Karta & all other major
coparceners.
5. Trusts 1. Copy of trust deed. All the trustees in their representative
2. Legal opinion regarding the capacity or as per trust deed and
power of trustee to supported by the legal opinion.
borrow.

6. Partnership firm 1. Copy of partnership deed. All partners in their representative

2. Declaration from all partners capacity i.e. as partner and also in their
to inform the bank of individual capacity.
any change in constitution.
7. Limited 1. Articles and Memorandum Documents to be signed by authorised
Companies Association persons in terms of board resolution in
2. Copy of Certificate of their representative capacity. The
incorporation. common seal of die company is also
3.Copy of Certificate of required to be affixed wherever
commencement of business necessary.
(only in case of public limited The charge created by the company
companies) over its assets will also require
4.Copy of Board Resolution registration under Section 125 of
empowering the company to Companies Act, 1956.
borrow from the bank and also
authorising managing
director/ directors/other
officers to execute the documents
as required by the bank.
5.Copy of the resolution of
general body meeting of the
company under Section 293 (1)
(D) authorising the company to
borrow in excess of its own paid
up capital and free reserve.
6.Declaration from the company
that borrowings will remain
within the powers conferred on it
as in (5) above

DOCUMENTATION
Banks have their own standard forms for promissory notes and other documents and no deviations are
normally permitted. The borrowers are expected to execute these documents as required by the bank. Banks
also do not generally give copies of these documents to the borrower which sometimes creates difficulty when
these documents become subject matter of a legal dispute. The following points must be kept in mind while
executing the documents as required by the Bank.
Precautions while executing loan documents
 18
The following are the precautions, in nutshell, which should be taken care of both by the borrower as well
as banker, at the time of preparation, execution and registration of loan documents etc.:
(a) Person, executing the loan documents must be competent to enter into a contract i.e., he or she should
have contractual capacity. Thus, minor, insolvent person, lunatic etc. are not competent persons to execute
documents.
(b) The loan documents should bear proper type of stamps i.e. adhesive, embossed etc. Further value of
stamp duty should be adequate, keeping in view the laws of the State in which the documents are executed.
The Non-Judicial Stamp papers, if used, should bear the date, prior to its execution and also the date should
not be earlier than six months. The text of the agreement may be written on the Stamp papers itself and plain
papers (additional sheets) may be used, if required in addition to Stamp papers.
(c) No column of the loan documents should be left blank. While executing the documents, the borrower
must sign in full and in the same flow in which his signatures are available in the bank. The cuttings & over
writings must be avoided and if at all, they become unavoidable, they should be authenticated by the
borrowers by signing in full.
(d) Sometimes the borrower does not understand the language of the loan documents. In such a case, a
separate letter, in the language of the borrower should he taken from him stating that the contents of the loan
documents have been well understood by him, including the terms and conditions of the loan sanctioned. The
letter should be got witnessed by another person.
(e) In the case of an illiterate borrower who puts his thumb impression on the loan documents, the bank
official in whose presence the documents are executed, should give a certificate on a separate paper that the
contents have been fully explained to the borrower in a language which he speaks and understands. This
certificate should be got witnessed by independent persons.
(f) Similarly, in case of a blind person, such a certificate should be obtained from lawyer or notary public
in whose presence the borrower executes documents.
(g) In case the borrowers reside at different places, the loan documents should he got executed through
the branches of the bank situated at those stations, after properly verifying the identity of the borrowers. As
regards stamp duty, it should be according to the state which attracts highest value of stamp duty. The
borrowers while signing the documents must put date and place of execution after their signatures.
(h) In the case of a partnership firm where a minor is admitted as partner to the benefits of partnership, he
should not be allowed to execute any loan document. This is so because a creditor i.e. lending banker cannot
proceed against the minor in person. However, minor's share in the firm can be proceeded against, as the
major partners of the firm have executed loan documents, thereby binding each other by their act of
execution. After the minor attains majority and elects to remain as partner in the firm, the bank should
proceed to obtain an undertaking from him stating that he (minor attaining majority) stands fully liable for the
dues of the bank against the partnership firm.
(i) Sometimes loan documents are executed by the holder of power of Attorney on behalf of a trading
concern, partnership firm, Hindu undivided family (HUF), company, individual etc. In such a case, a notice
should be sent to the principal, stating that the attorney has executed the documents on their behalf. A
certified copy of Power of Attorney should be kept along with main loan documents. And also the
letter/confirmation received from the principal in this regard, in response to the notice should be preserved.
(j) The borrowers must obtain a copy of the sanction and ensure that documents only for those facilities
which are sanctioned in their favour are executed.
(k) All the documents must be completely filled in before their execution.
(l) The guarantee form should be executed if so agreed and stipulated as a term of sanction.
(m) Copies of all the documents executed must be obtained and kept on record for any future reference.

Q.18. Non-performing loan

A sum of borrowed money upon which the debtor has not made his or her scheduled payments for at least 90
days. A nonperforming loan is either in default or close to being in default. Once a loan is nonperforming, the
odds that it will be repaid in full are considered to be substantially lower. If the debtor starts making payments
again on a nonperforming loan, it becomes a reperforming loan, even if the debtor has not caught up on all the
missed payments. Institutions holding nonperforming loans in their portfolios may choose to sell them to
other investors in order to get rid of risky assets and clean up their balance sheets. Sales of nonperforming
loans must be carefully considered since they can have numerous financial implications, including affecting
the company's profit and loss, and tax situations.
 19
A Non-performing loan is a loan that is in default or close to being in default. Many loans become non-
performing after being in default for 90 days, but this can depend on the contract terms.
―A loan is nonperforming when payments of interest and principal are past due by 90 days or more, or at least
90 days of interest payments have been capitalized, refinanced or delayed by agreement, or payments are less
than 90 days overdue, but there are other good reasons to doubt that payments will be made in full‖
(International Monetary Fund).[citation needed]
By Bank regulatory definition[citation needed] non-performing loans consist of:
other real estate owned which is taken by foreclosure or a deed in lieu of foreclosure,
loans that are 90 days or more past due and still accruing interest, and
loans which have been placed on nonaccrual (i.e., loans for which interest is no longer accrued and posted to
the income statement).
 20
01. Define SME?

Definition of SME:
Existing definition of SME is recommended by Better Business Forum and accepted as a uniform one by Ministry
of Industry and Bangladesh Bank.

According to the Industrial policy 2005, SME definition has been in terms of fixed assets and no. of employees of
three major sectors: service, manufacturing and trading but the present definition which was recommended by
Better Business Forum and accepted as a uniform one by Ministry of Industry and Bangladesh Bank included
Cottage and micro industry as SME in Bangladesh. Bangladesh Bank has revised the SME definition through its
ACSPD Circular No.08, dated 26th May, 2008 and then through its SMESPD Circular No.01, dated 19th June,
2011. The present SME definition is given below:

Medium Industry /Enterprise

Total Fixed Asset (in Lac
Sector No. of Employees
Tk.)
Service / Others Concern : 100-1500 50-100
Trading Concern: 100-1500 50-100
Manufacturing Concern: 1000-3000 100-250
Small Industry / Enterprise
Service/Others Concern : 5-100 10-25
Trading Concern: 5-100 10-25
Manufacturing Concern: 50-1000 25-99
Micro Industry /Enterprise
Service/Others Concern : Less than 5.00 Less than 10
Trading Concern: Less than 5.00 Less than 10
Manufacturing Concern: 5.00-50.00 10 - 24
Cottage Industry / Enterprise
Family Concern Less than 5.00 Less than 10
* Total Fixed Asset is excluding land and building but including replacement value.
 21

02. SME is considered as employment Generating Machine- Explain?

SME is considered as employment Generating Machine for the following reason:

 SME sector is the largest provider of employment in most countries, especially of new jobs.
 SMEs tend to employ poor and low -income Workers.
 SMEs are sometimes the only source of employment in poor regions and rural areas.
 There are approximately six million SMEs in Bangladesh, which include enterprises with up to 100
workers employing a total of 31 million people – equivalent to 40 per cent of the population of Bangladesh
aged 15 years and above.
 SME has huge Employment generation potential due to labor intensive nature of most of the SME
activities. Between 1986 and 2006, the labor force grew by nearly 3 percent while employment grew by
2.6 percent. In the small enterprises, employment grew by 4.8 percent during 1978-1991 and by 5.5
percent during 1991-2001. Employment growth in the medium enterprises is estimated at 9.6 percent
during 1988-2003. SEDF reports that between 80 percent and 85 percent of the total industrial employment
and 23 percent of the country‘s overall employment is accounted for by the SMEs.

03. How would you identify and select entrepreneurs for financing SME projects? Discuss.

Entrepreneurs are those persons (business owners) who seek to generate value, through the creation or expansion
of economic activity, by identifying and exploiting new products, processes or markets. A desire for independence
and a strong sense of initiative are usually characteristics of a successful entrepreneur. They have the following
characteristics:

 They are dedicated to their workings.

 They have Entrepreneurial Personality
 They have basic business competency, industry specific knowledge.
 They desire to win and succeed coupled with vision
 They are the creative type.
 They take risks and succeed. Risk involves looking into the future and believing that there is a probability
of the occurrence of certain events. And on this basis a decision is taken to do or not to do something.
 Successful entrepreneurs react quickly to change.

There are many types of entrepreneurs like Spiral (Helical) entrepreneurs, Occasional entrepreneurs, Habitual
entrepreneurs, Growth entrepreneurs etc. We need to select true entrepreneurs by their characteristics. We can say,
the characteristics which are discussed above are considerable to select entrepreneurs for financing SME projects.
 22

04. Discuss the roll of SMEs in the economic development of Bangladesh.

Small & Medium Enterprise (SME) plays a pivotal role in the economic growth and development of Bangladesh.
Actually, SME works as the platform for job creation, income generation, and development of forward and
backward industrial linkages and fulfillment of local social needs. SMEs occupy a unique position in the economy
of Bangladesh. Mainly private sector development depends on them.

In view of present economic development effort in Bangladesh the SME sector plays an important role. These are
reflected in the following performance /activities of this sector:
 SME contributions to value addition in manufacturing is in the range of 20 to 25 percent of GDP
 There are approximately six million SMEs, which include enterprises with up to 100 workers employing a
total of 31 million people – equivalent to 40 per cent of the population of our country aged 15 years and
above. Some private survey also found that the industrial structure of SMEs consisted of primarily
wholesale, retail trade and repairs (40 per cent), agricultural goods (22 per cent), services (15 per cent) and
manufacturing (14 per cent).
 During the Fourth Five year plan, a total of 0.35 million jobs were created against the target of 0.4 million.
 SME sector help alleviate poverty, increase income level of rural people and promote agro-industrial
linkage in Bangladesh.
 SME sector requires lower energy supply, lower infrastructure facilities and this sector imposes less
environmental risk.
 They contribute towards better utilization of local resources and skills that might otherwise remain
unutilized.
 Small industries being labor oriented are capable of generating more employment.
 They are necessary to maintain and retain traditional skills and handicrafts.
 They are the only medium for diversification of rural economy and for peaceful and concurrent socio-
economic development of all classes of people

To put it simply, SMEs are the heart of the industrial sector of the country, employs the bulk of the working
population and are owned by Bangladeshi entrepreneurs. They provide a huge range of goods and services to the
Bangladeshi population, especially in the rural areas, alongside providing vital support in the production chain to
large industries. From the above discussion, we can say that SMEs are playing an important role in our economy in
various ways.
 23

05. Discuss the main constraints to the growth of SME finance in Bangladesh?

The main Barriers / Constraints to the promotion of the SME Sector in Bangladesh are:
Lack of capital support: A majority of our small and medium industry entrepreneurs belong to the lower class or
lower middle class. They are hard workers, innovators, and-challenge-takers, but cannot get funding from
commercial banks due to their inability to provide collaterals.

Absence of policy for transfer of modern technology: The sector is suffering from lack of technological support
for upgrading the product quality.

Unavailability of appropriate infrastructure facilities: An Infrastructure facility as water, electricity and gas
hampers industrial activities.

Lack of marketing opportunities: SME sector includes a wide range of small and medium industries, but they do
not have marketing knowledge and capability to promote their products.

Inadequate policy reforms: Till now, do not have uniform definition of SME. The Bangladesh Bank, Bureau of
Statistics, and SME Foundation have different definitions of SMEs. Government may take necessary initiatives to
make it uniform.

Lack of exposure to international markets: Our SME sector is producing handicrafts and decorative and
household items having high demand in the developed market, but having the demand women entrepreneurs are
unable to attend international markets due lack of exposure and promotion.

Law and order situation: The members of the business community, especially those involved in the SME sector,
suffer because of the law and order situation

Illegal imports and non-tariff barriers: Both illegal import and non-tariff barriers are threats to our SME sector.
If banned products are smuggled into the country domestic production will be harmed. Our SME products are
facing many non-tariff barriers in different markets.

Lack of adequate investments:

High rate of interest on bank loans:

Inadequate availability of raw materials:

Fierce competition:

Lack of skilled technicians and workers:

Lack of research and development facilities:

 24

06. What are the existing sources and areas of SME Financing in Bangladesh?

Existing Sources of SME Financing:

The main sources of SME Financing are basically personal funds, family and friends, banks and NBFIs. Some
refinance Schemes from different organization are also available. These are discussing below:

SME Financing by Banks & NBFI: An important element of SME finance is not directly provided by banks
through traditional loans but rather by leasing or factoring companies. Bank loans and overdrafts are the most
widespread debt financing tools for SMEs, but also those alternative sources like leasing and factoring are of high
relevance.

The EEF: The Government had instituted the Equity Entrepreneurship Fund (EEF) in early 2002 in an effort to
make funding more widely available for agro-processing and information technology businesses in the country.

Small Enterprise Fund (SEF): Small Enterprise Fund (SEF), a scheme to refinance banks and other financing
institutions that lend to the SME sector create a capacity to specifically channel needed debt-finance.
Disbursements made by financial institutions and leasing companies into small-enterprises will be refinanced from
the proceeds of the SEF.

ADB Fund: The Small and Medium Enterprise Sector Development Program (SMESDP), which is financially
assisted by The Asian Development Bank, Manila and implemented by the Ministry of Industries, Govt. of
Bangladesh introduce a fund for SME entrepreneurs by Banks & NBFI.

Other Refinance Scheme:

1. Bangladesh Bank Fund:
2. EGBMP (IDA) Fund:
3. Japan International Cooperation Agency (JICA) Fund
The areas of SME Financing in Bangladesh:
 Agro Process, agro-based and agro supportive
industries.
 Handicrafts & other Cottage industries
 Computer software and ICT
 Plastic & Other Synthetics
 Poultry & cattle
 Jute goods (with renewed vigor)
 Electronics and Electrical appliance
 Leather and leather goods
 Pottery
 Light engineering
 Textile, RMG, Knitwear etc.
 Educational Services
 Health Care & Diagnostics Centers
 Pharmaceuticals/Cosmetics/Toiletries
 Event Management
 Internet Service Providers
 25

07. Discuss the roll of SME foundation in SME Development in the country.
Small and Medium Enterprise Foundation, an independent and unique non-profit organization got registration in
2006. After formatting SME Foundation, it is playing its role in helping the SME entrepreneurs including the
women entrepreneurs by conducting various programs with an aim to develop the SMEs of Bangladesh. One of the
major aims of SMEF is to bring the grassroots entrepreneurs into the main stream of economic development
through employment generation, reduction of social discrimination and poverty alleviation.

The major rolls of SME foundation in SME Development in the country are:

 Implementing SME Policy Strategy adopted by the Government of Bangladesh.

 Recommending SME friendly policies to different government ministries and agencies.
 Providing business support services to the SME entrepreneurs.
 Providing information and proper guidance for establishing new SMEs.
 Conducting sectorial study to ensure availability of latest information,
 Identify challenges and recommend preventing measures.
 Operating credit wholesaling programs for the SMEs through different banking and non-banking
financial institutions.
 Conducting training programs to create skilled labor for different SME sub-sector based on their
demands.
 Technology development, adopting new technology, conducting reverse engineering and supporting
SMEs to get quality certifications.
 Supporting SMEs in marketing their products and promotion of services.
 Bringing women entrepreneurs into the mainstream of development and helping them to achieve
economic self-dependency.
 Assisting SMEs in creating institutional bondage with foreign companies for capacity building,
technology transfer and improving productivity.
Training up and motivating SMEs in using ICT tools for more productivity and improving quality.

08. Explain the different aspects of appraising a SME project.

The purpose of project appraisal is to establish whether a project is worthwhile in the light of its costs in terms of
resource commitments and the projects expected benefits. That is, appraisal is an ex-ante assessment of a project
and is the key element in the decision as to whether or not to proceed with a project. This will involve the
consideration of alternative projects, or alternatively, by comparison with the status quo. In practice, this is an
intricate and sophisticated process of enquiry, with substantial data requirements. Examination of the viability of
the project may require the specialized services of appraisal missions and appointed consultants. Appraisal covers
four major aspects of the project: technical, institutional, financial and economic.
Technical aspects:
This is mainly concerned with issues related to physical scale, layout, location of facilities, technology used, cost
estimates and their relation to engineering or other data on which they are based, the potential impact on the
human and physical environment, and a range of other similar concerns related to the technical adequacy and
soundness of the project.
Institutional aspects:
The objective of many projects is not merely to add to physical assets and capital, but also to create and enlarge
human and institutional capabilities to manage and maintain development undertakings. This is possibly the most
challenging aspect of the project‘s overall success. There may be no shortage of technically well-designed and
well-endowed projects. However, many projects have limitations at the human and institutional level. Therefore
project appraisal requires careful and sensitive consideration of the institutional dimension and local conditions.
Financial and economic aspects:
Financial appraisal (investment appraisal) is concerned with such questions as the adequacy of funds, the financial
viability of the project, the borrower‘s ability to service debt, procedures for recovering investment and operating
costs, etc, This is different from economic appraisal which addresses the issue of whether a project is worthwhile
from the broader point of view of its contribution to aggregate or national economic and social welfare through the
use of social cost-benefit analysis as the appraisal technique.
 26

09. What are the risks inherent in lending? What are the risk mitigation tools and techniques? Discuss.

Credit risk arises from the potential that a bank‘s borrower will fail to meet its obligations in accordance with
agreed terms. Credit risk also refers the risk of negative effects on the financial result and capital of the bank
caused by borrower‘s default on its obligations to the bank.

The following risks are inherent in lending.

Business/ Industry risk Financial risk
 Industry  Profitability
 Size  Liquidity
 Maturity  Debt management
 Production  Post Balance sheet events
 Distribution  Projections
 Vulnerability  Sensitivity Analysis:
 Competition  Peer Group Analysis:
 Demand- supply situation  Other Bank Lines:
 Strategic importance for the group and
for the country
 Concentration
 Market reputation

Management Risk Structural Risk

 Experience/relevant background  working capital requirement
 Track record of management in see  requirement of asset conversion cycle
through economic cycles  Purpose of the facilities
 Succession  Payments of wages & salaries and other
 Reputation daily expenses.

Security Risk Account Performance Risk

 Perishability  Credit Turnover vs stock movement &
 Enforceability /Legal structure sales
 Forced Sale Value  Hard Core element or good swing
 Repayment track record of working
Risk mitigation Tools & Techniques:
Introduction to Accrual Accounting
1. Scrutinize the information provided by the balance sheet and profit and loss account
2. Identify the connecting links between the two statements
3. Prepare and manipulate simple financial statements that reflect the business activities of a small company
Industry Risk Analysis:
Managers should be addressing: Cost structure, Maturity, Cyclicality, Profitability, Dependence, Vulnerability to
substitute products & Regulatory environment (like Bangladesh Bank guidelines, Judiciary, Tax authority
guidelines e.g. work hazard, child labor etc.)

Business Risk Analysis

1. Determine whether the business‘s strategy increase or decrease the risks faced by all businesses in its
industry
2. State what additional risks are inherent in the company‘s strategy and practices on its financial statements-
state how you would expect those statements to look

Internal Credit rating system as like CRG & rating from authorized rating agency like CRISL, CRAB can mitigate
the credit risk some extent.
 27
10. Consumer Credit provokes inflation, do you agree with this statement? Discuss in the light of
monetary policy of Bangladesh Bank?

The word "inflation" originally applied solely to the quantity of money. It meant that the volume of money was
inflated, blown up, overextended. Inflation, always and everywhere, is primarily caused by an increase in the
supply of money and credit. When the supply of money is increased, people have more money to offer for goods.
If the supply of goods does not increase—or does not increase as much as the supply of money—then the prices of
goods will go up.

When banks lend money for consumer purchases (e.g. through personal loans or credit cards) in effect they are
increasing the purchasing power in the economy without increasing the amount of goods available. If the economy
operating at near to its full capacity (i.e. low unemployment, using all its available resources etc. ) then this is
likely to push up prices as there is no way to increase production any further. If the economy is operating below its
full capacity then the increase in demand from the consumer loan might lead producers to produce a bit more, so
that even though there is more demand and purchasing power there are also more goods to spend it on.

From the above discussion we can say Consumer credit provokes inflation.

The current monetary policy stance of the Bangladesh Bank intends to ensure reasonable price stability and
provide support to high and sustainable economic growth. In this context, the policy keeps in view an average
inflation rate of around 7.5 percent in FY13. For this reason, BB aims to ensure that the composition of credit is
focused on productive sectors with an envisaged reduction in the share of consumer credit.
11. Discuss the importance of monitoring & counseling in improving the quality of a SME Loan?

Banks need to enunciate a system that enables them to monitor quality of the credit portfolio on day‐to‐day basis
and take remedial measures as and when any deterioration occurs. Such a system would enable a bank to ascertain
whether loans are being serviced as per facility terms, confirm the adequacy of provisions, and establish that the
overall risk profile is within limits established by management and compliance of regulatory limits. Monitoring
procedures and systems should be in place so as to provide an early signal of the deteriorating financial health of a
borrower.
An Early Alert Account is one that has risks or potential weaknesses of a material nature requiring monitoring,
supervision, or close attention by management. If these weaknesses are left uncorrected, they may result in
deterioration of the repayment prospects for the asset or in the Bank‘s credit position at some future date with a
likely prospect of being downgraded to worse. Despite a prudent credit approval process, loans may still become
troubled. Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be
done to ensure swift action to protect the Bank‘s interest. Regular contact with customers will enhance the
likelihood of developing strategies mutually acceptable to both the customer and the Bank. Representation from
the Bank in such discussions should include the local legal adviser when appropriate.

12. What legal & non-legal measures would you take to recover a loan when it becomes bad?
Non-Legal Measures:
1. Review all documentation, meet the customer, and prepare a Classified Loan Review Report.
2. Letter, Follow up & Persuasion over phone, Group visit by team member.
3. Letters to Guarantor, Employer, and Reference all above effort follows.
4. Final Reminder & Serve legal notice
5. Letter to different banks/Association
6. Repossession starts & Legal proceedings begin.
7. An incentive package for bank officials of NCBs to speed up the recovery of bad loans
8. Rescheduled Loan as per Bangladesh Bank reschedules guideline.

Legal Measures:
There is a famous maxim ―justice delayed is justice denied‖. This can be applied to banks, especially in developing
countries like Bangladesh, owing to the presence of corruption and opaqueness in the settlement process as well as
 28
poor enforcement of laws that usually create a fertile ground for the willful defaulters. The following legal
measures should take:

1. Suits filed to Artha Rin Adalat.

2. Suits file at bankruptcy court as per the Bankruptcy Act and the PDR Act.

Concerning recovery strategies, it is observed that Bangladesh has concentrated mainly on legal measures to
address the recovery of bad loans. Unfortunately, these legal measures have been found to be very time
consuming, resource draining and ineffective, and have ultimately resulted in poor recovery performance. Despite
being aware of this fact, non-legal measures such as out of court settlements, compromise settlement schemes are
better for loan recovery.

13. What are the various methods of creating charge on securities? Explain in details.

Security can be obtained through various forms. These are:

1. Charge
2. Assignment
3. Pledge
4. Lien
5. Hypothecation

Charge: A charge is probably the most common form of security particularly when properties are frequently taken
as security. It can also be referred to as a Mortgage which usually relates to land or immovable property. A charge
or mortgage may be either legal or equitable. It is an interest in a property that passes conditionally to a charge,
normally without physical possession.
Charges can be either fixed or floating:
1. A fixed charge over the chargor‘s overall fixed assets. Fixed charges can also be created over specific
machinery, property and shares.

2. A floating charge, however, can be regarded as a charge coupled with permission to the company to
continue deal with its assets until the charge crystalizes upon the appointment of a receiver.

Assignment: An assignment involves a transfer of the rights under a contract by an assignor (borrower) to an
assignee (lender)
Pledge: In law, a pledge means the transfer of a movable asset. Possession of the asset is passed to the pledgee, but
the legal ownership remains with the pledger who has an equity of redemption for the physical possession. This
usually applies to cash deposits, shares, stocks and accounts receivable.
Lien: A lien can be taken on personalty or on realty. A lien is understood to be the right of a bailee to retain
possession of a mortgage entrusted to him until the debt due is paid. For example, a banker‘s lien conveys a
general right over documents of title subject to pledge (such as negotiable instruments) that pass through the
banker‘s hands while a debt is owing to him.
Hypothecation: This is a security whereby a debt is acknowledged and the particular goods or things are not in the
lender‘s possession. It is similar to the concept of pledge except that physical possession of the security is not with
the lender.
 29
SHORT NOTES
Working Capital:
Working capital is considered a part of operating capital. Working Capital measures company's efficiency and its
short-term financial health. Net working capital is calculated as current assets minus current liabilities.

Positive working capital means that the company is able to pay off its short-term liabilities. Negative working
capital means that a company currently is unable to meet its short-term liabilities with its current assets (cash,
accounts receivable and inventory).

Factoring
Factoring is an alternate receivable financing instrument widely used in the developed countries. Over the last
decade, Factoring has been successfully introduced in many developing countries including neighboring countries.
Factoring is ideally suited to finance receivables of SMEs who generally suffer from shortage of working funds.
Three parties are involved in factoring operation. Factor (Financier), Supplier/Manufacturer (Client), and Buyer
(Debtor). In the operational process a client sells its accounts receivable invoices to the factor at a discount in
exchange for immediate cash to cover financial needs during periods in which his needs exceed prospective cash
inflow. At the end of the payment-waiting period, the invoices are fully paid by the debtor directly to the factor;
the factor deducts the amount financed plus interest applicable for the waiting period plus service charge and pays
back the remaining amount to the client. By factoring a borrower can devote more time to market and product
development and improve his customer service.
Factoring ensures cash flow of fund constantly. Beyond this, factoring provides professional benefits such as:
Instant cash payments, No headache for credit collection, Continuous production, Time saving.

Venture Capital:
Venture Capital is a powerful and effective way for doing big and interesting things in cutting-edge technologies.
Venture Capital enables entrepreneurs to pursue their dreams by providing funds for their projects in exchange for
a share of the business they are creating. Venture Capital investment is not a loan; risks in funding a Venture
Capital project are very high.
Lack of an exit strategy and poor minority rights certainly are a hindrance to the development of the Venture
Capital sector, which is integral to proper SME growth in the country. However, a few cases of venture capital
financing took place in Bangladesh by different financial organization such as Grameen fund, UAE Bangladesh
Investment Company limited. Equity & Entrepreneurship fund (EEF) of Bangladesh Bank is a classic example of
venture capital financing in Bangladesh. Venture Capital companies are needed to serve and create entrepreneurial
cadre in Bangladesh. The government can create the environment by (i) formulating law to regulate Venture
Capital, (ii) by enacting venture-capital fund rule to raise Venture Capital fund and (iii) by streamlining tax law, in
such a manner that investors of Venture Capital don't need to pay double or additional tax.

Equity and Entrepreneurship Fund (EEF Fund):

In order to encourage investments especially in risky but prospective agro-based, food processing and IT sector
industries, the Equity and Entrepreneurship Fund (EEF) was established in 2002 through budgetary allocation of
the government. Initially, the government allocated Tk. one billion in FY01 for EEF and BB was entrusted with
the responsibility of administering the fund. Since its inception, a wide range of enterprises have availed the EEF,
most of which are SMEs. The major sectors include: poultry and feed, fish hatchery, shrimp hatchery, cattle and
goat feeding, meat processing, fruit processing, wood processing, and software development.
Until March2008, a total of 247 entrepreneurs received Tk 4,677.5 million from the EEF. The disbursement to
fisheries and fish cultivation sub-sector was the highest followed by software development, poultry and fish feed,
grand parent hatchery, potato flask, and fruit processing.
 30
Break-even point:
Break-even point is that level of activity where there is no profit or loss. At this level, total revenue equals to total
expenses and company‘s profit is zero, i.e., Total Sales Revenue = Total Variable Costs + Total Fixed Costs. If the
company exceeds break-even level, then the company earns profit and if the activity level is under the break-even
point, company suffers a loss. There are two methods for calculating break-even point, which are as follows:
 The Equation Method
 The Contribution Margin Method
BEP calculation is widely used in Cost-volume-profit (CVP) analysis, which is one of most powerful tools that
help management to make their decision. It helps management to understand the interrelationship between cost,
volume and profit in an organization by focusing on interactions among the following five elements:
 Prices of products
 Volume or level of activity
 Per unit variable cost
 Total fixed costs
 Mixed of product sold

Internal rate of return (IRR):

The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to
measure and compare the profitability of investments. The internal rate of return on an investment or project is the
"annualized effective compounded return rate" or "rate of return" that makes the net present value of all cash flows
(both positive and negative) from a particular investment equal to zero.
In more specific terms, the IRR of an investment is the discount rate at which the net present value of costs
(negative cash flows) of the investment equals the net present value of the benefits (positive cash flows) of the
investment.
The formula for IRR is:
0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n

where, P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively;

and IRR equals the project's internal rate of return.

Cash flow analysis:

Cash flow analysis is the study of the cycle of cash inflows and outflows of a business. Cash flow analysis
involves examining the components of a business that affect cash flow, such as accounts receivable, inventory,
accounts payable, and credit terms. By performing a cash flow analysis on these separate components, ability to
more easily identify cash flow problems and find ways to improve cash flow.
A quick and easy way to perform a cash flow analysis is to compare the total unpaid purchases to the total sales
due at the end of each month. If the total unpaid purchases are greater than the total sales due, need to spend more
cash than receive in the next month, indicating a potential cash flow problem.
Cash flow analysis is a very important tool to analyze credit risk to some extent. It also gives an idea about
working capital requirement.
 31
Consumer Banking:
Consumer banking is the cluster of products and services that banks provide to consumers and small businesses
through branches, the Internet, and other channels. The key Consumer banking products are consumer credit and
small business loans. Consumer credit includes credit cards, mortgages, home equity lending, auto loans, education
loans, and other personal loans. Although loans and deposits are the primary products, Consumer banking units
provide a range of other financial services to consumers and small businesses. Consumer Banking offer mortgage
services, debit and credit card services and ATM services--all of which have become essential to today's
consumers.
Now-a- day‘s people are very much concerned about enhancement of their standard of living with their limited
earnings. By considering this behavior pattern of people, banking sector especially private one is expanding their
services horizon toward community based services through Consumer Banking. At the bank level, the principal
attraction of consumer banking seems to be the belief that its revenues are stable and thus can offset volatility in
the corporate and commercial real estate lending, trading, and capital market activities.

Leasing
Leasing can be defined as ―a contract between two parties where one party (the lessor) provides an asset for usage
to another party (the lessee) for a specified period of time, in return for specified payments‖. Leasing is referred to
as asset based financing. As lessors retain ownership of the assets they lease throughout the life of the contract,
these leased assets are therefore an inherent form of collateral in such contracts.
 32
DEFINITION OF 'INTERNAL RATE OF RETURN - IRR'
The discount rate often used in capital budgeting that makes the net present value of all cash flows from a
particular project equal to zero. Generally speaking, the higher a project's internal rate of return, the more
desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is
considering. Assuming all other factors are equal among the various projects, the project with the highest IRR
would probably be considered the best and undertaken first.

IRR is sometimes referred to as "economic rate of return (ERR)."

INVESTOPEDIA EXPLAINS 'INTERNAL RATE OF RETURN - IRR'

You can think of IRR as the rate of growth a project is expected to generate. While the actual rate of return
that a given project ends up generating will often differ from its estimated IRR rate, a project with a
substantially higher IRR value than other available options would still provide a much better chance of strong
growth.

IRRs can also be compared against prevailing rates of return in the securities market. If a firm can't find any
projects with IRRs greater than the returns that can be generated in the financial markets, it may simply
choose to invest its retained earnings into the market.

Internal Rate of Return (IRR)

Internal rate of return (IRR) is the discount rate at which the net present value of an investment becomes zero.
In other words, IRR is the discount rate which equates the present value of the future cash flows of an
investment with the initial investment. It is one of the several measures used for investment appraisal.

Decision Rule

A project should only be accepted if its IRR is NOT less than the target internal rate of return. When
comparing two or more mutually exclusive projects, the project having highest value of IRR should be
accepted.

IRR Calculation

The calculation of IRR is a bit complex than other capital budgeting techniques. We know that at IRR, Net
Present Value (NPV) is zero, thus:
NPV = 0; or
PV of future cash flows − Initial Investment = 0; or
CF1 CF2 CF3
1+ 2+ + ... − Initial Investment = 0
( 1 + r ) ( 1 + r ) ( 1 + r )3
Where,
r is the internal rate of return;
CF1 is the period one net cash inflow;
CF2 is the period two net cash inflow,
CF3 is the period three net cash inflow, and so on ...
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But the problem is, we cannot isolate the variable r (=internal rate of return) on one side of the above
equation. However, there are alternative procedures which can be followed to find IRR. The simplest of them
is described below:
1. Guess the value of r and calculate the NPV of the project at that value.
2. If NPV is close to zero then IRR is equal to r.
3. If NPV is greater than 0 then increase r and jump to step 5.
4. If NPV is smaller than 0 then decrease r and jump to step 5.
5. Recalculate NPV using the new value of r and go back to step 2.

Example

Find the IRR of an investment having initial cash outflow of $213,000. The cash inflows during the first,
second, third and fourth years are expected to be $65,200, $96,000, $73,100 and $55,400 respectively.
Solution
Assume that r is 10%.
NPV at 10% discount rate = $18,372
Since NPV is greater than zero we have to increase discount rate, thus
NPV at 13% discount rate = $4,521
But it is still greater than zero we have to further increase the discount rate, thus
NPV at 14% discount rate = $204
NPV at 15% discount rate = ($3,975)
Since NPV is fairly close to zero at 14% value of r, therefore
IRR ≈ 14%
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Net Present Value (NPV)

Net present value is the present value of net cash inflows generated by a project including salvage value, if
any, less the initial investment on the project. It is one of the most reliable measures used in capital budgeting
because it accounts fortime value of money by using discounted cash inflows.
Before calculating NPV, a target rate of return is set which is used to discount the net cash inflows from a
project. Net cash inflow equals total cash inflow during a period less the expenses directly incurred on
generating the cash inflow.

Calculation Methods and Formulas

The first step involved in the calculation of NPV is the determination of the present value of net cash inflows
from a project or asset. The net cash flows may be even (i.e. equal cash inflows in different periods) or
uneven (i.e. different cash flows in different periods). When they are even, present value can be easily
calculated by using the present value formula of annuity. However, if they are uneven, we need to calculate
the present value of each individual net cash inflow separately.
In the second step we subtract the initial investment on the project from the total present value of inflows to
arrive at net present value.
Thus we have the following two formulas for the calculation of NPV:
When cash inflows are even:
1 − (1 + i)-n
NPV = R × − Initial Investment
i
In the above formula,
R is the net cash inflow expected to be received each period;
i is the required rate of return per period;
n are the number of periods during which the project is expected to operate and generate cash inflows.
When cash inflows are uneven:
R1 R2 R3
NPV = 1 + 2 + + ... − Initial Investment
(1 + i) (1 + i) (1 + i)3
Where,
i is the target rate of return per period;
R1 is the net cash inflow during the first period;
R2 is the net cash inflow during the second period;
R3 is the net cash inflow during the third period, and so on ...

Decision Rule

Accept the project only if its NPV is positive or zero. Reject the project having negative NPV. While
comparing two or more exclusive projects having positive NPVs, accept the one with highest NPV.

Examples

Example 1: Even Cash Inflows: Calculate the net present value of a project which requires an initial
investment of $243,000 and it is expected to generate a cash inflow of $50,000 each month for 12 months.
Assume that the salvage value of the project is zero. The target rate of return is 12% per annum.
Solution
We have,
Initial Investment = $243,000
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Net Cash Inflow per Period = $50,000
Number of Periods = 12
Discount Rate per Period = 12% ÷ 12 = 1%
Net Present Value
= $50,000 × (1 − (1 + 1%)^-12) ’ 1% − $243,000
= $50,000 × (1 − 1.01^-12) ’ 0.01 − $243,000
≈ $50,000 × (1 − 0.887449) ’ 0.01 − $243,000
≈ $50,000 × 0.112551 ’ 0.01 − $243,000
≈ $50,000 × 11.2551 − $243,000
≈ $562,754 − $243,000
≈ $319,754
Example 2: Uneven Cash Inflows: An initial investment on plant and machinery of $8,320 thousand is
expected to generate cash inflows of $3,411 thousand, $4,070 thousand, $5,824 thousand and $2,065 thousand
at the end of first, second, third and fourth year respectively. At the end of the fourth year, the machinery will
be sold for $900 thousand. Calculate the present value of the investment if the discount rate is 18%. Round
your answer to nearest thousand dollars.
Solution
PV Factors:
Year 1 = 1 ÷ (1 + 18%)^1 ≈ 0.8475
Year 2 = 1 ’ (1 + 18%)^2 ≈ 0.7182
Year 3 = 1 ’ (1 + 18%)^3 ≈ 0.6086
Year 4 = 1 ’ (1 + 18%)^4 ≈ 0.5158
The rest of the problem can be solved more efficiently in table format as show below:
Year 1 2 3 4
Net Cash Inflow $3,411 $4,070 $5,824 $2,065
Salvage Value 900
Total Cash Inflow $3,411 $4,070 $5,824 $2,965
× Present Value Factor 0.8475 0.7182 0.6086 0.5158
Present Value of Cash Flows $2,890.68 $2,923.01 $3,544.67 $1,529.31
Total PV of Cash Inflows $10,888
− Initial Investment − 8,320
Net Present Value $2,568 thousand

Advantage and Disadvantage of NPV

Advantage: Net present value accounts for time value of money. Thus it is more reliable than other
investment appraisal techniques which do not discount future cash flows such payback period and accounting
rate of return.
Disadvantage: It is based on estimated future cash flows of the project and estimates may be far from actual
results.
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Payback Period

Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the
cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.

Formula

The formula to calculate payback period of a project depends on whether the cash flow per period from the project
is even or uneven. In case they are even, the formula to calculate payback period is:

Initial Investment
Payback Period =
Cash Inflow per Period

When cash inflows are uneven, we need to calculate the cumulative net cash flow for each period and then use the
following formula for payback period:

B
Payback Period = A +
C
In the above formula,
A is the last period with a negative cumulative cash flow;
B is the absolute value of cumulative cash flow at the end of the period A;
C is the total cash flow during the period after A

Both of the above situations are applied in the following examples.

Decision Rule

Accept the project only if its payback period is LESS than the target payback period.

Examples

Example 1: Even Cash Flows

Company C is planning to undertake a project requiring initial investment of $105 million. The project is expected to
generate $25 million per year for 7 years. Calculate the payback period of the project.
Solution
Payback Period = Initial Investment ÷ Annual Cash Flow = $105M ÷ $25M = 4.2 years
Example 2: Uneven Cash Flows
Company C is planning to undertake another project requiring initial investment of $50 million and is expected to
generate $10 million in Year 1, $13 million in Year 2, $16 million in year 3, $19 million in Year 4 and $22 million in
Year 5. Calculate the payback value of the project.
Solution
(cash flows in millions) Cumulative
Year Cash Flow Cash Flow
0 (50) (50)
1 10 (40)
2 13 (27)
3 16 (11)
4 19 8
5 22 30
Payback Period
= 3 + (|-$11M| ÷ $19M)
= 3 + ($11M ÷ $19M)
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≈ 3 + 0.58
≈ 3.58 years

Advantages and Disadvantages

Advantages of payback period are:

1. Payback period is very simple to calculate.
2. It can be a measure of risk inherent in a project. Since cash flows that occur later in a project's life are
considered more uncertain, payback period provides an indication of how certain the project cash inflows are.
3. For companies facing liquidity problems, it provides a good ranking of projects that would return money
early.
Disadvantages of payback period are:
1. Payback period does not take into account the time value of money which is a serious drawback since it can
lead to wrong decisions. A variation of payback method that attempts to remove this drawback is
called discounted payback period method.
2. It does not take into account, the cash flows that occur after the payback period.