CASE STUDY – CREDIT APPRAISAL

Murali Krishna, proprietor of Krishna Steels, was in deep thought. He was convinced
that there would be substantial increase in sales of his firm over the next couple of
years. However, he had to look for borrowed funds, since he seemed to be
perpetually short of cash, in spite of good profits. At the end of the first quarter of
2016, his outstanding borrowings from Smaller Bank stood at Rs 4 crore, which
meant that he had fully utilized the credit limit granted for working capital by his bank,
Smaller Bank. He was doubtful if the bank would agree to a significant increase in
the present credit limit of Rs 4 crore. Krishna was just managing to stay within the
credit limit granted by the bank by relying heavily on credit from his suppliers.

Krishna had discussed his problem with Mr Jai, who headed the city branch of
Larger Bank. Jai had tentatively agreed to raise the credit limit to a maximum of Rs 7
crore. Krishna thought that a credit limit of this size would improve his firm’s cash
position and profitability. However, Jai made it clear that the sanction of credit limit
by his bank would be based on investigation and appraisal by his team of credit
officers, and that Murali would sever his relationship with Smaller Bank in case his
loan was sanctioned by Larger Bank

The following points are excerpts from the credit officers’ report to Jai:

1. Krishna Steels was founded in 1990 as a partnership between Murali Krishna and
his father, HariKrishna. The business was located on land owned by the firm, in the
growing suburbs of a large city in South India. The firm also owned four large
concrete sheds erected on this land, used for storage of steel.

2. The firm, which operated largely in South India, was involved in distribution of
steel and steel products.

3. In 2014, Murali bought out his father’s interest in the business for Rs 2 crore. In
order to give time to Murali to arrange for financing, Hari agreed to take the payment
in annual instalments beginning April 1,2016, with annual interest of 12%.

4. In addition to owning the steel business, Murali owned a house in an upscale

locality, jointly with his father. The house was mortgaged to Smaller bank. Apart from
the house and a life insurance policy, Murali had no sizable assets in his name.

5. Murali, an energetic man in his early fifties, was well known in the trade for his
integrity and business acumen.

6. Sales and profits were growing year after year. In 2016-17, sales were expected
to touch Rs 55 crore. There was a ready market for the firm’s products and the
prospects of future sales were favourable, since construction activity was increasing
rapidly.

7. The firm employed 20 people, of which half the number worked in the steel yard.
The remaining employees assisted in the office and in sales and distribution. Almost
90% of the employees had been working with the firm since inception.

8. Most of the sales were credit sales. Similarly, suppliers gave credit for purchases.
The usual terms of purchase in the trade provided for a discount of 2% for payments
made within 10 days of the invoice date. In other cases, payment for purchases had
to be made within 30 days of purchase at the total invoice price. Over the last two
years, Mr Murali seemed to have hardly availed of the purchase discount, since he
always seemed to be short of funds.

The financial statements for Krishna Steels are given in Tables 6.4 and 6.5

The credit officer also commented on the key aspects of the firm’s financial
performance, particularly the growth in sales, current assets and current liabilities,
and paid attention to key financial ratios that seemed to be impact Krishna’s cash
generation and profitability.

Note: 1. The bank loan for working capital has been availed at an interest of about
11%[floating rate].

2. Interest on term loan fixed at 10% on outstanding balance.

3. Both loans are secured by Krishna Steels’ fixed and current assets. Krishna’s
house and Life Insurance Policy form collateral securities for the bank loans.

TABLE 6.5 KRISHNA STEELS INCOME STATEMENT [FY 2015- FY 2016]

QUESTIONS ON THE CASE

1. Why was Krishna Steels facing shortage of cash in spite of making profits?

2. Should Larger bank lend to Krishna Steels?

3. If the Larger bank decides to lend, how much should it lend? What are the
conditions it should impose for the loan?