Contingent Liabilities:

Bank and Corporate Guarantees

Bank guarantees

 Although bank guarantees may be necessary for a business, they should be provided under proper sanctioned
Non Fund Based Limits from the Bank.
 Financial Guarantees are not so common and carry a direct higher financial risk and hence the purpose for
which it is issued must be looked at closely.
 For manufacturing and trading companies, the requirement of bank guarantee will be much lower and
generally linked to their Working Capital Cycle or Capital Goods Imports. For EPC and infrastructure sector
companies, the quantum of bank guarantee requirement is generally higher and linked to the order book and
projects under execution.
 • The bank guarantees carry a risk of being invoked and amount guaranteed becoming payable immediately
on demand. While the aggregate amount of bank guarantees in force can be measured against the net worth
of the company as a financial indicator, the more appropriate co-relation is to compare the percentage of bank
guarantees invoked in the past years.

Corporate guarantees

 Under the new Companies Act, there are restrictions on issuance of corporate guarantee by a company. Any
corporate guarantee provided should be closely examined for compliance with the Companies Act provisions.
 It must also be examined whether such a corporate guarantee was indeed required to be provided as part of
business requirement.
 The aggregate amount of corporate guarantees provided should be measured as a percentage of the net
worth and the total assets of the company.
 The Adjusted TNW of the company should be further moderated by reducing the amount of corporate
guarantee and simulating its impact of the balance sheet ratios discussed in Topic 2.

Analysing Financial Statements and Ratios 1

CRISIL Financial Ratios