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Annexure A

Credit appraisal for working capital finance
A PROJECT REPORT Under the guidance of Sri Debabrata Chakraborty, Manager Indian overseas Bank, Chowringhee Branch

Submitted by

Mitali Bagchi Roll No 520933922


November 2010


Annexure B

I hereby declare that the project report entitled Credit appraisal for

working capital finance is submitted in partial fulfillment of the
requirement for the degree of Master of Business Administration in Finance under Sikkim Manipal University, India, is my original work and not submitted for the award of any other degree, diploma, fellowship, or any other similar title or prizes.

Place: Kolkata Date:

(Mitali Bagchi) Roll No 520933922


Annexure C

Credit appraisal for working capital finance

Is approved and is acceptable in quality and form.

Internal Examiner
(Name, Qualification and Designation)

External Examiners
(Name, Qualification)


56. 5. 50.2 PD Dynamics 4. 20-28. Particulars Acknowledgement Bonafide Certificate Executive Summary Methodology and sources of data Page No 6.2 Data to be obtained for Credit Appraisal 4.3 Credit Monitoring: Common Issues 4. 18.4 Principles of Lending 4.Chapter No. 62 63 66-68 69 -93 94-95 Page no 96-98 99 1. 30.3. 45.1 Basel II consists of three pillars 4.8 Working Capital financing 3. 9.1 What is Credit Appraisal 4.5 Types of Working Capital 3. 7.3 Gross Working Capital and Net Working Capital 3.4 Concepts 3. 47-49. 1. 60-61.2 Need of Working Capital Management 3.6 Determinants of Working Capital 3.9 Working Capital Products 3.1 Steps involved in Financial Analysis of Lending 4. Appendices Bibliography .3.5 Principles of BASEL II Accord 4. Chapter No. 39. 57-59.2 1. Bank’s Loans and Advances Working Capital Management 3. 32-38. 13-14 15-17.2 Additional requirements in case of Loan is granted to Firm 4. 57.7 Working Capital Cycle 3.2 Gist of Recommendations 4 4. 52-53.6 Financial Analysis of Lending 4. 46.5.7 Clarification with regard to Classification of Working Capital limits Case Study Conclusion and Recommendation 6. 8. 19.4 Introduction Banking Sector in India An Overview of Indian Overseas Bank Rationale for Study Objective 2.1 Additional requirements in case of Loan is granted to Company 4.1 Comments on financial performance of the company Particulars 6.1 Introduction 3.3 1. 6. 6. 54 55. 40-43.1 1. 31. 51. 3.10 Various methods of Working Capital Assessment Credit Appraisal and Monitoring: Common Issues 4. 44.6.5. 29.

Acknowledgement The project report submitted in partial fulfillment of MBA Programme in Finance is a golden opportunity for learning and self-development. 5 . I consider myself very lucky and honored to have many distinguished personalities to lead and guide me in completion of this project.

In this opportunity I would like to thank my brother who has helped and encouraged me to complete the Project work smoothly. IOB. CHOWRINGHEE branch for giving me ample scope to continue my project work inside the branch. SUJIT DUTTA and Prof. CREDIT MANAGER.My grateful thanks to Mr. CHIEF MANAGER. CHIEF MANAGER. KOLKATA (1) arranged all the facilities to make the process very easier to me. husband and son for providing me all sorts of cooperation. I am highly indebted to Prof. Their guidance gave immense confidence and encouragement that helped me to put in my best. CHOWRINGHEE branch who in spite of being immensely busy with his duties. REGIONAL OFFICE. Last but not the least I am very grateful to my parents. K PARTHASARATHY. Mr. provided me the essential information and extended his best support providing me an insight into various issues pertaining to the case mentioned in the report. RANJAN DAS GUPTA for their mentorship and valuable suggestions that gave an entirely new dimension to the project under consideration. encouragement and inspiration. Bonafide Certificate: 6 . INDIAN OVERSEAS BANK. His sincere support and consistent guidance led to the completion of the project. INDIAN OVERSEAS BANK. DEBABRATA CHAKRABARTY. I choose this moment to acknowledge his contribution gratefully. PRABIR KUMAR ROY. My humble gratitude to Mr.

(P K Roy) Chief Manager Indian Overseas Bank Regional Office Kolkata I (Debabrata Chakraborty) Manager Indian Overseas Bank Chowringhee Branch EXECUTIVE SUMMARY 7 . a student of MBA Finance of Sikkim Manipal University who carried out the project work under my supervision during the period 21/06/2010 to 20/08/2010. I wish her all round success in her professional career.BONAFIDE CERTIFICATE Certified that this project report titled Credit appraisal for Working Capital Finance is the bonafide work of Smt Mitali Bagchi Roll No 520933922.

A banker approaches the proposal and then decides whether to lend the money or not. The most important part of the study includes case analysis of Working Capital Assessment/Appraisal of a partnership firm M/s XXX Co. This report gives a clear understanding with what goes behind the credit appraisal of the proposal. The present status of the project shown by the study of balance sheets sand other financial details furnished by the borrower and the bank. It explains different types of loans and advances offered by banks. ( Name of the firm changed ) which is a trading concern dealing in Indian manufactured foreign liquor (IMFL). It recently registered a core profit of Rs. 8 . Calculation of maximum permissible bank finance is shown with example. in a precise manner. This explains the significance of study of key financial indicators. Financial ratios. Working capital financing is discussed in the report. study of debt service coverage ratio. that has a substantive history since 1937.1325 crores in the financial year March‟08-March‟09. past performance and projected future performance. This report also deals with principles of lending and principles of BASEL II ACCORD. Chennai based Indian Overseas Bank is one of the nationalized banks in India. The report deals with the lending procedures followed by Indian Overseas Bank. agribusiness consultancy and e-banking. conclusion and recommendation as per the analysis during the training period winds up the report. It gives an insight of the steps involved in lending process. Common issues related to credit appraisal is discussed in detail. So everyone approaches the bank at the same point of time for business loan whether it is for running day to day business or for setting up a new project. study of cash flow statement and collateral security are helpful to the bank while taking lending decision. Finally.Almost all of the industrial enterprises whether they are into manufacturing trading or service sector need bank finance in order to run the businesses. The bank not only deals in retail banking providing utility services to its customers but has also expanded its area of operation in multidimensional services like merchant banking.

 It also involves active participation in banking transactions and internal functioning of the Advances Department of the branch. newsletters published by financial institutions and websites have been utilized for the analytical study of advances made by bank. Finally.METHODOLOGY AND SOURCES OF DATA The proposed methodology for fulfilling the objectives of the project is as follows:  The study of guidelines laid by the Reserve Bank of India and the governing authorities of Indian Overseas Bank to be adhered to (pertaining to advances) as published in the journals issued by these authorities from time to time. reference books. calculation of interest on loans and equated monthly installments and documentation of the same.  The observation of advances sanctioned by the bank in the past few years that resulted successful lending constitutes the most substantial part of the project work. pre and post requisites of lending. 9 . An elaborate study of loans and advances granted by the branch and analysis of the same has been the most significant component of the project.  The secondary data is deduced from the books of accounts maintained by the bank (without disclosure of any personal details of the borrower).  The data from the official books as maintained by the bank. the figures and facts given being realistic in nature.  The methodology includes a detailed study of the data collected from the bank. Information mentioned in the cases are deduced from the books of accounts as maintained by the bank branch. identification of the problems associated with advances by bank and the solution of the same with certain recommendations is to be provided after analyzing certain loans (stated as illustrations in the project) to help the advances department of the bank.

AR 84 . 5. EAD Exposure at Default 31. TOL Total of Liabilities 10 . Abbreviation Narration 1. Narration 3. 4. CC Cash Credit 27. 15. NWC Net Working Capital Financial Indicators 90 21. IBA Indian Bank Association 25. TNW Tangible Net Worth 40. DPG Deferred Payment Guarantee 38. NRI Non Resident Indian Securities 71 10. CLB Company Law Board 37. FORM III(B/S) Earnings per share EPS 79 .83 16.87 19. CIBIL Credit Information Burea India Limited 26. Serial No. WIP Work in Process 74 -76 12. FORM III(P & L Fixed Deposit Receipt FDR 14. 7. 9.Opportunity & Threat 36. Sanction of enhancement cum renewal of limits 93 KVP Kishan Vikas Patra 24.81 15. PD Probability of Default 34. Comparison SME Small Medium Enterprise 18. 11. 3. 12. ROE Return on Equity FORM I 73 11. 8. 2. LGD Loss Given default 30. FORM II NFS National Financial Switch A/C) 77 -79 13. FORM VI(B/S) Credit Monitoring Analysis CMA 88 . 10. 6. EL Expected Loss 35. IPO Initial Public Offer Collateral Securities details 8.Table 1. 13. SWOT Strength. 14. 16. ROC Registrars of Companies 28. NSC National savings Certificate 91 22. VISA Visa International Service Association 70 9. WCG Working Capital Gap 39. SCB levels Scheduled Commercial Banks Key Ratio 64 5. ISO Indian Standard Organization No. HO Head Office 29. CBS Core Banking Solution 2. FORM V(B/S) MPBF Maximum Permission Banks Finance 86 . MCR Minimum Capital Requirement 32. IMFL Indian Manufactured Foreign Liquor Page No: 4.89 20. Financial Position LIC Life Insurance Corporation 23.85 17. DSCR Debt Service Coverage Ratio FORM IV(B/S) Accounts Receivable 82 . RWA Risk Weighted Assets 33. FOREX Foreign Exchange Guarantors and their Networth 70 7.Weakness. ICRA Facilities International Credit Rating Agency Nature of 69 6.

Figure No Narration Fig 1 IOB Fig 2 Working Capital Fig 3 Working Capital Cycle Fig 4 Cash Operating Cycle Fig 5 Credit Appraisal Fig 6 BASEL II Page No 14 38 43 44 49 56 11 .

public sector bank holds over 75% of the total asset of the banking industry.000 branches and 17. They have a combined network of over 53. with the private and foreign bank holding 18. they may be publicly listed and traded on stock exchanges) and 38 foreign banks. INTRODUCTION 1. They are as mentioned below:  Early phase from 1786 to 1969 of Indian Banks  Phase from Nationalization of Indian Banks and up to 1991. the journey of Indian Banking System can be segregated into three distinct phases. India has 88 scheduled commercial banks (SCBs) . though conservative. 31 private banks (these do not have government stake.27 public sector banks (that is with the government of India holding a stake).1BANKING SECTOR IN INDIA Banking in India originated in the last decades of the 18th century.000 ATMs.Chapter 1. The first bank in India. prior to Indian banking sector Reforms.5% respectively. Currently.2% and 6. was established in 1786.  New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reform after 1991. a rating agency. 12 . From 1786 till today. According to a report by ICRA Limited.

rising income levels. It is no longer confined to only metropolitans or cosmopolitans in India. For the past three decades India's banking system has several outstanding achievements to its credit. Indian Banking market is growing at an astonishing rate. In correlation with the growth of the economy. Indian banks are considered to have clean. strong and transparent balance sheet relative to other banks in comparable economies in its region. With the growth in the Indian economy expected to be strong for quite some time. especially in its services sector -the demand for banking services. 13 . The country’s middle class accounts for over 330 million people.Currently (2007) banking in India is generally fairly mature in terms of supply. increased standard of living and affordability of banking products are promising factors of continued expansion. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factor. Without a sound and effective banking system in India it cannot have a healthy economy. with assets expected to reach US$1 trillion by 2010. The stated policy of the bank on the Indian rupee is to manage volatility but without any fixed exchange rate and this has mostly been true. middle class and technological innovations are all contributing to this growth. especially retail banking mortgages and investment services are expected to be strong.In terms of capital adequacy and quality of assets. with minimal pressure from the government. An expanding economy.range and reach even though reach in rural India still remains a challenge for private sector . The Reserve Bank of India is an autonomous body. product. The most striking is its extensive reach.

Indian Overseas Bank has nearly 1500 branches and 250 extension counters with more than 24. Shri M Ct M Chidambaram Chettiar. the founder.2 AN OVERVIEW OF INDIAN OVERSEAS BANK Fig 1. was a man of remarkable foresight and vision who focussed on overseas banking and foreign exchange business as the primary activities that the bank would concern itself with. Headquartered in Chennai – Tamil Nadu. IOB commenced operations on Feb 10. Chennai and Rangoon.1. IOB was founded in 1937 before World War II. IOB started up simultaneously at three branches. INDIAN OVERSEAS BANK (IOB) enjoys pride of place as the premier institution among the public sector banks in the country.IOB VISION Their vision is to emerge as one of the most competitive banks in the industry. It then quickly opened a branch in Penang and another in Singapore. one each in Karaikudi.000 employees all across India and overseas. Indian Overseas Bank was rated as one of Fortune 2000 companies last year with gross profits of nearly $295 million. Indian Overseas Bank (IOB or the Bank) 14 . 1937.

Dhaliyur village in Coimbotore District and Innambur village in Thanjavur. Indian Overseas Bank was one of the 14 major banks which were nationalized in 1969. Indian Overseas Bank has an ISO certified in-house Information Technology department. IOB has absorbed various banks including the latest — Bharat Overseas Bank — in 2007. etc. current accounts. Online Banking. Current Account. Any Branch Banking. and National Stock Exchange of India Ltd. which was founded in 1969 and had its head office in Pune. Bombay Stock Exchange. Mumbai. including Savings Account.provides various banking services. Retail Loans. IOB was the first bank to venture into consumer credit. Indian Overseas Band undertook an initial public offering (IPO) that brought the government's share in the bank's equity down to 75%. Tamil Nadu. It provides a wide range of consumer and commercial banking services. The Bank's services also include personal banking services. Payment of Bills / Taxes. Debit Cards. Provident Fund Scheme. NRI Account. which has developed the software that 2018 branches use to provide online banking to customers. the Bank launched an rural development project aiming at total village development called IOB-Sampoorna in Kuthambakkam and Padur villages in Tiruvallur District. Home Loans. In 2009. Depositary Services. It offers internet banking and is one of the banks that the Government Of India has approved for online payment of taxes. non-residential Indian (NRI) accounts. Indian Overseas Bank offers investment options like Mutual Funds and Shares. Since its inception. IOB also has a network of about 771 ATMs all over India and IOB's International VISA Debit Card is accepted at all ATMs belonging to the Cash Tree and NFS networks During fiscal 2009. the Bank started computerization in the areas of inter-branch reconciliation and provident fund accounts. IOB took over Shree Suvarna Sahakari Bank. Kameshwaram village in Nagapattinam District. credit facilities and other services.. In 1964. the bank has achieved 100% networking status as well as 100% CBS status of branches with a total number of 2018 CBS branchs and Extension Counters. After nationalization. corporate banking services. In the year 2000. In 2001 it acquired the 15 . IOB opened a Foreign Currency Banking Unit in the free trade zone in Colombo. including saving bank. In 1979. VISA Cards. Forex Collection Services. foreign exchange reserves (FOREX) collections services. the Bank emphasized on opening its branches in rural parts of India. The equity shares of IOB are listed in the Madras Stock Exchange (Regional). agri business consultancy and e-banking services. Credit Cards. Agricultural Loans. as it introduced the popular Personal Loan scheme.

which gave it a branch in Mumbai. This study aims to analyze steps involved in credit appraisal . Before offering credit to an organization. 16 .Mumbai-based Adarsha Janata Sahakari Bank. 2010 (fiscal 2010). During the fiscal year ended March 31. the interest rate guidelines circular is consulted to fix a price for the credit facilities i. On the basis of credit rating. These are used to determine the financial health. four representative offices. determine the interest rate.After analyzing credit health. turnover trends and rise and fall of profitability. Shree Suvarna Sahakari Bank has been in administration since 2006. South Korea. two remittance centers and one extension counter.e. Credit should be disbursed only after ascertaining satisfactory financial performance. the credit rating is determined. These credit ratings are used to fix the interest rate and quantum of installment. determine the interest rate. Companies present audited balance sheets of the current and previous years.3 RATIONALE FOR THE STUDY Offering credit is an operation fraught with risk. the credit rating is determined. The total employee strength is estimated to be little over 100. Sri Lanka and Bangkok). 1. its financial health must be analyzed. banks assign credit ratings. On the basis of credit rating. This study aims to analyze the credit health of organizations that approach Indian overseas bank for credit facilities. IOB had 13 establishments abroad. Based on the financial health of an organization. It has nine branches in Pune. Then credit rating is done. After analyzing credit health. consisting of six branches (two branches in Hong Kong and one each in Singapore. the interest rate guidelines circular is consulted to fix a price for the credit facilities i. two in Mumbai and one in Shirpur.e.

partnerships and. life policies. limited companies and the lending services that may be of benefit to them. Responsible Lending and The Banking Code. stocks and shares. Understand the implications and application of the lending cycle. in practice. Analyse the borrowing requirements of personal and commercial customers (including the interpretation of financial statements). including relevant law and codes of practice such as Treating Customers Fairly. Understand the nature of different types of borrowers (personal customers. 5. through lending and control. banks consider other factors such as history with client. from the lending decision. Understand the principles of good lending. Thus. However. management of early warning signals to the recovery of debts. 6. 2. 3. 4.4 OBJECTIVE 1. Provide an outline of the principles of credit scoring. Understand and apply the features and benefits of the whole range of lending products and services to each customer type and lending situation. Apply the principles of security including land and property.The financial health and credit rating are theoretical methods for determining the right interest rate. sole traders. market reputation and future benefits with clients. a difference exists between theory and practice. guarantees and debentures incorporating fixed and floating charges. 17 . 1.

a. Loan may be regarded as ‘credit’ granted where the money is disbursed and its recovery is made on a later date. Meaning of Loans and Advances The term ‘loan’ refers to the amount borrowed by one person from another. certifying the credit-worthiness of business.Chapter 2. Banks also render many other useful services – like collection of bills. safe-keeping of jewellery and other valuable items. The major part of the deposits received by banks is lent out. BANK LOANS AND ADVANCES Bank is a lawful organization. which accepts deposits that can be withdrawn on demand. While granting loans. credit is given for a definite purpose and for a predetermined 18 . It also lends money to individuals and business houses that need it. Lending of funds to traders. and so on. There is a considerable difference between the rate of interest which the commercial bank grants on deposits. Commercial banks accept deposits and also lend money to the people who require it for various purposes. 2. The amount is in the nature of loan and refers to the sum paid to the borrower. Operation and expansion of business and commercial activities depend a great deal on the availability of loans/advances from commercial banks. It is a debt for the borrower. It is this difference which constitutes the main source of bank earnings. businessmen and industrial enterprises is one of the important activities of commercial banks. it is ‘lending’. and a large part of their income is earned from interest on such lending. and the rate they charge on loans and advances. Thus from the view point of borrower. it is ‘borrowing’ and from the view point of bank. payment of foreign bills.

advances are also to be repaid. is a ‘credit facility’ granted by the bank. 3. because banks charge a reasonable rate of interest on such loans/advances. bank overdraft and discounting of bills. But it takes care to ensure that the money lent is used only for business purposes. Thus a credit facility. firms. whereas an advance is a facility being availed of by the borrower. Banks generally do not interfere with the use.b.repayable in instalments over a period is termed as loan while a credit facility repayable within one year may be known as advances. in the present lesson these two terms are used interchangeably. The amount raised as loan may be repaid within a short period to suit the convenience of the borrower. We can discuss the role played by banks in the business world by way of loans and advances as follows: 1. Loans and advances can be arranged from banks in keeping with the flexibility in business operations. However. 4. 2. and also the tax liability of business. ‘Advance’ on the other hand. Traders may borrow money for day to day financial needs availing of the facility of cash credit. For loans from money lenders. like loans. The growth and diversification of business activities are effected to a large extent through bank financing. Loans and advances from banks are found to be ‘economical’ for traders and businessmen. The interest charged by commercial banks is regulated by the Reserve Bank of India.period. Banks grant advances largely for short-term purposes. 2. Thus business may be run efficiently with borrowed funds from banks for financing its working capital requirements. Loans and advances are utilized for making payment of current liabilities. Loans and advances granted by banks help in meeting short-term and long term financial needs of business enterprises. 19 . companies and industrial concerns. wage and salaries of employees. management and control of the borrowed money. the rate of interest charged is very high. Utility of Loans and Advances Loans and advances granted by commercial banks are highly beneficial to individuals. There is a sense of debt in loan. Interest is charged on the loan at agreed rate and intervals of payment. However. such as purchase of goods traded in and meeting other short-term trading liabilities.

The rate is relatively lower on savings account deposits. bank funds mainly consist of deposits from the public. c. The borrowing rate refers to the rate of interest paid by a bank on its deposits. Banks are dutybound to maintain secrecy of their transactions with the customers. This facilitates planning for future and timely repayment of loans. Borrowing Rate and Lending Rate People make their funds available to the banks by depositing their ‘savings’ in various types of accounts. 6. This enhances people’s faith in the banking system. The lending rates also vary depending upon the nature of loans and advances. thus mobilizes funds through its deposits. For example if the loan is sanctioned for the purpose of activities for the development of backward areas. though banks may also borrow money from other institutions and the Reserve Bank of India. The rate at which commercial banks make funds available to people is known as ‘Lending-rate’. The rates which the banks allow depend upon the nature of deposit account and the period for which the deposit is made with the bank. On public deposits the banks pay interest at and the rate of interest vary according to the type of deposit. the rate of interest is relatively lower as against loans and advances for commercial/business purposes. Higher rates ranging from 6% to 12% per annum are paid on fixed deposit accounts according to the period of deposit. Bank loans and advances are found to be convenient as far as its repayment is concerned. Banks. Otherwise business activities would have come to a halt. Loans and advances by banks generally carry element of secrecy with it. The rates also vary according to the purpose in view. 2. No interest is generally paid on current account deposits. the rate of interest it charges for lending is known as ‘Bank Rate’.5. Similarly for smaller amounts of loan the 20 . Banks also borrow from other institutions as well as from the Reserve Bank of India. When the Reserve Bank of India lends money to commercial banks. In other words.

are relatively higher than for commercial borrowings. Different rates of interest are prescribed for various categories of advances. etc. While lending money by way of loan. shares of companies or any other asset. The nature of borrowing is that the money is disbursed and recovery is made in installments. e.rate of interest is higher as compared to larger amounts. such as advances to agriculture. if it is so agreed the amount of loan may be repaid in suitable installments. There are two types of loan available from banks:  Demand loan  Term loan (a) A Demand Loan is a loan which is repayable on demand by the bank. approved outlets. etc.g. Depending upon the purpose and period of loan. (c) overdraft. Lower rate is normally charged from agencies selling food-grains at fixed price through Govt. it is repayable at short-notice. loans for purchase of two-wheelers. Graded rates of interest are prescribed for backward areas. However. road transport.Lending of Money Commercial banks lend money in four different ways: (a) direct loans. small scale industries. and (d) discounting of bills. However the bank is at liberty to grant the loan requested or refuse it depending upon its own cash position and lending policy. credit is given for a definite purpose and for a pre-determined period. (b) cash credit. The security may include materials or goods in stock. Such loans are normally granted by banks against security. refrigerators. cars. The borrower can repay the loan either in lump sum (one time) or as agreed with the bank. Again lending rates for consumer durables. Lastly. each bank has its own procedure for granting loan. In other words. 2. Demand loans are raised normally for 21 . lower rate of interest is charged for loans granted to persons belonging to ‘weaker sections of the society’. d. For example. The entire amount of demand loan is disbursed at one time and the borrower has to pay interest on it. These are briefly discussed below: (a) Loans Loan is the amount borrowed from bank. the Reserve Bank of India from time to time announces changes in the interest-rate structure to regulate the lending of fund by banks.

Term loan is required for the purpose of starting a new business activity. purchase of plant and machinery. who binds himself under the agreement to give possession of goods to the banker whenever the banker requires him to do so. (c) Overdraft 22 . (b) Term Loans: Medium and long-term loans are called term loans. the limit of cash credit may be renewed by the bank at the end of year. purchase of land for setting up of a factory. Under this arrangement the banker specifies a limit of loan for the customer (known as cash credit limit) up to which the customer is allowed to draw. In ‘Hypothetication’. Term loans are granted for more than a year and repayment of such loans is spread over a longer period. So Hypothetication is a device to create a charge over the asset under circumstances in which transfer of possession is either inconvenient or impracticable. renovation. expansion/ extension of existing units. like purchase of raw materials. goods remain in the possession of the borrower. is one of the types of bank lending against security by way of pledge or / hypothetifcation of goods. The cash credit limit is based on the borrower’s need and as agreed with the bank. Against the limit of cash credit. It ensures recovery of loan in case of failure of the borrower to repay the borrowed amount. Its primary purpose is to put the goods pledged in the possession of the lender. building and the like. (b) Cash credit Cash credit is a flexible system of lending under which the borrower has the option to withdraw the funds as and when required and to the extent of his needs. These loans are generally secured against the mortgage of land. If the account is running satisfactorily. The interest is calculated and charged to the customer’s account. It is normally sanctioned for a period of one year and secured by the security of some tangible assets or personal guarantee. modernization. the borrower is permitted to withdraw as and when he needs money subject to the limit sanctioned. Cash credit.working capital purposes. construction of factory building or purchase of other immovable assets. plant and machinery. making payment of short-term liabilities. ‘Pledge’ means bailment of goods as security for payment of debt. The repayment is generally made in suitable installments of a fixed amount.

(iii) This mode of borrowing is simple and elastic and meets the short term financial needs of the business. Overdraft facility is the result of an agreement with the bank by which a current account holder is allowed to draw over and above the credit balance in his/her account. The interest rate on overdraft is higher than is charged on loan. For this purpose. i. (d) Discounting of Bills Apart from sanctioning loans and advances. which depends upon the need of the borrower. the bill of exchange facilitates this task with the help of the banking institution.e. The bill so 23 . before the due date.Overdraft facility is more or less similar to ‘cash credit’ facility. These bills may be payable on demand or after a stated period. discounting of bills of exchange by bank is another way of making funds available to the customers. (ii) There is no necessity of providing security and documentation again and again for borrowing funds. The customer is permitted to withdraw the amount of overdraft allowed as and when he/she needs it and to repay it through deposits in the account as and when it is convenient to him/her. Sometimes the bank also insists on either a promissory note from the borrower or personal security of the borrower to ensure safety of amount withdrawn by the customer. Overdraft facility is generally granted by a bank on the basis of a written request by the customer. When the seller of goods has to realize his dues from the buyer at a distant place immediately or after the lapse of the agreed period of time. This facility is made available to current account holders who operate their account through cheque. the bank charges discount on the bill at a specified rate. It is a short-period facility. In discounting a bill. The following are some of the benefits of cash credits and overdraft :(i) Cash credit and overdraft allow flexibility of borrowing. Bills of exchange are negotiable instruments. which enable debtors to discharge their obligations to the creditors. Such Bills of exchange arise out of commercial transactions both in inland trade and foreign trade. the bank pays the amount to the customer in advance. Banks invest a good percentage of their funds in discounting bills of exchange.

In case the borrower fails to repay the loan. the period ranges from 15 months to less than 5 years. Term Loans Medium and long-term loans are generally known as ‘term loans’. On the other hand Secured loans are those which are granted against the security of tangible assets. Thus. Nature and Security of Loans To ensure the safety of funds lent. Though banks may grant long-term loans. It can sell the assets offered as security and realize the amount. is retained by the bank till its due date and is presented to the drawee on the date of maturity. they avoid granting loan for more than 5 years. Such loans are sanctioned against the security of immovable assets. In case the bill is dishonoured on due date the amount due on bill together with interest and other charges is debited by the bank to the customer’s account. Medium term loans are generally granted for heavy repairs. In case of medium term loan. like stock in trade and immovable property.e. the first and most important factor considered by a bank is the capacity of borrowers to repay the amount of loan . the bank can recover the amount by attaching the assets.discounted . we can divide the loans into two categories: (a) secured. The bank therefore. expansion of existing units. purpose. which are not covered by the security of tangible assets. Unsecured loans are those loans. These loans are granted for more than 15 months. manager or director. while granting loan against the security 24 . But the bank can hardly afford to take any risk in this regard and hence it also has the security of tangible assets owned by the borrower. and (b) unsecured. relies primarily on the character. nature and amount of the loan. The normal rate of interest ranges between 12% to 18% depending upon the period. Thus from the viewpoint of security of loans. 2. Such loans are granted to firms/institutions against the personal security of the owner. capacity and financial soundness of the borrower. modernization /renovation etc.

f. and the financial status of the borrower. overdraft etc) required. Procedure of granting Cash Credit. The procedure of applying for and sanction of loans and advances differs from bank to bank. 2. nature of security offered. etc. Bills of exchange. period of repayment. 25 . This enables the bank to recover the dues from the customer out of the sale proceeds of the assets in case the borrower fails to repay the loan. However. but all of those are not acceptable to the banks. etc). overdraft and through the discounting of bills. building. etc. There are various types of securities which may be offered against loans granted. a charge is created over the assets of the borrower in favour of the bank. cash credit. like Railway Receipt (R/R). motor-van. It includes all information required about the borrower. the steps which are generally to be taken in all cases are as follows: (I) Filling up of loan application form Each bank has separate loan application forms for different categories of borrowers. When you want to borrow money from a bank. nature of facility (cash-credit. advances. Documents of title to goods. you will have to fill up a loan application form available with the bank free of cost.of some assets. The loan application form contains different columns to be filled in by the applicant. a) Financial Securities (Shares and Debentures) b) Life-Insurance Policy c) Real estates (Land. Overdraft and Discounting Bills We have studied in this lesson that banks provide financial assistance to its customers in the form of loans. The types of securities generally accepted by the bank are the following: Tangible assets such as plant and machinery. Jewellery etc. purpose of loan. d) Fixed Deposit Receipt (FDR) e )Gold ornaments.

National Savings Certificate. depending on the amount of loan. as per agreement. and other documents. he is allowed to get the amount of loan/advance/ over draft as sanctioned by the bank. the bank credits the amount of bill to the customer’s account before the realization of the bill and thus. normally the Branch Manager himself can take the decision and sanction the loan. the application is considered at regional. (iv) Executing the Agreement When the loan is sanctioned by the bank and the borrower is informed about it. In case. If it is found to be feasible.A running business limit may be required to furnish additional information in respect of : — Assets and liabilities — Profit and loss for the last 2 to 3 years. he will have to execute an agreement with the bank regarding terms and condition for the amount of loan raised. makes available the fund. debentures. customers and bankers) for reference purposes. Kisan Vikas Patra. suppliers. In case of ‘discounting of bills’. the bill is dishonored 26 . If the loan is for Rs 5000 or less. zonal or head office level. (ii) Submission of form along with relevant documents The loan application form duly filled in should be submitted to the bank along with the relevant documents. When the borrower completes all the formalities. These securities may be immovable properties. In case the amount of loan is more than Rs 5000. — The names and addresses of three persons (which may include borrowers. (v) Arrangement of Security for Loan The borrower will now arrange for security against the loan. (iii) Sanctioning of loan The bank scrutinizes the documents submitted and determines the credit worthiness of the applicant. like. shares. the loan is sanctioned. fixed deposit receipts.

Current liabilities ware those liabilities which intended at their inception to be paid in ordinary course of business. The major current assets are cash. bill payable. the amount due on the bill together with interest and other charges are payable by the party whose bill is discounted. Definition:1. within a year.1. According to Guttmann & Dougall “Excess of current assets over current liabilities”. WORKING CAPITAL MANAGEMENT 3. The goal of working capital management is to manage the firm’s current assets and current liabilities in such way that the satisfactory level of working capital is mentioned. The basic current liabilities are account payable. will be. taxes owned to government)”. turned in to cash within one year without undergoing a diminution in value and without disrupting the operation of the firm.on due date. out of the current assets or earnings of the concern. the current liabilities and the inter relationship that exist between them. 27 . or. bank over-draft. The current should be large enough to cover its current liabilities in order to ensure a reasonable margin of the safety. The term current assets refers to those assets which in ordinary course of business can be. and outstanding expenses. marketable securities. accounts receivables. Chapter 3. inventories) over current items owned to employees and others (such as salaries & wages payable. accounts payable. account receivable and inventory. According to Park & Gladson “The excess of current assets of a business (i. cash. 1.Introduction Working capital management is concerned with the problems arise in attempting to manage the current assets.e.

Then the company has to spend some amount for labour and factory overhead to convert the raw material in work in progress. WIP. and sundry debtors and day to day cash requirements. 28 . The amount required to be invested in this current assets is always higher than the funds available from current liabilities. finished goods. As already observed.2) Need of working capital management The need for working capital gross or current assets cannot be over emphasized. Thus some amount of cash is blocked in raw materials. If the company has certain amount of cash. Technically this refers to operating or cash cycle. There is a need for working capital in the form of current assets to deal with the problem arising out of lack of immediate realization of cash against goods sold. it will be required for purchasing the raw material may be available on credit basis.3. To achieve this. This is the precise reason why the needs for working capital arise. it is necessary to generate sufficient profits can be earned will naturally depend upon the magnitude of the sales among other things but sales cannot convert into cash. and ultimately finished goods. However some part of current assets may be financed by the current liabilities also. Therefore sufficient working capital is necessary to sustain sales activity. the objective of financial decision-making is to maximize the shareholders wealth. Sundry debtors are converting into cash after expiry of credit period. These finished goods convert in to sales on credit basis in the form of sundry debtors.

the concept of working capital. Net working capital can be positive or negative. The cash outflows resulting from payment of current liabilities are relatively predictable. The cash inflow are however difficult to predict. Gross working capital and Net working capital There are two concepts of working capital management 1.3. He compared this with ‘constant capital’ which according to him is nothing but ‘dead labour’. Gross working capital Gross working capital refers to the firm’s investment in current assets. in work-in-process along with other operating expenses until it is released through sale of finished goods. This ‘variable capital’ is nothing This ‘variable capital’ is nothing but wage fund which remains blocked in terms of financial management. Although Marx did not mentioned that workers also gave credit to the firm by accepting periodical payment of wages which funded a portioned of W. as we understand today was embedded in his ‘variable capital’. the less net working capital will be required. among other things. first evolved by Karl Marx. Net working capital Net working capital refers to the difference between current assets and current liabilities. The more predictable the cash inflows are. 29 . Current assets are the assets which can be convert in to cash within year includes cash. The concept of working capital was.I. Efficient working capital management requires that firms should operate with some amount of net working capital. 2. short-term securities. on the nature of industries net working capital is necessary because the cash outflows and inflows do not coincide. debtors. Marx used the term ‘variable capital’ means outlays for payrolls advanced to workers before the completion of work.3. Current liabilities are those claims of outsiders which are expected to mature for payment within an accounting year and include creditors. bills payable and outstanding expenses.P. the exact amount varying from firm to firm and depending. bills receivable and inventory.

30 . means the total current assets.CONCEPTS ◊ ◊ Gross working capital referred to as working capital. The portion of current assets which is financed with long term funds.4. Net working capital can be explained in two ways : • • The difference between the current assets and current liabilities.3.

It should be compared with some standard. The liquidity of a business firm is measured by its ability to satisfy short-term obligations as they become due. A ratio in itself has no meaning. The two basic measures of a frrm’s overall liquidity are –  Current Ratio  Liquid ratio CURRENT RATIO The current ratio is the ratio of total current assets to total liabilities. Standards of comparison may consist of: • • • • • • • • • A)Past ratios B)Competitors ratios C)Industry ratios D)Projected ratios A)Liquidity Ratio B)Degree of financial leverage of debt C)Profitability C)Efficiency D)Value The most frequently used ratios by bank and financial analysts are: The task of financial manager in managing working capital efficiently is to ensure requisite liquidity in the operations of the enterprise. It is calculated by dividing current assets by current liabilities. CURRENT ASSETS CURRENT RATIO = ---------------------------------CURRENT LIABILITIES 31 . a ratio is used as a benchmark for evaluating the financial position and performance of the firm.CALCULATION OF FINANCIAL RATIOS Ratio analysis is a powerful tool of financial analysis. In financial analysis.

32 .33. consist of –  Trade creditors  Bills payable  Working capital credit by banks  Provision for taxation  Dividends payable  Outstanding expenses The current ratio of a measures its short term liquidity. LIQUID RATIO: The acid test ratio provides a check on the liquidity position of a firm. the larger is the amount of rupees available per rupee of current liability. The acidtest ratio is a measure of liquidity designed to overcome the shortcomings of the current ratio. The higher the current ratio. its ability to meet short-term obligations. as originally contemplated. The current ratio measures the size of the short-term liquidity ‘buffer’. within a tear. The firm should maintain sufficient/ requisite amount of current assets which should be larger than current liabilities so that the firm would be assured of being able to pay its current maturing debts as and when it becomes due. A satisfactory current ratio would enable a firm to meet its obligations.Current assets include –  cash and bank balances  marketable securities  Inventory of raw materials  Semi-finished goods or work-in-progress  Finished goods  Debtors net of provision for bad and doubtful debts  Bills receivables  Prepaid expenses The current liabilities are defined as liabilities which are short-term maturing obligations to be met. Ideal current ratio should be 1. that is. the more is the firm’s ability to meet current obligations and the greater is the safety of funds of short-term creditors. The quick ratio or the acid test ratio is a more rigorous and penetrating test of the liquidity position of a position.

 Current liabilities exclude the bank borrowings. So. an acid-test ratio of 1:1 is considered satisfactory as a firm can easily meet all current claims. QUICK ASSETS LIQUID RATIO= ---------------------------------------CURRENT LIABILITIES The term quick assets refers to current assets which can be converted into cash immediately or at a short notice without diminution of value. The acid test ratio is the ratio between quick current assets and current liabilities and is calculated by dividing the quick assets and current liabilities. Prepaid expenses by their very nature are not available to pay off current debts.It is often referred to as quick ratio because it is a measurement of a firm’s ability to convert its liabilities. Thus. the ratio can be written as QUICK ASSET — PREPAID EXPENSES — INVENTORIES LIQUID RATIO= ------------------------------------------------------------------------------------------CURRENT LIABILITIES — BANK BORROWINGS Generally. Quick asset includes  Cash and Bank balances  Short-term marketable securities  Debtors/ receivables And it excludes  Prepaid Expenses  Inventory. The reason of excluding inventory is that it is not easily and readily convertible into cash. it is a measure of quick or acid liquidity. 33 .

Interest Coverage (or Times Interest Earned) Ratio = Earnings before Interest and Taxes / Annual Interest Expense This shows the firm’s ability to cover fixed interest charges (on both short-term and long-term debt) with current earnings. repayment of principal and periodic interest. with either of the above ratios. This is a question that can be answered only by further company and industry research. leases. it will be forced into bankruptcy. If the company is unable to pay its debt.e. i. Note that total debt includes short-term debt (bank advances + the current portion of long-term debt) and long-term debt (bonds. The margin of safety that is acceptable varies within and across industries. as applicable (e.ANALYZING DEBT: Debt ratios show the extent to which a firm is relying on debt to finance its investments and operations. and also depends on the revenue generation history of a firm (especially the consistency of earnings from period to period and year to year). -equity income + minority interest in earnings of subsidiary + deferred income taxes + depreciation + depletion + amortization expenses) Since depreciation is usually the largest non-cash item in most companies. the more conservative (and probably safer) the company is. Cash Flow Coverage = Net Cash Flow / Annual Interest Expense Net cash flow = Net Income is either subtracted from or added to non-cash items. and allows it to exploit business opportunities and grow. Leverage Ratios Debt to Equity Ratio = Total Debt / Total Equity This shows the firm’s degree of leverage or its reliance on external debt for financing. if a company is not using debt. On the positive side. notes payable) 1. and how well it can manage the debt obligation. it may be foregoing investment and growth opportunities. However. 34 . Debt to Assets Ratio = Total Debt / Total assets In general. use of debt is beneficial as it provides tax benefits to the firm. the lower the ratio. analysts often approximate Net cash flow as being equivalent to Net Income + Depreciation.g.

Net Profit Margin = Profit after taxes / Sales Return on Assets (ROA) = Profit after taxes / Total Assets Return on Equity (ROE) =Profit after taxes / Shareholders‟ Equity (book value) Earnings per Common share (EPS) = (Profits after taxes . Past or current profits are important only as they help us to ascertain future profits. If a company is showing high profits but has poor cash flow. Inventory Turnover = Cost of Goods Sold / Average Inventory This ratio shows how quickly the inventory is being turned over (or sold) to generate sales. The higher the ratio. ANALYZING PROFITABILITY: Profitability is a relative term. or the average inventory is sold in a month. Analysts prefer ratio #3 to ratio #2. Accounts Receivable Turnover = Annual Credit Sales / Average Receivables Average Collection period = Average Accounts Receivable / (Total Sales / 365) 35 . on competitive conditions in the industry. The inventory ratio shows how fast the inventory is being produced and sold.Preferred Dividend) / (# of common shares outstanding) Payout Ratio = Cash Dividends / Net Income. and on borrowing costs. A higher ratio implies the firm is more efficient in managing inventories by minimizing the investment in inventories. It is hard to say what percentage of profits represents a profitable firm. by identifying historical and forecasted trends of profits and sales. bank is mainly concerned with the present value of expected future profits. ANALYZING EFFECIENY: These ratios reflect how well the firm’s assets are being managed. one should investigate further before passing a favorable opinion on the company. Thus a ratio of 12 would mean that the inventory turns over 12 times. the better is the performance of the bank. as profits depend on factors such as the position of the company and its products on the competitive life cycle (for example profits will be lower in the initial years when investment is high). Total Assets Turnover = Sales / Average Total Assets This ratio shows how much sales the firm is generating for every dollar of investment in assets. For decision-making.Cash flow is a “critical variable” in assessing a company.

Thus days in Inventory and inventory turnover ratios are related. 36 . For example. VALUE RATIOS: Value ratios show the “embedded value” in stocks. be an act of default. it is calculated by: Net Operating Income/Total Debt Services A DSCR of less than 1 would mean a negative cash flow. Price to Earnings Ratio (P/E) = Current Market Price per Share / After-tax Earnings per Share 2. 1.95 would mean that there is only enough net operating income to cover 95% of annual debt payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. in the context of personal finance. the easier it is to obtain a loan.The last two ratios show the firm’s efficiency in collecting cash from its credit sales. how quickly the manufactured product is sold off the shelf. this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. in some circumstances. Breaching a DSCR covenant can. While a low ratio is good. lenders frown on a negative cash flow. but some allow it if the borrower has strong outside income. In general. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender. The higher this ratio is. A DSCR of less than 1 say 0. Generally. and are used by investors as a screening device before making investments.e. it may be a loan condition or covenant. Days in Inventory = Days in a year / Inventory turnover This is referred to as the “shelf-life” i. Dividend Yield = Annual Dividends per Share / Current Market Price per Share DEBT SERVICE COVERAGE RATIO: The debt service coverage ratio (DSCR) is the ratio of cash available for debt servicing to interest. it could also mean that the firm is being very strict in its credit policy. which may not attract customers. principal and lease payments.

To carry on business certain minimum level of working capital is necessary on continues and uninterrupted basis. while temporary working capital is fluctuating in the case of an expanding firm the permanent working capital line may not be horizontal. This portion of the required working capital is needed to meet fluctuation in demand consequent upon changes in production and sales as result of seasonal changes Fig 2. because of the cash cycle.3. this requirement will have to be met permanent as with other fixed assets.5) Type of working capital The operating cycle creates the need for current assets (working capital).However the need does not come to an end after the cycle is completed to explain this continuing need of current assets a destination should be drawn between permanent and temporary working capital. This requirement refers to as permanent or fixed working capital 2) Temporary working capital Any amount over and above the permanent level of working capital is temporary. Working Capital Graph shows that the permanent level is fairly castanet. 1) Permanent working capital The need for current assets arises. This may be because of changes in demand for permanent current assets might be increasing to support a rising level of activity. fluctuating or variable. 37 . working capital. as already observed. For all practical purpose.

As such. may increase the production and sales to take the benefit of favorable market. due to their very nature. there may more and more amount of funds blocked in stock and debtors etc. that their requirement of fixed capital is more rather than working capital.3. Business/ Trade cycle If the company is the operating in the time of boom. But if the business start growing after certain limit. Naturally there need of working capital is high. no founds are blocked in piling inventories and also no funds are blocked in receivables. as such medium size business positively has edge over the small companies. 2. working capital may be high as the sales terms of value and quantity may be reducing. where requirement of fixed capital is less but more money is blocked in inventories and debtors. Length of production cycle In some business like machine tools industry. similarly in the case of depressions also. Nature of business Some businesses are such.g. there requirement of working capital is less. the working capital requirement may be more as the company may like to buy more raw material. 4. Size and growth of business In very small company the working capital requirement is quit high due to high overhead. 3. These businesses sell services and not the commodities and that too on cash basis.public utility services like railways. E. due to increase in the sales. 38 . higher buying and selling cost etc. the time gap between the acquisition of raw material till the end of final production of finished products itself is quite high. the receivable may not be recovered in time etc.6 Determinants of working capital The amount of working capital is depends upon a following factors 1. there are some businesses like trading activity. the working capital requirements may adversely affect by the increasing size. As such amount may be blocked either in raw material or work in progress or finished goods or even in debtors. On the other hand. infrastructure oriented project etc. there may be unnecessary piling up of stack without getting sold.

the need for working capital is less. as result which more and more amount is locked up in debtors or bills receivables which increase the working capital requirement. 8)Production policy – The quantum of working capital is also determined by production policy. because the profits to the extent that they earned in cash may be used to meet the working capital requirement of the company. in the case of purchase.5. a part of working capital requirement may be financed by them. 39 . the working capital requirement will be higher. Higher book debts mean more working capital. The credit terms granted to customers have a bearing on the magnitude of working capital by determining the level of book debts. On the other hand. that is. but it is necessary to purchase on cash basis. but high profitability will positively reduce the strain on working capital requirement of the company. they are purchased during the certain months of the year. On the other hand. the demand for products is seasonal. 9) Credit policy— The credit policy relating to sales and purchases also affects the working capital. which is in turn its depend on numerous factors. Profitability The profitability of the business may be vary in each and every individual case. if the credit is offered by suppliers of goods and services. The credit policy influences the requirement of working capital in two ways: • • Through credit terms granted by the firm to its customers/ buyers of goods Credit terms available to the firm from its creditors. it may be necessary for the company to extend more and more credit to customers. Terms of purchase and sales Some time due to competition or custom. it can operate in profits which may reduce the strain on working capital. it may ensure proper utilization of existing resources by eliminating the waste and improved coordination etc. The credit sales result in higher book debts (receivables). In the case of certain lines of business. 7) Operating efficiency If the business is carried on more efficiently. if liberal credit terms are available from the suppliers of goods (trade creditors). 6.

affects the working capital to that extent. The availability of internal funds for working capital requirements is determined not merely by the profit margin but also by the manner of appropriating profits. thereby. cash is used for augmenting stock. the firm might be compelled to purchase and stock them far in excess of genuine production needs. in a sense. in the net profit. The amount of taxes to be paid is determined by the prevailing tax regulations. a basic question to be decided is whether profits will be retained or paid out to shareholders. Tax liability is. an important aspect of working capital planning. If any firm does not pay dividend but retains the profits. But it is true that growth industries require more working capital than those that are static. 13) Level of taxes – The first appropriation out of profits is payment or provision for tax. In general. Higher profit margin would improve the prospects of generating more internal funds thereby contributing to the working capital pool. But in practice. To sustain smooth production. of course. This will result in an excessive inventory of such materials. working capital increases. The net profit is a source of working capital to the extent that it has been earned in cash. it leads to an increase in the requirement of working capital and vice versa. If tax liability increases. it is logical to expect that a larger amount of working capital is required. short-term liability payable in cash. 40 . 12) Profit level – The level of profits earned differ from enterprise to enterprise. therefore. the nature of the product.10) Growth and Expansion— As a company grows. There may be some materials which cannot be procured easily either because of their sources are few or they are irregular. 14) Dividend policy – Another appropriation of profits which has a bearing on working capital is dividend payment. The cash profit can be found by adjusting non-cash items such as depreciation. hold on the market. book debts. It is. quality of management and monopoly power would determine the profit earned by a firm. therefore. difficult to determine precisely the relationship between the growth in the volume of business of a company and the increase in its working capital. 11) Vagaries in the availability of Raw Material – The availability of certain raw materials on a continuous basis without interruption would sometimes affect the requirement of working capital. The payment of dividend consumes cash resources and. In planning working capital requirements. An adequate provision for tax payment is. This will lead to a relatively high level of working capital. therefore. and fixed assets. outstanding expenses and losses written off.

Rising prices necessitate the use of more funds for maintaining an existing level of activity. 3.15) Depreciation policy— Depreciation policy also exerts an influence on the quantum of working capital. The effect of depreciation policy on working capital is indirect. higher cash layouts are required. 16) Price level changes – Changes in the price level also affect the requirements of working capital. Depreciation charges do not involve any cash outflows. To conclude. there is no serious problem regarding working capital. The effect of rising prices is that a higher amount of working capital is required. In the case of companies which can raise their prices proportionately. WORKING CAPITAL CYCLE 41 . For the same level of current assets.7. Efficient working capital management requires efficient planning and a constant review of the needs of an appropriate working capita strategy. the level of working capital is determined by a wide variety of factors which are partly internal to the firm and partly external (environmental) to it.

AR converted to cash


Collect Account receivable Sales Order Deliver goods/services

Cash to inventory Goods/services converted to accounts receivable Fig 3. Working Capital Cycle Produces goods/services



Working Capital is financed by following sources: •OWNED FUNDS A portion of long term funds, equity share capital and reserves & surplus is utilized to fund working capital •BANK BORROWINGS Various bank products like cash credit, packing credit, bills discounting etc. •CREDITORS


Raw Materials


Finished Good


Trade Payables

Bank Borrowings

+ LongTermfunds

Fig 4. Cash operating Cycle

3.9. WORKING CPITAL PRODUCTS Working Capital Products are broadly classified under three categories: 43


Cash Credit Over Draft Facility Bill finance Documentary Clean

• • • •

B) Export

Pre-shipment Postshipment

2) NON FUND BASED • • Letter of Credit Bank guarantee

3) STRUCTURED PRODUCT • • • • Commercial Papers Buyers’and Suppliers’ Credit Corporate Loan Securitisation 44

method and quantum of short-term finance that can be granted to a corporate was mandated by the Reserve Bank of India till 1994. 2crores (Rs. Estimated Sales Turnover as on current year 2. stipulated net working capital. 7. The calculation of bank finance under this method is as follows: 1. Maximum Permissible Bank Finance (5 or 6 whichever is lower)  MPBF-II METHOD— Borrowers enjoying working capital limits of Rs. Available net working capital in the past financial year 5. 5% of the Estimated Turnover as on current year 4. generally the banks evolved their lending policy accordingly to which borrowers with working capital limits upto Rs. 25% of the Estimated Turnover as on current year 3. 2 – 3 6.25% of total current assets . will be assessed as per the entirely traditional method of arriving at Maximum Permissible Bank Finance (MPBF) calling for the CMA data.5 crore and above for SME borrowers) and upto Rs. Min. 2 – 4 XXXX Lacs XXX Lacs XXX Lacs XXX Lacs XXX Lacs XXX Lacs XXX Lacs 7. Working Capital Gap XXXX Lacs XXX Lacs XXX Lacs 45 4. Total Current Assets 2.5 crore for SME borrowers) which will be assessed as per Nayak Commiittee Recommendations ( TURNOVER METHOD).VARIOUS METHODS OF WORKING CAPITAL ASSESSMENT: Like many other activities of the banks. 7. NAYAK COMMITTEE METHOD— With freedom given to the banks in evolving their own method of lending. 1.• • Factoring Forfeiting 3.10. 2 crore and above (Rs. Current Liabilities (other than bank borrowings) 3. 10 crores.

bankers are stipulating 50% margin on book debts and in case of valued debtors they are lowering the margin to the tune of 40% to 30% on case to case basis. Maximum permissible by bank finance (item 6 or 7 whichever is lower) 9. Excess borrowings. if any representing short fall in NWC (4-5) Excess borrowing (short fall in NWC) shall be ensured by additional funds to be brought in by the applicant or by additional bank finance over MPBF..e. Item 3 minus item 5 8. owned funds plus term borrowings. Consequently. A certain level of credit for purchases and other current liabilities will be available to fund the buildup of current assets and the bank will provide the balance (MPBF). Actual / projected net Working capital 6. Generally. Important Aspects of MPBF method • • • • Production/Sales estimates Profitability estimates Inventory/receivables norms Build up of Net Working Capital CMA data is a tool used by the bankers to assess the requirement of working capital.other than export receivables 5. Under this method. total current liabilities inclusive of bank borrowings could not exceed 75% of current assets specially inventory. it was thought that the borrower should provide for a minimum of 25% of total current assets out of long-term funds i. Item 3 minus item 4 XXX Lacs XXX Lacs XXX Lacs XXX Lacs XXX Lacs XXX Lacs 7. It is divided into six parts as follows: Form-I Particulars of Existing & Proposed Limits Form-II Operating Statement Form-III Analysis of Balance Sheet Form-IV Comparative Statement of Current Assets & Current Liabilities Form-V Computation of Maximum Permissible Bank Finance (MPBF) Form-VI Funds Flow Statement 46 .

 It does not give any clue whether a company is earning profit or not. 47 .  Funds flow statement is required to detect any diversion of funds. the existing system of assessment under the Cash Budget Method is followed. But this method does not include Funds flow statement. Limitations:  Will not reflect changes in various current assets and current liabilities. This method is applicable for:  Seasonal industries (sugar/ rice/ mills/ textiles/ tea/ tobacco/ fertilizers)  Contractors  Real Estate Developers  Software Exporters Borrowers enjoying working capital limits of Rs. For industries like the mentioned above where in the pattern of financing the peak cash deficit(s) is followed all along. 10 crores and above option has been given to the borrower to be assessed as per the Cash Budget Method.Limitations:  Represents position on a particular date  Not tuned to Peak Time Assessment  Not applicable for service industries  In practice may differ with Drawing Power  CASH-BUDGET METHOD In this method credit appraisal is entirely done by total inflows and outflows of the firm/ company during peak season and slack season throughout the year.

financial institutions are normally interested in the actual loan amount to be repaid along with the interest. KVPs. LICs.Chapter 4 CREDIT APPRAISAL AND MONITORING: COMMON ISSUES 4. NSCs. Proper evaluation of the customers is performed which measures the financial condition and the ability of the customer to repay back the loan in future.1. the credit facilities are extended against the security for which the credit limit is being sanctioned. to be considered as COLLATERAL SECURITY for the credit limits sanctioned by them. 48 . It is generally carried by the financial institutions which are involved in providing financial funding to its customer. WHAT IS CREDIT APPRAISAL? Credit appraisal is a process to ascertain the risks associated with the extension of the credit facility. it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Generally. immovable properties. known as PRIME SECURITY. Apart from that. But even though the loans are backed by collateral. Credit risk is a risk related to non-payment of the credit obtained by the customers of a bank. Thus. financial institutions take some other securities like fixed deposits.

Apart from that bankers are to obtain the market reports of the proposed borrower as also credit opinion from other banks/ financial institutions. A profile of the firm/ company.Fig 5. as per INDIAN BANKS ASSOCIATION (IBA) approved format. Estimates/ projections (with quantitative details) Asset liability statement of the borrowers/ guarantors. DATA TO BE OBTAINED FOR CREDIT ASSESSMENT:       Loan application of the credit facilities. Credit Appraisal 4.2. Supporting details of the financials including income tax return. In spite of that due to latest technological improvements bankers are viewing any default of payments towards credit obligations from other financial institutions through online CIBIL System. Financial Statements of previous years. 49 . if any. stock/ book debt statements etc.

Whenever borrower submits IT Return then it should be ensured that it has been filed every year rather all a time or in a short span of few months. 15 Lacs & above. It is obvious from such so-called compliance that IT Return has been filed just to meet the stipulation for processing of loan application. Bank should stipulate the condition that expansion plans would be executed only after consulting bank. Bank should stipulate the condition that unsecured loans should not be withdrawn till currency of Bank Loan. Loan should not be granted on the basis of income affidavit submitted by borrower.3.4. Bank should stipulate the condition that Key personnel appointment will be approved / confirmed 50 . Apart from obtaining usual credit report from existing bankers. Net worth of secureties should be ascertained to confirm that he has the capacity to pay the loan in case of default by borrower. CREDIT MONITORING: Common Issues Caution needs to be exercised when loan is to be sanctioned to a party who operates in rented premises and leave & license agreement period is less than repayment period of the loan. Reasons for not filing IT Return should be enquired. Specific enquiry should be made for approaching IOB and whether loan application has been simultaneously submitted to other banks. it is also necessary to find out from other sources about the borrower’s operation with that banker as it is quite likely for any banker to give normal report if they do not wish to retain account. Bank should prepare S (Strength) W (Weakness) O (Opportunity) T (Threat) analysis in case of advances of say Rs.

insurance policy. should be available on record. valuation report etc. KVP etc. in case he cannot close the account with other banks as the same may be required for ST. In such case. inspection report. then stamped receipt. Audit report. Flat. Assets & Liabilities statement of Borrower. of Borrower. Undertaking to deal exclusively with our bank is obtained and borrower blindly executes the same. e.Return etc. bills. Directors. Shares. 51 . followed by his letter confirming the affixing the nameplate. LIC. I. Burglary etc. Partners and Guarantors should be obtained every year. Bank’s nameplate should be given to borrower and his acknowledgement should be taken. Valuation report should be obtained say once in three years of security offered such as Land. Excise etc. Directors. Machinery. NSC. Accounts. More so when effective/economical life of the asset hypothecated is less than repayment period of loan. then we should specifically give permission & bank statements should be obtained monthly of such accounts Bank. installation report. Security documents should be verified periodically to confirm with entries in Security Register. depending on type of loan.T. Residential flat. and Vehicle etc. Term Loans should be reviewed every year. Collateral security should be taken to the extent possible. Caution is called for whenever lump sum payment is arranged by borrower to regularize the loan account. Post dated cheques (payable fortnightly) should be taken from large borrowers (New) as well as from existing borrowers not repaying the loan regularly Insurance policy of adequate sum should be taken covering the appropriate risks such as Fire. Bank should stipulate that borrower should submit Monthly Information as per the format stipulated by Bank. In case the same is to be reimbursed to borrower. Vendor etc. Gala.Otherwise account closure certificate should be obtained Disbursement should be directly made to Builder. In fact we are aware that borrower is operating with other banks. Partners and Guarantors should be obtained in November every year.

1 Additional requirements in case of Loan is granted to Company: • • • • Search Report of ROC records should be obtained in case loan is proposed to be given / Company Secretarial Compliance Report should also be obtained in case loan has Board resolution for making loan application to a Bank should also be obtained along with Board resolution for acceptance of terms & conditions of sanctions and for execution of given to Pvt. Loan application.Bank should avoid the temptation of ever greening / window dressing the CC / Loan account Recovery notice should be sent whenever overdue is noticed. documents should be kept on record. Or Public ltd. • • Common seal of the company should be affixed on all documents executed by the Form 8 & Form 13 should be filed with ROC within 30 days of loan documentation.3. Company. should be ascertained. then borrower should be requested to enhance authorized Capital List of shareholders & their relationship with the promoters /management of the company Details of Shareholding should be obtained. If Authorized capital is not adequate to accommodate promoter’s capital clause immediately. • • • • • • approval of Bank. Or Public ltd. Bank should stipulate the condition that dividend should not be declared without Promoter’s contribution should be brought in the form of Capital. . The said resolution should be typed on Company’s letterhead and authenticated by chairman of the meeting and not by any director. Copies of various forms filed with ROC should be obtained such Annual Audited 52 company. Contribution. Company. 4. been given to Pvt.

Resolutions etc. branches. 4. should be obtained. Annual Return. Bank should stipulate condition that says 25 % profit & Salary due to partner should be retained in the business REGISTERS • HO should prescribe the format of various loan registers to be maintained by HO should arrange to print these registers or procure them on behalf of branches to Security register (computer) should be up dated regularly. Relevant registration referred to confirm the Xerox copy.2 Additional requirements in case of Loan is granted to Firm: • • Certified true copy of Partnership Deed should be obtained. Allotment of Shares. Agreements. • • ensure uniformity. operations with Co-operative bank and how bank account will be operated? • certificate and other papers filed should be kept on record. Original deed should also be Partnership deed should be referred to confirm as to whether firm could do banking Partnership should be registered with Registrar of Firms.3.Accounts. 53 .

Profitability and yield on advances should be in line with the banks objective.4. Liquidity of advances made by the bank indicates its ability to meet its deposit liabilities. although being a profit generating unit. continues to build and retain the trust of the public at large.4. 54 . The following principles act as the foundation of a judicious lending: • • • • • • • • Safety of funds ensures that the bank. It should not be anti. Integrity of borrower is very vital to consider the loan proposal envisaged by him for further sanction. so the advances made must be successful. Security accepted from the borrower as an alternative for recovery of advances in case of default must be of significant value. Timely availability of funds to the borrowers helps the bank grow in the current scenario. Adequacy of bank finance is of prime importance for a borrower to accomplish his project so both under and over financing should be avoided by the bank. all mortgage originators should act in "good faith and with fair dealings" in any transaction. PRINCIPLES OF LENDING According to general principles of lending. A reliable customer forms the basis of a successful lending. Purpose or the objective of advances should remain in favor of nation‟s security. so the advances made should be adequately or illegal.

These principles strengthen the bank finance eventually leading to safe advances. To determine minimum capital requirements. There are three fundamental components to calculate the minimum capital requirement according to Basel II. Basel II PILLAR 1 It sets principles for minimum capital requirements to cover both credit and operational risks. 4.5. It is taken as equity in banks accounts.5 PRINCIPLES OF BASEL II ACCORD 4.1 Basel II consists of three pillars Fig 6. 55 . a bank can either use external sources or an internal rating base approach. Capital requirement is a guarantee amount against unexpected losses.

When supervisors think the validity of the rating process is not adequate. Banks should have a process for assessing overall capital adequacy in relation to their risk profile. The minimum capital requirement (MCR) estimation is shown in with respect to Basel II: MCR = 0. RWA is the risk weighted asset. Banks are expected to manage their internal capital assessments. LGD and remaining maturity of exposure. PILLAR 2 It defines principles for supervisors to review assessments to ensure adequate capital. they can take appropriate actions. Supervisors review process.08 RWA Here RW is the risk weight calculated by using PD. EL = PD*EAD*LGD MCL=EAD*LGD*PD-b*EL Where EL is the expected loss and b is the proportion of expected loss of loan covered by minimum capital requirement. b) Loss Given Default (LGD): It is the proportion of the exposure that will be lost if the applicant defaults. c)Exposure at Default (EAD): The nominal value of loan granted.a) Probability of Default (PD): It is the likelihood that an applicant will default in one year time period.08*RW*EAD = 0. to be sure that banks have adequate and valid techniques for capital requirements. The rating system and risk management activities are checked by supervisors. It has specific formulas for each asset type. Accurate and valid techniques lead to better credit risk management for the banks. there is a relation between capital required and banks risk. According to Basel Committee. PILLAR 3 56 . Supervisors are responsible for the review and evaluation of the assessment procedure. They can take early stage actions to prevent capitals from falling below the minimum levels required to support the risk characteristic.

According to the new accord. For each separate risk areas banks must describe their risk management objectives and policies. Its purpose is to maintain the market discipline by completing pillar 1 and pillar 2. banks should have a disclosure policy and implement a process to evaluate the appropriateness of the disclosure.It sets principles about banks disclosure of information concerning their risk. 57 . The Basel Committee encourages market discipline by developing sets of disclosure requirements.

One of the grades should be for no defaulted obligor and one for defaulted only. • The bank consents to a distressed restriction of credit obligation.2 PD Dynamics Probability of default is one of the challenging factors that should be estimated while determining the minimum capital requirement. Banks should have a rating system of its obligor with at least 7 grades having meaningful distribution of exposure. New Accord has sets principles in estimating PD. For each grade there should be one PD estimate common for all individuals in that grade. It is called as pooled PD. a) Historical experience approach: In this approach. firstly predictive statistical models are used to estimate default probabilities of obligor’s. for each grade the mean or median of PDs are taken as pooled PD. Then. b)Statistical Model Approach In that approach. • The obligor sought or has been placed in bankruptcy. the proportion of defaulted obligers in a specific grade is taken as pooled PD.4. There are three approaches to estimate pooled PD. b) The obligor past due more than 90 days on credit obligation to the bank. In other words. According to Basel II. c)External Mapping Approach 58 . there are two definitions of default: a) The bank considers that the obligor is unlikely to pay its credit. PD for the grade is estimated by using the historical observed data default frequencies. There are four main indicators that bank considers the obligor is unlikely to pat the obligation: • The bank puts the obligation on an non-accrued stratus • The bank sells the credit obligation at a material credit related economic Loss.5.

the rating classes are needed to be built.In this approach. While establishing the internal rating process. the historical data should be at least 5 years. After the estimation of PDs. the best model should be taken as the primary model representing the data. The scoring models are built by using a subset of available information. firstly a mapping procedure is established to link internal ratings to external ratings. Banks should guarantee to the supervisor that the estimates are accurate and robust and the model has good predictive power. The pooled PD of external rating is assigned to internal rating by means the mapping established before. Human judgment is also needed when evaluating and combining the results. Where only limiting data are available or there are limitations of assumptions of the techniques. just building the model is not enough supervisors need to know not only the application also the validity of the estimates. For this purpose. While determining the variables relevant for the estimation of PD. 59 . There should be only one primary technique used to estimate PD. banks should use human judgment. Therefore. The banks are allowed to use the scale of external institutions. Basel II allows the banks to use simple averages of one year default rates while estimating pooled PD. the other methods can be used just for comparison. In the PD estimation process. and the data used to build the model should be representative of the population. The margin of conservatism is determined according to the error rates of estimates depending on the satisfactory of the models. banks should add the margins of conservatism in their PD estimates to avoid over optimism. a validation process should be built.

60 .4. Essentially. stability and profitability of a business. financial analysis moves from a preliminary investigation of the client to an in depth examination of operating performance. sub-business or a project. as interpreted from historical and projected financial statements. It refers to an assessment of the viability. its present conditions and its future prospects.6 FINANCIAL ANALYSIS OF LENDING Financial analysis is the systematic examination and interpretation of financial data to evaluate the past performance of a business. the advances manager assesses the financial performance of the company to arrive at a conclusion about the future prospects of the loan repayment. With financial analysis.

its ability to pay its obligation to creditors and other third parties in the long-term. without having to sustain significant losses in the conduct of its business. A company's degree of profitability is usually based on the income statement.the firm's ability to remain in business in the long run. 61 . Solvency . Profitability .its ability to earn income and sustain growth in both short-term and long-term.6. Assessing a company's stability requires the use of income statement and balance sheet. 3.4. Liquidity . 4.1 FINANCIAL ANALYSIS ASSESSES THE FIRM’S: 1. while satisfying immediate obligations. which reports on the company's results of operations.its ability to maintain positive cash flow. 2. as well as other financial and non-financial indicators. Stability.

Notes accompanying the financial statements are also reviewed for additional information that may be significant to analysis. For example. relevant research about the company is done from the information available to find out the reason. The advances manager looks for the trends overtime. due to acquisitions or new facilities? Has the portion of debt grown rapidly.4. Revenue (sales) 2. earnings) For each key expense components on the income statement. Graphs and growth of the following entries over the past several years are calculated. If there is something suspicious. For example. percentage of cost of goods sold over sales. While examining. general and administrative 62 . to reflect a new financial strategy? Step 4: This level relates to an assessment of the income statement as furnished by the client.2 STEPS INVOLVED IN FINANCIAL ANALYSIS OF LENDING Step1: Company’s financial statement for at least 3 to 5 years is acquired. The financial statement must include the following:  Balance sheets  Income statements  Shareholders equity statement  Cash flow statements Step 2: A quick scanning of all the statements is done to look for large movements in specific terms from one year to the next. the advances manager looks for the large changes in overall components of company‟s assets and liabilities of equity. Net income (profit. have fixed assets grown rapidly in one or two years. 1. Step 3: This stage calls for an exhaustive scrutiny of the balance sheet. percentage of sales of each year is calculated.6.

00 60-90 45-90 1.50 >10. It gives information about the cash inflows and outflows from operations.25-2.00-10.20 <3. While the income statement provides information about both cash and non-cash items.00 63 . KEY RATIO LEVELS PARTICULARS LOW RISK Current Ratio TOL/TNW Interest Coverage PAT/SALES% Inventory (No.75 1.00 >3. Favorable and unfavorable trends are highlighted.25 days Debtors (No.50 2.00-3. of days <45 Debt –Equity Ratio <1.25-1.00 <4.00-3.25 DSCR (For TL) >2.Discussed in Chapter 3.40 2.40 <2. financing and investing.75 <1.00 >90. the cash flow statement attempts to reconstruct that information to make it clear how cash is obtained and used by the business.00 >90. of > 1.expenses over sales and development over sales are computed.50 4. Manager determines whether the spending trends support the company‟s strategies.00 <60 MEDIUMRISK 1.20-1.00 >1. Step 6: Calculation of financial ratios.50 <2. since that is what investors really care about. Step 5: The very phase pertains to an evaluation of the cash flow statement.00 Table 1: Key ratio levels HIGH RISK <1.


It is possible that certain industries may have production cycle of shorter/longer 3 months.the same may be sanctioned as there after decide the quantum of need based RBI guidelines stipulate bank finance at finance. If credit whether it is intended that banks should also requirement based on production/processing arrive at the requirement based on the traditional cycle is higher than the one assessed on project approach of production /processing cycle and turn over basis . In case the cycle is longer .the same principal could be applied as it the 65 intention to make available atleast 20% of turnover by way of bank finance. C Whether 5% promoter’s stake (Net Working In terms of extant guidelines the working Capital) should be reckoned with reference to the capital requirement is to be assessed at 25% of projected turnover with reference to working projeted turnover to be shared between the capital arrived at based on production and process borrower and bank viz.Issues raised by banks 1 Clarification 2 A Whether banks should sanction working capital The assessment of working capital credit limits limits on the basis of a minimum of 20 percent of should be done both as per projected turnover the projected annual turn over /output value or method and traditional method .whether bank should still give 20% ? projected turn over basis.the working capital finance arrived at could be the other hand of it the assessed credit either more than or less than .may be ‘gross sale’ interpreted as ‘gross sale’ which will include excise duty also. borrower contributing cycle ? 5% of the turnover as NWC and bank providing finance at a minimum of 20% of the turn over .actual drawals may be allowed on the basis of drawing power to be determined by the banks after excluding unpaid stocks. B Whether projected turnover/output value basis The projected turnover/output value .it is expected that the borrower .While in the case of shorter cycle .On .The above guideline were framed assuming the average production cycle of 3 months .In case it is less requirement is lower than the one assessed on than 20%. In case of selective credit control commodities the drawing power should be determined as indicated in the RBI directives.If the traditional approach is followed minimum of 20% of the projected turnover.while the credit limit can be sanctioned at 20% of the projected turn over .

66 .

C. It is expected that with the intervention of this lucrative branded BEER market. XXX Co. For this. their sales turnover would increase by leaps and bounds. 35 Lacs on 08-04-2003. They belong to the same family. 95 Lacs to the tune of Rs. 95 Lacs on 20-09-2004. A CASE STUDY While undergoing my project work under the guidance of Indian Overseas Bank authority. In this year. The business is sound and progressing. Mrs. Sales are going on increasing over the years. C. ( Name of the firm changed ) which is a trading concern dealing in Indian manufactured foreign liquor (IMFL). Partners are creditworthy. B and Mr. At first they availed a cash credit facility of Rs. A. Earlier in this nature of business a sizeable quantum of credit could be obtained from the manufacturers/ stockists. The unit being established on 09/09/2001 started wholesale dealership trading in Indian manufactured foreign liquor and beer since 2003. 200 Lacs.Chapter 5. but as per recent trend almost all the payments are to be made in advance to get the stocks due to shortage of supply and huge demand of the product resulting in stiff competition amongst the wholesale dealers. B and Mr. after then it had enhanced to the tune of Rs. well experienced and enjoying goodwill in the market. In this trade. In this year they appealed the bank to enhance the existing credit limit of Rs. The 67 . the manufacturer fix the price of the product and allow a certain percentage of discount to the wholesaler. A is the mother of Mr. I have been assigned to do the Working Capital Assessment/Appraisal of a partnership firm M/s XXX Co. opened their account with INDIAN OVERSEAS BANK since 09-01-2003. This limit expired on 31-07-2009.. BACKGROUND OF THE FIRM XXX Co. they need further Working Capital. The retailer sells the product at the predetermined price. Mr. So long they used to avail the same credit facility without further enhancement. they got an offer of stockistship of BEER under the brand name of KINGFISHER STRONG and KINGFISHER PREMIUM product of eminent UB GROUP which has already gain a lions share in the field of BEER market. The wholesaler keep a portion of the discount with them and pass the remaining discount to the retailer. is a partnership firm promoted by Mrs.

Good location of the shop establishment and possibility of getting stockistship of renowned beer of UB group.88 Turn over 6. Knowledge and Experience Advance payment to the stockists for getting the stock. Conduct of the account for full financial year from 01-04-2008 to 31-03-2009 (Rs. on the contrary sizeable receivables from the retailers.19 Average Income Utilization Earned 97. In crores) Nature of facility Cash Credit From 01-04-2009 to 14-08-2009 Limit 0.97 0. Min. 68 .97 0.26% 96.95 Max. but the same is shown as other income in the balance sheet.14 0.04 Interest serviced Upto 31-03-2009 31-07-2009 Table 2: Nature of Facility SWOT ANALYSIS OF THE FIRM: STRENGTH: WEAKNESS: OPPORTUNITY: THREAT: Good Entrepreneurship.58 2. Competitors.84 0.23% 0.95 0. O/s O/s allowed by the manufacturer to them as Stockiest/ Dealers/ Wholesalers is a lump sum profit.

11 LIC-0. Shop cum Godown-0.85 Total-1.D-0.02 Flat-0.13 0. 200.76 F. A Mr.56 Shop cum Godown-1.53 AAA & Consultants Collateral security coverage is 76.78 1. The details are as follows: Table 3: Guarantors and their net worth NAME Mrs.-0.02 Cash Credit Flat-0.11 LIC-0.SUBJECT’S PRESENT REQUEST XXX Co.88 Total-1. C Mr.16 1. They submitted all the required data which is very much necessary for the approval of the request. B Mr.42 Proposed F.04 NSC-0.10 LIC-0.42 Shop cum Godown-0.00 Lacs to the tune of Rs.02 Dated Flat-0. D AGE 59 38 37 62 ADDRESS WORTH (in crores) 1.10 AS ON 10/08/2009 -do-do-do- Table 4:COLLATERAL SECURITY DETAILS (in crores) Nature of Security Market Value Forced Sale Value Proposed Valuation Other details/percentage of security cover Date & Name of Approved Valuer Existing F.03 Total-1.D.04 NSC-0.00 Lacs.D-0.03 NSC-0.48 20/08/2009.50% with the total exposure of the cash credit limit of 200 lacs 69 . requested for Renewal cum Enhancement of cash credit limit of Rs. 95.

20 – Rs.50 crores.INSURANCE Table 5: Securities Prime Securities Stocks Collateral Securities Building Value of the Securities 1. 1. They have done so because if the securities are being insured at undervalue. the insurance company will not compensate the actual value of the securities in case of any untoward incidence would take place. they have made insurance on building to the extent of Rs.30 0. it has been observed that on an average they are keeping stocks to the tune of Rs. 0. VALUE OF THE CUSTOMER 70 .92 Insured Value 1. 1.30 crores in their godown. Hence. ** Though the value of the Flat and godown kept with the bank as collateral security stands at Rs.13 (in crore) Valid Upto 23/11/2010 22/11/2010 ** As per stock statement submitted by the firm to the bank.50 1. 1. keeping some margin they have made insurance on stock valued at Rs. 1.92 crores but the valuation has been done two years ago.13 crores. Keeping in view towards the escalation of immovable properties valuation.

In the year 2008-2009. fixed deposits are being held at card rates i. The corporates are required by all banks to analyse their balance sheet in this specific format called CMA data format and submit to banks. therefore.04. the normal rate of interest on deposits to various types of customers approved by the competent bank authority. assumes a lot of importance. The classification of assets and balance sheet analysis. RBI has mandated a certain way of analyzing the balance sheets. All the data available in the Balance Sheet give by the XXX Co. We are hopeful for bringing few other low cost and no cost accounts through the subject(s).e.2009 to 14.08. While most qualified accountants working with the firms are aware of the method of classification in this format. The requirements of this breakup of assets and liabilities differs slightly from that mandated by the Company Law Board (CLB). Financial Analysts for this analysis.2009. are extracted and put it in the CMA format for the required analysis. CMA FORMAT The basic foundation of all banks' appraisal of the needs of creditors is the level of current assets. ASSESSMENT OF WORKING CAPITAL REQUIREMENTS FORM-I 71 . average balance stands @97. The analysis of balance sheet in CMA data is said to give a more detailed and accurate picture of the affairs of a corporate.26% of the existing limit and the same stands @96. professional help is also available in the form of Chartered Accountants.63% on & from 01..

Particulars of the existing/proposed limits from the banking system. BALANCE O/S AS ON 20-08-2009 LIMITS NOW QUEST ED Indian Overseas Bank.Rs. Chow ringhee branch Cash credit 95 97 84 93 200 ASSESSMENT OF WORKING CAPITAL FORM.II 72 . (Limits from all Banks and Financial Institutions s on the date of application) Table 6: FORM1 (AMOUNT. MIN. FINANCIAL INSTITUTIO N NATURE OF THE FACILITY EXISTING LIMITS EXTENT TO WHICH LIMITS WERE UTILIZED DURING THE LAST 12 MONTHS MAX. IN LACS) SL NAME OF THE BANK/ NO.

00 1167.86 1241.30 73 .GROSS INCOME i. SALES (NET OR RETURNS) a) Domestic sales 692. Commn & brokerage on purchase] iii.69 405.44 73.62 577.22 470.91 ii. Sub-total [v-vi] 3. OTHER INCOME a) Duty drawback b) Cash assistant/ 29.37 518.05 533.54 73.41 571.00 1077.49 24.30 164.COST OF SALES i.44 0.96 -30.34 540.25 636.Table 7:FORM II As per Profit and Loss accounts /estimates for the year ended /ending LAST THREE YEARS ACCOUNT CURRENT FOLLOWI (AS PER AUDITED ACCOUNTS) YEAR NG YEAR ESTIMATES PROJECTI 31-03-2006 31-03-2007 31-03-2008 ON 31-03-2009 31-03-2010 1. Less : closing stock vii.78 505.05 514.03 13. Add: opening stock v.78 1167.22 1134.75 0.34 660.34 11.00 470.56 d) Percentage rise [+] or fall [-]in sales turnover as compared to previous year (%) ii.14 21.68 1158.80 53. Sub-total [ iii + iv] vi.00 518.60 171.17 483. Total [i]+[ii] 722.26 11.20 74. Other trading expenses [ carriage onward.18 53.12 540.75 44.65 622. Purchases 401.00 586.41 461.86 586.56 b) Export sales c) Sub-total [a +b] 692.60 622.22 44.30 2.00 82.34 497.39 551.49 74. Sub-total [ i + ii] iv.09 586.20 0.18 0.96 483.60 15.00 1134.74 discount c) Other assistance d) Sub-total [a +b +c] iii.

3] 5.53 21. i] Add: Other non operating-income a) Interest on FRD b) Interest on loan/ Income Tax Refund c) Others (lifting charges) d) Sub-total (income) ii] less: Other nonoperating expenses.72 11.40 26.66 (including Bonus payments) 4.51 11. DEPRECIATION 7.18 13.68 0.11 24.OPERATING PROFIT [after interest / depreciation] -0.94 5.71 3.64 29.61 3.47 [1 (iii) – 2 (vii) .76 22.3.50 5.50 8.80 1.6] 8.23 32.46 0. SELLING GENERAL & ADMINISTRATIVE EXPENSES 175.00 0.21 4.92 9.00 5. INTEREST 6.11 74 5.46 1.00 0.54 8.45 1.00 1.44 1.00 13.00 0.85 23.00 0.28 14.64 21.84 0.94 12.00 0.90 1. a) Preliminary expenses b) Interest on Partners’ Capital A/C c) Partners’ Remuneration d) Sub-total (expenses) 3.27 13.72 26.36 1.00 0.78 4.39 0. OPERATING PROFIT [interest & depreciation] 13.5.00 1.04 9.39 0.19 48.24 3.62 [ 4.92 .56 1.28 0.

48 5. RETAINED PROFIT (11-12) 14. 75 .21 -13.NET PROFIT / LOSS (9. PROFIT BEFORE TAX / LOSS 1.76 -3.03 100% 0.01 0.iii] Net of other nonoperating income / expenses 2.32 7.04 -1.03 0.12 3.38 8.04 100% 0.48 [ net of 8 (i) & 8 ( ii )] 9.83 11.44 6. PROVISION FOR TAXES 1.08 4.24 5.45 6. RETAINED PROFIT / NET POFIT (%) (13-11) 0.39 -8.01 100% 0. drawings made during the year by projectors / partners.83 -8.10) 12.86 [ 7+8( iii )] 10.92 ** In case of firms. a) Equity dividend paid** b) Dividend rate 13.06 -0.

LIABILITIES ASSESSMENT OF CAPITAL Table 8:FORM.III(P& L A/C) As per Profit and loss accounts actual / estimates for the year ended / ending 76 .

LAST THREE YEARS ACCOUNT ( as per audited accounts) CURRENT YEAR ESTIMAT ES FOLLOWI NG YEAR PROJECTI ON 31-03-2006 31-03-2007 31-03-2008 1.00 0. Short term borrowing from others 3.23 0. (due within one year) 9.16 168.07 0.02 10.92 56.06 96.90 74. Other current liabilities & provisions (due within one year) ( specially major terms) (sundry Expenses + other Finance) SUB-TOTAL ( B ) 5. Dividend payable 7.18 5. Advance payments from customers / deposits from dealers 5.65 69.37 0.93 31-03-2009 31-03-2010 94.10 95. Short term borrowings from banks ( including Bill purchased. Deposits / debentures / installments under term loans / DPGs.00 60.28 77 163.60 200.71 97.02 95.00 0.10 b) From other bank c) ( of which BP & BD ) SUB-TOTAL ( A ) 2.00 93. Provisions for taxation 6.12 89.13 49. TOTAL CURRENT LIABILITIES 11. discounted & excess borrowings placed on repayment basis) a) From applicant bank 93.46 0.07 8. Other statutory Liabilities ( due within one year) 0. etc.69 67. Sundry creditors ( trade ) ( months purchases) 4.00 7.00 66.60 200.93 94.43 61.34 7.02 .02 0. Debentures ( not maturing within one year ) 149.71 97.05 194.06 8.16 0.76 0.66 269.

Export receivables [ including bills purchased / discounted by bankers] [ month’s export sales] 4.10 24. Receivables other than deferred 7 exports 60. Government & other Trustee Securities ii.99 119.96 7. Other current assets [ specify major items] 29.67 27. Advance payment of taxes 8. Advances to suppliers of merchandise & deposits 7.21 2.83 28.48 112.83 13.46 [ including bills purchased & discounted by bankers] [Month’s export sales] ii. Cash and bank balances 22.55 78 26.03 98.40 8. i. Stocks-in trade ( month’s cost of sales) 6. Fixed Deposits with banks including Interest accrued 3.84 19. Installments of deferred receivables (due within one year) 5.00 CURRENT YEAR ESTIMAT ES FOLLOWI NG YEAR PROJECTI ON .Table 9:FORM-III(B/S) As per balance sheet as at LAST THREE YEARS ACCOUNT (AS PER AUDITED ACCOUNTS) CURRENT ASSETS 31-03-2006 31-03-2007 31-03-2008 31-03-2009 31-03-2010 1. Investments [ other than long term investments] i.32 159.

08 1.62 . which are not current assets i.27 1.87 10.84 9. Other non-current assets 16.44 iii.14 1. advances to suppliers of capital Goods & contractors.39 1.08 0.09 10. [ maturity exceeding one year] iv.64 10.99 8.14 1. TOTAL OTHER NON CURRENT 0. others / Debtor over 6 months 14.08 0.88 218. security deposits / tender deposits v.08 79 0.62 0. TOTAL CURRENT ASSETS 156. a) investments in subsidiary companies / at liabilities b) Others ii.64 8.08 0. Depreciation 12.73 1. Obsolete stocks 15.48 1. NET BLOCK [ 35 – 36 ] 13.08 1.78 233.Loan and Advances 9. deferred receivables 11.41 359.19 7.48 1. Investments / book debts/ advances/ deposits .39 [ TOTAL OF 26 TO 33] 199.08 7. Fixed Assets 11.40 7.04 6.

34 36. 41 & 42 ) 19.91 21.40 3.97 367. bad/doubtful debts not provided for .ASSETS ( total of 38 to 40) 17.93 98.95 47.78 4.43 208.63 57. Assets ( patents.74 {[ 17+24] – [37+41+42]} TO TALLY WITH [ 34 . 37.07 2.23 1.85 166.29 1.71 43. TOTAL OUTSIDE LIABILITIES/ TANGIBLE NW WORTH [ 18/44 ] 11. NET WORKING CAPITAL 8. preliminary expenses.74 39. goodwill.68 226.72 49. CURRENT RATIO [ 34/10] 22.75 90.05 1.10] 1.56 13.69 241. TANGIBLE NET WORTH ( 24-42 ) 20.etc) 18.20 1.91 2. TOTAL ASSETS ( total of 34.72 ASSESSMENT OF WORKING CAPITAL Table 10:FORM-IV(B/S) LAST THREE YEARS ACTUALS ( AS PER AUDITED ACCOUNTS) As per balance sheet as at CURRENT FOLLOWI YEAR NG YEAR ESTIMATE PROJECTI S ON 31-03-2009 31-03-2006 31-03-2007 31-03-2008 31-03-2010 80 .

86 164.A. Other current assets ( including cash and bank balances & deferred receivables due within one year) ( specially major items) (Loan and Advances) 6. Receivables other than export and deferred receivables ( including bills purchased and discounted by bankers) ( months domestic sales) 3.87 51.05 [ months cost of sales ] 2.41 359.78 233. Stocks.32 159. TOTAL CURRENT ASSETS 156.03 60. Export receivables ( including bills purchased and discounted by bankers) ( months domestic sales) 4.41 74. CURRENT ASSETS 1.00 81 .06 32.23 36.48 44.99 119.38 40.88 218.84 53. Advances to suppliers of merchandise 5.46 98.34 73.88 47.39 ( to agree with item 34 in Form-III ) 199.


65 11. unsecured loans dividend payable .46 89. public deposits.34 96.( other than bank borrowings for working capital) 7.00 10. etc.23 74.02 83 .00 0.13 0.06 69.12 0.16 60.02 0.02 66.69 7. Statutory Liabilities 0.18 67.37 8. debentures . TOTAL ( To agree with sub-total BForm-III) 56.76 61.06 7.07 0.92 5. installments of TL. DPG .43 0.07 0.90 8.00 0. Advance payments from customer / deposits from dealers 9. Other current liabilities ( specially major items such as short time borrowings.00 0.) 5. Sundry Creditors ( Trade) ( Months Purchases) 49.

88 96.87 69.06 359.18 84 199.78 67. Current liabilities ( 2 to 9 Form III) 156.COMPUTATION OF MAXIMUM PERMISSIBLE BY BANK [FINANCE FOR WORKING CAPITAL] Table 12:FORM-V(B/S) LAST THREE YEARS ACTUALS ( AS PER AUDITED ACCOUNTS) As per balance sheet as at CURRENT FOLLOWI YEAR NG YEAR ESTIMAT PROJECIO ES N 31-03-2006 31-03-2007 31-03-2008 31-03-2009 31-03-2010 1.39 56.34 233.23 218.02 . Total current assets (34 Form III) 2.41 74.

95 58.47 54.88 85 .74 82.( other than bank borrowings) 3.74 61. Excess borrowings. stipulated net working capital.92 49.25% of total current assets other than export receivables ( as at 28(ii) of form III ) 5.21 ( WCG) ( 1-2 ) 4.49 95. Item 3 minus item 5 8.75 200.85 200.00 61.11 91. Item 3 minus item 4 7.60 89.11 82. Min.18 89. Actual / projected net Working capital (45 in form III) 6.10 49.72 79.47 36.75 89.65 144.97 132. Maximum permissible by bank finance ( item 6 or 7 whichever is lower) 9. Working capital gap 100.75 94.35 290. if any representing short fall in NWC (4-5) 39.70 39.60 90.49 79.88 200.85 8.44 137.18 97.

29 1.26 0.64 30.94 As per balance sheet as at CURRENT FOLLOWI YEAR NG YEAR ESTIMAT PROJECTI ES ON 31-03-2009 31-03-2010 86 . SOURCES a) Net profit 0.40 3.01 ( after tax) b) Depreciation c) Increase in capital 1.04 40.Table 13: FORM – VI (B/S) FUNDS FLOW STATEMENT LAST TWO YEARS ACTUALS ( as per audited balance sheet) 31-03-2007 31-03-2008 1.99 1.19 10.04 1.

4 105.64 43.50 -105.59 2.43 11.47 -22.23 -2.10 141. ( 1-2) Increase / Decrease in current assets Increase / Decrease in current Liabilities other than bank borrowings Increase / decrease in working capital gap Net surplus (+) / deficit (-) 2.04 146.03 -15.02 34.89 5.21 -2.86 0.10 28.4 1.59 2. 6.41 3. Other NonCurrent assets d) Dividend payments e) Others f) TOTAL 3.45 10. Long term Surplus (+)/ deficit (-) 4.88 41.06 b) Decrease in term liabilities 1. Other NonCurrent assets f) Others g) TOTAL 2.11 0.28 0.46 -5. Fixed assets II.00 0.17 6. Fixed assets II.55 0.19 1. Increase / decrease in bank borrowings 87 .33 0.48 41.27 29.48 31. 5.19 2.33 -3.39 11.39 0.98 0. 7.d) Increase in term liabilities ( including Public Deposits) e) Decrease in I. USES a) Net Loss 1.88 ( including Public deposits) c) Increase in I.91 5.70 3.16 32.40 (Difference of 3 & 6) 8.







(Rs. In crores)

Table 14: Financial Indicators Year Ending Audit Status Net Sales 2006-2007 Audited 4.84 2007-2008 Audited 5.40 0.29 0.0004 2008-2009 Provisional 6.23 0.26 -0.0106 2009-2010 Estimated 11.34 0.49 -0.0048

Operating 0.23 Profit Net Profit After 0.0001 Tax


Cash 0.04 Generation Net Working 0.37 Capital Current Ratio TNW TOL/TNW 1.23 0.44 3.78

0.05 0.40

0.08 0.50

0.14 0.91

1.20 0.48 4.07 0.00 0.09 0.00

1.29 0.60 2.91 0.00 0.08 0.00

1.34 0.99 2.72 0.00 0.07 0.00

Term 0.05 Liability/TNW Gross Fixed 0.10 Assets Term Loan 0.02

N.B. : Net Profit After Tax in each year have been depicted very less as per the above charge. This is so that the subjects have debited the items like Interest in Partners’ Capital, Partners’ Remuneration etc. in their Profit and Loss account.

A BRIDGED FINANCIAL POSITION: (Rs. In crores) Table 15: Financial Position Year ending Audit Status LIABILITIESCapital and 89 2006-2007 Audited 2007-2008 Audited 2008-2009 Provisional 2009-2010 Estimated

Reserves 0.44 Long Term 002 Liabilities TOTAL LIABILITIES 2.09 ASSETSFixed Assets Non-Current Assets 0.09 0.48 0.00 0.58 0.00 0.99 0.00











Current Assets Intangible Assets TOTAL ASSETS

2.00 0.00

2.34 0.00

2.20 0.00

3.62 0.00





Chapter 6. 90

their turnover as per financial year 2009 stands at Rs. 218. In this year they got an offer of stockistship of BEER under the brand name KINGFISHER STRONG and KINGFISHER PREMIUM product of eminent UB GROUP which has already gain a lions share in the field of BEER market.CONCLUSION AND RECOMMENDATION 6. Operating Profit of the firm are going on increasing over the years. their sales turnover would increase by leaps and bounds. “other Current Liabilities” with break up details must be furnished with justification thereof. CR/ NWC: comments on large amounts held under “Non-Current Assets”. 91 . “other Current Assets”. Sales are going on increasing over the years. 1134. feasibility of achieving sales estimated/ projected.  PROFITS: comments on trend in profitability and feasibility of achieving estimates/ projections  TANGIBLE NET WORTH (TNW): comments of trend and feasibility of achieving the estimates / projections. So far in this financial year.   TOL/TNW: comments on acceptability of key ratios and other negative features.  TNW is also going on increasing over the years due to fresh induction of capital as also retained profit which includes partners remuneration. This is so that the subjects have debited the items like Interest in Partners’ Capital. we can presume that estimated sales target of Rs.1 COMMENTS ON FIANCIALS/PERFORMANCE OF THE COMPANY (conclusion)  SALES: Comments on achievements of sales vis-à-vis estimates given in the past.69 lacs upto JULY 2009 with induction of further Working Capital and ensuing festive season and winter season. in their Profit and Loss account.00 lacs in the financial year 2009-2010 would be achieved within rest period of 8months. Net Profit After Tax in each year have been depicted very less as per the above charge. current year sales achieved till previous month. interest on capital and capital and share of profit. Partners’ Remuneration etc. It is expected that with the intervention of this lucrative branded BEER market.

25% i. Table 16: SANCTION OF FOLLOWING ENHANCEMENT cum RENEWAL OF LIMITS ( IN CRORES) Nature of limit/ facility Cash Credit Working Capital purpose Existing limit 0. 3. at present @14. The firm is to deal exclusively with the bank for departmental stores with the bank. 92 .00 (+)/ (-) +1.95 Revised limit 2. creditworthiness and good entrepreneurship. 2.2GIST OF RECOMMENDATIONS: Based on the aforementioned facts and figure. 6. 95 Lacs to the tune of Rs.e.05 25% on stock Margin Interest% applicable rate BLPR +2. In a word. We recommend sanction of the same.25% i. TNW and NWC are in the increasing order. progressing trend of the business.91 & 2.  Current Ratio is gradually improving over the years and stands well within the benchmark level ie 1. working capital need. overall security aspects and guarantee offered. Partners’ Goodwill.72 in the financial year 2008-09 & 2009-10 respective acceptable especially in this time of business where much working capital is needed to run the show. we may consider favorably to enhance the existing cash credit limit of Rs. 200 Lacs. TOL/TNW IS 2. A processing charge of Rs 33. sales.32 in the estimated in the increasing order over the years.only is to be paid to the bank. financials of the company.600/.@14.e. 4. Interest % proposed BLPR +2. All sale transactions must be rooted through the cash credit account with the bank. Net profit. Hypothecation board must be displayed in the shop/ godown.75% debts TERMS AND CONDITIONS OF SANCTION 1.25% and 40% at present on book.

** The entire working capital credit assessment of the aforementioned appraisal has been done from one of the files of Indian Overseas Bank. Stock statements as on last date of each month must be submitted to the bank with the 10th day f the following month filing which 2% penal interest will be levied. 7. 8. manual of documentation and circulars issued by RBI/Central Office from time to time should be complied with.5. Chowringhee branch and the name of the firm being changed where the sanction has been based on the then current year estimates as on 20092010. All the other norms/guidelines as applicable for finance as per bank’s book of instructions. 93 . Stocks and land & Buildings are to ensured in full value with the respective bank clause 6. Bank officials must have an access in the shop/ godown and all immovable properties for the purpose of inspection as on when required.

After study and analysis of working capital I would like to recommend the following: 1. Company should take control on debtor’s collection period which is major part of current assets. Company has to take control on cash balance because cash is non earning assets and increasing cost of funds. Company should reduce the inventory holding period with use of zero inventory concepts. 4. Company should raise funds through short term sources for short term requirement of funds. 3. which comparatively economical as compare to long term funds. 94 . 2.

Ninth Edition of Working Capital. K.V.Financial Management . www. Pandey . Jain-Financial management – Vikas Publishing house ltd. . www. M. 95 .Principles of Financial Management-Everest Publishing House Websites References 1. Ltd.Vikas Publishing House Pvt.jains. New All the data regarding the subject of the case study are supplied by the bank. 4. M.Mc-Grow-Hill New York www. 3.APPENDICES Bibliography Books Referred 3. Satish Imandar. I. Khan and P. Images are collected from google images.K.

96 .