A REPORT ON

CREDIT APPRAISAL OF INDUSTRIAL FINANCE FOR SME’s

SUBMITTED BY:Kulbir Singh

Class roll no-2026, Examination roll no-581Session 2006-2008

A report submitted in partial fulfillment of the requirements of

MBA Program of Institute of Management Studies

Under the guidance of:Dr. Parmod Sharma

Senior LecturerINSTITUTE OF MANAGEMENT STUDIES

HIMACHAL PRADESH UNIVERSITY SHIMLA

1

TO WHOM IT MAY CONCERN

This is to certify that Miss. Mamta gaur of MBA, Institute of Management

Studies has undertaken a project on “CREDIT APPRAISAL OF

INDUSTRIAL FINANCE FOR SME’s.” under my guidance. To the best of

my knowledge that project is neither submitted nor published elsewhere”.

Project GuideDr.Parmod Sharma

ACKNOWLEDGMENT

2

I sincerely feel the credit of the project work could not be

narrowed to only one individual. This work is an integrated effort of all

those concerned with it, it would have been quite difficult without their

direct & indirect co-operation. I wish to express my appreciation and

gratitude to all the concerned people.

First and the foremost my intellectual debt is to Dr.Parmod

Sharma(Senior Lecturer Institute of Management Studies) and Mr.A.K

Sharma (Chief Manager Loan Department Union Bank of India, Shimla)

who have contributed significantly towards the completion of the project.

They have provided the guidelines on which this project was made.

I am thankful to all the people who have given their precious time

and provided me with requisite data without which this project would not

have completed .I also thank them for giving their valuable suggestions

during the entire period of research.

However, I accept the sole responsibility for any errors of omission

and commission.

Mamta gaur

Roll no-

3

Table of Contents

CONTENT PAGE NO.

1 Introduction

1.1 Objectives of the Study 5

1.2 Purpose of the Study 5

1.3 Limitation of the Study 6

1.4 Proposed Methodology 6

1.5 Abstract 7,8

2. Main Text

2.1 Overview of Indian banking industry 9,10,11

2.2 union bank of India 12,13,14

2.3 small scale industry 15,16,17,18,19,20

3 credit appraisal procedure and process21

3.1 assessment of credit need 22

3.2 financial statement analysis 23,24,25,26,27

3.3 risks in bank lending 27,28

3.4 financial ratio analysis 32,33,34

3.5 credit rating 35,36,37,38

4 loan facility

4.1 working capital loan 39,40,41,42,43

4.2 term loan 44,45,46,47,48,49,50

4

Table of Contents

CONTENT PAGE NO.

5 Documentation and formalities 51

5.1 NPA classification and recovery 52,53,54,55

Annexure

Annexure-I 56,57,58,59,60,61,62,63,64

Glossary 65,66

References 67

5

OBJECTIVES OF THE STUDY

The objective of research is to study the Corporate Banking in

Union Bank of India. The area of study in Corporate Banking in Union

Bank of India would include-

Working Capital Financing and Term loan financing- To support

extended both as Fund based and Non-Fund based facilities to

Corporate, Partnership firms, Proprietary concerns. Working Capital

finance extended to all segments of industries. The project research

focuses on determining the various factors considered in analyzing the

financial needs (working capital) of their clients and determining the

limit of finance. The objective of the project is also to study the well-

documented loan policy.

The study would involve following-

Assessment of the advances.

Processing of the advances.

PURPOSE OF THE STUDY FOR THE ORGANISATION

This study would involve working out and interpreting the

financial ratios in case of working capital financing and term

loans.

The study also involves the study of procedural formalities

included in sanctioning the finance to its clients.

This study would involve analyzing the balance sheets of their

clients in determining their financial needs.

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LIMITATIONS OF THE STUDY

Every study or research is conducted under some limits and there are

some restrictions which have some impact on the project.

Limitations of this project are–

Coverage: The study aims at covering the corporate banking of

Union Bank of India only.

The study aims at gaining the practical knowledge by taking

help of bank personals. So there might have been tendencies

among the personals to amplify or filter their responses due to

time limitation.

Credit appraisal for working capital finance is study that needed

specialized knowledge of the area, so there is chance for

interpretational error on my par

PROPOSED METHODOLGY

Since the research carried out for this project is descriptive in nature, the

various documents and official files would require for understanding the

methodology used by the banks. The data collection can be done by

personal interview or direct observations. At the same time, related

articles, newspapers, magazines, in-house journals of banks, etc were

referred. The information on the project under consideration can be

obtained by the bank employees and officials. Also I went through various

files and the official correspondence of the bank for better understanding

the topic under the study. The methodology also include finding out the

financial ratio, understanding the credit rating and assessment of working

capital and term loan of the companies by making the fresh proposal for

working capital and term

ABSTRACT

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The project undertaken is credit appraisal of industrial finance for

SMEs. The project emphasis on understanding the procedure and process

used by union bank of India to assess the credit worthiness of the borrower.

Small scale industry in India is booming and contributing to 40% of GDP,

many banks are focusing their attraction towards this sector.

The credit appraisal process is the scientific way of

giving the credit to corporate client by analyzing the credit worthiness of

the company through different parameters. The first step in credit appraisal

project is to understand the Indian banking industry and the performance

of the few Indian banks in the previous financial years since project

undertaken is in banking industry a glance on union bank of India and

small scale industry in India is given and the steps taken by the banks to

development and welfare of SSI.

The credit appraisal for SME starts with

Understanding the need of loan to the borrower i.e. for which purpose the

loan is required. After this next step is to analyse the financial statement of

the company to whom the loan is to be sanctioned. The main things which

are taken into consideration while analyzing the financial statement are

type of statement, nature of activity ,accounting policy, qualities of assets

and liabilities , unit wise performance result of the company & director’s

report.

After analyzing the financial statement the second

step is to study the principle given by Basel committee on banking

supervision which basically Indian banks have to be follow as per the order

by Reserve Bank of India.The third step is to analyse the key financial ratios

of the company such as :

Leverage ratio, liquidity ratio, profitability ratio, turnover ratio, inventory

norms.

The next step is to understand the methodology used to determine the

credit rating. Since the credit rating methodology differ from bank to bank

in term of the weight age given to the parameters but the parameter used

by the banks to assess credit worthiness are almost same to all company.

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The banks mainly provide two types of credit facility known as term loan

and working capital loan. The working capital loan is given by three

methods namely- projected balance sheet method, MFBF method and cash

budget method.

Term loan is the loan given by the company for a long

term gernally more than one year and less than 10 years to company. The

term loan is assessed by the break even analysis, cost benefit ratio,

payback period. While appraising the term loan technical, managerial,

financial feasibility is checked. The debt service coverage ratio is used for

assessing the company capacity to pay back installment of loan and int. on

term loan.

The sensitivity analysis is used to check the company

ability to pay back the loan by changing the independent variables and

consequently monitoring the effect on dependent variables. The last step is

to understand the classifications of NON PERFORMING ASSET and the

provision to recovery of NPA. The research report contains the whole

procedure & process which is used by the bank to give credit to SMEs.

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MAIN TEXT

The banking system in India was established in 18th century. The first

Indian bank which came into existence in1786 was THE GENERAL BANK

OF INDIA which is followed by BANK OF HINDUSTAN. Although both

these banks do not exist today but these banks made the foundation of

banking system in India. The oldest bank in existence in India is the state

bank of India being established as "The Bank of Bengal" in Calcutta in June

1806.The first fully Indian owned bank was the Allahabad bank, which was

established in 1865.

By the 1990s the market expanded with the

establishment of banks such as Punjab National bank in 1895 in Lahore

and Bank of India in 1906, in Mumbai - both of which were founded

under private ownership. The Reserve bank of India formally took on the

responsibility of regulating the Indian banking

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OVERVIEW OF BANKING INDUSTRY

RESERVE BANK OF INDIA

PRIVATE SECTOR BANKS

PUBLIC SECTOR BANKS

STATE CO-OPERATIVE

URBANCO-OPERATIVE

REGIONAL RURALBANKS

SCHEDULE BANKS

COMMERCIAL BANKS

FOREIGN BANK

CO-OPERATIVE BANKS

Sector from 1935 After India's independence in 1947, the Reserve Bank

was nationalized and given broader powers.

Nationalization

The nationalization of banks added a new chapter in the

Indian banking system in 1969 when the Indra Gandhi Government

nationalized the 14 largest commercial banks. A second phase of

nationalization of banks took place in 1980 by the nationalization of 6 more

commercial banks. The stated reason for the nationalisation was to give the

government more control of credit delivery.

Liberalizations

In the early 1990s the Narasimha Rao government embarked on

a policy of liberlisation and gave license to a small number of private banks,

which came to be known as NEW GENERATION TECH-SAVVY BANK which

included banks such as UTI Bank, ICICI Bank and HDFC Bank. This move, along

with the rapid growth in the economy of India, kick started the banking sector

in India, which has seen rapid growth with strong contribution from all the

three sectors of banks, namely, government banks, private banks and foreign

banks.

NO. OF COMMERCIAL BANKS IN INDIA

FINANCIAL YEAR MAR.-02 MAR.-03 MAR.-04 MAR.-05 MAR.-06

NO. OF COMMERCIAL BANKS (A+b) 297 292 290 289 222

{A} SCHEDULE COMMERCIAL BANKS 293 288 286 285 218

(-)OF WHICH: REGIONAL RURAL BANKS 196 196 196 196 133

{B} NON SCHEDULE COMMERCIAL BANKS 4 4 4 4 4

SOURCE: RESERVE BANK OF INDIA

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Since Indian banking sector is experience exponential growth, the profit

made by public sector and private sector banks are given below.

BANK MAR.-05 MAR.-06 % CHANGE

PRIVATE SECTOR BANK

ICICI BANK 20,052.00 25,400.70 26.67

HDFFC BANK 6,655.60 8,707.80 30.83

UTI BANK 3,345.80 4,850.80 44.98J& K BANK 1,150.70 1,768.40 53.68

KARUR VYSYA BANK 1,053.40 1,353.50 28.49

FEDRERAL BANK 900.90 2,252.10 149.98

KOTAK BANK 848.90 1,182.31 39.28

YES BANK NA 2,700.00 NA

INDUSIND BANK 2,101.50 368.20 -82.48

ING VYSYA BANK -381.30 90.60 NA

PUBLIC SECTOR BANK

STATE BANK OF INDIA 43,045.20 44,066.70 2.37

BANK OF BARODA 6,768.40 8,269.60 22.18

BANK OF INDIA 3,400.50 7,014.40 106.28

CORPORATION BANK 4,021.60 4,444.60 10.52

IDBI LTD. 3,072.60 5,608.90 82.55

DENA BANK 610.00 729.90 19.66

CANARA BANK 11,095.00 13,432.20 21.07

ALLAHABAD BANK 5,417.90 7,061.30 30.33

PUNJAB NATIONAL BANK 14,101.20 14,393.10 2.07

VIJAYA BANK 3,805.70 1,268.80 -66.66

BANK OF MAHARSHATRA 1,771.20 507.90 -71.32UNION BANK OF INDIA 3,015 3,610.00 19.7

NET PROFIT OF COMMERCIAL BANKS IN INDIA (MN) Rs.

Source: reserve bank of India

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Corporate Mission:

A logical extension of the Vision Statement is the Mission of the Bank, which is to gain market recognition in the chosen areas.

To build a sizeable market share in each of the chosen areas of business through effective strategies in terms of pricing, product packaging and promoting the product in the market.

To facilitate a process of restructuring of branches to support a greater efficiency in the retail banking field.

To sustain the mission objective through harnessing technology driven banking and delivery channels.

To promote confidence and commitment among the staff members, to address the expectations of the customers efficiently and handle technology banking with ease.

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ABOUT UNION BANK OF INDIA

“We should have the ability to carry on a

big bank, to manage efficiently Crores of rupees in the course of our

national activities. Though we have not many banks amongst us, it does

not follow that we are not capable of efficiently managing Crores and tens

of Crores of rupees."

MAHATMA GANDHI

Union Bank of India, a public sector bank was incorporated

in 1919.After the inauguration by father of nation “mahatma Gandhi” bank

has travelled a long successful journey of 88 yrs of banking. Union Bank of

India is committed to maintain its identity as a leading innovative

commercial Bank, alive to the changing needs of the society. Union Bank

has offered vast and varied services to its clientele taking care of their

needs. Today, with its efficient customer service, consistent profitability &

growth, adoption of new technologies and value added services, Union

Bank truly lives up to the image of, “GOOD PEOPLE TO BANK WITH”.

The key business areas of the bank are retail banking,

international banking, corporate banking & treasury. As Retail banking is

growing very fast in Indian banking industry union bank of India is also

showing strong growth in this sector. The bank provide housing, retailing

trade, automobile, consumer, education and other personal loans and

deposits services such as fixed , saving and demand deposits for the

valuable clients. The bank has increased forgeion exchange turnover from

361.02 bn in 2004-05 to408.94 bn in 2006-07 with annual growth rate of

13.27%. The corporate banking sector offers various loan and free based

products and services to its small and medium enterprises, agriculture

sector.

To boost SME Segment the bank has set up separate SME

cells .the total employee strength of bank are 25,421.

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Union bank of India is targeting a 25% growth in its SME portfolio. The

bank SME portfolio in 2005-06 was 6,839 crore and its target in 2006-07

is 8,540 crore. Union bank of India has made an agreement with SIDBI to

provide loan to SMEs. The bank is converting 32 small scale industry

branches to SME branches. Union bank of India and SIDBI are also in the

process of putting up marketing teams in 15 centers for identifying and

appraising SMEs units and lending them.

Union bank of India has a network of more than 2100 branches

all over India. The Bank came out with its Initial Public Offer (IPO) in

August 20, 2002 and govt.of India holds 55.4% of the bank followed by

FII 19.9% & Indian public hold14.8% of the bank. The Bank has over the

years earned the reputation of being a techno-savvy Bank and is one of

the front runners amongst public sector bank in the field of technology. It

is one of the pioneer public sector banks, which launched Core Banking

Solution in 2002. Online Tele banking facility is available to all its Core

Banking customers. The multi facility versatile Internet Banking Solution

provides extensive information in addition to the on line transaction

facility to both individuals and corporate banking with the Core Banking

branches of the Bank. In addition to regular banking facilities, today

customer can also avail variety of value added services like cash

management service, insurance, mutual funds, Demat from the Bank.

SMALL SCALE INDUSTRY: With the advent of planned economy from 1951 and the subsequent industrial policy

followed by Government of India, both planners and Government earmarked a special

role for small-scale industries and medium scale industries in the Indian economy.

Due protection was accorded to both sectors, and particularly for smallscale industries

from 1951 to 1991, till the nation adopted a policy of liberalization and globalization.

15

Certain products were reserved for small-scale units for a long time, though this list of

products is decreasing due to change in industrial policies and climate.

SMEs always represented the model of socio-economic policies of Government of

India which emphasized judicious use of foreign exchange for import of capital goods

and inputs; labour intensive mode of production; employment generation;

nonconcentration of diffusion of economic power in the hands of few (as in the case of

big houses); discouraging monopolistic practices of production and marketing; and

finally effective contribution to foreign exchange earning of the nation with low import-

intensive operations. It was also coupled with the policy of de-concentration of

industrial activities in few geographical centers. It can be observed that by and large,

SMEs in India met the expectations of the Government in this respect. SMEs

developed in a manner, which made it possible for them to achieve the following

objectives:

High contribution to domestic production

Significant export earnings

Low investment requirements

Operational flexibility

Location wise mobility

Low intensive imports

Capacities to develop appropriate indigenous technology

Import substitution

Contribution towards defense production

Technology – oriented industries

Competitiveness in domestic and export markets

At the same time one has to understand the limitations of SMEs, which are:

Low Capital base

Concentration of functions in one / two persons

Inadequate exposure to international environment

Inability to face impact of WTO regime

Inadequate contribution towards R & D

Lack of professionalism16

In spite of these limitations, the SMEs have made significant contribution towards

technological development and exports.

SMEs have been established in almost all-major sectors in the Indian industry such

as:

Food Processing

Agricultural Inputs

Chemicals & Pharmaceuticals

Engineering; Electricals; Electronics

Electro-medical equipment

Textiles and Garments

Leather and leather goods

Meat products

Bio-engineering

Sports goods

Plastics products

Computer Software, etc.

An industrial undertaking in which the investment in fixed assets in plant

and machinery whether held on owner ship term on lease or on hire

purchase does not exceed rs. 10 million.It is estimated that in terms of

value, the sector accounts for about 39% of the manufacturing output and

around 33% of the total exports of the country.As per available statistics,

this sector employs an estimated 31 million persons spread over 12.8

million enterprises and the labour intensity in the MSE sector is estimated

to be almost 4 times higher than the large enterprises.

In India 2.30 lakhs units are only registered in Gujarat providing

employments to 39 lakhs people in Gujarat, which contributes to 24% of

total employment provided by SSI in India.

Small Scale and ancillary units (i.e. undertaking with investment

in plant and machinery of less than Rs. 10 million) should seek registration

with the Director of Industries of the concerned State Government. The

govt. of India established ministry of small-scale industry in 2001.the role of

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ministry of small scale industry is to mainly assist the state in their effort to

promote the growth of SSI, increase the competition and gernation of

employments.

Performance of Micro & Small Enterprises

Employ- Exports

No of units(in lakh) Production ment

Year Regd Unregd. Total

(at 2001-02 prices)crores (in lakhs)

(Rs in crore)

2002-03

16.03 93.46 109.49 306771(8.7) 263.68 86.013

2003-04 17.12 96.83 113.95 336344(9.6) 275.3 97644

2004-05 18.24 100.35 118.59 372938(10.9) 287.55 124417

2005-06 19.3 104.12 123.42 418884(12.3) 299.85 150242

2006-07 20.32 108.12 128.44 471663(12.6) 312.52

N.A.

Sources:Office of the Development Commissioner(MSME)* Estimates based on definitions prior to anactment of MSMED Act 2006

Recently.major initiatives have been taken by the Govt. to revitalize the MSME sector. They include:

Implementation of the Micro, Small and Medium Enterprises

Development Act,2006.

A ‘Package for Promotion of Micro and Small Enterprises’was

announced in feb 2007.This includes measures addressing

concerns of credit ,fiscal support,cluster based

development.infrastructure,technology and marketing.

To make the Credit Guarantee Scheme more attractive, the

following modifications have been made:

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a. Enhancing eligible loan limit from Rs.25 lakh to Rs.50 lakh.

b. Raising the extent of guarantee cover from 75% to 80% for

micro enterprises for loans upto Rs.5 lakh.

c. The phased deletion of products from the list of items

reserved exclusive for small sector is being continued.On

March 13,2007,125 items were dereserved reducing the

number of reserved items to 114.

Further for inducing participation of foreign players and big

corporate in Small Scale Industries the government has formally

announced doing away with the 24% investment ceiling in the

sector.

Credit is one of the major inputs for the promotion and

development of SSI. Credit to SSI is the part of credit sector lending. For the

public sector bank 40% of net bank credit should given to priority sector.

However for the foreign banks 32% of net bank credit should be given to

priority sector, out of which 10% is required for SSI.SIDBI (small industry

development bank of India), is the premier financial institution in India

which is only dedicated for the promotion and development of SSI.

Credit given to SSI sector from the public sector bank in India

Source annual report of SSI

Credit to tiny sector (having investment up to 25 lakhs rs.)

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Source annual report of SSI

The process of economic liberalization and market reforms has opened up the

Indian Small scale sector to global competition. In order to enhance the

competitive strength of the small scale sector, the Government introduced an

incentive scheme for their quality improvement and environment management.

The scheme provides incentive (of up to Rs. 75,000 per unit) to SSI units which

acquire ISO 9000/ISO 14001 certifications. The scheme, in operation since March

1994, was enlarged to include reimbursement of expenses for acquiring ISO

14001 certification also w.e.f. 28th October 2002.

The SSI sector in India is booming but still some financial institute hesitate

to give credit to some specific sector due to the fear of non performing

assets (NPA). But by applying good credit policy and timely inspection of

SMEs banks can avoid these situations. The following table shows

decreasing trend in NPAs of union bank of India

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CREDIT APPRAISAL PROCEDURE AND PROCESS:

Credit appraisal is done to evaluate the credit worthiness of a borrower.

The credit proposal is prepared to indicate the need based requirement and

the rationale for its recommendation. Bank has in place a well-defined

framework for approving credit limits of different segments. Requests for

credit facilities from the prospective borrowers shall be on the prescribed

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format and the full-fledged proposal should be prepared for submission to

the appropriate sanctioning authority for approval. These proposals analyze

various risks associated with bank lending i.e. business risks, financial risks,

management risks, etc. and clarify the process by which such risks will be

managed on an on going basis The credit appraisals for any organization

basically follow the following process

Assessment of credit need

Financial statement analysis

Financial ratios of the company

Credit rating

Working capital requirement

Term loan and sensitivity analysis

NPA classification and recovery

ASSESSMENT OF CREDIT NEED

The first step in the process of credit appraisal is to assess the need for

loan to the borrower. In the first step the need of financial requirement is

under stand i.e. for which purpose the loan is required .The banks basically

provide two types of credit facilities to their clients.

Fund based facility

Fund based facilities provided by the banks are basically term loan &

working capital loan.

Non fund based facility

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Non fund based facilities provided by the banks are letter of credit, letter of

guarantee, packing credit.

The banks basically follow three method prescribed by TANDON COMITEE

REPORT to RBI {central bank in India}

1 FIRST METHOD: borrower will contribute 25% of working capital gap

75% would be financed by bank borrowing. Minimum current ratio would be

1:1

2 SECOND METHOD: borrower will contribute 25% of total current asset

and the remaining working capital gap is filled by bank borrowing {WC gap

–borrower contribution}.the current ratio given by this method would

be1.3:1.

3 THIRD METHOD: borrower will contribute 100% of core asset and 25%

of balance of current asset. The remaining working capital gap will be

bridged by the borrowing.

The first two method are accepted by RBI for the

implementation .This is applied to the entire borrower having the credit

limit in excess of 20 lacs from the banking system

FINANCIAL STATEMENT ANALYSIS

Key points to be checked in financial statement:

Type of statement: Examine weather financial statement is audited

or unaudited. If the report is audited study the auditor certificate.

Nature of activity: Engaged in trading or manufacturing activity or

services, what kind of the products the company dealt in. if it is a

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software industry does it have a technical component and skilled

manpower.

Series of statement: examine the financial statements important

factor to note the trend has taken place from one year to another

year. for the last 2 or 3 years to know about the trend in the

performance of the firm. The

Accounting policy which accounting policy the organization is

following. Weather depreciation is charged on WDV {written down

value} method or using SLM {straight line method}.

To understand this let us considerAverage annual profit =3, 00,000

Original cost of fixed asset =10, 00,000

Deprecation under WDV method =25%

Deprecation under SLM method =8%

Tax rate = 50%

DEPRECEATION METHOD

YEAR Written down value method{25%} Straight line method {8%}

Net fixed asset

Profit after deprecation

Profit after Deprecation And tax

Net fixed asset

Profit after deprecation

Profit after Deprecation And tax

0 10,00,000 10,00,000

1 -2,50,0007,50,000

50,000 25,000 -80,0009,20,000

2,20,000 1,10,000

24

2 -1,87,500 5,62,500

1,12,500 56,250 -80,0008,40,000

2,20,000 1,10,000

3 -1,40,6254,21,875

1,59,375 79,687.5 -80,0007,60,000

2,20,000 1,10,000

4 -1,05,468 3,16,407

1,94,532 97,266 -80,0006,80,000

2,20,000 1,10,000

5 -79,1022,37,305

2,20,898 1,10,449 -80,0006,00,000

2,20,000 1,10,000

TOTAL 3,68,652 5,50,000 NOTE: Wdv rates are approximately 3 times SLM

CHANGE IN NET WORTHYear Net Worth WDV method Net Worth SL Method

012345

5,00,0005,25,0005,81,2506,60,5007,58,2038,68,652

5,00,0006,10,0007,20,0008,30,0009,40,00010,50,000

This is clear from the above illustration that by adopting different method

of deprecation the value of profit after tax and net worth are different. So

there is every possibility of using SL method of deprecation to fixed asset

and value of fixed asset would be more which in turn greater solvency and

liquidity of the firm on paper which is not same in WDV method

The stock of the firm is based on FIFO and LIFO method.

PURCHASE AND CONSUMPTIONS OF ITEM (XYZ)

MONTH DATEPURCHASE(IN UNITS)

PRICE(PER UNITS)

TOTAL PURCHASE

CONSUMPTION(UNITS)

JANUARY 14 5000 15 75,00025

20 - - - 3,00028 7500 16 1,20,000

FEBRUARY 7 11,000 16 1,76,00015 - - - 12,00025 7,000 17 1,19,000

MARCH 5 9,000 18 1,62,00012 - - - 15,500

TOTAL 39,500 6,52,000 30,500

FIRST IN FIRST- OUT (FIFO) METHOD

MONTH DATECONSUMPTIONS

(IN UNITS) COST

(PER UNITS) COST TOTAL COST

JANUARY 20 3,000 15 45,000 45,000

FEBRUARY 15 2,000 15 30,0007,500 16 1,20,000 1,90,0002,500 16 40,000

MARCH 12 8,500 16 1,36,0007,000 17 1,19,000 4,90,000

CLOSINGSTOCK 31 9,000 18 1,62,000

PURCHASES 6,52,000

LAST IN FIRST –OUT (LIFO) METHOD

MONTH DATECONSUMPTIONS

(IN UNITS) COST

(PER UNITS) COST TOTAL COST

JANUARY 20 3,000 15 45,000 45,000

FEBRUARY 15 11,000 16 176,000 1,92,0001,000 16 16,000

MARCH 12 9,000 18 1,62,0006,500 17 1,10,500 2,72,500

CLOSINGSTOCK 31 500 17 8,500

6,500 16 10,4002,000 15 30,000

TOTAL 1,42,500

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PURCHASES 6,52,000

From the above example it is clear that by adopting different method of

stock valuation the closing stock of the company differ widely irrespective

of any point of time holding the same quantity in units. FIFO method of

inventory valuation inflates the inventory costs and which in turn shows the

higher book profit than justified. LIFO method on the other hand depresses

inventory cost and is considered to be more realistic estimate for the profit

for a period. Since price is increasing trend so FIFO method giving high

value of closing stock if the price would be in decreasing trend than LIFO

method give high value of closing stock. ICAI now allows inventory to be

valued either on the basis of the FIFO method or net realizable method.

Qualities of assets/ liabilities: a financial statement, which is

based on accounting standard, however not shows the quality of

assets and liability. The banker should therefore to check on

periodical checking, quality control certification like ISO certification.

Unit wise result: the company which has diversified business

should ask to produce activity wise financial statement for the better

understanding.

Director’s report: finally a director report of the company should

study which shows the company future plans, new initiative taken by

the company etc.

Risk associated with bank lending:

Banks mainly faces three kind of risk which has impact on profitability of the

bank. These risks are

Credit risk

Market risk

Operational risk

Credit risks basically is the major risk which is faced by the bank on

account of their business activity, which including the lending to

27

corporate world, individual bank, another bank or financial institution.

Credit risk is of two types

borrower risk

portfolio risk

Borrower risk may be the possibility of that a borrower will fail to

meet his financial obligations in accordance with agreed term.

Portfolio risk arises due to credit concentration/ investment

concentration.i.e most of the credit is given to only one type of group and

the possibility of default.

Market risk is the variability in the profitability of the firm due to

change in market variables. This is manly of three types.

interest rate risk

exchange rate risk

Interest rate risk: the risk in the erosion of earning due to variation in the

interest rate with in the time period is referred as interest rate risk.

Exchange rate risk: this risk is of two type

Transaction risk

Translation risk

Transaction risk: is the risk basically arises due to the fluctuation in the

price of a currency, upward or down ward; result in a loss on a particular

transaction.

Translation risk: in a situation of a translation the balance sheet of a

bank effected adversely due to exchange rate movement and change in

the level investment or borrowing in foreign currency even without having

translation at a particular time.

Liquidity risk: liquidity risk arises out of the possibility that would not be

able to meet its financial obligation as they become due for the payment.

the risk basically arise due to mismatch between the cash inflow or out flow

of the funds or funding the long term asset term asset by short term

28

liabilty.surplus liquidity also is the loss to the banks as the money is not

used to raise the income to the bank.

There are many indicators of Credit Risk Problems which show the risk in

bank lending.Gernally high level of non-performing assets of the bank or

Heavy Provisions show the greater risks. This can be also assessed through

the balance sheet and p/l account of the company. It is red indicator to the

bank which shows that bank has one of the problems with the credit policy.

I. Generally an indicator of poor quality of a credit portfolio.

II. Implies poor risk selection and/or poor credit monitoring.

III. Very rapid expansion of credit portfolio size.

It is not necessary that an above indicator of problems always be true

but it often reflect future problem.

The seventeen basic principles for bank lending are given below to

avoid the risks associated with bank lending.

ESTABLISHING AN APPROPRIATE CREDIT RISK ENVIRONMENT

Principle 1: The board of directors should have responsibility for

approving and periodically reviewing the credit risk strategy and significant

credit risk policies of the bank. The strategy should reflect the bank’s

tolerance for risk and the level of profitability the bank expects to achieve

for incurring various credit risks.

Principle 2: Senior management should have responsibility for

implementing the credit risk strategy approved by the board of directors

and for developing policies and procedures for identifying, measuring,

monitoring and controlling credit risk. Such policies and procedures should

address credit risk in all of the bank’s activities and at both the individual

credit and portfolio levels.

29

Principle 3: Banks should identify and manage credit risk inherent in all

products and activities. Banks should ensure that the risks of products and

activities new to them are subject to adequate procedures and controls

before being introduced or undertaken, and approved in advance by the

board of directors or its appropriate committee.

A. OPERATING UNDER A SOUND CREDIT GRANTING PROCESS

Principle 4: Banks must operate under sound, well-defined credit-granting

criteria. These criteria should include a thorough understanding of the

borrower or counterparty, as well as the purpose and structure of the

credit, and its source of repayment.

Principle 5: Banks should establish overall credit limits at the level of

individual borrowers and counterparties, and groups of connected

counterparties that aggregate in comparable and meaningful manner

different types of exposures, both in the banking and trading book and on

and off the balance sheet.

Principle 6: Banks should have a clearly established process in place for

approving new credits as well as the extension of existing credits.

Principle 7: All extensions of credit must be made on an arm’s-length

basis. In particular, credits to related companies and individuals must be

monitored with particular care and other appropriate steps taken to control

or mitigate the risks of connected lending.

B. MAINTAINING AN APPROPRIATE CREDIT ADMINISTRATION,

MEASUREMENT AND MONITORING PROCESS

Principle 8: Banks should have in place a system for the ongoing

administration of their various credit risk-bearing portfolios

Principle 9: Banks must have in place a system for monitoring the

condition of individual credits, including determining the adequacy of

provisions and reserves.

30

Principle 10: Banks should develop and utilize internal risk rating systems

in managing credit risk. The rating system should be consistent with the

nature, size and complexity of a bank’s activities.

Principle 11: Banks must have information systems and analytical

techniques that enable management to measure the credit risk inherent in

all on- and off-balance sheet activities. The management information

system should provide adequate information on the composition of the

credit portfolio, including identification of any concentrations of risk.

Principle 12: Banks must have in place a system for monitoring the

overall composition and quality of the credit portfolio.

Principle 13: Banks should take into consideration potential future

changes in economic conditions when assessing individual credits and their

credit portfolios, and should assess their credit risk exposures under

stressful conditions.

C. ENSURING ADEQUATE CONTROLS OVER CREDIT RISK

Principle 14: Banks should establish a system of independent, ongoing

credit review and the results of such reviews should be communicated

directly to the board of directors and senior management.

Principle 15: Banks must ensure that the credit-granting function is being

properly managed and that credit exposures are within levels consistent

with prudential standards and internal limits. Banks should establish and

enforce internal controls and other practices to ensure that exceptions to

policies, procedures and limits are reported in a timely manner to the

appropriate level of management.

Principle 16: Banks must have a system in place for managing problem

credits and various other workout situations.

D. ROLE OF SUPERVISORS

31

Principle 17: Supervisors should require that banks have an effective

system in place to identify measure, monitor and control credit risk as part

of an overall approach to risk management. Supervisors should conduct an

independent evaluation of a bank’s strategies, policies, practices and procedures

related to the granting of credit and the ongoing management of the portfolio.

Supervisors should consider setting prudential limits to restrict bank exposures to

single borrowers or groups of connected counterparties.

Source: Reserve Bank of India

KEY FINANCIAL RATIO:

LEVERAGE Ratios:

a) Debt-equity ratio: Long term liabilities

Tangible Net worth

Ratio indicates term lender’s stake vis-à-vis stake of the owner. It should be

between 1.5 and 2.

Long term liabilities may include term loans, debentures deferred payment

guarantees, fixed deposit.

Tangible net worth = Equity share capital + Preference share capital

redeemable after 3 years + reserves and surplus + Subsidy - Intangible

assets - accumulated losses, if any.

b) Fixed assets coverage ratio:

Fixed assets + Other non-current assets * 100

Tangible net worth + Long term liabilities

32

It indicates coverage of long-term uses by long term sources. Lower

percentage indicates extent of net working capital available.

PROFITABILITY RATIOS:

a) Profit margin on sales: Net Profit * 100

Sales

It indicates profitability of the firm after accounting for all the expenses and

taxes. To be compared with similar size units belonging to the same

industry. It is to be compared with the similar size units belonging to the

same industry.

b) Cost of sales to sale: Net profit * 100

Sales

It indicates cost efficiency. It is to be compared with the similar size units

belonging to the same industry.

c) Return on investment: PBIT * 100

Capital employed (Net fixed assets + Total CA)

It indicates the rate of return on total funds employed. It should be more

than average cost of capital.

d) Return on net worth: Net profit after preference dividend * 100

Equity capital +reserves and surplus

It is the ratio of return on owners’ fund.

d) Debt service coverage ratio:

33

Profit after tax + depreciation + interest * 100

Interest + Installments of term liabilities Payable during the year

The ratio indicates the extent to which the amount of interest and

installments payable during the year are covered by the funds generated

during the year. The minimum 1.5 is expected.

TURNOVER RATIOS

a) Total asset turnover ratio: Sales

Net fixed assets + current assets

It indicates how well the assets are used. It is to be compared with similar

size units belonging to the same industry.

b) Working capital turnover ratio: Sales

Total current assets

It indicates how well the current assets are used. It is to be compared with

similar size units belonging to the same industry. Location of the unit also

needs to be taken into consideration.

c) Inventory turnover ratio: Cost of goods sold

Average inventory

It indicates the extent of excess inventory. Trend over a period of line

compared with similar size units belonging to same industry.

34

OBJECTIVES OF CREDIT RATING

R.B.I. has given considerable emphasis on having a proper risk rating in

place as a credit rating system is considered as an instrument that helps

the bank in

Measuring the Credit Risk at the transaction level.

Pricing the Credit Risk

Providing triggers for action on Portfolio Management

Frequency of inspection

The following three credit rating models are used at UBI for evaluating the

credit worthiness of a borrower in the SME sector.

Rating Model 1 – For Small Borrowers with Credit Limit between 2 Lacs to

100 Lacks.

Rating Model 2 – For borrowers with Credit Limit between 10 Lacs to 5

Crores.

Rating Model 3 – For borrowers with Credit Limit between 1 Crore to 10

Crores.

The credit rating technique used by the banks differs from bank to bank.

35

As stated in the Basel committee reports the top management is

responsible for framing the policy of bank. The common parameters, which

are taken into consideration before preparing the credit rating module, are

below.

Operational performance of unit

Sales trend during last 3 years.

Profit trend during last 3 years.

Achievement of sales projections

Achievement of profit projections

Net worth

historical risks associated with unit

Geographical location

Threat of obsolescence

Industry type (sunrise, old, sunset)

Industrial relation

Regulatory risks and transaction/ compliance risk

Repayment records

Relationships of clients with the banks a/c

Sector specific threat (external macro economic factors)

Tax and duty barriers

Conduct of fund and non-fund based accounts with banks /financial

institutions- whether these are regular or irregular.

Compliance of terms and conditions stipulated by banks while

sanctioning of loan.

Position of annual renewal/ review of loan facilities.

Nature and value of securities (primary/ collateral) offered to cover

loan facility.

Validity of creation of charge on the securities.

Position of contingent liabilities, if any.

Transparency and disclosures in audited annual accounts.

36

Position with regard to submission of balance sheet and P&L account,

monitoring data and inventory statement etc.

Auditor’s comments on quality and valuation of all types assets.

Financial risk

Return on equity ratios

Debt service coverage ratio

Total debt to net worth

Operating profit to net sale

Returns on assets

Current ratio

Nwc/ current asset

Net profit to net sales

Return on capital employed

capacity utilization and management

Ownership pattern of the unit

Qualification, experience and knowledge of industry/ business.

Market reputation and credibility.

Track record of debt repayment.

Pending statutory dues and litigations, if any

Succession planning

Labour relation

Total capacity utilization

No. of NPA units of same sector

Strategic risk

Investment in technology for up gradation & R&D

Competitive threat (global, industry, new entrant)

Threat of substitute product ( if any)

Future potential

Market demand and growth potential of products.

37

Export potential of products.

Position with regard to availability of raw material.

The following table shows classification of the Credit quality based on the

Credit rating score, calculated from the appropriate rating model.

INVESTMENT GRADE NON INVESTMENT GRADE

CREDIT

QUALITY

RATING

NUMERIC

AGGREGATE

SCORE (of

100)

CREDIT

QUALITY

RATING

NUMERIC

AGGREGATE

SCORE (of

100)

Lowest risk CR-1 >90 Watch list CR-7 51-60

CR-2 86-90 Risk prone CR-8 51 & below

Moderate

risk

CR-3 81-85 Sub-

standard

CR-9 -

Satisfactory

risk

CR-4 76-80 Doubtful CR-10 -

Fair risk CR-5 71-75 Loss CR-11 -

Acceptable

risk

CR-6 61-70

Source: Union Bank of India

38

WORKING CAPITAL ASSESSMENT:

Apart from financing for investing in fixed assets,

every business also requires funds on a continual basis for carrying on day

to day operations. These include amounts expenses incurred for purchase

of raw material, manufacturing, selling, and administration until such goods

are sold and the monies. While part of the raw material maybe purchased

by credit, the business would still need to pay its employees, meet

manufacturing & selling expenses (wages, power, supplies, transportation

and communication) and the balance of its raw material purchases.

Working capital refers to the source of financing required to by businesses

on a continual basis for meeting the short term needs. Limits to the various

borrowers are assessed depending upon their requirements and their line

of activity.

OPERATING CYCLE OF THE COMPANY: The operating cycle is the

average time between purchasing or acquiring inventory and receiving

cash proceeds from its sale. From the operating cycle the bank can

understand about the future working capital requirement of the company.

39

DURATION OF OC = R.M stock + WIP + FG stock holding period +ACP – APP

NO. Of OC’s in a year = 360/ 12

Duration of OC’s

WC requirement forecast = annual operating cost

No. of OCs in a year

Stock holding period = stock

Cost at which stock is valued

R.M. stock holding period = Average stock of raw material

Value of R.M. consumed per day

WIP period = Average stock of WIP

Cost of production/day

FG stock holding period = Average stock of finished

COGS per day

ACP = debtors * 360

40

DRS.R.M.

WIPF.G.

CASH

Credit sale

APP = creditors *360

Cr. Purchase

1. Turnover Method: (Working Capital Requirements)

Under this method the bank finances maximum of 20% of the

projected sales of the borrower and the borrower has to contribute

5% as his margin. This method is applicable for the following sectors:-

i. For SSI borrowers up to Rs.5.00 crores. ii. For Non SSI borrowers up to Rs. 1.00 Crore.

Assessment of working capital by turnover method RS. IN LCS

A] TOTAL SALES / TURNOVERPROJECTED 2,25

B] 25% OFF TURNOVER [OF “A”] [WCG] 56.25

C] MARGIN AT 5% OF TURNOVER [OF “A”] 11.25

D] LIMIT 20% OF “A” [B –C] 45

E] LIMIT PERMISIBLE [B-C] 45

2. Maximum Permissible Bank Finance(MPBF) Method :

Under this method the borrowers requirements are assessed based on the

past practice/holding levels while the projections should be reasonably

41

conform with the past trends, deviations can be accepted subject to

satisfactory justification. This method is called as Tandon Committee

Method of lending. It is applicable for working capital requirement of the

borrowers coming under the following categories:

i) For SSI borrowers:

Rs.5 crores and above but less than Rs.50 crores

ii) For non SSI Borrowers:

Rs.1 crore and above but less than Rs.50 crores

Working Capital assessment on the formula prescribed by the

Tandon Committee.

Working Capital Requirement (WCR) = [Current assets – Current Liabilities]

Permissible Bank Financing [PBF} = WCR – Promoter’s Margin Money i.e.

PMM (to be brought in by the promoter)

As per Formula 1: PMM = 25% of [CA – CL] and thereby PBF = 75% of [CA –

CL]

As per Formula 2: PMM = 25% of CA and thereby PBF = 75% [CA] – CL

As is apparent Formula 2 requires a higher level of PMM as compared to

Formula 1. Formula 2 is generally adopted in case of bank financing. In

cases of sick units where the promoter is unable to bring in PMM to the

extent required under Formula 2, the difference in PMM between Formulae

1 and 2 may be provided as a Working Capital Term Loan repayable in

installments over a period of time.

Rs in lakh

2007(act.) 2008(est.)

TOTAL CURRENT ASSETS 199.72 277.42

42

OTHER CURRENT LIABILTIES ( other than bank

borrowing )

95.69 90.03

WORKING CAPITAL GAP 104.03 187.39

Calculation of working capital requirement

Working Capital Requirement for the year 2007-08 is Rs. 199.72lakh

Formula 1

PMM (Promoter Margin Money) as per formula 1 = 25% of 104.03 lakh ~ Rs.

26 lakh

Hence, Permissible Bank Finance 1 = Rs. 78.3 lakh

Formula 2

PMM as per formula 2 = 25% of Rs. 199.72 lakh = Rs. 49.93 lakh

Permissible Bank Financing as per formula 2 = [75% of 199.72 lakh –

Rs.95.69 lakh] = Rs. 149.79-95.69 lakh = 54.1 lakh

The difference between the 2 methods is Rs. 24.2 lakh (which maybe

extended as a Working Capital Term Loan in case of sick units. Since by the

second method the contribution by the promoter is high so it would be

accepted for bank financing.

3 Cash Budget Method:

The borrower is required to submit the cash budget to the bank along with

actual as well as projected financial statements. The budget in the

prescribed format is to be prepared for a period of one year and then split

into forecasts for shorter periods say monthly or quarterly. The budget will

provide the following information.

i. The peak level of bank finance required during the course of the year.

43

ii. The current level of bank finance required as forecasted by the split

budget (on monthly/quarterly) basis.

The following borrowers are assessed under this method :

a) Borrowers dealing in Cyclical industries like tea, sugar etc.

b) Borrowers availing Fund Based Working Capital limits of Rs.50 crores and

above from the banking industry. 36

Term loan:

Term loans are a lump-sum payment with payback over a specified period

of time. They may be used to finance equipment, a change in ownership, a

new business acquisition or other long-term needs of a company. The

period of loan vary from 3 to 10 years. Investment of these loans from firms

is in plant and machinery, vehicles and certain other equipments.

Repayment period for the term loan is calculated by DSCR and the

repayment should start immediately after the cash gernation. The formula

for calculating DSCR

(NPAT +int.on term loan + deprecation)

(Int. on term loan +installment of term loan)

The idle ratio is considered to be 2:1while in case of SSI 1.5:1 ratio is

considered to be good.

Appraisal for long term in case of an industry or a project is a long term

investment decision. So it should require a detailed study. The appraisal is

done on the basis of following steps:

1. Technical Feasibility:

The infrastructure required for the manufacturing process is studied

here. The location selected should be ideal with regard to

transportation, communication network, availability of water, climatic

44

conditions, and availability of manpower and disposal of waste. Size

of the plant & type of technology adopted is another important

aspect. The size of the plant or its capacity should be matching to the

requirements of the estimates of the project.

2. Economic Feasibility:

The unit should undertake detailed market study. The demand &

supply gap of the product should be assessed. The time of the unit

entering into the market is also important.

3. Financial Feasibility:

The cost of the project & the estimated time for execution is an

important factor. The promoter’s efficiency to complete the project

within the given period is most important. The source of finance,

without leaving any gap & availability of cash at the right time is to

be ensured. Possibility of cost escalation, cost overruns etc. to be

assessed. The financial feasibility is assessed by financial projection,

fund flow and cash flow statement, ratio analysis and by non

discounted and discounted cash flow statements.

Pay back period method: Payback period is calculated by

comparing cash out flow (investment) with cash inflow (cash profit)

and finding out that at what time they will be equal. Lower the

payback period better the project.

Average rate of return :

It is calculated as Average profit after tax

Average book value of investment

It is compared with the rate of return of other market investments.

Discounted cash flow technique

I. Net present value

It is calculated as =present value of cash inflow – present value of

cash outflow

45

The project is accepted if NPV is positive and rejected if NPV is

negative

2 Benefit cost ratio:

The entire cash inflow is discounted at the rate of interest to

arrive at present value rate.

BCR= present worth of the benefits (cash inflow)

Present worth of cost (investment)

The project is accepted if the BCR is more than one and rejected if BCR is

less than one.

Break even analysis:

Break even point is the point of sales at which a units makes no profit or no

loss. A unit can earn profit only if its level of sale is above the break even

point. Once the BEP is calculated, the sales projection made in the

profitability statement is compared with the break even point of sale. In

case the difference between projected sale and BEP sale is very low, it is

very risky to finance the project. On the other hand if projected sale is high

than BEP the profitability of earning some profit is still there are some

deviations in the project.

BEP can be classified in three ways 1 in terms of no. of units of sale 2 in terms of sale in rupees3 in terms of capacity utilisation

1 BEP in units = fixed cost Contribution/ unit OR fixed cost

Sales price/unit – variable cost/ unit

2 BEP in rupees = fixed cost * total sales in rupees Total contribution

3 BEP in terms of capacity utilisation BEP in capacity = No. of units at BEP * 100 Total capacity

46

To study the viability of the project the project having BEP above of 75% of capacity utilisation should not be accepted for finance

Sensitivity analysis:

While giving credit to the company an exercise is done known as sensitivity analysis.

In this method we basically check the volatility in the profit of the company due to

change independent variable. The subsequent DSCR is calculated and the ability to

pay back term loan is calculated.

Particular FY 2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2015

Sales2538.38 2951.45 3187.75 3410.89 3616.51 3757.63 3896.81 4004.34

R.M. Consumption

& others 1335.23 1401.99 1514.15 1589.85 1646.73 1707.73 1747.82 1786.11

Excise 173.42 180.35 189.36 200.72 205.05 212.09 216.74 220.38

Salaries and wages 93.47 98.14 102.06 107.16 109.60 112.64 114.95 116.67

Power & fuels 43.37 46.51 48.83 51.27 52.93 54.47 55.76 56.76

Stores and spares 13.75 14.71 15.02 15.77 16.12 16.47 16.82 17.03

Repair and maintenance 17.87 19.45 20.42 21.44 22.23 22.86 23.44 23.88

Administration and other

expenses 157 135.37 138.07 114.97 111.94 104.10 105.98 93.01

Deprecation 397.53 380 352.4 303.78 297.40 275.25 230.55 205.81

Selling cost 142.43 151.94 162.57 175.57 181.20 189.28 194.87 199.23

47

Packaging cost 82.32 84.78 90.71 94.33 97.02 100.14 102.02 103.92

Int.on working capital 45.23 58.97 58.97 60.37 65.32 62.32 67.12 58.78

Int. on term loan 272.02 257.20 202.20 178.12 135.07 93.02 75.12 65.12

Total cost 2773.64 2829.41 2894.76 2913.35 2940.60 2950.38 2951.18 2946.70

PBT -235.26 122.04 292.99 497.54 675.92 807.26 945.63 1057.64

TAX 0.00 0 96.6867 164.1882 223.05 266.39 312.06 349.02

NPAT -235.26 122.04 196.30 333.35 452.86 540.86 633.57 708.62

40

SCENARIO -1PARTICUAR FY-08 FY-09 FY-10 FY-11 FY-12 FY-13 FY-14 FY-15

DSCR-1 (5% Increase in RMC)

Sales 2538.38 2951.45 3187.75 3410.89 3616.51 3757.63 3896.81 4004.34

RM Cost 1401.99 1472.09 1589.86 1669.34 1729.06 1793.12 1835.22 1875.42

Other Cost 1438.41 1427.42 1380.61 1323.50 1293.87 1242.65 1203.36 1160.59

Total Cost 2840.40 2899.51 2970.47 2992.84 3022.93 3035.76 3038.58 3036.01

PBT -302.02 51.94 217.28 418.05 593.58 721.87 858.24 968.33

Tax 0.00 17.14 71.70 137.96 195.88 238.22 283.22 319.55

PAT -302.02 34.80 145.58 280.09 397.70 483.65 575.02 648.78

Depreciation 397.53 380.00 352.40 303.78 297.40 275.25 230.55 205.81

Interest on Term Loan 272.02 257.20 202.20 178.12 135.07 93.02 75.12 65.12

Total(A) 367.53 672.00 700.18 761.99 830.17 851.92 880.69 919.71

Interest on Loan 272.02 257.20 202.20 178.12 135.07 93.02 75.12 65.12

Installment on Term Loan 0.00 107.87 305.92 365.73 272.92 353.68 375.71 352.21

Total (B) 272.02 365.07 508.12 543.85 407.99 446.70 450.83 417.33

DSCR(A/B) 1.35 1.84 1.38 1.40 2.03 1.91 1.95 2.20

PARTICULAR 31.03.08 31.03.09 31.03.10 31.03.11 31.03.12 31.03.13 31.03.14 31.03.15DSCR 2 ( 5% Decrease in Sales)

Sales 2411.46 2803.88 3028.36 3240.35 3435.69 3569.75 3701.97 3804.12

48

Total Cost 2773.64 2829.41 2894.76 2913.35 2940.60 2950.38 2951.18 2946.70

PBT -362.18 -25.53 133.60 327.00 495.09 619.37 750.79 857.42

TAX 0.00 0.00 44.09 107.91 163.38 204.39 247.76 282.95

PAT -362.18 -25.53 89.51 219.09 331.71 414.98 503.03 574.47

Depreciation 397.53 380.00 352.40 303.78 297.40 275.25 230.55 205.81Interest on Term Loan 272.02 257.20 202.20 178.12 135.07 93.02 75.12 65.12

Total(A) 307.37 611.67 644.11 700.99 764.18 783.25 808.70 845.40

Interest on Term Loan 272.02 257.20 202.20 178.12 135.07 93.02 75.12 65.12Installment on Term Loan 0.00 107.87 305.92 365.73 272.92 353.68 375.71 352.21

Total (B) 272.02 365.07 508.12 543.85 407.99 446.70 450.83 417.33

DSCR(A/B) 1.13 1.68 1.27 1.29 1.87 1.75 1.79 2.03

SCENARIO-2

DSCR -3 ( 5% decrease in Sales and 5% increase in RMC)PARTICULAR FY-08 FY-09 FY-10 FY-11 FY-12 FY-13 FY-14 FY-15

Sales 2411.46 2803.88 3028.36 3240.35 3435.69 3569.75 3701.97 3804.12RM Cost 1401.99 1472.09 1589.86 1669.34 1729.06 1793.12 1835.22 1875.42

Other Cost 1438.41 1427.42 1380.61 1323.50 1293.87 1242.65 1203.36 1160.59

Total cost 2840.40 2899.51 2970.47 2992.84 3022.93 3035.76 3038.58 3036.01PBT -428.94 -95.63 57.90 247.50 412.75 533.99 663.40 768.11Tax 0.00 0.00 19.11 81.68 136.21 176.22 218.92 253.48PAT -428.94 -95.63 38.79 165.83 276.55 357.77 444.47 514.64Depreciation 397.53 380.00 352.40 303.78 297.40 275.25 230.55 205.81Interest on Term Loan 272.02 257.20 202.20 178.12 135.07 93.02 75.12 65.12Total(A) 240.61 541.57 593.39 647.73 709.01 726.04 750.14 785.57Interest on Term Loan 272.02 257.20 202.20 178.12 135.07 93.02 75.12 65.12Installment on Term Loan 0.00 107.87 305.92 365.73 272.92 353.68 375.71 352.21Total(B) 272.02 365.07 508.12 543.85 407.99 446.70 450.83 417.33DSCR(A/B) 0.88 1.48 1.17 1.19 1.74 1.63 1.66 1.88

Since by changing the three variables the DSCR of the project is less than 1.55 is only in two years, other wise it is more than 1.5. so the project should be accepted .

49

SCENARIO -3

DOCUMENTATION FORMALITIES

Once the credit limits are sanctioned main documents are obtained from

the client concerned. The nature of documents varies depending upon the

type of facility sanctioned and terms of sanction. They may include one or

more of the following-

Loan agreement conveying in terms and conditions of loan.

A comprehensive credit agreement.

Agreement of hypothecation of book debts.

Power of attorney to receive the business receivables.

Pledge letters of agreement in respect of documents of title to goods

covering credit limits.

Insurance / contingency insurance policy.

Appropriate standard policy or specific policy.

Corporate and personal guarantee.

Documents conveying equitable mortgage on primary security i.e.

fixed assets pertaining to the project and on the additional security

(collateral)

Personal guarantee of the borrower and guarantor (if any)

50

Compliance of registration of charge formalities.

Search report form an Advocate indicating a clear title for the last

fifteen years as per the land records; and

Approved building plans incase of constructed property.

This would involve submission of the relevant documents by enterprise.

The legal department in the financial institution would scrutinize these

documents for their validity and completeness.

Non Performing Asset:

Non Performing Asset means an asset or account of borrower, which has

been classified by a bank or financial institution as sub-standard, doubtful

or loss asset, in accordance with the directions or guidelines relating to

asset classification issued by RBI.

With a view to moving towards international best practices and to ensure

greater transparency, it has been decided to adopt the '90 days overdue'

norm for identification of NPAs, form the year ending March 31, 2004.

Accordingly, with effect form March 31, 2004.

A Non performing asset (NPA) shell be an advance where

i. Interest and /or installment of principal remain overdue for a period

of more than 90 days in respect of a Term Loan,

ii. The account remains 'out of order' for a period of more than 90 days,

in respect of an overdraft/ cash Credit(OD/CC),

iii. The bill remains overdue for a period of more than 90 days in the

case of bills purchased and discounted,

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iv. Interest and/ or installment of principal remains overdue for two

harvest seasons but for a period not exceeding two half years in the

case of an advance granted for agricultural purpose, and

v. Any amount to be received remains overdue for a period of more

than 90 days in respect of other accounts.

Reserve Bank of India (RBI) has issued guidelines on provisioning

requirement with respect to bank advances. They are classified mainly into:

Standard Assets: Such an asset is not a non-performing asset. In other

words, it carries not more than normal risk attached to the business.

Sub-standard Assets: It is classified as non-performing asset for a period

not exceeding 12 months.

Doubtful Assets: Asset that has remained NPA for a period exceeding 12

months is a doubtful asset.

Loss Assets: Here loss is identified by the banks concerned or by internal

auditors or by external auditors or by Reserve Bank India (RBI) inspection.

It should be noted that the above classification is only for the purpose of

computing the amount of provision that should be made with respect to

bank advances and certainly not for the purpose of presentation of

advances in the banks balance sheet.

After the implementation of Securitization Act, 2002 banks issue notice to

the defaulter to either pay back the dues to the bank or give the ownership

of the secured assets mentioned in the notice. However, there is a potential

52

threat to recovery if there is substantial attrition in the value of security

given by the borrower or if borrower has committed fraud with the

concerned bank. Under such a situation it will be prudent to directly classify

the advance as a doubtful or loss asset, as appropriate.

DRT

The bank can file a suit against the clients in court to recover its due. It is

filed in court so that the dues can be recovered through the Debt Recovery

Tribunal. The DRT came into existence in 1993 for debts with outstanding

of Rs.10 lakhs and more.

The other courts will not have authority to hear cases falling under this

jurisdiction, once the case is referred to DRT. The DRT has the powers to

attach and sell, to arrest and detain in jail.

DEBT ASSET SWAP

It is the takeover of unproductive / non core assets by mutual agreement.

Absence of legal problems in taking over is a precondition. Minimum value of

asset should be Rs.5 Crores.

ONE TIME SETTLEMENT (OTS)

One time settlement is one the resource for the bank to recover its debts.

The settlement amount is arrived at by the bank and borrower in order to

settle the loan account. The doubtful or loss account as on 31.03.2000, the

settlement amount is minimum 100 % of O/s as on the date it became NPA.

Sub standard as on 31.03.2000, which later became Doubtful/loss, the

settlement amount is minimum 100% O/s on date it became Doubtful/ Loss

+ interest at PLR from 01.04.2000 to date of settlement. Amount is to be

paid in lump sum. And if it is payable in installments, the minimum no of

installments are 12. The minimum amount to be paid immediately is 25%,

Interest at PLR from date of settlement to date of payment.

CORPORATE DEBT RESTRUCTURING

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Corporate debt restructuring is a viable and transparent mechanism for

ailing but viable corporate outside the structure of BIFR/legal proceedings.

It is applicable for only sub standard assets. Only manufacturing companies

are covered under the scheme. In corporate restructuring scheme only the

accounts of Rs. 20 Crores and above are covered. It is a three tier

structure- CDR Forum, CDR Empowered Group, and CDR cell CDR Forum

frames policies and guidelines. CDR Empowered Group makes sanctions,

approvals, commitments, etc. CDR cell scrutinizes, assesses, and monitors.

Features of the scheme are:

1. Revival plans is to be ready in 90 days

2. Lenders cannot exit from the agreement

3. Creditors with 20% or more exposure can approach the CDR

4. Restoration plan approved by 60% of value of creditors is binding

5. Amount of sacrifice is the amount of interest measured in P V terms,

which is provided fully or written off

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Annexure -1UNION BANK OF INDIA

Credit department: central office

PROPSAL FOR ENHANCEMENT OF NON FUND BASED AND FUND BASED LIMIT

1 a) NAME OF THE ACCONT :

b) BRANCH/ ZONE :

c) DATE OF INCORPORATION :

2 CONSITUTION :

3 ADDRESS- Registered office :

Corporate office

Unit/ works :

4 NAMES OF DIRECTORS AND :

THEIR MEANS

5 BACKGROUNDS OF THE PROMOTERS/ DIRECTORS:

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GROUP :

BANKING : LEAD BANK :

MONTH OF REVIEW : OUR SHARE :

ASSET CLASSIFICATION : FB

INTERNAL CREDIT RATING : NFB – 3.94%

STATUS OF ACCOUNT :

AS OF 31.03.2007 AMOUN AMOUNT (RS.)

6 CAPITAL

STUCTURE

Authorized capital

Paid up capital

Book value

Market value

6. (a) SHARE HOLDING

PATTERN

Particular No. of shares Face value % holding

Promoter

Institutional

Pvt.corp.bodies

NRIs and OCB

Clearing members

I Individuals

56

TOTAL

7 IN CASE OF PARTNER SHIP FIRMS INDICATE CAPITAL : NA CONTRIBUTED BY EACH PARTNER SEPRATELY

8 LINE OF ACTIVITY :

9 SECTOR/ BSR CODE :

COMMENTS ON LATEST CREDIT:

10 WHETHER A/C IS TAKEN /TO BE TAKEN OVER. IF SO NORMS FOR TAKE OVER ARE FULLFILLED 11. a) DEALING WITH BANK SINCE:

b) CREDIT FACILITIES SINCE:

12 TOTAL INDEBTNESSNON –FUND BASED FUND BASED TOTAL

Existing Proposed Existing Proposed Existing Proposed

OUR BANK Working capitalOther banksTOTAL

13 BRIEF BACKGROUND :

14. FINANCIAL INDICATOR: Rs. In

FY- FY- FY- FY- Paid up capital

RR Reserves and surplus Intangible assets

Tangible net worth

Long term liabilities Capital employed

Net blockInvestments

Non current assets Net working capital

Current assetsCurrent liabilities

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Current ratioDER

TOL/TNWNet sales

Other incomeNet profit after tax

DepreciationCash accruals

COMMENT ON FINANCIAL INDICATOR:14.2 AUDIT NOTES IN BALANCE SHEET IF ANY , TO BE SPECIFIED:14.3 COMMENT ON FINANCIAL INDICATOR ON CASH BASIS :--

31.03.2004 31.03.2005

Net cash flow from the operating activities

Net cash flow from investing activities

Net cash flow from financing activities

Increase in cash and cash equivalent Cash and cash equivalent at the end of year

14.4 COMMENT ON ESTIMATED BALANCE SHEET OF 31.03.2006

15 EVALUATION OF MANAGEMENT

16 EVALUATION OF INDUSTRY

17 EVALUATION OF BUSINESS RISK

18 CONDUCT OF THE ACCOUNT :

(1) A) regulatory in submission of Stock / book debt statement

QPR / half yearly statement Financial statement CMA data(2) name of the statement/ return

Stock statement /BD/MSOD QPR/ half yearly statement

b) COMMENTS ON OPERATION / OVERDUES(1) Turnover in the account is commensurate

58

No. of statement/ return received during the year

Last statement /return received

With the limit

(2) Frequent excesses are given

(3) Cheques are returned frequently

19 COMLIANCE TO TERM OF SANCTION: a) Completion of mortgage formalities : b) Registration of charges with ROC c) Whether document valid and in force d) Compliance of RBI guidelines e) Whether consortium meeting held At a prescribed periodic intervals Where the bank is the leader

20 a) DATE OF INSPECTON:DURING THE FINANCIAL YEAR

20 b) NATURE AND VALUE OF COLLETERAL SECURITY:

Nature / description of collateral security indicating area & location of property

Value (rs. )

Date of valuation Along with name of the valuer

Insurance Amount and date of expiry

c) PERSONAL GUARNTEE/ CORPORATE GUARNTEE

21a) WHETHER THE NAME OF THE COMPANY/ DIRECTORS FIGURE IN RBI DEFAULTER / CAUTION LIST / ECGC. IF YES, PLEASE FURNISH DETAIL

b) WHETHER DIRECTOR/ PARTNER / PROMOTERS IS A DIRECTOR IN OUR / OTHER BANK OR IS RELATED TO THEM

c) ANY LITIGATION IN FORCE AGAINST THE FIRM/COMPANY OR AGAINST THE PARTNER

59

/ DIRECTORS. IF SO MENTION DETAILS & PRESENT POSITION

22 AUDIT OBSERVATIONS a) Internal b) Concurrent c) Statuaryd) RBI inspection e) Stock audit 23 ANY IRREGULAR FEATURE OBSERVED IN THE MONITORING REPORT

24 EXPOUSRE DETAILS FROM OUR BANK

Limit existing

Limit recommended

D.P. o/s as on

date of inspection

Value of security

Irregularities

A} non fund based limit Import/inland/L/CLetter of guarantee

SUB LIMIT {a} B} fund based limitsWcdl/FclCc/pc/FdbpSUB LIMIT {b}C} TERM LOANTERM LOAN SUB LIMIT {C}GRAND TOTAL

{A+B+C}

b) DETAILS OF EXCESS ALLOWDED DURING THE YEAR:

c) OTHER EXPOUSRE, IF ANY, INCLUDING INVESTMENTS:

d) OTHER LIABILTIES OF DIRECTORS (IN THEIR INDIVIDUAL CAPACITY)

25a) EXPOUSRE DETAIL FROM BANKING SYSTEM

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NAME OF THE BANK

NON FUND BASED%Share Amt. % share Amt.

b) CONDUCT OF THE ACCOUNT AND EXPOUSRE DETAIL FROM FINANCIAL INSTITUTIONS: c) VALUE OF ACCOUNT d) DETAILS OF FOREIGN CURRENCY EXPOUSRE COMMITMENTS AND UNHEDGED POR

Amt. in USD

Name of the corporate Amount of exposure Unhedged portion

Due dates for payment (range)

1.External commercial borrowing

2. Importance usance bills received on collection basis duly accepted and outstanding

3. L/Cs & PAD for import of goods capital equipments.

4. Others exports Receivables

5. Other import obligation

6. Foreign currency loan availed from authorized dealers in India

7. Any other exposure, please specify

26 OPERATIONAL EXPERIENCES a) WITH RESPECT TO SISTER/ ALLIED CONCERN

b) COMMENTS ON OTHER BANKS CREDIT REPORT ON SISTER CONCERNS

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27 OMMENT ON ASSESMENT OF LIMITS

INVENTORY AND RECEIVABLE NORMInventory Previously

accepted level

Actual on the assessment year

Estimates Indicative Norms

Month value month value

RM-IMPORTRM-INDIGENOUS

WIP/ FIG

RECIEVABLE-LOCAL

RECIEVABLE EXPORTS

SUNDRY CREDITORS

OTHER CA

OTHER CL

raw material

stock in progress

Receivable ( domestic)

Receivable( exports)

Working capital assessment2005(act.) 2006(est.)

Total current assetsOther current liabilities ( other than bank borrowing )Working capital gap

Actual/ projected NWC

FBF

ASSESSMENT OF NON – FUND LIMITS A inland / import l/c

For purchase of raw material / stocks Imp. indigenous

Purposed purchase (% of total purchase) Purchase Purchase under l/c

A Average time taken from date of l/c till the date of shipment (days)

B Average time taken from date of shipment to the date of retirement of the bill under l/c (days) Total A (a+b)

C Average rotation of letter of credit in one year 62

(365/a) timesD Level of l/c ( projected purchase/import during the

year )/cContingencies (IF ANY)

Limit requiredTotal l/c requirement =

Our share –

Limited recommended

Bank guarantee

a. Year FY- FY-Total score obtained Grade

Parameter

Borrower ratingBorrower rating

Facility rating

Risk mitigators

Business aspects Total marks with grade

29. Credit rating

30. industry

31. industry scenario

32. out look

33. recommendation

Approved

63

GLOSSARY

Acid testA stern measure of a company's ability to pay its short term debts, in that stock is excluded from asset value. (liquid assets/current liabilities) Also referred to as the Quick Ratio.

Cost of goods sold (COGS)

The direct costs attributable to the production of the goods sold by a company. The directly attributable costs of products or services sold (usually materials, labour, and direct production costs). COGS = net sale -gross profit.

Cash flow statementThe statement showing the movement of cash in and out of a business from day-to-day direct trading and other non-trading or indirect effects, such as capital expenditure, tax and dividend payments.

Capital employed The value of all resources available to the company, typically comprising share capital, retained profits and reserves, long-term loans and deferred taxation.

Cost of debt The rate that has to be received from an investment in order to achieve the required rate of return from the creditors

Coverage ratios A group of ratios that measures a firm’s ability to meet its recurring fixed charge obligations, such as interest on long term debt, lease payments, and/or proffered stock dividends

Average collection period

This represents the no. of days’ worth credit sales that is locked in debtors.

Current liabilities Liabilities that is normally payable within a year and are not for along term.

Current ratio A liquidity measures defined as current assets divided by current liabilities.

Default risk

The uncertainty of expected returns from a security attributable to possible changes in the financial capacity of the security issuer to make future payments to the security owner. Treasury securities are considered to be default free. Default risk is also referred to as “financial risk” in the context of marketable securities management.

Inventory turnover The ratio of net sales to inventory.

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Letter of credit A letter from a bank mentioning that it has established a line of credit in favor of a certain party

Letters of guarantee

letters of guarantee are concerned with providing safeguards to buyers that suppliers will meet their obligations or vice-versa, and are issued by the supplier's or customer's bank depending on which party seeks the guarantee.

Net working capital Net working capital is the difference between total current assets total current liabilities.

Operating cycle The operating cycle of a firm begins with the acquisition of raw materials and ends with the collection of receivables.

Sensitivity analysisA technique of risk analysis which studies the responsiveness of the criterion of merit like net present value or internal rate of return to variations in underlying factors like selling price, quantity sold, etc.

Term loan A loan which is generally repayable in more than one year and less than ten years.

Turn over ratiosTurn over ratios, also referred to as activity ratios or asset management ratios, measure how efficiently the firm employs the assets.

Working capitalThere are two measures of working capital- gross working capital and net working capital. Gross working capital is the total of current assets. Net working capital is the difference between the total current assets and the total current liabilities.

65

BIBLIOGRAPHY Websites:-

www.marketresearch.com

www.Investopedia.com

www.cmia.com

www.unionbankofindia.com

www.google.com

www.rbi.org.in

www.sbi.com

BOOKS & PUBLICATIONS

I. M. Pandey, Financial Management

Union Bank manuals and circulars

Credit management ( a practical approach)

Pratiyogita Darpan

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