working capital financing

Objectives of the study Basic meaning of export financing, working capital and project appraisal. To understand the credit appraisal system for working capital financing. To know the basic structure of banking organization. To learn analysis of different aspects of the project with terms and conditions of loan and advances. How to make a final recommendation to sanction or reject the loan proposal. To understand the rationale behind various guidelines observed by J&K Bank.

Scope of the study With the opening up of the economy, rapid changes are taking place in the technology and financial sector, exposing banks to greater risks. Thus, in the present scenario efficient project appraisal has assumed a great importance as it can check and prevent induction of weak accounts to our loan portfolio. All possible steps need to be taken to strengthen pre sanction appraisal as prevention is better than cure.

The report seeks to present a comprehensive picture of credit management in the bank as its effectiveness is highlighted by the quality of its loan portfolio. The study is also undertaken to understand the process of preparation of CMA data for WC assessment as well as credit risk management. These form important pillars of any financial business.

In the Indian financial circumstances, it becomes important to keep a track on borrowers accounts to prevent from becoming NPA. This requires a continuous evaluation. Further, the sick units may undergo restructuring as well as bifurcating. Hence the study covers all these aspects.

Methodology

In order to learn and observe the practical applicability and feasibility of various theories and concepts, the following sources are being used: Primary Sources of Information Discussions with the project guide and staff members. Discussions with various other department head. Secondary Sources of Information RBI guidelines regulating the activities of the banks Banks Credit policy and related circulars and guidelines issued by the bank. Research papers, power point presentations and PDF files prepared by the bank and its related officials. Study of proposals and manuals Website of Jammu and Kashmir bank and other net sources Theoretical background Export financing Export financing can be defined as to provide credit for export trade. Export financing is very much encouraged by Govt. as exports show the economic strength of the country and it is by exports only that more money from outside comes into the country and as such the value of economy also increases. Govt. and RBI has extended vast concessions to boost exports.

Some of the concessions include: 1. Cheap credit to exporters. 2. Minimum of 12% of net credit should go to exports. 3. Refinance to Banks on eligible portion of export credit outstanding. 4. ECGC guarantee for export credits

5. No margin requirements for advance against export receivables. 6. Flexible approach to export lending and norms of lending. 7. Time norms for disposal of application for export credit. 8. Rejection with the concurrence of next higher authority 9. Bifurcation of WC limits into loan and cc component after excluding export limits. 10. Issue of Gold Card to exporters with good track record. Export credit can be broadly classified into Pre-shipment finance and post shipment finance. Pre-shipment finance refers to finance extended to purchase, processing or packing of goods meant for exports. Financial assistance extended after the shipment of exports falls within the scope of post shipment finance. PROJECT APPRAISAL Effectiveness of Credit Management in the bank is highlighted by the quality of its loan portfolio. Every Bank is striving hard to ensure that its credit portfolio is healthy and that Non Performing Assets are kept at lowest possible level, as both of these factors have direct impact on its profitability. In the present scenario efficient project appraisal has assumed a great importance as it can check and prevent induction of weak accounts to our loan portfolio. With the opening up of the economy rapid changes are taking place in the technology and financial sector exposing banks to greater risks, which can be broadly classified as under:

Industry Risks: Government regulations and policies, availability of infrastructure facilities, Industry Rating, Industry Scenario & Outlook, Technology Upgradation, availability of inputs, product obsolescence, etc.

Business Risks: operating efficiency, competition faced from the units engaged in similar products, demand and supply position, cost of labour, cost of raw material and other inputs like water and electricity, pricing of product, surplus available, marketing, etc.

Management Risks: background, integrity and market standing/ reputation of promoters, organizational set up and management hierarchy, expertise/competence of persons holding key position in the organization, delegation and decentralization of authority, achievement of targets, track record in execution of projects, track record in debt repayment, track record in industrial relations, etc.

Financial Risks:

Financial strength/standing of the promoters, reliability and

reasonableness of projections, past financial performance, reliability of operational data and financial ratios, adequacy of provisioning for bad debts, qualifying remarks of auditors/inspectors etc.

In light of the foregoing risks, the banks appraisal methodology should keep pace with ever changing economic environment. The appraisal system aims to determine the credit needs/requirements of the borrower taking into account the financial resources of the client. The end objective of the appraisal system is to ensure that there is no under financing or over - financing.

Following are the aspects, which need to be scrutinized and analyzed while appraising:

A)

MARKET (DEMAND & POTENTIAL)

Critical analysis is required regarding size of the market for the product(s) both local and export, based on the present and expected future demand in relation to supply position of similar products and availability of the other substitutes as also consumer preferences, practices, attitudes, requirements etc. B) TECHNICAL ASPECTS

In a dynamic market, the product, its variants and the product-mix proposed to be manufactured in terms of its quality, quantity, value, application and current taste/trend requires thorough investigation. i) ii) iii) Location and Site Raw Material Plant & Machinery, Plant Capacity and Manufacturing Process

C)

FINANCIAL ASPECTS

The aspects which need to be analyzed under this head should include cost of project, means of financing, cost of production, break-even analysis, financial statements as also profitability/funds flow projections, financial ratios, sensitivity analysis which are discussed as under:

1)

Cost of Project & Means of Financing

The major cost components of the project is given including land and building

including transfer, registration and development charges as also plant and machinery, equipment for auxiliary services, including transportation, insurance, duty, clearing, loading and unloading charges etc.

2)

Profitability Statement

It is prepared after considering the net sales figure and details of direct costs/expenses relating to raw material, wages, power, fuel, consumable stores/spares and other manufacturing expenses to arrive at a figure of gross profit. Generally speaking, a unit may be considered as financially viable, progressive and efficient if it is able to earn enough profits not only to service its debts timely but also for future development/growth.

3)

Break-Even Analysis

Analysis of break-even point of a business enterprise would help in knowing the level of output and sales at which the business enterprise just breaks even i.e. there is neither profit nor loss.

4)

Fund-Flow Statement

A critical analysis of the statement shows the various changes in sources and applications (uses) of funds to ultimately give the position of net funds available with the business for repayment of the loans

5)

Balance Sheet Projections

The statement helps to analyze as to what an enterprise owns and what it owes at a particular point of time.

6)

Financial Ratios

While analyzing the financial aspects of project, it would be advisable to analyze the important financial ratios over a period of time as it may tell us a lot about a unit's liquidity position, managements' stake in the business, capacity to service the debts etc. The financial ratios which are considered important are discussed as under:

i)

Debt-Equity Ratio

Debt (Term Liabilities)

Equity (Share capital, free reserves, premium on shares, development rebate reserves, etc. after adjusting loss balance)

The level of DER varies from case to case depending upon the nature of project, promoters strength, availability of collateral securities etc. apart from the type of industry. In capital intensive industries involving large capital investment, DER is normally higher as compared to the other industries.

Net Profit (After Taxes) + Annual

interest on long term debt + ii) Debt-Service Coverage Ratio = Depreciation .

Annual interest on long term debt + Amount of installments of principal payable during the year.

This ratio provides a measure of the ability of an enterprise to service its debts i.e. `interest' and `principal repayment' besides indicating the margin of safety. The ratio may vary from industry to industry but has to be viewed with circumspection when it is less than 1.5. Tangible Net Worth (Paid up Capital + Reserves and iii) Tangible Net Worth Outside Liabilities Ratio = Surplus - Intangible Assets) Total Outside Liabilities (Total Liability-Net Worth) .

This ratio gives a view of borrower's capital structure. If the ratio shows a rising trend, it indicates that the borrower is relying more on his own funds and less on outside funds and vice versa.

iv)

Profit-Sales Ratio

Operating Profit * ______________________ Sales

(Before Taxes and excluding Income from other Sources)

This ratio gives the margin available after meeting cost of manufacturing. It provides a yardstick to measure the efficiency of production and margin on sales price i.e. the pricing structure.

v)

Debt to Fixed Asset Ratio

Long Term Debt Fixed Assets

This ratio should be less than one in most industries because a portion of fixed assets must be financed with equity. A ratio of less than one offers greater cushion for the bank. A complement to Debt to Fixed Asset Ratio is to compare equity to fixed assets.

vi)

Current Ratio

Current Assets Current Liabilities

Higher the ratio greater the short term liquidity. This ratio is indicative of short term financial position of a business enterprise

vii) Internal Rate of Return (IRR) IRR is that rate of discount which makes the discounted value of the net cash flow from a project just equal to the amount which has to be invested to obtain that net cash flow. In other words, IRR is that rate of discount which gives the project an NPV equal to zero and cost benefit ratio equal to one.

8)

Sensitivity Analysis

The sensitivity analysis is carried out by the bank in order to evaluate capacity of the project to absorb shocks due to adverse movement in prices/ some other adverse developments and sustain financial viability.

The viability of a project is dependent on various factors which include selling price, cost of raw materials, cost of finance, availability of critical inputs and dependence on market like buyer/seller market, other key technical parameters etc. In the absence of any defined factors and its values for carrying out the sensitivity analysis, it has been decided that a common 5% sensitivity factor on sale price/cost price of major raw materials should be applied in appraisals of all the projects irrespective of the industry. However, 10% sensitivity factor may be applied in highly volatile industries by assessing the expected volatility in sale price/ cost price of major raw materials in future on case to case basis.

D)

MANAGEMENT AND ORGANISATION

Appraisal of project would not be complete till it throws enough light on the person(s) behind the project i.e. management and organization of the unit. It is seen that some projects may fail not because these are not viable but because of the ineffectiveness of the management and the organization in controlling various functions like production, marketing, finance, personnel, etc.

WORKING CAPITAL ASSESSMENT

Working capital is defined as the total amount of funds required for day to day operations of a business unit. It is often classified as gross Working capital and net working capital. Gross working capital refers to the fund required for financing total current assets whereas NWC refers to the difference between the total current assets and current liabilities and this difference can be positive or negative.

Each business unit has an operating cycle which can be illustrated below

This cycle continues and in order to keep the operating cycle going on, certain level of current assets are requires, the total of which gives the amount of total working capital

required. Thus total working capital can be obtained by assessing the level of various current assets in terms of time and value.

Stage Raw materials Work in progress

Time Holding period

Value Value of RM consumed

Time taken in converting RM + Mfg expenses (Cost RM to FG of production) period of FG RM + Mfg expenses + adm. Overhead (Cost of sales) RM + Mfg expenses + adm. Overhead + profit(sales)

Finished goods

Holding

before being sold Receivables Credit allowed to buyer

The assessment of the working capital requirements can be done through 3 different methods depending on the turnover of the company. These methods are: 1. Nayak Committee which states that of an acceptable sales turnover, 25% of total sales would be the required working capital, of which 20% would be financed by the bank and the remaining 5% would have to be the margin that is to be brought by the owner. 2. CMA data, which is provided by the concern in a prescribed format. This CMA data involves the analysis of balance sheet in order to find out the working capital requirements of the company and the maximum mount of permissible bank finance. This method is the most widely used method and requires a great deal of understanding in order to prepare a CMA data of the company. 3. Cash Budget method, which is used specially for industries where availability of raw materials is seasonal such as sugar industry. In this method, a cash budget is prepared for the next 12 months. The cash requirements for each month are

calculated and the highest value of cash required during any month becomes the working capital of the company. The balance sheet contains two important parts assets and liabilities. However, while talking about working capital assessment, we are basically interested in Current assets and current liabilities. Current Assets are those assets for the companies that are reasonably expected to be converted into cash within one year during the normal course of business. Current assets include cash, account receivables, inventories, short term investments, prepaid expenses and many others as explained in the form. These assets are used for the main activity of the business and must be kept at certain reasonable level for the efficient working of the business. For example, cash can be used to purchase raw materials from which finished goods can be manufactured. These current assets are very necessary for day to day operations of the concern.

Current Liabilities are the concerns debts or obligations that are due within one year. They appear on the balance sheet and include many important items such as short term debt, sundry creditors, provisions for taxation, dividend payable, advances from customers and installments of term loans. These liabilities are obligations that must be fulfilled within one year and form an important part of working capital since these are the short term sources of funds CONTENTS OF BALANCE SHEET The balance sheet is significant financial statement of affirm. In fact, it is called a fundamental accounting report. Other terms to describe this financial statement are statement of financial position or position statement. As the name suggests the balance sheet provides information about the financial standing/position of a firm at a particular point of time say, as at March 31. It can be visualized as a snap shot of the financial status of the company. The financial position of the company is valid for only one day_the reference day . on a preceding or following day it is bound to be different.

The financial position of a firm as disclosed by the balance sheet refers to its resources and obligations and the interest of its owners in the business. In operating terms , the balance sheet contains information in respect of assets, liabilities and shareholders equity. It can be presented in either of two forms Account form Report form

It is usually presented in account form. Both the forms are shown below. Balance sheet_ account form Balance sheet as at March 31 Liabilities and owners equity Share capital o Equity o Preference Reserve and surplus Long term loans Debentures Mortgages Current liabilities and provisions Bills payable Amount Assets Fixed assets o Land, building, plant ,etc. Less: depreciation Investments(at cost) Current assets o Inventory o Debtors o Cash and bank o Advance deposit, etc. Amount

Balance sheet_ report form Balance sheet as at March 31st Amount Assets, liabilities and owners equity Fixed Assets: Land, building, plant, machinery, etc. Less: depreciation Investments(at cost) Current Assets: Inventory Debtors Cash and bank balance Advance deposits, etc. Less current liabilities and provisions: Bills payable Creditors: For goods For expenses Customers advances Unclaimed dividend Provision for dividend Provision for taxation Net current Assets Other Assets Total Net Assets Financed by Share capital Reserves and surpluses Share holders equity Non-current liabilities: Debentures Mortgages Total obligations

The contents of the balance sheet , in whatever form presented, consists of assets of the firm and the means by which they have been financed, that is, liabilities and owners equity. Assets Assets may be described as valuable resources owned by a business which were acquired at a measurable money cost. As an economic resource, they satisfy three requirements. In the first place, the resource must be valuable. A resource is valuable if (i) it is cash/convertible into cash; or (ii) it can provide future benefits to the operations of the firm. Secondly, the resource must be owned. Mere possession or control of a resource would not constitute an asset; it must be owned in the legal sense of the term. Finally, the resource must be acquired at a measurable money cost. In case where an asset is not acquired for cash /promise to pay cash, the test is what it would have cost had cash been paid for it. The assets in the balance sheet are listed either in order of liquidity-promptness with which they are expected to be converted into cash- or in reverse order, that is, fixity or listing of the least liquid (fixed) first followed by others. All assets are grouped into categories, that is, assets with similar characteristics are put in one category. The assets included in one category are different from those in other categories. The standard classification of assets divides them into o Fixed assets o Current assets o Investments o Other assets.

Fixed Assets As the name suggests, such assets are fixed in the sense that they are acquired to be retained in business on a long term basis to produce goods and services and are not for resale. They are, in a sense, long term resources in that they are held for longer than one accounting period. Such assets are obviously of crucial significance as the future earnings/revenue/profits of firms are basically determined by them. The fixed assets fall into two categories : Tangible and Intangible.

Tangible fixed assets: are those which have physical existence and generate goods and
services. Included in this category are land, building, plant, machinery, furniture, and so on. They are shown in the balance sheet, in accordance with the cost concept, at their cost to the firmat the time they were purchased. Their cost is allocated to/charged against/ spread over their useful life. the yearly charge is referred to as depreciation. As a result, the amount of such assets shown in the balance sheet every year declines to extent of the amount of depreciation charged in that year and by the end of the useful life of the asset it equals the salvage value, if any. Salvage value signifies the amount realized by the sale of the discarded asset at the end of its usual life.

Intangible Assets: do not generate goods and services directly. In a way, they reflect
the rights of the firm. This category of the assets comprises patents, copyrights, trade marks and goodwill. They confer certain exclusive rights to their owners: patents confer exclusive rights to use an invention; copyrights relate to production and sale of literary, musical and artistic works; trademarks represent exclusive right to use certain names, symbols, labels, designs and so on. Intangible fixed assets are also written-of over a period of time. Current Assets: The second category of assets included in the balance sheet are current assets. In contrast to fixed assets, they are short-term in nature. They refer to assets/resources which are either held in the form of cash or are expected to be realized in cash within the accounting period or the normal operating cycle of the business. The term operating cycle means the time span during which cash is converted into inventory, inventory into receivables/cash sales and receivables into cash. Conventionally, such assets are held for a short period of time, usually not more than a year. These are also known as liquid assets. Current assets include cash, marketable securities, accounts receivable (debtors), notes/bills receivable and inventory. Cash: It is the most liquid current asset and includes cash in hand and cash at bank. It provides instant liquidity and can be used to meet obligations/acquire assets without any delay. Marketable Securities: These are short term investments which are both readily marketable and are expected to be converted into cash within a year. They provide an

outlet to invest temporary surplus/idle funds/cash. According to generally accepted accounting principles, marketable securities are shown in the balance sheet below the cost or the market price. When, however, shown at cost, the current market value is also shown in parenthesis. Accounts Receivable: These represent the amount that the customers owe to the firm, arising from the sale of goods on credit. They are shown in the balance sheet at the amount owed less an allowance (bad debts) for the portion which may not be collected. Notes/Bills Payable: These refer to amounts owned by outsiders for which written acknowledgements of the obligations are available. Inventory: It means the aggregate of those items which are I. II. III. Held for sale in the ordinary course of business (finished goods). In the process of production for such sales (work-in-process) or To be currently consumed in the production of goods and services (raw materials) to be available for sale. It is the least liquid current asset. Included in inventory are raw materials, work-in-process (semi-finished) and finished goods. Each of these serves a useful purpose in the process of production and sale. Inventory is reported in the balance sheet at the cost or market value whichever is lower. Investments: The third category of fixed assets is investments. They represent investment of funds in the securities of another company. They are long-term assets outside the business of the firm. The purpose of such investments is either to earn return or /and to control another company. It is customarily shown in the balance sheet at costs with the market value shown in parenthesis. Other Assets: Included in this category of assets are what are called deferred charges, this is, advertisement expenditure, preliminary expenses, and so on. They are prepayments for services/benefits for periods exceeding the accounting period. Liabilities: The second major content of the balance sheet is liabilities, defined as the clams of outsiders against the firm. Alternatively, they represent the amount that the firm owes to outsiders, that is, other than owners. The assets have to be financed by

different sources. One source of funds is borrowings- long-term as well as short-term. The firms can borrow on a long-term basis from financial institutions/banks or through bonds/mortgages/debentures and so on. The short-term borrowing may be in the form of purchase of goods and services on credit. The outside sources from which a firm can borrow are termed as liabilities. Since they finance the assets, they are, in a sense, claims against the assets. The amount shown against the liability items is on the basis of the amount owned, not the amount payable. Depending upon the periodicity of the funds, liabilities can be classified into o Long-term liabilities o Current liabilities Long-Term Liabilities: They are so called because the sources of funds included in them are available for periods exceeding one year. In other words, such liabilities represent obligations of a firm payable after the accounting period. The sources of long-term borrowings are (i) Debentores, (ii) Bonds, (iii) Mortgages, (iv) Secured Loans from financial institutions and commercial banks. They have to be repaid/redeemed either in lump sum and the maturity of the loan/debenture or in installments over the life of the loan. Long-term liabilities are shown in the balance sheet net of redemption/repayment. Current liabilities: in contrast, to the long-term liabilities, such liabilities are obligations to the outsiders repayable in a short period, usually within the accounting period or the operating cycle of the firm. It can be said to be the counterpart of the current assets. Conventionally, they are paid out of the current assets; in some cases, however, existing current liabilities can be liquidated through the creation of additional current liabilities. Included in this category are (i) accounts payable, (ii) bills/notes payable, (iv) accrued expenses, (v) deferred income, and (vi) short-term bank credit. The first categories may also be called trade credit. Trade credit: It represents the claims of such outsiders as have sold goods to the firm on credit for a short period depending upon trade practices. Usually, such credit is unsecured. One form of this type of short term credit (current liability) is that the buyer-firm will pay the amount after a lapse of time but there is no formal written loan agreement. This type is known as accounts payable. When the claims of supplier of the goods/services are evidenced by a note/bill-written acknowledgement of debt- called

bills/notes payable. A bill/note is a promise in writing to pay a pertain sum of money at some specific date. Another source of short term funds (current liability) is short-term bank credit in the form of overdraft, cash credit and loans and advances. Tex Payable: It refers to the amount to be paid to the government as taxes. Accrued expenses represent certain obligations which are claims against assets but there is no documentary evidence. Examples of this type of current liability are outstanding wages, salaries, rent and commission, and so on. Deferred Income: It represents the liability that arises out of receipt of income in advance, that is, rent received in advance. Owners Equity: The third major content of a balance sheet is the owners equity. Conceptually, it refers to the claims of the owners of the business against the assets of the firm. Alternatively, owners equity may be viewed as that part of the resources of a firm which are supplied by its owners. The owners of a business are know as share holder. There are two types of share holders- ordinary and preference. The preference share holders are entitled to a stated amount of dividend and return of principle at maturity. They are akin to creditors (liabilities) of the firm. The ordinary share holders, also called equity holders, are different from the preference share holders as well as creditors. They are entitled to the income/assets of the firm remaining after the claims of the creditors/preferences are met and full. Their claim against the assets of the firm is, thus, residual. This is also known as the equity of the owners. The owners equity may be said to consist of two elements: (i) paid-up capital, i.e. the initial amount of funds contributed by the share holders; (ii) retained earnings/reserves and surplus, i.e. that part of the profits belonging to the share holders which is not paid to them as dividends but instead is retained/ploughed back in the business.

Profit and loss account

The second major statement of financial information is the profit and loss account. It is also known by several other titles such as income statement, statement of earnings, statement of operations and profit and loss statement. While the balance sheet, as a stock/position statement, reveals the financial condition of a business at a particular point of time(date), the profit and loss account portrays, as a flow statement, the operation over/during a particular period of time. The period of time is an accounting period/year, April March. Since the purpose every business firm is to earn profit, the operations of a firm in a given period of time will truly be reflected in the profit earned by it. Thus the income statement/profit and loss account of a firm reports the results of operations in terms of income/net profit in a year. The profit and loss account can be presented broadly in two forms: (i) (ii) The usual account form, and Step-form.

A summarized view of the first type is presented below

Profit and loss account for the year ending March31 Expenses Cost of goods sold General and administrative expenses Expenses Selling expenses Interest Depreciation Non-operating expenses Provision for tax Net profit Provision for dividend Reserves and surplus Amount Revenue Sales Other incomes Amount

Net profit

The step-form of the profit and loss account is summarized below Income statement for the year ending March 31 Amount Revenues (A) Sales Other sources Total Expenses (B) Cost of goods sold General and administrative expenses Selling expenses Interest Depreciation Non-operating expenses Provision for tax Total Net profit after tax (C) Provision for dividends Reserves and surplus Amount

Revenues One group of items listed on the profit and loss account is revenues. It is defined as the income that accrues to the firm by the sale of goods/services/assets or by the supply of the firms resources to others. Alternatively, revenues mean the value that a firm receives from its customers. The value/income can arise from three sources: I. II. III. Sale of products/goods/services, Supply of firms resources to others, Sale of assets like plant, investments, and so on.

Sales income: the sales revenue equals net sales, that is, gross sales less i. ii. Returns and allowances, Sales discount

Gross sales is the total invoice price of the goods sold/services rendered plus the cash sales during the year. Sales return represents the sale value of goods that were returned by the customers. Sales discount is the amount of cash discounts taken by customers for prompt payment. Use of economic resources outside: the second source of revenue is obtained by investing a firms resources outside, and earning interest, rent, dividend, royalty, commission, fee, and so on. Sales of fixed assets: such assets are sold usually when they are not of much use in the operations of the firm. Expenses The cost of earning revenue is called expenses. An important item of expense appearing in the profit and loss account is the cost of goods sold. Included in this expense are material cost, labour cost, and other manufacturing expenses such as fuel and power, repairs and maintenance, consumable stores, insurance of goods, and so on. The general and administrative expenses include salary, managerial remuneration, rent, rate and taxes, staff welfare expenses and so on. Other items are self-explanatory. Net income/Profit The difference between revenues and expenses is net profit. The profit and loss account may also show the appropriation of the net profits between dividends paid to the share holders and retained earnings/amount transferred to reserves and surplus. This last item is transferred to the balance sheet in the owners equity. Thus, it is a link, in a way, between the profit and loss account and the balance sheet. To conclude, the two financial statements, namely, the balance sheet and the profit and loss account of a business firm contain useful information. The balance sheet shows the sources from which funds currently used to operate the business have been obtained, that is, liabilities and owners equity, and the type of property rights in which

these funds are currently locked up, that is, assets. The profit and loss account represents the score board of the performance of the firm in terms of the profitability of its operations. Ratio analysis Ratio analysis is a very important tool of financial analysis. It is process of establishing the significant relationship between the items of financial statements to provide a meaningful understanding of the performance and financial position of a firm. Activity ratios These ratios measure the effectiveness with which a firm uses its available resources . these ratios are also called Turnover ratios since they indicate the speed with which the resources are being turned or converted into sales. Usually the following turnover ratios are calculated: Capital turnover ratio Fixed assets turnover ratio Networking capital turnover ratio Stock turnover ratio Debtors turnover ratio Creditors turnover ratio

Capital turnover ratio This ratio establishes a relationship between net sales and capital employed. The objective of computing this ratio is to determine the efficiency with which the capital employed is utilized. There are two components of this ratio: Net sales which mean gross sales minus sales returns Capital employed

This ratio is computed by dividing the net sales by the capital employed in the form of formula, this ratio ican be expressed as:

Capital turnover ratio = Net sales / Capital employed

It indicates the firms ability to generate sales per rupee of capital employed. In general, higher the ratio, the more efficient the management and utilization of capital employed. A too high ratio may indicate the situation of over-trading ( or under capitalization) If current ratio is lower than that required reasonably and vice versa. Fixed assets turnover ratio This ratio establishes a relationship between net sales and fixed assets. The objective of computing this ratio is to determine the efficiency with which the fixed assets are utilized. Ther are two components of this ratio: Net sales

Net fixed assets which mean gross fixed (operating) assets minus depreciation thereon. Fixed assets turnover ratio = net sales / net fixed (operating) assets

It indicates the firms ability to generate sales per rupee of investment in fixed assets. In general, higher the ratio, the more efficient the management and utilization of fixed assets, and vice versa. It m ay be noted that there is no direct relationship between sales and fixed assets since the sales are influenced by other factors as well(eg. Quality of product, delivery terms, credit terms, after sales service, advertisement and publicity etc.). Working capital turnover ratio This ratio establishes a relationship between net sales and working capital. The objective of computing this ratio is to determine the efficiency with which the working capital is utilized. There are two components of this ratio: Net sales Working capital which means current assets minus current liabilities

Working capital turnover ratio = net sales / working capital

It indicates the firms ability to generate sales per rupee of working capital: higher the ratio, the more efficient the management and utilization of working capital and vice versa. Stock turnover ratio This ratio establishes a relationship between cost of goods sold and average inventory. The objective of this ratio is to determine the efficiency with which the inventory is utilized. There are two components of this ratio: Cost of goods sold which is calculated as; Cost of goods sold = opening inventory+ Net purchases +direct expenses closing inventory Or,= Net sales Gross profit Average inventory Average inventory = (opening inventory + closing inventory) / 2

Stock turnover ratio = cost of goods sold/ average inventory It indicates the speed with which the inventory is converted into sales. In general, a high ratio indicates efficient performance since an improvement in the ratio shows that either the same volume of sales has been maintained with a lower investment in stocks, or the volume of sales has increased without any increase in the amount of stocks. However, too high ratio and too low ratio call for further investigation. A too high ratio may be the result of a very low inventory levels which may result in frequent stock-outs and thus the firm may incur high stock-out costs. on the other hand, a too low ratio may be the result of excessive inventory levels, slow-moving or obsolete inventory and thus, the firm may incur high carrying cost. Thus, a firm should have neither a very high nor a very low stock turnover ratio, It should have a satisfactory level. To judge whether the ratio is satisfactory or not, it should be compared with its own past ratios or with the ratio of similar firms in the same industry or with industry average.

Stock turnover period or stock velocity This velocity indicates the period for which sales can be generated with the help of an average stock maintained and is expressed in terms of period.r it can be calculated by the formula as

Stock turnover period = average inventory/ cost of goods sold * 12 Or, = 12months, 52 weeks, 365days/ stock turnover ratio

Debtors turnover ratio ( or receivables turnover ratio) This ratio establishes a relationship between net credit sales and average trade debtors (or receivables). The objective of computing this ratio is to determine the efficiency with which the trade debtors are managed. There are two components of this ratio as follows: Net credit sales Average debtors

Debtors turnover ratio = Net credit sales/ average debtors. It indicates the speed with which the debtors turnover on an average each year. In general, a high ratio indicates the shorter collection period which implies prompt payments by debtors, and a low ratio indicates a longer collection period which implies delayed payments by the debtors. However, too high ratio and too low ratio calls for further investigation. A too high ratio may be the result of a restrictive credit and collection policy which may curtail the sales and consequently profits. On the other hand, a too low ratio may be the result of liberal and inefficient credit and collection policy which may involve the risk of bad debts and burden of high interest cost involved in maintaining a higher level of debtors. Thus, a firm should neither have a very high nor a very low debtors turnover ratio, but should have a satisfactory level. To judge whether the ratio is satisfactory or not, it should be compared with its own past ratios or with the ratio of similar firms in the same industry or with the industry average.

Debt collection period or debtors velocity or debtors period: This period shows an average period for which the credit sales remain outstanding or the average credit period actually enjoyed by the debtors. It measures the quality of debtors. It indicates the rapidity or slowness with which the money is collected from debtors. This period may be calculated as follows:

Debt collection period = average debtors/ average credit sales =12 months,52weeks,365 days/ debtors turnover ratio Creditors turnover ratio (or payables turnover ratio) This ratio establishes a relationship between net credit purchases and average creditors (or payables). The objective of this ratio is to determine the efficiency with which the creditors are managed. There are two components of this ratio: Net credit purchases Average creditors (or payables)

Creditors turnover ratio = Net credit purchases/ average creditors This ratio indicates the speed with which the creditors turn over on an average each year. In general, a high ratio indicates the shorter payment period which implies either the availability of less credit or earlier payments and a low ratio indicates a large payment period which implies either the availability of more credit or delayed payments. Debt payment period or Creditors velocity or Creditors period: The period shows an average period for which the credit purchases remain outstanding or the average credit period actually availed of. This period may be calculated as follows Creditors period = average creditors/average net credit purchases per day =12mnths,52weeks, 365 days/ creditors turnover ratio

Data Interpretation and Analysis JAMMU & KASHMIR BANK LTD. Foreign Exchange Business Department CHQ,M.A. Road, Srinagar Name of the Applicant Borrower M/s XYZ Ltd. General Information on the proposal

Name of the branch Date of receipt of the proposal/Last information Nature of proposal Existing banking arrangement Proposed banking arrangement Activity Sector Priority classification

M A. ROAD LAL CHOCK

29/04/2011

Renewal /enhancement of existing facilities. Sole banking arrangement

Sole banking arrangement

Manufacturer and export of carpets. Manufacturing Priority sector

Particulars of the existing facilities sanctioned by our Bank.

Type facility PCL PSL

of Limit

BOS as on

Margin

(amount in ` lacs)

Securities: Primary: a) Hypothecation of all stocks, stores and spares and book debts. b) Pledge of original prime bank letters of credit/ confirmed orders of financially sound overseas buyers. c) Title to goods and proceeds of export bills. d) ECGCs cover under ECIB (WT-PC)/ ECIB (WT-PS) policies. Collateral: a) Mortgage of lease deed No. 202 area 04 Bighas 15 Biswa 19 Dhur (including cost of building) situated at village Rayan Taluka Chathur Bhadohi valued at ` 537.51 lacs as per valuation enclosed. b) Under sale deed No.951,952 dated 08.05.2000 area 01 bigha 14 biswa 17 dhur standing in the name of Smt. Nasreen Banu W/O Mr. Zaffar Iqbal Ansari and sale deed No .21 miz area 01 bigha 05 biswa 01 dhur standing in the name of Haji Abdul Kalam, Zaffar Iqbal & Zaffar Hussain Ansari all S/o,s Late Ab.Hamid Ansari situated at Mehboobpur Bhadohi valued at 105.75 lacs..

REQUESTED /RECOMMENDATION
S OF THE BRANCH

Type of facility PCL PSL CC

Limit

Margin

(amount in ` lacs)

Securities: Primary: a) Hypothecation of all stocks, stores and spares and book debts. b) Pledge of original prime bank letters of credit/ confirmed orders of financially sound overseas buyers. c) Title to goods and proceeds of export bills. d) ECGCs cover under ECIB (WT-PC)/ ECIB (WT-PS) policies. Collateral: a) Mortgage of lease deed No. 202 area 04 Bighas 15 Biswa 19 Dhur (including cost of building) situated at village Rayan Taluka Chathur Bhadohi valued at ` 537.51 lacs as per valuation enclosed. b) Under sale deed No.951,952 dated 08.05.2000 area 01 bigha 14 biswa 17 dhur standing in the name of Smt. Nasreen Banu W/O Mr. Zaffar Iqbal Ansari and sale deed No .21 miz area 01 bigha 05 biswa 01 dhur standing in the name of Haji Abdul Kalam, Zaffar Iqbal

& Zaffar Hussain Ansari all S/o,s Late Ab. Hamid Ansari situated at Mehboobpur Bhadohi valued at 105.75 lacs.

Borrower Information

Address of Head / Registered office Address of the major Unit Date of constitution incorporation Period of dealing with the bank

Rayan Suriawan Road Bhadohi 221401

Address of Administrative Office

Rayan Suriawan Road Bhadohi 221401

Factory at Suriawan Road Bhadohi 03.10.2002

Constitution

Private Limited company

Date of commencement of business

03.10.2002

Since 2000

Particulars of partners Name Mr Zaffer Hussain Ansari Mr Abdul Kalam Ansari Mr Zaffer Iqbal Ansari Share Holding 33.93% 31.93% 29.74%

Ms. Rashika Ansari Ms. Shma Afroz

2.19% 2.21%

Capital Structure of the applicant company (Amount in` lacs) Equity Capital

1004.20

Internal Rating applicable in case of Applicant Borrower is enjoying credit facilities from the Bank

Borrower Risk Score Details Branch Name: M/S XYZ Ltd. Bhadohi Utter Pradesh

Model Name: Small and Medium Enterprise.

Financial Risk Score Management Risk Score Business Risk Score Industry Risk Score Basic Borrower Risk Score

5.44 4.00 1.50 4.00 4.08

Project Risk Score Borrower Risk Score (with project) Conduct of Account Risk Score Final Risk Grade Probability of Default

1.00 5.08

2.00 JKB-SME4 (4.41) 6.37%

As per our banks existing risk Management module, the firm has got the final risk grade of JKB-SME4, which envisages that the firm carries a low risk of default. Other related information

Whether name of the Applicant Borrower, its proprietor/ partners/directors is appearing in the caution / defaulter list of RBI/ CIBIL/ ECGC/. Whether proprietor/ any of the partners / directors of the Applicant Borrower firm /company is a director or a specified near relation of a director of a banking company. Whether proprietor/ any of the partners / directors of the Applicant Borrower firm /company is a specified near relation of any Senior Officer of the rank of Scale iv and above of the Bank.

No

No

No

Banks exposure to the group concerns/ associate concerns including the facilities availed by the proprietor / partners. (Amount in`Lacs) Name of the individual /firm/ Particulars Limit

Group Applicant Borrower Xyz ltd. (Applicant Borrower)

PCL PSL

200.00 150.00

Background of the Applicant Borrower

M/s XYZ Ltd Bhadohi formerly known as Eastern Spinning & Textile Mills Pvt Ltd is a private Ltd company incorporated in year 2000 by its directors Mr. Zaffer Hussain Ansari, Mr Zaffer Iqbal Ansari and Haji Abdul Kalam Ansari who belong to the same family are brothers in relation, the company is engaged in the business of manufacturing and export of carpets. The company is very reputed one in the area and the promoters are having good experience in the business and exports of the carpet and also enjoy satisfactory market reputation. Background of the promoters

All the three promoters of the company are experienced and energetic business man having good experience in the field of export of carpets. The company is enjoying aggregate export facility of ` 350.00 lacs from the business unit. Borrowing purpose

The company is having a handsome amount of export orders in hand and is expecting the same in the next financial year for the timely completion of export orders the company needs extra money to execute these orders. Details of site inspection

The factory is situated at Rayan Suriawan Bhadohi and was inspected by the Branch head and Forex in charge on 02.12.2010. The company keeps complete record of inventories and day to day business, the stocks were found in the factory and were found updated. Financial Analysis Rs lakhs Balance Sheet Spread in

STATEMENT INFORMATION PROFIT & LOSS STATEMENT Gross Sales / Receipts Export Sales Increase in % terms over last year Other Operating Income Total Operating Income Cost of Sales i) Raw Materials used in the process of Manufacture ii) Power & Fuel iii) Other Mfg. Expenses iv) Depreciation Cost of Production Add: Opening stock of finished goods Sub-Total Add: Purchase of finished goods Sub-Total Deduct: Closing stock of finished goods Total Cost of Sales(Cost of Goods sold / Cost of Sales) Selling, General and Admin Expenses

Audited Audited Estimated 31.03.2007 31.03.2008 31.03.2009 1829.80 130.97 1960.77 1726.42 2332.36 292.73 2625.09 891.18 1178.11 104.10 1282.21 499.64

53.85 39.88 1784.71 26.01 1810.72 1810.72 46.80 1763.92 169.70

1383.76 49.77 2299.98 46.80 2346.78 2346.78 44.08 2302.7 136.06

774.28 36.90 1118.05 22.18 1140.23 1140.23 41.07 1099.16 116.80

Sub-Total 1933.62 2438.76 1215.96 OPBIT 27.15 186.33 66.25 Interest 30.27 58.16 17.97 Operating Profit after Interest -3.12 128.17 48.28 PBT/ LOSS 22 98.47 86.99 Provision for Taxes 10.21 38.42 Net Profit/ LOSS 11.79 60.05 86.99 (a) Drawings made by prop. / partners during the year (b) Loss brought forward from previous year. Sub-Total (a+b ) Retained Profits Retained Profit/ Net Profit (%) BALANCE SHEET Current Liabilities Short Term Borrowings from Banks (including bills purchased/ discounted and excess borrowing placed on repayment basis) (i) From Applicant Bank 210 259.17 257.75 (ii) From other Banks A. Sub-Total 210 259.17 257.75 Sundry Creditors (Trade) 415.74 404.62 439.53 Provision for Taxation Other Current Liabilities & Provisions 77.61 135.13 194.65 (due within one year) B. Sub-Total 493.35 539.75 634.18 Total Current Liabilities (A + B) 703.35 798.92 891.93 Term Liabilities 75.69 43.63 15.12 Total Term Liabilities 75.69 43.63 15.12 Total Outside Liabilities 779.04 842.55 907.05 Net Worth Equity Capital 452.37 496.57 622.31 Surplus (+) or Deficit (-) in Profit & Loss Account Total Net Worth 452.37 496.57 622.31

Deferred Tax Liability Total Liabilities Assets Current Assets Cash & Bank Balances Investments (other than long term investments) (i) Receivables other than Deferred and Exports (including bills discounted by banks) (ii) Export Receivables including Bills Purchased/ discounted by banks) Inventory/ Stock in Trade: i) Raw Materials (incl. Stores and other items used in the process of manufacture) (a) Imported (b) Indigenous ii) Stocks in Process iii) Finished Goods iv) Other Consumable Spares Sub Total Other Current Assets (realizable within one year) (i) Advances (ii) Deposits (iv) Others (Specify major items) Sub Total Total Current Assets Fixed Assets Gross Block Depreciation to Date Add: Capital Work in Progress Net Block Other Non-current Assets Total Intangible Assets Total Assets

1231.4

1339.12

1529.36

13.57

15.43

2.54

273.97

238.83

236.14

140.47 187.45 46.80 374.72

103.79 212.18 44.08 360.05

129.09 416.62 41.07 586.78

86.23 46.89 133.12 795.38 457.03 39.88 18.87 436.02

169.75 88.78 258.53 872.84 515.54 49.77 0.526 466.29

170.07 47.48 217.55 1043.01 486.35

1231.4

1339.12

1529.36

Tangible Net Worth Net Working Capital Current Ratio Total Outside Liabilities/ Tangible Net Worth Total Term Liabilities/ Tangible Net Worth

452.37 92.03 1.13 1.72 0.166

496.57 73.92 1.69 1.69 0.087

622.31 151.08 1.45 1.45 0.024

(Amount in Lacs of `) KEY FINANCIAL INDICATORS

Particulars Export Sales PAT Net Sales to Net Profit Capital Tangible Net Worth Working capital Net Fixed Assets Current Assets Current Liabilities Current Ratio TOL/TNW FG Holding Period

2007 2008 2009 1829.80 2332.36 1178.11 11.79 155.19 452.37 452.37 92.03 436.02 795.38 703.35 1.13 1.72 10 days 60.05 38.84 496.57 496.57 73.92 466.29 86.99 13.54 622.31 622.31 151.08 486.35

872.84 1043.01 798.92 1.09 1.69 7 days 891.93 1.16 1.45 14 days

1 month 9 1 month 6 Raw Mat Holding Period Debtors Period days 1 month 23 days days

4 month 16 days

1month 6 2 months days 12 days

2 months 5 months 10 months Creditors Period Comments on financials Sales: there has been an increase in sales from Rs 1829.80 lakh to Rs2332.36 lakh during financial year 2007 to 2008, while as the sales have decreased to Rs 1178.11 lakh in financial year 2009. 26 days 15 days 16 days

Net working capital: the net working capital for the financial year 2007 is Rs 92.03 lakh and it has decreased to Rs73.92 lakh for financial year 2008. For financial year 2009it again shows a very high increase to Rs 151.08 lakh. Total Net Worth: the total Net Worth of the firm has shown contineous increase during all three financial years. The total Net Worth for 2007 is 452.37, 496.57 for 2008 and for 2009 it increased to Rs 622.31 lakh. Fixed Assets: the firm employs reasonable amount in increasing its fixed assets from year to year. The net block of fixed assets for all three financial years are Rs436.02lakh , Rs 466.29 lakh , Rs486.35 lakh respectively. Total outside liabilities/ tangible net worth: there is a decreasing trend of total liabilities/ tangible net worth as the Net worth increases by year to year while as the increase in outside liabilitied is not proportionate to that. Current Ratio: current Ratio shows little variations during the three financial years as it was 1.13 for financial year 2007, 1.09 for financial year 2008, and 1.16 for financial year 2009.

Debtors period; debtors period for the year 2007 was 1month 23 days and it decreases for financial year 2008 to 1month 6 days and then for financial year 2009 it gets doubled to 2 months 12 days. The firm may have increased the debtors period in order to increase the sales as there has been decrease in sales compared to the last year. It may have increased the period to attract more customers. Creditors period: Creditors Period shows very high increase from financial year 2007 to 2009. It is as follows; 2months 26 days for FY 2007 5months15 days for FY 2008 10months 16 days for FY 2009 Increase in this period may be for the reason that the firm wants to increase its sales as there has been a decrease in sales for last year. So to increase the sales they increased creditors period as by doing so more customers will get attracted towards the firm. Stock Turnover Period: i. Stock in Process Turnover Period This period shows abit of decrease from financial year 2007 to 2008 as it is 1month 9days for 2007 and 1mnth 6days for financial 2009. There is a rapid increase to 4 months 16 days period. This period is more than stock of finished goods period as it takes time to get raw material process that and change it to final product, as such the period is a bit longer. ii. Stock of finished goods Turnover Period: this period is very small as it is just 10 days for 2007 , 7 days for 2008, and 14 days for 2009. This period is very small for the reason as the firm does not hold finished goods for longer time once the goods are manufactured they are quickly made for sale.

Maximum permissible bank finance

S No. 1. 2. 3. 4. 5. 6 7 8. 9.

Particulars

2009

Total current assets

1043.01

Other current liabilities (excl. bank borrowings) 616.18 Working capital gap (1-2) Min. stipulated working capital (25% of WCG) Actual/projected NWC Item 3-4 Item 3-5 MPBF (6 or 7 whichever is lower) Excess borrowing (4-5) 426.83 201.72 151.08 225.11 275.75 225.11 50.64

Recommendations The firm should be financed for working capital because of following reasons: o The firm is technically sound and is well furnished with modern equipments and machines to carry the production process successfully. o The industry has global reach and is globally growing industry o The financials of the company are really impressive, the firm is continuously showing increasing profits year by year and the various financial ratios are very much satisfactory. o The firm seems very keen in expanding its business as it has increased its fixed assets year by year.

Conclusion

The Working Capital is used to meet day to day business activities. Jammu and Kashmir Bank follows a four step procedure for credit appraisal which involves purpose and cost of project, future trends of production and sales, estimation of cost and earning and profitability, cash flow statements during the period of the loan. Following Fundamentals are studied: Technical feasibility: This includes Plant Capacity, technology used in manufacturing products etc. Economic Viability: This includes Industry Scenario Globally as well as in India. Financial Viability: This includes detailed analysis of Balance Sheet Profit & Loss Account so as to ensure that enough surplus would be generated so as to make timely payment of loan installments and interest. Managerial Competence: A detailed study of management and the promoters of the company should be done to ensure that the company is in right hands and has potential of fulfilling its obligations. Risk Analysis: It is done to determine the risk associated with the project, it can be done in two ways i.e. by Sensitivity Analysis which determines the capacity to service the debts under worsened conditions or by Credit Rating (Internal/External) which suggests the credit worthiness of the company.

After studying all these aspects a final decision is taken by the managers and necessary changes are made to approve the project. This shows that Jammu and Kashmir Bank has sound system for credit appraisal.