Table of contents

1. Executive summary 1.1.1. Title of the project 1.1.2. Main objectives 1.1.3. Rationale behind choosing the project 2. Methodology 2.1.1. Research design 2.1.2. Data collection method 2.1.3. Data analysis method 3. Industry profile 4. Company Profile 4.1.1. History of bank 4.1.2. Mission 4.1.3. Bank statistics 5. Introduction to the project 6. Forms of bank finance 7. Steps in credit appraisal process 7.1.1. Conducting Feasibility Study 7.1.2. Financial analysis 7.1.3. Credit risk rating 7.1.4. Determination Of Interest Rate 7.1.5. Term Sheet 7.1.6. Appraisal note 7.1.7. Disbursement 7.1.8. Follow up 8. Case study 8.1.1. CC renewal of Raj pharma 8.1.2. CC and term loan for Impact packaging

Chapter 1 Executive summary

Executive Summary
As a part of curriculum, every student studying MBA has to undertake a project on a particular subject assigned to him/her. Accordingly I have been assigned the project work on the study of credit appraisal system for SME Sector in Bank of Maharashtra. As it is rightly said that finance is the life blood of every business so every business need funds for smooth running of its activities and bank is the one of the source through which the business get funds, before financing the bank appraise the projects and if the projects meet the requirement of the bank rules than only they will finance. Credit appraisal system is commonly used as a financing method in capital-intensive industries for projects requiring large investments of funds, such as the construction of power plants, pipelines, transportation systems, mining facilities, industrial facilities and heavy manufacturing plants. The core area of this project focuses on the credit appraisal of RAJ PHARMA and IMPACKT PACKAGING who belongs to pharma industry and manufacturing of corrugated boxes respectively. Main objective of the project if to study the process of Credit Appraisal of the projects financed by Bank of Maharashtra. Once a project opportunity is conceived and it is considered after the preliminary screening, a detailed feasibility study has to be undertaken covering marketing, technical, and financial aspects of the project. The study in the form of cases deal with calculations of MPBF (Maximum Permissible Finance), along with going through the borrowers information, general information of the proposal, past record of borrower and details of security mortgaged. Financial records of the borrower audited, provisional and projected such as Profit and loss account statements, Balance Sheet and Cash and Fund Flow Statements needed to be considered. The ratios such as current Ratio, Debt Service Coverage Ratio etc are also checked. The ultimate decision whether to grant the credit to borrower for the application or not and how to go about it , is undertaken after this study which discloses whether the borrower has good past record and information provided are true and fair. 2

My project concerns with the Calculations of MPBF i.e. Credit Appraisal System, in which I need to asses if the borrower should be granted credit, and what should be the recommended loan amount. This all is done after carefully evaluating the financials and securities provided by the borrower.

Rationale behind choosing this topic:

Credit Appraisal System is a comparatively new field for Indian banks, at present scenario India is becoming developed country so because of that many projects are going on that may be infrastructure, power generation, mining etc. considering all these the projects must need finance, to fulfill these objectives the project undertaken companies raise the funds through capital market, debt market and through banks. Whenever bank wants to finance these types of projects it must study the feasibility of the project and then it will go for financing that project. Because of this it is very necessary to study the process of project financed by the bank so I choose this topic to study how BOM study the projects and the method of financing the projects.

Chapter 2 Methodology
Methodology
Research design- in the project undertaken following research studies has been used: Exploratory researchThe main purpose of using this study in my project is that of formulating a problem for more precise investigation or of developing the working hypotheses from an operational point of view. The major emphasis in such studies is on the discovery of ideas and insights. As such the research design appropriate for such studies must be flexible enough to provide opportunity for considering different aspects of a problem under study. Three methods in the context of research design for such studies are talked about: (a) The survey of concerning literature; (b) The experience survey of the project guide and (c) The analysis of insight-stimulating examples. Descriptive research studies have been used in the project to describe the characteristics of the firm whose projects have been financed. Data collection method In the project undertaken both primary and secondary data collection method has been usedThe primary data were collected by visiting the firm with and with branch manager, BoM, Narayan Peth Branch, Pune and talking to the owner and the employees of the firm. There I verified the stock statement, fixed assets, HR strength and infrastructure. The secondary data was collected through Banks website - www.bankofmaharashtra.in Company manuals Commercial Banks Book RBI manuals for CRR Financial data (balance sheet, P & L account, stock statements) of the borrower. 4

Data analysis methods: Following techniques are used for analysisRatio analysis Financial indicators analysis NWC (Net Working Capital) requirements Risk analysis MPBF calculations

Chapter 3 Industry Profile

Industry profile
Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades Indias banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons for Indias growth. The governments regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.

Chapter 3

Industry Profile

Central Bank

Reserve Bank of India State Bank of India, Allahabad Bank, Andhra Bank, Bank of Baroda, Bank of India, Bank of Maharastra, Canara Bank, Central Bank of India, Corporation

Nationalised Banks

Bank, Dena Bank, Indian Bank, Indian overseas Bank, Oriental Bank of Commerce, Punjab and Sind Bank, Punjab National Bank, Syndicate Bank, Union Bank of India, United Bank of India, UCO Bank,and Vijaya Bank. Bank of Rajastan, Bharath overseas Bank, Catholic Syrian Bank, Centurion Bank of Punjab, City Union Bank, Development Credit Bank, Dhanalaxmi Bank,

Private Banks

Federal Bank, Ganesh Bank of Kurundwad, HDFC Bank, ICICI Bank, IDBI, IndusInd Bank, ING Vysya Bank, Jammu and Kashmir Bank, Karnataka Bank Limited, Karur Vysya Bank, Kotek Mahindra Bank, Lakshmivilas Bank, Lord Krishna Bank, Nainitak Bank, Ratnakar Bank,Sangli Bank, BOM

Commercial and International Bank, South Indian Bank, Tamil Nadu Merchantile Bank Ltd., United Western Bank, UTI Bank, YES Bank.

The growth in the Indian Banking Industry has been more qualitative than quantitative and it is expected to remain the same in the coming years. Based on the projections made in the "India Vision 2020" prepared by the Planning Commission and the Draft 10th Plan, the report forecasts that the pace of expansion in the balance-sheets of banks is likely to decelerate. The total assets of all scheduled commercial banks by end-March 2012 is estimated at Rs 40,90,000 crores. That will comprise about 65 per cent of GDP at current 7

market prices as compared to 67 per cent in 2002-03. Bank assets are expected to grow at an annual composite rate of 13.4 per cent during the rest of the decade as against the growth rate of 16.7 per cent that existed between 1994-95 and 2002-03. It is expected that there will be large additions to the capital base and reserves on the liability side.

Structure of Indian Banking

Reserve Bank of India is the regulating body for the Indian Banking Industry. It is a mixture of Public sector, Private sector, Co-operative banks and foreign banks. The private sector banks are further spilt into old banks and new banks. The Indian Banking Industry can be categorized into non-scheduled banks and scheduled banks. Scheduled banks constitute of commercial banks and co-operative banks. There are about 67,000 branches of Scheduled banks spread across India. As far as the present scenario is concerned the Banking Industry in India is going through a transitional phase. The Public Sector Banks (PSBs), which are the base of the Banking sector in India account for more than 78 per cent of the total banking industry assets. Unfortunately they are burdened with excessive Non Performing assets (NPAs), massive manpower and lack of modern technology. On the other hand the Private Sector Banks are making tremendous progress. They are leaders in Internet banking, mobile banking, phone banking, ATMs. As far as foreign banks are concerned they are likely to succeed in the Indian Banking Industry.

Chapter 3

Industry Profile

Reserve Bank of India Scheduled Banks

Scheduled Commercial Banks

Scheduled Co-operative Banks

Public Sector Banks

Private Sector Banks

Foreign Banks

Regional Rural Banks

Scheduled urban co-operative bank

Scheduled State cooperative Banks

Nationalized Banks

BOM & its Associates

(Source: www.mapsofindia.com)

Chapter 4

Company Profile

COMPANY PROFILE
Bank of Maharashtra is an Indian bank based in the city of Pune. The bank was established in the year 1935 with an initial authorized capital worth Rs. 10.00 Lacs, although it became operational in the early phase of the next year. The bank got nationalized by the Government of India in the year 1969. With a total number of 1421 branches located all over India as of April 2009, the bank claims to have the largest number of branches within the state of Maharashtra, among all the Public Sector banks. Commonly known as a common man's bank, Bank of Maharashtra adopts a philosophy of "Technology with personal touch", and follows its motto stating "One Family, One Bank, Bank of Maharashtra". Apart from providing regular banking services to the customers, Bank of Maharashtra has established two Joint Ventures to fulfill its other commitments towards the general public and society. These Joint Ventures are M-SETI and Mahabank Info Centre. Mahabank SelfEmployment Training Institute (M-SETI) is an effort initiated by Mahabank Agricultural Research & Rural Development Fund (MARDEF), a trust run by Bank of Maharashtra receiving help from National Bank for Rural Development (NABARD). The institute runs various selfemployments oriented training courses for the rural unemployed youth from the districts of Pune, Kolhapur, Satara, Sangli, Nashik, Ahmednagar, Jalgaon, Dhule and Nandurbar. Mahabank Info Centre is a yet another initiative by Bank of Maharashtra aimed at providing various retail baking related information to the customers, and enabling smoother operations for them. History of bank THE GENESIS Prof. V. G. Kale and the late Shri D. K. Sathe and registered as a banking company on the 16th of September, 1935 at Pune. The authorized capital was Rs. 10 Lakhs and issued capital of Rs. 5 Lakhs. Their vision was to reach out to and serve the common man and meet all their banking needs. Successive leadership of the Bank and the employees have endevoured to fulfill their vision.

Chapter 4

10

Company Profile

MILESTONES Milestones: Pre Nationalization 1936 1945 1946 1958 : : : : Commenced business on February 8th. Deposits crossed Rs. 1.00 crore mark. Maharashtra Executor and Trustee Company (METCO) established. Listed on Bombay Stock Exchange.

Milestones: Since Nationalization

1969

The Bank was nationalized with 153 branches.

1978

Set up first Regional Rural Bank (RRB) 'Marathwada Gramin Bank' with headquarters at Nanded. The Bank was appointed as Convener to the State Level Bankers' Committee (SLBC)

1979

Bank's business crossed Rs.1,000 crore.

1980

500th branch of the Bank at Narian Point, Mumbai inaugurated by the late Smt. Indira Gandhi, the then Prime Minister of India. Set up the second RRB Aurangabad Jalna Gramin Bank.

1981

1984

Dr Manmohan Singh, the then Governor, Reserve Bank of India, launched the Bank's Golden Jubilee Celebration. Set up the third RRB Thane Gramin Bank

1986

1987

1000th branch of theBank opened at Indira Vasahat, Pune.

11

1996

Bank's Diamond Jubilee Celebration launched by the then RBI Governor, Dr. C. Rangarajan

2004

Bank came up with Initial Public Offering (IPO)

2006

Launched ATM-cum-International Bancassurance business

Debit

Car

Commenced

Commenced distribution of Mutual Fund products. Surpassed business landmark of Rs. 50,000 crore. 1st CBS branch rolled out on 13th November at Karve Nagar, Pune.

2009

1444 branches, 345 ATMs, Total Business over Rs. 90,000 crore, 902 CBS branches.

2nd Mar 2010

The Bank achieved 100% CBS coverage.

Mission To ensure quick and efficient response to customer expectations. To innovate products and services to cater to diverse sections of society. To adopt latest technology on a continuous basis. To build proactive, professional and involved workforce. To enhance the shareholders wealth through best practices and corporate governance. To enter international arena through branch network.

Our Logo The Deepmal With its many lights rising to greater heights. The Pillar Our institution- Symbolizing strength. 12

The Diyas Our Branches- Symbolizing service.

The 3 M's symbolizing Mobilization of Money Modernization of Methods and Motivation of Staff.

Bank is the convener of State level Bankers committee. Bank offers Depository services and Demat facilities at 131 branches. Bank has a tie up with LIC of India and United India Insurance Company for sale of Insurance policies. All the branches of the Bank are fully computerized. Parameters Total Business Total deposits Aggregate deposits Net Bank Credit CD ratio Total Investments Operating Profit Net profit No. of branches Metro Urban Semi-urban Rural March 2008 57381.62 33919.34 33663.20 23220.87 69.70 11298.40 613.20 271.84 1345 264 290 202 589 March 2009 71556.36 41758.33 41580.37 29285.81 71.66 12282.95 672.63 328.39 1375 351 257 251 516 March 2010 87072.20 52254.92 52219.43 34290.77 66.67 18382.14 793.52 375.16 1421 368 271 262 520

(Source: website Bank of Maharashtra)

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Chapter 5 Introduction to project

Project - Credit appraisal

Introduction
Credit appraisal Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is generally carried by the financial institutions which are involved in providing financial funding to its customers. Credit risk is a risk related to non repayment of the credit obtained by the customer of a bank. Thus it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Proper evaluation of the customer is performed which measures the financial condition and the ability of the customer to repay back the loan in future? Generally the credits facilities are extended against the security know as collateral. But even though the loans are backed by the collateral, banks are normally interested in the actual loan amount to be repaid along with the interest. Thus, the customer's cash flows are ascertained to ensure the timely payment of the principal and the interest. Objectives of the project

To assess the financial health of organizations those approach Bank of Maharashtra for credit for import export purposes. This would entail undertaking of the following procedures:

Analysis of past and present financial statements Analysis of Balance Sheet Analysis of Cash Flow Statements Examination of Profitability statements Examination of projected financial statements 14

Examination of CMA data

To assess the suitability of the company for disbursement of credit. This would involve the following actions: Use of credit rating charts Evaluation of management risk Evaluation of financial risk Evaluation of market-industry risk Evaluation of the facility Evaluation of compliance of sanction terms Calculation of credit rating

Determination of interest rate: This would entail the following sequence of actions. Collect data regarding financial health evaluation Noting down of credit rating Referencing the banks interest rate guidelines circular Choosing the interest rate from the circular on the basis of financial health and credit rating RATIONALE OF STUDY Credit appraisal also known as project financing. Project financing is commonly used as a financing method in capital-intensive industries for projects requiring large investments of funds, such as the construction of power plants, pipelines, transportation systems, mining facilities, industrial facilities and heavy manufacturing plants. The sponsors of such projects frequently are not sufficiently creditworthy to obtain traditional financing or are unwilling to take the risks and assume the debt obligations associated with traditional financings. Project financing permits the risks associated with such projects to be allocated among a number of parties at levels acceptable to each party.

15

Chapter 6 Form of bank finance

FORM OF BANK FINANCE

A firm can draw funds from its bank within the maximum credit limit sanctioned. It can draw fund in the following forms:

6.1) Overdraft
Under the overdraft facility, the borrower is allowed to withdraw funds in excess of the balance in his current account up to a certain specified limit during a stipulated period. Though overdrawn amount is repayable on demand, they generally continue for a long period by annual renewals of the limits. It is a very flexible arrangement from the borrowers point of view since he can withdraw and repay funds whenever h desires within the overall stipulations. Interest is charged on daily balances- on the amount withdrawn-subject to some minimum charges. The borrower operates the account through cheques.

6.2) Cash Credit

It is the most popular method of bank finance for working capital in India. Under this method a borrower is allowed to withdraw funds from the bank up to the sanctioned credit limit. Borrower is not required to borrow the entire sanctioned credit once, rather, he can draw periodically to the extent of his requirements and repay by depositing surplus funds in his cash credit account. There is no commitment charge; therefore, interest is payable on the amount actually utilized by the borrower. Cash credit limits are sanctioned against the security of current assets. Though funds borrowed are repayable on demand, banks usually do not recall such advances unless they are compelled by adverse circumstances. Cash credit is the most flexible arrangement from borrowers point of view. It is more often than not is used for working capital.

6.3) Purchase of Discounting Bills

Under the purchase or discounting of bills, a borrower can obtain credit from bank against its bills. The bank purchases or discounts the borrowers bills. The provided under this agreement is covered within the overall cash credit or overdraft limit. Before purchasing or discounting the bills, the bank satisfies itself as to the creditworthiness of the drawer. Though the term bills purchased implies that the bank becomes owner of the bills, in practice, bank holds bills as security for the credit. When a bill is discounted, the borrower is paid the discounted amount of the bill. 16

6.4) Letter of Credit

Suppliers, particularly the foreign suppliers, insist that the buyer should ensure that his bank will make the payment if he fails to honor its obligation. This is ensured through a letter of credit arrangement. A Bank opens a Letter of Credit in favor of a customer to facilitate his purchase goods. If the customer does not pay to the supplier within the credit period, the bank makes the payment under the L/C arrangements. This arrangement passes the risk of the supplier to the bank. Bank charges the customer for opening the L/C. The Bank extends such facility to the financially sound customers. Unlike cash credit or overdraft facility, the L/C arrangement is an indirect financing; the bank makes payment to the suppliers on behalf of the customer only when he fails to meet the obligation. There are two banks involved in L/C arrangements. The L/C opener Bank on behalf of the applicant or purchaser and the advisory bank on behalf of the beneficiary or supplier. The L/C opener Bank issues L/C after taking required security. The beneficiary or supplier gives the goods invoice & bill of exchange to the advisory bank. The advisory bank sends the same to the Opener Bank for acceptance, the opener bank take an acceptance from the applicant and sends back the same to the advisory bank. Now the L/C opener Bank makes payment to the beneficiary or supplier in case of purchaser default. The bank charges the customer for opening the L/C.

6.5) Education loan

BOM also provide assistance to gain education to the Indian Nationals, who have secured admission to professional/technical courses through entrance test/selection process or have secured admission to foreign universities/institutions or have passed the qualifying examination for admission to the courses or to employed person intending to improve their educational qualification and/or receive training in modern technology in India or abroad provided training offers prospects of better placement.

Maximum amount
Security

In India : Rs. 10.00 lacs Abroad : Rs. 20.00 lacs

Up to Rs. 4.00 lacs - Clean Guarantor Above Rs.4.00 lacs to Rs.7.50 lacs - Satisfactory third party Guarantee Above Rs. 7.50 lacs -Value of collateral security after providing requisite margin as below should be equal to the quantum of finance plus 2 acceptable 17

guarantors. Computers purchased out of loan are hypothecated. Margin Up to Rs. 4.00 lacs Nil Above Rs.4.00 lacs - 5% for studies in India 15% for studies abroad Rate of Interest Loans up to Rs. 4.00 lacs (BPLR 2.00%) Loans above Rs. 4.00 lacs (BPLR - 1.25%)

Simple interest during moratorium period, there after compounded monthly 1% interest concession may be provided to the loanees if the interest is serviced regularly as and when applied during the study period when repayment holiday is specified for interest/ repayment under the scheme. Interest concession is available only for moratorium period.

Repayment EMI 60 Months (Loan plus interest accrued together) Moratorium: Course Period + 1 year OR 6 months after getting job whichever is earlier.

6.6) Housing Loan

The Bank provides facility of housing loan to consumers fork purchase, construction, Renovations or for repairs of the house. Eligibility Salaried Persons, Professionals, Businessmen with sufficient disposable income. Farmers having min five acres of irrigated land holding. Non Resident Indians are also eligible. Age Minimum 21 years Maximum 50 Maximum 55 years for other than salaried persons Quantum of Loan: For salaried class 50 times of Gross Salary or 60 times of Net Monthly salary whichever is higher subject to applicable margin yrs. for salaried persons.

18

For Businessmen Equal to avg annual income (Net profit + Depreciation) of last 3 yrs X 4 times (B/S, IT returns) Also note repayment of any other term liabilities. For Farmers 4 times of avg annual net income. Cross check Gross income, land holding, cropping pattern, Sugar Factory/APMC/ other agencies bills etc. Maximum Loan Quantum: No maximum limit for Metro/Urban area Rs.15 lakh in Semi Urban/Rural area Rs.5 lakh for repairs/renovation in all areas Security Upto Rs 25000/- One Guarantor with sufficient income/networth Above Rs 25000/- Equitable/Regd. Mortgage of property or Equal amount of paper security (NSCs, FDRs of our Bank etc. excluding shares) guarantee of the spouse, guarantee of relatives whose income is considered for quantum.

Tenor

Fixed/ Floating Upto P.A. inclusive years floating fixed floating fixed

Sanctioned Loan amount upto Rs.30.00 lakh. Sanctioned Loan amount above Rs.30.00 lakh.

and Above 5 years of 5 and Upto and inclusive of 10 years BPLR-3.75% BPLR-3.50% 8.50% 8.75% 9.50% 10.00% BPLR-3.25% 9.00% 10.25% BPLR-2.75% 9.50% 10.50%

Above 10 years but below & inclusive of 20 years BPLR-3.25% 9.00% BPLR-2.50% 9.75% -

(source: website Bank of Maharashtra) For Repairs and renovation: BPLR-3.00% i.e.9.25% p.a. Margin : 25%

19

Project undertaken was to analyze the financial position of firms and determine their credit worthiness. We mainly dealt with cash credit and term loans. Cash credit or working capital loan Banks are the main institutional sources of working capital finance in India. After trade credit, bank credit is the most important source of financing working capital requirements. A bank considers a firms sales and production plans and the desirable levels of current assets in determining its working capital requirements. The amount approved by the bank for the firms working capital requirements is called credit limit. Credit limit is the maximum funds which a firm can obtain from the banking system. In case of firms with seasonal businesses, banks may fix separate limits for the peak level credit requirements indicating the periods during which the separate limits will be utilized by the borrower. In practice, banks do not lend 100% of the credit limit; they deduct margin money. A margin requirement is based on the principle of conservatism and is meant to ensure security. If the margin requirement is 30%, bank will lend only up to 70% of the value of the asset. This implies that security of banks lending should be maintained even if the assets value falls by 30%. A borrower may sometimes require ad hoc or temporary accommodation in excess of sanctioned credit limit to meet unforeseen contingencies. Banks provide such accommodation through a demand loan account or a separate non operable cash credit account. The borrower is required to pay a higher rate of interest above the normal rate of interest on such additional credit. Cash credit is the issuance of a short term cash loan to a business. A cash loan of this type if often utilized to meet the expenses associated with a specific task or project, with repayment expected within a period of one year or less. Successfully receiving cash credit and paying off the loan within terms can open the way for the business to be extended a more liberal line of credit for future use. Cash credit works in a manner that is very similar to that of a line of credit. The difference is that cash credit establishes a cash account with the lender institution that can be drawn upon by the debtor. This is different from a conventional loan, in that the debtor does not have to receive the entire amount of the loan at one time. Cash credit is also different from a line of credit, as the amount of resources extended are pre-approved and the repayment schedule is the same whether the debtor is actively using the cash credit or not. As with many types of financial assistance, cash credit is extended under terms that are set and controlled by the institution that provides the loan. Typically, cash credit involves the presentation of some form of security in order to be covering the amount of cash credit that is extended by the bank or loan agency. The security of collateral remains accessible to the lender until the cash credit is repaid in full. One of the advantages for a new company is that cash credit can be an excellent way of setting the stage for a long term working relationship with a lender. Upon successfully complying with 20

the terms of the cash credit agreement, the company may become eligible for other forms of assistance from the financial institution, including other forms of cash loans and the establishment of a conventional line of credit. For working capital facilities with or without Term Loan component: Risk grade as per Existing CRRF interest AAA rate of Concessional ROI Concessional ROI For Micro for Small & Medium Enterprises Enterprises BPLR2.75% BPLR2.25% BPLR 2.25%

BPLR1.75%

AA

BPLR1.25%

BPLR1.75%

BPLR0.75%

BPLR1.75%

BPLR1.25

BBB

BPLR0.50%

BPLR1.50%

BPLR1.00%

BB

BPLR0.25%

BPLR1.25%

BPLR0.75%

BPLR+0.25%

BPLR0.75%

BPLR0.25%

BPLR+0.75%

BPLR0.25%

BPLR+0.25%

(Source: website Bank of Maharashtra) Interest rates are determined by the risk grade assigned to borrower on the basis of credit risk rating models given by RBI.

21

TERM LOANS: Term loan is an installment credit repayable over a period of time in monthly/quarterly/half yearly/yearly installments. Term loan is generally granted for creation of fixed assets required for long-term use by the unit. Term loans are further classified in three categories depending upon the period of repayment as under:

Short term repayable in less than 3 years. Medium term loans repayable in a period ranging from 3 years to 7 years. Long term loans repayable in a period over 7 years. Risk grade as per Existing CRRF Interest Rate of Concessional ROI Concessional ROI For Micro for Small & Enterprises Medium Enterprises BPLR2.25% BPLR1.75%

AAA

BPLR1.25%

AA

BPLR0.75%

BPLR1.75%

BPLR1.25%

BPLR0.50%

BPLR1.50%

BPLR1.00%

BBB

BPLR+0.25%

BPLR0.75% BPLR 0.25%

BPLR0.25%

BB

BPLR+0.75%

BPLR+0.25%

B&C

BPLR+1.25%

BPLR+0.25%

BPLR+0.75%

(Source: website Bank of Maharashtra)

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Factors to be taken into consideration while determining requirements for working capital:
Production policies: A sugar factory which belongs to a seasonal industry would obviously have its working Capital need affected by the length of the crushing season. The production schedule i.e. the plan for production, has great influence on the level of inventories. In some cases raw material can be procured only in a particular season and have to be stocked for the production of the whole year. In many others, the production cycle is limited to a part of the year and raw materials have to be accumulated throughout the year. In all such cases the need for working capital will vary according to the production plans. Similarly, the decision of the management regarding automation, etc, also affects working capital requirements. In a labor- intensive process, the requirements of working capital will be higher. In the case of highly automatic plant, the requirements of long-term funds would be greater. Nature of the business The shorter the manufacturing process, the lower is the requirements of working capital. This is because, in such a case, inventories have to be maintained at a low level. Longer the manufacturing process, higher will be the requirements of working capital. This is the reason why highly capital-intensive industries require large amount of working capital to run their sophisticated and long production process. Similarly, a trading concern requires lower working capital than a manufacturing concern. Credit policy The credit policy of the company also determines the requirements of working capital. A company, which allows liberal credit to its customers, may have higher sales but consequently will have large amount of funds tied up in sundry debtors. Similarly a company, which has very efficient debt collection machinery and offers strict credit terms, may require lesser amount of working capital than the one where debt collection system is not so efficient or where the credit terms are liberal. The credibility of a company in the market also has an effect on the working capital requirements. Reputed and established concerns can purchase raw material on credit and enjoy many other services also like door delivery, after sales service etc. This would mean that they could easily have large current liabilities; therefore the required working capital may not be very high. Inventory policy The inventory policy of a company also has an impact on the working capital requirements since a large amount of funds is normally locked up in inventories. An efficient firm may stock material for a smaller period and may, therefore, require lesser amount of working capital. Abnormal factors Abnormal factors like strikes and lockouts also require additional working capital.

23

Recessionary conditions necessitate a higher amount of stock of finished goods remaining in stock. Similarly, inflationary conditions necessitate more funds for working Capital to maintain same amount of current assets. Market conditions Working capital requirements are also affected by market conditions like degree of competition. Large inventory is essential as delivery has to be off the shelf or credit has to be extended on liberal terms when market competition is fierce or market is not very strong is a buyers market. Conditions of supply If prompt and adequate supply of raw materials, spares, stores etc. is available it is possible to manage with small investments in inventory or work on the just in time (JIT) principle. However if the supply is erratic, scant seasonal, channel zed through government agencies etc., it is essential to keep large stocks increasing working capital requirements. Business Cycle Business fluctuations lead to cyclical and seasonal changes in production and sales and affect the working capital requirements. Growth and expansion The growth in volume and growth in working capital go hand in hand. However, the change may not be proportionate and the increased need for working capital is felt right from the initial stages of growth. Level of taxes The amount of taxes paid depends on taxation laws. These amount usually have to be paid in advance. Thus need for working capital varies with tax rates and advance tax provisions. Dividend policy Payment of dividend utilizes cash while retaining profits acts as a source of working capital. Thus working capital gets affected by dividend policies. Price level changes Inflationary trends in the economy necessitate more working capital to maintain the same level of activity.

24

Chapter 7 Credit appraisal process

Steps in process of Credit Appraisal
Submission of Project Report along with the Request Letter

Financial analysis

Credit risk rating

Determination of interest rates

Preparing and submission of Term Sheet If not approved

If approved Preparation of appraisal note

Submission of Proposal to designated authority If No queries raised If queries raised

Project Rejected

Solve the queries

Disbursement

25

Follow up

26

Chapter 7 Credit appraisal process

7.1) CONDUCTING FEASIBILITY STUDY
The success of a feasibility study is based on the careful identification and assessment of all of the important issues for business success. A detailed Project Report is submitted by an entrepreneur, prepared by a approved agency or a consultancy organization. Such report provides in-depth details of the project requesting finance. It includes the technical aspects, Managerial Aspect, the Market Condition and Projected performance of the company. It is necessary for the appraising officer to cross check the information provided in the report for determining the worthiness of the project. Project Details: Definition of the project and alternative scenarios and models

List the type and quality of product(s) or service(s) to be marketed. Outline the general business model (ie. how the business will make money). Include the technical processes, size, location, kind of inputs Specify the time horizon from the time the project is initiated until it is up and running at capacity.

Relationship to the surrounding geographical area

Identifies economic and social impact on local communities. Identifies environmental impact on the surrounding area.

7.1.1) MARKET FEASIBILITY Industry description

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Describes the size and scope of the industry, market and/or market segment(s). Estimates the future direction of the industry, market and/or market segment(s). Describes the nature of the industry, market and/or market segment(s) (stable or going through rapid change and restructuring). Identifies the life-cycle of the industry, market and/or market segment(s) (emerging, mature)

Industry Competitiveness

Investigates industry concentration (few large producers or many small producers). Analyzes major competitors. Explores barriers/ease of entry of competitors into the market or industry. Determines concentration and competitiveness of input suppliers and product/service buyers.

Identifies price competitiveness of product/service.

Market Potential

Will the product be sold into a commodity or differentiated product/service market? Identifies the demand and usage trends of the market or market segment in which the proposed product or service will participate.

Examines the potential for emerging, niche or segmented market opportunities. Explores the opportunity and potential for a "branded product". Assesses estimated market usage and potential share of the market or market segment.

Sales Projection

Estimates sales or usage. Identifies and assess the accuracy of the underlying assumptions in the sales projection. Projects sales under various assumptions (ie. selling prices, services provided).

28

7.1.2.) MANAGERIAL FEASIBILITY Managerial Personnel play a key role in directing the working of the company. It is important for an organization to have a pool of efficient personnel who bear the capacity to bail the company out from crisis situation and work towards optimum utilization of organizational resources. Such capacity of the personnel can be determined by having complete details on following key aspects: Market reputation on the promoter / management of the company Hands on experience of the management personnel in the industry / Business managed by qualified personnel Ability of the promoters / management to bail out the company in case of crisis (for example, this could be derived from a strong group company) Decision making Is it concentrated? Organisation structure / Succession planning / Labour relations Is any group company in default / Any Directors on RBIs negative list / Borrowers trackrecord in honouring financial commitment Length of relationship with the bank

7.1.3) TECHNICAL FEASIBILITY Technology plays an important role in maintaining a competitive position in this highly competitive market conditions. Investing in the proper technology is the key to success it irrespective of size of business thus for achieving its projected performance, it is important for it to have sound technological background. Such technical competence of the project can be determined by having detailed study done on following key aspects:

29

Determining Facility Needs

Estimates the size and type of production facilities. Investigates the need for related buildings, equipment, rolling-stock

Suitability of Production Technology

Investigates and compare technology providers. Determines reliability and competitiveness of technology (proven or unproven, state-of-theart).

Identifies limitations or constraints of technology.

Availability and Suitability of Location Access to markets. Access to raw materials. Access to transportation. Access to a qualified labor pool. Access to production inputs (electricity, natural gas, water, etc.). Investigate emissions potential. Analyze environmental impact. Identifies regulatory requirements.

Raw materials

Estimates the amount of raw materials needed. Investigates the current and future availability and access to raw materials. Assesses the quality and cost of raw materials and markets of easily substituted inputs.

Other inputs

Investigates the availability of labor including wage rates, skill level, etc. Assesses the potential to access and attract qualified management personnel.

Chapter 7 Credit appraisal process

30

7.1.4) FINANCIAL FEASIBILITY Estimate the total capital requirements.

Assesses the capital needs of the business project and how these needs will be met. Estimates capital requirements for facilities, equipment and inventories. Determines replacement capital requirements and timing for facilities and equipment. Estimates working capital needs. Estimates start-up capital needs until revenues are realized at full capacity. Estimates contingency capital needs (construction delays, technology malfunction, market access delays, etc.

Estimates other capital needs. Estimates equity and credit needs. 1. Identifies alternative equity sources and capital availability -- producers, local investors, angel investors, venture capitalists, etc. 2. Identifies and assess alternative credit sources -- banks, government (ie. direct loans or loan guarantees), grants, local and state economic development incentives. 3. Assesses expected financing needs and alternative sources -- interest rates, terms, conditions, covenants, liens, etc. 4. Establishes debt-to-equity levels.

Budgets expected costs and returns of various alternatives.

Estimates expected costs and revenue. Estimates the profit margin and expected net profit. Estimates the sales or usage needed to break-even. Estimates the returns under various production, price and sales levels. This may involve identifying "best case", "typical", and "worst case" scenarios or more sophisticated analysis like a Monte Carlo simulation. 31

Assesses the reliability of the underlying assumptions of the financial analysis (prices, production, efficiencies, market access, market penetration, etc.)

Creates a benchmark against industry averages and/or competitors (cost, margin, profits, ROI, etc.).

Identifies limitations or constraints of the economic analysis. Determines project expected cash flow during the start-up period. Identifies project an expected income statement, balance sheet, etc. when reaching full operation.

7.2) Financial analysis

Various financial indicators are calculated and a credit report is prepared which is an important determinant of an individual's financial credibility. They are used by lenders to judge a person's creditworthiness. They also help the person concerned to narrow down on the financial problem areas. Credit report is a document, which comprises detailed information about the credit payment history of an applicant. It is mostly used by the lenders to determine the credit worthiness of an applicant. The business credit reports provide information on the background of a company. This assists one to take crucial business related decisions. Various financial ratios are calculated for the past and future data provided by the borrower after checking the veracity of the same. The various ratios, which are frequently calculated include: Current ratio= (Receivables + material and finished goods inventory)/ (creditors for goods and expenses)

It determines the liquidity position of the company over a period of one year. The current ratio is an indication of a firm's market liquidity and ability to meet creditor's demands. It is excess of current assets over current liability. If current liabilities exceed current assets (the current ratio is below 1), then the company may have problems meeting its short-term obligations. If the current ratio is too high, then the company may not be efficiently using its current assets. The ideal level is at 1.33:1 however the acceptable level is more than 1. however its level depends on the industry. Long term debt-equity ratio= [Long Term Debt/ Net worth] 32

Indicates the relative proportion of equity and debt used to finance a company's assets. This ratio is also known as Risk, Gearing or Leverage. A high debt equity ratio is not preferable by an investor as the company already has acquired high amount of funds from market thereby reducing the investor share over the securities available, increasing the risk. BoM permits this ratio up to 3:1. If a firm has 25% of the funds bank can provide the rest of the 75%.

Interest coverage ratio= [(Profit Before Interest Provision for Tax)]/(Interest payments due for the year] Fixed assets coverage ratio= [Fixed Assets/ (Term loan and other long term debt obligations)] Debt-service coverage ratio= [{(Profit after tax + Interest on term loan + Depreciation} + other non-cash charges]/ [Interest on term loan + Principle Repayment] Debtors Velocity= [Average Receivables/Credit Sales* No. of days in a year.] Creditors Velocity= [Average Payables/Credit Purchase* No. of days in a year.] Stock Velocity= [Average Stocks/Cost of goods Sold* No. of days in a year.]

Two other important criterions are IRR and DSCR Financial institutions calculate the Internal Rate of Return (IRR). The Internal Rate of Return refers to the rate of return that the project is expected to generate based on its Projected cash flows accruing over its expected lifespan. Institutions have a threshold IRR that the project needs to surpass to assess its viability. DSCR refers to the ability of the project to generate sufficient cash flows to repay the debt taken to finance the project. This includes the principal along with the interest component. Its minimum acceptable level is 1.50. The above ratios are taken and matched with the standard, though a certain amount of flexibility is exercised depending on the perception and personal judgment of the appraising officer. A rating is assigned to the project based on the scores of the different ratios. A cut-off rating determines financing decision (whether the project would financed or not). Above the rating, the projects may be categorized into excellent, good and average.

33

Based on this and the project characteristics, the final terms and conditions of financial assistance are decided upon like: Moratorium Repayment period Availability period Security (like first charge, personal guarantee etc.) Interest rate All the expenses like service fee, processing fee, document fee and other expenses like Inspections of site, factory, etc. are charged to the applicant and are a source of income for the lending institution. Following financial indicators are also calculated Net sales (% Increase/ Decrease) Net Profit after tax (% of NP to Net Sales) Cash available NWC(Long term source- Long term uses) Tangible NetWorth (NW-Intangible assets)=capital + reserves & surplus- intangible assets Debt Equity Ratio=total outsiders liability/net worth Current Ratio= current assets / current liabilities (Source: company manuals)

34

7.3) Credit risk rating

Credit risk rating is done to assess various aspects of the projects and assigns scores against them thereby determining the risk level involved with the project. In October 1991, RBI has issued guidelines on implementation of risk management system in banks. In line with these guidelines bank has put in a place a risk management policy for 200304 vide circular dated 19-05-2003 duly approved by BoDs. The objective of risk management is about taking risk with prudential safeguard and not avoidance of risk. The objective is to optimize the risk and maximize the returns. Credit risk is one of the major risk faced by the bank and credit risk management (CRM) is the most important element of risk management. As such CRR framework is recognized as a key instrument for CRM. Following risks are considered: Financial risk Account operating risk Management risk Industry risk Business risk Project risk

There are 8 models for CRM CRR model1 - industrial and hi-tech agricultural activities(excluding PSUs) for exposure exceeding Rs. 100 lakhs. CRR model2 - industrial and hi-tech agricultural activities(excluding PSUs) for exposure between 10 to Rs. 100 lakhs. CRR model3- industrial and hi-tech agricultural activities(excluding PSUs) for exposure between Rs. 2 to 10 lakhs. 35

CRR model 4 for PSUs CRR model 5 traders (general and agriculture indirect) and services(exceeding 100 lakhs) CRR model 6 traders (general and agriculture indirect) and services(10 to 100 lakhs) CRR model 7 traders (general and agriculture indirect) and services(2 to10 lakhs) CRR model 8 - Agricultural borrowers(2.00 lakhs and above)

CRR models are based on activity and size of the credit exposure. These are the scientific tools that help all functionaries in decision making process as well as in monitoring the account. Types of risk a) Financial risk These are the risks associated with the sponsors or the borrowers themselves. The question is whether they have sufficient resources to manage the construction and operation of the project and to efficiently resolve any problems which may arise. Of course, credit risk is also important for the sponsors' completion guarantees. To minimize these risks, the financiers need to satisfy themselves that the participants in the project have the necessary human resources, experience in past projects of this nature and are financially strong (e.g. so that they can inject funds into an ailing project to save it). Past financial performance o Achievement of sales target o Net profit o TOL/TNW o Net profit/sales o Current ratio

Future risk o Ability of promoter funding o Cash flow adequacy 36

o TOL/TNW o Current ratio o Debt service coverage ratio(DSCR) Ability of promoter/parent group funding shall be perceived from their resourcefulness and their market standing and credibility. In cases where associate concerns are existing, a perception about their operations can help the rating official for deciding a judgmental value and assign score as per scoring norms. b) Account operating riskThese are general risks that may affect the cash-flow of the project by increasing the operating costs or affecting the project's capacity to continue to generate the quantity and quality of the planned output over the life of the project. Operating risks include, for example, the level of experience and resources of the operator, inefficiencies in operations or shortages in the supply of skilled labour. The usual way for minimising operating risks before lending takes place is to require the project to be operated by a reputable and financially sound operator whose performance is secured by performance bonds. Operating risks are managed during the loan period by requiring the provision of detailed reports on the operations of the project and by controlling cash-flows by requiring the proceeds of the sale of product to be paid into a tightly regulated proceeds account to ensure that funds are used for approved operating costs only. Following are included in this riski. Security coverage 1. Execution of document and compliance with the terms of sanction 2. Collateral support 3. Realizable value of collateral 4. Aggregate net worth of all guarantors

37

ii. Conduct of the account 1. Submission of hypothecation statement by the borrower(timeliness and quality) 2. Submission of financial statement

3. Trend of overdrawing 4. Turnover in the account 5. Servicing of principal and interest 6. Delay in realization of discounted bills iii. Observation of financial disciplines 1. Return of cheques issued by the borrowers 2. Cooperation in review/renewal of the facility

c. Management and business risk It is the management of the company that acts as guiding force for the firm. The key managerial personnel should bear the capacity to bail out the company frm crisis situation. Inorder to remain competitive it is essential to take initiatives. Such skills are developed over years of experience, thus for better performance it is required to have a team of well qualified and experienced personnel.\ No. of years of experience in activity Product quality and competitiveness Selling arrangement Achievement in sales projections Achievement in profit projections Achievement in net working capital projections Increase/decrease in net sales over last years Increase/decrease in net profit over last years Debtors velocity

38

d. Project risk This is the risk of technical difficulties in the construction and operation of the project's plant and equipment, including latent defects. Financiers usually minimize this risk by preferring tried and tested technologies to new unproven technologies. Technical risk is also minimized before lending takes place by obtaining experts reports as to the proposed technology. Project risks are managed during the loan period by requiring a maintenance retention account to be maintained to receive a proportion of cash-flows to cover future maintenance expenditure. e. Industry risk

A Company does not operate in isolation there are various market forces that acts in either favorable or unfavraouble manner towards its performance. Thus the rating would not give true picture if does take market or demand situation in consideration.

The demand supply situation / market Potential plays an important role in determining the growth level of the company like

i) Level of competition: monopoly, favorable , unfavorable ii) Seasonality in demand : affected by short term seasonality, long term seasonality or may not be affected by seasonality in demand. Iii ) Raw Material Availability iv) Location Issues like proximity to market, inputs, infrastructure: Favorable, neutral, unfavorable. v) Technology ie, proven Technology- not to be changed in immediate future, technology undergo change, outdated technology. vi) Capacity utilization

39

Rating of the Facility: The company can start functioning only after completing statutary obligations laid down by the governing authority. Such statutary obligation involves obtaining licenses, permits for ensuring smooth operations. Perparation and Submission of Finacial Statements, Stock statements in the standard format within the given time schedule. Business Consideration: The length of relationship with the bank enables the lender to assess the previous performance of the account holder. A good track record acts in the favour of the applicant, however a underperformance make the lender more vigilant.

Credit rating scales

Weighted average score >75 65-75 60-64 55-59 40-54 <40 Rating scale MBR1 MBR2 MBR3 MBR4 MBR5 MBR6 MBR7 description Low risk (AAA) Moderate risk(AA) Fair risk(A) High risk(BBB) Very high risk(BB) Exceptionally high risk Doubtful accounts

(Source: company manuals)

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7.4) DETERMINATION OF INTEREST RATE

The interest rate is determined from the interest rate guidelines circular. This circular is regularly updated to reflect the banks latest credit policies. The rupee credit is based on BPLR and the foreign exchange loans are based on LIBOR. The guidelines define how much interest rate is to be assigned for a particular credit rating and credit duration(as per the tables shown on page13). However, credit rating and its use in determining interest rate is a theoretical concept and the bank may allow a reduction in interest rate under the following conditions: Good Client

The organization is a long term client and brings good business to the bank. The organizations actions show that it intends to become a long term customer of the bank Banking Consortium

The organization is seeking credit from a consortium of banks. In some cases like this, the lead bank might decide the interest rate and all the member banks of the consortium follow this interest rate.

7.5)

TERM SHEET

Following a favorable feasibility check, credit rating the next step is preparing term sheet . A Term Sheet is brief document that provides details on aspects like:

Account Details Financial highlights for immediate previous two audited years and projection for proceeding year Nature of Project Cost of Project Means of finance a. Nature of Facility b. Purpose c. Tenure of Term Loan d. Interest rate Reset

41

e. Margin f. o o o o Interest Rate, Commission

Door to Door Tenor i.e. the period within which the entire amount I sto be disbursed. Repayment Terms Prime Security Collateral Security Upfront fees i.e. the charges levied by the bank for processing the documents.

7.6) Appraisal note

An approved term sheet leads to preparation proposal. A proposal is prepared in standard format, this enables the bank to keep a proper track record and also facilitates proper comparision. A proposal a full fledged document providing details on project submitted and requesting finance from bank. A proposal contains information on following aspects:

* Details of Account: It includes name of the Account Holder, Date of incorporation, Line of Activity, Internal Credit Rating level, Address of the Registered Office, Name of Directors, Share Holding Pattern, Asset Classification, Purpose of the Loan.

* Securities: Lenders often feel more confident about a loan if they are given a security interest in the assets of a business. Then, if the borrower does not repay the loan as promised, the lender can take the property the borrower pledged, sell it and use the proceeds to repay (or partially repay) the borrowed amount. It provides detailed information on nature of securities given in lieu of the Loan. They are of two types Prime securities, Collateral Securities Prime Securities: is a term used in banking transactions which means that the charge to be created is in continuation of an earlier charge which might be held by the same institution or by another institution.

42

Collateral Securities: In lending agreements, collateral is a borrower's asset that is forfeited to the lender if the borrower is insolvent --- that is, unable to pay back the principal and interest on the loan. When insolvent, the borrower is said to default on the loan, in which case the lender becomes the owner of the collateral. It includes details on Nature / Description of collateral security indicating area & location of property Value in Rupees. Date of valuation along with name of owner Insurance Amount & Date of Expiry

Personal guarantee / Corporate Guarantee if any, includes Name of the guarantor, Value of Guarantee. * Financial Highlights: It provides details of important financial elements over a period of years. It includes details on Paid capital, Tangible NetWorth, Net working Capital, Current Assets, Current Liabilities, Net Profit, Net Sales, Reserves and Surplus, Intangible Assets, Long Term Liabilities, Fixed Assets, Investments, Non-current Assets like guarantees , Cash Accruals, Capital employed. It also includes ratios like Debt Equity Ratio, Current Ratio, Debt Service Coverage Ratio and so. The interpretation of the financial data presented provides information on the performance trend of the company also of the Projections made. Such financial highlight plays an important role in assessing the financial strengths and weakness of the business.

43

* Status of the project: A brief of Project is prepared. In this part of proposal a brief about the project is explained, it includes information on nature, type of project, purpose of the project, commencement details, the promoters and related details of the project. If it is a on-goin project it also gives details on progress and status of progress. * Evaluation of Industry: This Section gives brief details on the 1. Scope of the industry 2. Growth level and overall performance of the industry 3. Recent Developments and Trend Evaluation

* Conduct of the Account: This section provides details on : Regularity in Submission of Stock Statements / Book Debt Statement QPR Statements / Half Yearly Statement Financial Statements CMA Data

44

Compliance to Terms of Sanction It furnishes information on following aspect: Completion of Mortgage formalities Registration of Charges with RoC Whether documents valid and in force Compliance of RBI guidelines Whether consortium meetings held at prescribed periodic intervals where the Bank is the leader. * Terms and Condition: It is important both for the bank and the applicant to safeguard its interest, this could be achieved by settling at mutually acceptable terms and condition in order to ensure that both the parties the lender and borrower perform their part of obligation thereby not putting other party at loss. All loans are subject to regulations and conditions. The legal information relating to these regulations and conditions can be viewed in this section. It is advisable for both the parties to read this information carefully before approval.

7.7) DISBURSEMENT:
After submission Proposal to Designated/ Sanctioning Authority for sanctioning the Term Loan. The authorities may raise queries, if any relating to projects and thereby convey it to the processing officer the processing officer in turn addresses them to the borrower for necessary step to be taken; such queries are required to be solved to the earliest by the applicant for further processing of the proposal. If the authorities are satisfied and have no further queries with respect to proposal, the Loan gets sanctioned and the disbursement would be released in as per the terms decided.

45

7.8) FOLLOW-UP:
This is most crucial stage in the process of term loan assessment. Since amount of credit required is usually high, such amount is disbursed in one installment, but they are paid in several Installments. This lender bank to is required to assess periodically the utilization of funds disbursed. Such evaluation is done by obtaining Lenders Engineer Report; it is report that provides complete details of the status of the project. It is prepared on monthly basis. It also provides CA Report, it verifies the Financial details furnished to bank for further disbursement. This is known as renewal of account.

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Chapter 8 Case study

8.1Case study RAJ PHARMA

Brief Summary of the Firm: Raj Pharma is a trading firm. It trades in medical and pharmaceutical products. It was established in the year 2008. Mr. Naresh Jain is an experienced entrepreneur as he worked for more than 10 years with Raj Medicals agencies. He purchased SHOP NO. 20 and established his own business of trading in medical and pharmaceutical equipments or products. Name of the Applicant Borrower: Address of the Regional Office: Mr. Naresh Jain SHOP NO. 20, Shanivar Peth Pune (Mah.) Status of the Dealer: Nature of the Business: Banking with BOM since: Type of loan: Proprietorship Trading of Pharmaceutical Products 2008 Cash Credit

Mr. Naresh Jain wants to take some additional distributorship for 3 companies so he need more funds for giving them advance. Uptill now firm has distributorship of1.) 2.) 3.) 4.) 5.) 6.) Aristo Cipla Alensic Unifass Life medicare Blare mark

47

VISIT REPORT: On Visit I found that 1.) 2.) 3.) 4.) Stock: Debtors: Creditors: Fixed Assets: 19.20lacs 7.42lacs 3.92lacs 2.34lacs

Details of Security: 1.) Primay Security: 2.) Collateral Security: Hypothecation of stock and recievables Equitable Mortgage of SHOP NO. 20,Shanivar Peth, Pune (Mah.), which is valued at 17.00lacs.

N OTE

ON

PROPOSAL :

N EW /R EVIEW /R ENEWAL

WITH

ENHANCEMENT

REVIEW / RENEWAL WITHOUT ENHANCEMENT

Request: For the sanction of the under noted facilities: FACILITIES A) Fund Based B) Non Fund Based Total EXISTING AMT ( in lacs) 10.00 10.00 PROPOSED AMT. ( in lacs) 20.00 20.00

The unit was initially granted a cash credit limit of 10 lacs on 11th march,2008 against the security of land property worth 14.28lacs, which was proposed to increase to 20lacs, for which review is to be done.

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Details of Existing Facilities (funded and non funded ) Sr. no. Facility Amount (in lacs) Sanctioned Date of Particular by sanction of M.V. of securities (in lacs) BOM 11.03.08 Equitable mortgage of shop Drawing Balance power (in Outstanding lacs) (in lacs)

1.

Cash Credit

10.00

10.00

9.63

Name of Proprietor/ Directors and their worth Sr. no. 1. Names Naresh Jain Net Worth (in lacs) 39.39

Name of the Guarontors and their worth: 1. Rekha Devi Jain 77.50

1.) Details of collaterals: Equitable mortgage of Shop no. 20 Shanivar Peth,Pune (Mah.). MARKET VALUE is 14.28 lacs Insurance Details: Whether all terms and conditions of sanction in force are fulfilled? If not, what are the reasons: Whether existing set of documents are in order & in force? YES Turnover of the Account: Credit turnover 2009 10.83 2010 92.3 2011 66.83

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Abridged Balance Sheet: Particulars Capital Employed N.W. Capital Profit Term Loans Dep/Borrowing repayable after one year Long Term u/s Loans Other Term Liab. Current Liabilities Bank C/C 7.14 Creditors 0.30 Provisions Term Liabilities payable within 1 year Other CL Total CL 7.47 Total Liabilities 8.17 Fixed Assets 0.50 Current Cash/Bank 0.06 Assets Debtors/Receivers 2.54 Other CA Stocks 5.10 Total CA 7.67 Non Current Investments Assets Other NCA Preliminary Expenses Intangible Preliminary Expenses Assets Losses Others TOTAL ASSETS Achievement vis--vis Projection: 9.37 8.02 20.00 1.50 20.00 2.50 2008 0.69 1.83 2009 1.39 3.03 2010 7.32 5.13 2011 11.99 6.21

Term Liabilit y

1.18

17.38 19.96 1.99 0.98 6.24 10.26 18.46

21.50 28.82 3.10 1.09 12.85 11.53 26.47

22.50 34.49 2.01 2.46 15.59 1.00 13.43 32.50

8.17

19.96

28.82

34.49

(Source: submitted by the firm)

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Observations on Balance Sheet:1.) The capital of the firm is continuously increasing due to the ploughing back of profits. The projected figures are in line with past trends, hence accepted. 2.) Creditors Payment Period: AMOUNT (in lacs) Particulars Purchases Creditors Creditors payment period 2008 7.99 0.304 0.46mnthns 2009 86.89 8.02 1.11mnths 2010 138.45 1.50 0.13mnths 2011 167.09 2.50 0.18mnths

There is a bit fluctuation in creditors payment period because as the firm could not get required c/c limit, it could not pay creditors in advance. So its amount increased. 3.) Debtors collection period: AMOUNT (in lacs) 2008 Sales 3.47 Debtors 2.54 Debtors collection 8..82mnths period Particulars 2009 89.86 6.22 0.83mnths 2010 150.88 8.75 0.70mnths 2011 181.73 15.59 1.09mnths

Debtors collection period is increasing. As the sales and profitability is increasing, lenient credit policy adopted by them is accepted. 4.) Stock holding period: AMOUNT (in lacs) Particulars Stock Purchases Stock period 2008 5.06 7.99 holding 1.58mnths 2009 10.26 86.89 1.42mnths 2010 11.52 138.45 0.998mnths 2011 13.43 167.09 0.9646mnths

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Firm is slightly increasing its stock in comparison to its purchases. Hence its turnover increases, thereby reducing the stock cost.

Key Financial indicators: Net sales (% Increase/ Decrease) Net Profit after tax (% of NP to Net Sales) Cash NWC(Long term source/ Long term uses) Tangible NW (NW/Intangible assets) Debt Equity Ratio Current Ratio 2009 89.9 3.03 (3.37%) 3.53 1.08 2010 150.9 (67.80%) 5.13 (3.4%) 5.88 4.95 2011 181.73 (20.43%) 6.21 (3.42%) 2.46 10.00

1.39

7.32

11.99

13.33

2.93

1.83

1.06 1.23 1.45 (Calculated figures as per the Banks standard format)

Observations on Key Financial Indicators: 1. The sales of unit have grown 67.88%in 2009-10 and is expected to grow by 20.43% in 2010-11 which is reasonable and can be accepted. 2. The net profit is increasing in both absolute as well as in percentage terms. The projected figures are in line with past trends. 3. NWC is increasing. But it is less than projected and is not in line with projected figures. 4. TNW is increasing due to ploughing back of profits. 5. TL/TNW is decreasing as firm is increasing its NW due to increase in profits. 6. Current ratio is increasing as projected.

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Computation of Working Capital Requirement as per Nayak/ vaz Committee recommendations: Rs. (in lacs) as per the projected figures of 2011 Projected accepted turnover 181.73 W/C requirement i.e. 25% of a 45.43 Minimum margin required { 5% of sales ( item a)} 9.08 Actual Margin Available 10.00 Item b minus item c 36.34 Item b minus item d 35.43 Maximum PBF (item e of f whichever is less) 35.43 Drawings in the account should be allowed as per the Drawing Power based on Stocks Debtors Creditors statements.

a b c d e f g

Computation of limits by traditional method (based on accepted projections): Working of MPBF: Particulars Year Audited Year Estimated Year Projected A) Total Current Assets 18.46 26.47 32.50 B) Other Current 8.02 1.50 2.50 Liabilities (excluding short term bank borrowings) C) WC gap (a-b) 10.44 24.03 30.00 D) Minimum stipulated 4.61 6.62 7.50 NWC [25% of (c)] E) Actual Projected NWC 1.08 4.97 10.00 F) Item (c)-(d) 5.83 17.41 22.50 G) Item (c)-(e) 9.36 19.06 20.00 H) MPBF 5.83 17.41 20.00 I) Excess borrowing, if 4.17 0 0 any Comments: (access borrowing if any and acceptability of MPBF): In 2009, there is some excess borrowing because firm has started in January, 2008. But this
was accepted because of the growth potential and profit making capability of the firm.

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Ratio analysis
1. Current ratio= Current assets/current liabilities

Year Current assets (in lacs) Current liabilities (in lacs) Current ratio

2009 18.46 17.38

2010 26.47 21.50

2011 32.50 22.50

1.06 1.23 1.45 (Source: calculated from firms balance sheet)

1.45 1.23

1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 2009 2010 1.06

2011

Interpretation It is an indicator of the extent to which short term creditors are covered by assets that are expected to be converted to cash in a period corresponding to the maturity of claims. The ideal current ratio is 2:1. The firm current ratio indicate that the firm is in a position to meet its short term obligation because the ratio is in increasing trend , by observing the above table we can say that though the firm does not maintain ideal current ratio, it is still in a position to meet its current obligations. After clearing all the dues the firm is still in a position to maintain liquidity.

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2. Debt equity ratio- This ratio measures the long term or total debt to shareholders equity. This ratio reflects claims of creditors and shareholders against the assets of the firm. Debt Equity Ratio is given by: Debt Equity Ratio = Shareholders equity Particulars Debt 2000 2010 2011 22.5 11.99 1.88 Long term debt

18.56 21.5 7.32 2.94

Equity(Promoter contribution) 1.39 Debt equity ratio 13.3

(Source: calculated from firms balance sheet)

13.3

2.94 1.88 2009 2010 2011

InterpretationThe debt equity ratio is an important tool of financial analysis to appraise the financial structure of the firm. The ratio reflects the relative contribution of creditors and owners of the business in its financing. A high ratio shows a large share of financing by the creditors of the firm; a low ratio implies a smaller claim of the creditors. Debt Equity ratio indicates the margin of safety to the creditors. Here debt-equity ratio is continuously decreasing by increase in capital and almost negligible increase in loan and creditors.

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3. Net profit marginIt is also known as net margin. This measures the relationship between the net profits and sales of a firm. This ratio is based on the premise that a firm should earn sufficient profit on each rupee of sales. If adequate profits are not earned on sales, there will be difficulty in meeting the operating expenses and no returns will be available to the owners. Depending on the concept of net profit employed. , this ratio can be computed as followsEarnings after tax Net Profit ratio = Net sales particulars Profit after tax Net sales Net sales margin 2009 3.03 89.9 3.37% 2010 5.13 150.9 (67.80%) 3.4% 2011 6.21 181.73 (20.43%) 3.42% 100

(Source: calculated from firms balance sheet) Interpretation The net profit margin is indicative of managements ability to operate the business with sufficient success not only to recover from revenues of the period, the cost of services, the operating expenses and the cost of borrowed funds, but also to leave a margin of reasonable compensation to the owners for providing their capital at risk. A high profit margin would ensure the adequate return to the owners as well as enable the firm to withstand adverse economic conditions. A low net profit margin has the opposite implications. This firm has low margin however this is considerable as the firm is new and has high future growth potential.

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Return on assetsThe profitability ratio is measured in terms of relationship between net profits and assets. It measures the overall effectiveness of management in generating profits with its available assets. The ROA may also be called profit-to-asset ratio. It can be computed as followsNet profit after tax Return on Assets = Average total assets particulars Profit after tax Average total assets ROA 2009 3.03 19.96 15.18% 2010 5.13 28.82 17.8% 2011 6.21 34.49 18.0% 100

17.80% 18.00% 17.00% 16.00% 15.00% 14.00% 13.00% 2009 2010 ROA 15.18%

18%

2011

InterpretationReturn on assets employed is favorable. That means the firm is in a position to employ its assets in an efficient manner.

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Return on Capital EmployedIt is similar to ROI except in one respect. Here the profits are related to the total capital employed. The term capital employed refers to long term funds supplied by the lenders and owners of the firm. It is given by the formula-

EBIT Return on Capital employed = Average total capital employed 100

particulars Profit after tax Total capital employed ROA

2009 3.03 1.39 217.99%

2010 5.13 7.32 70.08%

2011 6.21 11.99 51.79%

(Source: calculated from firms balance sheet) Interpretation:The ROCE provides a basis for the test of profitability related to the source of long term funds. The higher the ratio, the more efficient is the use of capital employed. Here the ratio is very high in 2009 while it follows a decreasing trend because the firm is introducing more and more capital by ploughing back of profits and thus reducing the dependence on outside sources.

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RISK ANALYSIS Assessment of financial risk Past financial performance Value Achievement of sales target Net profit TOL/TNW Net profit/sales Current ratio 92.3 __ 13.36 3.3% 1.06 Score 4 __ 3 0 1 Weight 1.5 1.0 1.0 1.5 1.0 Weighted score 6.00 N.A. 4.5 0 1.00

(Determined as per CRR model given by RBI) Future risk Value Ability of promoter funding Cash flow adequacy TOL/TNW DSCR Current ratio __ 5.28 N.A. 1.23 Score 4 __ 0 N.A. 1 Weight 1.0 1.0 1.0 N.A. 1.0 Weighted score 4.00 N.A. 0.0 N.A. 1.00

(Determined as per CRR model given by RBI) o Total weighted score 16.50 o Maximum weighted score 40.00 o Weighted score percentage 41.25% o Risk rating MBR5 (BB)

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Assessment of account operating risk Security coverage Value Execution of document and Full compliance with the terms of sanction Collateral support Realizable value of collaterals Aggregate guarantors Total (Determined as per CRR model given by RBI) 91.00 NW of 14.3 lacs 143% 4 5 5 4.0 5.0 5.0 16 25 25 Score 5 Weight 5.0 Weighted score 25

all 77lacs

Conduct of the account

Value Score Weight Weighted score Submission of hypothecation 15days statement by the borrower (timeliness & quality) Submission statements Trend of overdrawing of financial Within months Not more than 3 5 times Turnover in the account 96% 4 4 5.0 5.0 20 20 4.0 12 4 4 2.0 8 4 3.0 12

Servicing of principal and Within 5 days interest Total

Chapter 8.1 Case study-Raj Pharma

72.0

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Observation of financial discipline Value Return of cheques issued by None borrower Cooperation in review and Well renewal of facility Total o Total weighted score 183.0 o Maximum weighted score 210.0 o Weighted score percentage 87.14% o Risk rating MBR1 (AAA) Assessment of management and business risk Value No. of years of experience in 10 years activity Product quality and Wide range general Selling arrangement Achievement projection Achievement projection Achievement in net working 99% capital projection Debtors velocity Total 61 0.7 month 4 4.0 16 134.0 2 4.0 8 in profit 152% 5 5.0 25 in Sufficient sales 92.3% 3 4 5.0 6.0 15 24 & 5 2.0 10 Score 5 Weight 6.0 Weighted score 30 time 20 in 5 2.0 10 Score 5 Weight 2.0 Weighted score 10

competitiveness

(Determined as per CRR model given by RBI) o Total weighted score 134.0 o Maximum weighted score 175.0 o Weighted score percentage 76.57% o Risk rating MBR1 (AAA) Assessment of overall rating Total weighted score Financial risk 16.5 Maximum weighted score 40.00 Weighted score percentage 41.25% MBR5 BB Account operating risk Management and business risk Total 333.5 425.0 78.47% 183.00 210.0 87.14% MBR1 AAA MBR1 AAA MBR1 AAA (Determined as per CRR model given by RBI)
OVERALL RATING MBR1 (AAA)

Rating

134.00

175.0

76.47%

Based on details embodied in the note following facilities are recommended: Nature of Facility: Cash Credit Amount: Rs. 10 lacs Margin: 25% Rate of interest: as per CRR Rating, BPLR + 1% i.e. 13.25% (at present BPLR is 12.25%) Security: hypothecation of stocks and receivables Other Conditions: The facilities to be secured collaterally by following:

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(i) (ii) (iii) (iv)

Equitable mortgage of Shop no. 20, Narayan Peth, Pune (Mah.) owned by Naresh Jain, valued at 14.28 lacs as a security for c/c limit. The facility is further secured by personal guarantee of SMT. REKHA DEVI JAIN. Non submission of stock statements every month will attract penal interest @1% over & above regular rate of interest chargeable to the facility. Any overdrawing in c/c account will attract penal interest @ 2% over & above regular rate of interest chargeable to the facility.

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Chapter 9 Findings
Credit appraisal is done to check the commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary or collateral security cover available for the recovery of such funds Credit is core activity of the banks and important source of their earnings which go to pay interest to depositors, salaries to employees and dividend to shareholders Credit and risk go hand in hand In the business world risk arises out of:o Deficiencies /lapses on the part of the management o Uncertainties in the business environment o Uncertainties in the industrial environment o Weakness in the financial position Banks main function is to lend funds/ provide finance but it appears that norms are taken as guidelines not as a decision making A bankers task is to identify/ assess the risk factors/ parameters and manage/ mitigate them on continuous basis The CRA models adopted by the bank take into account all possible factors which go into appraising the risk associated with a loan These have been categorized broadly into financial, business, industrial, management risks & are rated separately The assessment of financial risk involves appraisal of the financial strength of the borrower based on performance & financial indicators After case study, we found that in some cases, loan is sanctioned due to strong financial parameters From the case study analysis it was also found that in some cases, financial performance of the firm was poor, even though loan was sanctioned due to some other strong 64

parameters such as the unit has got confirm order, the unit was an existing profit making unit and letter of authority was received for direct payment to the bank from ONGC which is public sector.

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Chapter 10 Conclusions
It is boom time for those working in the financial sector. There are opportunities galore in finance and more will come in the next few years so finance is exciting is exciting both as a subject and a career option with the greater expansion of the global economy. Finance management is the backbone of any organizations and hence yields a number of job options ranging from strategic financial planning to sales. The CRA models adopted by the bank take into account all possible factors, which go into appraising the risk associated with a loan, these have been categorized broadly into financial, business, industrial, and management risks & are rated separately. Usually, it is seen that credit appraisal is basically done on the basis of fundamental soundness. But, after different types of case studies, my conclusion was such that credit appraisal system is not only looking for financial wealth. Other strong parameters also play an important role in analyzing creditworthiness of the firm.

Morover, the study at BOM gave a vast learning experience to me and has helped to enhance my knowledge. During the study I learnt how the theoretical financial analysis aspects are used in practice during the working capital finance assessment. I have realized during my project that a credit analyst must own multi-disciplinary talents like financial, technical as well as legal knowhow.

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The credit appraisal for working capital finance system has been devised in a systematic way. There are clear guidelines on how the credit analyst or lending officer has to analyze a loan proposal. It includes phase-wise analysis which consists of 5 phases:

1. 2. 3. 4. 5.

Financial statement analysis Working capital and its assessment techniques Credit risk assessment Documentation Loan administration

To ensure asset quality, proper risk assessment right at the beginning, is extremely important. That is why Credit Appraisal system is an essential ingredient of the Credit Appraisal exercise. The SBI was the first to formulate a Credit Risk Assessment model. It considers important parameters like profitability, repayment capacity, efficiency of the unit, historical / industry comparisons etc which were not factored in other models. It is equally efficient as the SIDBIs CART (Credit Assessment and Rating Tool) model. In all, the viability of the project from every aspect is analyzed, as well as type of business, industry, promoters, past records, experience, projected data and estimates, goals, long term plans also plays crucial role in increasing chances of getting project approved for loan.

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The study conclusions contain the information you will use for deciding whether to proceed business. The major categories this section should include are:

Identify and describe alternative business scenarios and models.

Compare and contrast the alternatives based on their business viability. Compare and contrast the alternatives based on the goals of the producer group. Outline criteria for decision making among alternatives.

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Bibliography
Internet o www.bankofmaharashtra.com o www.mapsofindia.com o www.wikepedia.com o www.indiainbusiness.nic.in o www.wisegeek.com

Books o Financial management by Khan and Jain o Management accounting by S. N. Maheshwari

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