Credit Management

Credit
The word credit is derived from the Latin word "Credo"- meanings I believe. It is
usually defined as one's ability to buy with a promise to par. From the banker's
point of view, Credit is the confidence on the lender on the ability and willingness of
the borrower to repay the debt as per schedule of the repayment.

Principle of lending:
Banks are profit oriented organization for which a bank invests its fund in many
ways to earn income. At the same time bank runs the risk of default in repayment.
As such the banks required to follow certain basic principles of lending.

Basic principles areSafety - "safety is the first which depends upon(i)

The repaying Capacity and willingness of the borrower to repay the loan with
interest.

(ii)

The security and its value offered by the borrower.

Liquidity- Ability of an asset to convert in to cash without loss and

Within a short time to meet depositors demand for cash.
Profitability - A Bank must employ its fund in such a way that they will bring
adequate return for the bank which should be more than cost of fund.
Purpose - The purpose should be productive so that the money not only safe but
also provides a definite source of repayment.
Spread Diversification of Advance.

Credit Management

Different Form of Bank Credit

All types of Credit facilities can be broadly classified into two groups
Funded facility
Non funded facility
Funded facility: Any type of credit facility which involve direct outflow of banks
fund on account of borrower is termed as funded facility. It may be classified into
four major types.
Loans : Two types of loans-- Demand loan: To meet short term working capital need that is usually for
the period up to 1 year.
Term Loan: To meet fixed capital expenditure, that is usually for the period
one to five years.
Cash Credit: Under this arrangement borrowers can borrow any time within the
agreed limit and can deposit money to adjust whenever he has surplus cash in hand.
CC Pledge
CC Hypothecation
Overdraft (OD): This is an arrangement between a banker and his customer by
which the later is allowed to withdraw over and above his credit balance in his
current account. OD is allowed in the following way OD clean
OD against guarantee
OD against FDR
OD against DPS.
OD against registered Mortgaged
2

Credit Management

Bill discount: Bank allows advances to the client by discounting usance bills which
matures after a fixed tenor.
In this method, the BANK calculates & realizes at a prefixed rate and credit the
amount after deducting the interest from the amount of instrument. Discounting of
bill, in fact is an extension of credit facilities for a specific period.
Bill purchased: Financing against sight and demand bills are treated as purchase of
bill. In this case the banks become the purchaser or owner of such bill which is
treated as security for the loan.
Before purchasing Banker has to give consideration to the following aspect Bills to be purchased from regular customer of the Bank.
Integrity & Creditability of the Customer.
Bills to be purchased against sanction limit arranged accommodation.
Documents of title of goods are clean and supported with all documents.

Other important funded advances/ facilities are:

Transport Loan
Consumer loans
Agricultural Loan
Weaving loan
Micro credit
Consortium loan
Lease financing
Hire Purchase
Import Financing (LIM, PAD etc)
Export Financing (Packing credit, trust receipt)
3

Credit Management

Non Funded Facility: Though these types of facilities are non funded in nature but
at times it may turn into funded facility. As such liabilities against these types of
credit facilities are termed as Contingent Liability.
[

Major Facilities are Letter of credit (L/C)

Bid bond
Performance bond
Advance /payment guarantee

Credit facilities given by the Bank can be classified in the following wayOn the basis of security obtainedClean

: Without collateral

Secured: With collateral

On the basis of term Short term : One year
Medium term: More than one year to up to five years
Long term

: More than five years

On the basis of sectorial classification Private

Public
Commercial & Industrial
Agricultural
Transport
House Building etc.
4

Credit Management

Analytical Framework for assessing Risk:

It refers to the assessment of a loan proposal from different point of view to decide
whether the bank should go for finance or not.
Credit Risk Analysis helps the banker to ensure selection of right type of loan
proposals/projects/enterprise and right type of a borrower.
Borrower analysis cover a well develop loan proposal analysis of a project from six
point of viewBusiness Analysis:
Market demand of the product
Availability of raw materials (for manufacturing unit) or product (for trading)
Govt. policy guiding the industry
Possibility of growth of business compare with competitor
Age of the business
Mode of the sales (Credit and cash sales)
Industry growth
Market competition
Marketing and distribution system
Product diversity- multi product business
Customer diversity

Financial Analysis:
Profitability Analysis:

Efficiency of management in turning over the companys goods at a profit

5

Credit Management

Growth rate of profitability

Profitability of investment (ROA)
Profitability of equity (ROE)
Efficiency of expense management
Cash flow analysis:

Efficiency of Working capital management

Cash inflow and out flow trend
Efficiency of Receivables collection process
Ability to meet current liability
Efficiency of inventory turnover management
Projected cash flow
Debt equity ratio

Management Risk analysis:

Management feasibility refers to the assessment of the ability of the management of

a particular project. An assessment of a principle promoter i. e their integrity,
experience and capability to implement and run the project is of prime importance
before extending credit facility. As because the project is viable from economic,
marketing, technical and financial aspect may fail if wrong person are chosen to
execute and run the project. The ultimate success of a project depends on mainly on
its management ability and sincerity.
Academic Qualification
Identification of Management competence
Skilled & Efficient staff.

Credit Management

Good management employee relationship.

Participative Management.
No Turnover of good employee.
Management Integrity
Pay Income Tax ( if applicable)
Report from supplier.
Mis presentation / hide of information.
Fund diversion.
Business and industrial Experience
Experience from family back ground
Training
Reputation in the society.
Technical Competence.
Knowledge of labor law, factory law.
Honesty, Integrity & resource fullness.
Borrowers personal net worth & social status.
Market Reputation
Succession Plan.
Past performance of the borrower- (if any credit facility availed)

Credit Management

Technical risk:
Availability of all utilities required for business operation
Legality and suitability of business location
Supply of skilled labour

Security risk:
Primary security coverage
Collateral security coverage
Quality of security
Value of security
Relationship risk:
Banking transaction behavior
Previous repayment history
Personal deposit

Relationship risk:
Banking transaction behavior
Previous repayment history
Personal deposit

Credit Management

Income Statement:
It presents the revenues and expenses and resulting net income or net loss for a
specific period of time.
Items of Income statement:
Revenue from sales.
Cost of goods sold: It is simply the purchase price of goods it sells. For a
manufacturing concern COGS is based upon manufacturing cost which
includes direct material cost, direct labor cost and other cost directly
required for producing goods.
Gross Margin: The excess of net sales over the cost of goods sold
Operating expenses: Expenses incurred in the process of earning sales
revenues that are deducting from gross margin in the income statement.
Operating profit.
Withdrawal.
Balance sheet: The balance sheet shows the financial position (assets, liability and
equity) of a business at a specific time.
Items of Balance sheet:
Current assets: Current asset is an asset that must be capable of being convertible
into cash within relatively short period of time, usually one year. Example: Cash,
Inventory, receivables, advanced to supplier etc.
Fixed assets: Fixed assets are to be held for many years and are not acquired, with
an intention of disposing them in the near future. Example: Property, plant,
machineries etc.
Intangible asset: Intangible asset has no physical substances. Example: goodwill,
trademark.

Credit Management

Current liability: Current liabilities are an existing debt which must be paid within
a relatively short period of time, usally one year, without interfering with normal
business operation. Example: payables, short term loan, accrued expenses.
Long term liabilities: Long term liabilities are those debts not due for a relatively
long period of time, usually more than one year. Example: long term loan.
Cash flow statement: The statement of cash flows report the cash receipt, cash
payments, and net cash change in cash resulting from the operating, investing and
financing activities of an enterprise during a period in a format that reconciles the
beginning and ending cash balance.

Cash inflow

Cash out flow

Cash received from sales.

Sales on credit

Cash collection from receivables

Payment to suppliers

Cash from the sale of property

Purchase plant machineries

Collecting fund by loan

Repayment of debt

Working Capital :
Working Capital is capital, which is needed to complete a whole operating
cycle of a business. It is needed for the smooth operation of the firm. Needed
volume of working capital depends on the length of the operating cycle. To get
cash earlier small length of operating cycle is required. Length of operating
cycle depends on three factors:
1. Conversion of cash into inventory
2. Conversion of inventory into receivable
3. Conversion of receivable into cash.

10