Credit Appraisal For Term Loan and Working Capital Assessment

A SUMMER TRAINING PROJECT REPORT
ON
CREDIT APPRAISAL FOR TERM LOAN AND

WORKING CAPITAL FINANCING
SUBMITTED UNDER THE PARTIAL FULFILLMENT FOR THE AWARD
OF DEGREE OF MASTER IN BUSINESS ADMINISTRATION (2012-2014)
UNDER THE GUIDANCE OF:
Dr. DIVYA CHOWDHRY

FACULTY, RDIAS
SUBMITTED BY:
TARANDEEP SINGH
ENROLLMENT NO:06015903912
BATCH NO:2012-2014
RUKMINI DEVI INSTITUTE OF ADVANCED STUDIES
An ISO 9001:2008 Certified institute

NAAC Accredited Grade A
(Approved by AICTE,HRD Ministry, Govt. of India)
Affiliated to Guru Gobind Singh Indraprastha University, Delhi
2A & 2B, Madhuban Chowk, Outer Ring Road,Phase-1,Delhi-110085

CERTIFICATE (From Guide)
This is to certify that the project titled Credit Appraisal For Term Loan & Working Capital
Financing is an academic work done by Tarandeep Singh submitted in the partial
fulfillment of the requirement for the award of the degree of Master of Business
Administration in Finance from Rukmini Devi Institute Of Advanced Studies, New
Delhi under my guidance and direction. To the best of my knowledge and belief the data and
information presented by him in the project has not been submitted earlier elsewhere.
Dr. Divya Chowdhry
(Project Guide)
RDIAS
ACKNOWLEDGEMENT
First and foremost I am grateful to the Head of the Organization, Mr. K. R. Kamath, CMD,
Head Office, Punjab National Bank for giving me an opportunity to be a part of their
esteemed organization and enhance my knowledge by granting permission to complete my
SIP under their guidance. I express my sincere gratitude to my company guide Mr.
Madhukar Kapoor(Chief Manager, Credit Administrative Division), for rendering me his
continuous support, encouragement and guidance and also for lending a patient ear when it
came to solving my problems related to the project. The project would not have been possible
without his valuable time and support. I humbly thank my faculty project guide; Dr. Divya
Chowdhry who provided her valued guidance that helped me to work on this project
comprehensively which enabled me to hone my skills.
I am deeply indebted to all the faculty members of my institute for their valuable contribution
during the academic session. Also I want to acknowledge the support of the staff of the
Central Library of the bank for providing with various books and study material relevant in
the preparation of the project report.
Last but not the least, I would like to thank everyone I was associated with, whose names
have remained unmentioned here, but who have contributed by giving me a sharp and
gratifying imminent approach and insight during the course of my project.
Regards,
Tarandeep Singh
RDIAS, New Delhi

EXECUTIVE SUMMARY
This project reflects the role of a financial analyst.

This project was undertaken at the Punjab National Bank Head Office, New Delhi, at the Credit
Administration Department. The project studies the credit appraisal methodology at Punjab
National Bank for a proposal received either for term loan or working capital financing or both
for Rs. 700 crore or more and where the borrower wants to avail the facility from a consortium of
banks. This project explains various credit facilities and processes followed by one of the most
reputed bank in the country, Punjab National Bank. Each bank has its own set of policies that
must be followed while sanctioning a loan and care must be taken that the money provided by the
bank is being used up for the intended purpose only. The task ranging from acceptance of loan
proposal to sanctioning of loan is carried out at Credit Division of the bank. Moreover, each loan
proposals fall under powers of different levels depending on the size of the proposal.
The study is undertaken to understand the process of project appraisal for term loans and
assessment for working capital requirements being followed at PNB. With a developing economy
and many multinational companies coming up, new projects are being undertaken. These projects
require huge amount of capital and thus banks come forward to finance these projects depending
on the feasibility of the project. PNB carries out an extensive study of the project and checks for
it feasibility and if the project seems to be feasible, a decision is taken. This process of carrying
out the feasibility test of the project based on the financial position of the company is called
Project Appraisal.
Credit appraisal is the process of evaluating a proposals worthiness of being provided with the
type of credit facility the borrower has asked for. This includes the evaluation of current financial
status, appraisal of projected cash flows, fund flows, P&L and Balance sheets, purpose for which
the facility is availed, technical and financial feasibility of the project, credit history, managerial
competence and past experience, etc. in case for a term loan. As part of the appraisal process,
credit rating is done for the proposal and is conducted either by the bank itself or is get done by
approves external agencies. Financial requirements for Project Finance and Working Capital
purposes are taken care of at the Credit Department. Companies that intend to seek credit
facilities approach the bank. Primarily, credit is required for following purposes:
a. Working capital finance
b. Term loan for mega projects
c. Non Fund Based Limits like Letter of Guarantee, Letter of Credit etc.
The project covers the most important aspect of a company, Working Capital. Different firms
have different approaches to finance their working capital needs to carry out their day to day
operations. After receiving proposals for working capital loans, as a precaution banks need to
assess the amount of working capital loan which can be granted and also to determine the interest
rate at which the loan can be provided. The RBI and its committees have introduced new methods
for the calculation of credit eligibility for the working capital financing of firms. The newer
methods are firmer on risk management front and also the stability of economy in case of any
excessive default rate.
Project Financing discipline includes understanding the rationale for project financing, how to
prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In
addition, one must understand some project financing plans have succeeded while others have
failed. Project finance is different from traditional forms of finance because the credit risk
associated with the borrower is not as important as in an ordinary loan transaction; the most
important is the identification, analysis, allocation and management of every risk associated with
the project.
The purpose of this project is to explain, in a brief and general way, the manner in which risks are
approached by financiers in a project finance transaction. Such risk minimization lies at the heart
of project finance. Efficient management of credit portfolio is of utmost importance as it has a
tremendous impact on the Banks assets quality & profitability. The ongoing financial reforms
have no doubt provided unparalleled opportunities to banks for growth, but have simultaneously
exposed them to various risks, which need to be effectively managed.
Also, lending continues to be a primary function in banking. In the liberalized Indian economy,
clientele have a wide choice. External Commercial Borrowings and the domestic capital markets
compete with banks. In another dimension, retail lending- both personal advances and SME
advances- competes with corporate lending for funds and for human resources. But lending by
nature cannot be an aggressive selling activity, disregarding the risks involved. Bank has to be
competitive without compromising on the basic integrity of lending. The quality of the Banks
credit portfolio has a direct and deep impact on the Banks profitability.
The study has been conducted with the purpose of getting in-depth knowledge about the credit
appraisal and credit risk management procedure in the organization for the above said first two
purposes. To understand the process completely and clearly, I appraised a project by a company
in sugar industry for the term loan. After appraisal, I compared my findings, analysis and
recommendations with those of PNB appraising officers and found out the reasons for
discrepancies. Depending on the type of project, a suitable model is chosen and based on
financials of the company and the track record of the management, rating is done. This rating also
helps in determining the rate of interest at which the loan should be given. Generally, a company
with good ratings is given loan at a lower ROI as the risk involved is lower.
Case study shows how the policies and procedures are implemented during the actual appraisal of
a loan proposal. Report ends with the conclusion and recommendations for further refining and
strengthening of the credit appraisal process. Various components of appraisal process viz.
financial evaluation, techno-economic evaluation, risk analysis etc. have been explained in detail.
Chapter -1
Introduction
Banking industry at a glance

Bank is the main confluence that maintains and controls the flow of money. Government
uses it to control the flow of money by managing Cash Reserve Ratio (CRR) and thereby
influencing the inflation level. The function of the bank include accepting the deposit from the
public and other institutions and then to direct as loans and advance to parties for growth and
development of industries. It extends loans for the purpose of education, housing etc and as a part
of social duty, some percentage of agricultural sectors as decided by the RBI. The bank takes the
deposit at the lower rate of interest and gives loan at the higher rate of interest. The difference in
the transaction constitutes the main source of the income for the bank. This is known as Net
Interest Margin.
Banking in India has undergone starling changes in terms of growth and structure. Organized
banking was active in India since the establishment of the General Bank of India in 1786. The
Reserve Bank of India (RBI) was established as a central bank in 1995. The imperial bank of
India, the biggest Bank at that time, was taken over by the Government to form State owned
STATE BANK OF INDIA (SBI). RBI under took an exercise to reduce the fragmentation in the
Indian Banking Industry post independence by merging weaker banks with stronger banks. The
total number of banks reduced from 566 in 1951 to 85 in 1969.
With the objective of reaching out to the masses and servicing credit needs of all sections of
people, the government nationalized 14 large banks in 1969. This period saw the enormous
growth in the number of branches and Banks branch network become wide enough to reach the
weaker section of the society in a vast country like INDIA.
Major Banking Operations

The main operations of a bank can be segregated into three main areas:
(i) Balancing Profitability with Liquidity Management

(ii) Management of Reserves
(iii) Creation of Credit.
Main Operations of a Bank

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Balancing Profitability with Liquidity Management

Banks are commercial concerns which provide various financial services to customers in
return for payments in one form or another, such as interest, discount fees, commission etc.
Their objective is to make profits. However, what distinguishes them from other business
concerns is the degree to which they have to balance the principle of profit maximization with
certain other principles.
Banks in general have to pay much more attention in balancing the profitability with liquidity.
Therefore, they have to devote considerable attention to liquidity management. Banks deal in
other peoples money, a substantial part of which is repayable on demand. That is why, for
banks unlike other business concerns liquidity management is as important as profitability
management.
Management of Reserves
Banks are expected to hold voluntarily a part of their deposits in the form of ready cash
which is known as cash reserves and the ratio of cash reserves to deposits is known as Cash
Reserve Ratio (CRR). The Central Bank in every country is empowered to prescribe the reserve
ratio that all banks must maintain. The Central Bank also undertakes as the lender of last resort,
to supply reserves to banks in times of genuine difficulties. Since the banks are required to
maintain a fraction of their deposit liabilities as reserves, the modern banking system is also
known as the fractional reserve banking.
Creation of Credit
Unlike other financial institutions, banks are not merely financial intermediaries but they
can create as well as transfer money. Banks are set to create deposits or credit or money or it can
be said that every loan given by bank creates a deposit. This has given rose to the concept of
deposit multiplier or credit multiplier. The importance of this is that banks add to the money
supply in the economy and hence, banks become responsible in a major way for changes in the
economic activities.
Structure of Banking Industry
Scheduled banks
Scheduled commercial Scheduled cooperative

Banks Banks
Public Region Foreig Privat Urban State

sector al rural n e Cooperativ cooperativ
banks Banks Banks sector e Banks e Banks
Banks
SBI & its Nationaliz Old New

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Banks Banks
COMPANY PROFILE
Punjab National Bank (PNB)
VISION
To evolve and position the Bank as a world class progressive, cost effective and customer
friendly institution providing comprehensive financial institution providing : To evolve and
position the Bank as a world class progressive, cost effective and customer friendly institution
providing comprehensive financial and related services; integrating frontiers of technology and
serving various segments of society especially the weaker sections; committed to excellence in
serving the public and also excelling in corporate values.
MISSION
To provide excellent professional services and improve its position as a leader in the field
of financial and related services; build and maintain a team of motivated and committed
workforce with high work ethos; use latest technology aimed at customer satisfaction and act as
an effective catalyst for socio-economic development.
PUNJAB NATIONAL BANK

Established in 1895 at Lahore, Punjab National Bank (PNB) has the distinction of being
the first Indian bank to have been started solely with Indian capital. It was founded by Lala
Lajpat Rai. Now its headquarter is at Delhi. The bank was nationalized in July 1969 along with
13 other banks. Today, PNB is a professionally managed bank with a successful track record over
110 years. The bank has the largest branch network In India, with 5100+ branches across 764
cities and serves over 63 million customers. PNB was ranked as 515 th biggest bank in the world
by Bankers Almanac, London.
Parent company Government of India.
Category Banking Services.
Sector Banking and Finance.

Tag line The name you can bank upon.
USP Punjab national bank if one of big four banks of India.
Financial Performance (2012-2013)

The Banks business crossed Rs.6.73 lakh crore as on March 31, 2013 registering a YoY
growth of 21.3%. This has positive impact on productivity indicators with business per employee
increasing to Rs.11.32 crore. Business per branch increased to Rs.116 crore. Total deposits have
touched Rs.3.80 lakh crore recording YoY increase of 21.3%, culminating in improving the share
of bank in the system by 32 bps to 5.60% in March 2012. Net advances are around Rs.2.94 lakh
crore with 21.3% YoY growth. The Banks CASA deposits at Rs.1, 34,129 crore are the highest
among all the Nationalized Banks.
Business Parameters (Rs. Crore)
PARAMETERS Mar-12 Mar-13 Y-o-Y (%)

Total Business 555005 673363 21.3
Total Deposits 312899 379588 21.3
Net advances 242107 293775 21.3
CASA deposits 120325 134129 11.5
Business per employee 10.18 11.32 11.2
Business per branch 105 116 10.5
Deposit Market Share(%) 5.28 5.60 32 bps
Source: Annual results 2013
Bank has also done well in profitability parameters viz. Operating profit and Net Income in
absolute terms. Net Interest Income at over Rs.13,414 crore during FY12 has been the highest
among all the Nationalized Banks. PNB is the first Nationalized Bank to cross Operating
Profit of Rs. 10,000 crore. Net interest Margin remains the best (at 3.84% for FY 2012) once
again among all the Peer Banks. Earnings per share also increased to Rs.154.02 during the
FY13.
Profit Parameters (Rs. Crore)

PARAMETERS Mar-12 Mar-13 Y-o-Y (%)
Operating Profit 9056 10614 17.2
Net Profit 4433 4884 10.2
Net Intt Income 11807 13414 13.6
Source: Annual results 2013
Organization structure: PNB

The bank has its corporate office at New Delhi and supervises 65 circle offices under
which branches function. The delegation of powers is decentralized up to the branch level to
facilitate quick decision making.
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UCT AND SERVICES

1. Savings Account
2. Current Account
3. Fixed Deposits Scheme
4. Credit Scheme
5. Social Banking
6. Corporate Banking
VARIOUS TYPES OF LOAN PROVIDED BY PNB
1. Agriculture & Allied Activity
2. Industry
a. MSME Manufacturing
b. Large Industry
3. Retail Loans of which

a. Housing
b. Other Retail Loans car loan, housing loan, personal loan etc..
4. Comm. Real estate
5. Services and Others
AREAS OF CONCERN FOR PNB FOR CURRENT YEAR
Loss of Number One position in Deposits, Net Profit and Return on Equity.
Dependence on high cost deposits to shore up the deposits base.
Uncontrollable growth in NPAs.
Lead over the immediate competitor getting reduced to Rs. 1115 crore.
Lack of uniform growth in business of various Circles/Branches.
THE ACTION POINTS FOR THE CURRENT YEAR AREAS OF

CONCERN DISCUSSED ABOVE
Focus on CASA: Sustainable growth in savings Deposits by offering wealth management
services to the customers. Business value base current accounts be opened
Retail credit especially the housing loans be marketed aggressively to record high growth.
Wealth management products sales be maximized offering full range e.g. Gold coins to
Insurance.
Monitoring of Irregular Accounts be stepped up to prevent Slippages.
NPA reduction by one on one meetings, immediately targeting freshly slipped accounts.
CREDIT ADMINISTRATION DIVISION (CAD)

Commercial lending organization structure in PNB consists of branches, Mid Corporate
Branches(MCB), Large Corporate Branches(LCB) and Head Office(HO). CAD looks after the
proposal for all type of loans which fall within the preview of GMs-HO/ED/CMD/MC/Board.
Credit proposal goes through different level of sanctioning to enforce internal control and other
practices to ensure that exception to policies, procedure and limits are reported in a timely
manner to the appropriate level of management for action. Authority to handle loan proposals is
distributed as detailed below:
1. Loan proposals less than 35cr are dealt by MCB and LCB at their level and all other
proposals are reffered to Circle Office which are finally handled at Head Office.
2. MCB handle proposals between Rs.5 crore and Rs.25 crore.
3. CAD at Head Office prepares finals proposals which are then placed before ED, CMD, or
MC as per the quantum of proposals.
4. ED has authority to approve loan proposals less than Rs.75 crore. CMD approve
proposals betwee Rs.75 crore and Rs.100 crore. Any proposal greater than Rs.100 Crore
need the approval of management committee.
RISK MANAGEMENT DEPARTMENT (RMD)

The credit administration division is assisted by RMD and industry desk for risk analysis and
technical feasibility of credit proposals.Credit risk is the possibility of loss associated with
changes in the credit quality of the borrowers or counter parties. In a banks portfolio, losses stem
from outright default due to inability or unwillingness of a borrower or counter party to honour
commitments in relation to lending, settlement and other financial transactions.
PNB has an elaborate risk management structure in place. Credit Risk management structure at
PNB involves
Integrated Risk Management Division (IRMD)

IRMD frames policies related to credit risk and develops systems and models for
identifying, measuring and managing credit risks. It also monitors and manages industry
risks.
Circle Risk Management Departments (CRMDs)
Risk Management Departments at circle level are known as CRMD. Their responsibilities
include monitoring and initiating steps to improve the quality of the credit portfolio of the
Circle, tracking down the health of the borrowers accounts through regular risk rating,
besides assisting the respective Credit Committee in addressing the issues on risk.
Risk Management Committee (RMC)
It is a sub-committee of Board with responsibility of formulating policies/procedures and
managing all the risks.
Credit Risk Management Committee (CRMC)
It is a top level functional committee headed by CMD and comprises of EDs, CGMs/GMs
of Risk Management, Credit, Treasury etc. as per the directives of RBI.
Credit Audit Review Division (CARD)
It independently conducts Loan Reviews/Audits.
The risk management philosophy & policy of the bank focuses reducing exposure to high risk
areas, emphasizing more on the promising industries, optimizing the return by striking a balance
between the risk and the return on assets and striving towards improving market share to
maximize shareholders value.
The bank has robust credit risk framework and has already placed credit risk rating models on
central server based system PNB TRAC, which provides a scientific method for assessing
credit risk rating of a client. Taking a step further during the year, the bank has developed and
placed on central server score based rating models in respect of retail banking. These processes
have helped the bank to achieve fast & accurate delivery of credit, bring uniformity in the system
and facilitate storage ofdata & analysis thereof. The analysis also involves analysing the
projections for the future years.
RISK ANALYSIS
PNB has elaborate risk management structure, processes and procedures in place. For the
appraisal of the loan proposals, RMD provides the risk ratings for the client and project based in
the patented internal models of the PNB that have been developed based on statistical analysis of
data. These models are placed on central server based system PNB TRAC, which provides
facility to assess credit risk rating of a client.
This credit risk rating captures risk factors under four areas:
1. Financial evaluation (40%)

2. Business or industry evaluation (30%)
3. Management evaluation (20%)
4. Conduct of account (10%)
Various External Credit Agencies in India:
1. CIBIL
2. CARE
3. FITCH
4. ICRA
Factors determining credit risk:
State of economy
Wide swing in commodity prices
Fluctuations in foreign exchange rates and interest rates
Trade restrictions
Economic sanctions
Government policies
Cumulative weighted score is calculated and rating of the project/company is ascertained as

per the chart below:
CREDIT FACILITIES
PNB provides different types of credit facilities according to the banking norms and convenience
of the clients. Different types of facilities provided are classified below:
1. FUND BASED FACILITIES

Fund based facilities are those that require immediate outlay of funds towards the
borrowing party.
a) Overdraft
Overdraft account is treated as current accounts. Normally overdrafts are allowed
against the Banks own deposit, government securities approved shares and/or
debentures of companies, life insurance policies, government supply bills, cash
incentive and duty drawbacks, personal security etc.
b) Demand loans
Demand loan would be a loan, which is payable on demand in one shot i.e. bullet
repayment. Normally, demand loans are allowed against the banks own deposits,
government securities, approved shares and/or debentures of companies, life insurance
policies, pledge of gold/silver ornaments, mortgage of immovable property.
c) Cash credit advances

Cash credit account is a drawing account against the credit granted by the bank and is
operated in exactly the same way as a current account on which an overdraft has been
sanctioned. In cash credit accounts the borrower is allowed to draw on account within
the prescribed limit as and when required.
d) Bill finance
Bill finance are the advances against the inland bills are sanctioned in the form of
limits for purchase of bills or discount of bills or bills sent for collection. Bills are
either payable on demand of after usage period.
2. NON FUND BASED FACILITIES

While fund based credit facilities require immediate outlay of funds from the bank, non-
fund based facilities basically include the promises made by banks in favor of third party
to provide monetary compensation on behalf of their client if certain situations emerge or
certain conditions are fulfilled. The non-fund based business is one of the main sources of
bank income. Income is in the form of fees and commissions as compared to interest
income in case of fund based lending.
Non fund based credit plays an important role in trade and commerce. The borrowing
clients of banks prefer to avail of the non-fund based facilities mainly because:
a) The facility does not require immediate outlay of funds and therefore the cost of such
funds tend to be lower than the cost of fund based credit facilities.
b) A bank guarantee(BG) or letter of credit(LOC) issued by a bank on behalf of its client
is an off-balance sheet item in the books of clients, hence do not show up as debt or
liability.
For the lending banks, cost of providing non-fund based facilities is significantly lower than
the cost of providing fund-based facilities.
(i) Bank Guarantees

BG may be financial of performance in nature. In a financial guarantee, the issuing bank
assumes an usual credit risk which is the domain of the banks. However, issue of a
performance guarantee involved technical competency and managerial ability of a
customer to ensure the performance of the contract for which guarantee has been drawn.
Issuing banks responsibility against the BG is absolute. So proper appraisal needs to be
done before issuing BG as it is the responsibility of the issuing bank to honor its
guarantee when invoked.
(ii) Letter of credit
A document issued by a bank that guarantees the payment of a customers draft;
substitutes the banks credit. It is an undertaking issued by bank on behalf of the buyer to
the seller, to pay for the goods and services. All letters of credit are irrevocable, i.e. cannot
be amended or canceled without prior agreement of the beneficiary, the issuing bank and
the confirming bank, if any. It is different from BG in the sense that in case of LOC, the
issuing bank does not wait for the buyer to default, and for the seller to invoke the
undertaking. While in BG, comes into play only when the principal party (the buyer) has
failed to pay its supplier.
Competition Information
1. Indian bank
2. Andhra Bank
3. Canara bank
4. ICICI Bank
5. HDFC Bank
6. SBI
SWOT Analysis of PNB
Strengths 1. Diversified operations with 5100 branches.

2. Strong I. T support with best fit approach.
3. Schemes for small and medium scale businesses.
4. It is the second largest state-owned commercial bank in India
with about 5000 branches across 764 cities.
5. Its 56,000+ workforce serves over 37 million customers.
Weakness 1. Less penetration in the urban areas.
2. Inadequate advertising and branding as compared to other banks.
3. Legal issues regarding employees caused a bad name of PNB.
Opportunities 1. Small scale business banking across India.
2. Expansion in other countries for international banking.
3. Installation of more ATMs and better customers services.
Threats 1. Economic crisis and economic fluctuations.
2. Highly competitive environment.
3. Stringent Banking Norms by the RBI and the Governments.
Chapter-2
Literature Review &
Conceptual Discussion
REVIEW OF LITERATURE
1. WORKING CAPITAL
1.1. Sagan in his paper (1955), perhaps the first theoretical paper on the theory of working
capital management, emphasized the need for management of working capital accounts
and warned that it could vitally affect the health of the company. He realized the need to
build up a theory of working capital management. He discussed mainly the role and
functions of money manager inefficient working capital management. Sagan pointed out
the money managers operations were primarily in the area of cash flows generated in the
course of business transactions. However, money manager must be familiar with what is
being done with the control of inventories, receivables and payables because all these
accounts affect cash position. Thus, Sagan concentrated mainly on cash component of
working capital. He suggested that money manager should take his decisions on the basis
of cash budget and total current assets position rather than on the basis of traditional
working capital ratios. This is important because efficient money manager can avoid
borrowing from outside even when his net working capital position is low.
1.2. Walker (1964) made a pioneering effort to develop a theory of working capital
management by empirically testing, though partially, 3 management. Walkerstudied the
effect of the change in the level of working capital on the rate of return in nine industries
for the year 1961 and found the relationship between the level of working capital and the
rate of return to be negative. On the basis of this observation, Walker formulated three
following propositions:
Proposition I If the amount of working capital is to fixed capital, the amount of
risk the firm assumes is also varied and the opportunities for gain or loss are
increased.
Proposition II The type of capital (debt or equity) used to finance working
capital directly affects the amount of risk that a firm assumes as well as the
opportunities for gain or loss.
Proposition III The greater the disparity between the maturities of a firms debt
instruments and its flow of internally generated funds, the greater the risk and
vice-versa.
1.3. Weston and Brigham (1972) further extended the second proposition suggested by
Walker by dividing debt into long-term debt and short-term debt. They suggested that
short-term debt should be used in place of long-term debt whenever their use would
lower the average cost of capital to the firm. They suggested that a business would hold
short-term marketable securities only if there were excess funds after meeting short-term
debt obligations. They further suggested that current assets holding should be expanded
to the point where marginal returns on increase in these assets would just equal the cost
of capital required to finance such increases.
1.4. Abramovitz (1950) and Modigliani (1957) highlighted the impact of capacity
utilization on inventory investment. Existing stock of inventories is expected to take
account of adjustment process to the desired levels. Thus the variable, existing stock of
inventories, is postulated to be negatively related with the desired stock. The ratio of
inventory to sales may affect inventory investment positively because a high ratio of
stocks to sales in the past suggests the maintenance of high levels of inventories in the
past and thus also calling for high investment in inventories in the current period.
1.5. Chakraborty (1973)approached working capital as a segment of capital employed rather

than a mere cover for creditors. He emphasized that working capital is the fund to pay all
the operating expenses of running a business. He pointed out that return on capital
employed, an aggregate measure of overall efficiency in running a business, would be
adversely affected by excessive working capital.
Similarly, too little working capital might reduce the earning capacity of the fixed capital
employed over the succeeding periods. For knowing the appropriateness of working
capital amount, he applied Operating Cycle (OC) Concept. He calculated required cash
working capital by applying OC concept and compared it with cash from balance sheet
data to find out the adequacy of working capital in Union Carbide Ltd. and Madura Mills.
Co. Ltd. for the years 1970 and 1971. He extended the analysis to four companies over the
period 1965-69 in 1974 study. The study revealed that cash working capital requirement
were less than average working capital as per balance sheet for Hindustan Lever Ltd. and
Guest, Keen and Williams Ltd. 61indicating the need for effective management of current
assets. Cash working capital requirements of Dunlop and Madura Mills were more than
average balance sheet working capital for all years efficient employment of resources.
For Union Carrbide Ltd., cash working capital requirements were more in beginning years
and then started reducing in the later years as compared to conventional working capital
indicating the attempts to better manage the working capital.
Chakraborty emphasized the usefulness of OC concept in the determination of future cash
requirements on the basis of estimated sales and costs by internal staff of the firm. OC
concept can also be successfully employed by banks to assess the working capital needs
of the borrowers.
2. CREDIT RISK
2.1. According to the Saraiya Commission, "the grant of credit is a business which involves a
risk of increasing bad debts if proper care is not taken and banks therefore ascertain the
creditworthiness of borrowers from time to time and maintain credit reports on them.
The process of grant of credit by banks comprise in the filing in of applications by the
borrowers, scrutiny of the applications, assessment of creditworthiness and sanctions of
limits by the branch manager or higher authority as well as the follow-up actions on the
advances after they have been granted.
2.2. The modern rating system dates back to 1909 when John Moody started rating US
railroad bonds. In India in 1962, a Credit Information Division was established in RBI
with the view of collection of information from banks and other financial institutions
regarding data relating to the prescribed limits sanctioned by RBI even the RBI Act was
amended into 1962 given powers to collect information in regard to credit facilities
granted by individual banks and notified financial institutions to their constituents and to
supply to these banks and institutions on application the relative information in a
consolidated form. Apart from all the above steps, banks constantly keep a check on the
customers by obtaining information from all the other sources pertaining to their
customers in any form. The Saraiya Commission also suggested the formation of credit
information bureaus on the lines of those prevalent in the US and the UK.
3. COMPLIANCE TO EXPOSURE NORMS

Exposure includes credit exposure (funded and non-funded credit limits) and investment
exposure (including underwriting and similar commitments) as well as certain types of
investments in companies. The sanctioned limits or outstanding, whichever are higher, shall
be reckoned for arriving at exposure limit. Further, non-fund based exposure is calculated at
100% of the limits or outstanding, whichever are higher.
Maximum industry exposure

The bank has developed a model for fixation of industry wise credit exposure ceilings.
The model captures external factors like rating of industry by external agency, nature
of industry and its importance in economy as well as internal factors like level and
trend of asset impairment, exposure level and quality of exposure in the industry. This
model provides scientific assessment and corresponding exposure ceiling level to an
industry. These limits shall be reviewed on the basis of data analysis regularly. As the
ceilings proposed are internal ceilings to achieve diversified growth of portfolio and
reduce portfolio concentration, it is provided that the monitoring against such limits
would be based on actual outstanding.
WORKING CAPITAL LOANS

Working capital refers to the current assets holdings of the firm. Net working capital is the
difference between current assets and current liabilities. Working capital requirements depend
on various business specific internal factors like operating efficiency, technology employed
and the level of quality control.
A manufacturing enterprise has to maintain level of inventory at any point of time below
which production could get impacted. This minimum level of current asset is called Core
Current Asset level. This would be constantly tied up in the business with changes in sales
and activity level. Fluctuating component is the portion above this level that is continuously
changing due to changes in demand, seasonality of product etc.
Businesses finance permanent core component through long-term sources of fund like equity
or long term loans. Fluctuating component is financed mainly by availing the short term loans
and other credit facilities from the bank. Main focus here is to avoid overfunding or
underfunding of the operations. While overfunding will amount to locking up of assets
unproductively as idling cash or inventories, at the same time under funding would seriously
hamper the day-to-day operations and pose a threat to the survival of the business. Hence it is
critical to correctly determine the maximum bank finance that should be provided.
1. Types of Lending (Fund based and Non-Fund based limits)

After arriving at MPBF on the basis of current assets and current liabilities and appropriate
method of lending, various Fund based and Non Fund based Limits have to be decided. The
Fund based limits should not exceed MPBF in any case.
Working capital loan is of two types:
A. Fund Based Working Capital (FBWC) include those where actual funds are proposed to
be given. In FB earnings are in form of interest. Eg. Cash Credit (CC), Packing Credit
(PC) etc.
B. Non-Fund Based Working Capital (NFBWC) actual fund flow does not take place. In
NFB earnings are in form of commission. Eg. Letter of Credit (LC), Bank Guarantee
(BG) etc.
1.1 Fund Based Limits

The inventory limits are set up in the shape of Cash Credit. The receivable limit either by
way of C/C against book debts or by way of bills limit.Cash credit is the most popular
credit system adopted in India and accounts for more than 70%of total bank credit. Under
this system, banker specifies a limit, called the cash credit limit, for each customer up to
which the customer can borrow money against the security of tangible assets or
guarantees. The customer can withdraw money when he needs funds and deposit any
amount of money that he finds surplus with him. The borrower is charged on the actual
amount and tenure of the amount utilized. Under this system, banks prescribe the cash
credit limit for each of their customer on annual basis.
To avoid situations wherein customers seeking excessive cash credit limit, banks charge a
nominal fees on the unutilized amount of cash credit limit. These nominal charges are
known as commitment charges.Within the sanctioned limit, Drawing Power may be
allowed on the basis of value of security. The concept of Drawing Power is explained as
under:
Take for an example, a company ABC Ltd. which does not use any Non fund based
facilities. This company takes cash credit advances from the bank. This cash credit limit is
calculated using the value of current assets and current liabilities of the company.
Financing Fund Based Requirements
An exporter may require credit facilities for completion of export contracts at two stages:
A. Pre Shipment (Packaging credit)

Pre Shipment credit means any loan/advance granted by a bank to an exporter for
financing the purchase, processing, manufacturing or packing of goods prior to shipment
on the basis of letter of credit opened in his favour by an overseas buyer.
Pre-shipment finance can be broadly classified into the following:
Packing Credit
Advance against Duty drawback entitlements
Packing Credit in foreign currency (PCFC)
B. Post Shipment
Post Shipment credit means any loan/advance granted by a lending bank to an exporter of
goods from India from the date of extending credit after shipment of goods to the date of
realisation of exports proceeds. Post shipment credit facilities are as follows:
Export Bills purchased/discounted/negotiated
Advances against bills for collection
Advances against duty drawback receivables from government
1.2 Non fund based Limits
The credit facilities given by the banks where actual bank funds are not involved are termed
as 'non fund based facilities'. These facilities are divided in three broad categories as under:
1.2.1 Guarantees
Sec 126 of Indian Contract Act defines guarantee as a contract to perform the promise
of discharge the liability of a third person in case of default.
Parties to a Guarantee:
(a)Surety (Guarantor): Person, who gives the guarantee
(b)Principal debtor: Person on whose behalf guarantee is given
(c)Creditor: the person to whom guarantee is given (Beneficiary of LG)
Types of Guarantees:
Financial Guarantee: In financial guarantee , the guarantor is undertaking to pay
damages in monetary terms on the happening of some defaults. In these cases the
LGs are issued in Lieu of Financial transactions, e.g. (1) LG for payment of
determined liabilities towards tax, excise duties, custom duties octroi etc. (ii) LG
issued towards disputed liabilities.
Performance Guarantee: Under this head, the LGs are issued mostly to secure
performance of the contracts, the need to pay LG amount will arise only in the
event of non-performance of the contractual obligation. For example
performance with regard to construction of building installation of plant &
machinery.
o Performance of plant and machinery up to agree level.
o Performance related to supply of goods/ materials.
o Securing Advance payment / in lieu of security money deposit, earnest
money deposit/ tender deposit/ Bid bonds
Deferred Payment Guarantee (DPG): Like term loans, deferred payment
guarantees are also given for acquisition of fixed assets. Term loan involves
payment in cash whereas in the deferred payment guarantee, the Bank commits to
pay the beneficiary in case of default made by its customer (purchaser). Therefore,
the issuance of deferred payment guarantees should be treated at par with the grant
of term loans and the proposals for the two should be examined in the same
manner.
The proposal for issuances of a deferred payment guarantee can be entertained in

either of the following two ways:
1. The Bank executes a guarantee deed on behalf of the customer
(Purchaser) in favor of the manufacturer/supplier/financial institution.
OR
2. The Bank accepts/co-accepts usance bill on behalf of its customer
(purchaser) drawn by manufacturer/supplier.
1.2.2 Letter of Credit(L/C)

Bank also provides companies with the facility of letter of credit, a type of non-fund
based facility which enables the companies to purchase raw materials or other
components at credit and paying them later. Letter of credit is issued by the bank at the
request of the customer in favour of a third party informing him that the bank undertakes
to accept the bills drawn on its costumer up to the amount stated in the LC subject to the
fulfilment of conditions stipulated therein. In simple language, LC is a letter issued by the
bank on behalf of the customers. The bank charges a particular fee from the customers for
opening of an LC and at a suitable rate of interest.
Main parties to documentary credit:

a. The Buyer (Applicant for L/C) issuing bank at his request and instructions
opens the L/C. He has liability to pay the issuing bank for the drafts drawn under
the L/C.
b. Issuing or Opening Bank is the bank which opens/issues the L/C at the request
of applicant (buyer) and undertakes to pay/ to accept bill drawn by the beneficiary.
c. The Seller (Beneficiary of L/C) is in whose favour the L/C is opened and to
whom the L/C is addressed. Beneficiary is entitled to obtain payment under L/C.
d. Advising Bank is the intermediary bank; advises the Letter of Credit to the
beneficiary, Advising Bank undertakes the responsibility of providing the
authenticity of L/C.
e. Confirming bank Confirming Bank is a bank that may be requested by the
issuing bank to add its confirmation. If agreed to, the bank becomes a party to L/C
and undertakes the responsibility to honor the bills, i.e., to pay, to accept or to
negotiate the same. Generally the Advising Bank is asked to add confirmation to
L/C.
f. Negotiating Bank is a bank to whom the seller is supposed to submit the
documents for negotiation and get the payment as per the drawn bill.
g. Reimbursing Bank is a bank who is authorized by issuing bank (normally one
of its correspondent banks) to reimburse the paying or negotiating bank.
Working Capital Assessment

The objective of running any industry is earning profits. An industry will require funds to acquire
fixed assets like land and building, plant and machinery, equipment, vehicles etc. and also to
run the business i.e. its day to day operations.Working capital is defined, as the fund required
carrying the required levels of current assets to enable the unit to carry on its operations at the
expected levels uninterruptedly.
Each business unit has an operating cycle which can be illustrated below:
This cycle continues and in order to keep the operating cycle going on, certain level of current
assets are requires, the total of which gives the amount of total working capital required. Thus,
working capital required (WCR) is dependent on:
1. The volume of activity (viz. level of operations i.e. Production and Sales).
2. The activity carried on viz. manufacturing process, product, production program, and the
materials and marketing mix.
Working capital loan is of two types:
1. Fund Based Working Capital (FBWC) include those where actual funds are proposed to
be given. In FB earnings are in form of interest. Eg. Cash Credit (CC), Packing Credit (PC)
etc.
2. Non-Fund Based Working Capital (NFBWC) actual fund flow does not take place. In
NFB earnings are in form of commission. Eg. Letter of Credit (LC), Bank Guarantee (BG)
etc.
Assessment of Working Capital Limits (Fund based)
How much Working Capital loan should be given to the borrower is determined by evaluating the
Working Capital Requirement and the Assessed Bank Finance (ABF). This is done by 3 methods:
A. Simplified Turnover Method/Nayak Committee:

The Reserve Bank of India constituted on 9 December 1991, a Committee under the
Chairmanship of Shri P.R. Nayak, Deputy Governor to examine the difficulties
confronting the small scale industries (SSI) in the country in the matter of securing
finance. The representative of the SSI associations had earlier placed before the Governor,
Reserve Bank of India, various problems, issues and the difficulties which the SSI sector
had been facing.
So for SSI with annual sales of less than Rs 1000 Cr the working capital requirement was
set to 25% of the annual sales out of which 20% would be financed by the Banks and the
rest 5% would be contributors margin.
B. Traditional Method/Tandon Committee/Chore Committee:
In PNB, MPBF is assessed by using the method recommended by Chore Committee.
Preparation of CMA data forms an integral part of CAD and it is based on this data that
the further steps are taken. CMA consists of six Forms and they are:
FORM I: Break up of facility: This form give details regarding the different
forms in which credit has been asked by company such as Cash Credit, Packing
Credit, Letter of Credit, Bank Guarantee, etc.
FORM II: Operating statement or Profit and Loss statement: This help banker to
know about the expenses and tells about the expenses and income generated
during the year.
FORM III: Analysis of Balance sheet: This helps bankers to assess the financial
health of an entity on date of documentation of the business entity
FORM IV: Comparative Statement of Current assets and current liabilities: This
form explains the operating cycle of the company.
FORM V: Maximum permissible bank finance: This forms will show how much
loan bank is eligible to give to company.
FORM VI: Fund flow statement: Many companies do window dressing in their
financial statements and fudge with their accounting figures. A profitable firm may
have negative operative cash flows. Thus fund flow and cash flow analysis helps
the bankers to check the sources of inflow and points of outflow.
The CMA is prepared by both the company as well as the bank. The bank uses the
CMA prepared by the company to analyse the correctness of the working capital
requirements and understand its validity. However, it must be noted that the entire CMA
data is prepared using the balance sheet of the company and certain other documents
submitted by the company to the banks. Here we explain the preparation of CMA data
using a balance sheet of SAP TELECOM Ltd.
The Study Group to frame guidelines for follow up of Bank Credit (commonly referred to
as the Tandon Committee) set up in July 1974, recommended radical changes in the
system of bank lending. Besides shifting the basis of bank lending from the erstwhile
security-oriented system to a production oriented one, it also recommended certain norms
to facilitate meeting the genuine credit needs of industry while, at the same time,
preventing pre-emption of scarce bank resources by the large industry.
The Tandon Committee suggested norms for 15 major industries (norms have since been
finalized for 45 industries) on the basis of various studies conducted earlier discussions
with the representatives of industry. These norms represent the maximum levels for
holding inventory and receivables in each industry for the purpose of sanctioning short-
term credit limits to supplement the borrowing units own resources to carry an acceptable
level of current assets. It, however, a borrowing unit has managed with lower levels of
inventory and receivables in the past, banks are to finance the level of current assets on
the basis of such reduced levels of holding unless warranted otherwise.
Hence for Working Capital limit of greater than Rs 5 Cr the Maximum Permissible Bank
Finance (MPBF) is calculated to assess the Assessed Bank Finance (ABF) and the
contributors margin.
CMA data is provided by the company in a prescribed format. This CMA data involves
the analysis of balance sheet in order to find out the working capital requirements of the
company and the maximum amount of permissible bank finance. This method is the most
widely used method and requires a great deal of understanding in order to prepare a CMA
data of the company.The Committee also suggested three ways to assess the maximum
permissible level of bank finance (MPBF). These are:
I. 1st Method of lending (Tondon Committee)
Total Current Assets (TCA)

Less: Other Current Liability (OCL)
Working Capital Gap (WCG)
Minimum stipulated NWC is 25% of the WCG (1)
Actual/Projected NWC (2)
WCG (1) (3)
WCG (2) (4)
Maximum permissible Bank Finance is Minimum of (3) or (4)
Margin is (1) or (2) whichever is more
II. 2nd Method of lending (Chore Committee)

Minimum stipulated NWC is 25% of the TCA (1)
WCG (1) (3)
WCG (2) (4)

Margin is (1) or (2) whichever is more & CR will be =1.33 or more
III. 3rd method of lending
Chargeable Current Assets (CCA)

Add: Other Current Assets (OCA)
Minimum stipulated NWC is 25% of CCA (1)

WCG (1) (3)

WCG (2) (4)

Margin is (1) or (2) whichever is more (However this method is not into use)
C. Cash Budget System:
Cash Budget method, which is used specially for industries where seasonality is involved
like availability of raw materials is seasonal such as sugar industry, cotton textiles and
where sales is seasonal like AC, Woolens etc. In this method, a cash budget is estimated
for the next 12 months. The cash requirements for each month are calculated and the
highest value of cash required during any month becomes the working capital of the
company.
Assessment of Working Capital (Non-Fund Based)
The credit facilities given by the banks where actual bank funds are not involved are termed as
Non-Fund based facilities. These facilities are divided in three broad categories as under:
A. Letters of credit
Letter of credit (LC) is a method of settlement of payment of a trade transaction and is
widely used to finance purchase of machinery and raw material etc. It contains a written
undertaking given by the bank on behalf of the purchaser to the seller to make payment of
a stated amount on presentation of stipulated documents and fulfillment of all the terms
and conditions incorporated therein.
Letter of credit is of two types:
1) Delivery against payment (DP) SIGHT: The beneficiary is paid as soon as the
paying bank or borrowers bank has determined that all necessary documents are
in order.
2) Delivery against acceptance (DA) USANCE: the borrower pays after certain
due date of payment specified.
LC involves three types of pricing = Basic Cost (C) + Insurance (I) + Freight (F)
Further LC is categorized in various type which are:
Letter of Credit: - Inland Letter of Credit (ILC)

- Foreign Letter of Credit (FLC)
Letter of Credit: - Transferable LC

- Non-Transferable LC
Letter of Credit: - Revocable LC
- Irrevocable LC
Assessment of LC limit
Annual Raw Material Consumption (a)
Annual Raw Material Procurement (through ILC/FLC) (b)
Monthly Consumption (c)
Usance (d)
Lead Time (e)
Total Time [(d) + (e)] (f)
LC limit required [(f) x (c)] (LC limit recommended)
B. Guarantees
A contract of guarantee can be defined as a contract to perform the promise, or discharge
the liability of a third person in case of his default. Bank provides guarantee facilities to
its customers who may require these facilities for various purposes.
The guarantees may broadly be divided in two categories as under :
1) Financial guarantees Guarantees to discharge financial obligations to the

customers.
2) Performance guarantees Guarantees for due performance of a contact by
customers.
Assessment of BG limit
Outstanding BG as per Audited Balance Sheet

Add: BGs required during the period
Less: Estimated maturity/cancellation of BGs during the period
Requirement of BGs(Recommended BG limit)
C. Bills Co acceptance
Bills co-acceptance is same as Letter of credit the difference is in Bills co-acceptance LC
is accepted by buyer as well as by co-accepting bank.
D. Deferred Payment Guarantees

DPG is a bank facility where the bank does not directly extend a loan. Instead, it extends a
guarantee to the seller on behalf of its client that the financing extended by the seller (by
himself or through its preferred financer) would be repaid as per the terms agreed upon.
The advantage to the buyer here is that he benefits to the extent of savings in interest
charges accruing on account of opting for equipment financing under installment payment
system less the guarantee charges paid to the bank.
Key Working Capital Ratios:

Current Ratio:A liquidity ratio that measures a company's ability to pay short-term
obligations.
Company has to maintain a current ratio of 1.33:1.The higher the current ratio, the more capable
the company is of paying its obligations. A ratio under 1 suggests that the company would be
unable to pay off its obligations if they came due at that point. While this shows the company is
not in good financial health.
Quick Ratio:An indicator of a company's short-term liquidity. The quick ratio measures a
company's ability to meet its short-term obligations with its most liquid assets. Higher the
Quick ratio betters the position of the company. Quick ratio is effective in case stocks are
obsolete, non-saleable or waste.
Debt Equity Ratio:Represent the ratio between capital invested by the owners and the
funds provided by lenders.
Higher the ratio greater the risk to a present or future creditor. Debt Equity Ratio should be less
than 2:1. Too much debt can put your business at risk... but too little debt may mean you are not
realizing the full potential of your business and may actually hurt your overall profitability.
Gross Profit Margin:A financial metric used to assess a firm's financial health by
revealing the proportion of money left over from revenues after accounting for the cost of
goods sold. Gross profit margin serves as the source for paying additional expenses and
future savings.
Operating Profit to Sales:This ratio gives the margin available after meeting cost of
manufacturing. It provides a yardstick to measure the efficiency of production and
margin on sales price i.e. the pricing structure.
Return on Equity:The amount of net income returned as a percentage of shareholders
equity. Return on equity measures a corporation's profitability by revealing how much
profit a company generates with the money shareholders have invested.
TOL/TNW:This ratio gives a view of borrower's capital structure. If the ratio shows a
rising trend, it indicates that the borrower is relying more on his own funds and less on
outside funds and vice versa.
Where, Tangible Net Worth =
Paid up Capital
Add: Reserves & Surplus
Add: Compulsory Convertible Debenture
Add/Less: Deferred Tax Liability/Assets
Add: Share Application Money
Less: Misc. exp. Not written off
Less: Accumulated Loss
Inventory Turnover Ratio: A ratio showing how many times a company's inventory is
sold and replaced over a period.
TERM LOANS
Term loans are those loans that are lent for extended period of time majorly for the capital
expenditure by the firm. This is different from the short term loans which are mainly provided for
meeting working capital requirements and maintaining short term liquidity.
Term loans are provided for acquisition of fixed assets are to be repaid from the cash generated
from the operations. Credit delivery for term loans are broadly through two means:
1. Fund based
2. Non- fund based
Term loans are sanctioned for acquisition of fixed assets like land, building, plant/machinery,
office equipment, furniture-fixture and other capital expenditure like purchase of transport
vehicles and other vehicles, agricultural equipment etc. The term loan is a loan which is not a
demand loan and is repayable in terms of instalments irrespective of the period or the security
cover.
Term loans are normally granted for the periods varying from 3-7 years and under exceptional
circumstances beyond 7 years. The term loan with remaining maturity period of above 5 years
shall not exceed 50% of the term deposits. Since term loans are provided for long tenure ensuring
the viability of the project and sufficient generation of cash over the long tenure of the loan
becomes critical.
TERM LOAN APPRAISAL
Prior to the sanctioning of a loan it goes through a well-defined appraisal process where it is
evaluated on various parameters. Proper due diligence is followed to mitigate the risk of default
and fraud inherent in the lending process. The process followed is reviewed regularly to account
for new guidelines from the RBI and changes in banks credit policies. Various components of the
appraisal process are as detailed below:
Financial evaluation
It involves evaluation of financial statements of the borrower to ascertain the financial health of
the company. Financial statements are rearrangement as described in detail below and rearranged
financial statements are used to ascertain the capital requirements, liquidity, long term solvency,
debt-repayment capacity etc. of the business involved. Various components of financial
evaluation are as follows:
Reclassification and rearrangement of balance sheet items:

Financial statements contain the information about the financial health of enterprise. Since
different applicants use different formats and classification of some of the items present in the
balance sheet is subjective, it becomes necessary to re-arrange the balance sheet items to achieve
standardization. Components of the balance sheet are used in calculating ratio like Debt Equity
ratio(DER), Debt Service Coverage Ratio(DSCR), Current ratio, Fixed asset coverage
ratio(FACR), Maximum Permissible Bank Finance(MPBF) etc. There are guidelines from the
RBI and bank on the permissible values of these ratios. Therefore, proper rearrangement of
financial statements becomes critical in credit lending decision making.
Current Liabilities
o Short term borrowings including bills purchased and discounted excluding bank
finance.
o Unsecured loans.
o Public deposits maturing within the year.
o Sundry creditors.
o Interest and other charges accrued but not due for payment.
o Advances/progress payments from customers.
o Deposits from dealers, selling agents etc.
o Installments of deferred payments, debentures, redeemable preference shares, long
term deposits payable within one year.
o Statutory liabilities like provision for PF dues, taxes etc.
o Miscellaneous current liabilities like proposed dividends, liabilities for expenses
etc.
Current Assets
o Cash and bank balances.
o Investments in government/trust securities, for short term and fixed deposits with
banks, investment in shares and debentures etc. should be excluded from current
assets.
o Raw material and consumable spares including that under transit. But slow
moving and obsolete items should be excluded from current assets and should be
grouped as non-current assets.
o Stock in progress and finished goods (including goods in transit).
o Advance payment for tax, prepaid expenses, advance for purchase of raw material
and consumables.
Treatment of Export Receivables
For calculating MPBF, the amount of export receivables may be excluded from the current assets
as need based limits for export receivables could be sanctioned and in respect of such receivables
borrowers are not required to bring in 25% by way of Net Working Capital.
Treatment of Redeemable Preference Share
Preference share redeemable within one year should be considered as current liabilities. However,
preference share redeemable after one year should be considered as term liabilities.
Treatment of Unsecured Loan
In case of Partnership, Proprietorship, and Private Ltd. Companies, the unsecured loans raised by
friends, relatives, and directors etc. that remain in the business for continuous basis may be
treated as quasi capital to the extent not exceeding 100% of tangible net worth of the party
subject to the condition that these loans shall not be withdrawn during the currency of the loan
and shall be subordinate to bank borrowings. Amount of unsecured loans over and above the net
worth of the party should be treated as term liability for calculating various financial ratios. For
Public Ltd. Companies, the unsecured loans should be treated as long term debts.
Cost of Project and means of Financing
Cost of project and sources of finance are ascertained to ensure the financial viability of the
project for which funding is sought. The major cost components of the project is given including
land and building including transfer, registration and development charges as also plant and
machinery, equipment for auxiliary services, including transportation, insurance, duty, clearing,
loading and unloading charges etc. the means of financing the project cost may be one or more of
the following:
Equity capital from shareholders
Preference capital from preference shareholders
Capital subsidies from government
Debentures/ bonds issued by the company public issue or private placements
Public deposits
Unsecured loans from friend and relatives
Term loans
Lease finance
Projections of Sales, Profit, Cash Flow and Balance Sheet
Revenues during the tenor of the loan are estimated for the project, base on the Techno-Economic
evaluation and past performance. Revenue projection, in addition to the estimates of sales and
other expenses are used to arrive at balance sheet projections. Generally, speaking, a unit may be
considered as financially viable, progressive and efficient if it is able to earn enough profits not
only to service its debts timely but also for future development/growth.
CALCULATING KEY FINANCIAL RATIOS
Current financials of existing operations, project funding information like sources of fund etc.
and future projections are used for calculating key financial ratios for a period of time. These
ratios tell us about a units liquidity position, managements stake in business, capacity to service
the debts etc. the financial ratios which are considered important are discussed as under:
Debt Equity Ratio(DER)
DER = DEBT (Term Liabilities)
Equity shares capital, free reserves, premium on shares
etc. after adjusting profit and loss balance.

DER signifies how much the project is leveraged. For a project of private firm, equity capital is
brought in by promoter and hence lowers the DER. DER also varies from industry to industry. In
capital intensive industries involving large investments, DER is normally higher as compared to
the other industries.
Debt Service Coverage Ratio (DSCR)
DSCR = (Net Profit (after Taxes)+Annual interest on long debt+Depriciation)
Annual interest on long term Debt + Amount of Principle
This ratio provides a measure of the ability of an enterprise to service its debts i.e. interest and
principle repayment besides indicating the margin of safety. The ratio may vary from industry
to industry but has to be viewed with circumspection when it is less than 1.5, this ratio shows the
relationship between cash generating capacity of the unit and its repayment obligation and
indicates whether the cash flow would be adequate to meet the debt obligations and whether there
is sufficient margin for the lending banker.
Tangible Net Worth to Total Outside Liabilities (TNW/TOL)
TNW/TOL = tangible net worth (paid up capital + reserve and surplus tangible assets)
total outside liabilities
This ratio gives a view of borrowers capital structure. If the ratio shows a rising trend, it
indicates that the borrower is relying more on his own funds and less on outside funds and vice
versa.
PROFIT SALES RATIO
PSR = Operating profit before tax excluding other income
Sales
This ratio gives the margin available after meeting cost of manufacturing. It provides a yardstick
to measure the efficiency of production and margin on sales price i.e the pricing structure.
Security
Charging of a security means creating right of the creditor (bank) over the security so that in case
of default by the borrower, creditor (bank) cab realize the security to recover its advance. A
charge could be fixed charge or floating charge. Fixed charge is created on specific property like
land, building etc whereas floating charge is an equitable charge over the assets of the company.
A floating charge crystallizes when the company ceases to be a going concern or the charge
holder (bank) initiates action to enforce security for recovery of the amount loan.
1st, 2nd and paripassu charge: When charge is created in favor of more than one creditor, then the
creditor in whose favor the charge was created earlier will have the first charge and any
subsequent charge will be called as 2nd charge and so on. If a charge is created on several
creditors with the condition that all creditors will have equal priority in proportion to the amount
of their advance it is called paripassu charge. When consortium advance is granted this type of
charge is created by the borrower. In case of paripassu charge sale proceeds of the property are
shared among creditors in the proportion of their outstanding within sanctioned limits.
Two types of security:
A. Primary Security
A primary security is the security against which bank finance is made or the security
(asset) which is created out of bank.
B. Collateral Security
Security obtained in addition to prime security is known as collateral security. Properties
or assets that are offered to secure a loan or other credit. Collateral becomes subject to
seizure on default. Properties or assets that are offered to secure a loan or other credit.
Collateral becomes subject to seizure on default. Collateral is a form of security to the
lender in case the borrower fails to pay back the loan.
Charge on securities can be created by various methods depending on the type of security
charged.
Nature of charge (Security)
Nature of Charge Type of Security

Pledge Movable goods like stocks
Hypothecation Movable goods like stock, vehicles
Lien Assignment, hypothecation
Mortgage Immovable property
Assignment Book Debts, LIP, NSC, FDR
Lien: The right of a person to retain the possession of a property till dues are paid in full.
A lien may be general of particular.
TRANSFER OF OWNERSHIP OR PROPERTY: no
TRANSFER OF POSSESSION OF SECURITY: yes
POWER OF SALE: yes

Remarks: a particular lien confers right to retain the property in which a particular debt
arise. A general lien confers a right to retain all goods or any property (which is in
possession of holder) of another until all the claims of the holder are satisfied. Banker has
a general lien on all securities deposited by a customer.
Negative lien is an undertaking in writing form the borrower not to encumber or deposit
off his assets without banks permission as long as the banks advance is continued.
Pledge: Bailment of goods as security for payment of s debt or performance of a promise.
TRANSFER OF OWNERSHIP OR PROPERTY: no
TRANSFER OF POSSESSION OF SECURITY: yes
POWER OF SALE: yes, through intervention of court and after reasonable notice without
intervention of the court.
Remarks: the person delivering the goods as security is called pledger or pawer. The
person to whom the goods are delivered is called pledge or pawnee. A pledge may be in
respect of goods, stocks, shares or any other movable property.
Hypothecation:When possession of the property and other movable offered as a security

remains with the borrower and only constructive charge is created in favor of the lender,
the transaction is called hypothecation.It is created by an instrument in writing viz,
hypothecation agreement.
TRANSFER OF OWNERSHIP OR PROPERTY : no
TRANSFER OF POSSESSION OF SECURITY : no, but normally the creditor takes the
right to obtain possession in certain circumstances.
POWER OF SALE: yes, through intervention of court or after obtaining possession and
giving reasonable notice without intervention of court.
Remarks: in hypothecation advances, effectiveness supervision over the goods and
possession is absolutely necessary. For, this purpose, period stock statements are obtained
and the stocks are checked at regular intervals.
Mortgage:A mortgagees a transfer of interest in specific immovable property for the

purpose of securing the payment of money advance by the way of loan, an existing or
future debt or the performance of an engagement which may give rise to a pecuniary
liability.
FUND FLOW STATEMENT
A fund-flow statement is often describes as s Statement of Movement of Funds or where got:

where gone statement. It is derived by comparing the successive balance sheet specified dates
and finding out the net changes in the various items appearing in the balance sheets.
A critical analysis of the statement shows the various changes in sources and applications of
funds to ultimately give the position of net funds available with the business for the repayment of
the loans. A project Fund Flow Statements helps in answering the under mentioned point:
How much funds will be generated by internal operations/external sources?
How the funds during the period are proposed to be deployed?
Is the business likely to face liquidity problem?
BALANCE SHEET PROJECTIONS
The financial appraisal also includes study of projected balance sheet which gives the position of
assets and liabilities of a unit at a particular future date. In other words, the statement helps to
analyse as to what an enterprise owns and what it owes at a particular point of time. An appraisal
of the projected balance sheet data of the unit would be concerned with whether the projections
are realistic looking to various aspects relating to the same industry.
Analysis of balance sheet
Balance sheet analysis is the process of identifying the financial strength and weaknesses of the
firm by properly establishing relationship between the item of the balance sheet and profit and
loss account. It is concerned with the following parties:
Lender
Managements
Investors
Trade Credits
FINANCIAL RATIOS
While analysing the financial aspects of project, it would be advisable to analyse the important
financial ratios over a period of time as it may tell us a lot about a units liquidity position,
managements sate in the business, capacity to service the debts etc. The financial ratios which
are considered as important are disused below:
A. LIQUIDITY PARAMETER
1) Current ratio: This ratio is to assess the short term financial position of the
enterprise. The relationship of current assets to current liabilities is known
as the current ratio. Current assets mean that the assets are in the form of
cash or cash equivalents or can be converted into cash or cash equivalents
in a short time (say within a years time).
Current ratio= current assets/ current liabilities
Current assets = cash and bank balance + investments in government security +

sundry debtors + bills discounted + inventories + loans and advances (other than
group/associate/other companies)+ advances payment of tax + pre-paid expenses
+ other current assets.
Current liabilities = short term bank borrowings + commercial paper + loan from
corporate bodies (including group / associate co) + bills discounted + Sundry
creditors + int. accrued + un matured financial charges + advance against work in
progress + inter office adjustment + provision for tax dividend + diminution in
investment + other current liabilities.
Company has to maintain a current ratio of 1.33:1. The higher the current ratio, the
more capable the company is of paying its obligations. A ratio under 1 suggests
that the company would be unable to pay off its obligations if they came due at
that point. While this shows the company is not in good financial health.
It shows the number of times the current assets are in excess over the
current liabilities. It is generally accepted that the current assets should be
2 times the current liabilities, then only will realization from current assets
be sufficient to pay the current liabilities on time and enable the firm to
meet the day to day expenses. A very high ratio will indicate idleness of
funds and not a good sign. It thus indicates poor investment policies of the
management and poor inventory control.
2) Quick Ratio:An indicator of a company's short-term liquidity. The quick ratio
measures a company's ability to meet its short-term obligations with its most
liquid assets. Higher the Quick ratio betters the position of the company. Quick
ratio is effective in case stocks are obsolete, non-saleable or waste.
B. LONG-TERM SOLVENCY PARAMETER

1) Debt Equity Ratio:Represent the ratio between capital invested by the owners
and the funds provided by lenders.
Debt= Total borrowings + preference capital short-term bank

borrowing commercial paper- loans from corporate bodies
(including group/associate co.).
Equity = Tangible net worth.
Higher the ratio greater the risk to a present or future creditor. Debt Equity Ratio should be less
than 2:1. Too much debt can put your business at risk... but too little debt may mean you are not
realizing the full potential of your business and may actually hurt your overall profitability.
C. PROFITABILITY PARAMETER
1) Return on Investment:The net result of a business is profit or loss. The sources
used by the business to attain this (profit or loss) consists of both the
shareholders funds and loans. The overall performance can be judged by
working out a ratio between profit earned and capital employed. The
resultant ratio usually expressed as a percentage is called the ROI, ROCE,
Rate of Return , Net Profit to Capital Employed.
ROI = (Profit before interest, tax and dividend/ capital employed)* 100
Wherein , Capital Employed= share capital (both equity & preference) + reserves +
long term loans fictitious assets non-operating assets like investments.
Or,
Fixed assets cost less depreciation + working capital
Since, non- operating assets are excluded while determining capital employed, profit
should also exclude income from investment outside the business. Return on
investment judges the overall performance of concern. It measures how efficiently the
sources entrusted to the business are being used or what is the earning power of
the assets of the business.
2) Operating profit ratio:

OPBDIT
Net sales
Where, OPBDIT (Operating profit before depreciation, interest and tax)=Profit before
depreciation, interest and tax- extra ordinary income + extra ordinary expenses other
income.
D. OPERATING EFFICIENCY PARAMETER

1) Operating Leverage
Sales revenue
Less: Variable cost
= Contribution
Less: Fixed cost
=EBIT
The relation between sales revenue and EBIT is defined as operating leverage.
Operating leverage = % change in EBIT

% change in sales revenue
It means that for every increase or decrease in sales level, there will be more than
proportionate increase or decrease in the level of EBIT. It may be noted that this
is due to the existence of fixed cost. As long as DOL is greater than 1, there is
an operating leverage. A positive DOL means that the firm is operating at a sales
level above the break even level and EBIT will be positive. Once all fixed costs
are recovered by the contributions, profits grow proportionately faster than the
growth in volume. A high DOL is considered a high risk situation and even a
small decrease in sales can excessively affect the firms ability to record profits.
E. OTHERS
1) Total outside liability to tangible net worth
TOL
TNW
TOL (Total outside liabilities) = Total Borrowing + Preference Capital + Current
Liabilities & Provisions + Bills Discounting.
TNW (Tangible net worth) = Equity capital + surplus Revolution reserve-Accumulated

losses-Misc. expenses not written off intangible assets accumulated depreciation not
provided for.
This ratio gives a view of borrower's capital structure. If the ratio shows a rising trend, it
indicates that the borrower is relying more on his own funds and less on outside funds and
vice versa.
2) Interest coverage ratio

EBITDA
Total Interest
EBITDA (Earnings before interest, tax, depreciation and amortization) = Profit before
depreciation, interest tax and amortization + extra ordinary expenses extra ordinary
income.
Total interest = Gross interest + interest capitalized.
3) Debt-service coverage ratio:
It measures the number of times a companys earning cover its total long term debt,
including interest and principal repayments in term debts, over a period of one year.
A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say
0.95, it would mean that there is only enough net operating income to cover 95% of
annual debt payments.
Net Profit (After Taxes) + Annual

interest on long term debt +Depreciation
Debt-Service Coverage Ratio =
Annual interest on long term debt +Amount of
installments of principalpayable during the year.
For example, in the context of personal finance, this would mean that the borrower would
have to delve into his or her personal funds every month to keep the project afloat.
Generally, lenders frown on a negative cash flow, but some allow it if the borrower has
strong outside income.
CREDIT RISK RATING
An overview:
An opinion offered by Rating Agency on the relative ability and willingness of an issuer of debt
instrument to make timely payments on specific debt or related obligations over the lift of
instrument. Relative ranking of credit quality of debt instrument.Not a recommendation to invest
since it does not evaluate reasonableness of issue price, possibility of capital gains, liquidity in
the secondary market, risk of pre-payment by issuer.
Various External Credit Agencies in India:
CISIL
CARE
FITCH
ICRA
Factors determining credit risk:
State of economy
Wide swing in commodity prices
Fluctuations in foreign exchange rates and interest rates
Trade restrictions
Economic sanctions
Government policies
Some company specific factors are:
Management expertise
Company policies
The internal factors within the bank, influencing credit risk for a bank is:
Deficiencies in loan policies/administration

Inadequate defined lending limits for loan officers/credit committees
Deficiencies in appraisal of borrowers financial position
Absence of loan review mechanism
Credit risk rating by PNB:
Credit risk rating assigned to the borrower, based on the detailed analysis for their ability and
willingness to repay the debt from the bank. Credit risk rating helps a bank in assigning as
probability of default.
Uses of credit risk rating:Whether to lend to a borrower or not: the credit risk rating of a borrower
determines the appetite of the bank in determining exposure level. A bank would be willing to
lend highly rated borrowers but would not like exposure to borrowers with very poor credit risk
rating.
The credit risk rating tool has been developed with a view to provide the standard system for
assigning a credit risk rating to the borrower of the bank according to their risk profile. The tool
evaluated the credit risk rating of a borrower on 7 scales from AAA to D indicating AAA as
minimum risk and D as maximum risk.
The credit risk rating tool incorporates and includes possible factors of risk for determining the
credit rating of borrower. This risk could be internal and specific to a company.The credit risk
rating tool has been developed to capture credit risk under four areas:
1. Financials
2. Business/Industry
3. Management
4. Conduct of Account
PNB also have a small weightage about the key risk factors. According to these head credit score
is determined based on the following weight age:
Factor affecting Credit Rating
S. No. Factors Weight assigned

1 Financial 40
2 Business/Industry 20
3 Management 20
4 Conduct of Account 20
Total 100
Usage of Credit Risk Rating Tool:
The scores are assigned to each of the parameters on a scale of 0 to 4 with 0 being very
poor and 4 being excellent. The scoring of some of these parameters is subjective while
for some others it is done on the basis of predefined objective criteria.
The score given to the individual parameters multiplied by allocated weights are then
aggregated and a composite score for the company is arrived at, in percentage terms.
Higher the score obtained by a company, better is its credit rating. Weights have been
assigned to different parameters based on their importance. After allocating/evaluating
scores to all the parameters, the aggregate score is calculated.
The overall percentage score obtained is then translated into a rating on a scale from AAA
to D according to the pre-defined range of credit scores.
The credit rating according to the credit scores are:
Rating with AAA, AA, A and BB grade signifies Investment Grade. B rating grade is known as
Marginally Acceptable Risk Grade and C and D rating grade are called High Risk Grade.
Chapter - 3
Research Methodology
Objectives of the Study
1. To gain insights into the Credit Administration processes of PNB.
2. To understand the different types of credit facilities and credit delivery
mechanisms provided to industrial customers viz. Overdraft, Cash Credit,
Drawing Rights, Fund Based Credit, Non Fund Based Credit etc.
3. To understand the appraisal process of Term Loan and Working Capital Financing
proposals of PNB.
4. To understand the factors affecting rate of interest levied viz. risk assessment,
bank guidelines, sectoral policies, business considerations etc.
5. To understand various norms like credit exposure limits etc., that influence credit
disbursal for various sectors, companies and business groups.
Scope of the Study

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

This project will help to get insight into credit appraisal procedure of PNB. It is useful in
todays time. This project has usefulness for the people working with PNB and also for the people
who are in corporate world and need credit facilities either for expansion orfor working capital
requirements.
For the people working with PNB they come to know what are parameters to be
evaluated while studying an application for credit demanded by the companies.
For the people who belong to the corporate world and wants credit either for
expansion or working capital requirement comes to know about the procedure of
the bank for credit appraisal. So whenever the need credit they are familiar with
the procedure.
Type of Research
In this project report ExploratoryResearch has been used which includes:
Search of secondary data.

Survey of knowledgeable persons.
Case study.
Data Collection Method
Secondary Sources
o Study of various bank guidelines and circulars.
o Study of pre-approved proposals.
o Material provided by project guide.
o Study of proposal.
o Annual report of company.
o CMA of company.
Limitations of the Study
All the information cannot be included as most of the information is confidential and not
approachable.
The study is being done keeping in mind the policies of the head office.
The data availability is proprietary and not readily shared for dissemination.
The staff although are very helpful but are not able to give much of their time due to their
own job constraints.
The data is used in the study is secondary which can lead to some kind of discrepancy,
anomaly or biasness in the study
Due to the ongoing process of globalization and increasing competition, no one model or
method will suffice over a long period of time and constant up gradation will be required.

Credit Appraisal For Term Loan and Working Capital Assessment

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A SUMMER TRAINING PROJECT REPORT

CREDIT APPRAISAL FOR TERM LOAN AND

UNDER THE GUIDANCE OF:

Dr. DIVYA CHOWDHRY

RUKMINI DEVI INSTITUTE OF ADVANCED STUDIES

An ISO 9001:2008 Certified institute

Affiliated to Guru Gobind Singh Indraprastha University, Delhi

2A & 2B, Madhuban Chowk, Outer Ring Road,Phase-1,Delhi-110085

Dr. Divya Chowdhry

RDIAS, New Delhi

This project reflects the role of a financial analyst.

b. Term loan for mega projects

Banking industry at a glance

Major Banking Operations

(i) Balancing Profitability with Liquidity Management

Main Operations of a Bank

Balancing Profitability with Liquidity Management

Structure of Banking Industry

Scheduled commercial Scheduled cooperative

Public Region Foreig Privat Urban State

SBI & its Nationaliz Old New

Punjab National Bank (PNB)

PUNJAB NATIONAL BANK

Parent company Government of India.

Category Banking Services.

Sector Banking and Finance.

USP Punjab national bank if one of big four banks of India.

Financial Performance (2012-2013)

Business Parameters (Rs. Crore)

PARAMETERS Mar-12 Mar-13 Y-o-Y (%)

Profit Parameters (Rs. Crore)

Organization structure: PNB

CMD Chief Managing Director

UCT AND SERVICES

3. Retail Loans of which

AREAS OF CONCERN FOR PNB FOR CURRENT YEAR

THE ACTION POINTS FOR THE CURRENT YEAR AREAS OF

CREDIT ADMINISTRATION DIVISION (CAD)

RISK MANAGEMENT DEPARTMENT (RMD)

Integrated Risk Management Division (IRMD)

1. Financial evaluation (40%)

Various External Credit Agencies in India:

Factors determining credit risk:

Cumulative weighted score is calculated and rating of the project/company is ascertained as

1. FUND BASED FACILITIES

c) Cash credit advances

2. NON FUND BASED FACILITIES

(i) Bank Guarantees

SWOT Analysis of PNB

Strengths 1. Diversified operations with 5100 branches.

1.5. Chakraborty (1973)approached working capital as a segment of capital employed rather

3. COMPLIANCE TO EXPOSURE NORMS

Maximum industry exposure

WORKING CAPITAL LOANS

1. Types of Lending (Fund based and Non-Fund based limits)

1.1 Fund Based Limits

Financing Fund Based Requirements

A. Pre Shipment (Packaging credit)

The proposal for issuances of a deferred payment guarantee can be entertained in

1.2.2 Letter of Credit(L/C)

Main parties to documentary credit:

Working Capital Assessment

Assessment of Working Capital Limits (Fund based)