A REPORT ON

CREDIT APPRAISAL OF INDUSTRIAL FINANCE FOR SMES

SUBMITTED BY: Kulbir Singh Class roll no-2026, Examination roll no-581 Session 2006-2008
A report submitted in partial fulfillment of the requirements of MBA Program of Institute of Management Studies

UNDER THE GUIDANCE OF: Dr. Parmod Sharma Senior Lecturer

INSTITUTE OF MANAGEMENT STUDIES

HIMACHAL PRADESH UNIVERSITY SHIMLA

1

TO WHOM IT MAY CONCERN

This is to certify that Miss. Mamta gaur of MBA, Institute of Management Studies has undertaken a project on CREDIT APPRAISAL OF

INDUSTRIAL FINANCE FOR SMEs. under my guidance. To the best of my knowledge that project is neither submitted nor published elsewhere.

Project Guide Dr.Parmod Sharma

ACKNOWLEDGMENT

I sincerely feel the credit of the project work could not be narrowed to only one individual. This work is an integrated effort of all those concerned with it, it would have been quite difficult without their direct & indirect co-operation. I wish to express my appreciation and gratitude to all the concerned people. First and the foremost my intellectual debt is to Dr.Parmod Sharma(Senior Lecturer Institute of Management Studies) and Mr.A.K Sharma (Chief Manager Loan Department Union Bank of India, Shimla) who have contributed significantly towards the completion of the project. They have provided the guidelines on which this project was made. I am thankful to all the people who have given their precious time and provided me with requisite data without which this project would not have completed .I also thank them for giving their valuable suggestions during the entire period of research. However, I accept the sole responsibility for any errors of omission and commission.

Mamta gaur Roll no-

Table of Contents
CONTENT
1 Introduction 1.1 Objectives of the Study 1.2 Purpose of the Study 1.3 Limitation of the Study 1.4 Proposed Methodology 1.5 Abstract 5 5 6 6 7,8

PAGE NO.

2. Main Text 2.1 Overview of Indian banking industry 2.2 2.3 union bank of India small scale industry 9,10,11 12,13,14 15,16,17,18,19,20

3 credit appraisal procedure and process 3.1 assessment of credit need 3.2 financial statement analysis 3.3 risks in bank lending 3.4 financial ratio analysis 3.5 credit rating

21 22 23,24,25,26,27 27,28 32,33,34 35,36,37,38

4 loan facility 4.1 working capital loan 4.2 term loan 39,40,41,42,43 44,45,46,47,48,49,50

Table of Contents
CONTENT
5 Documentation and formalities

PAGE NO.
51 52,53,54,55

5.1 NPA classification and recovery Annexure Annexure-I Glossary References

56,57,58,59,60,61,62,63,64 65,66 67

OBJECTIVES OF THE STUDY

The objective of research is to study the Corporate Banking in Union Bank of India. The area of study in Corporate Banking in Union Bank of India would includeWorking Capital Financing and Term loan financing- To support extended both as Fund based and Non-Fund based facilities to Corporate, Partnership firms, Proprietary concerns. Working Capital finance extended to all segments of industries. The project research focuses on determining the various factors considered in analyzing the financial needs (working capital) of their clients and determining the limit of finance. The objective of the project is also to study the welldocumented loan policy. The study would involve followingAssessment of the advances. Processing of the advances. PURPOSE OF THE STUDY FOR THE ORGANISATION This study would involve working out and interpreting the financial ratios in case of working capital financing and term loans. The study also involves the study of procedural formalities included in sanctioning the finance to its clients. This study would involve analyzing the balance sheets of their clients in determining their financial needs.

LIMITATIONS OF THE STUDY Every study or research is conducted under some limits and there are some restrictions which have some impact on the project. Limitations of this project are Coverage: The study aims at covering the corporate banking of Union Bank of India only. The study aims at gaining the practical knowledge by taking help of bank personals. So there might have been tendencies among the personals to amplify or filter their responses due to time limitation. Credit appraisal for working capital finance is study that needed specialized knowledge of the area, so there is chance for interpretational error on my par

PROPOSED METHODOLGY
Since the research carried out for this project is descriptive in nature, the various documents and official files would require for understanding the methodology used by the banks. The data collection can be done by personal interview or direct observations. At the same time, related articles, newspapers, magazines, in-house journals of banks, etc were referred. The information on the project under consideration can be obtained by the bank employees and officials. Also I went through various files and the official correspondence of the bank for better understanding the topic under the study. The methodology also include finding out the financial ratio, understanding the credit rating and assessment of working capital and term loan of the companies by making the fresh proposal for working capital and term 7

ABSTRACT
The project undertaken is credit appraisal of industrial finance for SMEs. The project emphasis on understanding the procedure and process used by union bank of India to assess the credit worthiness of the borrower. Small scale industry in India is booming and contributing to 40% of GDP, many banks are focusing their attraction towards this sector. The credit appraisal process is the scientific way of giving the credit to corporate client by analyzing the credit worthiness of the company through different parameters. The first step in credit appraisal project is to understand the Indian banking industry and the performance of the few Indian banks in the previous financial years since project undertaken is in banking industry a glance on union bank of India and

small scale industry in India is given and the steps taken by the banks to development and welfare of SSI. The credit appraisal for SME starts with

Understanding the need of loan to the borrower i.e. for which purpose the loan is required. After this next step is to analyse the financial statement of the company to whom the loan is to be sanctioned. The main things which are taken into consideration while analyzing the financial statement are type of statement, nature of activity ,accounting policy, qualities of assets and liabilities , unit wise performance result of the company & directors report. After analyzing the financial statement the second step is to study the principle given by Basel committee on banking supervision which basically Indian banks have to be follow as per the order by Reserve Bank of India.The third step is to analyse the key financial ratios of the company such as : Leverage ratio, liquidity ratio, profitability ratio, turnover ratio, inventory norms.

The next step is to understand the methodology used to determine the credit rating. Since the credit rating methodology differ from bank to bank in term of the weight age given to the parameters but the parameter used by the banks to assess credit worthiness are almost same to all company. The banks mainly provide two types of credit facility known as term loan and working capital loan. The working capital loan is given by three methods namely- projected balance sheet method, MFBF method and cash budget method. Term loan is the loan given by the company for a long term gernally more than one year and less than 10 years to company. The term loan is assessed by the break even analysis, cost benefit ratio, payback period. While appraising the term loan technical, managerial, financial feasibility is checked. The debt service coverage ratio is used for assessing the company capacity to pay back installment of loan and int. on term loan. The sensitivity analysis is used to check the

company ability to pay back the loan by changing the independent variables and consequently monitoring the effect on dependent variables. The last step is to understand the classifications of NON PERFORMING ASSET and the provision to recovery of NPA. The research report contains the whole procedure & process which is used by the bank to give credit to SMEs.

MAIN TEXT
The banking system in India was established in 18th century. The first Indian bank which came into existence in1786 was THE GENERAL BANK OF INDIA which is followed by BANK OF HINDUSTAN. Although both these banks do not exist today but these banks made the foundation of banking system in India. The oldest bank in existence in India is the state bank of India being established as "The Bank of Bengal" in Calcutta in June 1806.The first fully Indian owned bank was the Allahabad bank, which was established in 1865. By the 1990s the market expanded with the

establishment of banks such as Punjab National bank in 1895 in Lahore and Bank of India in 1906, in Mumbai - both of which were founded under private ownership. The Reserve bank of India formally took on the responsibility of regulating the Indian banking 10

Sector from 1935 After India's independence in 1947, the Reserve Bank was nationalized and given broader powers. Nationalization The nationalization of banks added a new chapter in the Indian banking system in 1969 when the Indra Gandhi Government nationalized the 14 largest commercial banks. A second phase of nationalization of banks took place in 1980 by the nationalization of 6 more commercial banks. The stated reason for the nationalisation was to give the government more control of credit delivery. Liberalizations In the early 1990s the Narasimha Rao government embarked on a policy of liberlisation and gave license to a small number of private banks, which came to be known as NEW GENERATION TECH-SAVVY BANK which included banks such as UTI Bank, ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, kick started the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks.

NO. OF COMMERCIAL BANKS IN INDIA

FINANCIAL YEAR NO. OF COMMERCIAL BANKS (A+b) {A} SCHEDULE COMMERCIAL BANKS (-)OF WHICH: REGIONAL RURAL BANKS {B} NON SCHEDULE COMMERCIAL BANKS MAR.-02 297 293 196 4 MAR.-03 292 288 196 4 MAR.-04 290 286 196 4 MAR.-05 289 285 196 4 MAR.-06 222 218 133 4

SOURCE: RESERVE BANK OF INDIA

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Since Indian banking sector is experience exponential growth, the profit made by public sector and private sector banks are given below. NET PROFIT OF COMMERCIAL BANKS IN INDIA (MN) Rs.
BANK PRIVATE SECTOR BANK ICICI BANK HDFFC BANK UTI BANK J& K BANK KARUR VYSYA BANK FEDRERAL BANK KOTAK BANK YES BANK INDUSIND BANK ING VYSYA BANK PUBLIC SECTOR BANK STATE BANK OF INDIA BANK OF BARODA BANK OF INDIA CORPORATION BANK IDBI LTD. DENA BANK CANARA BANK ALLAHABAD BANK PUNJAB NATIONAL BANK VIJAYA BANK BANK OF MAHARSHATRA UNION BANK OF INDIA 43,045.20 6,768.40 3,400.50 4,021.60 3,072.60 610.00 11,095.00 5,417.90 14,101.20 3,805.70 1,771.20 3,015 44,066.70 8,269.60 7,014.40 4,444.60 5,608.90 729.90 13,432.20 7,061.30 14,393.10 1,268.80 507.90 3,610.00 2.37 22.18 106.28 10.52 82.55 19.66 21.07 30.33 2.07 -66.66 -71.32 19.7 20,052.00 6,655.60 3,345.80 1,150.70 1,053.40 900.90 848.90 NA 2,101.50 -381.30 25,400.70 8,707.80 4,850.80 1,768.40 1,353.50 2,252.10 1,182.31 2,700.00 368.20 90.60 26.67 30.83 44.98 53.68 28.49 149.98 39.28 NA -82.48 NA MAR.-05 MAR.-06 % CHANGE

Source: reserve bank of India

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Corporate Mission: A logical extension of the Vision Statement is the Mission of the Bank, which is to gain market recognition in the chosen areas. To build a sizeable market share in each of the chosen areas of business through effective strategies in terms of pricing, product packaging and promoting the product in the market. To facilitate a process of restructuring of branches to support a greater efficiency in the retail banking field. To sustain the mission objective through harnessing technology driven banking and delivery channels.

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

ABOUT UNION BANK OF INDIA We should have the ability to carry on a big bank, to manage efficiently Crores of rupees in the course of our national activities. Though we have not many banks amongst us, it does not follow that we are not capable of efficiently managing Crores and tens of Crores of rupees."
MAHATMA GANDHI

Union

Bank

of

India,

public

sector

bank

was

incorporated in 1919.After the inauguration by father of nation mahatma Gandhi bank has travelled a long successful journey of 88 yrs of banking. Union Bank of India is committed to maintain its identity as a leading innovative commercial Bank, alive to the changing needs of the society. Union Bank has offered vast and varied services to its clientele taking care of their needs. Today, with its efficient customer service, consistent profitability & growth, adoption of new technologies and value added services, Union Bank truly lives up to the image of, GOOD PEOPLE TO BANK WITH.

The key business areas of the bank are retail banking, international banking, corporate banking & treasury. As Retail banking is growing very fast in Indian banking industry union bank of India is also showing strong growth in this sector. The bank provide housing, retailing trade, automobile, consumer, education and other personal loans and deposits services such as fixed , saving and demand deposits for the valuable clients. The bank has increased forgeion exchange turnover from 361.02 bn in 2004-05 to408.94 bn in 2006-07 with annual growth rate of 14

13.27%. The corporate banking sector offers various loan and free based products and services to its small and medium enterprises, agriculture sector. To boost SME Segment the bank has set up separate SME cells .the total employee strength of bank are 25,421. Union bank of India is targeting a 25% growth in its SME portfolio. The bank SME portfolio in 2005-06 was 6,839 crore and its target in 2006-07 is 8,540 crore. Union bank of India has made an agreement with SIDBI to provide loan to SMEs. The bank is converting 32 small scale industry branches to SME branches. Union bank of India and SIDBI are also in the process of putting up marketing teams in 15 centers for identifying and appraising SMEs units and lending them. Union bank of India has a network of more than 2100 branches all over India. The Bank came out with its Initial Public Offer (IPO) in August 20, 2002 and govt.of India holds 55.4% of the bank followed by FII 19.9% & Indian public hold14.8% of the bank. The Bank has over the years earned the reputation of being a techno-savvy Bank and is one of the front runners amongst public sector bank in the field of technology. It is one of the pioneer public sector banks, which launched Core Banking Solution in 2002. Online Tele banking facility is available to all its Core Banking customers. The multi facility versatile Internet Banking Solution provides extensive information in addition to the on line transaction facility to both individuals and corporate banking with the Core Banking branches of the Bank. In addition to regular banking facilities, today customer can also avail variety of value added services like cash management service, insurance, mutual funds, Demat from the Bank.

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SMALL SCALE INDUSTRY:

With the advent of planned economy from 1951 and the subsequent industrial policy followed by Government of India, both planners and Government earmarked a special role for small-scale industries and medium scale industries in the Indian economy. Due protection was accorded to both sectors, and particularly for smallscale industries from 1951 to 1991, till the nation adopted a policy of liberalization and globalization. Certain products were reserved for small-scale units for a long time, though this list of products is decreasing due to change in industrial policies and climate. SMEs always represented the model of socio-economic policies of Government of India which emphasized judicious use of foreign exchange for import of capital goods and inputs; labour intensive mode of production; employment generation;

nonconcentration of diffusion of economic power in the hands of few (as in the case of big houses); discouraging monopolistic practices of production and marketing; and finally effective contribution to foreign exchange earning of the nation with low importintensive operations. It was also coupled with the policy of de-concentration of industrial activities in few geographical centers. It can be observed that by and large, SMEs in India met the expectations of the Government in this respect. SMEs developed in a manner, which made it possible for them to achieve the following objectives: yHigh contribution to domestic production ySignificant export earnings yLow investment requirements yOperational flexibility yLocation wise mobility yLow intensive imports yCapacities to develop appropriate indigenous technology yImport substitution yContribution towards defense production yTechnology oriented industries yCompetitiveness in domestic and export markets 16

At the same time one has to understand the limitations of SMEs, which are: yLow Capital base yConcentration of functions in one / two persons yInadequate exposure to international environment yInability to face impact of WTO regime yInadequate contribution towards R & D yLack of professionalism In spite of these limitations, the SMEs have made significant contribution towards technological development and exports. SMEs have been established in almost all-major sectors in the Indian industry such as: yFood Processing yAgricultural Inputs yChemicals & Pharmaceuticals yEngineering; Electricals; Electronics yElectro-medical equipment yTextiles and Garments yLeather and leather goods yMeat products yBio-engineering ySports goods yPlastics products yComputer Software, etc.

An industrial undertaking in which the investment in fixed assets in plant and machinery whether held on owner ship term on lease or on hire purchase does not exceed rs. 10 million.It is estimated that in terms of value, the sector accounts for about 39% of the manufacturing output and around 33% of the total exports of the country.As per available statistics, this sector employs an estimated 31 million persons spread over 12.8 17

million enterprises and the labour intensity in the MSE sector is estimated to be almost 4 times higher than the large enterprises. In India 2.30 lakhs units are only registered in Gujarat

providing employments to 39 lakhs people in Gujarat, which contributes to 24% of total employment provided by SSI in India. Small Scale and ancillary units (i.e. undertaking with investment in plant and machinery of less than Rs. 10 million) should seek registration with the Director of Industries of the concerned State Government. The govt. of India established ministry of small-scale industry in 2001.the role of ministry of small scale industry is to mainly assist the state in their effort to promote the growth of SSI, increase the competition and gernation of employments.

Performance of Micro & Small Enterprises Employ- Exports

No of units(in lakh) Year
2002-03

Production (at 2001-02 prices)crores 306771(8.7) 336344(9.6) 372938(10.9) 418884(12.3) 471663(12.6)

ment (in lakhs) 263.68 275.3 287.55 299.85 312.52 (Rs in crore) 86.013 97644 124417 150242 N.A.

Regd 16.03 17.12 18.24 19.3 20.32

Unregd. 93.46 96.83 100.35 104.12 108.12

Total 109.49 113.95 118.59 123.42 128.44

2003-04 2004-05 2005-06 2006-07

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

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Recently.major initiatives have been taken by the Govt. to revitalize the MSME sector. They include:  Implementation of the Micro, Small and Medium Enterprises Development Act,2006.  A Package for Promotion of Micro and Small Enterpriseswas announced concerns in of feb 2007.This credit includes measures addressing based ,fiscal support,cluster

development.infrastructure,technology and marketing.  To make the Credit Guarantee Scheme more attractive, the following modifications have been made: a. Enhancing eligible loan limit from Rs.25 lakh to Rs.50 lakh. b. Raising the extent of guarantee cover from 75% to 80% for micro enterprises for loans upto Rs.5 lakh. c. The phased deletion of products from the list of items reserved exclusive for small sector is being continued.On March 13,2007,125 items were dereserved reducing the number of reserved items to 114.  Further for inducing participation of foreign players and big corporate in Small Scale Industries the government has formally announced doing away with the 24% investment ceiling in the sector.

Credit is one of the major inputs for the promotion and development of SSI. Credit to SSI is the part of credit sector lending. For the public sector bank 40% of net bank credit should given to priority sector. However for the foreign banks 32% of net bank credit should be given to priority sector, out of which 10% is required for SSI.SIDBI (small industry development bank of India), is the premier financial institution in India which is only dedicated for the promotion and development of SSI.

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

Source annual report of SSI

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

Source annual report of SSI

The process of economic liberalization and market reforms has opened up the Indian Small scale sector to global competition. In order to enhance the competitive strength of the small scale sector, the Government introduced an incentive scheme for their quality improvement and environment management. The scheme provides incentive (of up to Rs. 75,000 per unit) to SSI units which acquire ISO 9000/ISO 14001 certifications. The scheme, in operation since March 1994, was enlarged to include reimbursement of expenses for acquiring ISO 14001 certification also w.e.f. 28th October 2002. The SSI sector in India is booming but still some financial institute hesitate to give credit to some specific sector due to the fear of non performing assets (NPA). But by applying good credit policy and timely inspection of

20

SMEs banks can avoid these situations. The following table shows decreasing trend in NPAs of union bank of India

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CREDIT APPRAISAL PROCEDURE AND PROCESS:

Credit appraisal is done to evaluate the credit worthiness of a borrower. The credit proposal is prepared to indicate the need based requirement and the rationale for its recommendation. Bank has in place a well-defined framework for approving credit limits of different segments. Requests for credit facilities from the prospective borrowers shall be on the prescribed format and the full-fledged proposal should be prepared for submission to the appropriate sanctioning authority for approval. These proposals analyze various risks associated with bank lending i.e. business risks, financial risks, management risks, etc. and clarify the process by which such risks will be managed on an on going basis The credit appraisals for any organization basically follow the following process Assessment of credit need Financial statement analysis Financial ratios of the company Credit rating Working capital requirement Term loan and sensitivity analysis NPA classification and recovery

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 ASSESSMENT OF CREDIT NEED

The first step in the process of credit appraisal is to assess the need for loan to the borrower. In the first step the need of financial requirement is under stand i.e. for which purpose the loan is required .The banks basically provide two types of credit facilities to their clients.  Fund based facility Fund based facilities provided by the banks are basically term loan & working capital loan.  Non fund based facility Non fund based facilities provided by the banks are letter of credit, letter of guarantee, packing credit.

The banks basically follow three method prescribed by TANDON COMITEE REPORT to RBI {central bank in India}

1 FIRST METHOD: borrower will contribute 25% of working capital gap 75% would be financed by bank borrowing. Minimum current ratio would be 1:1

2 SECOND METHOD: borrower will contribute 25% of total current asset and the remaining working capital gap is filled by bank borrowing {WC gap borrower contribution}.the current ratio given by this method would be1.3:1.

3 THIRD METHOD: borrower will contribute 100% of core asset and 25% of balance of current asset. The remaining working capital gap will be bridged by the borrowing. The first two method are accepted by RBI for the implementation .This is applied to the entire borrower having the credit limit in excess of 20 lacs from the banking system

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 FINANCIAL STATEMENT ANALYSIS

Key points to be checked in financial statement:

 Type of statement: Examine weather financial statement is audited or unaudited. If the report is audited study the auditor certificate.

 Nature of activity: Engaged in trading or manufacturing activity or services, what kind of the products the company dealt in. if it is a software industry does it have a technical component and skilled manpower.

 Series of statement: examine the financial statements important factor to note the trend has taken place from one year to another year. for the last 2 or 3 years to know about the trend in the performance of the firm. The

 Accounting policy which accounting policy the organization is following. Weather depreciation is charged on WDV {written down value} method or using SLM {straight line method}.

To understand this let us consider Average annual profit =3, 00,000 Original cost of fixed asset =10, 00,000 Deprecation under WDV method =25% Deprecation under SLM method =8% Tax rate = 50%

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DEPRECEATION METHOD YEAR Written down value method{25%} Net fixed asset 0 1 2 3 4 10,00,000 -2,50,000 7,50,000 -1,87,500 5,62,500 -1,40,625 4,21,875 -1,05,468 3,16,407 -79,102 2,37,305 50,000 1,12,500 1,59,375 1,94,532 25,000 56,250 79,687.5 97,266 Profit after deprecation Profit after Deprecation And tax Straight line method {8%} Net fixed asset 10,00,000 -80,000 9,20,000 -80,000 8,40,000 -80,000 7,60,000 -80,000 6,80,000 -80,000 6,00,000 2,20,000 2,20,000 2,20,000 2,20,000 1,10,000 1,10,000 1,10,000 1,10,000 Profit after deprecation Profit after Deprecation And tax

5 TOTAL

2,20,898

1,10,449

2,20,000

1,10,000 5,50,000

NOTE:

3,68,652 Wdv rates are approximately 3 times SLM

CHANGE IN NET WORTH Year Net Worth WDV method Net Worth SL Method

0 1 2 3 4 5

5,00,000 5,25,000 5,81,250 6,60,500 7,58,203 8,68,652

5,00,000 6,10,000 7,20,000 8,30,000 9,40,000 10,50,000

25

This is clear from the above illustration that by adopting different method of deprecation the value of profit after tax and net worth are different. So there is every possibility of using SL method of deprecation to fixed asset and value of fixed asset would be more which in turn greater solvency and liquidity of the firm on paper which is not same in WDV method

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

PURCHASE AND CONSUMPTIONS OF ITEM (XYZ)
PURCHASE (IN UNITS) 5000 7500 11,000 7,000 9,000 39,500 PRICE (PER UNITS) 15 16 16 17 18 TOTAL PURCHASE 75,000 1,20,000 1,76,000 1,19,000 1,62,000 6,52,000 CONSUMPTION (UNITS)

MONTH JANUARY

DATE 14 20 28 7 15 25 5 12

3,000

FEBRUARY

12,000

MARCH TOTAL

15,500 30,500

FIRST IN FIRST- OUT (FIFO) METHOD

CONSUMPTIONS (IN UNITS) 3,000 2,000 7,500 2,500 8,500 7,000 COST (PER UNITS) 15 15 16 16 16 17

MONTH JANUARY FEBRUARY

DATE 20 15

COST 45,000 30,000 1,20,000 40,000 1,36,000 1,19,000

TOTAL COST 45,000

1,90,000

MARCH

12

4,90,000

CLOSING STOCK PURCHASES

31

9,000

18

1,62,000 6,52,000

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LAST IN FIRST OUT (LIFO) METHOD

CONSUMPTIONS (IN UNITS) 3,000 11,000 1,000 COST (PER UNITS) 15 16 16

MONTH JANUARY FEBRUARY

DATE 20 15

COST 45,000 176,000 16,000

TOTAL COST 45,000 1,92,000

MARCH

12

9,000 6,500

18 17

1,62,000 1,10,500

2,72,500

CLOSING STOCK

31

500 6,500 2,000

17 16 15

8,500 10,400 30,000 1,42,500 6,52,000

TOTAL PURCHASES

From the above example it is clear that by adopting different method of stock valuation the closing stock of the company differ widely irrespective of any point of time holding the same quantity in units. FIFO method of inventory valuation inflates the inventory costs and which in turn shows the higher book profit than justified. LIFO method on the other hand depresses inventory cost and is considered to be more realistic estimate for the profit for a period. Since price is increasing trend so FIFO method giving high value of closing stock if the price would be in decreasing trend than LIFO method give high value of closing stock. ICAI now allows inventory to be valued either on the basis of the FIFO method or net realizable method.

 Qualities of assets/ liabilities: a financial statement, which is based on accounting standard, however not shows the quality of assets and liability. The banker should therefore to check on periodical checking, quality control certification like ISO certification. 27

 Unit wise result: the company which has diversified business should ask to produce activity wise financial statement for the better understanding.  Directors report: finally a director report of the company should study which shows the company future plans, new initiative taken by the company etc. Risk associated with bank lending: Banks mainly faces three kind of risk which has impact on profitability of the bank. These risks are  Credit risk  Market risk  Operational risk Credit risks basically is the major risk which is faced by the bank on account of their business activity, which including the lending to corporate world, individual bank, another bank or financial institution. Credit risk is of two types  borrower risk  portfolio risk Borrower risk may be the possibility of that a borrower will fail to meet his financial obligations in accordance with agreed term. Portfolio risk arises due to credit concentration/ investment

concentration.i.e most of the credit is given to only one type of group and the possibility of default. Market risk is the variability in the profitability of the firm due to change in market variables. This is manly of three types.  interest rate risk  exchange rate risk Interest rate risk: the risk in the erosion of earning due to variation in the interest rate with in the time period is referred as interest rate risk.

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Exchange rate risk: this risk is of two type  Transaction risk  Translation risk Transaction risk: is the risk basically arises due to the fluctuation in the price of a currency, upward or down ward; result in a loss on a particular transaction. Translation risk: in a situation of a translation the balance sheet of a bank effected adversely due to exchange rate movement and change in the level investment or borrowing in foreign currency even without having translation at a particular time. Liquidity risk: liquidity risk arises out of the possibility that would not be able to meet its financial obligation as they become due for the payment. the risk basically arise due to mismatch between the cash inflow or out flow of the funds or funding the long term asset term asset by short term liabilty.surplus liquidity also is the loss to the banks as the money is not used to raise the income to the bank.

There are many indicators of Credit Risk Problems which show the risk in bank lending.Gernally high level of non-performing assets of the bank or Heavy Provisions show the greater risks. This can be also assessed through the balance sheet and p/l account of the company. It is red indicator to the bank which shows that bank has one of the problems with the credit policy. I. Generally an indicator of poor quality of a credit portfolio. II. Implies poor risk selection and/or poor credit monitoring. III. Very rapid expansion of credit portfolio size. It is not necessary that an above indicator of problems always be true but it often reflect future problem.

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The seventeen basic principles for bank lending are given below to avoid the risks associated with bank lending.
ESTABLISHING AN APPROPRIATE CREDIT RISK ENVIRONMENT

Principle 1: The board of directors should have responsibility for approving and periodically reviewing the credit risk strategy and significant credit risk policies of the bank. The strategy should reflect the banks tolerance for risk and the level of profitability the bank expects to achieve for incurring various credit risks. Principle 2: Senior management should have responsibility for

implementing the credit risk strategy approved by the board of directors and for developing policies and procedures for identifying, measuring, monitoring and controlling credit risk. Such policies and procedures should address credit risk in all of the banks activities and at both the individual credit and portfolio levels. Principle 3: Banks should identify and manage credit risk inherent in all products and activities. Banks should ensure that the risks of products and activities new to them are subject to adequate procedures and controls before being introduced or undertaken, and approved in advance by the board of directors or its appropriate committee.
A. OPERATING UNDER A SOUND CREDIT GRANTING PROCESS

Principle 4: Banks must operate under sound, well-defined credit-granting criteria. These criteria should include a thorough understanding of the borrower or counterparty, as well as the purpose and structure of the credit, and its source of repayment. Principle 5: Banks should establish overall credit limits at the level of individual borrowers and counterparties, and groups of connected

counterparties that aggregate in comparable and meaningful manner different types of exposures, both in the banking and trading book and on and off the balance sheet.

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Principle 6: Banks should have a clearly established process in place for approving new credits as well as the extension of existing credits. Principle 7: All extensions of credit must be made on an arms-length basis. In particular, credits to related companies and individuals must be monitored with particular care and other appropriate steps taken to control or mitigate the risks of connected lending.

B. MAINTAINING AN APPROPRIATE CREDIT ADMINISTRATION, MEASUREMENT AND MONITORING PROCESS

Principle 8: Banks should have in place a system for the ongoing administration of their various credit risk-bearing portfolios Principle 9: Banks must have in place a system for monitoring the condition of individual credits, including determining the adequacy of provisions and reserves. Principle 10: Banks should develop and utilize internal risk rating systems in managing credit risk. The rating system should be consistent with the nature, size and complexity of a banks activities. Principle 11: Banks must have information systems and analytical techniques that enable management to measure the credit risk inherent in all on- and off-balance sheet activities. The management information system should provide adequate information on the composition of the credit portfolio, including identification of any concentrations of risk. Principle 12: Banks must have in place a system for monitoring the overall composition and quality of the credit portfolio. Principle 13: Banks should take into consideration potential future changes in economic conditions when assessing individual credits and their credit portfolios, and should assess their credit risk exposures under stressful conditions.

31

C.

ENSURING ADEQUATE CONTROLS OVER CREDIT RISK

Principle 14: Banks should establish a system of independent, ongoing credit review and the results of such reviews should be communicated directly to the board of directors and senior management. Principle 15: Banks must ensure that the credit-granting function is being properly managed and that credit exposures are within levels consistent with prudential standards and internal limits. Banks should establish and enforce internal controls and other practices to ensure that exceptions to policies, procedures and limits are reported in a timely manner to the appropriate level of management. Principle 16: Banks must have a system in place for managing problem credits and various other workout situations.

D. ROLE OF SUPERVISORS

Principle 17: Supervisors should require that banks have an effective system in place to identify measure, monitor and control credit risk as part of an overall approach to risk management. Supervisors should conduct an
independent evaluation of a banks strategies, policies, practices and procedures related to the granting of credit and the ongoing management of the portfolio. Supervisors should consider setting prudential limits to restrict bank exposures to single borrowers or groups of connected counterparties.

Source: Reserve Bank of India

32

KEY FINANCIAL RATIO:

LEVERAGE Ratios:

a) Debt-equity ratio: Long term liabilities Tangible Net worth Ratio indicates term lenders stake vis--vis stake of the owner. It should be between 1.5 and 2. Long term liabilities may include term loans, debentures deferred payment guarantees, fixed deposit. Tangible net worth = Equity share capital + Preference share capital redeemable after 3 years + reserves and surplus + Subsidy - Intangible assets - accumulated losses, if any.

b) Fixed assets coverage ratio: Fixed assets + Other non-current assets Tangible net worth + Long term liabilities It indicates coverage of long-term uses by long term sources. Lower percentage indicates extent of net working capital available. * 100

PROFITABILITY RATIOS:

a) Profit margin on sales: Net Profit * 100 Sales

It indicates profitability of the firm after accounting for all the expenses and taxes. To be compared with similar size units belonging to the same

33

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

b) Cost of sales to sale: Net profit * 100 Sales It indicates cost efficiency. It is to be compared with the similar size units belonging to the same industry.

c) Return on investment:

PBIT

* 100

Capital employed (Net fixed assets + Total CA) It indicates the rate of return on total funds employed. It should be more than average cost of capital.

d) Return on net worth: Net profit after preference dividend * 100 Equity capital +reserves and surplus It is the ratio of return on owners fund.

d) Debt service coverage ratio: Profit after tax + depreciation + interest * 100

Interest + Installments of term liabilities Payable during the year The ratio indicates the extent to which the amount of interest and installments payable during the year are covered by the funds generated during the year. The minimum 1.5 is expected.

TURNOVER RATIOS

a) Total asset turnover ratio:

Sales

Net fixed assets + current assets

34

It indicates how well the assets are used. It is to be compared with similar size units belonging to the same industry.

b) Working capital turnover ratio:

Sales

Total current assets It indicates how well the current assets are used. It is to be compared with similar size units belonging to the same industry. Location of the unit also needs to be taken into consideration.

c) Inventory turnover ratio:

Cost of goods sold Average inventory

It indicates the extent of excess inventory. Trend over a period of line compared with similar size units belonging to same industry.

35

OBJECTIVES OF CREDIT RATING

R.B.I. has given considerable emphasis on having a proper risk rating in place as a credit rating system is considered as an instrument that helps the bank in Measuring the Credit Risk at the transaction level. Pricing the Credit Risk Providing triggers for action on Portfolio Management Frequency of inspection The following three credit rating models are used at UBI for evaluating the credit worthiness of a borrower in the SME sector. Rating Model 1 For Small Borrowers with Credit Limit between 2 Lacs to 100 Lacks. Rating Model 2 For borrowers with Credit Limit between 10 Lacs to 5 Crores. Rating Model 3 For borrowers with Credit Limit between 1 Crore to 10 Crores.

The credit rating technique used by the banks differs from bank to bank. As stated in the Basel committee reports the top management is responsible for framing the policy of bank. The common parameters, which are taken into consideration before preparing the credit rating module, are below.

Operational performance of unit Sales trend during last 3 years. Profit trend during last 3 years. Achievement of sales projections Achievement of profit projections Net worth 36

historical risks associated with unit Geographical location Threat of obsolescence Industry type (sunrise, old, sunset) Industrial relation Regulatory risks and transaction/ compliance risk Repayment records Relationships of clients with the banks a/c Sector specific threat (external macro economic factors) Tax and duty barriers Conduct of fund and non-fund based accounts with banks /financial institutions- whether these are regular or irregular. Compliance of terms and conditions stipulated by banks while sanctioning of loan. Position of annual renewal/ review of loan facilities. Nature and value of securities (primary/ collateral) offered to cover loan facility. Validity of creation of charge on the securities. Position of contingent liabilities, if any. Transparency and disclosures in audited annual accounts. Position with regard to submission of balance sheet and P&L account, monitoring data and inventory statement etc. Auditors comments on quality and valuation of all types assets. Financial risk Return on equity ratios Debt service coverage ratio Total debt to net worth Operating profit to net sale Returns on assets Current ratio 37

Nwc/ current asset Net profit to net sales Return on capital employed

capacity utilization and management Ownership pattern of the unit Qualification, experience and knowledge of industry/ business. Market reputation and credibility. Track record of debt repayment. Pending statutory dues and litigations, if any Succession planning Labour relation Total capacity utilization No. of NPA units of same sector Strategic risk Investment in technology for up gradation & R&D Competitive threat (global, industry, new entrant) Threat of substitute product ( if any) Future potential Market demand and growth potential of products. Export potential of products. Position with regard to availability of raw material.

38

The following table shows classification of the Credit quality based on the Credit rating score, calculated from the appropriate rating model. INVESTMENT GRADE
CREDIT QUALITY Lowest risk RATING NUMERIC CR-1 CR-2 AGGREGATE SCORE (of 100) >90 86-90

NON INVESTMENT GRADE

CREDIT QUALITY Watch list Risk prone RATING NUMERIC CR-7 CR-8 AGGREGATE SCORE (of 100) 51-60 51 & below

Moderate risk

CR-3

81-85

Substandard

CR-9

Satisfactory risk Fair risk Acceptable risk

CR-4 CR-5 CR-6

76-80 71-75 61-70

Doubtful Loss

CR-10 CR-11

Source: Union Bank of India

39

WORKING CAPITAL ASSESSMENT:

Apart from financing for investing in fixed assets, every business also requires funds on a continual basis for carrying on day to day operations. These include amounts expenses incurred for purchase of raw material, manufacturing, selling, and administration until such goods are sold and the monies. While part of the raw material maybe purchased by credit, the business would still need to pay its employees, meet manufacturing & selling expenses (wages, power, supplies,

transportation and communication) and the balance of its raw material purchases. Working capital refers to the source of financing required to by businesses on a continual basis for meeting the short term needs. Limits to the various borrowers are assessed depending upon their requirements and their line of activity. OPERATING CYCLE OF THE COMPANY: The operating cycle is the average time between purchasing or acquiring inventory and receiving cash proceeds from its sale. From the operating cycle the bank can understand about the future working capital requirement of the company.

CASH

DRS.

F.G. WIP

R.M.

40

DURATION OF OC = R.M stock + WIP + FG stock holding period +ACP APP NO. Of OCs in a year = 360/ 12

Duration of OCs WC requirement forecast = annual operating cost No. of OCs in a year Stock holding period = stock

Cost at which stock is valued R.M. stock holding period = Average stock of raw material Value of R.M. consumed per day WIP period = Average stock of WIP Cost of production/day FG stock holding period = Average stock of finished COGS per day ACP = debtors * 360 Credit sale APP = creditors *360 Cr. Purchase

41

1. Turnover Method: (Working Capital Requirements) Under this method the bank finances maximum of 20% of the projected sales of the borrower and the borrower has to contribute 5% as his margin. This method is applicable for the following sectors:i. ii. For SSI borrowers up to Rs.5.00 crores. For Non SSI borrowers up to Rs. 1.00 Crore.

Assessment of working capital by turnover method A] TOTAL SALES / TURNOVERPROJECTED B] 25% OFF TURNOVER [OF A] [WCG] C] MARGIN AT 5% OF TURNOVER [OF A]

RS. IN LCS 2,25 56.25 11.25 45 45

D] LIMIT 20% OF A [B C] E] LIMIT PERMISIBLE [B-C]

2.

Maximum

Permissible

Bank

Finance(MPBF)

Method

Under this method the borrowers requirements are assessed based on the past practice/holding levels while the projections should be reasonably conform with the past trends, deviations can be accepted subject to satisfactory justification. This method is called as Tandon Committee Method of lending. It is applicable for working capital requirement of the borrowers coming under the following categories: i) For SSI borrowers: Rs.5 crores and above but less than Rs.50 crores ii) For non SSI Borrowers: Rs.1 crore and above but less than Rs.50 crores

42

Working Capital assessment on the formula prescribed by the Tandon Committee. Working Capital Requirement (WCR) = [Current assets Current Liabilities] Permissible Bank Financing [PBF} = WCR Promoters Margin Money i.e. PMM (to be brought in by the promoter) As per Formula 1: PMM = 25% of [CA CL] and thereby PBF = 75% of [CA CL] As per Formula 2: PMM = 25% of CA and thereby PBF = 75% [CA] CL As is apparent Formula 2 requires a higher level of PMM as compared to Formula 1. Formula 2 is generally adopted in case of bank financing. In cases of sick units where the promoter is unable to bring in PMM to the extent required under Formula 2, the difference in PMM between Formulae 1 and 2 may be provided as a Working Capital Term Loan repayable in installments over a period of time.

Rs in lakh 2007(act.) TOTAL CURRENT ASSETS OTHER CURRENT LIABILTIES ( other than bank borrowing ) WORKING CAPITAL GAP 104.03 187.39 199.72 95.69 2008(est.) 277.42 90.03

Calculation of working capital requirement Working Capital Requirement for the year 2007-08 is Rs. 199.72lakh

43

Formula 1 PMM (Promoter Margin Money) as per formula 1 = 25% of 104.03 lakh ~ Rs. 26 lakh Hence, Permissible Bank Finance 1 = Rs. 78.3 lakh Formula 2 PMM as per formula 2 = 25% of Rs. 199.72 lakh = Rs. 49.93 lakh Permissible Bank Financing as per formula 2 = [75% of 199.72 lakh Rs.95.69 lakh] = Rs. 149.79-95.69 lakh = 54.1 lakh The difference between the 2 methods is Rs. 24.2 lakh (which maybe extended as a Working Capital Term Loan in case of sick units. Since by the second method the contribution by the promoter is high so it would be accepted for bank financing. 3 Cash Budget Method: The borrower is required to submit the cash budget to the bank along with actual as well as projected financial statements. The budget in the prescribed format is to be prepared for a period of one year and then split into forecasts for shorter periods say monthly or quarterly. The budget will provide the following information. i. The peak level of bank finance required during the course of the year. ii. The current level of bank finance required as forecasted by the split budget (on monthly/quarterly) basis. The a) following Borrowers borrowers dealing in are assessed under like this tea, method sugar : etc.

Cyclical

industries

b) Borrowers availing Fund Based Working Capital limits of Rs.50 crores and above from the banking industry. 36 44

Term loan:
Term loans are a lump-sum payment with payback over a specified period of time. They may be used to finance equipment, a change in ownership, a new business acquisition or other long-term needs of a company. The period of loan vary from 3 to 10 years. Investment of these loans from firms is in plant and machinery, vehicles and certain other equipments. Repayment period for the term loan is calculated by DSCR and the repayment should start immediately after the cash gernation. The formula for calculating DSCR (NPAT +int.on term loan + deprecation) (Int. on term loan +installment of term loan) The idle ratio is considered to be 2:1while in case of SSI 1.5:1 ratio is considered to be good. Appraisal for long term in case of an industry or a project is a long term investment decision. So it should require a detailed study. The appraisal is done on the basis of following steps: 1. Technical Feasibility: The infrastructure required for the manufacturing process is studied here. The location selected should be ideal with regard to

transportation, communication network, availability of water, climatic conditions, and availability of manpower and disposal of waste. Size of the plant & type of technology adopted is another important aspect. The size of the plant or its capacity should be matching to the requirements of the estimates of the project.

45

2. Economic Feasibility: The unit should undertake detailed market study. The demand & supply gap of the product should be assessed. The time of the unit entering into the market is also important. 3. Financial Feasibility: The cost of the project & the estimated time for execution is an important factor. The promoters efficiency to complete the project within the given period is most important. The source of finance, without leaving any gap & availability of cash at the right time is to be ensured. Possibility of cost escalation, cost overruns etc. to be assessed. The financial feasibility is assessed by financial projection, fund flow and cash flow statement, ratio analysis and by non discounted and discounted cash flow statements. Pay back period method: Payback period is calculated by

comparing cash out flow (investment) with cash inflow (cash profit) and finding out that at what time they will be equal. Lower the payback period better the project. Average rate of return : It is calculated as Average profit after tax Average book value of investment It is compared with the rate of return of other market investments. Discounted cash flow technique I. Net present value It is calculated as =present value of cash inflow present value of cash outflow The project is accepted if NPV is positive and rejected if NPV is negative 2 Benefit cost ratio: The entire cash inflow is discounted at the rate of interest to arrive at present value rate.

46

BCR= present worth of the benefits (cash inflow) Present worth of cost (investment) The project is accepted if the BCR is more than one and rejected if BCR is less than one. Break even analysis: Break even point is the point of sales at which a units makes no profit or no loss. A unit can earn profit only if its level of sale is above the break even point. Once the BEP is calculated, the sales projection made in the profitability statement is compared with the break even point of sale. In case the difference between projected sale and BEP sale is very low, it is very risky to finance the project. On the other hand if projected sale is high than BEP the profitability of earning some profit is still there are some deviations in the project. BEP 1 in 2 in 3 in can be classified in three ways terms of no. of units of sale terms of sale in rupees terms of capacity utilisation fixed cost Contribution/ unit

1 BEP in units = OR

fixed cost Sales price/unit variable cost/ unit 2 BEP in rupees = fixed cost Total contribution * total sales in rupees

3 BEP in terms of capacity utilisation BEP in capacity = No. of units at BEP * 100 Total capacity To study the viability of the project the project having BEP above of 75% of capacity utilisation should not be accepted for finance Sensitivity analysis: While giving credit to the company an exercise is done known as sensitivity analysis. In this method we basically check the volatility in the profit of the company due to 47

change independent variable. The subsequent DSCR is calculated and the ability to pay back term loan is calculated.

48

SCENARIO -1
Particular Sales 2538.38 2951.45 3187.75 3410.89 3616.51 3757.63 3896.81 4004.34 FY 2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2015

R.M. Consumption & others Excise Salaries and wages Power & fuels

1335.23 173.42 93.47 43.37

1401.99 180.35 98.14 46.51

1514.15 189.36 102.06 48.83

1589.85 200.72 107.16 51.27

1646.73 205.05 109.60 52.93

1707.73 212.09 112.64 54.47

1747.82 216.74 114.95 55.76

1786.11 220.38 116.67 56.76

Stores and spares Repair and maintenance

13.75 17.87

14.71 19.45

15.02 20.42

15.77 21.44

16.12 22.23

16.47 22.86

16.82 23.44

17.03 23.88

Administratio n and other expenses Deprecation Selling cost Packaging cost Int.on working capital Int. on term loan Total cost PBT TAX NPAT

157 397.53 142.43 82.32

135.37 380 151.94 84.78

138.07 352.4 162.57 90.71

114.97 303.78 175.57 94.33

111.94 297.40 181.20 97.02

104.10 275.25 189.28 100.14

105.98 230.55 194.87 102.02

93.01 205.81 199.23 103.92

45.23 272.02 2773.64 -235.26 0.00 -235.26

58.97 257.20 2829.41 122.04 0 122.04

58.97 202.20 2894.76 292.99 96.6867 196.30

60.37 178.12 2913.35 497.54 164.1882 333.35

65.32 135.07 2940.60 675.92 223.05 452.86

62.32 93.02 2950.38 807.26 266.39 540.86

67.12 75.12 2951.18 945.63 312.06 633.57

58.78 65.12 2946.70 1057.64 349.02 708.62 40

49

PARTICUAR

FY-08

FY-09

FY-10

FY-11

FY-12

FY-13

FY-14

FY-15

DSCR-1 (5% Increase in RMC) Sales RM Cost Other Cost Total Cost PBT Tax PAT Depreciation Interest on Term Loan Total(A) Interest on Loan Installment on Term Loan Total (B) DSCR(A/B) 2538.38 1401.99 1438.41 2840.40 -302.02 0.00 -302.02 397.53 272.02 367.53 272.02 0.00 272.02 1.35 2951.45 1472.09 1427.42 2899.51 51.94 17.14 34.80 380.00 257.20 672.00 257.20 107.87 365.07 1.84 3187.75 1589.86 1380.61 2970.47 217.28 71.70 145.58 352.40 202.20 700.18 202.20 305.92 508.12 1.38 3410.89 1669.34 1323.50 2992.84 418.05 137.96 280.09 303.78 178.12 761.99 178.12 365.73 543.85 1.40 3616.51 1729.06 1293.87 3022.93 593.58 195.88 397.70 297.40 135.07 830.17 135.07 272.92 407.99 2.03 3757.63 1793.12 1242.65 3035.76 721.87 238.22 483.65 275.25 93.02 851.92 93.02 353.68 446.70 1.91 3896.81 1835.22 1203.36 3038.58 858.24 283.22 575.02 230.55 75.12 880.69 75.12 375.71 450.83 1.95 4004.34 1875.42 1160.59 3036.01 968.33 319.55 648.78 205.81 65.12 919.71 65.12 352.21 417.33 2.20

SCENARIO-2
PARTICULAR 31.03.08 DSCR 2 ( 5% Decrease in Sales) Sales Total Cost PBT TAX PAT Depreciation Interest on Term Loan Total(A) nterest on Term Loan Installment on Term Loan Total (B) DSCR(A/B) 2411.46 2773.64 -362.18 0.00 -362.18 397.53 272.02 307.37 272.02 0.00 272.02 1.13 31.03.09 31.03.10 31.03.11 31.03.12 31.03.13 31.03.14 31.03.15

2803.88 2829.41 -25.53 0.00 -25.53 380.00 257.20 611.67 257.20 107.87 365.07 1.68

3028.36 2894.76 133.60 44.09 89.51 352.40 202.20 644.11 202.20 305.92 508.12 1.27

3240.35 2913.35 327.00 107.91 219.09 303.78 178.12 700.99 178.12 365.73 543.85 1.29

3435.69 2940.60 495.09 163.38 331.71 297.40 135.07 764.18 135.07 272.92 407.99 1.87

3569.75 2950.38 619.37 204.39 414.98 275.25 93.02 783.25 93.02 353.68 446.70 1.75

3701.97 2951.18 750.79 247.76 503.03 230.55 75.12 808.70 75.12 375.71 450.83 1.79

3804.12 2946.70 857.42 282.95 574.47 205.81 65.12 845.40 65.12 352.21 417.33 2.03

50

SCENARIO -3
DSCR -3 ( 5% decrease in Sales and 5% increase in RMC) PARTICULAR FY-08 FY-09 FY-10 FY-11 Sales RM Cost Other Cost Total cost PBT Tax PAT Depreciation Interest on Term Loan Total(A) Interest on Term Loan Installment on Term Loan Total(B) DSCR(A/B) 2411.46 1401.99 1438.41 2840.40 -428.94 0.00 -428.94 397.53 272.02 240.61 272.02 0.00 272.02 0.88 2803.88 1472.09 1427.42 2899.51 -95.63 0.00 -95.63 380.00 257.20 541.57 257.20 107.87 365.07 1.48 3028.36 1589.86 1380.61 2970.47 57.90 19.11 38.79 352.40 202.20 593.39 202.20 305.92 508.12 1.17 3240.35 1669.34 1323.50 2992.84 247.50 81.68 165.83 303.78 178.12 647.73 178.12 365.73 543.85 1.19

FY-12 3435.69 1729.06 1293.87 3022.93 412.75 136.21 276.55 297.40 135.07 709.01 135.07 272.92 407.99 1.74

FY-13 3569.75 1793.12 1242.65 3035.76 533.99 176.22 357.77 275.25 93.02 726.04 93.02 353.68 446.70 1.63

FY-14 3701.97 1835.22 1203.36 3038.58 663.40 218.92 444.47 230.55 75.12 750.14 75.12 375.71 450.83 1.66

FY-15 3804.12 1875.42 1160.59 3036.01 768.11 253.48 514.64 205.81 65.12 785.57 65.12 352.21 417.33 1.88

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

51

DOCUMENTATION FORMALITIES Once the credit limits are sanctioned main documents are obtained from the client concerned. The nature of documents varies depending upon the type of facility sanctioned and terms of sanction. They may include one or more of the following-

Loan agreement conveying in terms and conditions of loan. A comprehensive credit agreement. Agreement of hypothecation of book debts. Power of attorney to receive the business receivables. Pledge letters of agreement in respect of documents of title to goods covering credit limits. Insurance / contingency insurance policy. Appropriate standard policy or specific policy. Corporate and personal guarantee. Documents conveying equitable mortgage on primary security i.e. fixed assets pertaining to the project and on the additional security (collateral) Personal guarantee of the borrower and guarantor (if any) Compliance of registration of charge formalities. Search report form an Advocate indicating a clear title for the last fifteen years as per the land records; and Approved building plans incase of constructed property. This would involve submission of the relevant documents by enterprise. The legal department in the financial institution would scrutinize these documents for their validity and completeness.

52

Non Performing Asset:

Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by RBI. With a view to moving towards international best practices and to ensure greater transparency, it has been decided to adopt the '90 days overdue' norm for identification of NPAs, form the year ending March 31, 2004. Accordingly, with effect form March 31, 2004. A Non performing asset (NPA) shell be an advance where i. Interest and /or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan, ii. The account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit(OD/CC), iii. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, iv. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and v. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

53

Reserve Bank of India (RBI) has issued guidelines on provisioning requirement with respect to bank advances. They are classified mainly into: Standard Assets: Such an asset is not a non-performing asset. In other words, it carries not more than normal risk attached to the business.

Sub-standard Assets: It is classified as non-performing asset for a period not exceeding 12 months. Doubtful Assets: Asset that has remained NPA for a period exceeding 12 months is a doubtful asset. Loss Assets: Here loss is identified by the banks concerned or by internal auditors or by external auditors or by Reserve Bank India (RBI) inspection. It should be noted that the above classification is only for the purpose of computing the amount of provision that should be made with respect to bank advances and certainly not for the purpose of presentation of advances in the banks balance sheet. After the implementation of Securitization Act, 2002 banks issue notice to the defaulter to either pay back the dues to the bank or give the ownership of the secured assets mentioned in the notice. However, there is a potential threat to recovery if there is substantial attrition in the value of security given by the borrower or if borrower has committed fraud with the concerned bank. Under such a situation it will be prudent to directly classify the advance as a doubtful or loss asset, as appropriate. DRT The bank can file a suit against the clients in court to recover its due. It is filed in court so that the dues can be recovered through the Debt Recovery Tribunal. The DRT came into existence in 1993 for debts with outstanding of Rs.10 lakhs and more. 54

The other courts will not have authority to hear cases falling under this jurisdiction, once the case is referred to DRT. The DRT has the powers to attach and sell, to arrest and detain in jail. DEBT ASSET SWAP It is the takeover of unproductive / non core assets by mutual agreement. Absence of legal problems in taking over is a precondition. Minimum value of asset should be Rs.5 Crores. ONE TIME SETTLEMENT (OTS) One time settlement is one the resource for the bank to recover its debts. The settlement amount is arrived at by the bank and borrower in order to settle the loan account. The doubtful or loss account as on 31.03.2000, the settlement amount is minimum 100 % of O/s as on the date it became NPA. Sub standard as on 31.03.2000, which later became Doubtful/loss, the settlement amount is minimum 100% O/s on date it became Doubtful/ Loss + interest at PLR from 01.04.2000 to date of settlement. Amount is to be paid in lump sum. And if it is payable in installments, the minimum no of installments are 12. The minimum amount to be paid immediately is 25%, Interest at PLR from date of settlement to date of payment.

CORPORATE DEBT RESTRUCTURING Corporate debt restructuring is a viable and transparent mechanism for ailing but viable corporate outside the structure of BIFR/legal proceedings. It is applicable for only sub standard assets. Only manufacturing companies are covered under the scheme. In corporate restructuring scheme only the accounts of Rs. 20 Crores and above are covered. It is a three tier structure- CDR Forum, CDR Empowered Group, and CDR cell CDR Forum frames policies and guidelines. CDR Empowered Group makes sanctions, approvals, commitments, etc. CDR cell scrutinizes, assesses, and monitors. 55

Features of the scheme are: 1. Revival plans is to be ready in 90 days 2. Lenders cannot exit from the agreement

3. Creditors with 20% or more exposure can approach the CDR 4. Restoration plan approved by 60% of value of creditors is binding 5. Amount of sacrifice is the amount of interest measured in P V terms, which is provided fully or written off

56

Annexure -1 UNION BANK OF INDIA Credit department: central office PROPSAL FOR ENHANCEMENT OF NON FUND BASED AND FUND BASED LIMIT GROUP BANKING MONTH OF REVIEW ASSET CLASSIFICATION INTERNAL CREDIT RATING STATUS OF ACCOUNT : : : : : : LEAD BANK : OUR SHARE : FB NFB 3.94%

1 a) NAME OF THE ACCONT b) BRANCH/ ZONE c) DATE OF INCORPORATION 2 CONSITUTION 3 ADDRESSRegistered office Corporate office Unit/ works

: : : : :

4 NAMES OF DIRECTORS AND THEIR MEANS

5 BACKGROUNDS OF THE PROMOTERS/ DIRECTORS:

57

6 CAPITAL STUCTURE
Authorized capital

AS OF 31.03.2007

UN

AMOUNT (RS.)

Paid up capital Book value Market value

6. (a)

SHARE HOLDING PATTERN Particular Promoter Institutional Pvt.corp.bodies NRIs and OCB Clearing members No. of shares Face value % holding

Individuals TOTAL 7 IN CASE OF PARTNER SHIP FIRMS INDICATE CAPITAL CONTRIBUTED BY EACH PARTNER SEPRATELY

NA

8 LINE OF ACTIVITY 9 SECTOR/ BSR CODE

: :

COMMENTS ON LATEST CREDIT: 10 WHETHER A/C IS TAKEN /TO BE TAKEN OVER. IF SO NORMS FOR TAKE OVER ARE FULLFILLED 11. a) DEALING WITH BANK SINCE: b) CREDIT FACILITIES SINCE: 58

12

TOTAL INDEBTNESS NON FUND BASED Existing Proposed

FUND BASED Existing Proposed

TOTAL Existing Proposed

OUR BANK Working capital Other banks TOTAL 13 14. BRIEF BACKGROUND : FINANCIAL INDICATOR: Rs. In FYRR Paid up capital Reserves and surplus Intangible assets Tangible net worth Long term liabilities Capital employed Net block Investments Non current assets Net working capital Current assets Current liabilities Current ratio DER TOL/TNW Net sales Other income Net profit after tax Depreciation Cash accruals COMMENT ON FINANCIAL INDICATOR: 14.2 AUDIT NOTES IN BALANCE SHEET IF ANY , TO BE SPECIFIED: 14.3 COMMENT ON FINANCIAL INDICATOR ON CASH BASIS :-31.03.2004 Net cash flow from the operating activities Net cash flow from investing activities Net cash flow from financing activities Increase in cash and cash equivalent Cash and cash equivalent at the end of year 59 31.03.2005 FYFYFY-

14.4 COMMENT ON ESTIMATED BALANCE SHEET OF 31.03.2006 15 16 EVALUATION OF MANAGEMENT EVALUATION OF INDUSTRY 17 18 EVALUATION OF BUSINESS RISK CONDUCT OF THE ACCOUNT :

(1) A) regulatory in submission of Stock / book debt statement QPR / half yearly statement Financial statement CMA data (2) name of the statement/ return Stock statement /BD/MSOD No. of QPR/ half yearly statement/ statement return received during the year

Last statement /return received

b) COMMENTS ON OPERATION / OVERDUES (1) Turnover in the account is commensurate With the limit (2) Frequent excesses are given (3) Cheques are returned frequently 19 COMLIANCE TO TERM OF SANCTION: a) Completion of mortgage formalities : b) Registration of charges with ROC c) Whether document valid and in force d) Compliance of RBI guidelines e) Whether consortium meeting held At a prescribed periodic intervals Where the bank is the leader 20 a) DATE OF INSPECTON: DURING THE FINANCIAL YEAR

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20 b) NATURE AND VALUE OF COLLETERAL SECURITY: Nature / description of collateral security indicating area & location of property Value (rs. ) Date of valuation Along with name of the valuer Insurance Amount and date of expiry

c) PERSONAL GUARNTEE/ CORPORATE GUARNTEE

21a) WHETHER THE NAME OF THE COMPANY/ DIRECTORS FIGURE IN RBI DEFAULTER / CAUTION LIST / ECGC. IF YES, PLEASE FURNISH DETAIL b) WHETHER DIRECTOR/ PARTNER / PROMOTERS IS A DIRECTOR IN OUR / OTHER BANK OR IS RELATED TO THEM c) ANY LITIGATION IN FORCE AGAINST THE FIRM/COMPANY OR AGAINST THE PARTNER / DIRECTORS. IF SO MENTION DETAILS & PRESENT POSITION 22 AUDIT OBSERVATIONS a) Internal b) Concurrent c) Statuary d) RBI inspection e) Stock audit 23 ANY IRREGULAR FEATURE OBSERVED IN THE MONITORING REPORT

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24 EXPOUSRE DETAILS FROM OUR BANK

Limit existing

Limit recommended

D.P.

o/s as on date of inspection

Value of security

Irregularities

A} non fund based limit Import/inland/L/C Letter of guarantee SUB LIMIT {a} B} fund based limits Wcdl/Fcl Cc/pc/Fdbp SUB LIMIT {b} C} TERM LOAN TERM LOAN SUB LIMIT {C} GRAND TOTAL {A+B+C}

b) DETAILS OF EXCESS ALLOWDED DURING THE YEAR: c) OTHER EXPOUSRE, IF ANY, INCLUDING INVESTMENTS: d) OTHER LIABILTIES OF DIRECTORS (IN THEIR INDIVIDUAL CAPACITY) 25a) EXPOUSRE DETAIL FROM BANKING SYSTEM NAME OF THE NON FUND BASED BANK %Share Amt. % share

Amt.

b) CONDUCT OF THE ACCOUNT AND EXPOUSRE DETAIL FROM FINANCIAL INSTITUTIONS: c) VALUE OF ACCOUNT d) DETAILS OF FOREIGN CURRENCY EXPOUSRE COMMITMENTS AND UNHEDGED POR 62

Amt. in USD

Name of the corporate External commercial borrowing Importance usance bills received on collection basis duly accepted and outstanding L/Cs & PAD for import of goods capital equipments. Others exports Receivables Other import obligation Foreign currency loan availed from authorized dealers in India Any other exposure, please specify

Amount of exposure

Unhedged portion

Due dates for payment (range)

1. 2.

3.

4.

5. 6.

7.

26 OPERATIONAL EXPERIENCES a) WITH RESPECT TO SISTER/ ALLIED CONCERN b) COMMENTS ON OTHER BANKS CREDIT REPORT ON SISTER CONCERNS 27 OMMENT ON ASSESMENT OF LIMITS INVENTORY AND RECEIVABLE NORM
Inventory Previously accepted level Actual on the assessment year Month RM-IMPORT RM-INDIGENOUS WIP/ FIG RECIEVABLE-LOCAL RECIEVABLE EXPORTS SUNDRY CREDITORS value Estimates Indicative Norms

month

value

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OTHER CA OTHER CL

raw material stock in progress Receivable ( domestic) Receivable( exports) Working capital assessment
2005(act.) Total current assets Other current liabilities ( other than bank borrowing ) Working capital gap Actual/ projected NWC FBF 2006(est.)

ASSESSMENT OF NON FUND LIMITS A inland / import l/c For purchase of raw material / stocks Purposed purchase (% of total purchase) Purchase Purchase under l/c Average time taken from date of l/c till the date of shipment (days) Average time taken from date of shipment to the date of retirement of the bill under l/c (days) Total A (a+b) Average rotation of letter of credit in one year (365/a) times Level of l/c ( projected purchase/import during the year )/c Contingencies (IF ANY) Limit required Total l/c requirement = Our share Limited recommended Bank guarantee

Imp.

indigenous

A B

C D

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29. Credit rating 30. i a. n d u s t r y Year Total score obtained Grade Parameter Borrower rating Borrower rating Facility rating Risk mitigators Business aspects Total marks with grade FYFY-

31. industry scenario

32.

out look

33. recommendation Approved

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GLOSSARY
Acid test A stern measure of a company's ability to pay its short term debts, in that stock is excluded from asset value. (liquid assets/current liabilities) Also referred to as the Quick Ratio. The direct costs attributable to the production of the goods sold by a company. The directly attributable costs of products or services sold (usually materials, labour, and direct production costs). COGS = net sale -gross profit. The statement showing the movement of cash in and out of a business from day-to-day direct trading and other non-trading or indirect effects, such as capital expenditure, tax and dividend payments. The value of all resources available to the company, typically comprising share capital, retained profits and reserves, long-term loans and deferred taxation. The rate that has to be received from an investment in order to achieve the required rate of return from the creditors A group of ratios that measures a firms ability to meet its recurring fixed charge obligations, such as interest on long term debt, lease payments, and/or proffered stock dividends This represents the no. of days worth credit sales that is locked in debtors. Liabilities that is normally payable within a year and are not for along term. A liquidity measures defined as current assets divided by current liabilities. The uncertainty of expected returns from a security attributable to possible changes in the financial capacity of the security issuer to make future payments to the security owner. Treasury securities are considered to be default free. Default risk is also referred to as financial risk in the context of marketable securities management. The ratio of net sales to inventory. A letter from a bank mentioning that it has established a line of credit in favor of a certain party letters of guarantee are concerned with providing safeguards to buyers that suppliers will meet their obligations or vice-versa, and are issued by the supplier's or customer's bank depending on which party seeks the guarantee. Net working capital is the difference between total current assets total current liabilities. The operating cycle of a firm begins with the acquisition of raw materials and ends with the collection of receivables. A technique of risk analysis which studies the responsiveness of the criterion of merit like net present value or internal rate of return to variations in underlying factors like selling price, quantity sold, etc. A loan which is generally repayable in more than one year and less than ten years.

Cost of goods sold (COGS)

Cash flow statement

Capital employed Cost of debt Coverage ratios Average collection period Current liabilities Current ratio

Default risk

Inventory turnover Letter of credit

Letters of guarantee Net working capital Operating cycle

Sensitivity analysis Term loan

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Turn over ratios

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

Working capital

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

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BIBLIOGRAPHY
Websites:www.marketresearch.com www.Investopedia.com www.cmia.com www.unionbankofindia.com www.google.com www.rbi.org.in www.sbi.com BOOKS & PUBLICATIONS I. M. Pandey, Financial Management Union Bank manuals and circulars Credit management ( a practical approach) Pratiyogita Darpan

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