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P L N F E P P E F D Review of Literature The tendon committee examined the different aspects of prevalent bank lending practices during the period and suggested implementation of some far reaching steps that would streamline and rationalize the process of credit dispensation process by the commercial banks in India. The important suggestions are given below. 1. Assessment of the credit requirements of the borrowers should be directly related to the level of operations and activity of the borrowing enterprise. This envisaged a distinct shift from the security centric approach of lending to a production-oriented approach of lending in future. 2.The promoters must bring in a minimum amount of margin out of the total working capital requirements of the unit. Bank should finance only the residual portion of the working capital requirements as bank credit should be viewed only as a supplementary source of finance. 3.The committee prescribed standard norms for holding raw material. Stock in process, finished goods, consumables and receivables etc. for different industries. This would ensure level of homogeneity in the assessment of working capital requirement of similar industries. The holding level of individual components of working capital therefore no longer be fixed arbitrarily setting level of bank credit for working capital purposes without having any linkage with level of production of the borrowing enterprise. 4.The committee also felt that it was necessary to standardize different methods practiced by the banks for computing the level of bank credit for working capital requirements. The committee prescribed three method for computation of MPBF (Maximum permissible bank Finance) in this regard. 5.Depending on the holding level of the individual components of working capital, the amount of bank credit computed in accordance
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PL NF E PP EFD Review of Literature
The tendon committee examined the different aspects of prevalent bank lending practices during the period and suggested implementation of some far reaching steps that would streamline and rationalize the process of credit dispensation process by the commercial banks in India. The important suggestions are given below.
1. Assessment of the credit requirements of the borrowers should be directly related to the level of operations and activity of the borrowing enterprise. This envisaged a distinct shift from the security centric approach of lending to a production-oriented approach of lending in future.
2.The promoters must bring in a minimum amount of margin out of the total working capital requirements of the unit. Bank should finance only the residual portion of the working capital requirements as bank credit should be viewed only as a supplementary source of finance.
3.The committee prescribed standard norms for holding raw material. Stock in process, finished goods, consumables and receivables etc. for different industries. This would ensure level of homogeneity in the assessment of working capital requirement of similar industries. The holding level of individual components of working capital therefore no longer be fixed arbitrarily setting level of bank credit for working capital purposes without having any linkage with level of production of the borrowing enterprise.
4.The committee also felt that it was necessary to standardize different methods practiced by the banks for computing the level of bank credit for working capital requirements. The committee prescribed three method for computation of MPBF (Maximum permissible bank Finance) in this regard.
5.Depending on the holding level of the individual components of working capital, the amount of bank credit computed in accordance with the MPBF prescription would be bifurcated into different components of credit. Delivery of the different components of credit also conform to the prescription pertaining to that working capital components, if any. The committee also suggested method to follow up the bank credit after delivery to verify whether the actual levels of production and utilization of bank credit were close to the initially projected levels on the basis of which assessments were done. Tendon committee made an observation that a banker role as working capital lender should be to supplement the resources already available to the borrower in carrying a reasonable level of current asset in relation to his production requirements. The committee recognized that the other current liabilities are very important sources for funding the ongoing working capital requirements and these should be used diligently before availing bank credit as a source of finance.All three methods recognized that the bank would lend only a portion of working capital gap(wag),which is the value of acceptable level of current assets after netting off the other sources of funding were represented by all current liabilities except bank borrowing for working
Three methods of computing MPBF are summarized in the table below
First methods MPBF =(CA-OCL)-25% of (CA-OCL)
Second methods MPBF=(CA-OCL)-25%of CA
Third methods MPBF= (CA-OCL)-CCA-25%of (CA-OCL)
Executive Summary
It may be easy to bring an elephant home but it’s very difficult to nurture him. Similarly it
may be easy to start a business but it’s difficult to run it. To run a business you need finance for
acquiring fixed assets, you need funds for carrying out day to day activities like purchase of raw
material, making payments to the labor etc. Role of commercial banks is to make sure that the
businesses of deserving candidates run smoothly and effectively. The required funds needed by
these organizations are made available from time to time by the commercial banks. But it is
important that every borrower gets fund commensurate to their need and size. This will ensure
no diversion of funds and funds will be utilized for the purpose for which it has been borrowed.
By doing the exercise of working capital assessment a banker can decide how much exposure he
is willing to take on a particular client after assessing his need, size and purpose. Report tries to
highlight different methods of working capital assessment. It also underlines various tools with
which a banker is equipped while appraising a loan proposal. Along with the well being of the
borrower it is equally important that bank’s fund remain safe. Report covers different types of
measures taken by the banks to ensure the safety of their principal (funds) as well as interest
(income generated) while appraising a proposal. Report also spells out different parameters
evaluated by the banks before taking any decision.
With globalization entire world has become a market. Any one around the world can
become a participant in this market. But any corporate wanting to participate in world market
either as a buyer or seller cannot always do it on his own. The major impediments being 1) they
do not have different country’s currency for executing the transaction 2) small corporate
exporting something neither have the resources nor a communication network to find out the
credit worthiness of the other party 3) similarly an importer needs a guarantor who can
ascertain his credentials in the world market. Banks act as the troubleshooter for all this
problems. Report tries to cover how banks can mitigate all this friction and facilitates a smooth
global trading. Banks are authorized dealer in foreign currency market. They make finance
available to the customer in any currency as desired by him. Banks also gives access to critical
info through its own network in the banking fraternity. They act as guarantor in case of importer
by issuing LC and liquidator in case of exporter by discounting his foreign bills.
Introduction The importance of working capital in any industry needs no special emphasis. Working capital is considered to be life-giving force to an economic entity. Management of working capital is one of the most important functions of corporate management. Every organization, whether profit oriented or not, irrespective of its size and nature of business, needs requisite amount of working capital. Capital to keep an entity working is working capital. The efficient working capital management is the most crucial factor in maintaining survival, liquidity, solvency and profitability of the concerned business organization. It needs sufficient finance to carry out purchase of raw materials; payment of day-today operational expenses including salaries and wages, repairs and maintenance expenses etc. and funds to meet these expenses are collectively known as working capital. In simplicity, working capital refers to that portion of total fund, which finances the day-to-day working expenses during the operating cycle. The term "working" here implies continuity of production and distribution of want removing goods and services required by the society. Working capital is necessary to finance current assets which include inventories, debtors, marketable securities, bank, cash, short term loans and advances, payment of advance tax and so on. Fundamentally, there are two concepts of working capital and they are (I) Gross Working Capital and(ii) Net Working Capital. GrossWorking Capital refers to financial resource remaining invested in current assets and Net Working Capital represents the gulf between the GrossWorking Capital and Current Liabilities or simply it is the difference between Current Assets and Current Liabilities.A business organization should determine the exact requirement of working capital and maintain the same evenly through out the operating cycle. It is worth mentioning that a firm should have neither excess nor inadequate working capital as both the phenomena of over capitalization and under capitalization of working capital generate adverse effects on the profitability and liquidity of the concerned firm. The effective working capital necessitates careful handling of current assets to ensure short-term liquidity and solvency of the business. To be more specific, neither under stocking nor overstocking of raw materials, careful maintenance and trade off between credit receiving period from sundry creditors and credit allowing period to sundry debtors (generally credit period from sundry creditors should be more than credit period allowed to sundry debtors and the gulf between these two periods is technically known as float of comfort), maintenance of requisite cash and bank balance including provision for contingency and planning both the short term and long term investment in appropriate manner without allowing any cash/bank balance to remain idle in the business are strictly required to be practiced by management. Practice of judicious and effective system of working capital management demands hire of yeomen service and expertise of hard-core finance professionals.Keeping in view the pragmatic importance of working capital management as a gray area of corporate finance function, an attempt has been made to examine working capital management practices and the problems faced by the firms in working capital management process particularly in heavy engineering industries. An engineering firm having two hundred years old legacy of culture and heritage and being located in Eastern India has been selected for the purpose of our research. The company has two subsidiary corporate. The corporate office of the company selected for study is in Kolkata and the name of the company is being kept undisclosed
as per the request of the same and thus let the firm be named as "M/S Heavy Engineering Company Limited" for the purpose of our study though the name of the firm is hardly material here
BANK’S NEW INITIATIVES:
ACQUISITION:
The Bank has finalized acquiring 76% stake in P T Bank Swadesi Tbk, a listed Bank in Indonesia
and the formalities to take over the management of the said Bank is in final stages.
JOINT VENTURE:
Bank entered into an arrangement with Dai-Ichi Mutual Life Insurance Company, second largest
Japanese company in the field of Life Insurance (sixth largest in the world) and Union Bank of
India for setting up a Joint Venture Life Insurance Company with capital stake of 51%, 26%, and
23% respectively. Formalities for incorporation of JV Company are in advanced stage.
STRATEGIC ALLIANCE:
Bank has entered into a strategic alliance with Union Bank of India and Infrastructure
Development Finance Co. (IDFC) for Loan Syndication, International Business, Cash
Management, Cheque collection and Training.
BRANCH EXPANSION:
Bank opened 63 new branches and converted 41 Extension counters to full-fledged branches.
Total number of domestic outlets is 2845.
CAPITAL ENHANCEMENT:
To strengthen Capital Adequacy, Bank issued Hybrid Tier I capital bond of USD 85 mn on
27.03.2007 out of our Medium Term Note Programme. Issue received overwhelming response
from the investors. Moodys and BB by S & P rated the issue Baa3.
Bank raised Upper Tier II Capital of Rs.732 crores s in Domestic market and Rs.1108 crores s (US
$240 Mn.) in Foreign market.
I.T. INITIATIVES:
1044 branches are currently on Core Banking (CBS) mode as against 555 branches as on
31.03.2006
ISO 27001:2005 certification
Bank’s Data Centre has been awarded the prestigious ISO 27001:2005 certificate. The certificate
represents the formal recognition of the Information Security Management System of the Bank as
being in conformance with the International Standard for Information Security. It covers the Data
Center and Disaster Recovery site of the Bank. BOI is one of the first among public sector banks in
India to have achieved the certification.
Mumbai Corporate Banking Branch (MCBB):
Banks play a very crucial in economic growth of any country. Economic growth depends upon the
corporate performance of the country and for growing corporate needs financial assistance from banks
and other financial institutions. Development intuitions help in building up the project but in real terms
it is the commercial banks that actually run that project. Banks run the project by providing working
capital financing the most important part of any enterprise.
Bank of India has been performing the crucial function of corporate financing for more than a century
and with its expertise and experience it has been able to maintain the business with its old customers
and also acquire new customers. Initially corporate lending at Mumbai was done through a single
branch named as Mumbai Corporate Branch. Then Bank of India with the help of Boston Consultancy
Group (BCG) undertook Business Process Re-engineering for Bank as a whole. Under this process
corporate lending was divided between two Branches
1) Mumbai large Corporate Branch:
This Branch is responsible for corporate lending of 50 crores and above for both fund based and
Non-fund based credits.
2) Mumbai Corporate Banking Branch:
This Branch is responsible for corporate lending of 5-50 crores both fund based and non-fund
based credits. It comes under Mumbai South Zone.
Organization structure at MCBB
DGM: Deputy General Manager.
AGM: Assistant General Manager.
RSM: Relationship Manager.
CO: Credit Officer.
On paper MCBB has a department wise organization structure. But in practice the structure has good
amount of flexibility. This is mainly because the head count is very small. Jobs and roles, duties and
responsibility and authority of every one are well defined. There is clarity of command at each level
of hierarchy. Culture here to some extent resembles to a culture prevailing in a conventional PSU.
But the department along with BSG is trying to adopt professionalism and new management styles.
Bank Facilities
1. Fund Based:
Demand Loan : A Loan Granted for tenure of 36 months (including moratium Period) is
treated as Demand Loan .It is repayable in agreed installments. Demand Loans are usually
granted for meeting short term needs of a borrower such as packing credit loans granted to
exporters to meet their needs for pre shipment finance. Interest is charged on the amount
utilised by the borrower. In this case Demand Promissory Note is taken as a security document.
Term Loan : Term loan is an installment credit repayable over a period of time in
monthly/quarterly/half yearly/yearly installments. Term loan is generally granted for creation of
fixed assets required for long-term use by the unit. Term Loan Agreement is taken as a Security
in this type of loan. Interest is charged on funds actually utilized by the borrow Term loans are
further classified in three categories depending upon the period of repayment as under:
Short term repayable in less than 3 years.
Medium term loans repayable in a period ranging from 3 years to 7 years.
Long term loans repayable in a period over 7 years.
Demand Loan and Term Loan are not so operative accounts and does not have a chequebook
facility. Disbursements from these accounts are done through Pay Order.
Cash Credit (CC) : Commercial banks in India have traditionally been using the cash credit
system for delivery of bank credit for WC purposes. The system is quite popular because the CC
method of delivery allows drawing by a borrowing enterprise to the extend of value of
chargeable assets less margin. Any withdrawal of funds beyond this limit renders the account
irregular that serves as a warning signal to the lending banker and also prompts him to monitor
the account closely. Also CC satisfies the need for an omnibus account where the sale proceeds
of the enterprise may be routed through conveniently. However CC gives rise to an uncertainty
in the liquidity management of the banks as the borrower in this account can draw as much as
they need and deposit moneys received from time to time. Bank charges interest on the daily
debit balances in the accounts. Securities in these types of credits are mainly Book Debts and
Stock. In case of sole banking debit balance of account is equal to its expenses and credit
balance is equal to its sales.
Overdraft : Here a limit is sanctioned to a borrower and borrower is allowed to withdrawn
money within his sanctioned limit and the bank charges interest on the amount withdrawn in
overdraft limit. Security in this account can be Insurance Policy, Fixed Deposit Receipt, Shares,
and Mutual funds units.
Over draft and Cash Credit are more operative accounts as compared to loan accounts
where there are limited operations. These accounts have chequebook facility.
Working Capital Demand Loan : In view of the problems associated with cash credit
system of delivery of bank credit, RBI had introduced the loan system of delivery of bank credit
known as the WCDL system of lending. Under this system a larger portion of WC credit provided
by the banks is in the form of a loan repayable over a period of time. The only difference
between the cash credit and WCDL is that in WCDL interest is charged on the entire sanctioned
amount irrespective of actual utilization of funds by borrower whereas in cash credit interest is
charged on the funds actually utilized by the borrower.
Advance against Bills : Here bank sanctions advances to the borrower against the bills
of future date discounted with the bank
Channel Credit : Corporate borrower’s channels are mainly its supplier and customers. A
channel credit is availed when the bank pays to the borrower's suppliers and on later date
recovers from the borrower and in case of its customer’s bank discounts borrower’s bills drawn
on its customers and on later date recovers that amount from its customers.
2. Non-fund based facilities:
Credit facilities which don not involve actual deployment of funds by banks but help the obligations to
obtain certain facilities from the third parties are termed as non fund based facilities. These facilities
include:
Issuance of Letter of Credit: It has become an ideal method of settlement of payment of a trade
transaction and helps the obligator to make purchases anywhere from the world.
Issuance of Bank Guarantees
RBI has issued various guidelines to banks in this regard.
Risk to the bank for granting such facilities is almost the same as for granting loans and advances and
banks employ the same appraisal techniques while granting these facilities. In fact, non-fund based
facilities are generally not granted in isolation and are linked with other facilities granted to a customer.
Details in respect of these facilities are presented later.
3.1 Types of Banking:
The credit requirements may be dispensed by any one of following modes -
A) Sole Banking Arrangements
B) Multiple Banking
C) Consortium Lending
D) Syndication
A) Sole Banking:
In this type of arrangement Bank of India acts as a sole Banker financing all the needs of the borrower.
In “AAA” and “AA" rated accounts where bank is sole banker, banks endeavor to retain such accounts.
Borrowers have obtained bank’s prior approval in case they would like to switch over to Multiple Banking
Arrangement or consortium lending.
Whenever a customer’s credit requirements exceed 50% of the exposure ceiling or Rs.100 crores
whichever is higher, the borrower would be encouraged to scout for another Bank/institution to share
the credit facility/ies under Multiple Banking, Consortium or syndication arrangement.
As a matter of corporate policy, bank emphasizes financing accounts of "AAA" and "AA" borrowers
under sole banking arrangements (subject to banks exposure ceilings). "A" rated borrowers shall
continue to be financed in the normal course of business as per Bank’s policies.
B) Multiple Banking:
In this type of arrangement the borrower avails facilities from other banks also along with bank of
India. Where bank is the sole banker and the borrower desires to avail of credit limits from other bank/s
without a formal consortium arrangement, the reasons for the borrower wanting to shift to another
bank are ascertained and recorded.
Bank may decide to permit the borrower to bank elsewhere provided the borrower agrees to furnish
from time to time details of the various facilities availed from other bank/s and also provided that the
total working capital limits availed by the borrowers are within a 10% tolerance of the working capital
limits assessed by Bank of India. Acceptance of distinct and separate security or otherwise may be
considered by the sanctioning authority on the merits of each case. In such cases, Bank's exposure for
working capital needs should normally not exceed 75% of the total working capital requirements of the
borrower. Where it exceeds this limit, justification for the same shall be mentioned in the appraisal note.
C) Consortium Lending:
Consortium lending is when two or more banks come together for financing a single borrower. It is a
formal arrangement among the bankers for financing requirements of single borrower. In consortium
lending bank having maximum share in credit is considered as lead bank and it is lead banks
responsibility to conduct quarterly consortium meeting of all banks in consortium and review the
performance of the borrower and decide upon its credit limits. Banks have been given the freedom to
frame the ground rules for lending under consortium arrangement. In case of accounts where bank is a
member, bank may accept the rules framed by the leader, provided they do not jeopardize Bank's
interest and generally conform to Bank' policies.
D) Syndication:
A syndicated credit is an arrangement between two or more lending institutions to provide a credit
facility using common loan documentation. Bank shall encourage financing under such arrangements.
Bank will also act as syndication leader whenever such opportunity is spotted.
Trade finance:
Trade finance division at MCBB offers a range of Trade Finance Services to cover trade finance
needs of the corporate clients. This includes both, Export and Import Finance and Guarantees.
Banks philosophy is to provide premium quality service by offering the widest array of choices,
supplemented by world-class products. Banks Trade finance department is built on a advance
technological platform to meet the client's needs. All the transactions are carried out on software like
Finnacle and SWIFT for fast and effective execution. This philosophy has resulted in this division being of
paramount importance for the branch and contributing to the bottom-line of the branch.
With the expertise and experience of the people working in the division, it helps in offering a wide
range of trade services designed to assist in building on client’s strengths and eliminating their hassles.
4.1 Import finance:
DGFT and its regional offices functioning under the Ministry of Commerce, Government of India,
regulate the import trade. Bank of India follows the policies and procedures for imports into India as
announced by DGFT, from time to time. Bank therefore, sell the foreign exchange or transfer rupees to
non resident account towards payment for imports into India from any country in conformity with the
EXIM Policy in vogue and rules framed by government of India and the directions issued by Reserve Bank
of India from time to time under the Act.
Bank of India grants the import finance facilities to the clients who are regularly dealing with them and
who are known to be participating in the trade. This facility is usually not granted in isolation at this
branch it is usually linked with other facilities granted to the customer like CC facility, WCDL, term loan
etc. Bank obtains the following information to establish the bonafides of the importer:
Import-Export Code Number: this number is allotted by trade control authority, which goes to
establish that they are registered importer. The application form for obtaining the EXIM code is
normally forwarded to DGFT through an authorized dealer who is expected to under take foreign
exchange transactions at their end itself. The IEC application form will accompany bank’s
certificate who will get a copy of such IEC code certificate from the licensing authority directly on
issuance of the code.
Import Licence: It means a licence granted specifically for import of goods that are subject to
import control. Import licenses are issued by Central Government or by any other officers
authorized under the Act. Import of goods under a licence and also provision of the import
policy of the period in which it is issued
After client selection and assessment the facilities required is assessed taking the same precautions as
would be taken for fund based facilities keeping in view the credit guidelines of the Reserve Bank of
India. Normally assessment is made considering the factors like production trading capacity of the unit,
its import requirements, time taken for shipment\arrival of the goods credit period offered etc.
Margin Money on imports financed varies from customer to customer depending on their status and
business with the bank and accordingly the customers are charged.
Bank of India adheres to know your customer guidelines issued by Reserve Bank of India in all their
dealings
Bank of India’s MCCB Trade division grants the import finance facilities in the following manner.
Types of import finance:
Letter of Credit:
Definition:
A letter of credit (LC) or a documentary credit is an undertaking issued by a bank, on behalf of the
buyer to the seller, to pay for the goods and services, provided that the seller presents documents which
comply with the terms and conditions stipulated in the LC.
When a LC is issued in course of international trade, the buyer is the importer of goods and the seller is
the exporter. It is therefore necessary that the terms of LC comply with the relevant exchange
regulations prevalent in the respective countries. In India, the foreign exchange management act (FEMA)
and the exchange control manual prescribe the terms and conditions in this regard. Besides, such
transactions relating to foreign LC are also governed by the rules framed by FEDAI (foreign exchange
dealers association of India). The modalities for issuing documentary credits are also subject to the
provisions of Uniform Customs and Practices for Documentary credit (UCPDC) framed by thee
International Chamber of Commerce (ICC), especially in case of foreign LC.
Parties in a LC transaction:
A Transaction in a LC may involve several parties at different stages i.e. from the issue of the LC till
making payment of the bills to the seller as promised in the LC. The various parties with different rights
and responsibilities are the following:
Applicant:
The buyer finalizes the terms and conditions of a purchase transaction and submits a request to his
bank for issuing a LC in favour of the seller.
Beneficiary:
The beneficiary of the LC is the person in whose favour the credit has been issued. Generally, the
credit is issued favoring the seller of the goods and services.
Issuing/Opening bank:
On receipt of request from its customers the applicant’s (purchaser’s) bank examines the proposal
and opens a LC in favour of the beneficiary with the stipulated terms and conditions. This bank is known
as issuing/opening bank.
Advising bank:
In case the seller (beneficiary) resides in a distant place or in a foreign country, the issuing bank may
contact some other bank in the beneficiary’s country. The identified bank in beneficiary’s country may
agree to advise the credit to the beneficiary and thus play the role of an advising bank. the issuing bank
may have its own branch in that foreign country or may arrange with a correspondent bank operating in
the foreign country for rendering the advisory and authentication services.
Confirming bank:
Though the advising bank may advise the authenticity of the credit to the beneficiary, the later may
desire too have an additional confirmation from a bank in his own country which provides its own
independent undertaking for making payment in addition to that of the issuing bank. The beneficiary
may stipulate the need for additional confirmation, if he feels that there is a political risk in dealing with
the country in which the issuing bank is situated. Further, this confirmation protects the beneficiary
against failure or defaults of the issuing bank in meeting the promises made in the LC.
Nominated/Negotiating bank:
The issuing bank may nominate another bank in the beneficiary’s country to which the beneficiary
presents its documents and from which it obtains payment of the sum against the LC. An issuing bank,
an advising bank, or another bank, depending on the terms of the documentary credit, may play the role
of a nominated/negotiating bank. In a freely negotiable credit, any bank is a nominated bank.
Reimbursing bank:
The issuing bank of the LC may arrange with another bank which may reimburse the amount under LC to
the bank that has made a payment to the beneficiary. Such banks are known as reimbursing bank.
Types of LC:
There are various types of LC issued by commercial banks. The type of LC required may depend on the
method of payment envisaged under the credit, whether the LC is revocable or otherwise, whether any
middleman is involved in the transaction, or any other terms and conditions. Various types of LCs are as
follows:
Revocable and Irrevocable LC: When LC is issued, it is deemed to be an irrevocable credit, which
can neither be amended nor cancelled without an express agreement of all the parties concerned,
i.e. the applicant, the issuing bank, the confirming bank (if any) and the beneficiary. Further, a
confirmation of an irrevocable LC made by another bank constitutes a definite undertaking to pay in
favour of the beneficiary, in addition to that of the issuing bank, provided that the documents are
presented as stipulated in the LC. The confirmation of an irrevocable LC also helps the process of
verification of the documents in a conclusive manner. This is also a measure to effectively counter
the commercial or country risks emanating from the status of the issuing bank.
On other hand, revocable credit issued by bank may be amended or cancelled by the issuing bank at
any point of time. The amendment/cancellation can be done without giving any prior notice to
beneficiary. In these cases, however, the issuing bank has to reimburse any other bank (whether
advising, confirming, or to a negotiating bank) which has paid or has accepted a liability to pay any
amount in accordance with the terms and conditions of the credit, before the receipt of a notice of
amendment or cancellation of the credit by the issuing bank.
Sight Credit and Acceptance (Usance) Credit: If the LC prescribes the condition of ‘payment at
sight’ the credit is known as Sight Credit. In a sight credit the beneficiary gets the benefit of
immediate payment upon presentation of the proper document laid down as per the terms of LC at
thee paying bank. As per UCPDC provisions banks are allowed a reasonable time to examine the
documents. Such time does not exceed 7 banking days following the day of receipt of the
documents. The paying banks have to take a decision within this time frame whether to accept the
documents and make payments to the beneficiary, or to refuse acceptance of the documents (in
case they are not in accordance with the terms and conditions of the credit)
On the other hand if a beneficiary decides to grant a period of credit to the importer after sight (date
of sighting the documents), the LC stipulating such condition is termed as an Acceptance credit. The
period of credit granted is popularly called Usance. In an acceptance credit the beneficiary draws a
usance draft on the buyer or the issuing bank or the confirming bank largely depending on thee
terms of credit. When the usance draft is presented along with the documents the draft is accepted
instead of making payments at sight. The beneficiary is advised that the amount covered by the draft
will be paid on a prefixed future date, if documents are found to be in conformity with the credit
terms. The usance period or the payment date under an acceptance credit may be after ‘x’ days of
invoice date or date of shipment.
Revolving LC: Sometimes, a buyer may need a specific type of merchandise on a regular basis
and the supply may also be required to be replenished regularly. Besides, buyers may also like to
obtain a better price available on lump sum orders, which effectively means that they may purchase
a higher volume of merchandise than usually required by them in course of business. In such cases,
though the contract may include the entire volume of merchandise, delivery of goods is often made
in installments and at stipulated intervals. Inn such cases, the seller may lay down a condition that a
revolving credit is issued in his favour guaranteeing payment against individual consignments.
The text for such a credit may be different from the usual LC covenants. For example, the text may
read as: “Amount of credit Rs 1 lakh revolving eleven times to maximum Rs 12 lakh”. In this case, as
soon as the first installment of Rs 1 lakh has been utilized and payments made, the credit
automatically becomes valid for the next tranche of Rs 1 lakh until the maximum amount of Rs 12
lakh under the LC is utilized.
Transferable and Back-to-Back LC: Sometimes, an LC is expressly stated as transferable.
Transferable LCs are generally issued in favour of middlemen, where the beneficiary may request the
bank to transfer the credit available in whole or in part to one or more other beneficiary. Such
transfer is permitted provided partial shipments/drawings are not prohibited under the original LC.
In these cases the first beneficiary of the LC (trading house/middlemen) makes available the
documentary credit to the actual producer of goods without making use of his own credit lines.
Many trading houses accept orders to supply /export commodities from different importers. The
trading houses, in their turn, procure the commodities from different manufactures. The trading
houses may have LCs established in their favour that is not transferable or issued in different
currencies. In such cases these trading houses, which act as middlemen between the actual suppliers
and importers, may request their banks to issue LCs in favour of the actual suppliers of the goods on
the strength of the existing LCs already established in favour of the former. These LCs are called Back-
to-Back LCs. Though the first LC issued in favour of the middleman is distinct form the second LC
issued in favour of the actual supplier, both the LCs are parts of the same commercial transaction.
UCPDC
In a LC, there are many parties involved spread over different geographical regions and countries. These
parties function under different legal systems and jurisdiction, and settlement of nay dispute arising out
of any terms and conditions of the LC through normal legal channel may become a very complicated
process, if not impossible. It was against this backdrop that codification and publication of a common set
of rules applicable to documentary credits were done at the behest of the International Chambers of
Commerce. The document is known as Uniform Customs and Practices for Documentary Credit. It has
been revised several times and the latest version is popularly known as UCPDC 500.
There are 49 articles in UCPDC.
Some important points to be remembered while issuing LC:
Issuing banker needs to examine integrity and credit worthiness of the applicant, financial
strength and solvency of the applicant, profitability of the business he engages in, projected
liquidity of business on the due date on payment.
A proper analysis of the cash flow pattern of the customer should be made to ensure that
sufficient funds are available to meet the liability when payment under the credit falls due.
Stocks procured under the LC opened by the bank are not used as security for any other
borrowings of the company.
Banks usually obtain a margin from the applicant against the amount of LC to be issued. In case
of an LC relating to working capital requirements the amount of margins obtained against LC is
on the lines of the margin stipulated against working capital credit requirements. Though a
smaller margin may be stipulated while issuing the LC, there should be a constant monitoring of
the operating account of the borrower, in order to ensure that there is continuous accumulation
of margin leading to a 100% margin build up by the time the bills against LC mature for payment.
This can be done by reducing the drawing power to the extent of the expected margin build up,
or by setting aside the funds from the operating account on a regular basis.
In course of appraisal, it should be ensured that the amount/limit of the LC facility sanctioned is
commensurate with the borrower’s turnover and LC relates to genuine trade/manufacturing
activity of the borrower. The non-fund based limit should be in proportion with fund-based limit
as the danger of devolvement (crystallization of the liability under the LC at the hands of the
issuing bank) of LC on cash credit limit always rules high. It may also happen that the opener and
the beneficiary are sister concern or are otherwise linked. In these cases, there should ordinarily
be no need for LCs. LCs issued in these cases more often serve as a means of ‘kite flying’
between the applicant and the beneficiary.
An issuing bank may grant delivery against acceptance (D/A) facilities only to the applicants of
undoubted standing and where the security available is much more than the value of the LC.
Under normal circumstances, only delivery against payment (D/P) bills should be accepted and
the documents of title to the goods parted with after receipt of the payment.
Issuing banks should not establish LCs against guarantees of other banks or issue guarantees to
other banks for opening LCs on behalf of their clients. However, authorized dealers in foreign
exchange are permitted to accept, at their discretion, guarantees/margin from third parties as
security for opening of LCS for imports in India.
Assessment of LC Limit for Working Capital:
Once the MPBF limit is sanctioned to the customer it is further divided into sub limit as Cash Credit
facility, Working Capital Demand Loan, Packing Credit, LC (foreign and inland), Bank Guarantee and Bill
discounting/purchase/negotiated. This point will be covered in detail in the second part of the report.
We will see here how the limit for LC is worked out. There are always numbers of variables at work which
impact the computation of the LC limit, as a part of the overall working capital credit requirements of an
enterprise. It is therefore difficult to prescribe a standard method to work out the exact amount of LC
limit to be provided to a manufacturing unit. Nevertheless, the following major factors are taken into
account in any quantitative method of assessment of LC limit.
Annual consumption of the material being
purchased
C (Rs Lakh)
Lead time from opening of credit to shipment L (months)
Transit period for goods till it arrives at the
factory
T (months)
Credit (usance) period available U (months)
The sum of L, T and U is called the purchase cycle. We denote the purchase cycle by P (months). The
cycle commences at the point of placement of the order, whereas the final payment is made at the end
of the cycle.
Thus the quantum of LC limit will be:
(P*C)/12.
This represents the cost of the material that will be consumed during one purchase cycle. An actual
example is illustrated in the loan proposal ahead.
Onerous Clauses in LC:
Sometimes the beneficiary or the buyer of the LC, are in a monopolistic position to influence the terms
and conditions of the LC, who may insist on insertion of onerous clauses in the covenants. These clauses
pose multifarious risks for the bank issuing the LC and a close examination of the covenants is necessary
to ensure that these clauses casting onerous responsibilities onto the issuing banks may be avoided to
the extent possible. The following are a few examples of such onerous clauses:
The applicant at his discretion may extend the date of payment by informing the bank in writing.
Interest may be paid at a predetermined rate fixed by the applicant.
Goods are to be sent on Railway’s/carrier’s risk and are not required to be insured against any
risk while in transit.
In case the value of the consignment exceeds the amount of the LC due to increase in the price
of the goods, excise duties or other levies of a statutory or semi statutory nature, full payment
will nevertheless be made by the issuing bank.
Payment under LC shall not be withheld or delayed by reason of non delivery or delay in delivery
of any goods comprised in any transport document or delivery orders or for any claim made by
the opener of the LC relating to such documents or any objection made by him or for any other
reason whatsoever.
Bank guarantee (BG)
Section of the Indian contract act defines a guarantee as: “A contract to perform the promise or
discharge the liability of a third person in case of his default”. Thus, there are 3 parties involved in a
contract of guarantee i.e. the applicant (the client on whose behalf the guarantee is being issued), the
beneficiary (to whom the guarantee is issued) and the guarantor (in case of a bank guarantee, it is the
issuing bank). In case of a bank guarantee, the liability of the issuing bank begins only after the default is
committed by the principal debtor (applicant of the BG) and such default is brought to the notice of the
issuing bank by the beneficiary, thereby demanding the compensation for the consequential loss
suffered by him. The demand made in this manner by the beneficiary is called invocation in banking
language.
Situations where guarantees are issued by banks:
1) Enterprise participating in tenders, auctions etc are generally required to submit the bank
guarantee for a minimum stipulated amount in respect of security deposits/earnest money
deposit etc.
2) It is common practice to provide mobilization advance by the principal to contractors/vendors
executing turnkey projects, or civil projects that may take considerable time for completion.
Mobilization advance may be provided both before the commencement of the project and at
various stages of progress in respect of plant layout design, drawings, construction etc. as a
security against funds provided in advance, the contractors are often required to submit BG.
3) Even after the goods have been supplied in terms of the contract, the buyers may hold a portion
of the supply bills till they are finally satisfied about the quality of the material supplied. The
retained amount is released only after the supplier submits a BG for an equivalent amount.
Situations when BG should not be issued:
The RBI has imposed restrictions in the matter of issuing guarantees by banks in certain situations.
1) RBI explicitly prohibits banks from executing guarantees which promises refund of any types of
loans or deposits (including ICD and loans) by NBFCs.
2) Bank should not issue guarantee to banks/offices outside India for the purpose of grant of loans
or overdrafts abroad. Similarly, guarantees should not be issued by banks in favor of other
financial institutions, other banks or other lending institutions on behalf of their client against
the loan facilities provided by these institutions.
Appraisal of BG requirements of an enterprise:
The purpose of the BG proposed to be issued should be in tune with the usual business of
the client.
An examination of the frequency of issue of such bank guarantees and also whether these
are issued on an adhoc or continuous basis, throws important light on the pattern of
trade/business and also the expected pattern of the cash flow of the customer.
The amount of guarantee should be specified and it should not contain any clause that
imparts variability to the guarantee amount.
The past record of the applicant with regards to invocation of guarantee issued on its behalf
indicates the financial, technical and managerial competency of the client. Also the time
taken to make good the losses and kind of response in case of invocation of BG are
important parameters.
The amount of margin retained and other collateral security offered to the bank against non-
fund based credit exposure has a vital say in the decision making process. A counter
guarantee signed by the applicant in favour of the issuing bank in a standard format is
generally insisted upon while issuing a guarantee. The counter guarantee serves the purpose
of additional security wherein the applicant promises to recompense the bank with the
guaranteed amount and the associated charges, should the guarantee be invoked.
Types of bank guarantee on the basis of nature:
Depending upon the nature of the guarantee issued, BG are classified into two main categories Financial
and Performance guarantees. Though they are different, there is a very thin line of difference between
the two, as invocation of either of the type leads to a monetary/financial liability for the bank.
Financial guarantee: A financial guarantee may be seen as a certificate issued by bank regarding
the financial ability/worth of its client to meet certain financial obligations, making payments
and satisfying the dues etc.
Performance guarantee: In performance guarantee, on the other hand, the issuing bank
provides a guarantee to the beneficiary to make good the monetary loss in the event of non-
performance or short performance of a contract by the client (applicant). Two important factors
should be considered while issuing of performance guarantee, first, issue of such guarantees
should be backed by adequate securities and secondly, guarantee should not call upon the bank
to complete a task, which the client has not been able to do.
Types of BG on the basis of purpose:
Advance payment guarantee: These are issued by banks on behalf of customers who are in the
business of execution of major export orders, implementation of turnkey projects, construction
contracts and major servicing projects etc. which entail high outlay of funds. Such providers of
products/services needs funds in advance from time to time for purchase of RM, making labor
payments etc. such advance payment also form part of the contract entered into by the supplier
and the buyer. The buyer, however, releases the advance payment only after a bank issues an
advance amount, in case the latter fails to complete the contract as agreed.
As precautionary measure it is important to monitor the development of the project through flow
charts submitted by the applicant. A cash budget method of monitoring a contract specific
account is a preferred option for the banks. As a matter of abundant caution banks insert a
clause to the effect that such guarantees will be effective only after receipt of the advance
payment, though the guarantees may actually be issued before the customer receives the
advance payment. Besides, another relevant clause is that the guaranteed amount should be
automatically reduced in proportion to the value of any part delivery or shipment made in
course of the execution of the contract.
4.1.4 Mode of Payment:
Documentary credit/Letter of Credit: Concerned officer is responsible for scrutiny of documents,
making sure that goods to be imported are not in RBI’s and Government of India (GOI) negative
list, checking importer’s license, checking terms and conditions of LC, checking importer’s
account for previous outstanding LC’s to make sure that LC amount is within drawing power,
debiting importer’s account with the amount of LC margin. Once all the documentation work is
done operator enters all the detail of LC in computer through OCDM (outward documentary
credit menu). Concerned officer is then responsible for disposing the LC to either
advising/correspondent bank depending on the terms of LC. Disposal of LC is required to be
done before a specific date as mentioned in LC. Disposal of LC is done through SWIFT. SWIFT is a
software which connects all the banks globally and is very useful for fast and effective
communication. SWIFT enables all the banks to communicate various orders and place different
requests like confirmation of receipt and payment (release) of remittance, transfer of LC etc.
Advance remittance: Advance remittance means payment for goods by importer in part or full
before the exporter has shipped the goods. Some time exporter may be in monopolistic situation
and in a commanding position to define the terms and conditions of transaction and thus
demanding importer for advance payment. Sometime importer has actually visited the exporter
place and is satisfied with exporter, in such cases importer may wish to give advance payment.
The need for bank is necessitated, only for making the transaction legitimate. Here the bills are
outside LC. However the shipment should reach exporters country within six month of advance
remittance. Any delay beyond six month should be brought to the notice of central bank.
Direct drawing of bills/Foreign inward collection bills (FIBC): This is reverse of advance
remittance. Here shipment reaches the importer country but money has not been paid. These
bills are outside LC.
4.2 Export finance:
Export finance is short-term working capital finance allowed to an exporter. Such financial
assistance is provided from Bank of India to its regular corporate clients. Each export transaction
has two parts
Physical exports of commodities and service from India
Repatriation of proceeds into India
Director General of Foreign Trade (DGFT) regulates physical Export of commodities through Exim policy;
Reserve Bank of India monitors repatriation of export proceeds through authorized dealers under
Exchange control Regulations.
Besides, above export transactions are governed by:
EXIM Policy
FEDAI rules
UCPDC
URR
Incoterms
ECGC
Assessment of Export Finance:
The basic principles for assessment of Credit proposals, working capital requirements etc. stipulated for
domestic business apply to foreign business credit limits also.
Assessment of the Client:
Facilities are extended only to bank’s regular constituents. Limits to got sanctioned and sanction terms
are complied with, before extending the facilities. While processing the export, credit facilities in
addition to the usual assessment procedure followed, the following points are considered:
The exporter should hold Import Export code number allotted by DGFT
There are no overdue export finance outstanding either in the pre-shipment credits or in
the post shipment credits either with their earlier banker or with own branches
If exporter is banking with more than one banker, details o overdue position of export
finance should be called for.
Types of export finance:
Packing Credit: Packing Credit means any loan or advance granted or any other credit provided
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 favor or in favor of some
other person, by an overseas buyer or a confirmed and irrevocable order for the export of goods
from India or any other country with evidence of a order for export from India having been
placed on the exporter or some other person, unless lodgment of export order or letter of credit
with the bank has been waived.
Shipping Loan: This a type of Pre shipment finance where the exporter completed the
processing of goods in accordance with the export order or letter of credit and awaiting the
arrival of the steamer or named vessel if any under the letter of credit. To avoid blocking the
funds on account of non-shipment of the goods arrival of the steamer\vessel, the exporter may
need finance from the bank for execution of further export order. Under such circumstances
banks can explore sanctioning of additional\ sub limit facility to overcome the difficulties of
blocking the execution of further export orders. Bank lends the shipping loan under such
circumstances.
Advance against receivables: Government of India releases incentives to exporter of few
specified commodities to make their products completive at the international level. The financial
assistance against cash incentive entitlement can be granted in tow stages of export financing, in
pre shipment stages and post shipment stages, at the pre-shipment stages it can be granted
along with the packing credit advance when cost of the goods sought to export exceeds the
export value.
Export Bills Negotiated: When export documents drawn under letter of credit are presented to
the banker for availing post-shipment finance and when bank grants such finance against such
documents, when it is covered under letter of credit are known as Negotiation of export
documents.
When a bank negotiates, it effectively buys the beneficiary right to receive payment under the
LC. Here issuing bank is at the risk as any irregularity from the side of importer will translate that
the former have to honour the commitment. Whereas the negotiating bank faces the least risk,
it either pays to the client upfront or communicates the negotiation (promise by the issuing
bank) to him. However it should be noted that all the documents should be as per the terms and
conditions of the LC and all the documents should be reached the issuing before the stipulated
date. Bill of lading is with the issuing bank.
Export bills purchased/discounted: These types of advances are originated out of export orders
extended between the buyers and exporters. The export bills representing genuine trade
transaction, strictly drawn in terms of the sale contract/order may be purchased if drawn on
sight basis or discounted of it is drawn on usance basis. Proper limit is sanctioned to the exporter
for purchase or discount of export bills. Since the export is not covered under LC, risks of non
payment may arise, the risk is more pronounced in case of documents under acceptance. In
order to safe guard the interest of the bank and also the exporters, Export Credit Guarantee
Corporation Ltd offers coverage of credit risk through their guarantees to the banker and policies
to the exporters at the post shipment.
Transport document should not show as goods consigned to overseas buyer. It should be either order of
the shipper, endorsed on the reverse of bill of lading or it should be consigned to the order of the foreign
bank with prior arrangements. The exporter should surrender full sets of transport documents.
The principal documents necessary when purchasing/discounting bills are:
drafts, invoices, bills of lading/airway bills/postal receipts, insurance policy of applicable, packing list,
certificate origin or generalized system of preference certificate, transportation document (shipping bill).
These documents should relate to goods identically described and all must be consistent with one
another.
FEMA has prescribed export declaration forms called as exchange declaration forms which includes GR
forms, PP forms, Softex forms and SDF forms. These are to be duly filled and submitted with all the
documents. Banks tends to negotiate/purchase/discount export bills for three reasons partly internal
and partly external. The first is the target achievement; commercial banks need to achieve the export
finance target fixed from time to time by RBI. The second is linked to the availability of a credit guarantee
covered by sole credit insurer ECGC which is a PSU. This cover is available at low cost with maximum risk
coverage. Third reason is they are safer and more productive sourced of income than many other forms
of financing.
Assessment of working capital limits
Working Capital Cycle:
Cash flows in a cycle into, around and out of a business. It is the business's lifeblood and every manager's
primary task is to help keep it flowing and to use the cash flow to generate profits. If a business is
operating profitably, then it should, in theory, generate cash surpluses. If it doesn't generate surpluses,
the business will eventually run out of cash and expire. There are two elements in the business cycle that
absorb cash - Inventory (stocks and work-in-progress) and Receivables (debtors owing you money). The
main sources of cash are Payables (your creditors) and Equity and Loans.
Each component of working capital (namely inventory, receivables and payables) has two
dimensions ...TIME ......... and MONEY. When it comes to managing working capital - TIME IS MONEY. If
you can get money to move faster around the cycle (e.g. collect monies due from debtors more quickly)
or reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will
generate more cash or it will need to borrow less money to fund working capital. As a consequence, you
could reduce the cost of bank interest or you'll have additional free money available to support
additional sales growth or investment. Similarly, if you can negotiate improved terms with suppliers e.g.
get longer credit or an increased credit limit; you effectively create free finance to help fund future sales.
BOI assess the working capital requirements of concerns engaged in trade business and industry by
determining the total working capital requirements of the borrowers. They are broadly bifurcated into
two categories.
1) Borrowers having working capital limits (fund based) up to Rs.5 Crs.
2) Borrowers having more than Rs.5 Crs. working capital limits from the
Working Capital Limits Up to Rs.5 Crs. from the Banking System
1 Turnover Method
i) Bank of India mostly applies this method to all borrowers enjoying fund-based working
capital credit limits up to and inclusive of Rs.5 crores with the Banking System. The
working capital requirements of the borrower may be computed at 25% of the projected
annual turnover of which at least four-fifth (i.e. 20% of the projected annual turnover)
should be provided by the Bank as working capital finance, and balance one-fifth (i.e. 5%
of the projected annual turnover) contributed by the borrower, as margin towards
working capital.
ii) This method has been formulated assuming average production/ business cycle of 3
months. In reality, this cycle could be longer or shorter. The proponent’s working capital
requirements may be discussed on the basis of traditional approach of
production/business cycle and limits may be considered in excess of 20% of the
projected annual turnover wherever warranted due to longer cycle, keeping a minimum
margin of one-fifth of the working capital requirements. On the other hand, in case of
shorter production/ business cycle, working capital limits at 20% of the projected annual
turnover may be sanctioned and actual drawing should be allowed on the basis of
drawing power after excluding unpaid stocks/stocks acquired under D/A L/C.
EXAMPLE:
Rs in Lakhs
1. Projected Turnover 300
2. Working Capital
(25% of the projected Turnover)
75
3. Bank finance for working capital
(20% of Projected Turnover)
OR
(4/5th of Working Capital Requirement)
300*20/100= 60
75*4/5= 60
4. Margin Money for Working Capital
(5% of projected turnover)
OR
(1/5th of Working Capital Requirement)
300*5/100= 15
75*1/5=15
Working Capital Limits More Than Rs.5 Crs. from the Banking System
ii) Level of Holding/MPBF and
iii) Cash Budget Method*(* Also used for certain seasonal activities and construction
industry).
Borrowers enjoying working capital limits (fund-based) above Rs.5 crores from the
banking system may be given the option to choose between the system of lending based on
holding level of inventory and receivables and the Cash Budget System of lending. The decision
to allow the borrower to switch over to Cash Budget System of assessment would rest with the
Bank.
The method of lending on the basis of levels of inventory and receivables (MPBF
method):
This method has been in existence for the past two decades. At present, Banks have the
freedom to determine the level of holding for inventory and receivables for various
industries. Bank continues to accept those levels that are in conformity with the past levels
of holding of the borrower (on the basis of actual for last 2 years), the industry level in
general as may be advised by RBI from time to time and level of activity. Deviations in this
regard may be permitted depending upon merits of each case by the sanctioning authority. In
case of A rated accounts with fund based limits exceeding Rs 5 crores, cash flow statements
should be obtained and scrutinized. Cash Debt Service Coverage Ratio and Cash interest
coverage ratios is also worked out and commented in the proposal.
A detail example on how to arrive at working capital limit using this method has been discussed in the
loan proposal ahead.
Cash Budget System:
Customers enjoying working capital limits in excess of Rs.5 crore may be given option to adopt the Cash
Budgeting Method at the discretion of the Bank. In case such borrowers choose the Cash Budget System
of lending, they have to satisfy the Bank that they have necessary infrastructure in place to submit the
required information periodically in time. The scope of internal Management Information System should
be satisfactory and commensurate with the level of operations. The borrower must have a finance
professional and computerised environment.
Under this method, the peak level cash deficit will be the level of total working capital finance to be
extended to the borrower by the Banking System. The peak level cash deficit will be ascertained from
the Projected Cash Budget Statement submitted by the borrower.
Assessment of the working capital requirements may be done on the basis of the Projected Cash Budget
Statement (Annual) comprising of projected receipts and payments for the next 12 months on account of
-
Business Operations;
Non-business Operations;
Cash flow from capital accounts; and
Sundry items.
Summary of Assessment of Working Capital requirements under Cash Budget System
Rs in lakhs
02 03 04 05
I. Cash flow from business operations -
(a) Receipts -
(b) Payments -
Cash flow from business operation
Net of (a) & (b)
-
II. Cash flow from non business operations -
(c) Receipts -
(d) Payments -
Cash flow from non business operations
Net of (c) & (d)
-
III Cash flow from capital account -
(e) Receipts -
(f) Payments -
Cash flow from capital account
Net of (e) & (f)
-
IV Cash flow from sundry items -
(g) Receipts -
(h) Payments -
Net cash flow on sundry items
Net of (g) & (h)
-
Overall position of cash budget -
Opening Cash Balance
Add: Net Cash Flows
Closing Cash Balance
-
-
-
Classification of current assets and current liabilities in Working Capital Assessment:
The current assets and current liabilities as of past and projected balance sheet dates are analyzed to
arrive at the current ratio and net working capital to evaluate liquidity of the borrowers. Bank classifies
the current assets and current liabilities based on RBI guidelines issued in this regard. However for the
sake of uniformity in approach for arriving at current ratio and assessment of working capital
requirement, the modifications may be made in asset classification for arriving at current ratio:
i. Bills negotiated under L/Cs. As working capital requirements for the same are assessed
separately, receivables under LCs are not included in current assets. Similarly, banks
borrowings under bills purchased/negotiated under LCs are not included under current
liabilities. They are shown as contingent liability as additional information.
ii. Cash margin for LCs and guarantees, cash/term deposit with banks as margin for LC and
guarantees relating to working capital facilities are included as current assets.
iii. Investments: All investments of temporary nature like fixed deposits with banks,
Commercial Papers, CD, Inter Corporate Deposits, Shares and Debentures are treated as
other non-current assets.
iv. ICDs taken: These are treated as short-term borrowings from others under current
liabilities.
v. Term Loan installments: Term Loan installments/DPG installments falling due for
payment during the next 12 months are included under current liabilities.
Certain financial ratios for Working Capital Assessment:
Debt Equity Ratio:
This ratio is calculated by dividing the total liabilities of the company with the tangible net worth of the
company. This ratio reflects the financial soundness and the solvency of the corporate. Lower the ratio
indicates the high degree of solvency and higher the ratio indicates the over extended financial position
of the company.
At present bank treats debt equity ratio of 3:1 as the acceptable norm. Subordinated funds with
undertakings from the borrower to retain the same at the existing level during the currency of Bank’s
finance may be also included as equity to arrive at debt equity ratio. Such sub-ordinate funds however
not to exceed borrower's 1st tier capital i.e. capital plus free reserves less intangible assets. We may
generally accept the following debt equity ratios as the acceptable benchmark. In case of infrastructure
projects and capital goods manufacturer sanctioning authority also permits deviations taking into
considerations the size of the project, total funds, outlay, gestation period, etc. The debt equity ratio is
calculated after bringing into the balance sheet such entries that are sometimes shown as footnote - like
Bills Purchase/Bills Discounted.
Current Ratio:
This ratio indicates the solvency of the company to meet the liabilities, which are due for
payment within the next 12 months from out of the current assets. Though the lending agencies
derive a lot of comfort from this ratio, in reality the ratio may not reflect the true picture about
the solvency of the company as the realisable value of the current assets in the event of the
forced sale cannot be determined as against the current liability which are clearly quantified. It is
not uncommon that even many going concerns having comfortable current ratio will be
struggling to meet the day-to-day commitments due to improper cash management. Like - wise, a
corporate not having comfortable current ratio will be meeting all its maturing obligations
without much delay due to efficient cash management policies pursued. The ratio is calculated
based on the current assets and current liabilities, as on the last date of the accounting year and it
is quite possible that this can be easily managed even on the last date of the Balance Sheet by
any corporate. As the assessment of working capital requirement is done based on the projected
Balance Sheet keeping the audited Balance Sheet as a base, it is desirable for the lending
agencies to relate this ratio with other operating ratios which give qualitative analysis on the cash
management efficiency of the corporate.
At present the acceptable level of current ratio by the bank is minimum 1.33:1 and sanctioning authority
is permitted to approve of certain deviations. Bank continues with same for other than exports and
companies availing deferred Bills Discounting facility, etc. However, current ratio of 1.33:1 may be
treated as a benchmark rather than minimum. The reasons for a ratio lower than or higher CR ratio to
this benchmark is to be examined by the sanctioning authority. The financial management in general and
liquidity management in particular is to be examined if a lower CR is projected. The sanctioning authority
may take a view regarding acceptability of the same or need for the borrower to infuse additional long-
term funds to improve the same.
Further, measures like injection of additional funds and/or ploughing back of profits may be advised to
the borrowers for improving the ratio and borrower also may be advised to desist from declaring
dividend until current ratio improves. The additional funds brought in/internal surpluses retained in the
business should generally be utilized for building up assets that are current in nature. If the borrower
does not improve the current ratio within the stipulated period, the sanctioning authority may consider
obtaining additional tangible security collateral security outside the business depending upon merits of
the case.
Interest Coverage Ratio (PBIT/Interest): -
This ratio will indicate the ability of the corporate to service the interest on the loan taken from
the lenders. If the ratio is increasing, it gives an indication that corporate is generating sufficient
profit to service the interest on the loans borrowed. It will increase the comfort level of the
lenders in taking higher exposure to the corporate.
Net Profit Margin (Net Profit i.e. PBT/Net Sales):
This ratio will indicate the profitability of the corporate in relation to the volume of the sales
achieved. Even though the profit of the corporate in absolute terms may be increasing but in
terms of the percentage to sales it may be shrinking. This ratio will reflect whether the corporate
is able to maintain the profitability in relation to the growth in the sales.
Investment in subsidiary and sister concerns :
Investment in subsidiary and sister concerns beyond a permissible level of 10% should be excluded
from current assets to arrive at the current ratio. Increase in such investment in case of borrowers
having minimum current ratio of more than 1.33:1 may not be treated as diversion of funds.
Investments in subsidiaries/sister concerns in excess of 60% of Tangible Net Worth shall generally
require prior approval of the Bank. The sanctioning authority not below the rank of Zonal Manager
may grant such approvals. However, for proposals falling within the authority of M. Com./Board, the
Executive Director may grant by the Chairman & Managing Director and in his absence such
approval. Further, investments in excess of 10% of the tangible net worth of the borrower /
proponent in associates and subsidiaries may be deducted from the tangible net worth of the
borrower/proponent for computing various ratios connected with net worth.
6.0 Credit rating:
Credit rating helps to integrate all the qualitative and quantitative parameters on which the
company is to be assessed. By doing this exercise at branch level, head office is spared from
getting into the details and intricacies of the loan proposal. They get a holistic view about the
company in numeric terms and thus can take their decision rapidly and effectively. In
addition to this, the credit rating grades represents the risk of the asset. Borrower risk grades
is used as a basis for calculating probability of default which will be an input for capital
charge calculations, under the advanced approaches of Basel II. It is very important that all
eligible borrowers should be rated.
There are Two Credit Rating Models followed at Bank Of India. They are as follows:
6.1 Traditional Model: This model has been discussed in detail in the loan proposal ahead.
6.2 New Credit Rating Model: New Credit Rating Model known as Large Corporate
model is a statistical model (using Multiple Discriminant Analysis) developed using Bank’s own
data with effect from 01.11.2006. It has been developed by ICRA (Indian Credit Rating
Association) for BOI. Rating Exercise for all future new/review proposals is carried out based
on the annual accounts for the last two years i.e., 2003-04 and 2004-05 in addition to 2005-06.
As regards non-financial parameters for the previous years, bank endeavors to complete the
same keeping in mind the situation prevailing during the relevant year.
The above model is applicable to the following categories of borrowers-
All domestic exposures for which the credit limit (Fund based and Non Fund based) is Rs.5 crores
and above or the turnover of the obligor (borrower) is Rs.50 crores or above.
External Commercial Borrowings (ECBs).
Syndicated Loans.
It is a computer-based program for arriving at the rating. The program is in VBA Excel format.
Bank Executives are required only to fill in the Balance Sheet and P&L figures along with non-
financial parameters without undertaking any calculations for ratios, which is done by the
system. The system also generates:
Borrower Risk Grade (based on financial ratios and qualitative parameters) --- to be
used for calculation of PD (probability of default) and migration analysis.
Adjusted Borrower Risk Grade (based on borrower risk grade and monitoring
parameters) ---- to be used for monitoring purposes.
Borrower Pricing Rating (based on certain parameters) to be derived manually from
Pricing Factors as given by the system ----- to be used for fixing the borrower grade for
pricing purpose.
1. Borrower Risk Grade:
The model considers both quantitative [financial] and qualitative parameters.
Three indices (numerical scale for comparing various variables with one another) have been
constructed for three broad qualitative parameters namely
Management Risk Factors-- It contributes 18%
Firm standing—It contributes 8%
Industry Risk—it contributes to 7% to the model's predictive power.
The contributions (coefficient) of the financial parameters and indices have been arrived at using
statistical techniques [multiple regression]. Financial Parameters contribute about 67% of the
predictive ability.
The qualitative parameter indices consist of sub parameters with each of the sub parameters
contributing to the index. To facilitate measurement, subjective parameters have been classified
into 4 tiers from lower to higher, based on increased desirability (denoted by numbers 1 to 4. For
example sub parameter –integrity has four tiers-
Excellent (1),
Good (2),
Marginal (3),
Doubtful (4)
These are then converted into values corresponding to the tier and used in further calculations
along with the coefficient for that sub parameter. The Contribution (coefficient) of the sub
parameter has been arrived at through analytical hierarchical programming (mathematical
techniques) Details of the parameters, sub parameters are as follows:
Quantitative Parameters:
Generic Ratio Parameter Remarks
a) Leverage Tangible Net worth/Total Outside Liabilities [TNW/TOL]
TNW: Equity/Preference Capital +Free Reserves +Profit & Loss Account – Misc. Expenditure[Intangible Assets] + Unsecured loans(Long term unsecured loans from promoters)
b) Liquidity Net Working capital/Total Assets (NWC/TA)
c) Long Term
Profitability
Retained earning/Total Assets
Long Term Profitability
(Measures the extent of financing of total assets through internal accruals. A higher ratio shows a higher level of historical profitability and greater financial resilience in the face of an economic downturn.)
d) Profitability Earnings Before Interest & Tax/Total Assets [EBIT/TA]
e) Efficiency Sales/Total Assets This ratio (commonly known as asset turnover ratio) shows how efficiently the firm uses its assets to generate sales. Higher levels indicate greater efficiency].
Qualitative Parameters:
Parameter
I. Management Risk
A Management Character B. Management Capacitya. Integrity [willingness to pay] a. Key Managerial persons [Promoters and key
persons] competence
b. Diversion of funds b. Key Managerial persons [promoters and key persons] Business experience
c. Business commitment c. Industrial/ employee relations
d. Payment record of group cos. with the bank d. Internal Control
e. Corporate governance e. Business planning
f. Financial strength/Group Support
g. Intra company / group conflicts
C. Management Succession
a. Succession planning
b. Succession preparation
II. Firm StandingIII. Industry Risk
a. Age of the firm a. Industry Phase
b. Reputation with customers and suppliers b. Competition - impact on GP margin
c. Competitive position of the firm c. Regulatory issues/fiscal policy risk
d. Technologyd. Technology dependence
e. Customer quality & concentratione. Environmental concern
f. Supplier Quality and concentration f. Demand supply situation
g. Ability to raise funds [next 12 months]
h. Reputation with Banks/FIs.
i. Business loan history
j. Credit track record
The values of the quantitative and qualitative parameters are combined to arrive at a discriminate
score, which is mapped, to the different risk grades (on the basis of relationship established
through Discriminate analysis)
The model consists of 10 borrower risk grades from LC1 to LC10.
The risk grades represent as under-
LC 1 and LC 2Good quality creditLC 3 & up to LC 5No immediate concernLC
6 Require intensive monitoring LC 7 up to LC 10NPA/could turn NPA over the
medium term
The minimum grade for considering sanction of advance ( including additional limits) to a
borrower other than PSU is LC 5. For PSU the minimum grade for considering sanction is LC 7.
Monitoring the accounts under this model
For existing accounts the account operations will impact the Borrower Risk Grade and the Adjusted
Borrower grade will be arrived at by upgrading/downgrading the Borrower Risk Grade based on the
monitoring parameters. While Borrower Risk Grade will be used for entry level as mentioned above and
for arriving at the Probability of Default, the Adjusted Borrower Grade will be considered for monitoring.
The monitoring factors proposed to be considered for Adjusted Borrower Grade are as under;
1. No. Of days delay in receipt of [a] installment’s [principal/ equated]
[b] Interest.
2. Submission of progress reports/stock statement/MSOD.
3. Compliance with sanctioned/disbursement conditions.
4. Key employee turnover.
5. Comments on operations [conduct of the account]
6. Comments during site visits.
7. Change in accounting period during the last five years.
8. No. of times rescheduling/relief obtained from lending institutions
9. No of times over limit/ad-hoc limit allowed
2. Borrower Pricing Rating
As per best practices borrower risk rating should be distinct from facility rating. Pending developing the
technical capabilities for facility rating, it is proposed to continue with the existing procedure of
translating Borrower Risk Grade into Pricing Risk Grade by factoring in
a) General observations in conduct and ancillary business.
b) Length of satisfactory relationship
c) Share in Non-fund based business.
d) Collateral coverage available for total limits (%)
e) Threat of loss of business due to competition.
f) Rater’s perception about long term benefit to Bank from the borrower/group.
g) Overall image/reputation of the Company/Group.
The maximum marks applicable for the above additional factors are 20. The Borrower Pricing Rating
will be arrived at after factoring in marks allotted for pricing factors in the Borrower Risk Grade/ Adjusted
Borrower Risk Grade as under:
Marks for Pricing Factors Modification in Adjusted Borrower Grade
15-20 Upgrade by one Grade
7-15 Retaining Same Grade
Less than 7 Down grade by one Grade
For e.g.: Adjusted Borrower Grade – LC 6
Marks for Pricing Factors - 6
Borrower Pricing Rating – LC 7
The spreads for fixing rate of interest for the risk grades:
Grade Quality Representation Spread applicable
LC 1 to LC 2 Good quality credit As applicable to existing ‘AAA’ accounts
LC 3 to LC 4 No immediate concern As applicable to existing ‘AA’ rated accounts
LC 5 No immediate concern As applicable to existing ‘A’ rated accounts
LC 6 Require intensive
Monitoring
As applicable to existing ‘A’ rated accounts
LC 7to LC 10 NPA/Could turn NPA over the medium term
As applicable to existing ‘B’ rated accounts
The following guidelines are to be adhered to during the credit rating exercise:
Aggregate of both FB+NFB limits (with aggregate limits of Rs.5 crore and above or Turnover of
borrower is Rs.50 crore or above) to be taken into account for applicability of model. Borrowers
enjoying only NFB will also be covered.
In case of new units, the quantitative parameters (financial ratios) are based on realistic
projections and the qualitative parameters (like management quality, business/industry factors)
are completed and assigned most suitable slot.
All three risk grades i.e. Borrower Risk Grade, Adjusted Borrower Risk Grade and Borrower
Pricing Grade are necessarily be mentioned in the proposal.
All authorities recommending the proposal including the Relationship Managers at various levels
and supervisory staff at controlling offices in their note specifically mention confirmation
(agreement) of the Credit Rating exercise or otherwise.
Credit rating exercise to be undertaken in case of any major event/report/development
etc.
All rating sheets where there is a downward rating (except marginally) say two notches or to
default is commented upon in detail in the covering letter/memo and is exhaustive enough to
come to a decision on further exposure. In addition the previous/current rating is verified and
commented upon (validated) by the concurrent auditor as to the accuracy of the rating exercise
and is be used for the purpose of back testing.
6.3 Comments on Rating
AAA or LC 1 to LC 2: Quality of lending is considered to be high and risk is at its minimal. Probability of
default and perceived loan loss is minimal. Historically, it is recorded that the borrower is maintaining
liquidity and financial strength consistently for the last 3 to 4 years. Business is having enough potential
to service the debt and interest thereon. Management is known for sharing the factual position of
business happenings with Bank and honouring their commitments in time. The interest rate applicable is
Prime Lending Rate Plus one Percent (Plr+1).
AA or LC 3 to LC 4: Well established borrowers with financial liquidity, strength and stability. The
probability of default and risk perception among this group of clients is a little higher than that of AAA
borrowers. They share the business results freely with the Bank and are known to honour their
commitments in a reasonable time. The interest rate applicable is Plr+2%
A or LC 5 to LC 6: This group belongs to the lower end of quality range. Their financial liquidity, financial
strength and stability are relatively weak. Lending to such borrowers is no doubt, sound but for
temporary disruptions. More likely to be affected by fluctuation in business cycles and thereby may look
for intermittent support by way of additional funds etc. They demand for constant monitoring. Interest
rate applicable is Plr+3.35
B or LC 7to LC 10: Borrowers of average liquidity, financial strength and stability. Unless they are with us
for long with satisfactory dealings, it cannot be said that they are risk free.
Interest rate applicable is Plr+3.5
Objective of the Research:
Following are fundamental objectives of the Study:
a. To examine the effectiveness of working capital management practices of the firm.
b. To assess short-term liquidity and solvency of firm.
c. To find out how adequacy or otherwise of working capital affects commercial operations of the company.
d. To prescribe remedial measures to encounter the problems faced by the firm
Research Methodology: The Study under reference is based on secondary data I. e. Annual Reports/ Published Accounts as well as primary data/ information obtained through personal interview and discussions with the concerned executives of the corporate. It has already been mentioned earlier that our period of Study is four years i.e. 2005-2006 and traditional method of data analysis and application of financial statement analysis tools and techniques for examining the degree of efficiency of working capital management has been adopted in systematic order. We show component wise Gross Working Capital Analysis in EXHIBIT I and Working Capital Ratio Analysis in EXHIBIT II.
Limitations of the Research: The study suffers from the following limitations:
a. The management of the firm is very conservative and was found reluctant to provide off balance sheet information.
b. Operating cycle is not found to be uniform and the same was found to be varying from one period to another due to several inherent problems in production and distribution system/delivery system/logistic system prevailing in the organization.
c. Non availability of necessary and relevant data for assessing working capital requirements due to VRS/Retirement of the key personnel’s and there was vacuum and lack of proper interface between the firm and the researcher.
d. Financial analyses are based on historical data and information.
Hypotheses :
The research is based on the following Hypotheses :
a. The firm under study suffers from inadequacy of working capital.
b. There is poor and ineffective working capital management practice in the firm.
c. Non-performing assets dominate and eclipse the working capital finance of the Company.
d. Too much interference and dominance of non-finance professional affects systematic working capital management practice of the firm
Data Analysis and Interpretation:
Component wise Gross Working Capital and Net Working Capital is depicted in EXHIBT I hereunder. It is evident from EXHIBIT I that the firm suffers from acute crisis of working capital through out the period under study. There is negative working capital and short-term liquidity
and solvency of the company is in jeopardy. Current liabilities in totality are more than gross capital and the excess of current liabilities over current assets is negative net working capital. Debtors & receivables and loans represent 60% or more of gross working capital. Percentage of inventory ranges from 22% to 37% of the gross working capital. From this circumstance, we may infer that the firm is badly constrained to smoothly run the day-to-day commercial operation. It may not be out of place to state that the company simply cannot afford to hold 20 to 40% of gross working capital as inventory and 60% or more debtors & receivable and loans & advances when it is having negative working capital. Besides, the firm's cash and bank balance comprises 5 to 11 % of gross working capital and this is not at all a standard practice of a manufacturing firm belonging to the category of heavy engineering industry. Moreover, the liquidity of loans & advances and other current assets is a very doubtful case, as it remains more or less static in the balance sheet through out the entire period of study. Under the prevailing situation, the company should not lock up inventory to the extent of 40% or more of gross working capital and Just- In- Time (JIT) Approach of InventoryManagement is the sole answer to appropriate inventory control for the firm under study
Exhibit I
Component wise Working Capital Analysis (Rs. in Lakh)l.
Components of Current Assets
& Current Liabilities as per
Balance sheet
Rs in Lakes
Current Assets 05-06 06-07 07-08 08-09
Inventory 3,477.0 3,465.0 2,981.0 3,450.0
Debtors & Receivables 3,483.0 3,643.0 3,245.0 3,990.0
Loans & Advances 4,388.0 4,990.0 3,764.0 5,386.0
Cash & Bank Bal 696.0 437.0 1,192.0 1,270.0
Other CA 1,220.0 1,012.0 523.0 1,596.0
Total 13,264.0 13,547.0 11,705.0 15,692.0
Current Liabilities
Trade Creditors 4,418.0 4,947.8 4,464.0 5,191.8
Acceptances 3,534.4 3,958.2 3,571.2 4,153.4
Advance from Customers 2,827.5 3,166.6 2,857.0 3,322.7
Short Term Loans 5,301.6 5,937.3 5,356.8 6,230.1
Interest Accrued but not due 883.6 989.6 892.8 1,038.4
Statutory Dues 706.9 791.6 714.2 830.7
Total 17,672.0 19,791.0 17,856.0 20,767.0
Major portion of current liabilities includes salaries and wages, sundry creditors for raw materials, expenses& others, statutory liabilities towards retired employees, short term loan from holding company, deposits from contractors, advances on- account - billing against WIP and partial delivery of goods, advances against orders etc.Components of provisions include dues towards gratuity payment; leave encashment, cuss & cuss surcharges, contingency provisions etc. It can be observed in the aforementioned table that 24% of current liabilities were unrepresented by current assets in 05-06and the.
However, 24% in 2008-09 but the volume of business has also been drastically reduced during this period. Thus, there is hardly any scope to generate internal resource for working capital from commercial operation of the firm. Simply speaking, there has been a vicious circle like, it cannot generate sales due to lack of working capital and it has no working capital due lack of sales! The overall business prospect is bleak and the company is found to be in the state of financial perplexity without any means to break the aforesaid vicious circle for effective working capital management.
Data Analysis and Interpretation of Working Capital Ratios: Working Capital Ratios in order to examine short-term liquidity and solvency of firm is shown in EXHIBIT II.Note: CR=Current Ratio,QR=Quick Ratio,
CA=Current Assets,
QA= Quick Assets,
CL=Current Liabilities,
WCT= Working Capital Turnover (times),
S=Sales, D = Debtors,
IT=Inventory Turnover (times),
CAT=Current Assets Turnover (times),
DT=Debtors Turnover (times),
ACP=Average Collection Period (days),
WC=Working Capital.Working Capital Ratios show the financial ability of the firm to meet its current liabilities as well as its efficiency in managing currents assets for generation of sales. It needs no mention that cash/bank balance is converted into raw materials, raw materials is converted into work-in progress, work-in-progress into finished goods, finished goods is converted into debtors and receivables through credit sales and finally debtors to cash/bank and this cash to cash phenomenon is technically known as operating cycle and shorter the operating cycle, greater the degree of efficiency in working capital management Now, let us offer our analyses on each item of EXHIBIT II under the forthcoming discussion.
Exhibit II
Working Capital Ratios
Year05-06 06-07 07-08 08-09
CR=CA/CL
0.75:1 0.68:1 0.65:1 0.75:1
QR=QA/CL
0.55:1 0.50:1 0.65:1 0.59:1
WCT=S/WC
-3.74 –2.66 –1.49 –1.61
IT=S/I
4.74 4.80 3.08 2.37
DT=S/D
4.74 4.56 2.83 2.04
CAT=S/CA
1.24 1.23 0.78 0.52
ACP=(D/S)
365DAYS
77Days
80Days
130Days
179Days
Current Ratio: It can be observed in EXHIBIT II that Current Ratio of Heavy Engineering Company Limited varied is 0.76: 1during the period from 2005- 2006 to 2008-2009. It is evident that, on an average, per every one rupee of current liability, the company has been maintaining 0.563 rupee of current assets as a cushion to meet the short-term liabilities. Usually, a Current Ratio of 2:1 is considered to be the standard to indicate sound liquidity position but in the case of the firm under study, it is far below the standard Current Ratio meant for the industry.
Quick Ratio : The Quick Ratio of the firm for the study period ranges in between 0.17: 1 to 0.59:1. Normally, 1:1 is considered to be the standard Quick Ratio. Current Assets minus Inventory are Quick Assets and on an average, it has been maintained at Re. 0.407 for every rupee of quick liabilities. The Current Ratio and Quick Ratio of Heavy Engineering Company Limited reflect that short-term liquidity and solvency is in danger and it of course doubtful how the short-term financial obligation of the firm would be met under such unsound financial position. The combined interpretation of these two ratios reflects that the interest of short-term creditors is not at all protected by inadequate solvency and liquidity of near money assets.
Working Capital Turnover Ratio: Working Capital Turnover Ratio indicates the efficiency of the firm in utilizing the working capital in the business. Working Capital Turnover Ratio has been found to be negative through out the period under study. It varies between -0.43 times and -3.74 times. This ratio signifies that on an average, a rupee of negative working capital fails to generate Rs. 1.80 worth of business/sales of the firm, which is obviously an alarming situation for the management of the firm.Inventory Turnover Ratio: Inventory Turnover Ratio declines from 4.10 times in 2005-06 to 2.37 times in 2008-2009. It indicates that, on an average, a rupee invested in inventory generates Rs. 3.80 worth of sales, which is moderately good. But Inventory Turnover Ratio in 2008-2009 is not at all satisfactory in comparison to the earlier years, However, on overall analysis, it may be opined that inventory management is moderately satisfactory.
Debtors Turnover Ratio : The Debtors Turnover Ratio is highest (4.74 times) in 2005-2006 and lowest (2.04 times) in 2008-2009 and average is 4.234 times. Debtors and Receivables management appears to be satisfactory. However, average Debtors Turnover Ratio should be six times or more during a financial year. Simply speaking, more the number of times debtors' turnover, better the liquidity position of the firm. The combined effect of better management of inventory and debtors & receivables has enabled the firm to generate reported business of the firm.
Current Assets Turnover Ratio:
The Current Assets Turnover Ratio varied between 0.52 times and 1.28 times during the entire period of study. This ratio indicates that, on an average, the firm has generated sales of Rs. 1.07 with the current assets worth Re. 1.00 and this is indeed a very low ratio in comparison to the standard norms of the industry. Moreover, current assets worth Re. 1.00 has been able to generate only Re. 0.78 and Re. 0.52 worth of sales in 2001-2002 and 2002-2003 respectively and this is obviously a frustrating and discouraging picture of inefficient utilization of current assets of the firm in these two years.
Average Collection Period: Finally, the average collection period is 97 days and it indicates that the firm has to wait for 97 days for receiving collection from debtors on account of credit sales. On year-wise analyses, it can be observed that the lowest collection period was 52 days in 1998- 1999 and the worst suffering years are 2001-2002 and 2002-2003 when the collection period is 4.5 months to 6 months and this has badly injured short-term solvency of the firm during these two years under the study period. It indicates that the marketing functionary of the firm is very weak, inactive and ineffective. On the basis of overall analysis, it is therefore pertinent to state that the company has been suffering from acute crises of working capital. Short-term liquidity and solvency of the firm is in alarming position. Interest and financial security of the short-term creditors is at high risk. Utilization of current assets should have been made in much more effective manner. Under the prevailing circumstances, average inventory and debtors turnover should have been in between 6 to 9 times if not 12 times. Current Assets consisting of "Loans & Advances" and "Other Current Assets" are practically "nonperforming assets". Current Assets under these two Heads include escalation, residual and claim for extra work, loans and advances to the subsidiary companies of the firm under study and the subsidiaries of the firm under study have become chronically sick long ago and they are just about to receive order of winding up from the appropriate authority. It can thus be inferred that "Loans & Advances" and "Other Current Assets" have hardly any role to contribute in sales/ business generation of the firm during the period under study. Last but not the least, working capital is the blood and life-giving force to the company and negative working capital cannot save the life of the firm in any way.
Suggestions and Conclusion:
We have studied and analyzed the Balance Sheet of the company for a period of ten years viz. 1993-1994 to 2002-2003 and it has been observed that the company has under its possession huge real estate including land in the most posh locality in Kolkata and industrial belts across the country The firm holds legacy of culture and heritage of more than two hundred years of existence in industrial map of the country and as a consequence, it has built up "Goodwill" to a remarkable extent. It has a modern foundry works. Reduction of huge employment cost and fixed overhead has been achieved through drastic reduction in manpower from 12,000 in 1993- 1994 to 2,000 in 2002-2003 through VRS/Normal retirement and all these steps essentially constitute
valuable strength of the company. Real estate and land is shown in the Balance Sheet at nominal historical cost. Moreover, it has huge idle assets in the form of plant and machineries, material handling equipments and other assets. Thus the company may make revaluation of real estate including land and other assets and make valuation of goodwill and disposal of idle assets and selling off certain percentage of company goodwill can enable the company infuse fresh blood in the form of working capital to run the show. Goodwill of the company may also attract strategic stakeholder/ s in the business and they can join the firm through the process of merger and or corporate restructuring. The company should make trade off between "Make and Buy". The core product/spare-parts etc. can be manufactured with the assistance of in-house infrastructure and stop going for outright buying out/subcontracting so that the work force on the pay roll can be effectively utilized and at the same time, a full-fledged management accounting system should be installed for efficient and effective information generation for management planning and control purpose. During the course of personal interview sessions with the executives of the company, we came to know that a multi-product engineering firm has been functioning year after year without having a sound management accounting system under the control and supervision of a qualified management accountant. The company needs to make SWOT Analysis and frame the business strategy accordingly. During the course of interview and discussion, it has been revealed that there is too much interference of non-finance professionals in day-to-day financial management practices in the organization. It is thus strongly recommended to arrange for periodical workshops/seminars/educational circle on "Finance for Non-Finance Executives" so that they can understand the relevance and importance of financial management by finance professionals only.
Although the condition of the company is not very good there is a silver lining in the form of export order very recently received by the company. This order is expected to double the top line of the company & also contribute handsomely to the bottom-line of the company. However to execute the order company has to undertaken capacity expansion & make an capital investment for which it has taken a bridge loan which shown as a short tem borrowing in the current liabilities. In due course this short liability is going to be converted into long term liability once company finds a project financer. On the basis of the confirm export order the bank has approved the working capital requirement of the company & has decided to keep net working capital to zero i.e. has agreed to finance the entire Working capital gap with zero margin.
Computation of Maximum Permissible Bank Finance
Rs in Lakhs Current Year
Next Year
Current Assets
Inventory 2,981.0 3,450.0
Debtors & Receivables 3,245.0 3,990.0
Loans & Advances 3,764.0 5,386.0
Total (A) 9,990.0 12,826.0
Current Liabilities
Trade Creditors 4,464.0 5,191.8
Advance from Customers 2,857.0 3,322.7
Statutory Dues 714.2 830.7
Total (B) 8,035.2 9,345.2
Working Capital Gap (C=A-B) 1,955 3,481
Less: Margin @ 0% of C (D) 0 0
MBPF (C-D) 1,955 3,481
Break up of MPBF in different facilities:-
Facilities Rs in Lakhs
Fund Based Amount Security Margin Repayment Pricing
WCDL 1,000.0
Primary:-Parri Passu charge on Company's Fixed &
Immovable (land in Calcutta) properties.
Collateral/Secondary:- General Lien of goods covered under BOE
20% BPLR
Cash Credit 450.0
1 year from the date of draw down
Bill Discounting On the due date of bill
Non Fund Based
Inland/Foreign LC
505.0
Primary: - By way hypothecation of goods
under the LC. Collateral/Secondary:- Parri
Passu Charge on company's Fixed Asset.
10% On the due date of LC
Commission:- 1% p.a.
Bank Guarantee
On the due date of BG
Note: Full two way
interchangeability between NFB &
FB limits
Bibliography:
Book References:
1) Credit Appraisal, Risk Analysis and Decision Making by D.D.Mukherjee
2) Documentary Letter of Credit with Export Import finance case studies by R.R.Beedu.
3) Key Management Ratios by Carren Walsh.
4) How to Borrow from Banking and Financial Institutions by Nabhi Publication.
Manuals:
1) Bank of India Credit Policy.
2) Bank of India Credit Monitoring Policy.
Circulars:
1) RBI Master Circular for Exports of Goods and Services.
2) RBI Master Circular for Import of Goods and Services.
3) UCPDC 500 Provisions and Definitions.
Websites:
1) www.rbi.org.in
2) www.iba.org.in
3) www.bankofindia.com
4)www.google.com
![Hudcova 533/78c, 612 00 Brno Czech Republic - · PDF file20 mm Oerlickon [20 x 110] 20 mm Hispano-Suiza [20 x 139] 23 mm NR-23 [23 x 115] 23 mm ZU-23 [23 x 152 B] 23 mm GS [23 x 115]](https://static.fdocuments.in/doc/165x107/5ab3e1b17f8b9a156d8b5ed3/hudcova-53378c-612-00-brno-czech-republic-mm-oerlickon-20-x-110-20-mm-hispano-suiza.jpg)
