Axis Final Report Credit Appraisal

7/28/2019 Axis Final Report Credit Appraisal

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ANALYSIS OF CREDIT APPRAISAL PROCEDURE IN

THE AGRI-BASED SME DIVISION OF AXIS BANK LTD,

ITS TOOLS AND TECHNIQUES EVOLVED AND USED

BY THE BANK

SUBMITTED TO SUBMITTED BY

PROF. L RAMANI RAJAT BANSAL

BIMTECH PGDM-IB (2011-13)

ROLL NO. - 11IB237


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INDUSTRY GUIDE DECLARATION

This is to certify that Mr. RAJAT BANSAL, Roll No. 11IB237 a student of PGDM-IB, Birla

Institute of Management Technology has worked on summer internship project titled

ANALYSIS OF CREDIT APPRASIAL PROCEDUE IN THE AGRI-BASED SME DIVISION

OF AXIS BANK LTD, ITS TOOLS AND TECHNIQUES EVOLVED AND USED BY THE

BANK from 18/04/2011 to 18/06/2011, after trimester-III in partial fulfilment of the requirement

for the programme. This is his original work to the best of my knowledge.

He was a keen student and participated actively in learning the operations and processes involved

at the Bank. His performance was found satisfactory.

Date: June 21, 2012

______________________

Mr. Krishna Mohan

Branch Head,

Axis Bank Ltd, Rudrapur

Axis Bank seal


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LETTER OF TRANSMITTAL

June 21, 2012

Mr. Krishna Mohan

Axis Bank Ltd

Plot no. 20, Avas Vikas Colony

Nainital road, Rudrapur-263153

Uttrakhand

Dear Sir,

Re: Summer Project Report

Attached herewith is a copy of my summer-project report Analysis of Credit Appraisal

Procedure in the agri-based SME division of Axis Bank Ltd, its tolls and techniques

evolved and used by the bank which I am submitting in order to mark the completion of an 8-

week summer project at you organization. This report was prepared by me using the best of

practices and summarizes the work performed on the project and is being submitted in partial

fulfillment of the requirements for award of diploma.

I would like to mention that the overall experience with the organization was very good, and

helped me to know how work is carried out in real practice with the help of your esteemed

organization. I feel honored that I got an opportunity to work with Company Name, a company

of great repute.

I hope I did justice to the project and added some value to the organization.

Suggestions/comments would be appreciated.

Yours truly,

Rajat Bansal


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SUMMER PROJECT CERTIFICATE

This is to certify that Mr. Rajat Bansal, Roll No. 11IB237 a student ofPGDM-IB (Finance)

has worked on a summer project titled Analysis of credit Appraisal Procedure in the agri-

based SME division of the Axis Bank Ltd, its tools and techniques evolved and used by the

bank at Axis Bank Ltd, Rudrapur, after Trimester-III in partial fulfillment of the requirement

for the Post Graduate Diploma in Management program. This is his original work to the best of

my knowledge.

Date: June 22, 2012

BIMTECH SEAL Prof L. Ramani


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LETTER OF AUTHORIZATION

I, Rajat Bansal, a student of Birla Institute of Management Technology (BIMTECH), hereby

declare that I have worked on a project titled Analysis of Credit Appraisal Procedure in the

agri-based SME division of the Axis Bank Ltd, its tools and techniques evolved and used by

the bank during my summer internship at Axis Bank Ltd, in partial fulfillment of the

requirement for the Post Graduate Diploma in Management program.

I guarantee/underwrite my research work to be authentic and original to the best of my

knowledge in all respects of the process carried out during the project tenure.

My learning experience at Axis Bank, under the guidance of Mr. Krishna Mohan, Branch Head,

and L Ramani, Professor (BIMTECH), has been truly enriching.

Date: June 21, 2012

(Rajat Bansal)


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ACKNOWLEDGEMENT

I would like to gratefully acknowledge the contribution of all the people who took active part andprovided valuable support to me during the course of this project. To begin with, I would like to

offer my sincere thanks to Mr. Krishna Mohan, Branch Head, for giving me the opportunity to

do my summer training at Axis Bank ltd. Without his guide, support and valuable suggestions

during the research, the project would not have been accomplished.

My heartfelt gratitude also goes to the entire Agri Retail Credit Cell and Agri Cluster at the

Axis Bank Ltd for their co-operation and willingness to answer all my queries and provide

valuable assistance.

I also sincerely thankProf L Ramani, my faculty mentor at BIMTECH, who provided valuable

suggestions, shared his rich corporate experience and helped me script the exact requisites.

A special thanks to all the staff at Axis Bank who assisted me with my day to day work,

answered my queries and helped to sort out minor problems I encountered. I am grateful to them

for making the hectic and busy work environment a very fruitful and conducive for my learning

and growth.

These two months have been a very fruitful experience providing me with valuable work

experience in a professional banking environment while simultaneously conducting the project.

It would contribute immensely to my academic studies in future and work thereafter.


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TABLE OF CONTENTS

EXECUTIVE SUMMARY..7

INTRODUCTION TO THE COMPANY9

LITERATURE REVIEW.13

RESEARCH METHODOLOGY.15

FUNDAMENTALS OF CREDIT APPRAISAL PROCESS-RISK ANALYSIS...17

CREDIT APPRAISAL PROCEDURE AT AXIS BANK...20

CREDIT APPRAISAL- PRE SANCTION PROCESS22

SANCTION..29

POST SANCTION PROCESS.30

CREDIT INVESTIGATION32

PROPOSAL FEASIBILITY STUDY..35

RATING TOOL FOR SMALL AND MEDIUM ENTERPRISE39

ASSESSMENT OF WORKING CAPITAL42

INTERPRETATION OF FINANCIAL STATEMENTS.45

CIBIL REPORT55

CASE STUDY...57

FINDINGS AND ANALYSIS..78

SUGGESTIONS80

CONCLUSION.....82

REFERENCES..84


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EXECUTIVE SUMMARY

The individual client requirements are subject to large variations, subjective proposalevaluation and comparatively higher credit risk exposure for the banks. The SME credit

sector of the banks is exposed to negotiations with the clients on various terms such as

interest rates, additional benefits such as temporary overdrafts (TODs) etc.

In this project, an attempt is made to understand the complex credit appraisal procedure

followed by the SME division of the Axis bank, the tools used by the bank in analyzing

the viability of any proposal. This was done in various phases.

The first phase starts from the Sales Team. Sales team is involved in the sourcing ofapplication for the proposal. The team goes into the market to find out the suitable

proposals that could be appraised by the credit team and finally sanctioned. Sales team is

responsible to collect the necessary documents required for the purpose of the clients

identification as made mandatory by the central bank also called Know Your Customer

(KYC) norms. These documents are then carefully examined for any forgery or duplicity

and submitted to the credit team. The team prepares the terms and conditions on the loan

being sanctioned to the client and is also responsible for the customer relationship

management.

The second phase starts with the Credit Team. Credit team analyses the client on variousparameters such as financial performance, market performance, experience in the line of

industry, reputation, actual credit requirements, past performance, future projections,

business model, property valuation etc. Credit team plays a major role as it determines

whether the client can be given any loan to meet the working capital requirements or not.

The credit team approves the proposal and verifies the documents. An important source

of information regarding the credit worthiness of the borrower is the CIBIL (Credit

Information Bureau of India Limited) report. This report helps the team to make sure that


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the client is not a defaulter listed with the RBI. The team finally prepares the Appraisal

and the Sanction letter.

The third and the final phase start with the operations team. This team is involved in thedisbursement of the approved sanction limit to the customer. The account is opened in the

name of the firm who has applied for the loan.

Finally, a case study has been done to identify the gaps in the funding process followedby the bank and the recommendations have been made based on the findings from the

case study.


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INTRODUCTION TO THE COMPANY

Axis Bank is the first of the new private banks to have begun operations in 1994, after the

Government of India allowed new private banks to be established. The Bank was promotedjointly by the Administrator of the specified undertaking of the Unit Trust of India (UTI - I), Life

Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC) and

other four PSU insurance companies, i.e. National Insurance Company Ltd., The New India

Assurance Company Ltd, The Oriental Insurance Company Ltd. and United India Insurance

Company Ltd.

The Bank is capitalized to the extent of Rs. 403.63 crores with the public holding at 53.72%. The

Bank's Registered Office is at Ahmedabad and its Central Office is located at Mumbai. The Bank

has a very wide network of more than 896 branches and Extension Counters. The Bank has a

network of over 4055 ATMs (as on 31st December 2009) providing 24 hrs a day banking

convenience to its customers. This is one of the largest ATM networks in the country.

SUUTI shareholding 24.09% - Erstwhile Unit Trust of India was set up as a body corporate

under the UTI Act, 1963, with a view to encourage savings and investment. In December 2002,

the UTI Act, 1963 was repealed with the passage of Unit Trust of India (Transfer of Undertaking

and Repeal) Act, 2002 by the Parliament, paving the way for the bifurcation of UTI into 2

entities, UTI-I and UTI-II with effect from 1st February 2003. In accordance with the Act, the

Undertaking specified as UTI I has been transferred and vested in the Administrator of the

Specified Undertaking of the Unit Trust of India (SUUTI), who manages assured return schemes

along with 6.75% US-64 Bonds, 6.60% ARS Bonds with a Unit Capital of over Rs. 14167.59

crores.

VISION 2015- To be the preferred financial solutions provider excelling in customer delivery

through insight, empowered employees and smart use of technology


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CORE VALUES

Customer Centricity Ethics Transparency Teamwork Ownership

MISSION

Customer service and product innovation tuned to diverse needs of individual andcorporate clientele.

Continuous technology up gradation while maintaining human values. Progressive globalization and achieving international standards.

BUSINESS DIVISIONS

Treasury managementThis department is responsible for the maintenance of the statutory requirements such as

the cash reserve ratio (CRR), statutory liquidity ratio (SLR) and the investing such funds.

It also manages the assets and liabilities of the bank. Primary activities are as follows:

Derivatives Money market operations Foreign exchange operations

Merchant Banking and capital marketsAxis Bank is a registered merchant banker. The services offered are:

Debenture trustees Depository services Private placement Issue management


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Project advisory services, capital market services, advisory on Mergers &Acquisition

Retail financial servicesAll branches have a dedicated financial advisory desk, wherein the mutual fund schemes

are marketed. The objective is to provide customers with a larger portfolio of investment

avenues thereby enhancing customer relationship. Other products handled by the

department include sale of Gold Coins as well as marketing of Depository services.

Corporate and institutional banking Cash management Services Business current Accounts Correspondent Banking Government Business

Retail BankingRetail banking is one of the key departments in the bank. It has the largest variety in its

portfolio which consists of retail asset and retail liability products. Retail banking by

definition implies banking services which are offered to individual customers as opposedto corporate banking which is meant for companies.

International bankingMajor functions include

Handling regulatory issues which include compliance with regulations of variousauthorities such as RBI regulations, FEMA etc

Keeping a track of the business volumes being generated by the branches andcontrolling the margins


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Maintaining relationship with correspondent Banks outside India

AdvancesThe function involves extending fund and non-fund based credit facilities to different

clients in the country, the department aims to maximize the interest spread earned on

funds available with the bank while keeping the risk on the credit portfolio at acceptable

limits. The department also tries to maximize fee-based income from both fund based and

non-fund based activities.

BOARD OF DIRECTORS

Dr. Adarsh Kishore Non-Executive Chairman

Smt. Shikha Sharma Managing Director & CEO

Shri M. M. Agrawal Deputy Managing Director

Shri N.C. Singhal Director

Shri J.R. Varma Director

Dr. R.H. Patil Director

Smt. Rama Bijapurkar Director

Shri R.B.L. Vaish Director

Shri M.V. Subbiah Director

Shri K. N. Prithviraj Director

Shri V. R. Kaundinya Director

Shri S. B. Mathur Director

Smt. Shikha Sharma CEO CEO & Managing Director


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LITERATURE REVIEW

Undertaking a detailed credit analysis of a proposal by a client has been the major area of

concern for many credit analysts as the role is handled by different categories of persons atdifferent banks. Research has shown that this problem arises mainly due to the fact that there is

no data that provides thorough coverage on what to consider while these risks are being

analyzed. Hrishikes Bhattacharya through his book: Banking Strategy Credit Appraisal and

Lending Decisions, 1999, Un iversity of Oxford Press, has tried to provide such material for

credit appraisal, but as a matter of fact he has failed to raise all the important issues that may

arise in due course of time. Different banks have also tried to design manuals that provide

information on these risks but they have been unsuccessful in doing it except simply describing

the risks, and not all the areas under each type of risk. They have also failed to understand

various questions one needs to get answered to obtain the required information.

Another research conducted by Mr. M.V. Subba Rao, B.com, FCA, and MICA on Monitoring

of Advancesa New Look, he has made an attempt to give two views on the commencement

of the process of monitoring the advances lent by the banks:

(i) The Narrow Approachthis approach says that the monitoring starts only after theadvance is disbursed to the customer.

(ii) The Broad Approach - this approach proposes that the monitoring starts at the timeof conducting credit investigation of the borrower and it further continues in all other

stages of the credit appraisal procedure.

In yet another book written by Ernest Aryeetey, Machiko Nissanke: F inancial I ntegration and

Development, theyhave given an insight about the reduction of the credit risk exposure faced by

the banks and loan administration by the lenders, Standards of Credit Analysis, Increasing

Project equity requirements, Screening of Loans by the Banks and assessing creditworthiness of


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the borrower during the screening phase. Banks consider the return on the project as an important

indicator for appraising the projects.

A study was conducted by Mritunjay Kumar Pandey on F inancial Perf ormance Appraisal of

Tata I ron and Steel Company, the paper which was published in the Accounting World,

September 2008, The ICFAI University Press, and his objective of the study was to check the

profitability and efficiency of the firm in the near future. He also tried to establish a brief

summary about the ratios which affect the organizations financial structure and to point out the

relationship between these ratios and the reasons behind the same.

There are various articles on how to undertake an in-depth financial analysis covering the whole

gamut of ratios, financial data and the importance of whole process on the credit appraisal

process. Eric Helbert in his book: Techniques of F inancial Analysis, McGraw Hi ll 11th

Edition, gives a helpful insight on what is important in financial information. He tries to

establish the importance of financial ratios and their usage in the interpretation of the financial

statements of the clients.

A research paper was written by Eleanor Charles Appraising the Role of the Appraiser

which was published on September 3 1995. In his paper, Charles talked about the centralized

function of the appraiser in order to grant loans and advances and eventually every loan applicant

will have to rely on an appraisal to set a value on the property against which the loan is to be

made. Charles says that APPRAISERS, whether independent or hired by a bank or other lender,

are somewhat remote figures compared to the real estate agents, lenders and lawyers involved in

home sales or home equity loans. But virtually every loan applicant will have to rely on an

appraisal to set a value on the property against which the loan is to be made. Despite a fleeting

one-time appearance, the appraiser's function is central to the lender's decision to grant the loan,

deny it or reduce it.


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RESEARCH METHODOLOGY

PROBLEM DEFINITION

Credit risk is defined as the uncertainty in the counterpartys ability to meet its financial

obligations. It is the lenders risk of loss arising from a borrower who doesnt makes payments or

defaults in fulfilling the obligation as promised. As banks are concerned, systematic analysis as

well as management of credit risk arising due to loans made to individual clients and businesses

is critical to their core business operation.

Credit appraisal is the process of assessing the credit-worthiness of the prospective client and

thereby accepting or rejecting the proposals for funding. Whenever any prospective borrower

makes an application to the bank for granting him loan, he has to go through various stages of

the credit appraisal process. Every bank has its own criteria to satisfy itself on the credit-

worthiness of the borrower. The terms and conditions of the proposal such as eligibility of the

borrower and stipulations (limit, interest rate, processing fee, margin etc) for the loan depend

upon the credit worthiness of the borrower.

The efficiency of the credit appraisal process is therefore important for survival in the era of

competition, profitability and sustainability of the banks lending business. For the commercial

business banking, the credit appraisal procedure is complex and unique in nature requiring

customized parameters for each client and involves high level ofjudgement from the banks loan

appraisal managers.

The appraisal process should be highly integrated. Due to its ad-hoc nature, a large number of

gaps and inefficiencies creep into the system especially with regards to the client data used in the

evaluation process. These gaps have to be identified so as to make the appraisal process more

efficient without compromising on the quality. As these gaps are removed, it would greatly

impact the profitability and the sustainability of the banks SME lending decision function.

The project lays an emphasis on the entire credit appraisal procedure followed by the SME

division of the Axis Bank, its tools and techniques followed by the bank.


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The project also highlights the gaps in the appraisal procedure of the bank and the strategies to

mitigate such gaps.

OBJECTIVES:

To study the tools and techniques of the credit appraisal procedure. To identify the gaps in the appraisal procedure. To understand the feasibility of the proposal and the pattern of its funding on

various aspects such as commercial and financial.

To make recommendations after analyzing the gaps in the entire appraisalprocess.

RESEARCH DESIGN: The research design is analytical in nature.

DATA COLLECTION

Primary data: primary data was collected through the informal interaction with theAgri-cluster head and the other team members involved in the credit appraisal procedure.

Secondary data: the source of secondary data is the database at the Axis bank.LIMITATION OF THE STUDY:

As the credit appraisal is one of the crucial areas for any bank, some of the criticalinformation associated with the clients is not revealed.

The study done is only focused on a small area limited to only a few branches of AxisBank in that area, so the results cannot be generalized.

Credit appraisal system includes detailed study for different areas, but due to timeconstraint, analysis was limited to specific areas only.

There was limited interaction with the customers of the bank. Thus the customerrequirements could not be understood.

Time constraint is another limitation of the study. In a limited time period of 7 weeks, itis not easy to understand the complex nature of the entire credit appraisal procedure.


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Whether the operations of the business are labor intensive or capital intensive. The condition of the companys facilities. The impact of technological changes on the business and its performance. Whether the sales and production of the company is seasonal or continuous. Availability of raw material Payment terms offered by the suppliers. Labor relations and unions

2. MANAGEMENT RISKThe management risk of a company refers to the risk associated with personnel who are engaged

in the affairs of the company. The analysis of the management risk should take into consideration

the persons who are able to influence the decision-makers as they are the persons who influencethe entire operations of the company. Moreover, such analysis should also consider the

organizational politics and struggle for power between the key personnel.

The bank must seek information on the borrower to determine the management risk. The source

of such information is quite large. It includes the borrower himself, his neighbors and business

partners, on-site company visits, his relationship with bank, staff and any other person whom the

bank has access to and who knows the borrower properly. It is necessary for the banker to

arrange a meeting with the management so that he can discuss various relevant issues that may

have come up during the information seeking process. This meeting gives a deep insight into the

fiber that the management is made of. One of the most important topics of debate is the integrity

of the management. An honest management will provide authentic financial information and

present the facts as they are on the ground. Sometimes, as a matter of fact, expertise is also

considered to be most important factor to understand the risk associated with the management.

Integrity and expertise are undoubtedly the most critical success factors for the management.

3. ENVIRONMENTAL RISKA business entity is affected by the economic, political, legal and socio-cultural factors in various

ways. Environmental issues which are related to health hazards are now very important, since a


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clients failure to complywith the government regulations may lead to reduction in the clients

solvency ratio which would lead to reduction in the value of security held by its banker. Socio-

cultural factors such as demographics, income distribution, social mobility, lifestyle changes and

normal practices of people also form part of environment, along with health and other factors.

The possible source of information for a banker can be the business magazines, local

newspapers, the borrower himself and other clients.

4. COLLATERAL RISKCollateral is the security offered by the borrower in order to secure loan facility from the bank.

For every facility that a bank grants to its clients, bank has to decide whether it should cover the

exposure or not. Bank must clearly define what kind of collateral is acceptable to the bank as

security, since each collateral security has an element of risk attached to it. The analysis of this

risk is necessary to ensure that the bank adequately evaluates its collateral for each borrower, so

as to realize its dues in case the borrower defaults. If the bank decides to leave an exposure

uncovered without any security, it must sufficiently justify the same, as it is a rule of lending that

facilities should only be granted when cash flows can support its repayment.

5. FINANCIAL RISKOne of the most important aspects of the credit appraisal process is the analysis of the financial

information provided by the borrower in the form of audited balance sheets, profit and loss

statements etc. Such analysis enables the banker to evaluate the financial risk for its client. Other

sources of information on the financial standing of the company are the borrowers accountant,

finance manager or auditor, solvency reports etc.

6. ACCOUNT PERFORMANCE RISKDuring the credit appraisal process, the banker also considers the history of the company and

account performance with the previous banker. With a new client, the bank looks at its existing

account with the previous banker. However, if the accounts of the company are not available, the

bank may look at the management or the shareholders accounts.


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CREDIT APPRAISAL PROCEDURE AT AXIS BANK

Receipt of application from the prospective borrower

Pre-sanction visit by the sales team officers

Proposal Assessment

Preparation of Proposal

Receipt of documents from the applicant

(financial statements, KYC papers, property documents etc)

Preparation of financial data for analysis

(CMA- Credit Monitoring Appraisal)

Valuation reports of the properties to be obtained from empanelled valuers

Title clearance reports of the properties of the borrower to be obtained from empanelled

Advocates

Checking for RBI defaulters list, CIBIL data, Caution list etc


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Sanction of the proposal by appropriate sanctioning authority

Post sanction activities such as review of accounts, renew of accounts, etc (On regular basis)

Final Documentations

Final Disbursement of Loan


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CREDIT APPRAISAL PRE- SANCTION PROCESS

1. APPRAISAL

PRELIMINARY APPRAISAL credit appraisal process starts with the initial analysis of the

proposal submitted by the borrower. The sales team is responsible for sourcing the application

from the prospective clients. As the application is received by the sales team, the next step is to

collect the necessary documents from the borrower as a matter of KYC (Know Your Customer)

norms and other documents such as property papers, audited balance sheets and income

statement etc. The application is then forwarded to the credit team with necessary documents.

Following are the points borne in my mind by the various teams involved in the appraisal

procedure:

Lending policy of the bank RBI List of defaulters Industry exposure RBI guidelines Credit risk rating Profile of the promoters of the company Industry related risk factors Government regulations which have an impact on the industry; e.g. ban on financing of

industries producing harmful gases responsible for ozone layer depletion

If its a case of takeover of account from previous bank then, compliance regardingtransfer of borrowers accounts.

Status of the borrower vis-a-vis other units of the industry. Financial status of the company in broad terms. Bank must attain the MOA and AOA

from the company to understand various internal and external policies of the company

and to make sure whether it is in compliance to the policies of the bank.


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Documents required for the processing of Loan are as follow:a) Application for loan requirementb) Copy of incorporation of businessc) Copy of commencement of businessd) Copy of Memorandum & Article of Associatione) Brief history of company, its customers & supplies, previous track records, orders In

hand.

f) Information on the directors of the companyg) Audited Financial statements of last 3 yearsh) Copy of PAN/TAN number of companyi) Copy of last Electricity bill of companyj) Copy of Excise numberk) Address proof of all the directorsl) Photo I.D. of all the directorsm)Property related papers such as lease or sales deed, Possession

As the above preliminary appraisal of the procedure is done, the bank arrives at a decision

whether to accept the proposal for further sanctioning or not. If the bank finds the proposal

acceptable, it will ask the borrower to submit a detailed application in the prescribed format

along with necessary documents required for the credit assessment of the borrower. The

information, among other things, includes the following aspects:

A list of Board of Directors mentioning their qualifications and experience. Projection of cost of production, sales and profitability. Current practices followed by the company regarding its products or services such as

those relating to credit sales, bad debts, etc.

Projections of demand and supply based on the overall scenario of the market. Themarket scenario covers geographical spread, demand and supply gap, competition,

marketing arrangement etc.

Projected income statement and balance sheet for the next two years.


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DETAILED APPRAISAL- after the preliminary appraisal of the proposal, the bank then carries

out the detailed appraisal of the proposal. The credit team is responsible for performing various

activities at this stage of the appraisal procedure. Following are the activities carried out by the

credit team analysts:

The credit team examines the viability of the proposal to make sure that the company willbe able to fulfill its loan and interest obligations out of cash accruals from the business.

While appraising a proposal, the critical information furnished by the borrower is verified

and the team also emphasizes on the inter-firm and inter-industry comparisons.

The team carries out the financial analysis on the basis of the companys audited balancesheets and income statement for the last three years.

Besides the financial analysis, the following aspects are also examined by the team: The method of depreciation followed by the company and also whether the

company has changed the method of depreciation in the past and, if so, the reason

therefore.

If the company has revalued any fixed assets in the past and the present status ofthe revaluation reserve, if any created for the purpose.

CIBIL report of the borrower indicating any defaults made previously with anyfinancial institution.

The companys position regarding its tax assessment to understand whetheradequate provisions have been made to fulfill its liabilities related to tax in future.

The purpose of the contingent liabilities. Pending suits by or against the company and their implications on the financial

status of the company (e.g. cases relating to sales tax, vat etc.)

Critical Remarks, if any, made by the statutory auditors on the accounts of thecompany.

Dividend policy followed by the company. A detailed analysis of the financial ratios of the company. Production capacity in the past and projected.


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Estimated requirement of working capital finance with reference to makeup ofinventory, receivables and other current assets.

Compliance with lending policy and other necessary guidelines of the bank.

If the bank requires to make an inter-firm comparison and other information. The datacan be sourced from directory published by the stock exchange, financial journals,

documents etc. Emphasis is laid on following aspects:

Financial ratios analysis Efficiency of the production facility and costs involved Perceptions regarding the capital markets

Comparison of the units on the basis of market share Pattern of financing the company Level of inventory and receivables Utilization of the current capacity Pattern of bank borrowings Market price of the product Share price of the stock showing 52 week high and low price

Yield percentage (half yearly or yearly basis) Price-Earnings Ratio

After the above appraisal, the sales team goes for a pre-sanction visit to the manufacturing

concern. The team members have the main objective of ensuring a higher degree of commitment

from the promoters as the portion of equity which the promoters, their family members and

friends propose to bring in should be brought as soon as possible. However, bank may give

relaxation to the borrowers in this regard for genuine and acceptable reasons, but with acondition that the promoter should make sure that he has an acceptable plan to meet his

contribution.


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Risk rating based on credit profile: rating of the applicant is done so as to understand the credit

risk exposure of the applicant. Rating is done on various parameters such as financial

perspective, managerial perspective, industry outlook etc.

Existing charges on assets of the company: if the company has any charge on the assets with

the previous banker, the report on such charge should be provided to the bank. Bank must ask for

the report from the customer to understand the type of charge created.

Facility structure and the terms of sanction:

The general terms and conditions for the proposals are as follows:

Limit for each facility Temporary overdrafts facility granted and interest rate on it Security - Primary & Secondary Guarantee, if applicable Marginsas applicable for each facility Interest rate on the facility granted Commission rate and other fees Concessional facilities and value thereof Terms of repayment

Review of the proposal:

A detailed review of the proposal is then done in order to ensure that no important thing related

to the assessment of the borrower has been missed out by the teams involved in the appraisal

process. Review of the proposal is done which covers the following aspects:

Strengths and weaknesses of the proposal. Various risk factors associated with the proposal and steps to ensure their mitigation. Deviations seen from the general guidelines of the lending policy of the bank and the

reasons for the same are mentioned mentioned.


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Proposal for sanction:

A detailed proposal for the final sanction to the borrower is prepared with all the necessary

information on it. The proposal contains the recommendations for sanctioning the limit to the

borrower company.

2. ASSESSMENT:

As the credit team carries out the credit appraisal process, after the detailed appraisal of the

borrower firm on various aspects, the next step is to make a comprehensive assessment of the

proposal which involves review of the financial and managerial details of the borrower.

Following are the major highlights of the assessment process:

Review of the draft proposal together with notes kept for reference, the borrowersapplication, financial statements and other reports as examined by the credit team

member.

Pre sanction visit to the company is made to see the actual operations of the company. Review of the financial statement analysis is done in order to make sure that they comply

with the policy of the bank for lending purposes.

Following critical aspects of the exposure are also verified: Lending policy of the bank List of defaulters as published by the RBI Profile of the management of the company If there are any deviations in the proposal from the banks policy, then the

justifications have to be provided by the credit team members.

Industry exposure Guidelines prescribed by the RBI Rating of the borrower based on credit risk profile Risk factors related to the industry outlook


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Government regulations which have an impact on the industry; e.g. ban onfinancing of industries producing harmful gases responsible for ozone layer

depletion

If its a case of takeover of account from previous bank then, complianceregarding transfer of borrower accounts.

Current status of the borrower as compared to other units of the industry. If any modifications are required by the appraisal team to be made, such

modifications should be provided with the sanction letter and justifications for the

same have be made.

Risk factors associated with the proposal and necessary steps taken to mitigatethose risks.

The appraiser then draws up the final proposal with the terms and conditionsattached with the proposal.

Recommendation for sanction: The terms and conditions of the appraisal arethen recaptured briefly to state the economic feasibility of the proposal. The

appraisal team then understands the value of the companys affairs and the

operations. Finally the recommendations are granted for the requisite fund-based

or non-fund based credit facilities.


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SANCTION

As the credit team appraises the borrower on various aspects such as financial and managerial

perspectives by analyzing the data provided by the borrower company, if the proposal if found

worth funding, the concerned sanctioning authority approves the proposal for final funding

process. The sanctioning process involves the provision of the funds to the borrower. The

account in the name of the client company is then opened by the operations team and funds are

made available to the client. The sanction process involves the following aspects:

Cross verification of the proposal is done to check whether the proposal is presented inthe detailed manner as required by the bank. However, if any important information has

not been provided by the borrower to the bank such as any necessary document regarding

the property of the borrower, the proposal is given back to the credit team for the supply

of the required information. The appraisal team examines the following aspects of the

proposal by keeping in mind the bank lending policies:

Lending policy of the bank List of defaulters as published by the RBI If there are any deviations in the proposal from the banks policy, then the

justifications have to be provided by the credit team members.

Industry exposure Guidelines prescribed by the RBI Rating of the borrower based on credit risk profile Level of projected operations of the firm Critical risk factors and the steps taken to mitigate those risks. Value of the security given by the borrower as collateral to secure the risk of default of

the borrower.


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POST SANCTION CREDIT PROCESS

NEED

Lending decisions are made by the bank on the basis critical appraisal and analyzing the credit

worthiness of the borrower. However as a matter of fact, the credit appraisal team also knows

that past performance is not the guarantee of the future performance. However, the past records

provide a critical insight to understand the performance trend in future. Assessment of the credit

worthiness of a prospective applicant is done on the basis of financial and industrial outlook and

also the promises made by the applicant. One should keep in mind that a loan granted may turn

to a bad asset as the borrower did not carry his obligations as promised by him. Hence, it is

essential that a proper follow-up and supervision is done by the lending bank on regular basis. A

banker cannot compromise its funds in sufficiency of the security provided by the borrower

against the loan. After the sanction, it is really necessary for every banker to ensure the

following:

a) He has made a proper selection of the borrower.b) Make sure that the borrower complies with the terms and the conditions of the facility

granted.c) Monitor the borrowers performance after the loan has been granted to him.d) Make sure that the funds are utilized properly and are not lying idle in the account of the

borrower.

e) Finally ensure the security of the advances given to the borrower.


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STAGES OF POST SANCTION PROCESS

The post-sanction credit process is classified into three stages i.e. follow-up, supervision and

monitoring, which together enables the bankers for effective credit management and maintaining

high level of asset standards. It is very important on the part of the banker to make sure that the

funds given to the borrower are being effectively utilized by him and that the operations of the

firm are in the interest of both the banker and the company. The objectives of the three stages of

post sanction process are detailed below:

1. FOLLOW-UP- The first stage of the post sanction process is the follow-up of theaccount of the borrower. Follow-up has the following two objectives:

Ensuring the compliance with the terms and conditions of sanction on the regularbasis.

Ensuring performance safety and recoverability of assets.

2. SUPERVISION- After the follow-up, the next step is to supervise and continuousreview of the operations of the borrower and the position of his account. Supervision has

following aspects:

Ensuring effective follow up to maintain asset quality.

Keeping look-out for early warning signals.

3. MONITORING- Monitoring of the accounts after they have been sanctioned is anotherimportant aspect of the credit appraisal post sanction process. Monitoring of the accounts

and the borrowers activities provide the banker critical information on the performance of

the operations of the company and also that whether the account has a probability of

becoming NPA or not. Monitoring has the following aspects:

Ensuring effective supervision. Monitoring customer satisfaction. Ensuring quick response to early warning signals.


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CREDIT INVESTIGATION

INTRODUCTION:

Credit investigation starts from the time bank officials starts getting the lead for the prospective

credit clients. It basically involves collection of data about the client through various mediums.

After collection of data (both financial and non financial data) trying to understand them and

apply the same in credit sanctioning decision. In earlier times the nationalized banks used to have

officers designated as Credit Investigator. The Credit Investigators job was to go into the market

and gather as much information about both existing and the prospective borrowers of the bank

and give his report to the credit analyst. His role was independent of the credit analyst. Now

those special designated officers are not there. The credit officer himself does that job. The

banker gets fully satisfied with the replies received from the client for all the queries raised by

him during the process of sanctioning loan.

Data received about the client are to be investigated by bankers both efficiently and effectively.

Efficient investigation will ensure that time and money is not wasted in the process. Effective

investigation means the collection and interpretation of all the relevant data. Much of the data

that could be collected may not be really needed. Unnecessary data can make the investigation

costly and prohibitive. However, too little data can lead to a poor decision.

Good credit investigation may be said to be an art developed through experience and training.

The investigation aims at understanding the character and nature of the borrower by acquiring

necessary information needed to determine his ability to service the proposed loan. The success

of any credit investigation depends on the relevancy of the data collected, the speed with which it

is acted upon having regard to the needs of the business and the intelligent interpretation of the

data for effective decision making at the operative level.

NEED

The main purpose of credit investigation is to determine the business reputation, credibility and

responsibility of the individuals involved with particular reference to:


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Experience in the line of their activity Dealings with customers trading or dealing with them Management capability Professional reputation with their bankers History of payment record and fulfillment of financial obligations Honesty and integrity Willingness to repay the debt

WORKING OF CREDIT INVESTIGATION

Before commencing the investigation, the credit officer will consider all the information that is

already available to support the loan decision in question. Investigation should thereafter be

conducted to obtain the other necessary information. A checklist is normally prepared before the

actual investigation so that no point is omitted. The information obtained will be thoroughly

checked and also counter checked wherever required. A credit officer has to be very alert all the

time and has to be very diplomatic in his efforts

As said earlier the credit investigation involves study of both financial and non-financial aspects

of the prospective borrower. It includes ascertaining the creditworthiness of the guarantors also.

The credit officer has to consider a number of aspects before sanctioning the loan. The data to be

collected during credit investigation depends on a number of factors, some of which are

mentioned below.

How well the customer is already known to the bank? How much of information was obtained during the initial interview? The size of the proposed loan? The information already available with the bank about the customer The risks that are specifically associated with the case The borrower's financial strength The value and liquidity of the prime and collateral security


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Where to source the information required for credit investigation?

The sources of information available for credit investigation may be broadly classified as

internal and external.

Internal sources are those, which are available within the bank, like the following:

Particulars relating to the account including its past history Its past financial statements and analyses thereof Current or previous borrowings and ratings awarded Summary of past dealings with the borrower Operations in current and borrower accounts Conduct of the account Financial discipline practiced by the borrower in the past Cooperation extended in documentation Balances in other deposit accounts Previously gathered information on the borrower and kept in record.

External sources are those, which may be got from other sources like the following:

References provided by the borrower Meetings with the borrower Circulars issued by the IBA/FEDAI Information obtained from other banks and institutions Reports of credit rating agencies like CRISIL, ICRA etc. Credit investigating entities like Dun and Bradstreet References with Government bodies and organizations Search in the office of Registrar of Companies

Meetings with customers of the borrower and third parties Information from present and past employees of the borrower Informal and social get together Websites of RBI, Various Trade Councils etc.


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PROPOSAL FEASIBILITY STUDY

When the bank receives any proposal for funding, it analyses the proposal on various aspects to

understand its feasibility. Feasibility of the proposal is necessary for the banks as profitability

depends upon the sound appraisal of the project.

1. Financial Analysisfinancial analysis is the most important part of the credit appraisal process.The borrower has to provide audited financial statements to the banks for the previous three

years and also the future projections. The firm is then evaluated on several financial parameters

like current ratio, profitability ratio, TOL/TNW ratio, debtors turnover ratio, creditors turnover

ratio, projections regarding future cash flows, projected balance sheets etc. The bank accepts a

project for funding only when the various ratios and parameters fall within the acceptable range

and an increasing sales and profit trend is forecasted thereby

2. Technical AnalysisBesides the financial analysis, the proposal is also evaluated on the basisof technology, the kind of plant and machinery used by the company, location of the site, the

production capacity of the plant, manufacturing process used (whether the process is a

conventional process or a new technology is being used), the viability of the technology (whetherit is going to be obsolete in a near future or not), if a foreign technology is being used, whether it

is adapted to be consumed by local people and generate enough sales etc.

3. Managerial Analysis Another parameter of the proposal feasibility analysis is the managerialanalysis. A detailed managerial analysis is undertaken for the reason that a firm may be

financially and technically sound, but it may face problems if not run efficiently by the

promoters. Therefore, critical evaluation of management is an essential part of appraisalprocedure. Appraisal of the promoters is done on the basis of past financial statement, credit

record, qualities of the management, the management problems faced by the firm with the bank


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and also by personally visiting the firm and talking to the debtors and employees of the

entrepreneur etc.

4. Commercial Analysis Sometimes a borrower comes to the bank with a proposal for lendinghim funds for such a product which is not easy to market. In order to have a proper appraisal of

the demand forecast made by borrowers, the lending institutions require following information

regarding demand, supply, distribution, pricing & external forces:

Appraisal of the Borrower: Apart from appraising the project on financial, commercial,

managerial and industrial aspects, the borrower is appraised on several other aspects.Points to be

kept in mind while appraising the borrowings are as follows:

1. Character (of the borrower) - A good character can be the greatest asset for a borrowerwhich can enable him to secure loans from the banks as his market reputation would be

sound. It is a critical ingredient that determines the granting of credit. Men with bad

character history cannot be trusted. The assessment of an individuals character is done

on the following basis:

Educational background of the borrower Health conditions, hard work capacity, energy General reputation among social & business circles, acquaintances, associates,

employees and creditors.

Previous business records. Behavior and dealing with bank and others.

2. Capacity: The credit appraisal team must ascertain the capacity of the borrower i.e. hisability and experience to run the business in a profitable manner. The earning capacity of

the borrower will depend on the efficient managerial capabilities and is the guiding factor

for determining whether the bank should lend or not. Other guiding factors are as

following:

The experience to run the business in a profitable manner.


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Past business results & income Technical expertise of the borrower. Defaults if any made previously.

3. Capital: The capital or financial strength of the borrower as measured by equity or networth of the business should be enquired into to assess the borrowers credit worthiness

and ability to pay. In case of a new business, the sources of required capital contribution

must be easily identifiable. The borrower must not have utilized short term sources to

finance long term usage for the company.

4. Collateral: It should be ensured by the bank that the security made available by theborrower as collateral should be reasonable & its value should be sufficient to cover the

advance. The borrowers title should be valid & transferable. Security is obtained as an

insurance against any unforeseen contingencies. The security so offered by the borrower

cannot turn a bad loan good but it can make a good loan better. Different banks have

different norms as regards the requirement for collateral security. For example Axis bank

requires the customer to offer 120 % of the exposure as collateral in case of overdraft and

100% of the exposure as collateral incase of cash credit.

5. Condition: The borrower should meet all the terms and conditions of the lending bank.For e.g. Axis bank requires the customer to maintain around 50% of the amount of

exposure as capital and unsecured loans ( 25% as capital and rest 25% of the amount as

unsecured loans), to have TOL/TNW ratio not more than 6.

6. Experience -The borrower should have adequate experience in the line of business orshould have employed competent personnel for management of the business.


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7. Purpose - It should be ensured that the purpose of advance is acceptable to the bank &the borrower has the capacity & ability to conduct his business affairs in a successful

manner& that he can be trusted for not misusing the facilities & divert the funds available

in the business.

8. Quantum of Advance: The amount of advance asked by the borrower needs to becarefully assessed to ensure the following:

The amount of finance together with other resources made available to thebusiness is reasonable.

The amount of finance granted by the bank is need based & as per the actualrequirements of the business.

Adequate cushion is provided to meet the unforeseen contingencies on account ofa possible escalation in the cost.


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RATING TOOL FOR SMALL AND MEDIUM ENTERPRISES

Axis bank has developed SME rating tool for assigning a credit rating to borrower firm. The

objective of this rating tool is to provide a standardized system for evaluating the credit risk of

different categories of the borrowers. However one should bear in mind that this credit rating

tool is not the only exercise for the purpose of sanctioning loan to the SME borrower. It is

accompanied with other important tools in the appraisal process.

Various parameters under of SME manufacturing tool are as under:

i) Financial performanceSr. No. Sub parameters Weightage (%)

F1 Net Sales Growth Rate (%) 10

F2 PBDIT Growth Rate (%) 7

F3 PBDIT/Sales (%) 10

F6 TOL/TNW 10

F7 Current Ratio 10

F8 Operating Cash Flow 8

F9 DSCR 8

F10** Foreign exchange risk 10

F11 Expected values of D/E, if 50% of NFB credit

devolves (corrected for margin)

5

F12 Realization of Debtors 12

F13* State of export country economy 5

F14* Fund repatriation risk 5

TOTAL 100

** Applicable for export units

*Applicable for units having imports and or exports


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ii) Operating performance of businessSr. No. Sub parameters Weightage (%)

B1 Credit period allowed 10

B2 Credit Period Availed 10

B3 Working Capital Cycle 20

B4 Tax incentives 10

B5 Production Related Risk 10

B6 Product Related Risks 10

B7 Price Related Risk 10

B8 Client Risk 10

B9 Fixed Asset Turnover 10

TOTAL 100

iii) Quality of managementSr. No. Sub parameters Weightage (%)

M1 HR policy/track record of industrial unrest 15

M2 Track Record in Default of Statutory Dues 16

M3 Market Report of Management reputation 15

M4 History of FERA violation/ED enquiry 8

M5 Too Optimistic Projections of Sales and Other

Financials

16

M6 Technical & Managerial Expertise 15

M7 Capability to raise money 15

TOTAL 100


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RATING SCALES

The rating tool for the Small and Medium Enterprise has an 8-point rating scale, which ranges

from SME 1 to SME 8 as shown below:

Borrower Rating Range of Scores Risk Level

SME 1 Above 85 Lowest risk

SME 2 76-85 Lower risk

SME 3 66-75 Low risk

SME 4 56-65 Moderate risk

SME 5 46-55 High risk

SME 6 36-45 High risk

SME 7 26-35 Higher risk

SME 8 Below 26 Highest risk


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ASSESSMENT OF WORKING CAPITAL

BACKGROUND

A borrower requires working capital funds mainly to carry current assets required for itsoperations. The working capital funds can be illustrated as given below:

Proper assessment of funds required for working capital is critical, as inadequate levels may

result in under-utilization of capacity and financial distress. Similarly excessive levels may lead

to unproductive use of credit. With a view to have a proper assessment of working capital

requirements, the concept of Maximum Permissible Bank Finance (MPBF) was introduced in

November, 1975 as part of implementation of the Study Group to frame guidelines for follow-up

of bank credit (Tandon Study Group).

Consistent with the liberalization of the financial environment in the country, greater operational

freedom has been provided to banks for dispensing credit. In April, 1997, RBI decided to

withdraw the prescription with regard to assessment of working capital needs based on the

MPBF concept. Banks are required to lay down a transparent policy and guidelines for credit

dispensation. However, most banks continue to follow the same RBI guidelines based on the

concept of MPBF, to assess working capital requirements of borrowers. The proper assessment

of working capital requirements is described below

NORMS FOR INVENTORY AND RECEIVABLES

The Tandon Study Group had recommended norms for inventory and receivables for 15 major

industries. The norms suggested by the Tandon Study Group are reviewed on regular basis by the

Committee of Direction constituted by RBI. The norms are given for raw materials, stock-in-

process, finished goods and receivables. The norms are flexible and deviations are permitted

under certain circumstances. These norms indicate maximum levels for holding inventory and

receivables in each industry and are not to be taken as entitlements to hold inventory or

receivables up to the prescribed levels.

Inventory and receivables suggested by RBI on regular basis are only broad indicators and banks

are free to decide the policies based on their own experience.


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Fixed Assets

Current Assets

Net Worth +

Term Liabilities

NWC

Other than bank borrowing

Current Liabilities

In the case of industries, where such policies have not been fixed, levels of inventory and

receivables are computed using the process time or lead time, trade practices, past trends etc. It

should be borne in mind that since sundry creditors are taken as source of current assets, it is

necessary to project them correctly, while calculating the need for bank finance for working

capital.

COMPUTATION OF MPBF

Once the estimation of level of current assets required for the operation of the unit is made, the

source of financing it is then decided. A part of the total current assets can be financed by credit

for purchases and other current liabilities. The funds for financing the working capital gap is

bridged from the borrower's owned funds and long term borrowings and partly from borrowings

from the bank.

The Tandon Study Group suggested the following three alternatives for arriving at the MPBF:

First Method of Lending: Finance a maximum of 75% of the working capital gap (totalcurrent assets minus current liabilities other than bank borrowings), with the balance to

be financed from the long-term funds, namely owned funds and term borrowings.

Second Method of Lending: Borrower to provide for a minimum of 25% of total currentassets out of their long term funds i.e. owned funds and term borrowings. Credit for

purchases and other current liabilities will be available to finance a part of the remaining

amount of current assets with banks financing the remaining portion. Thus total current

liabilities inclusive of bank borrowings will not exceed 75% of the current assets.


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Third Method of Lending: Methodology is same as above, but core current assets areexcluded from total current assets. Core current assets are expected to the financed by

long term funds. Under this method, long term funds are required to finance core current

assets and an additional 25% of the remaining current assets. RBI did not accept this

method for implementation. The borrower's contribution from long term funds would be

25% of working capital gap under the First Method of lending and 25% of total current

assets under the second method of lending.

In the first method, where the borrower has to provide for a minimum of 25% of working

capital funds from long term funds, the minimum current ratio is 1:1. The second method,

where the borrower has to contribute a minimum of 25% of total current assets from long

term sources, gives the minimum current ratio as 1.33:1. Banks generally calculate

MPBF using the second method of lending.

Turnover Method- The genesis of the Turnover Method of assessment is based on therecommendations of Nayak Committee for ensuring adequate flow of credit to small

borrowers. Under this method, the working capital requirements are estimated at 25% of

the projected turnover. Of the working capital requirement, banks can finance to the

maximum extent of 20% of the projected turnover and the balance 5% is the Net

Working Capital to be brought in by the borrower as his margin.

Cash Budget Method- Under this method of assessment, cash budgets are submitted bythe borrower for the future period. Bank finance is limited to cash deficit i.e the excess of

payments over receipts. While assessing under this method, the profitability statement,

balance sheet for future period is taken into account to prepare the cash budget. The

operating cycle is also considered for cash flow assessment. The borrower submits cash

flow statement, which provides information for the relevant period, on how cash was

generated and used. Generally this method of assessment is used for seasonal industries

like tea, sugar, construction etc.


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INTERPRETATION OF FINANCIAL STATEMENTS

RATIO ANALYSIS

Ratio analysis has gained wide acceptance as a quantitative technique of financial management

and is used widely by banks and financial institutions all over the world. This tool helps in

assessing the financial health of a unit and is also considered as an important tool for

credit/project appraisal by banks and financial institutions.

This tool helps in measuring the past performance of an organization and helps in projecting

future trends. Analysis and interpretation of various ratios, gives the credit analyst a better

understanding of the financial condition and performance of the firm than what the analyst would

have obtained from the analysis of the financial data alone.

Bankers generally compute and evaluate the following ratios:

I) Liquidity Ratio, II) Solvency Ratio, III) Gearing Ratio, IV) Profitability Ratio, V)

Activity Ratio and VI) Misc Ratio

1. LIQUIDITY RATIOS.The basic objective in computing this ratio is to find out whether the business concern will have

sufficient cash and other resources to meet the liabilities as and when they arise. An organization

is said to have liquidity if it is in a position to meet its current liability out of its current assets.

The two liquidity ratios which are generally computed are (a) Current Ratio and (b) Quick or

Acid test ratio.

(a) Current Ratio (C/R)

This indicates the extent to which the organization can meet its Current Liabilities out of its

Current Assets. It is found out as under.

Current Ratio = Current Assets

Current Liabilities


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Though the ideal current ratio is 2:1, practically a credit officer sees such ideal ratio. As per II

Method of lending minimum current ratio suggested is 1.33. In any case a banker must ensure

that current ratio is at least 1:1

What does a higher current ratio say 3:1 or 4: 1 indicate?

A Comfortable position for short-term lenders.

The firm is having more long term fund than required and is utilizing this excess fund for

holding flabby current assets.

Low Current Liabilities say low Sundry Creditors, Bills payable, short-term advances etc. that

are generally cheap finance available in the market.

The higher current ratio affects profitability of the organization. Composition of various types of

current assets is to be seen while interpreting this ratio.

What does a lower current ratio say less than 1.33:1 or 1 indicate?

The organization liquidity is under strain.

The persistent trend of less than 1 over a period of time is a sure indicator of sickness of the

organization.

The lower current ratio affects the liquidity of the firm. The firm will face problem of meeting its

short-term liabilities.

Composition of various types of current assets and current liabilities should be strictly as per RBI

guidelines while calculating this ratio.

To improve the poor current ratio the banker will always advise the borrower to bring in fresh

long-term funds or by plough back profits.

(b) Quick or Acid test ratio.


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This indicates the extent to which liquid assets are available to meet the current liabilities

(obligations) immediately/quickly. It is found out as under.

Quick Ratio = Quick Assets = Current Assets - Inventory

Current Liabilities

The ideal Quick ratio is 1:1

This ratio should be studied along with Current ratio and not in isolation. A higher C/R but low

Q/R may indicate large stock of inventory. The banker then probes into the reasoning of such

large build up of stocks/inventory to get a satisfactory answer from the borrower.

(c) The liquidity of the organization is also found out by calculating Net Working Capital

(NWC).

Excess of Current Assets over Current Liabilities is known as Net Working Capital.

A positive NWC indicates liquidity and for this reason NWC is also known as Liquid Surplus,

Current Surplus or Working Capital Surplus.

NWC, excess of current assets over current liabilities, is to be funded out of surplus of Long

Term Source of funds after meeting Long Term Uses.

2. SOLVENCY RATIOThe basic objective in computing this ratio is to find out whether the business concern has

sufficient tangible assets to meet its all its liabilities both short term as well as long term. An

organization is said to be solvent if its Tangible Net Worth (TNW) is positive. (TNW = Net

WorthIntangible Assets).

Two important ratios which are computed under this are : 1) Total Outside Liabilities/Equity

(TOL/TNW) and 2) Funded Debt/Equity.

(a)The ratio TOL/TNW is commonly known as debt/equity ratio (DER) and is calculated asunder.


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DER = TOL/TNW.

TOL = includes both short term as well as long-term liabilities of the organization.

Normally the banker accepts if the ratio is 3:1 for SSI units and 2: 1 for large concerns.

(b)Funded Debt/Equity ratio (FDER) is calculated as under.FDER = Long Term Debts

Tangible Net Worth.

This ratio measures the long -term solvency and ability of the organization to meet long-term

liabilities. It excludes current liabilities. Acceptable ratio for the bankers is SSI 2:1 and Large

Corporate - 1.5:1.

3. GEARING/ LEVERAGE RATIOTo understand this ratio, one should know the term Financial Leverage. Utilising outside

borrowing (just like a lever) to increase return on shareholders fund is known as Financial

Leverage. Gearing is another name of Financial Leverage.

A company can arrange its funds either from sources, which carry fixed charge by way of

interest or dividend, or which do not carry such fixed charge. Eg. Term loan, Preference capital,

Debentures etc. are the ones which carry fixed charge under long term funding and Equity

capital, Quasi Capital, other types which are classified as owners fund are the ones which will

not carry fixed charge.

A companys financial structure is said to be highly geared when its interest bearing (fixed

charge bearing) funds are disproportionately high.


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Capital Gearing Ratio: (CGR)

This ratio also known as Financial Leverage Ratio, measures the proportion of fixed charge

bearing Long Term Fund to the Total Long Term Fund arranged by the company. CGR is

calculated as under.

CGR = Fixed Charge Bearing Long Term Fund*

Total Long Term Fund**

* Includes items under liabilities of the balance sheet like Term loan, Debentures, Fixed

Deposits, and Preference Capital etc.

** Includes Net Worth + Term Liabilities.

A high gearing gives boost to rate of return on shareholders fund. But it is also equally risky in

case the unit fails to earn enough profit in future years, as it will be difficult on its part to serve

its fixed charge obligations. Non-Payment of such commitments may result in debt crisis

situations including closure of business. Further such highly geared company cannot borrow

more. Thus the company should be prudent enough to keep its gearing in a prudent limit.

When the company maintains a highly geared capital structure it is said to be Trading In

Equity. In other words trading in equity means having a very thin equity and a high borrowing

capacity with an objective to increase return on net worth.

4. PROFITABILITY RATIOA credit analyst should not be complacent after seeing impressive net profit figure in the

financial statement, as this does not necessarily indicate the business profit of the concern. A

commercially viable concern is one, which achieves the profit at each stage of operation as

detailed below.

It should be able to manufacture goods at least cost and generate reasonable/sufficient profit

known as Gross Profit.


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It should keep operating expenses under control and earn satisfactory profit known as

Operating Profit.

It should earn enough for its Shareholders by earning more profit known as Net Profit after

Tax (NPAT).

Operating profit and Net Profit must be adequate enough to cover:

1) Repayment of long-term debt obligations.

2) Income Tax.

3) Reasonable dividend to share holders.

4) And still leave a surplus, which can be ploughed back for building up reserves and maintain at

least the minimum required net working capital.

The profitability ratios are generally expressed in terms of percentage and the following are the

ratios, which are normally calculated by the bankers.

(a)Gross Profit Ratio = Gross Profit X 100Net Sales

This ratio indicates manufacturing efficiency of the concern. A higher Gross Profit Ratio

indicates efficiency in production.

(b)Operating Profit Ratio = Operating Profit (GP- Opg.Exp.) X 100Net sales

Higher ratio indicates operational efficiency of the concern.

(c)Net Profit Ratio = Net Profit (Profit before tax) X 100Net sales

This ratio measures overall efficiency. Net Profit ratio may go up due to non-business income,

which should be looked into by the credit analyst.


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(d)Return on Net Worth = Net Profit after tax X 100TNW (tangible Net Worth)

This ratio is also known as Shareholders ratio or return on Tangible Net Worth. Investors of the

company will normally be interested in this ratio.

(e)Return On Capital Employed = Profit Before Interest and tax X 100Capital Employed (TNW+TL+CL)

This ratio indicates the overall efficiency of the management in utilizing the total fund available

for running the business. It is very suitable ratio for inter firm comparison.

This ratio can be improved by increasing sales turnover or the selling price or both.

5. ACTIVITY RATIOS

This ratio is calculated to find out the efficiency of operation. Some of the important ratios,

which are calculated by the bankers, are as follows.

(a)Inventory Turnover Ratio = Cost of Sales/Cost of the Goods sold.Average Inventory*

* = Opening Stock of Inventory + Closing stock of Inventory

(For approximate calculation closing stock of inventory may be taken in place of average

inventory. Similarly Net Sales may be taken in place of Cost of sales. )

This ratio indicates the number of times the inventory is rotated (turned over) during the relevant

accounting year.

Higher ratio (turn over) compared to past year or compared to that of units in same industry

indicates better management of inventory/working capital.


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Lower ratio (turn over) must be viewed with concern as it may be due to depressed sales or some

of the stocks may be non saleable/non- moving/slow moving.

If it is due to excess (flabby) inventory, it may be due to over finance, which requires further

analysis. In case it is due to slow moving/non-moving /non-saleable inventory, there is problem

of lack of demand which should be studied in detail by the analyst.

(b)Debtors Turnover Ratio/ Debtors Velocity Ratio.This ratio is also known as Average Collection Period or Period of credit given by the borrower

and is calculated as under.

Average Outstanding of Receivables*

Credit Sales per day**

* Includes Sundry Debtors, Bills Receivables and Bills Discounted.

** Is calculated by dividing total credit sales during the year by 365 days.

The period so calculated represents the average time lags in days/weeks/months between sales

(in credit) and its realization in cash.

This ratio is studied by comparing it with the past years and also of similar units in the industry.

Lower the period, quicker is the realization of cash and better efficiency.

Higher period indicates inefficiency in the receivable s management. It results in expansion of

operating cycle and accordingly requirement of working capital goes up.

A prudent banker probes further in such cases and ensures that bad and doubtful receivables if

any are not financed, since continuance of such trend will lead to the concern facing liquidity

problems and erosion of profits.

(c)Creditors Turnover Ratio/ Creditors Velocity Ratio.


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This ratio is also known as Average Payment Period or Period of credit enjoyed by the borrower

and is calculated as under.

Average Outstanding of Payables*

Credit Purchases per day**

* Includes Sundry Creditors, Bills Payables.

** Is calculated by dividing total credit purchases during the year by 365 days.

This ratio can also be expressed in weeks or months by replacing 365 days by 52 weeks or 12

months. The period so calculated represents the average time lags in days/weeks/months between

purchases (in credit) and its payment in cash i.e. the period of credit enjoyed by the concern.

Sundry-creditors are a cheap source of fund and should be availed by the concern to the extent

possible as it reduces the dependence on Banks working capital finance which has a higher cost.

The concern is facing a liquidity crunch (cash shortage) and is unable to honor its commitments

in time. It may be due to diversion of fund, non-realization of debtors or reduction in sales each

being danger signal. Delayed payments not only spoil the creditworthiness of the concern, it also

costs by way of payment of penal interest & scarcity in supply of raw materials.

6. MISC.RATIO

Besides the above-mentioned ratios, a banker also calculates another important ratio known as

Debt Service Coverage Ratio (DSCR). This ratio is normally calculated on term loan assessment

and is based on the projected financial statement submitted by the borrower. This is calculated to

ascertain the repaying capacity of the concern.

The ratio is calculated as under.* Net Profit after tax + Depreciation + Interest on Term loan

Installments on term loan + Interest on Term Loan


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* Before appropriation of dividends.

If there are any existing obligations like installments of term loans/DPG/Lease rentals, such

amounts should also be added up with installments of proposed term loan while calculating the

ratio. The DSCR will have to be calculated on a yearly basis from the year of commercial

production to the last year of proposed repayment.

The ratio helps to fix the holiday period, repayment period and the amount of each installment.

Where the DSCR is low, repayment can be extended and where it is high, the repayment period

can be reduced.

The ideal ratio is 2:1. Normally average ratio of 2:1 and in each year not below 1.5:1 is

acceptable ratio for any banker.

SUMMARY

1) All the ratios within the group are linked to each other and must be studied together.

2) Meaningful interpretation is possible only when ratios are computed for a period of 3 to 5

years and compared.

3) The ratios are to be used for further investigation rather than to make final judgments. The

findings based on the ratio analysis have to be studied along with other findings like Fund flow

analysis, other financial data like notes to balance sheet, Directors Report, Auditors report and

non-financial data having a bearing on financial events.


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CIBIL REPORT

Credit Investigation Bureau of India Limited is Indias first and the only fully operational creditinformation bureau. CIBIL is one of the largest repositories of information, which contains the

credit history of commercial and individual borrowers. Banks and other financial institutions

require credit history of these categories of borrowers in order to make sure that the borrower

will not default in the loan repayment. CIBIL provides this information to its members in the

form of reports. CIBIL report is a critical source of understanding the credit worthiness of the

borrower. The report shows whether a person has defaulted in fulfilling his financial obligations

with any financial institution previously.

CIBIL is one of the 4 credit bureaus that have been licensed by the RBI under the Credit

Information Companies Regulations Act, 2005 (CICRA). CIBIL is the only bureau that has been

operational for a long time and has the credit repayment history of around 14 crores loans and

credit cards. CIBIL has provided the banks and financial institutions with the important credit

information of the individual borrowers and also companies.

CIBILs equity share is held by State Bank of India, Housing Development Finance Corporation

Limited, Dun & Bradstreet Information Services India Private Limited and Trans Union

International Inc. The shareholding pattern is in the proportion of 40:40:10:10 respectively.

Recently, there has been a change in the shareholding pattern, including various categories of

Credit Grantors. The distribution is as shown in the chart below:
http://www.equitipz.com/2009/12/should-i-prepay-my-loan-or-invest-that-money.htmlhttp://www.equitipz.com/category/credit-cardshttp://www.equitipz.com/category/credit-cardshttp://www.equitipz.com/2009/12/should-i-prepay-my-loan-or-invest-that-money.html


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All the Banks, Financial Institutions, State Financial Corporations, Non-Banking Financial

Companies, Housing Finance Companies and Credit Card Companies are the Members of

CIBIL. These members are responsible for providing the information about the individuals

credit history with them which can later be used by the other institution while taking decisions to

lend money to that individual or not.

A Credit Information Report (CIR) contains a record of a borrowers credit payment history. The

report is formulated using the information provided by different lending institutions such as

banks, NBFCs etc which are the members of the bureau. It contains all the necessary

information about a borrowers transaction in the past. Its only purpose is to help these credit

institutions to make informed lending decisions. Gradually, all the lending agencies have started

using the CIBIL Database before they lend money to any individual person or company.
http://www.equitipz.com/wp-content/uploads/2010/04/CIBIL-share-holders-distriution.png


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CASE STUDY

A. Client DetailsName M/s ABC

Address RO: Vill. Dhoulpur, Tehsil- Gadarpur, Distt. U.S.Nagar

Distance from Branch 8 Km from Rudrapur Branch (servicing branch)

Constitution Partnership firm Date of Incorporation 01/04/2003

Listed / Unlisted Unlisted IRAC Status Standard (Takeover)

Group NA CIBIL Score Neelam Kaur -1

Harnam Singh -1

Remarks on CIBIL of the firm The firm/partners do not appear in CIBIL defaulters list.

Internal Rating AB1-NSExternal

NA

Industry Pre & Post-harvest activities for cultivation, processing and marketing of Wheat,

Paddy & other crop seeds.

Existing Exposure Presently, the firm is enjoying CLWF facility of Rs. 100.0 Lacs from Rudrapur

Branch. Account conduct is satisfactory.

Dealings with Bank Brief Details of dealings of M/s ABC & M/s XYZ Seeds (An Associate concern)

with our bank are as follows:

Name of the Firm Present Exposure Remarks

ABC

CLWF Facility of

Rs.100.00 lacs

M/s ABC is associated with us since May 2011. Account

conduct is satisfactory.

Credit Summation: Rs.120.80 lacs and Debit Summation:

Rs.154.29 lacs (from 11.05.2011 to 10.03.2012). O/s as on

10.03.2012 is Rs. 33.50 lacs.

XYZ Seeds

(An Associate concern)

CC facility of Rs.

20.00 lacs

M/s XYZ Seeds is associated with us since Nov. 2011.

Loan has been disbursed recently in Nov.2011 and account

conduct is satisfactory.

O/s as on 16.03.2012 is Rs.19.91 lacs.

Term Loan of Rs.

80.00 lacs

Account conduct is satisfactory. Term Loan Installments

are regular.

Last Credit made on 11.02.2012.

O/s as on 16.03.2012 is Rs. 56.46 lacs.


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B. Proposal Details:Proposal 1. Approval of Cash Credit facility of Rs.200.00 lacs.

2. Approval for reduction of interest rate from Base Rate +1.75% i.e.pre

Axis Final Report Credit Appraisal

Documents

Transcript of Axis Final Report Credit Appraisal