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Credit Management

ABOUT THE ORGANIZATION

Established in 1911, Central Bank of India was the first Indian commercial
bank, which was wholly owned and managed by Indians. The establishment
of the Bank was the ultimate realisation of the dream of Sir Sorabji
Pochkhanawala, founder of the Bank. Sir Pherozesha Mehta was the first
Chairman of a truly 'Swadeshi Bank'. In fact, such was the extent of pride felt
by Sir Sorabji Pochkhanawala that he proclaimed Central Bank as the
'property of the nation and the country's asset'. He also added that 'Central
Bank lives on people's faith and regards itself as the people's own bank'.
During the past 92 years of history the Bank has weathered many storms and
faced many challenges. The Bank could successfully transform every threat
into business opportunity and excelled over its peers in the Banking industry.
A number of innovative and unique banking activities have been launched by
Central Bank of India and a brief mention of some of its pioneering services
are as under:
 1921: Introduction to the Home Savings Safe Deposit Scheme to build
saving/thrift habits in all sections of the society.
 1924: An Exclusive Ladies Department to cater to the Bank's women
clientele.
 1926: Safe Deposit Locker facility and Rupee Travellers' Cheques.
 1929: Setting up of the Executor and Trustee Department.
 1932: Deposit Insurance Benefit Scheme.
 1962: Recurring Deposit Scheme.
 Subsequently, even after the nationalisation of the Bank in the year
1969, Central Bank continued to introduce a number of innovative
banking services as under:
 1976: The Merchant Banking Cell was established.
 1980: Centralcard, the credit card of the Bank was introduced.
 1986: 'Plantinum Jubilee Money Back Deposit Scheme' was launched.
 1989: The housing subsidiary Cent Bank Home Finance Ltd. was
started with its headquarters at Bhopal in Madhya Pradesh.

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 1994: Quick Cheque Collection Service (QCC) & Express Service was
set up to enable speedy collection of outstation cheques.
Further in line with the guidelines from Reserve Bank of India as also the
Government of India, Central Bank has been playing an increasingly active
role in promoting the key thrust areas of agriculture, small scale industries as
also medium and large industries. The Bank also introduced a number of Self
Employment Schemes to promote employment among the educated youth.
Among the Public Sector Banks, Central Bank of India can be truly described
as an All India Bank, due to distribution of its large network in 27 out of 28
States as also in 4 out of 7 Union Territories in India. Central Bank of India
holds a very prominent place among the Public Sector Banks on account of its
network of 3126 branches and 286 extension counters at various centres
throughout the length and breadth of the country
In view of its large network of branches as also number of savings and other
innovative services offered, the total customer base of the Bank at over 25
million account holders is one of the largest in the banking industry.
Customers' confidence in Central Bank of India's wide ranging services can
very well be judged from the list of major corporate clients such as ICICI, IDBI,
UTI, LIC, HDFC as also almost all major corporate houses in the country.

AHMEDABAD
S.M.Road branch is a 27 years old branch. It presently has Deposits of 45
Crores and advances of 28 Crores. The senior manager Mr. K.B.Mehta heads
this branch.

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THE ART OF LENDING

Credit decision-making is compared to match making. The idea is that the

lender, while selecting a borrower, should take the same degree of care as is
taken by the parents while finalizing alliance of their daughter. In selecting the
borrower, the banker should not only satisfy himself that the project is viable
but also that the borrower is one who can be entrusted with bank‟s money.
Before entertaining any credit application, the banker should ask the following
questions:

i. Who is the borrower?

ii. What is the project?
iii. How the bank funds are going to be repaid?

If answers to these questions are satisfactory, then only the banker should go
ahead and take decision on the credit application.

WHO IS THE BORROWER?

The most vital part of credit analysis is identifying the right type of borrower. In
case of existing entrepreneurs, banker can formulate his opinion on the
person by referring to his past record. However, in case of first generation
entrepreneur, this information is missing. Experience has shown that an
academically qualified person does not necessarily make a successful
businessman. On the contrary, a person low on qualification but high on
practical experience has a fair chance of succeeding in his business activity. It
is necessary to make enquiries with the existing customers to know about the
antecedents of the applicant. Such enquiries should include questions about
the habits of the person, his friend circle, family background etc.

It is advisable to interview the applicant singly, when his consultant is not

around. This will give an opportunity to the banker to find out whether he has
complete idea about the project. If it is found that he requires external

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assistance to provide such information like manufacturing process in general

or sources of finance etc., it would mean that his involvement in the project is
not total. Such an attitude on the part of the promoter is likely to spell
danger to the success of the project.

A banker should be wary of any applicant who is in the habit of dropping

names or citing his contacts with high officials, as he is not confident of the
project getting approved on merits. Many bankers have burnt their fingers by
entertaining applications on extraneous consideration like third party deposit,
contact of the party with bigwigs etc. Decisions taken based on threat of the
party that he will approach another bank too have, at times, proved
disastrous.

Does your interaction with the party give you a feeling that he wants to
become rich overnight? Then it is better to avoid such a customer. A person,
who wants to start in a small way and then builds upon it brick by brick, has a
strong chance of succeeding as against one having grandiose plans. A
promoter that allocates more space for his office and plans to decorate it very
lavishly sends message that he does not know how to run the business. A
person, who has not done his costing exercise but wants to launch himself
because there is some other person minting money in a particular line of
activity, is not the type who can be trusted by a banker.

The applicant is expected to take his banker into confidence and share with
him the strong points as also pitfalls about his business. Where the banker
has reasons to believe that the applicant is holding back critical
information that has vital bearing on the success of project, it is better not
to entertain the credit request.

It is likely that the applicant has promised to submit certain document or do

something by a specific date, but has failed to honor the commitment. He has
also not bothered to inform the bank why he could not comply with the
requirement in time. If in the initial stage itself the applicant is going to behave

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in this manner, you can very well imagine the type of relationship he is going
to have with the bank, once the loan is disbursed.

The applicant is required to contribute margin towards the project out of his
own resources. Quite often a part of the capital is brought in the form of quasi-
equity by way of loan from friends and relatives. It is important to ascertain the
source of capital, who the donors are, and their relationship with the applicant,
terms of repayment etc. to make sure that there will not be sudden demand
for refund of amount as this is going to cause liquidity problem for the
promoter.

A promoter of a small project has to perform several functions, as his finances

do not permit engaging the services of various professionals. Naturally in
order to succeed in his enterprise, he should be the type of person who can
get along with people and having flexible approach.

If the applicant maintains his savings with some other bank but has
approached your bank for finance, you have right to know why he has
preferred your bank to his previous banker for finance. Needless to say a
confidential enquiry should be made with the other bank to ascertain whether
that bank declined the loan request of the applicant.

WHAT IS THE PROJECT?

Not being a technical person, a banker does insist for project report prepared
by a consultant to know about the technical feasibility and financial viability of
the project. Where the project report is prepared by a consultant, who is
dependant on the applicant for his regular source of income, it can be said
that the report has lost its objectivity. Then again it is said that not a single
project so far has failed on paper. The lesson to be drawn from the
experience is that a project report, however well prepared, does not
guarantee success of the project.

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If units manufacturing a particular product are doing well in the area, that
means requisite infrastructure is available and sanctioning of finance to one
more unit will not entail any risk provided there is no oversupply of the
particular product in the market, A project requiring raw material in bulk has a
fair chance of succeeding if it is located near the source of raw material.
Projects with very high break-even point take long to generate surplus and
should be avoided.

Instances are not lacking where the borrowers got the quotations deliberately
inflated with a view to acquire machinery without contributing their share
towards margin money. Likewise second hand machinery was acquired by
making the bank pay the cost of brand new machinery. To put an end to such
malpractices, a banker should make enquiries on telephone with the suppliers
of machinery to know the exact cost. Alternately, the party should be made to
produce quotations from two/three suppliers.

We come across units where the commercial production is held up due to

non-availability of power supply, even though the promoter had submitted no-
objection certificate from Electricity Department. Against this backdrop, it will
be prudent to make discreet enquiries as to whether Electricity Department is
releasing new connections and whether the project to be financed stands a
chance of getting power supply in the immediate future.

With the integration of Indian economy with the global economy, doors have
been thrown open for international competition. It has become imperative for
the banker to satisfy himself that the technology to be employed is the latest
and that in the market there is no over- supply of product proposed to be
manufactured by the party.

HOW THE BANK FUNDS ARE GOING TO BE REPAID?

The banker should scrutinize the projections to satisfy himself that they are
not over optimistic and that the project report has not been doctored to make

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the project viable on paper. Industry specific data published by financial

papers, financial institutions etc. may be used to determine the reliability of
projections. Pre-sanction inspection should be carried out to crosscheck the
authenticity of details mentioned in the project report. Disbursements should
be made in stages depending upon the progress of work. Implementation
schedule should be strictly adhered to for avoiding cost over-runs.

The banker should be vigilant to see that the borrower observes financial
discipline and that terms and conditions of sanction are strictly complied with.
Stock statements and monthly statements of Select Operational Data (MSOD)
should be scrutinized scrupulously to ensure that the sale proceeds are
routed through the account. When there is delay in submission of stock
statement, a surprise inspection should be carried out to ascertain whether
the delay is willful. Borrowers have a tendency to delay filing of stock
statement whenever the stock on hand is not adequate to cover the
outstanding balance. In that event, banker should insist for refund of excess
drawings in the account or for additional security to cover the excess.

It must be impressed upon the borrower the necessity of proper maintenance

of books of accounts and to see that they are updated from time to time. Any
inspection of stock will be meaningless so long as the stock movement
register is not brought up-to-date. Returns relating to quarterly
projections/achievement must be compared with annual projections to ensure
that the performance is not behind schedule. If there is wide gap between
projections and actual, a dialogue should be held with the borrower to know
the reasons for shortfall and remedial measures initiated to rectify the
situation.

It is noticed that international developments have started affecting the

performance of Indian units. Naturally it becomes incumbent upon the banker
to keep himself abreast about the developments by reading financial papers,
magazines, trade journals, industry data published by C.M.I.E., I.D.B.I.,

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I.C.I.C.I., etc. so that remedial measures could be initiated whenever there is

adverse development affecting the unit financed by the bank.

A visit to the customer‟s office should not be looked upon as an occasion to

exchange pleasantries but as an opportunity to observe elements of business
that are overlooked by financial statements and market studies. What are the
orders on hand? Has any order been cancelled and on what grounds?
Whether any key personnel have left the organization and what reasons have
been cited in his resignation letter? Is any labor unrest brewing in the factory,
which can snowball into a crisis? Is the unit maintaining proper books of
accounts and whether stock movement register is posted up-to-date? Is the
unit losing market share and what steps are proposed to push up sales?

There is no substitute to personal inspection and the following experience of

one banker should convince you that a lender could ignore the maxim `Seeing
is believing‟ only at its own peril. The bank had sanctioned large limits to a
company against the security of industrial oil stored in huge containers. The
bank officer deputed for inspection was received with due hospitality. He was
taken around the unit and shown all records. When he expressed desire to
check the stock of oil, „the supervisor questioned the wisdom of going up a
narrow ladder about 25 meters high. The supervisor offered to get it done
through a worker of the unit. The officer persisted and when he peeped inside
the container he saw a narrow cylinder in the storage tank, which alone
contained oil. Same was the case with all the remaining storage tanks. The
fraud was detected because the officer insisted on doing the job himself rather
than getting his job done through someone else. The incident goes to
establish that while examining accounts can check capital, the character and
capability must be judged through wider observation.

Time and again Reserve Bank of India and Finance Ministry have re-iterated
that they are against further re-capitalization of nationalized banks by the
government. On the contrary, they would like to see the share of government
holding in these banks coming down in the near future. The investors will

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repose confidence in any bank only when the quality of its assets is high. This
can be achieved only through proper identification of the borrower and then
preserving the quality of assets through close monitoring.

The list is illustrative and not exhaustive and has been compiled on the basis
of experiences of various bank officials working in the field.

As if for no reason it is said that lending is an art and not a science. No

amount of textbook reading can make you a successful lender. This art is
primarily gained through experience as lender. Gaining the confidence of
borrower and being able to identify the true qualities of success in a company
constitute the elusive art of lending.

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BANK CREDIT: THE POLICY FRAMEWORK

Credit management is one of the essential functions of banking. Credit

management includes appraisal of credit proposals, loan delivery and,
monitoring of borrower accounts. Although, the management of credit
portfolio is as old as commercial banking, the liberalization of industrial sector
coupled with the financial sector reforms reemphasizes about the importance
of credit management. Building of qualitative credit portfolio and maximizing
return on the portfolio with minimization of risk is continued to be an area of
learning to the bankers. This paper presents the importance of credit
management in the current scenario and outlines the important aspects of
credit policy.

FINANCIAL SECTOR REFORMS: IMPLICATIONS ON CREDIT

PORTFOLIO

The RBI has introduced several measures based on recommendations of

Narasimham committee I [1991]. These measures have a direct impact on
the credit portfolio of any commercial bank.

Important among them are:

(i) Capital Adequacy Ratio [CAR]

(ii) Maintenance of accounts according to Prudential Accounting Norms.
(iii) Phased reduction of CRR & SLR.
(iv) Deregulation of interest rates.
(v) Thrust on financing Small Scale Industries.

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In 1998, RBI has moved towards the introduction of second generation

reforms based on the recommendations of Narasimham Committee II,
R.V.Gupta Committee on agricultural advances and Kapoor Committee on
financing Small Scale Industries.

The implications of these reforms on credit portfolio are complex and far
reaching on the banking sector.

Every bank has to maintain a minimum of 9% Capital Adequacy Ratio [CAR]

from March 2000 onwards. CAR is relationship between Capital of the bank
and risk weighted assets. It simply indicates that, if Rs.100 advances are
made Rs.9 Capital should be provided. Unless it is a quality advance,
substantial return will not be generated to add a portion to the capital. This
emphasizes on quality lending.

According to the prudential accounting norms, advances are to be classified

as Standard, Sub-standard, Doubtful and Loss; further provisioning is to be
made in the profit and loss account of bank. Higher provisioning reduces the
profitability of the bank. All assets other than standard assets are indicated as
Non-performing Advances (NPAs). The percentage of NPAs for any bank is
an indicator of overall performance of the bank. The rating of a bank depends
on the level of its NPAs. In granting the autonomy to banks, RBI considers
NPAs as also one of the factors. To achieve Capital Account Convertibility,
the Tarapore Committee has suggested that the banking sector Net NPAs
should come down to 5%.

Phased reduction of CRR and SLR by RBI over a period of time released
substantial deposits, which are at the disposal of commercial banks.
Commercial Banks should deploy these sources efficiently, to increase the
profitability.

In a phased manner RBI has deregulated the interest rates on advances and
deposits. Since October 1994, banks have to price the advances on the basis

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of Prime Lending Rate [PLR]. Prime Lending Rate is the rate of interest
charged to highly rated borrowers. Each bank has to announce the PLR on
the basis of their cost of deposits and operating expenses from time to time.
This has created competition among the banks. Banks are attracting the
various customers by evolving suitable pricing strategies.

POLICY FRAME - WORK FOR CREDIT

In 1995, RBI advised the commercial banks to formulate a structured loan

policy. The policy should lay emphasis on thrust areas, industry exposures,
credit rating system, sanctioning powers and other procedures to be followed
in the case of credit decisions. RBI has indicated prudential exposure norms.

Prudential exposure norms

(i) With effect from March 31, 2002, the credit limit shall not exceed 15%
of the capital and free reserves of the bank to any single borrower
(individual / partnership / company).
(ii) Further, the credit limit shall not exceed 40% of the capital and free
reserves of the bank to any group with effect from 31.03.2002.
(iii) Total bank credit to any single borrower shall not normally exceed 4
times of net worth of borrower. It may be relaxable in the case of
consortium accounts, where the consortium decides the norms.
(iv) Till 31.03.2003, 50% of the total non-fund based facilities sanctioned to
a borrower with partial margin will be taken into consideration for
arriving at the total exposure limit prescribed for a borrower.
(v) However, in line with best international best practices, RBI has decided
that non-fund based exposures should be reckoned 100% from April 1,
2003. In addition, banks are also to include forward contracts in foreign
exchange and other derivative products like currency swaps and
options, at their replacement cost value in determining individual/group
borrower exposure ceiling.

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Exposure limit for infrastructure projects:

The RBI has enhanced the credit exposure limits by 10% for infrastructure
projects. Banks can exceed the exposure norms of 40% of its capital funds
by an additional 10% [i.e. up to 50 percent] provided the additional credit
exposure is on account of infrastructure projects [i.e. power, telecom, road
and ports].
MPBF AND WORKING CAPITAL

With effect from April 1997 full operational freedom has been given to banks
in assessing Working Capital requirements of borrowers. Banks are free to
evolve their own methods of assessing the Working Capital requirements of
borrowers within the prudential guidelines and exposure norms. All
instructions relating to Maximum Permissible Bank Finance [MPBF] are being
withdrawn. Banks may follow cash budget system for assessing the Working
Capital Finance in respect of large borrowers.

TERM LOAN FOR PROJECTS

Banks have the discretion to sanction term loans to all projects within the
overall ceiling of the prudential exposure norms prescribed by RBI. Banks
have the freedom to decide the period of term loans keeping in view the
maturity profile of their liabilities.

LOAN DELIVERY SYSTEM

A Loan Delivery System was introduced in April 1995 with a view to imparting
an element of discipline in the utilization of bank credit, has been extended in
phases to cover larger number of borrowers with the percentage of loan
component of the working capital. Presently,
Rs.10 cr. and above Minimum of 80 percent of loan component*

Less than Rs.10 cr. At the discretion of the bank

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* In the Credit Policy announced by RBI on 22/10/2001, banks have been

given freedom to change the composition of working capital by increasing
cash credit component beyond 20%.

INTEREST RATE STRUCTURE

Prime Lending Rate (PLR) concept was introduced in October 1994. PLR is
the rate charged to highly rated borrowers. The broad interest rate structure
is as follows.

Advances up to Rs.2 lakhs - Not more than PLR

Advances against term deposits - Equal to PLR or less

Interest rates on remaining all - Linked to PLR as specified

advances by respective bank polices.

The interest rates on Export Credit are not linked with PLR and banks fix the
rates as per RBI guidelines. The present Export Credit rates in Central Bank
of India are as under:

w.e.f.
1.5.2002

Interest on pre-shipment credit Rupee Export Credit up to 180 days 8%

Beyond 180 days up to 270 days 11%

Interest on Loan against incentives receivables from Govt. and

8%
Covered with ECGC up to 90 days

Post-shipment Credit up to 90 days 8%

Post-shipment Credit beyond 90 days up to 6 months from the date

10%
of shipment.

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Over due export bills ECNOS

ADVANCES AGAINST SHARES

Banks can extend loans to corporate against shares held by them to enable
such corporate to meet the promoters‟ contribution to the equity of new
companies in anticipation of raising resources. Such loans shall be treated as
banks‟ investment directly in shares and would thus come under the ceiling of
5% of its outstanding domestic credit of the previous year. Regarding the
margin and the period of repayment of such loans, banks determine the
same.

Banks are allowed to grant advances against shares and debentures to

individuals subject to a ceiling of Rs.10 lakh per borrower. Banks are required
to maintain a minimum margin of 40% for advances against shares. If the
shares are in dematerialized form the ceiling has been enhanced to Rs.20
lakh. However, the minimum margin against dematerialized shares is also
40%.

EXPORT FINANCE

Physical target for Export Credit is fixed at 12% to total credit. If the advances
are for SSI Export units it forms part of Priority Sector. Any Export Credit
proposal should not be kept pending for more than 45 days in the case of
fresh advance, 30 days in case of renewal and for adhoc facility 15 days from
the date of receipt of application.

Export finance is broadly governed by FEMA (Exchange control Management

Act), EXIM policy of Govt. of India, FEDAI Guidelines, International Chamber
of Commerce (UCP ICC 500), and Internal guidelines of respective banks.

IMPORT FINANCE:

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Multiple options are available to traditional credit products (Cash Credit, Term
loans), the new products are Suppliers credit, Buyer‟s credit and lines of credit
broadly known as External Commercial Borrowings. FERA, FEDAI and RBI
guidelines govern these.

HOUSING FINANCE
Banks are required to allocate 3 percent of incremental deposits of previous
financial year towards housing finance. Banks may even exceed these levels
if permitted by their resources. Direct housing loans up to Rs.5 lakhs in
rural/Semi urban areas and up to Rs.10 lakhs in urban and metropolitan areas
are treated as priority sector advances.

All indirect housing loans extended by banks to housing intermediary

agencies against the loans sanctioned by them will be reckoned as part of
housing finance allocation.

All the investment in bonds issued by NHB/HUDCO exclusively for financing

of housing irrespective of the loan size per dwelling unit will be reckoned for
inclusion under priority sector advances.

EDUCATIONAL LOANS

Educational Loans are treated as Priority Sector Advances. Loans are allowed
both for studies in India and at abroad. The rate of interest charged under the
scheme is PLR linked and depend upon the quantum of loan amount.

PRIORITY SECTOR ADVANCES:

The target set by RBI for priority sector advances is 40 percent of the net
advances of the Bank. The agricultural advances should be 18 percent of the
Net Advances and the other areas of Priority Sector are Small Scale
industries, Advances for weaker section, DRI, Housing Finance etc. The
credit to agricultural sector is thoroughly revised of R.V.Gupta Committee

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(1998). Similarly in the area of loans to Road and Water transporters the
number of ownership vehicles increased from Six to Ten.

EMERGING TRENDS IN BANKING CREDIT

1. Emergence of commercial paper as a substitute to working capital.

2. Variety of debt instruments and Lease Finance as sources of Long
Term Finance.
3. International Factoring, Forfeiting and counter trade as new techniques
of export finance and FCNR (B) loans.
4. Credit cards, Hire purchase finance and various consumer finance
schemes are alternatives to traditional personal & consumer Finance.

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CREDIT EXPOSURE LIMIT AND RESERVE

BANK OF INDIA

CREDIT EXPOSURE LIMIT

As a prudential measure aimed at better risk management and avoidance of

concentration of risks, Reserve Bank of India has fixed limits on a bank‟s
exposure to individual borrower and group of borrowers in India w.e.f. May
1989.

Ceiling

The exposure ceiling is fixed in relation to banks‟ capital funds and it shall not
exceed 15 per cent of capital funds w.e.f. April 1, 2002 in the case of
individual borrowers and 40 per cent in the case of group concerns. In case of
Infrastructure projects the ceiling is 25% and 50% respectively for individual
and group concerns.

Capital Funds

“Capital Funds for the purpose will comprise paid up capital and free reserves
as per the published accounts. Reserves, if any, created by way of revaluation
of fixed assets etc. should not be included for the purpose.

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Exposure

Exposure shall include funded and non-funded credit limits and underwriting
and similar commitments. The sanctioned limits or outstanding, whichever is
higher shall be reckoned for arriving at exposure limits. However, in respect of
non-funded credit limits, only 50% of such limits or outstanding, whichever is
higher, need be taken into account for the purpose. With effect from April 1,
2003, 100% of non-fund based limits shall be reckoned for arriving at
exposure limits.
Applicability

These stipulations shall apply to all borrowers. In so far as Public Sector

Undertakings are concerned, only single exposure limit would be applicable.
Borrowers, which are allotted credit limits directly by Reserve Bank of India,
such as for food credits, will however, be exempted. Investments by banks in
PSU bonds, shares and debentures of companies, commercial paper should
also be included for arriving at single borrower/group concern exposure
ceilings.

Reporting of Credit Limits to Reserve Bank of India

As part of its policy to secure optional deployment of the limited resources of

the country and in order to channelise credit in desired directions, Reserve
Bank of India had introduced Credit Authorization Scheme (CAS) in
November 1965 requiring scheduled commercial banks to obtain Reserve
Bank‟s prior authorization before sanctioning any credit limit of Rs. 1 crore
and above to any single party or any limit that would take the total limits
enjoyed by such party from the banking system as a whole to Rs. 1 crore or
more. This scheme, with stipulated limits enhanced from time to time, was
dispensed with effective from October 10, 1988 and a Credit Monitoring
Arrangement (CMA) was introduced requiring the banks to submit to RBI
proposals for working capital limits of Rs. 10 crores and above from the entire

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banking system and term loans, including DPG, where the share of the
banking system was Rs. 5 crores and above for post sanction scrutiny along
with relevant data in the prescribed CMA format. In the wake of full
operational freedom granted to banks in the assessment of working capital
requirements of borrowers, CMA was considered no longer necessary. In
order however, to have a database in relation to the flow of bank credit to
borrowers in various industries, Reserve Bank has asked the banks to follow
the under noted reporting system:

a) Weekly statement in the prescribed proforma giving details of

addition/enhancement in credit limits or reductions effected in respect
of borrowers availing of working capital credit or term loan including
deferred payment guarantee limit of Rs. 10 crore or above from the
banking system.

b) Monthly statement in the prescribed form giving industry-wise break-up

of net additional credit limits sanctioned to borrowers availing of
working capital credit or term loan limit including deferred payment
guarantee of Rs. 1 crore and above but less than Rs. 10 crores from
the banking system.

In respect of consortium/syndicated loans, banks as under will share

the responsibility of reporting sanction of fund-based working capital
credit limits or the term loans including DPGs:

i) When a bank sanctions the entire facility, the said sole bank
should do the reporting.
ii) Where the facility is sanctioned by more than one bank but
under a formal consortium, either voluntary or obligatory, or
through syndication, the lead bank/lead manager should do the
reporting, as the case may be.

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iii) Where the facility is sanctioned by more than one bank, but
under multiple banking arrangements, each financing bank
should report the facility extended by it.

BALANCE SHEET CLASSIFICATION OF ASSETS

AND LIABILITIES

I. BALANCE SHEET FORMAT AS PER COMPANIES ACT

1956.

The classification of assets and liabilities as per the balance sheet drawn
under the provisions of the Companies Act, 1956 differs in many respects
from that according to the usually accepted approach of the bankers, based
on the guidelines prescribed by the Reserve Bank of India. As per the
balance sheet, the classification is done under the following main heads:

Liabilities Assets
Share capital Fixed assets
Reserves & Surplus Investments
Secured Loans Current assets, loans and advances
Unsecured loans Miscellaneous expenditure and
losses
Current liabilities and provisions

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The classification adopted by the bankers is done under the following broad
heads:

Liabilities Assets
Current liabilities Current assets
Term Liabilities Fixed assets
Net worth Other non-current assets
Intangible assets

The balance sheet classification is sometimes given in the column form under
sources of funds and uses of funds. Items like capital and reserves and
secured and unsecured loans are shown under sources of funds, while, under
application of funds, fixed assets, investments and current assets are shown.
At times, instead of showing current assets and current liabilities separately,
“net current assets” figure is only shown, which is equal to the total current
assets minus total current liabilities. In that case, the details of total current
assets and total current liabilities are given in the schedules attached to the
balance sheet.

II. NEED FOR SEPARATE CLASSIFICATION

Bankers want to study previous two years' actual, current year's estimates
and following year's projections. While the balance sheet gives previous one-
year's position, it does not indicate future projections. The Companies Act,
which has prescribed the balance sheet format, looks at the classification of
the assets and liabilities from the point of view of shareholders and
Government, whereas the banker has different perspective. The balance
sheet form along with other forms as prescribed by the Reserve Bank
(popularly known as CMA forms) are designed to serve the following main
purposes: -

a. To verify whether the projections are in accordance with the past

trends and current working, subject to technological and other

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developments;

b. To work out the bases (i.e. cost of raw materials consumed, cost of
production, cost of sales and sales) to which the inventory and
receivable norms are related;

c. To verify whether the projected levels conform to the prescribed norms;

d. To verify whether the various accounting ratios projected are realistic;

and

e. To fix the need - based limits.

III. HOW THE CLASSIFICATION ADOPTED BY THE

BANKERS DIFFERS?

The banker's classification of assets and liabilities differs from that as per the
Companies Act formats in the following major respects:

a. Share Capital

All accounts of share capital are included under one head as per the format of
balance sheet under the Companies Act. However, bankers as current
liabilities treat preference shares redeemable within one year while those
redeemable between one year and 12 years are treated as term liabilities and
beyond 12 years they form part of the net worth.

Preference shares redeemable within 12 years are not treated as equity but
are classified as debt as they have to be redeemed or repaid; the provisions
of Capital Issues (Control) Act also follow this method.

b. Secured and unsecured loans

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The balance sheet classification is done on the basis of security and both
term loans and working capital advances are clubbed together. Also,
debentures are included as secured loans in the balance sheet. The
classification of loans adopted by the bankers is generally based on the
period – if the loan is repayable in one year, irrespective of the security, it is
classified under current liabilities and that repayable after one year is
classified under term liabilities. In fact, it would be more correct to say that
the bankers classify under current liabilities all working capital advances
(including working capital term loans) and installments of term loans/deferred
payment credits/debentures, which are repayable within one year.

c. Bills purchased and discounted

These are normally shown as contingent liability or indicated in the footnote to

the balance sheet. As per the classification followed by the bankers, the
amount involved is treated as short term borrowing from banks under current
liabilities and as receivables under current assets.

d. Current liabilities and provisions

The classification in the Companies Act format does not meet fully the
banker's requirements. For example, details of statutory liabilities like excise
duty, sales tax, obligations towards workers considered as statutory (other
than provident fund) may not be separately shown in the Companies Act
format, while these have to be specifically indicated in the classification
followed by the bankers. Similarly, sundry creditors comprise conglomerate
items in the balance sheet and may also include sundry creditors for
acquisition of capital assets. However, as per the classification followed by
the bankers, only trade creditors, i.e., those arising out of purchase of raw
materials and stores etc. are to be shown.

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e. Fixed Assets

Under fixed assets, goodwill, patent rights, etc. are also included, as per the
Companies Act format. However, as per the banker's classification, these
items are classified as intangible items. As such while working out tangible
net worth, they are reduced from the figure of net worth.

f. Investments

Under this item, only Government and trustee securities and fixed deposits
with banks are normally included as per the banker's classification. If,
however, the investments in Government and trustee securities and fixed
deposits are made for long term purposes like sinking fund, gratuity fund, etc.,
such investments are excluded from investments under current assets.
Further, as per the Companies Act format, shares held by the borrowing
companies in their subsidiaries or other companies are also included under
the head. But such investments are to be classified as non – current assets.

IV. CURRENT LIABILITIES

The main headings under current liabilities as per the classification followed
by the bankers are as under:

a. Short - term borrowings from banks (including bills purchased and

discounted and excess borrowings placed on repayment basis, i.e.
WCTL)

b. Short - term borrowings from others

c. Deposits (maturing within one year)

Deposits maturing after one year are to be classified under term liabilities.

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Manufacturers of automobiles, two wheelers, etc. who accept deposits while

booking orders for new vehicles are required under the government rules to
earmark a part of such funds in certain approved securities, etc. In such
cases, the benefit of netting may be allowed to the extent of such investment
and only the balance amount need be classified as current liabilities.

d. Sundry creditors (trade)

e. Unsecured loans

f. Unsecured loans taken from the Directors of the borrowing company,

where no period is mentioned, are to be treated as current liabilities.

ADVANCES/PROGRESS PAYMENTS FROM CUSTOMERS

In the case of construction companies/turnkey projects, the advance

payments/progress payments received against work – in - progress may be
set off and only the net position should be shown either as a current liability or
a current asset, as the case may be.

Deposits from dealers and selling agents may be treated as term liabilities
(and not under this head) irrespective of their tenure, if such deposits are
repayable only when the dealership/agency is terminated.

g. Interest and other charges accrued but not due for payment

h. Provision for taxation

This relates to income - tax and not other taxes.

Advance tax paid and provision therefore should be netted and the net
position may be shown but netting should be made uniformly for all the years

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under consideration.

i. Dividend payable

If dividend is only recommended and not appropriated from profits, pending

approval of shareholders in the Annual General Meeting, the amount may be
shown here after deducting it from general reserve and/or surplus in the profit
and loss account.

j. Other statutory liabilities (due within one year)

When provision for excise duty is made it should be classified as current

liability. The disputed excise liability shown as contingent liability or by way of
notes to the balance sheet will not be treated as current liability unless it has
been collected or provided for in the accounts of the borrowers. Provision for
disputed excise duty may be classified under current liability unless the
amount is payable in installments, spread over a period exceeding one year,
as per the orders of a competent authority like the Excise Department or in
terms of the directions of a competent court, in which case the installments
payable after one year are to be classified as long term liabilities. Where the
provision made for disputed excise duty is invested separately, say, in fixed
deposits with banks, such provision may be set off against the relative
investment.

k. Installments of term loans/deferred payment credits/ debentures /

redeemable preference shares (due within one year)

Inter corporate Deposits to be treated as current Liabilities

l. Other current liabilities and provisions

In case specific provisions have not been made for known liabilities like
dividend payable, tax payable, etc., estimates thereof should be made

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for eventual payment during the year and the amounts, though not
provided, should be shown as current liabilities.

V. TERM LIABILITIES

a. Debentures (not maturing within one year)

b. Redeemable preference shares (not maturing within one year but of

maturity not exceeding 12 years)

c. Term loans (exclusive of installments payable within one year)

d. Deferred payment credits (exclusive of installments payable within one

year)

e. Term deposits (repayable after one year)

f. Other term liabilities

VI. NET WORTH

a. Ordinary share capital

b. Preference share capital (maturing after 12 years)

c. General reserve

d. Development rebate reserve

e. Other reserves (excluding provisions)

f. Surplus (+) or deficit (-) in profit and loss account Capital reserve,
arising out of revaluation of property, may be excluded from the net
worth. Consequently, the value of fixed assets to the extent they have

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been revalued upwards may not be increased.

As stated earlier, intangible assets are deducted from the figure of net worth
to arrive at tangible net worth.

VII. CURRENT ASSETS

a. Cash and bank balances

b. Investments (other than long - term investments, e.g. sinking fund,

gratuity funds, etc.)

i. Government and other trustee securities

ii. Fixed deposits with banks.

The question whether deposits representing or earmarked for margin money

for issuing guarantees or opening letters of credit should be classified as
current assets or non - current assets is not very clear. Some banks, inclined
to be conservative, classify such deposits as non - current assets; otherwise,
once they are included in current assets, the borrowers' permissible level of
bank finance goes up by 75% there of under the 2nd Method of lending. Dena
Bank treats the investments in F.D. [encumbered] with banks including trustee
securities on current Assets. Central Bank depending upon period treats as
non-current asset.

Investments in shares in subsidiaries and other companies should not be

included under this head. Shares in which the borrowing company has made
investments may be highly marketable but such investments are to be treated
as non - current assets as bank finance is meant for deployment in borrower's
line of activity and not in inter – corporate locking of funds. Further,
shares/debentures are to be raised from the public mainly.

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c. Receivable

i. Receivables other than deferred and export receivables (including bills

purchased and discounted by banks)

ii. Export receivables (including bills purchased and discounted by banks)

Bills purchased/discounted, though not shown, as liabilities/assets in the

balance sheet should be classified as such, as indicated earlier.

In the balance sheet drawn as per the provisions of the Companies Act,
debtors are required to be classified as "Debts Outstanding for a period
exceeding six months" and "other debts". Also, particulars are required to be
provided relating to debts considered good and secured, debts considered
good for which there is no security other than debtors' personal security and
debts considered doubtful or bad. Debts, which are collectable within 12
months and after 12 months are not required to be segregated.

Under CMA format, receivables realizable within 12 months (not six months)
may be classified under current assets. However, some banks, taking a
conservative view, do not treat receivables outstanding for more than six
months as current assets and the remaining as non-current assets.

Receivables from subsidiaries/sister/associate concerns will be included,

provided these receivables arise in the normal course of business and
represent dues for sales made to them in the ordinary course of business on
usual credit terms.

As per the extant instructions, export receivables and Bills negotiated tender
A/cs. are to be included under receivables but, for the purpose of calculating
the maximum permissible level of bank finance, those are to be deducted
from the total current assets for arriving at the minimum stipulated net working

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capital (i.e. 25% of total current assets under the 2nd method of lending).

In case, the excise duty component is very large, the level of receivables may
become distorted in relation to the norm/past trend. In order to make
meaningful study of the position, data relating to excise duty component may
be furnished separately. Similarly, if the sales tax element included is large,
separate figures there of may be also furnished.

d. Installments of deferred receivables (due within one year)

e. Inventory

i. Raw materials (including stores and other items used in the

process of manufacturing)

a. Imported
b. Indigenous

Coal, fuel, packing materials, labels, etc. may be included

under this head.

ii. Stock - in - process

Except in industries where the process cycle is long and

involves various stages, the classification is fairly
uncomplicated.

iii. Finished goods

In certain cases, where the excise duty component is very large

(e.g., tobacco industry), inclusion of duty – paid stock in finished
goods and relating it to cost of sales which does not include
excise duty creates distortion in the level of holding. In such a

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case, data relating excise duty may be shown separately.

iv. Other consumable spares -

Normally loose tools or spares for machinery are not included

but unused dies in a printing press or an extrusion plant poses a
problem. If utilized within the maximum period of one year, such
items may be classified under this head. Spares should not be
linked to inventory levels but we should go by the consumption
pattern in an industry. Spares should not exceed 12 months'
consumption for imported items and 9 months' consumption for
indigenous items. Beyond this level they should be considered
as non - current assets and shown under non - current assets.

'Dead inventory' i.e. slow - moving or obsolete items should not

be classified as current assets. In certain industries where the
operating cycle is beyond 12 months, inventories held during
such longer operating cycle will be treated as current assets.

f. Advances to suppliers of raw materials and stores/consumable

spares.

g. Advance payment of taxes

As stated earlier, advance tax paid and provision therefore should be

netted.

h. Other current assets

Security and tender deposits should not be classified under this head,
irrespective of whether they mature within the normal operating cycle of one
year or not but should be classified as non - current assets.

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VIII. FIXED ASSETS

a. Gross block (land, buildings, machinery, construction - in - progress,

etc.)

b. Depreciation to date

c. Net Block

Depreciation will normally include actual balances of depreciation. If,

however, it is not provided and the arrears of depreciation are indicated
in the notes to the balance sheet, extreme conservatism will dictate
that such arrears should be included and, to that extent, accumulated
profits/general reserves would be reduced.

If the assets have been revalued, the increase in the value due to
revaluation may be ignored.

IX. OTHER NON - CURRENT ASSETS

a. Investments/book - debts/advances/deposits, which are not current

assets

i. a. Investments in subsidiary companies affiliates

b. Others

Advances to other firms/companies not connected with

the business of the borrowing firm should be included
under this head and not under current assets. Note 3 in
the Explanatory Notes on classification of current

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liabilities and current assets given in the Reserve Banks'

circular DBOD No. CAS/BC/119/C446-75 dated
31.12.1975 states: "Investments in shares and advances
to other firms/companies not connected with the business
of borrowing firms should be excluded from the current
assets". That is to say,

1. Investments in shares in other companies should

be treated as non - current assets and
2. Advances to other firms/companies not connected
with the business of the borrowing firm should also
be treated as non – current assets.

If such advances are given to the firms/companies,

which are connected with the business of the
borrowing firm they may, only then, be treated as
current assets. However, amounts representing
inter -connected company transactions should be
treated as current only after examining the nature
of transactions and merits of the case. For
example, advance paid for supplies for a period
more than the normal trade practices, in spite of
any other consideration such as regular and
assured supply, should not be considered as
current.

ii. Advance to suppliers of capital goods/spares and contractors for

capital expenditure

iii. Deferred receivables (other than those maturing within one year)

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iv. Others

b. Non - consumable stores/spares

c. Other miscellaneous assets including dues from directors

X. INTANGIBLE ASSETS

(Patents, goodwill, preliminary and formation expenses, bad/doubtful debts

not provided for etc.)

As stated earlier, for working out the tangible not worth of a borrowing unit,
intangible assets are deducted from its net worth.

(A list of current assets and current liabilities as appearing in CAS format is

given below with explanatory notes for the guidance. The classification is as
per the directives of RBI received from time to time. The list is only illustrative
and not exhaustive.)

For classification of current liabilities and current assets, the Tandon study
Group has suggested that the level of bank finance permissible may be
determined on the basis of the working capital gap arrived at after taking into
account the projected levels of current assets and current liabilities (other than
bank borrowings). Although the items to be classified as current assets and
current liabilities will be on the basis of the accepted approach of bankers,
some of the bankers present in the Trainers seminar held in the Bankers
Training College in August, 1975, expressed a desire that the Reserve Bank
of India should specify the nature of items to be classified as current assets
and current liabilities. It was accordingly decided in the first meeting of the
Committee of Direction that the committee might study the various items to be
classified under the heads “current assets” and “current liabilities” so that the
bankers can adopt a uniform approach in this regard. Broadly speaking,
current liabilities would include items payable or expected to be turned over

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within one year from the date of balance sheet and the term is used principally
to designate obligations whose liquidation is reasonably - expected to require
the use of existing resources properly classified as current assets or the
creation of other current liabilities. The term current assets is used to
designate cash and other assets or resources commonly identified as those
which are reasonably expected to be realized in cash or sold or consumed or
turned over during the operating cycle of the business usually not exceeding
one year.

In the background of the common understanding as above the components of

current assets and current liabilities for the purpose of determining working
capital gap may broadly be taken as shown below.

I. Current Liabilities [See Note 1] II. Current Assets

1. Short –term borrowings (Including 1. Cash and bank balances
bills purchased and discounted
from:
a. Banks
b. Others
2. Unsecured loans 2. Investments (see note (3))
a. Government and other Trustee
Securities (other than for long
term purposes e.g. Sinking
Fund, Gratuity Fund, etc.)
b. Fixed deposit with banks
3. Public deposits maturing within 3. Receivable arising out of sales
one year other than deferred receivables,
(including bills purchased and (see
Note 10)
4. Sundry creditors (trade) for raw 4. Installments of deferred
material and consumable stores receivables due within one year

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and spares

5. Interest and other charges 5. Raw materials and components

accrued but not due for payment used in the process of
manufacture-including those in
transit [see Note (4)]
6. Advances/progress payments 6. Stocks in Process including semi
from customers [see Note (6)] finished goods
7. Deposits from dealer, selling 7. Finished goods including goods in
agents, etc. (see Note 97)) transit
8. Installments of term loans, 8. Other consumable spares (see
deferred payment credits, Note (4) and (ii)
deferred payment credits,
debentures, redeemable
preference shares and long-term
deposits payable within one year.

9. Statutory Liabilities 9. Advance payment for tax

a. Provident fund dues
b. Provision for taxation (see
Note (2) and (8)
c. Sales – Tax, excise etc. (see
Note (9)
d. Obligation towards workers
considered as statutory
e. Others (to be specified)

10. Miscellaneous Current Liabilities: 10. Pre – Paid expenses

a. Dividends (see Note (2))
b. Liabilities for expenses
c. Gratuity payable within one
year

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d. other provisions
e. Any other payments due
within 12 months
11. Advances for purchase of raw
materials, components and
consumable stores.
12. Monies receivable from contracted
sale of fixed assets during the next
12 months

Notes:

1. The concept of current liabilities would include estimated or accrued

amounts which are anticipated to cover expenditure within the year for
known obligations, viz, the amount of which can be determined only
approximately, as for example, provisions, accrued bonus payments,
taxes etc.

2. In cases where specific provisions have not been made for these
liabilities and will be eventually paid out of general reserves, estimated
amounts should be shown as current liabilities.

3. Investments in shares and advances to other firms/companies, not

connected with the business of the borrowing firm should be excluded
from current assets.
4. 'Dead inventory' i.e. slow moving or obsolete items should not be
classified as current assets.

5. Amounts representing inter - connected company transactions should

be treated as current only after examining the nature of transactions
and merits of the case. For example, advance paid for suppliers for a
period more than the normal trade practice, in spite of any other
considerations such as regular and assured supply should not be

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considered as current.

1. Advance/Progress payments from customers

(Item (4) under current liabilities)

These deposits are to be classified as current liabilities. Where deposits are

required, in terms of regulations framed by the Government, to be invested in
a specified manner (e.g. advances for booking of vehicles), the benefit of the
netting may be allowed to the extent of such investment in approved
securities and only the balance amount need be classified as current liability.
(c.f. paragraph 2(ii) of Circular IECD. No. PMS. 206/27c - 87/88 dated 12
May 1988). Where on account of different accounting procedure progress
payment are shown on the liabilities side without deduction from work - in -
progress, banks may set – off the progress payments against work - in -
progress. Advance payments received are also adjusted progressively form
the value of work completed, as agreed in the contract. Outstanding advance
payment is to be reckoned as current liabilities or otherwise, depending upon
whether they are adjustable within a year, or later (e.f. Annexure to Circular
IECD. No. CAD (PMS) 11/WGCC - 81 dated 24 October 1981).

6. Deposits from dealers, selling agents etc.

(Item (7) under current liabilities)

These deposits may be treated as term liabilities irrespective of their tenure if

such deposits are accepted to be repayable only when the dealership/agency
is terminated after due verification by banks. The deposits which do not
satisfy the above condition should continue to classified as current liabilities
(c.f. paragraph 2 (i) of circular IECD. No. PMS. 206/27c - 87/88 dated 12 - 5 -
988). Security deposits/Tender deposits may be classified as non - current
assets irrespective of whether they mature within the normal operating cycle
of one year or not (c.f. Para 2(iii) of Circular IECD. No. PMS. 206/27c - 87/88
dated 12 - 5 - 1988).

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8. Provision for taxation

(Item (9) (b) under current liabilities)

Netting of tax provision and advance tax paid (vide item (ix) of current assets)
may be effected for all the years uniformly and, as such, for the current year
also the advance tax paid can be set off against the provision, if any made for
that year (Circular IECD.No.CAD. (PMS) - 89/c.446 (PMS) - 84 dated 4 June
1984).

9. Sales - tax, excise etc.

(Item (9) (c) under current liabilities)

Disputed excise liabilities shown as a contingent liability or by way of note to

the balance sheet need not be treated as a current liability for calculating the
permissible bank finance, unless it has been collected or provided for in the
accounts of the borrower (c.f. pare 3 of circular IECD.PMS.170/c.446 (PL) -
86/87 dated 24 June 1987).

Provision for disputed excise duty should be classified as current liability,

unless the amount is payable in installments spread over a period exceeding
one year as per the orders of competent authority like the Excise

Department or in terms of the directions of a competent court. In such cases,

if the installments payable after one year are classified as long-term liability,
no objection may be taken to such classification. (Para 4 of Circular
IECD.No.CAD (PMS) 1/C. 446(PMS) - 85 dated 2 January 1985).

Where the provision made for disputed excise duty is invested separately, say
in fixed deposits with banks, such provision may be set off against the relative
investment. (Para 5 of circular IECD. No. CAD (PMS) 1/c 446(PMS)/-85
dated 2 January 1985).

Disputed liabilities in respect of income - tax, customs and electricity charges

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need not be treated as current liability for the purpose of computation of

maximum permissible bank finance except to the extent provided for in the
books of the borrower. (Circular IEDC.No.PMD>252/c.446 (PL) - 88/89 dated
18 May 1989).

10. Receivables arising out of sales other than deferred receivables,

(including bills purchased and discounted by bankers)

(Item (3) under current assets)

Export receivables may be included in the total current assets for arriving at
the Maximum Permissible Bank Finance but the minimum stipulated Net
working Capital (i.e. 25% of total current assets under 2nd Method of Lending)
may be reckoned after excluding the quantum of export receivables from the
total current assets (Para 3 of circular ECD.No.PMS.206/27c.87/88 dated 12
May 1988).

11. Other consumable spares

(Item (8) under current assets)

Projected levels of spares on the basis of past experience but not exceeding
12 months' consumption for imported items and 9 months' consumption for
indigenous items may be treated as current assets for the purpose of
assessment of working capital requirements.

(Circular IECD.No.PMD 231/7c.88/89 dt. 16 October 1988)

12. The above list of current liabilities and current assets is only
illustrative and not exhaustive.

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INCOME – STATEMENT

1. profit / loss account: statement of income and expenses, statement of

operation etc. are the other names of income statement.

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income-expenses = profit / loss is the simplest form of the income

statement. however income or expenses for a given period of time
consist of series of revenue or expenses transactions. if these
transactions are grouped systematically and compared, year wise, may
throw useful information for a banker to understand and analyze the
“operations” of the business concerns.

2. income statement is prepared for a given period generally one year. it

is prepared on the basis accrual concept. income earned but not
realized is included: so also expenditure incurred but not paid is
included and prepaid expenses are excluded.

there is no prescribed format for preparing p/l account. however

schedule vi – part ii of companies act 1956 enlists requirements and
the minimum disclosures, which are statutory.

3. let us understand and discuss the p/l statement as per credit

authorization scheme format. this is known as “operating statement”
and forms part ii or the cas format.

it may be noted that this statement is not named as income statement

or p/l account, but „operating‟ statement. this is so because only p/l
figure may not disclose actual position about the operations of the unit.
there may be loss but it could be for valid reasons. likewise there may
be substantial profits, which might have been possible because of
income arising out of activity other than main business activity. in both
these cases, the reliance on only net p/l figure may be misleading.
therefore apart from p/l figure, banker is also curious to know the
efficiency of unit in using installed capacity, streamlining of expenses,
increase in sale volume, gross cash generating capacity and so on.
therefore p/l account as per cas format is designed in such a way that
all desired information would be readily available to the banker.

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4. please refer the format of operating statement annexed to this chapter.

the operating statement can be divided into four sections: -

a. sales
b. trading / mfg. a/c
c. operating profit
d. net profit/loss.

5. the consumption of raw material is calculated as under. opening stock

+ purchases - closing stock.

this figure is to be calculated for imported and indigenous raw materials

separately and to be entered in the respective columns.

the holding level of raw material is calculated by using the formula as

given here under.

consumption of raw material

= monthly holding
12

let us understand these sections.

A. SALES

items 1 to 4 relate to sales activity. we desire to find out the „net sales‟
figure from gross sales figure. therefore items like excise duty, sales
returns should be excluded from gross sales to arrive at net sales
figure. the separation of sales into domestic and export would be
necessary. this gives an idea about the quantum of export sales in
total sales. accordingly banker can fix priority in the disposal of loan
proposal of export-oriented unit.

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B. TRADING / MANUFACTURING ACCOUNT: (ITEM 3 TO 5)

this part of operating statement includes all costs/expenses relating to

manufacturing or trading activity. all these costs are direct costs and
has relation with quantity of goods produced.

this cost when deducted from net sales, we get gross profit.

in case of manufacturing unit, the total of all direct cost known as „cost
of sales‟ i.e. cost of goods produced for sale (and not the sale price of
goods sold.)

item 5 [ i ] to [ vi ] covers all direct costs. to this figure when net stock
of work in progress is added. we get cost of production [5(x)]. we
can work out levels of holdings of work in progress on the basis cost of
production by using formula given below: -

wip 12
x
c of p 1

further, when we add net stock of finished good to cost of production

we get cost of sales. the levels of stock of finished good can be
worked out by using cost of sales figure.

fg 12
x
c of s 1

we get gross profit/loss when we deduct cost of sales from the net
sales. i.e. gross profit/loss = net sales – cost of sales

C. OPERATING PROFIT

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we get operating profit when indirect costs relating to sale such as

selling and general expenses, administrating expenses, etc. are
excluded from gross profit. it can be worked out before or after
interest.

D. NET PROFIT / LOSS

so far all direct or indirect costs relating to sales have been considered.
there may be other expenses such as donations, loss on sale of
assets/investments, fire/theft etc. or other income such as profit on sale
of assets /investments, commission, brokerage which do not arise out
of normal operation of the business. therefore such non – operational
income and expenses required to be considered separately.

similarly tax is of the head of expenses, which is not at all in the hands
of the management. government stipulates tax tariff.

we get net profit after adding net effect of non-operating income and
expenses and deducting the tax provisions.

the net profit is further transferred to p/l appropriation account. profit is

appropriated as per the decision of the management. the declaration
of dividend is the main feature, which interests the shareholders and
also the bankers, as it will affect the profit retained in the business. i.e.
plough back of profit by the concerned unit.

ANALYSIS OF OPERATING STATEMENT

1. having understood the main structure of operating statement, let us

discuss as to how the information / data can be analyzed.

it is to be noted that the study of operating statement for an isolated

year may not lead to any meaningful conclusion. it would be necessary

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to study comparative figures of, say, past 3 years minimum. this would
enable reader to reasonably establish some trends. in light of past
average performance the rational of the projections for the ensuing
year would be more clear and visible.

the operating statement can be analyzed as follows: -

2. SALES

A. sales in general should show an upward trend. percentage

increase in sales (item4) is a good indicator to judge the
progress made in stepping up the sales. however it is subject to
following limitations.

I. growth may be due to inflation and/or increase in price

level only. in reality production level might not have
increased.

II. the figure should be compared with industry level (if such
a data available). if it is above industry level, the
performance may be considered impressive.

III. if unit has reached point of optimum capacity utilization,

sale may not show noticeable growth.

B. export sales may be given special consideration. if more then

25% of sales consists of export sales, unit may be given
preferential treatment. the cash and sales incentives should be
treated as part of sales and not as „other‟ income.

C. projection of „sale target‟ for the following year is the „key‟ figure
of all the credit appraisal exercise. the requirement of credit

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appraisal exercise. the requirement of credit limits would

ultimately depend upon the levels of sales planned and
estimated. banker has to make sure that sale target projected is
realistic. it must keep pace with past trends, market potentials,
installed capacity, aggressiveness of the management to push
the sales etc. some times, sale target may be feasible but might
not have been supported with adequate share of owners in
bringing in matching contribution of own funds. thus if reliance
is on more borrowings from bankers and others, bankers has to
take careful decision.

3. COST OF SALES AND GROSS PROFIT

gross profit is the indicator of operational efficiency of the unit on the

floor. i.e. manufacturing or trading.

gross profit percentage for last three years may be compared

horizontally. improvement is a welcome feature. if there is decline, the
reasons should be traced back.

the fall may be because –

I. sales price may not have increased with increase in cost of
inputs
or
II. some of the heads of expanses may have been showing upward
trend. such heads should be identified and clarification may be
sought from the management.
the gross profit (or margin) may also be compared with industry level figure.
the gross profit / margin generally remains the same for all units because cost
of inputs would be almost same for all. for some reason if margin is less as
compared to industry level, it signals some shortcomings in the working of the
unit.

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for comparative study of various heads of expenses, the percentage method

may be used. all heads of expenses can be worked out as the percentage of
net sales of that year. the percentage figures of a particular head of
expenses, when compared horizontally gives fairly good idea about its
comparative increases / fall during the year under review. the
reasonableness of projection can also be properly judged by this method.

amongst various heads of expenses, the consumption of raw materials

(opening stock + purchases – closing stock) is an important figure because
generally the cost of raw materials is the major head of expense for industries.
any increase in % share of raw materials is not a good sign. the increase may
be due to problems in production process. the same may be ascertained. the
increase in cost of repairs and maintenance may suggest that condition of
plant and machinery may not be proper. increase in wage bill beyond normal,
may signal aggressiveness of work force.

depreciation is a non – cash expense. profit or loss figure can be adjusted

with changes/adjustments in depreciation. therefore it should be ensured that
depreciation is charged as per accepted practices and there is no change in
current year for the current year.

levels of closing stock work in progress and finished goods should be watched
carefully and it should be ensured that they are at normal holding levels. the
gross p/l figure can be adjusted, if need be, by adjusting the figure of closing
stocks, because valuation of the closing stock is done and certified by
management and not by auditors or bankers.

4. OPERATING PROFIT

I. selling and general expanses is a domain perfectly under control

of the management. while there is limited scope to reduce cost
of sales, the expenses under various heads of selling and
administration could be minimized or avoided. perhaps, if the

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goods produced are of good quality the expenses could be on

lower side. on the other hand if there is fierce competition or
goods are sub-standard, selling expenses may be on higher
side.

II. interest is incidental to the sums borrowed. the borrowing is the

decision of the management. strictly, interest is not a
operational cost but financial cost. therefore we work out
operating profit before interest and as well as after interest.
increase in burden of interest may be the result of not retaining
sufficient profits in business or fresh capital is not being injected
in the business. some times the borrowings from friends and
relatives are seen to be carrying interest rates higher than bank
rates.

III. operating profit is a indicator of profits generated through main

business activity because income and expenses relating to
business activity have been only considered. this is one of the
basic financial indicators to the bankers for their credit decisions.

5. NET PROFIT/LOSS

A. in operating statement heads of other non-operational income

and expenses have been separated from main business
operations. it may happen sometimes that unit may receive
sizable, „other‟ income due to say profits on sale of
investments/assets. resultantly it may be in a position to show
impressive figures of profits. bankers would not like to be
misleading by such a figures. therefore figures of other income
and expenses should be carefully scrutinized and it should be
made sure that such income or expense are incidental to normal
circumstances and there is no intention to divert from main
business activity.

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B. tax is a sensitive area. if tax tariff is on the higher side, we

should understand that the firm would find ways and means to
minimize tax burden. there is nothing wrong in doing so, so far
the means adopted are perfectly legal and not detrimental to the
interest of bankers, share holders, government etc.

C. please note that due to higher taxes, firm prefers to borrow more
than raising own capital (high gearing) because interest paid on
borrowing can be changed to profit/loss account.

D. study of p/l appropriation account is also equally important. it

suggest whether management acknowledges its role of
conserving working capital, strengthening reserves positions or
prefer to woo the share holders by declaring higher dividends
despite forbidding financial position.

whatever may be the management policy in appropriating p/l,

banker would have a definite say, if retained profits are not
sufficient to conserve working capital, maintain debt/equity ratio,
honor repayment schedules.

while summarizing, we may remember –

1. operating statement should not be looked upon as only the

indicator of p/l figure.
2. it gives an idea about the gross fund generating capacity of unit.
it helps in fixing repayment schedules.

3. we can make out whether profits are generated through main

business activity or through other income.

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4. the comparative study of various heads of expenses helps to

know whether unit is working efficiently.

5. we can judge the potentials of profitability of the unit.

6. it helps to judge the reasonableness of projected sale target and

other heads of expenses.

7. the exercise of „profit engineering” would be based on operating

statement only.

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ASSESSMENT OF WORKING CAPITAL

REQUIREMENTS

FORM II : OPERATING STATEMENT

NAME : AMOUNT RS. IN LACS
ESTIMATES FOR THE YEAR ENDING
/ENDED
19.. 19.. 19.. 19..
LAST 2 YEARS CURR. FOLLO
ACTUAL (AS PER YEAR W-ING
AUDITED ESTIMAT YEAR
ACCOUNTS) ES PROJ.

1. GROSS SALES 1 2 3 4
I. DOMESTIC SALES
II. EXPORT SALES
TOTAL
2. LESS EXCISE DUTY
3. NET SALES (1-2)
4. % RISE (+) OR FALL (-) IN NET
SALES AS COMPARED TO
PREVIOUS YEAR.
5. COST OF SALES

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I. RAW MATERIALS
(INCLUDING STORES
AND OTHER ITEMS
USED IN THE
PROCESS OR
MANUFACTURE
A IMPORTED
B INDIGENOUS
II OTHER SPARES
A IMPORTED
B INDIGENOUS
III POWER & FUEL
IV DIRECT LABOR
(FACTORY WAGES &
SALARIES
V OTHER MFG.
EXPENSES
VI DEPRECIATION
VII SUB-TOTAL (I-IV)
VIII ADD: OPENING STOCK
IN PROCESS
SUB-TOTAL
IX DEDUCT: CLOSING
STOCK-IN-PROCESS
X COST OF PRODUCTION

XI ADD: OPENING STOCK

OF FINISHED GOODS
SUB – TOTAL
XII DEDUCT CLOSING
STOCK OF FINISHED
GOODS

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XIII SUB-TOTAL (TOTAL

COST OF SALES)
6. SELLING GENERAL &
ADMINISTRATIVE EXPENSES
7. SUB-TOTAL (5-6)
8. OPERATING PROFIT BEFORE
INTEREST (3-7)
9. INTEREST
10. OPERATING PROFIT AFTER
INTEREST (8-9)
11. I. ADD OTHER NON-
OPERATING INCOME
A.
B.
SUB-TOTAL (INCOME)
II DEDUCT OTHER NON-
OPERATING
EXPENSES
A.
B.
SUB-TOTAL
(EXPENSES)
III NET OF OTHER NON-
OPERATING INCOME/
EXPENSES (NET OF 11
( I )& 11 ( II )
12. PROFIT BEFORE TAX/LOSS
(10+11 (III)
13. PROVISION FOR TAXES
14. NET PROFIT /LOSS (12-13)
15. A. EQUITY DIVIDEND PAID
B. DIVIDEND RATE

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16. RETAINED PROFIT (14-15)

17. RETAINED PROFIT /NET
PROFIT (1)

RATIO ANALYSIS

“Ratio Analysis are not ends in themselves, rather on a selective basis they
may help answer significant questions” – Erich A. Helfert.

INTRODUCTION:

Ratio-analysis is a concept or technique, which is as old as accounting

concepts. Extensive studies on the choice and use of productivity, finance
and operating ratios are made. Financial analysis is a scientific tool. It has
assumed important role as a tool for appraising the real worth of an
enterprise, its performance during a period of time and its pit falls. Financial
analysis is a vital apparatus for the interpretation of financial statements. It
also helps to find out any cross – sectional and time series linkages between
these ratios.

Ratio-analysis means the process of computing, determining, and presenting

the relationship of related items and groups of items of the financial
statements. They provide in a summarized and concise form a fairly good
idea about the financial position of a unit. They are important tools for
financial analysis.

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The bankers use the information contained in the ratio for the purpose of
control and monitoring. Bankers are concerned with the unit‟s ability to re-pay
its interest, installment obligations in time and abide by the terms and
conditions of sanction during the time the loan is outstanding. Bankers are
also interested in determining the financial strength of the company and its
performance. A ratio relates absolute figures and brings out the meaningful
information. Ratios are processed data. When ratios are calculated the
attention of the analyst is drawn towards the numerator and the denominator,
which will indicate to him the manipulability of each variable for the purpose of
making any improvement on the ratio. The manipulability of the ratio depends
upon the relationship between the two variables. In case where the two
variables are mutually independent, then it is very difficult to manipulate one
variable by keeping the other constant.

Absolute figures do not convey much meaning to the analysis; one is able to
appreciate the significance if he relates to the other figures. For example to
understand the profit generating capacity of a company, the amount of capital
employed is also to be seen. Thus ratio analysis helps to describe the
significant relationship between any two figures in the financial statements.
Ratio analysis can provide insight into the important areas of management
like (1) Return on Investments (2) Soundness of company‟s financial position
(3) clues as to the areas which are to be focused in the subsequent analysis.

CLASSIFICATION OF RATIOS

The ratios can be classified into:

1. Balance Sheet ratios

2. Profit and loss account ratios
3. Inter-statement ratios – a combination of P & L and Balance sheet.

They are also classified on functional basis:

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4. Profitability ratios
5. Turn-over ratio (Activity ratios)
6. Liquidity ratios
7. Leverage ratios.

USES OF RATIOS

Ratios are important indicators of the financial capacity of an organization to

meet its commitments. The analysis can be done either internally by an
organization, which will be a detailed one, or externally by people outside the
organization like creditors, investors, etc. on the basis of information available
in the published financial statements. Ratio analysis is a quantitative
technique in financial management. This is a technique for assessing the
financial health of a unit from the accounting data. This is a tool for
credit/project appraisal for bankers and financial institutions. This measures
the past performance of an organization and helps projecting the future
trends.

Selection of proper standards is a very important element in ratio analysis.

There are four types of standards against which an actual figure can be
compared.

1. Historical Standards: Comparison is done of current performance

with past figures of the same company.

2. External Standards: When one company is compared with another,

the environmental and accounting differences affecting the two sets of
figures may raise serious problems of comparability. The analyst
should allow for these differences. Comparison can also be made with
the averages for the industry, if figures are available.

3. Experience: An analyst gradually builds up his own idea as to what

constitutes “good” or “poor” performance, thus subjective standards of

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a competent analyst are more important than standards based on

mechanical comparisons.

4. Goals: Many companies prepare budgets, which show what

performance is expected to be under the circumstances prevailing. If
the actual performance corresponds with budgeted performance, there
is a reasonable inference that the performance is good.

The ratios themselves have little meaning and to extract most meaningful
comparison with previous months/years or benchmarks of other companies is
needed. Before looking at the ratios there are a number of cautionary points
concerning their use that need to be identified:

a. The dates and duration of the financial statements being compared

should be the same. If not, the effects of seasonality may cause
erroneous conclusions to be drawn.

b. The accounts to be compared should have been prepared on the same

bases. Different treatment of stocks or depreciation or asset valuations
for example will distort the results.

c. In order to judge the overall performance of the firm a group of ratios,

as opposed to just one or two should be used. In order to identify
trends at least three years of ratios are normally required.

The utility of ratio analysis will get further enhanced if following comparison is
possible.

1. Between the borrower and its competitor.

2. Between the borrower and the best company in the industry.
3. Between the borrower and the average performance in the industry.
4. Between the borrower and the global average.
5. Between two years.

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6. Between two months/quarters.

Ratio analysis gives overall evaluation of the company‟s health.

Ratio analysis is not an end by itself. This is only a starting point in our
endeavor to know the performance of an organization vis–a–vis its objectives.
At best, this analysis can throw up the symptoms of the problems, if any, and
this enables the analyst to look into their causes. In other words, the ratios
are used for further investigation rather than to make final judgments. The
findings based on ratio analysis has to be studied along with the findings of
other quantitative techniques like funds flow analysis, cash budgeting, etc. as
also other relevant financial and non-financial data. Thus, ratio analysis is
one of the important management tools available that aids decision-making.

LIMITATIONS OF THE ANALYSIS:

1. Ratios are not standard formula for judging the performance. They can
only guide, since management problems are so complex that they
cannot be reduced to a formula.

2. The make–up of ratios should be chosen with care. Otherwise the

relationship may be misleading.

3. While ratios are compared on an historical basis, the time periods may
be of equivalent duration, but price level changes between the periods
may distort the results if no allowance is made for this factor.

4. Since the analysis is based on the financial statements, this will have
all the limitations, which the financial statements themselves have (e.g.
Balance sheet is as on a particular date and hence there is a possibility
of window-dressing. Balance sheet is not a valuation statement. It
gives value of assets in–use and not in–acquired at different points of
time. Fictitious assets are also given in the balance sheet. Non–

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financial changes, although, very important from the point of view of

business are not reflected).

5. Ratio based on profit, which is generally used as an indicator of

effectiveness and efficiency, has certain limitations. For example, profit
measures current rather than long–run performance. There is also no
reliable way of measuring the profit potential of a business as to
compare the reported profit with the profit that could have been earned
under the circumstances.

6. Generally Accepted Accounting Principles give wide latitude in

measuring profit in a company. This dilutes the validity of inter–firm
comparisons.

Nevertheless, ratio analysis is a useful aid and could be used along with other
quantitative techniques in financial management to assess the financial health
of an organization.

IMPORTANT FINANCIAL RATIOS FOR BANK

1. Liquidity Ratios

(i). Current Ratio = Current Assets

-------------------------
Current Liabilities

Current Assets: Raw material, Stores, Spares, Work-in-progress, Finished

Goods, Debtors, Bills Receivables, Cash.

Current Liabilities: Sundry Creditors, Installments of T/L, DPG, etc. payable

within a year and other liabilities payable within a year.

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This ratio of 1.33: 1is generally preferable to ensure minimum margin of 25%
of current assets as margin from long-term sources. Under method I of
Tandon Committee it will be 1.17: 1 and it will be 1.25: 1 as per turnover
method.

 Measures short – term liquidity of the company and its ability to meet its
short terms obligations within a time span of a year.

 Shows the liquidity position of the enterprise and its ability to meet current
obligations in time.

 Higher ratio may be good from the point of view of creditors. In the long
run very high current ratio may affect profitability. (E.g. High inventory
carrying cost)

 Quality of current assets is not measured. Hence Quality composition of

various types of current assets has to be seen while interpreting this ratio.
The ratio indicates only the quantitative coverage.

 Shows the liquidity at a particular point of time. The position can change
immediately after that date. So trend of the current ratio over the years is
to be analyzed.

 Current ratio is to be studied along with the changes of Net Working

Capital [NWC]. It is also necessary to look at this ratio along with the
Debt-Equity ratio.

Total outside liabilities

Tangible Net worth

In short it indicates the extent to which short-term creditors are covered by

assets that are expected to cash in a period roughly corresponding to the
maturity of assets.

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2. Leverage Ratios or Solvency Ratios

These ratios are also known as Gearing or financial leverage ratios.

Measures the long–term financial stability of the company. It reflects on the

capacity of business unit to assure the long-term creditors with regard to their
repaying capacity of both interest and installment. It also reveals whether
there is satisfactory balance between owned funds and borrowed funds. The
ratio can be 2.
Long Term Liabilities
i. Debt: Equity = -----------------------------------
Tangible Net Worth

Total outside liabilities

Total Debt: Equity = -----------------------------------
Tangible Net Worth

Debt should come down over a period of time in relation to equity, indicating
plough back of profits.

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EVOLUTION OF WORKING CAPITAL FINANCE

From lending exclusively against the security of collaterals to financing future

receivables, Indian banking has come a long way. The metamorphosis
brought about by Reserve Bank through appointment of various committees
was done with a view to streamline credit delivery system of commercial
banks so as to fall in line with international practices.

DAHEJA COMMITTEE

Appointed in 1968 came, to the view that bank lending was unrelated to
borrowers‟ actual needs or activities as it was extended based on financial
worth of borrower, collateral security and guarantee offered. The result was
that there was concentration of bank finance to industrial sector. As a sequel
to committee‟s recommendations, RBI issued guidelines for systematic
appraisal of working capital requirements of the industrial borrowers.

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TANDON COMMITTEE (1975)

It recommended scientific approach for considering credit requirements of

borrowers. The appraisal should be based on production plan, lead time for
supplies, economic ordering levels and a reasonable level of receivables and
other current assets. The Committee suggested three methods for fixing
maximum permissible bank finance. The methods provide for a progressive
increase in the contribution from the borrower‟s long-term sources for
financing current assets. Maximum permissible bank finance was to be
bifurcated in loan and fluctuating cash credit component norms for holding of
inventory and receivables were also prescribed.

CHORE COMMITTEE (1978)

Borrowers having working capital limits of Rs.10 lakhs and above should be
compulsorily brought under the Second Method of lending Working Capital
limit should be fixed on the basis of normal „non peak level‟ as well as „peak
level‟ requirements. Borrowers with working capital limits of over Rs.10 lakhs
were required to submit „Monthly Select Operational Data: Banks were asked
to fix operational limit on the basis of Quarterly Information System returns.

NAYAK COMMITTEE (1993)

The working capital requirements of village industries, tiny industries and

other SSI units enjoying aggregate fund based working capital credit up to
Rs.50 lakhs from the banking system should be computed on the basis of a
minimum of 25 per cent of their projected annual turnover for new as well as
existing units, of which at least four-fifth should be provided by the banking
sector and the balance one-fifth should be borrower‟s contribution towards
margin for the working capital. The norms of inventory and receivables as
also first method of lending will not be applicable to such units. This method of
computation of working capital finance suggested by the Nayak Committee
has since been rechristened as „Turnover Method‟.

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IN HOUSE COMMITTEE (OCTOBER 1993):

The guidelines set out for arriving at working capital facilities, for village and
tiny industries and other SSI units enjoying fund-based working capital limits
up to Rs.50 lakhs, on the basis of minimum of 20 per cent of their projected
annual turnover were extended to all borrowers enjoying aggregate fund-
based working capital limits of less than Rs.1 crore from the banking system,
which was raised to Rs.2 crores with effect from May 1997 as per slack
season Monetary and Credit Policy 1997-98 of Reserve Bank.

As per the pronouncements made by Finance Minister in his budget

speeches, the limit for fund based working capital credit finance of SSI Units
to be fixed under „Turnover Method‟ stands raised to

1. Up to Rs.4 crores from June 1998 and further

2. Up to Rs.5 crores with effect from April 1999

Freedom to Banks to determine working capital credit requirements of

borrowers:

In Monetary and credit Policy for the first half of 1997-98 announced on April
15, 1997, Reserve Bank informed Commercial Banks about the withdrawal of
prescription in regard to assessment of working capital needs based on
maximum permissible bank finance (MPBF) enunciated by Tandon Working
Group, and advised them to evolve an appropriate system for assessing the
working capital credit needs of borrowers, within the prudential guidelines and
exposure norms already prescribed. The revised Method of Lending adopted
by Central Bank of India and Dena Bank in response to the freedom granted
by RBI, appears elsewhere in the booklet.

Reserve Bank has also prescribed that:

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a. Borrowing units engaged in export activities need not bring in any

contribution from their long-term source towards financing that portion
of current assets as is represented by export receivables.

b. Additional credit needs of exporters arising out of firm orders of

confirmed letters of credit (and which were not taken into account while
fixing the regular credit limits of borrowers) should be met in full even if
sanction of such additional credit limits exceeds MPBF.

c. Borrowing Units marketing/trading exclusively (100 per cent) the

products and merchandise manufactured by village, tiny and SSI units
will be subject to the First Method of Lending while assessing their
MPBF provided dues of the said village, tiny and SSI Units have been
settled by such borrowers within a maximum period of 30 days from the
date of supply.

d. Credit limits of borrowing units in the sugar industry may be determined

on the basis of current ratio of 1.1untill further advice.

e. Sick/Weak units under rehabilitation will be exempt from the application

of the Second Method of Lending.
CALCULATION OF MAXIMUM PERMISSIBLE BANK
FINANCE:

First Method of Lending Second Method of Lending

Total current assets (CA) Total current assets (CA)

Less Current liabilities Less Current liabilities
Excluding bank borrowings excluding bank borrowings
(OCL) (OCL)
----------------------------------- ---------------------------------------

Working Capital Gap (WCG) Working Capital Gap (WCG)

Less: 25% of Working Capital Less: 25% of total current assets
Gap or

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Net working Capital or

(NW i.e. (CA-CL) Net Working Capital
Whichever is higher (NW i.e. CA-CL)
Whichever is higher?
----------------------------------- -------------------------------------------
Maximum Permissible Maximum Permissible
Bank Finance Bank Finance
----------------------------------- ---------------------------------------------
Min. Current Ratio 1.17:1 Min Current Ratio 1.33:1

WORKING CAPITAL: REVISED METHODS

DENA BANK’S APPROACH

As part of financial sector reforms, Reserve Bank of India granted operational

freedom to commercial banks to evolve an appropriate system for assessing
the working capital credit needs of borrowers within the prudential guidelines
and exposure norms already prescribed. Accordingly Dena Bank at its Board
meeting held on 8.1.1998, approved the revised methods of assessment of
working capital limits as explained hereunder.

1) Turnover Method

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Fund Based Working Capital limits up to Rs. 5 crores will be assessed

under Turnover Method.

2) a) Modified MPBF Method or

b) Cash Budget Method

Fund Based working capital limits of Rs. 5 crores and above will be
assessed under Modified MPBF Method or Cash Budget Method, at
the discretion of the Bank.

TURNOVER METHOD

The methodology for computation of working capital limits has been

explained in the chapter “Turnover Method” appearing elsewhere in the
booklet. The projected annual turnover figure should be realistic and in
the opinion of Branch Manager, achievable. The reasonableness of
projections should be satisfied by comparing with sales recorded
during the past 2/3 years, industry growth etc. Achievement of
projections in the past, setting up of additional capacity, change in
Government policy, large/bulk recurrent orders on hand etc. may be
given due weightage while accepting projections.

The computation of working capital finance should be done both under

“Turnover Method” and Traditional Method” and the “need based” limit
should be fixed. It is proposed that the current ratio of 1.33:1 will now
be the Bench Mark and not the minimum requirement, with the
desirable current ratio fixed at 1.15:1.

For all borrowers with working capital limits up to Rs. 10 lacs, the CAS
form need not be insisted upon. However the borrower will have to
submit projected balance sheet and P&L account. For borrowers with
limits of Rs. 10 lacs and up to Rs. 5 crores, the existing forms as

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prescribed by RBI would continue to be submitted/applicable except

Form No. V i.e. computation of MPBF for working capital sheet.

MODIFIED MPBF METHOD

The existing MPBF method based on norms of inventory and

receivables had inherent defect of rigidity. Modified MPBF Method has
replaced this method. Under the Modified MPBF method the norms
prescribed by Tandon Committee for the level of inventory and
receivables stand withdrawn. The projected levels of inventory and
receivables would now be based on actual level in the past with
developments like establishment of additional capacity, diversification
by way of addition to product lines etc given due weightage while
determining holding levels. In case of new units, since no past data
would be available, the holding level will be based on future projections
only (wherever available comparative data of similar units may be
taken as base).

The working capital limits would continue to be assessed under second

method of lending with slight modification in definition of current assets
and current liabilities listed hereafter. There is no change in CAS
format except that on page No. 8 compliance under Inventory &
Receivables level in the columns.

It is proposed that the current ratio of 1:33:1 will now be the Bench
Mark and not the minimum requirement, with desirable current ratio –
fixed at 1:25:1.

CASH BUDGET METHOD

While the borrower would have option to be assessed either under the
Cash Budget or Modified MPBF method, the discretion to accept
assessment based on Cash Budget Method would be that of the Bank.
This discretion will be exercised depending upon the quality of data

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submitted by the corporate borrower. In other words only where the

data is adequate, timely and satisfactory, the borrowers request for
being assessed under Cash Budget Method would be considered by
the Bank.

A corporate borrower put under Cash Budget System would have to

submit monthly profit and loss account, the Balance Sheet and the
projected cash budget for the next 12 months along with details of
assumptions behind the projections. The working capital limits would
be based on Monthly Cash Deficits. The peak or maximum cash deficit
over the next 12 months would be the working capital limits. The
borrower would have to give the Cash Budget separately for operation
and all other non-operational areas such as investment in long-term
assets of new projects etc. would have to be excluded from the
operational Cash Budget. The bank would finance 100% of maximum
monthly deficit. The drawings would be monitored on the basis of
Quarterly Budget to be submitted by the company before the
commencement of the quarter. For the purpose of arriving at drawing
power, usual margin stipulation would apply. The success of the cash
budget would depend upon the proper analysis of the cash budget –
both past actual and projections. Current ratio of 1.33:1 will be the
Bench Mark and not the minimum requirement with desirable current
ratio fixed at 1.25:1.

a) Loans from friends and relatives:

50% of unsecured loans from friends and relatives can be treated as

quasi capital. Quasi capital should not exceed the owner‟s fund.
Owner‟s funds mean paid up capital + free reserves excluding
revaluation reserves minus intangible assets. Ship breaking industry,
construction industry and other similar industries will be exempt from
this stipulation. Appropriate letters/undertakings are to be obtained not

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to withdraw the loan without prior permission of the Bank during the
currency of bank loan.

The Bank has discontinued the practice of treating loans from friends
and relatives as quasi capital for the purpose of credit analysis with
effect from 11th March 2000 except in the case of traders and has fixed
benchmark in terms of total debt equity ratio (TOL/TNW) for different
types of borrowers.

Category of borrower Bench Mark

1. Industries (Medium & Large) 3:1
2. Industries (SSI) 3.5:1
3. Traders 4:1
4. Ship breaking 6:1
5. Service industry 4:1

The existing borrowers whose unsecured loans were treated as quasi

capital while assessing the credit limits will have to bring in adequate
funds in place of unsecured loans so as to comply with the prescribed
benchmarks latest by 31st March 2001.

b) Interest Coverage Ratio

This is a risk parameter and an indicator to the extent to which the

interest liability will be serviced on time. Interest for this purpose would
mean gross interest payable by the borrower and profit would mean the
gross profit before interest. Interest coverage should be minimum 2.25
times.

c) Classification of Current Assets & Liabilities

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The following modification has been done in classification of Current

Assets & Current Liabilities.

- Cash margin for LC/Guarantees (maximum 1 year period) will

be treated as Current Asset
- Bills negotiated under LC and Export Receivables though
Current Assets would be excluded from NWC for the purpose of
assessment of MPBF.
- Inter Corporate Deposits (ICDs) taken will be current liability
- Investment in FD (unencumbered) with banks including trustee
securities will continue to be current assets
- Installments of term loan due in one year are reckoned only for
the purpose of current ratio and not for computing MPBF as per
existing procedure
- Investment in
shares/debentures/advances/association/subsidiary will
continue to be non-current assets.

d) Supervision and Follow-up.

MSOD and QIS statement have been withdrawn. Fixation of quarterly

operative limit based on QIS statement is also similarly withdrawn.
However, QIS statements are now replaced, by a new set of “Financial
Follow-up Report” statement II and I. This will be applicable to
borrowers with credit limit of Rs. 1 crore and above. Though late
submission of these statements would not attract penal interest, it must
be ensured that the borrowers for control purpose submit the
statements. Borrowers whose working capital limits are assessed
under the Cash Budget Method must submit Quarterly Cash Budget
before the commencement of the quarter for monitoring the drawing.

e)

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i. Commitment charges for unutilized portion of fund based

working capital limits are withdrawn in view of credit delivery
system.

ii. Penal charges for non-submission/delayed submission of QIS

are similarly withdrawn.

iii. Any adhoc limit will continue to be part of total MPBF/assessed

working capital limit.

iv. Regarding selective credit control, guidelines of RBI would

continue to be applicable.

v. For sugar industry, the current ratio requirement would be as per

RBI stipulation.

CENTRAL BANK OF INDIA’S APPROACH

As part of financial sector reforms, Reserve Bank of India in its Monetary and
Credit Policy, for the first half of 1997-98, bestowed operational freedom in the
area of credit dispensation upon banks. The prescription in regard to
assessment of working capital needs based on the concept of maximum
permissible bank finance (MPBF) enunciated by Tandon Committee was
withdrawn and banks were advised to evolve an appropriate system for
assessing the working capital credit needs of borrowers subject to observance
of prudential guidelines and exposure norms already prescribed.

In tune with liberalized environment, Central Bank of India has adopted the
following system for assessment of working capital requirements of the
borrower.

Turnover Method

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Fund based working capital requirements

i) Up to Rs. 1 crore for non-SSI borrowers

ii) Up to Rs. 5 crores for SSI borrowers
iii) For assessing credit requirements of Trading Concerns upto Rs
1 crore, a simplified format introduced by the Bank including the
methodology prescribed therein should be followed.

Traditional Method

Fund based working capital requirements

i) Rs. 1 crore and above but less than Rs. 50 crores for non-SSI
borrowers
ii) Rs. 5 crores and above but less than Rs. 50 crores for SSI
borrowers should be assessed under Method II of Tandon
Committee.

Cash Budget Method

i) Cyclical industries like tea, sugar etc.

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

METHODOLOGY

Turnover Method

The methodology for computation of working capital under this method

is explained in the chapter on „Turnover Method‟ appearing in the
booklet. The entitlement of the borrower should be computed both

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under “Turnover Method” and “Traditional Method”. Where the

entitlement under “Turnover Method is higher than that under
“Traditional Method”, need based limit should be fixed.

Traditional Method (Modified MPBF System)

Traders (Stockiest)

1) The credit requirements will be assessed on the basis of past

indicators and future projections.
2) The current ratio should be min. 1.33 with deviation upto 1.20
permitted during peak trading periods.
3) Subordinated debt/quasi-capital with usual declaration may be
treated as part of capital employed.
4) TOL: TNW up to 4:1 may be allowed subject to availability of
collateral securities to cover the entire bank credit.

Modified MPBF System

The Tandon Committee Norms on holding levels of inventory and

receivables have been dispensed with. Holding levels as per the past
practice will continue to be the basis under the modified system. While
the projections should reasonably conform to the past trends,
deviations can be accepted subject to satisfactory justification.

Diversion of Funds

In case of borrowers with a current ratio above 1.50, the bank may
permit investments that will facilitate improved profitability, tax savings,
growth etc provided such investments are planned and projected in
financial statements furnished to the Bank subject to the condition that

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the current ratio does not fall below 1.50 and under no circumstances
below 1.33. Where the current ratio falls below 1.33, the existing
penalties for diversion of funds should be invoked.

Loan Delivery System

Where the MPBF entitlement is Rs. 10 crores and above, RBI

guidelines on Loan Delivery System will be applicable

The Cash Budget Method

The borrower is required to submit the cash budget to the bank along
with actual as well as projected financial statements. The budget in the
prescribed format is to be prepared for a period of one year and then
split into forecasts for shorter periods say monthly or quarterly. The
budget will provide the following information.

1) The peak level of bank finance required during the course of the
year.
2) The current level of bank finance required as forecasted by the
split budget (on monthly / quarterly) basis.

I. Appraisal by the bank

The budget must be scrutinized vis-à-vis the financial statements to

satisfy that the forecasts are reasonable. Once the forecasts are found
acceptable, the credit limit required by the borrower is to be determined
as the peak level of cash deficit as shown in the budget. The
sanctioning of the limit will be subject to observance of the following
benchmarks.
1. Maintenance of Current Ratio – desired level 1.33
2. The Debt: Equity Ratio (TTL: TNW) normally not to exceed 2:1

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3. Borrower/Group exposure to be within norms determined by the

Bank internally, but within the Reserve Bank of India
parameters.
4. The appraisal will also include assessment of the Company
profile and Industry profile.
5. There has to be an evaluation of risks at the time of fixing
lending limits and if felt expedient, the level of operations and
cash budget projections will be pruned down by the Bank at the
time of discussions before finalizing credit limits.
6. The disbursal of credit facilities will be by way of Loan and Cash
Credit components as per stipulation of Loan Delivery System.
Flexibility will be allowed in fixing maturity periods of the loans,
which can correspond to the quarterly budgets if the borrowers
so choose. Once the maturity period is fixed, prepayment of the
loan component, if required, shall be subject to RBI guidelines
and also payment of a penalty upto 2% of the prepaid loan
amount for the un-expired period, as may be decided by
sanctioning authority at his discretion.
7. Credit facilities on preferential terms like export credit should be
assessed and disbursed in terms of existing procedure.
However, the total of such facilities and all other fund based
facilities availed should be within the limits sanctioned under the
Cash Budget.

Note: The method of assessment as above includes only determination of

working capital finance. Means of finance for long-term requirements will have
to be assessed separately. Similarly, requirement of Non Fund Based facilities
will be assessed as per existing practice, and it has to be ensured that the
operations in L/C limits are dovetailed with the cash budget.

MONITORING OF ACCOUNT:

The credit limit sanctioned will correspond to the peak level of cash deficit,
and the availment of limit should be monitored at the operating level to ensure

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that the drawings are as per forecasts for the short term. It would be advisable
to fix monthly/quarterly-operating limit as projected by the cash budget. The
borrower will also be required to furnish the actual at the end of each short-
term budget, which should be monitored to see that progress of working is as
per projections.

The other monitoring tools, like regular stock inspections, etc will continue to
be employed.

Commission Agents
The credit requirements of the individual borrower should be assessed
on the basis of financial projections subject to availability of collaterals and
D.E (TOL/TNW) ratio of about 2:1. Subordinated debt/quasi capital in the form
of loans from family members and friends may be treated as a part of capital
employed subject to objection of an undertaking that such funds will be
retained in business during the currency of bank finance. The quantum of
bank finance should be restricted to operating expenses.

FOLLOW-UP OF ADVANCES

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INTRODUCTION:

Keeping pace with the developments in economic and industrial fronts, the
Banking Industry has undergone rapid transformation during the last two
decades. A banker is now required to take cognizance of concepts like (a)
diversification of credit areas; (b) meeting socio-economic needs; (c) reducing
inter-regional disparity in development; (d) need-based lending on the basis of
viability; (e) purpose-oriented lending; (f) providing stake in the financial
strength and operations of the borrower; (g) disciplined use of credit
resources (h) increasing the profitability (I) keeping quality of lending portfolio
etc. Hence, it has become important for a banker to involve himself in the
financial operations of the borrower to ensure that the unit is running in proper
direction. This can be accomplished only by a meaningful follow up of the
borrowers‟ operations. The objectives of follow-up, thus, may be stated: (1)
controlling end-use of credit; (ii) ensuring good health of the account
throughout (iii) safety of advances; (iv) checking diversion of funds; (v) seeing
that borrowers observe financial discipline (vi) Identifying early alarm signals
and initiate remedial action. The follow up of advances is a continuous
process and not a one-time job. An effective follow up system can show
danger signals if the account is not running in desired direction and helps the
bank to take immediate corrective measures.

The proposal for advances is sanctioned on several assumptions, regarding

integrity of the borrower, purpose of the loan, end use of funds and financial
discipline. Certain assumptions are made about production schedule, activity
levels and marketing efforts. Follow-up gives first hand opportunity to re-
examine the assumptions on which the original proposal was sanctioned. This
will include actual results, Profit & Loss Account and Balance Sheet, Cash
Flow, Operating Statements and other financial data to reassess, the
assumptions and renewal of facilities with necessary corrections.

The security against which the loans are sanctioned is a cushion to fall back
upon in case of contingency. Follow-up includes proper supervision and

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control over security and inspection from time to time to ensure the good
condition and marketability of the securities.

While demand for bank funds is ever increasing, social objectives accepted by
the banks demand judicious allocation of available funds. Follow-up provides
opportunities to reassess the same and arrange for redistribution of funds
based on need-based approach.

AREAS OF FOLLOW-UP

The follow-up areas may be identified as under:

A. Communicating borrower about sanction:

Firstly, it is desirable to inform the borrower about the sanction of
proposal in writing, along with the terms and conditions and guarantor,
if any. It is better to accept an acknowledgement, from the borrower.
The letter should contain the following points.

1. Amount of sanction with sub-limits, if any.

2. Margin
3. Rate of Interest
4. Nature of Security and Charge
5. Names of Guarantors
6. Repayment Schedule
7. Insurance
8. Date of Renewal of Facility
9. Submission of necessary information systems required by
banks.

Any special terms or conditions such as Import Licenses, Raw Material,

Debt Equity, introduction of new capital, technical know-how, plough
back of profits, dividend policy, marketing arrangement, managerial

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competence, lien on assets, bridge finance, etc should be mentioned in

sanction letter clearly.

A register of advances sanctioned to be maintained with all details.

In case of a running unit, it is advisable to make it known to the

concern that any decision regarding operation of the unit, which are
likely to affect the income generating capacity or structure of assets
and liabilities should be taken with the knowledge and approval of the
lending institutions.

Following are some of the instances:

1. Additional acquisition of fixed assets

2. Expansion Plans
3. Borrowing from outside sources
4. Investment in subsidiaries
5. Dividends out of years earnings
6. Extending guarantees to sister concern
7. Earlier repayment of loans before maturity to financial
institutions
8. Disposal of assets

DOCUMENTS

The execution of documents in proper form according to the requirement of

law is known as documentation.

Before disbursement of an advance to the borrower, proper documents are to

be obtained from the borrower and guarantor, if any. The twin objectives for
obtaining documents, viz. to bind the borrower and guarantor‟ and „to create
effective charge on securities‟ are to be kept in mind. Following points should
be borne in mind while obtaining documents.

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a) Complete set of documents in standard formats should be obtained.

b) No blank document should be obtained. The documents should be

filled up before execution and documents should be executed always in
representative capacity of the borrower/guarantor.

c) The documents should be duly stamped before execution.

d) No addition/alterations should be made after execution of documents.

The executants should duly authenticate any alteration.

e) The documents should be executed before an Officer of the Bank. The

officer should certify in a separate paper that the documents executed
were duly read and understood by the executants and the same should
be enclosed with the document set. In case the borrower could not
understand English, then the documents are to be explained to him in
his vernacular language and a certificate to this effect has to be
enclosed with the documents.

f) Superfluous documents need not be taken since if the basic document

turns out to be defective, no superfluous document can safeguard
bank‟s interest. It is prudent to take appropriate document set only
keeping in view the objectives for obtaining documents.

g) In the case of consortium accounts documents should be obtained as

prescribed by Indian Banks Association.

h) The documents so obtained should be entered into the security register

and should be got verified by Chief Internal Auditor or Panel Advocate
as per the policy of the Bank.

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i) The comprehensive Insurance Policy with bank clause should also be

obtained along with documents.
j) The entire set of documents is to be renewed before expiry of the
existing documents.

k) Acknowledgement of Debt should be obtained every six months

including from the guarantors if any. In case of Limited Companies, the
appropriate documents should be executed under the common seal of
the company along with the copy of resolution of the Company.

l) Every time the limits are increased to the borrower fresh set of
documents are to be taken and in case of corporate a/c it should be
registered with registrar of companies with regard to modification etc.
The required fee paid should be kept along with the documents as a
proof of having done so.

CONFIDENTIAL LIMIT BOOK

The Confidential Limit Book contains information relating to the limits

sanctioned, authority of sanction, terms and conditions of the sanction,
documents etc. This book gives a fair idea about the sanction and documents
of an advance at a glance. This book is to be updated every time when there
is a change.

FILING CHARGE WITH REGISTRAR

In pursuance to Sec.125 of the Indian Companies Act, when advance is made

to a Limited Company, charge is to be registered with the Registrar of
Companies.

In pursuance to Sec 135 of the Indian Companies Act, when any modification
is to be registered with the Registrar of Companies Bank will lose priority to
other creditors if charge is not properly registered as per the requirements of

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law as stated above. The charge has to be registered/modified within 30 days

(as per the latest amendment) from the date of creation of charge.

INSURANCE

While disbursing any advance, comprehensive insurance policy with a bank

clause should be obtained. The details of policy, such as Policy No., Date,
and Risks covered, Amount, Date of Expiry, Name of the Insurance Co. with
branch etc. are to be entered into the Insurance Register. Verify whether
borrower‟s name and address of the go down is properly mentioned in the
policy. If not necessary endorsements are to be obtained from the insurance
company to this effect. If a claim is lodged to the Insurance Company, bank
should follow-up the claim and ensures that claim is disbursed through bank
only.

DISBURSEMENTS ACCORDING TO TERMS

The loan sanctioned should be disbursed according to the terms and

conditions stipulated in the sanction. If the branch wants to waive some
conditions, already stipulated, on the basis of representation from the
borrower, permission from appropriate authority should be obtained for the
same before disbursement. The terms of advances should be officially
informed to the borrower and confirmation should also be obtained from him.
Such a confirmation letter will be of help in case the bank resorts to legal
recovery proceedings in a future date.

In case of term loans, borrowers are to be advised to keep the margin amount
in their account. The branch should issue a pay order to the supplier of
machinery/article directly. The details of the pay order are to be noted down in
the loan ledger clearly for quick reference at a future date. The details of the
machinery are also to be noted and verified by the purchase bill so that
identification of machinery becomes easier. Installments should be intimated
to the borrower and any default should be followed-up by demand notice
immediately.

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STOCK STATEMENTS

The submission of stock statement by borrowers on regular monthly basis is

to ensure that the advance is always covered by adequate inventory and the
banker should satisfy himself that this arrangement is fully complied with.
Bank usually conducts regular inspection based on the stock statements to
verify the availability of stocks of description, Quantity and value described as
per statement submitted to them. The banker has to ensure that:

(a) Adopting the same principle as for the financial statements should do
valuation of stock in the stock statement.

(b) Stocks – Quantity and value should be reconciled from month to

month.

(c) During inspection, the available stocks are to be verified with the
purchase invoices to ascertain the purchase value of stocks. Ascertain
that the bank‟s board is displayed prominently in the go down.

(d) Calculate % of slow moving stock to the total stock. Depending upon
the nature of industry, the % to be fixed. The value of slow moving
stock is to be removed from the total value before arriving at the
drawing power for the account. Branches have to do ABC analysis of
the stock statement and pay more attention to high value items of
inventory, their movement etc so that bank‟s interest is protected.
(e) Unpaid stocks to be removed from the total stock. Branches have to
take all precautions to remove the value of D/A L/C stock before
arriving D.P to avoid double financing. Wherever the borrowers are not
furnishing the particulars of unpaid stocks, branches has to get the

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position clarified and necessary steps are to be taken before arriving at

drawing power for operating the account.

The regular submission of stock statements is mandatory. Bunched

submission of stock statement, i.e. submission of stock statements for
3 or 4 months together is one of the earliest symptoms of liquidity
problem, which the branch has to take care.

It is advisable for the branches to verify the stock statements submitted by the
borrowers with the previous stock statements in the file to ensure, opening
and closing balance of raw materials, price fluctuations, unpaid stocks, level
of holding etc., to satisfy themselves about the quality of current assets which
are the prime security against banker‟s finance. The value of stock vis-à-vis
value of insurance is also to be checked and always the insurance amount
should be more than the total value of the stock in the go down.

Statement of debtors

When bank sanctions overdraft against book-debt, a statement of debtors,

indicating age-wise classification is to be obtained. Branch should not allow
drawing power on the old debtors. Once in three months the book debt
statements are to be certified by Chartered Accountants. Branch is also
advised to have the banker‟s opinion of the debtor‟s financed in their files for
reference.

The branch is also to verify that the book debts are well spread and there is
no concentration of book debts involving large amounts against a few or
allied/associated/sister concerns unless there is a specific sanction available
to this effect. Even in such cases individual limit fixed for each concern should
be adhered to.

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Normally, back-debts of more than 90 days old are not to be financed. In

exceptional cases if there are specific sanctions, certain book debts can figure
up to six months only.

During the visit to the borrowers‟ office in order to verify the correctness of the
book-debts statement submitted by the borrower, it is advisable to verify that
the debts are properly entered in the books of accounts such as debtors‟
register, party-wise register etc and tally with the borrowers‟ invoices.
Examine whether fresh book debts are appearing in the name of the
customers who have already defaulted for the previous supplies and have
received the goods on credit terms.

Also ascertain whether there is any double counting of receivables by way of

book-debts and receivables through negotiation of bills of the same party.

It is also to be ensured that, whether book-debts are raised on the traders

from whom the borrower purchases raw materials and all other items for his
manufacturing activity.

Bills

Bank should pay attention to the bills returned unpaid and acceptances
dishonored so that repurchase/discount of the bills of the same drawers can
be done away with. While allowing limit for bills purchased, Report on the
drawers whose bills are negotiated/purchased are to be obtained from their
bankers and is to be kept on record. It is to be updated every year.

Bill financing is a sales financing. The quick realization of bills indicates to the
bankers‟ the marketability of their customers goods. The return of the bill may
indicate loosing of market share; quality of goods manufactured or the client‟s
market share is slipping due to various reasons. The bankers have to analyze
and find out the correct reason on this score. Further if there is delay in
realization of bills, which normally happens before return, banker has to take

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corrective steps immediately. The branch has to calculate the percentage of

over due bills to current bills regularly to maintain a healthy bills portfolio of
their borrowers and avoid slippage in the quality of their assets.

CURRENT/CASH CREDIT/OVERDRAFT ACCOUNTS

It is to be observed from the account as to whether the borrower is frequently

overdrawing the account or asking for adhoc increases. Frequent overdrawing
in the account is a bad sign of operation. Frequent requests for ad-hoc
increase may be due to over trading non-realization of debtors etc. Branch
should not encourage any such practice of the borrower. The branch has to
immediately identify these symptoms to satisfy it to know whether there is any
liquidity problem. This phenomenon may be preceded by return of cheques
both inward and outward. Usually outward cheques are returned for want of
drawing power or limit, indicating therein that there is liquidity strain. This is
not a healthy sign. At the same time if outward cheques also started returning
means, borrower is not in a position to realize his dues. This will lead to a
situation of borrowers not paying their credits in time. All these are signs of
incipient sickness. The branch has to take immediate steps to remedy the
situation by taking suitable alternative actions so that the account is not
slipped from performing to non-performing asset. The operations in the
account are one of the very important indicators to the banker with regard to
the health of the account. The branch has also to verify for any round-sum
credits introduced in the account by the borrower to verify whether it is a
temporary outside borrowing or actual sales realization. It is also advised that
the branch may verify the cheques issued for big amounts in the cash-
credit/over-draft accounts by the borrowers regularly to ensure that they are
being issued only to genuine trade transactions. The branches should as far
as possible avoid withdrawal of cash from the accounts. Frequent cash
withdrawal is again a symptom of incipient sickness.

There may be three types of inspection reports, which require follow-up.

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1. Inspection Report of the branch

2. Inspection Report by SIO/Internal Auditors
3. Inspection Report by Auditors/RBI Inspectors.

Branch should follow-up the irregularities indicated in the inspection reports.

The irregularities indicated by the inspecting agency should never be allowed
to be continued. A certificate should be sent to higher authorities certifying
that the irregularities indicated in the report have been rectified.

Where advances are further covered by security, proper care of security and
timely visits form a part of follow-up. It is desirable to keep clear record of
visits to the shop/factory/go down or to the place where security is located.
Surprise element in timing of visits and sample checking of goods, wipes
away the feeling of complacency that may be created at either side.

There should be monthly inspection by branch officials on a rotation basis.

During their visits they have to verify the latest stock statements submitted by
the borrower with the purchase register, sales register, movement of goods
register maintained by the party and to verify the authenticity and veracity of
the statements submitted by them to the bank. They can also satisfy
themselves about payment of electricity bills and staff muster roll to have an
idea about the working of the factory. Physical verification of stock is also
necessary on a sample basis.

Further, hypothecation statement should be received regularly. Reconciliation

of statement with monthly sales and purchases figures must be done. This
can be further crosschecked with balance sheet figures of stocks, Sales Tax
or Excise Returns, Insurance Cover and Stock Registers maintained by
shopkeepers.

Visits to the shop/factory can give bankers a better idea of location of shop,
customer service, cash and credit sales, display of goods, morale of

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employees and condition of existing stocks and quality of management,

internal feuds and disputes can also be disclosed during the visits.

Some time operational irregularities may be noticed due to outside agencies

or extraneous factors. These are –
a) Shortage of raw material due to non-availability of quota.
b) Power shortage
c) Change in Government Policies etc.

Branch should enquire from the borrower as to the genuine problem and the
authorities responsible for it. They may also raise certain issues in various
forums to help out the borrower in overcoming such problems.

FINANCIAL STATEMENT

Financial Statements exhibit the results of operations for a particular period

and position of the borrower as on a date. The important indicators of the
financial statements like Sales, Stock, Debtors, Projected creditors, Net
Worth, Net Working Capital and ratio analysis should be done and a report
should be maintained in the file. The information generated by the verification
of statements like Q.I.S. previous years achievement, of the borrower vis-à-vis
projections as per C.M.A formats, submitted by the borrowers for renewal of
accounts and the variations in cost of sales to sales if any and ratio of PBT to
sales etc are also to be taken into account during the discussion with the
borrower. If any negative growth or feature is noticed in the analysis, dialogue
should be made with the borrower on such issues, and necessary corrective
measures are to be initiated.

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Credit Management

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