Working Capital of Borrower-Bank of Baroda

5/21/2018 Working Capital of Borrower-Bank of Baroda

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ASSESSMENT OF WORKING CAPITAL OFBORROWERS

A Project Submitted ToTHE UNIVERSITY OF MUMBAI

For The degree ofBACHELOR OF MANAGEMENT STUDIES

In the partial fulfillment of requirement of thecourse

BYPRITI SAKHARAM KOPADE

UNDER THE SUPERVISION OFPROF. PRACHI KULKARNI

DEPARTMENT OF BMSD.G. RUPAREL COLLEGE

MUMBAI-400016

JANUARY, 2011


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ASSESSMENT OF WORKING CAPITALOF BORROWERS

BY

PRITI SAKHARAM KOPADE

UNDER THE SUPERVISION OFPROF. PRACHI KULKARNI

DEPARTMENT OF BMSD.G. RUPAREL COLLEGE

MUMBAI-400016

JANUARY, 2011


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STATEMENT BY THE CANDIDATE

I , Priti Sakharam Kopade, wish to state that the workembodied in this project entitled Assessment of WorkingCapital of Borrowers is carried out under thesupervision of Prof.Prachi Kulkarni, Department ofB.M.S., D. G. Ruparel College, Mumbai. This work hasnot been submitted for any other degree of this or anyother universities.

(Priti Sakharam Kopade )Name of Candidate

(Prof. Prachi Kulkarni )Supervisor

(Dr. Prakash Salvi)BMS Coordinator


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ACKNOWLEDGEMENT

This is to acknowledge the invaluable support and co-operative

assistance extended to me by various individuals who are all very

great personalities in their very own fields.

First of all I would like to express my sincere gratitude to my

project mentor Mrs.Prachi Kulkarni for providing her valuable

time and assistance.

I would also like to take this opportunity to thank our

Coordinator, Mr.Prakash Salvi & our library staff to coordinate

with us.

My heart-felt thanks to Bank of Baroda for providing valuable

information on project. I would like to give special thanks to all

my friends.


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ASSESSMENT OF

WORKING CAPITAL OF BORROWERS


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Index

No. Contents PageNo.

1 Executive Summary 1-2

2 Objective of Study 3-4

3 Profile of Organisation 5-8

4 Research Methodology 9-10

5 Introduction To Working CapitalDefinitionCharacteristics

ConceptNeedsOperating cycleComponent

TypesDeterminants

11-28

5 Small & Medium Enterprise Sector ( SME )

CompositionGuidelines for lending to SME sectorProcedure for Working Capital FinanceCredit Monitoring ArrangementCredit Rating ModelSecurityBanking ArrangementsRegulation of Bank Finance

Level of Credit LimitDrawing Power of Borrower

29-60


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6 Data Presentation, Analysis &Interpretation

Case Study on working capital

61-65

7 Findings & Suggestions 66-67

8 Annexure 68-70

9 Conclusion 71-72

10 Bibliography 73-74


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EXECUTIVE

SUMMARY


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EXECUTIVE SUMMARY

Banking is "accepting, for the purpose of lending or investment of depositsof money from the public, repayable on demand or otherwise and withdraw

able by cheques, draft, order or otherwise."

Bank is defined as a person who carries on the business of banking. Banks

also perform certain activities which are ancillary to this business of

accepting deposits and lending. Since Banking involves dealing directly with

money, governments in most countries regulate this sector rather

stringently.

Banks' activities can be divided into retail banking, dealing directly with

individuals; business banking, providing services to mid-size business;

corporate banking dealing with large business entities; private banking,

providing wealth management services to High Net Worth Individuals; and

investment banking, relates to helping customers raise funds in the Capital

Markets and advising on mergers and acquisitions. Banks are now moving

towards Universal Banking, which is a combination of commercial banking,

investment banking and various other activities including insurance.

Financial managers of today are responsible for shaping the fortunes of

enterprise & are involved in the most important management decision of

allocation of working capital. It is their duty to raise the funds most

economically & use it in an efficient manner.

Bank of Baroda gave me a broad view of how actually banks assess the

working capital requirements of borrowers. I have put my best efforts to get

the necessary information from concern persons as well as my search.


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OBJECTIVE

OF

STUDY


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Objective of Study

To study various types of working capital finance.

To analyze in detail the assessment of working capital finance

extended by the bank.

Scope of Study

The project provides an understanding of the various types of Working

capital finance given by the bank to various institutions.

An overview of the operations carried out in the bank regarding the

assessment of working capital finance has been given in this stu


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PASSION TO SERVE

PASSION TO PERFORM


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Bank Of Baroda

On 20th July 2008, the Bank completed its Centenary year. For Bank of

Baroda, it has been a long and eventful journey over 100 years and across25 countries. After undergoing a massive transformation by changing its

logo in June 2005, the Bank won many industry level awards for its

marketing and business initiatives and strived to optimize its competitive

edge in the banking space. The Baroda brand positioning was entrenched in

the consumer mind as Indias International Bank, balancing its time tested

values over its 100 years of existence with the contemporary challenges of

being market sensitive and responsive as it marches tirelessly towards its

next century.

Being a Bank with a strong overseas presence, it in its fold has more than

36 million global customers enjoying the state-of-the-art technology. Its

performance in 2008-09 reflects its strength to consolidate its position as a

premier Public Sector Bank given its growing geographical reach, a vast

bouquet of products and services and robust risk management capabilities.

The value proposition of the Bank to its customers lies in its impregnable

foundation and inner strength as a financial service provider by leveraging

its technology and brand.

M. D. Mallya

Chairman & Managing Director


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MSME Business

The Micro, Small and Medium Enterprises (MSME) segment has been a vital

component of Indian economy. This sector accounts for around 40.0% oftotal industrial production, 34.0% of industrial exports, 95.0% of industrial

units and 35.0% of total employment in manufacturing and service sectors

of India. The unorganized sector which forms a major component of the MSE

segment comprises almost 95.0% of total industrial units and employs over

65 million people.

The contribution of Services Sector within the SME segment is quite

significant; especially IT enabled services, hospitality services, tourism,couriering, transportation, etc. The SMEs have also been playing a vital role

in the job creation process.

To give a focused attention to emerging SMEs in India, the Bank has been

considering other commercial units with a turnover up to Rs 150 crore at

par with the SMEs.

To promote the growth of SME Sector, the Bank has launched a special and

novel delivery model, viz. SME Loan Factory, which at present, is operate

nationalised in 36 centres of the Bank and well accepted in the marketplace.

The SME Loan Factory is an innovative model for streamlining processes

and for timely sanctions of SME loan proposals. The model comprises of the

Central Processing Cell for speedy appraisal and sanctioning of proposals

within the stipulated deadline.

Out of 36 SME Loan Factories as on 31st March 2010, three SME Loan

Factories have been established during the year. The Bank has SME Loan

Factories at all major business centres across the country.

These SME Loan Factories sanctioned loans aggregating Rs.11,071 crore

during FY10 as against Rs 8,508 crore in the previous year.


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Growth of Business

The total outstanding in MSME Sector works out to Rs 21,111 crore as on

31st March 2010. The growth in lending to MSME Sector during the last

three years is given in the table below.

Year Percentage

2007-08

2008-09

2009-10

31.11%

24.18%

43.98%

The percentage growth of MSME credit during FY10 is relatively high as the

advances up to Rs 20 lakh to Retail Trade are, now, classified under the

Micro & Small Enterprises Sector after the RBIs revised guidelines issued

during September, 2009. The Bank has taken the following initiatives in its

SME business segment during the year under review.

Initiatives in SME Financing During FY10

The Bank set up three new SME Loan factories during FY10

The SME Meets and interactive sessions were held at various centres

with SME customers.

The Bank introduced seven new customer-centric area specific

products to suit the local cluster needs.


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RESEARCH

METHODOLOGY


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RESEARCH METHODOLOGY

This is analytical research area where we analyze information with cause

and its effects relationship. This analysis leads to the simple conclusions of

whether to lend money to the institution for business.

Certain financial parameters are taken into consideration while lending

funds to the borrowers.

Also if the money is lent then there is reality the norms are not alwaysperfect and hence it is essential to priorities stringent parameters and

secondary parameters.

Primary Data:

Discussion with employees & manager.

The company profile, annual reports have been obtained from BOB.

Secondary Data:

Secondary data relating to the procedure of assessment of workingcapital finance, old sanction proposals, RBI guidelines etc. have beensourced from reference books.


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INTRODUCTION


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INTRODUCTION TO WORKING CAPITAL

The capital required by a firm to run its daily business/activities is referred

to as working capital. Working Capital is defined as the gap between currentassets and current liabilities. To run a business, working capital is like

blood of human body which circulates to maintain human life. In the same

way, working capital is very essential to maintain a smooth running of a

business. No business can run successfully without an adequate amount of

working capital.

If working capital is more than the requirement that is also harmful for the

business because either the funds may remain idle or it will be deployedwithout assessing the needs/requirements of the firm. Excess of anything

is bad.

Working capital refers to the part of firms capital which is required for

financing short term or current assets such as marketable securities,

debtors, inventories, etc. Working capital is the amount of funds necessary

for the cost of operations. Thus working capital, the funds available/used

for day-to-day operations of a business that is related to current operations.In the present era, there are many financers/lenders which provide working

capital.

Every business requires capital to finance its fixed and long-term assets. It

is known as fixed capital. Business also requires capital to maintain certain

level of short-term assets. This requirement of short-term assets depends on

the nature of activity, availability of raw materials, level of production,

storage capacity and funds available. So, then funds/capital needed for asmooth conduct of business and to maintain this required level of short-

term assets is called as Working Capital.


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Definitions

Working capital like many other accounting terms and financial terms has

been used by different people in different senses. One school of thought

believes that, as all capital resources available to a business organization

From shareholders, bondholders, and creditors (secured and unsecured)

works up in the business activities to generate revenues and facilitate future

expansion and growth; they are to be considered as working capital.

Another school of thought links working capital with current assets and

current liabilities. According to them, the excess of current assets over

current liabilities is to be rightly considered as the working capital of a

business organization.

He defines working capital as the amount of funds necessary to cover the

cost of operating the enterprise. Working capital in a going concern is a

revolving (circulating fund), it consists of cash receipts from sales which are

used to cover the cost of current operations.

Circulating capital means current assets of the company that are changedin the ordinary course of business from one form to another, as for example

from cash to inventories, inventories to receivables and receivables to cash.

Working capital is descriptive of that capital which is not fixed. But, the

more common use of working capital is to consider it as the difference

between the current assets and the current liabilities.

Current assets and current liabilities are assets and liabilities which arise in

the course of business.


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Characteristics of Working Capital

Short-term needs: Working Capital is used to acquire current assets which

get converted into cash in a short period. The duration of working capitaldepends on the production process. In other words, the time that elapses

between the sale and waiting period of cash receipt.

Circular Movement: Working capital cycle is continuous in nature. It

begins with purchase of current assets for which cash is used. When the

goods are produced and are sold; these current assets are converted into

cash. This is the circular movement of working capital. So, working capital

is also known as circulating capital.

Permanent Working Capital: Though, working capital is short-term is

nature, it is required regularly. It is essential for the smooth production

process of a firm. Therefore, the working capital which is required

permanently is known as permanent or regular working capital.

Temporary Working Capital: Working capital needs in a business keep

fluctuating from time-to-time. These needs may arise unexpectedly during

the course of operations. So every firm must have additional funds to meet

such contingencies. So, temporary working capital is also known as variable

working capital.

Liquidity: Working capital is short-term in nature. Hence, it can be

converted into cash in a short duration. This can be done by quick recovery

of bills receivables and accelerating the sales. In other words, working

capital has good liquidity as compared to fixed capital.

Less Risky: Funds should be properly invested in long & short term assets.

Investment in long-term assets is irreversible. Hence, it involves risk for the

firm. In the other case, working capital gets converted into cash in a very

short period and, so, it is less risky as compared to fixed capital.


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Accounting System: It is essential to adopt accounting systems for

knowing the current position of business and, also, for estimating the

further financial requirements of the business. Working capital is required

for a short period for day-to-day activities. Hence, accounting system is not

required.


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Concepts of Working Capital

Working capital can be conceptually classified as:

Gross Working Capital

Net Working Capital

Gross working capital:

A firms investment in the current assets is called as gross working capital.

Current assets are the assets that can be converted into cash in an

accounting year. They include cash, marketable securities, inventory,receivables and bills receivables. This concept helps to make financial

arrangements as and when working capital needs arise.

Net working capital:

Excess of current assets over current liabilities is referred to as net working

capital. It shows the liquidity position of the firm. Therefore, net working

capital plays a vital role in measuring the financial position of the firm. It

can be positive or negative. Positive net working capital refers to excess of

current assets over current liabilities. And reverse is the case for negative

working capital.

Net Working Capital = Current AssetsCurrent Liabilities


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Need of Working Capital

The main objective of any firm is to earn profits. For earning profits and

continuing production activity, the firm has to invest capital in current

assets. This is done because sometimes sales do not convert into cash

immediately. There is a time lag between sales and realization of sales into

cash. This involves an operating cycle.

Therefore, the need of working capital arises from the operating cycle of a

firm. It refers to the length of time required to complete the following stages:

conversion of cash into inventory, inventory into receivables and receivables

into cash. The longer the duration of operating cycle the more amount of

working capital will be needed. Thus operating cycle helps the firm toestimate its working capital needs.

The operating cycle begins with the procurement of raw materials, which is

the basic function of a manufacturing unit. After purchase, the raw

materials undergo production process, which may range from a day to 90

days. The raw material procurement involves various costs incurred which

requires capital viz., cost of raw materials, labour charges, power, rent,

water, etc. The raw material is now converted into finished goods.

Once finished goods are produced, they may or may not be sold

immediately. If not sold immediately, they are stored in a warehouse that

involves holding and other related costs. Finished goods are thus sold either

on cash or credit. Cash sales helps to complete the operating cycle

immediately. Credit sales block the funds till they are not realized.

Oncethese sales proceeds are realized, the funds generated are used to

purchase raw materials. The whole cycle starts again.

The total time taken from the procurement of raw materials to the

realization of sales proceeds is called the operating cycle.


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Operating Cycle

RawMaterial

FinishedGoods

Sales

Debtors

Cash


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Different businesses have different working capital requirements as it

depends on what kind of business activity is carried out. Manufacturing and

trading enterprises require large amounts of working capital. Service

enterprises require less working capital as they do not deal in commodities.

Larger companies may be able to use their bargaining strength as customers

to obtain more favorable and extended credit terms from suppliers. In the

case of smaller companies, particularly those that have started trading may

be required to pay their suppliers immediately. This is because the new

companies that have started trading do not have a track record of credit

worthiness.

Some businesses will earn at certain times of the year, although they may

incur expenses throughout the year at a fairly consistent level. This is often

known as seasonality of cash flow. For example, travel agents have peak

sales in the weeks immediately following Christmas.

Working capital needs also fluctuate during the year. The amount of funds

invested in the working capital may not remain constant throughout the

year.

Thus, working capital needs can be categorized into:

Fixed part

Fluctuating part

Fixed part, probably, is referred to as the minimum working capital

requirement for the year. So the fixed part of working capital should be

adequately financed well in advance. It can be done by using permanent

sources i.e. equity capital.

Fluctuating part of working capital refers to the need for working capital

during the variations or fluctuations in business conditions. So, the

fluctuating element should be financed from the short-term sources i.e.

bank overdraft. It can be drawn and repaid easily that too in a short period.


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Fixed Working Capital

Fluctuating Working Capital

TIME

AM

O

U

N

T Permanent current asset

A

M

O

U

NT

Temporary current asset

Permanent current asset

T I M E


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Component of Working Capital

Cash and cash equivalents: Cash is the most liquid form of working

capital. An adequate level of cash helps to meet regular expenditures. It also

helps to overcome unexpected contingencies. The inflow and outflow of cash

should be continuous since it is of vital importance to the daily operations of

a business.

Inventory: Inventory includes all types of stocks. Stocks of raw materials,

stores and spares, work-in-process, and finished goods form the inventory.

Inventory needs to be managed effectively to ensure effective working capital

management. Holding inventory is important if sales or production are not

stable and predictable. Therefore, inventory is held to ensure timely

availability of goods for sale or raw materials for production.

Accounts Receivables: Accounts receivables are also known as

receivables. These receivables get converted into cash over a short period

of time. There is an inflow of cash during the actual receipt of receivables.

Amount received from debtors during the credit period granted to them,

ensures timely inflow of funds.

Accounts Payables: Accounts payables are also known as payables . The

firms obligation to pay-off its creditors represents accounts payables. There

is an outflow of funds while paying off this short-term debt. The regular

payments enable the firm to get good credit facilities from its creditors.


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Types

Types ofWorking Capital

Fund Based

Cash Credit

DAUE

WC Loan

Bill Financing

Export Financing

Non Fund Based

Bank Gaurantee

Letter of Credit

Structured

Product

Factoring

Inter-corporate

Deposit

Commercial

Paper


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Types of Working Capital Finance

Bank credit is the primary source of working capital finance in India. It

represents the most important source for financing of current assets.

A. Fund Based

The fund-based form of working capital finance refers to the finance that the

banks provide to its borrowers up to a certain limit assessed by the bank.

The borrower then has to repay to the bank the principal amount along with

the interest within a stipulated time.

1) Cash Credit

Under cash credit form of bank finance, the bank sanctions a limit to it

borrower. The borrower is allowed to borrow up to this limit at any time

interval up to the specific period of credit. This facility is available against

the security of tangible assets viz., stocks, book debts, etc. this cash credit

facility covers the fluctuating part of working capital.

2) DAUE

Drawing against Unclear effects (DAUE) is allowed only to those parties

which maintain satisfactory and well conducted current accounts in the

bank. Such customers can draw cheques against unclear balances. In other

words, they can draw against the cheques which are deposited in their

accounts but not yet realized. Then the bank may allow payment of such

cheques.

3) Working Capital Loans

The working capital loans cover that part of working capital which is fixed or

permanent in nature. This facility can be availed by the borrower when the

bank assesses the limit on the basis of its working capital requirements.

4) Bills Financing

Bills of exchange are popularly used in a credit transaction of sale-purchase

in the trading business. The seller of the goods draws the bill on the


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purchaser of goods. On acceptance by the purchaser, the seller offers it to

the bank for discounting. On discounting the bill, the bank will provide

funds to the seller. The bill is then presented to the banker of the purchaser.

5) Export Financing

Export financing is a form of working capital finance that banks provide to

the exporters for a short period of time.

B. Non-Fund Based

Non Fund-based form of finance involves the guarantee by the bank to the

borrowers client. In this case, the bank first issues a guarantee to the

borrowers client to provide him a credit period. If the borrower fails to pay

off its liability, then this non fund based form of financing gets converted

into the fund-based form. The bank bears the risk only in case of default by

the buyer.

1) Bank Guarantee

Bank guarantee is a form of non-fund based finance. Here, the bank issues

a guarantee for its borrower to their clients to grant them credit period. The

borrower is liable to pay off this amount within a stipulated time. If the

borrower fails to do so, then bank will make the payment.

2) Letter of Credit

Letter of credit is a document that a buyer can request his bank in order to

guarantee that the payment of goods will be made to the seller. The purpose

of this document is to provide reassurance to the seller that he will receive

the payment for the goods. The bank undertakes the responsibility to makepayment to the seller if the buyer fails to meet his obligations.


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C. Structured Products

1) Factoring

Factoring is a financial service provided by specialised agents to help

manufacturers and traders etc. to manage their receivables. It is a processof selling receivables to a third party on a discount. The supplier (exporter)

assigns his accounts receivables in favour of the factor and gives notice of

assignment to the debtor. It has been popular in developed countries. The

factors undertake collection/accounting and management of debts of their

clients. Factor may either lend against accounts receivables or by

purchasing invoices. He will take responsibility of collecting debt. The

factoring service may be offered with or without recourse. Factoring with

recourse refers to right of the factor to claim bad debts from his client,

whereas in without recourse factoring, the risk of bad debt will be borne bythe factoring agent himself.

2) Inter-corporate Deposits

Inter-corporate deposits are deposits made by one company with another

company, and usually carry a term of six months. An Inter-Corporate

Deposit (ICD) is an unsecured loan. The inter-corporate deposits market

shows a number of interesting characteristics. The biggest advantage of

inter-corporate deposits is that the transaction is free from bureaucratic and

legal hassles. The business world otherwise is regulated by a number of

rules and regulations. The existence of the inter-corporate deposits market

shows that the corporate world can be regulated without rules.

3) Commercial Papers

These are short-term promissory notes. An To give a boost to the money

market and for reducing the dependence of highly rated corporate borrowers

on bank finance for meeting their working capital requirements, corporate

borrowers were permitted to arrange short term borrowings by issue of

Commercial Paper (CP).


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Who can issue Commercial Paper (CP)

1. Corporates; primary dealers (PDs) and satellite dealers (SDs), and the

all India financial institutions (FIs) that have been permitted to raiseshort-term resources under the umbrella limit fixed by Reserve Bank

of India are eligible to issue CP.

a. "corporate" or "company" means a company as defined in

Section 45 I (aa) of the Reserve Bank of India Act; 1934 but does

not include a company which is being wound up under any law

for the time being in force.

b. 'Primary Dealer" means a financial institution which holds a

valid letter of authorisation as a Primary Dealer issued by theReserve Bank, in terms of the "Guidelines for Primary Dealers in

Government Securities Market dated March 29, 1995, as

amended from time to time.

c. "Satellite Dealer" means a financial institution which holds a

valid letter of authorisation as a Satellite Dealer issued by the

Reserve Bank, in terms of the "Guidelines for Satellite Dealers in

Government Securities Market dated December 31, 1996, as

amended from time to time.

d. "All India Financial Institutions (FIs)" means those financial

Institutions which have been permitted specifically by the

Reserve Bank of India to raise resources by way of Term Money,

Term Deposits and Certificates of Deposit within umbrella limit.

2. A corporate would be eligible to issue CP provided

a. The tangible net worth of the company, as per the latest auditedbalance sheet, is not less than Rs.4 crore.

b. Company has been sanctioned working capital limit by banks orall India financial institutions; and

c. The borrower account of the company is classified as aStandard asset by the financing bank institutions.


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Determinant of Working Capital

Nature of Business: There are various types of business. Nature of business

is an important determinant of working capital. Trading and financial forms

of business have a very small investment in fixed assets but require a large

sum of money to be invested in working capital. So, they have to maintain

sufficient amount of cash, inventories and book debts. The manufacturing

industry requires small or large investment in working capital depending on

the length of production cycle and the production policies they follow. There

are businesses that have small working capital requirements. Such

businesses generally trade more on cash basis or are involved in sale of

services. Thus, the working capital requirements of the business depends on

its nature.

Size of business: Working capital requirements depend on the size of

business. Size is generally measured in terms of the scale of operating cycle.

The larger the scale of operating cycle the larger will be the working capital

requirement and vice-versa. Therefore, size of business affects the working

capital requirements to a great extent.

Business Cycle: Every business experiences fluctuations which lead to

cyclical and seasonal changes. This affects the working capital position of

the firm. The business cycle variations are categorized into:

(i) upswing phase during boom periods

(ii) downswing phase in recession

The working capital needs are likely to grow during an upswing phase as the

level of activity expands. The level of inventories and book debts increase

due to the increase in the volume of sales. There may be additional

requirement of funds in this stage. The reverse case may be seen during the

downswing phase. The decline in the needs of working capital is witnessed

due to fall in the sales volume. In brief business fluctuations influence the

size of working capital.


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Production Cycle: Production cycle or manufacturing cycle is an important

factor determining the amount of working capital needed by the firm. It is

the conversion of raw materials in to work-in-process into finished goods, a

component of operating cycle. The longer the production cycle, the larger

will be the working capital requirement. The manufacturing cycle dependson the firms choice of technology and production policy. Therefore,

production cycle is a major determinant of working capital.

Production Policy: If a firm follows steady production policy, even when

demand is seasonal, inventory will accumulate during off-season periods

and there will be higher inventory costs & risks. Firms whose physical

facilities can be utilized for manufacturing a variety of products can have

the advantage of diversified activities. Such firms manufacture their mainproducts during the season and other products during off-season. Thus,

production policies may differ from firm to firm. Accordingly, the need for

working capital will also vary.

Credit Policy: A credit policy relating to sales and purchases also affects the

working capital needs. The credit policy affects in two ways:

(i) Credit policy for the customers

(ii) Credit policy to the firm from its creditors

The level of book debts determines the credit terms granted to its customers.

A long collection period will generally mean tying of larger funds in book

debts. If liberal credit terms are available from the creditors, the need for

working capital is less. The credit policies adopted by the firms are subject

to change with the changing economic conditions.

Price Level Changes: Generally, rising prices requires a higher investment

in working capital. With increasing prices the same levels of current assets

need enhanced investment. The effects of increasing price level may,

however, be felt differently by differently firms due to variations in individual

prices. It is possible that some companies may not be affected by the rising

prices, whereas others may be badly hit.


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SMALL & MEDIUM

ENTERPRISE SECTOR


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SMALL & MEDIUM ENTERPRISE SECTOR

Manufacturing Industries

1. Micro Enterprise is an enterprise where investment in plant and

machinery (original cost excluding land and building and the items specified

by the erstwhile Ministry of Small Scale Industries) does not exceed Rs.

25.00 Lacs

2. Small Enterprise is an enterprise where the investment in plant and

machinery (original cost excluding land and building and the items specified

by the erstwhile Ministry of Small Scale Industries) is more than Rs. 25.00

lacs but does not exceed Rs. 5.00 crores and

3. Medium Enterprise is an enterprise where the investment in plant and

machinery (original cost excluding land and building and the specified

items) is more than Rs.5.00 crores but does not exceed Rs.10.00 crores.

Service Sector

Enterprises engaged in providing or rendering services whose investments in

equipment (original cost excluding land & Building and Furniture, Fittings

and other items not directly related to the service rendered or as may be

notified under MSMED Act, 2006) are as detailed here under:

1) Micro Enterprise is an enterprise where the investment in equipment

does not exceed Rs.10.00 lacs;

2) Small Enterprise is an enterprise where the investment in equipment is

more than Rs.10.00 lacs but does not exceed Rs.2.00 crores and

3) Medium Enterprise is an enterprise where the investment in equipment

is more than Rs.2.00 crores but does not exceed Rs.5.00 crores. Units with

investment in plant and machinery in excess of Rs.5.00 crores & up toRs.10.00 crores in case of manufacturing units and in excess of Rs.2.00

crores & up to Rs.5.00 crores in respect of Service Sector will be treated as

Medium Enterprises (ME) and will not form the part of Priority Sector

advance. Financing to Micro & Small Enterprises will only be treated as part

of Priority Sector advance.


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COMPOSITION OF SME SECTOR

The SME Sector includes Micro Enterprises, Small Enterprises, Artisans &

Village Industries, Medium Enterprises, Service Sector units & individual

sub-sector units.

a. Micro Enterprises :

Micro Enterprises are those engaged in manufacturing, processing,

preservation of goods, mining, quarrying, servicing & repairing of specified

type of machinery & equipment, agro service units whose investment in

Plant and Machineries does not exceed Rs. 25.00 lacs irrespective of location

of the unit in respect of manufacturing units and investment in equipments

not exceeding Rs 10.00 lacs in respect of Service Sector units.

b. Small Enterprises :

A Small Enterprise industrial undertaking / unit is one which is engaged in

the manufacture, processing or preservation of goods or is a servicing and

repair workshop undertaking repairs of machinery used for production,

mining or quarrying or custom service unit (except water service units),

having investment in Plant and Machineries (original cost) above Rs 25.00

lacs but not exceeding Rs. 5.00 crores in respect of manufacturing unit and

above Ra 10.00 lacs but not exceeding Rs 2.00 crores in respect of Service

Sector unit.

c. Medium Enterprises :

A Unit which is engaged in the manufacture, processing or preservation of

goods or is a servicing and repair workshop undertaking repairs of

machinery used for production, mining or quarrying or custom service unit

(except water service units), with investment in Plant & Machinery in excess

of Rs 5.00 crores and upto Rs.10.00 crores in respect of manufacturing

units and investment in equipments in excess of Rs 2.00 crores and upto Rs

5.00 crores in respect of Service Sector units will be treated as MediumEnterprises (MEs).


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COMMON GUIDELINES/INSTRUCTIONS FOR LENDING TOSME SECTOR:

1. Application Forms for Financial Assistance:

Application forms in use to grant credit facilities are detailed as under :

1. Application form for credit facilities upto Rs.10/- lacs.

2. Application form for credit facilities of over Rs. 10/- lacs and uptoRs.50/- lacs.

3. Application form for credit facilities of over Rs. 50/- lacs and upto

Rs. 2/- crore.4. Application form for credit facilities over Rs. 2/- crore.

Application forms as aforesaid are devised for assistance by way of either

term loans or working capital or both and are applicable to new projects,

expansion, diversification and modernisation of existing projects. Bank is in

process of devising application forms for ME units and will be provided to

the branches on its approval by the competent authorities. In the meantime,

above forms may be used for ME units also.

2. Receipt of applications and acknowledgment: With a view to facilitate

timely sanction of adequate credit facilities, the following guidelines have

been issued to the branches:

An acknowledgment with the date of receipt for credit application

received to be given. A definite date to be intimated to the applicant for

discussions, clarifications etc. if considered necessary. The banks decision regarding credit assistance to be communicated

to the applicant within the prescribed period.

3. Register of Credit Applications Received:

All applications received should be entered in a Register of Loan Application

Received for recording therein the complete particulars such as date of

sanction, rejection, reasons for rejection etc.


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4. Time norms for disposal of loan applications:

In order to provide better customer service and to ensure that applications

for loans for all categories of borrowers are dealt with and disposed off

expeditiously, the following norms shall be adhered to, provided the loan

applications received are complete in all respects and duly accompanied by

a check list.

In respect of loans upto Rs.25,000/- within a maximum period of one

week of receipt of loan applications complete in all the respects and

duly accompanied by a check list.

In respect of other cases for loans above Rs.25,000/- and upto

Rs.5.00 lacs, within a maximum period of two weeks on receipt of

duly completed loan applications in all the respects and accompanied

by a checklist. In respect of loans over Rs. 5.00 lacs, within a maximum period of 4

weeks on receipt of duly completed loan applications in all respects

and accompanied by a check list.

In respect of credit applications processed at SME loan Factories, it

should be disposed off within 14 working days on receipt of full

information if no TEV study is required and within 21 working days

on receipt of full information if TEV study is required.

5. Types of Facilities:

SME Units may be granted a variety of credit facilities for their different

needs which will include the following:

(a) Term Loan / Demand loan / Deferred Payment Guarantee:

For acquisition of capital goods (including second hand), fixed assets,

vehicles, plant & machinery, purchase of land, construction of buildings etc.

(b) Working Capital by way of Cash Credit, Overdraft etc for:

1. Purchase of raw material, components, stores, spares and maintenance of

stock of these items at minimum level and stock in process and finished

goods.

2. Finance against receivables including receipted challans / invoices.

3. Meeting marketing expenses where the units have to incur large-scale

expenditure towards marketing of their products.


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(c) Bills Purchase / Discounting under L/C or outside L/c.

(d) Export Credit facilities like Packing Credit, FBP / UFBP.

(e) Letter of Credit on sight/usance basis for purchase of raw

material/capital goods

(f) Bank Guarantees for Performance, Advance Payment, Tender Money

Security

Deposit, Guarantees for getting orders, for procurement of raw materials

etc.


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6. Assessment of Working Capital Limits:

Presently, the following guidelines are in place for financing Working capital

facilities of SME units:

Limits upto Rs. 5.00 crores:

The credit requirements of village industries, Micro Enterprises, Small

Enterprises and Medium Enterprises having aggregate fund based working

capital limits upto Rs.5.00 crores from the banking system, will be

computed on the basis of a minimum of 20 % of their acceptable projected

annual turnover for new as well as existing units as per Nayak Committee

recommendations.

Limits above Rs. 5.00 crores:

For assessment of Working Capital requirements beyond Rs.5 crores of

Small Scale Industrial Units / Medium Enterprises, the guidelines on PBF

method of lending will be followed.

7. Margin

(a) For Term Loan

In case of factory land & building, overall margin of 30%

In case of Plant & Machineries and Equipments margin is proposed

at 25%

(b) For Working Capital

25% uniform margin is proposed on stocks and receivables. For export

credit margin may be stipulated @ 10 %.

8. Rate of interest:

If accounts are falling under SME category as per statutory guidelines, rates

as applicable to Micro, Small & Medium Enterprises to be applied.

However, if accounts are falling under SME category based on expanded

coverage i.e. they are outside the purview of regulatory definition, interest to

be applied as per separate guidelines being issued from time to time.

Rates of interest applicable for SME lending are displayed separately on

banks website.


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9. Penal Interest

Penal Interest @ 1% to 2% to be charged for the period of default in

repayment, non submission of financial statement, non-compliance of terms

and conditions etc. as per extant guidelines of Bank.

10. Credit rating:

Internal Credit Rating System

The internal comprehensive credit rating system under CRISIL Model has

been approved by the bank and is already in place as advised to all

branches. Pricing of loan to be decided based on the guidelines issued from

time to time.

External Credit Rating System

Small Enterprises borrowers are rated by few external credit rating agencies.

In case of MEs, some of the borrowers are getting their accounts rated by

external credit agency like CRISIL etc.

External credit rating should be carried out in all Medium Enterprise

accounts going for expansion and fresh sanction involving exposure above

Rs 5.00 crores by the agencies approved by RBI. Due weightage will be given

for the credit rating of the external agency.

Collateral Free Loans:

Presently, Banks guidelines for providing collateral free loans are as under:

a) Collateral free loan upto Rs.5.00 Lacs to Micro & Small Enterprises.

b) Collateral free loans (including third party guarantee/ security) upto a

limit of Rs. 25.00 lacs to units having satisfactory dealings with the branch

for last 3 years and having sound and healthy financial position.


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It is already decided to dispense with collateral security including third

party guarantee for loans to Medium Enterprises upto a limit of Rs. 25.00

lacs as in case of loans to Micro & Small Enterprises in manufacturing

activities subject to satisfying the following criteria in case of existing

borrower as also takeover accounts:

1. Consistent growth in sales for last 3 years.

2. Continuous profit for last 3 years.

3. Credit rating of A or equivalent and above and no slippage in credit

rating during last 3 years.

4. The units assets (fixed as also current) are charged to the bank and

promoters /

directors personal guarantee are available

5. Asset coverage ratio of more than 1.5

6. Other take over norms are complied with.

Coverage of loans under Credit Guarantee Fund Scheme for Micro & Small

Enterprises:

All the collateral free loans upto Rs.50.00 lacs sanctioned to Micro &

Small Enterprises are eligible for cover under the Scheme.

Our bank is sharing the upfront fees and annual service charges on

50:50 basis with the borrower to reduce the cost burden to the

borrower.

11. Composite Loan Scheme:

As per RBI guidelines, Credit assistance to artisans, village and

cottage industries and other Small Industrial units upto Rs.100.00

lacs for equipment finance or working capital or both should be

considered as Composite Term Loan.

This will enable majority of Micro and Small Enterprises to avail loans

from a single window eliminating the need for borrowing term loan

from SFCs and working capital from banks.

This will also facilitate to sign one set of documents only instead of

signing facility-wise separate documents.


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12. SME PRODUCTS

Sr. No Name of the Product/Scheme

1. Baroda Laghu Udhyami Credit Card

2. Baroda Artisan Credit Card

3. Loans under KVIC Margin Money Scheme

4. Collateral free loans under Credit Guarantee Fund TrustScheme

5. Composite Loans to SSI units

6. Loans under Technology Upgradation Fund Scheme forTextile units

7. Loans under Credit Linked Capital Subsidy Scheme for

Technology Upgradation of Small Enterprises8. Loans under National Equity Fund Scheme

9. Scheme for financing Energy Efficiency Projects

10 SME Short Term Loans

11. SME Medium Term Loans

12. Baroda SME Gold Card

13. Baroda Overdraft against Land and Building

14. Baroda Vidyasthali Loan

15. Baroda SME Loan Pack

16. Baroda Arogyadham Loan

17. Scheme for financing existing borrowers under SME Segmentfor purchase of new vehicles.


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PROCEDURE FOR WORKING CAPITAL FINANCE

CREDIT SANCTION PROCESS

The revised credit process is introduced with a view of reducing the time lag

in the sanction of credit besides clearly delineating the areas of

responsibilities of various functionaries. As per this the revised process is

divide into two components that is

Pre sanctioning

Post sanctioning

In the pre sanctioning it is the only time that the bank can take due

assessment and precautions to make sure that the investments are done forthe benefit of the bank. The post sanctioning is the follow of the payment. In

case the payment defaults then the account will go into NPA in stages and

the bank is then said to scrutinize the said account.

PRE SANCTION PROCESS:-

Obtain loan application

When a customer required loan he is required to complete application form

and submit the same to the bank also the borrower has to be submit the

required information along with the application form.

The information, which is generally required to be submitted by the

borrower along with the loan application, is under: -

Audited balance sheets and profit and loss accounts for the previous

three year (in case borrower already in the business)

Estimated balance sheet for current year.

Projected balance sheet for next year.

Profile for promoters/directors, senior management personnel of the

company.

In case the amount of loan required by borrower is 50 lacs and above

he should be submit the CMA Report.


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Examine for preliminary appraisal

RBI guidelines. Policies

Prudential exposure norms and bank lending policy

Industry exposure restriction and related risk factors.

Compliance regarding transfer of borrowers accounts from one bank

to another bank

Government regulation / legislation impact on the industry

Acceptability of the promoter and applicant status with regards to

other unit to industries.

Arrive at the preliminary decision.

Examine/analysis /assessment

Financial statement (in the prescribed forms) refers figure WC cycle &

BS assessment thumb rules.

Financial ratio & Dividend policy.

Pre SanctionProcess

Apprasial &Recommendation

Assessment Santioning


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Depreciation method

Revaluation of fixed assets.

Records of defaults (Tax, dues etc.)

Pending suits having financial implication (Customs, excise etc.)

Qualifications to balance sheet auditors remarks etc.

Trend in sales and profitability and estimates /projection of sales.

Production capacities and utilization: past & projected production

efficiency and cost.

Estimated working capital gap W.R.T acceptable build-up of

inventory/receivables/other current assets and bank borrowing

patterns.

Assess MPBFdetermine facilities required

Assess requirement of off balance sheet facilities viz.L/cs,B/gs etc.

Management quality, competence, track records Companys structure

and system

Market shares of the units under comparison.

Unique feature

Profitability factors

Inventory/Receivable level

Capacity utilization

Capital market perception.


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POST SANCTION PROCESS

Supervision and follow up: -

Sanction credit limit of working capital requirement after proper assessment

of proposal is alone not sufficient. Close supervision and follow up areequally essential for safety of bank credit and to ensure utilization of fund

lend. A timely action is possible only close supervision and followed up by

using following techniques.

Monthly stock statement

Inspection of stock

Scrutiny of operation in the account

Quarterly/half quarterly statements.

Under information system

Annual audited report

Post SanctionedProcess

Follow Up SupervisionMonitoring &

Control


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CREDIT MONITORING ARRANGEMENT

Consequent upon the withdrawal of requirement of prior authorization

under the erstwhile credit authorization scheme (CAS) and introduction of a

system of post sanction scrutiny under credit monitoring arrangement

(CMA) the database forms have been recognized as CMA database. The

revised forms for CMA database as drawn up by the sub-committee of

committee of directions have come into use from 1st April 1991.

The existing forms prescribed for specified industries continue to remain in

force. With a view to imparting uniformity to the appraisal system, database

from all borrowers including SSI units enjoying working capital limits of Rs.

50 lacs and more from the banking system should be obtained.

The revised sets of forms have been separately prescribed for industrial

borrowers and traders/merchant exporters. The details of forms are as

under: -

Form 1: - particulars of the existing/proposed limit from the banking

system.

Form 2: -Operating statement. It contains data relating to gross sales, netsales, cost of raw material, power and fuel, etc. It gives the operating profit

and the net profit figures.

Form 3 : - Analysis of balance sheet.

It is complete analysis of various items of last years balance sheet; current

years estimate and following years projection are given in this form.

Form 4 : - Comparative statement of current asset and liabilities. Details

of various items of current asset and current liabilities are given. The figures

in this form must tally with those in form III.

Form 5: - Computation of maximum permissible bank finance for

working capital.The calculation of MPBF is done in this form to obtain the

fund based credit limits to be granted to the borrower.


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Form 6: - Fund flow statement It provides the details of fund flow from

long term sources and uses to indicate weather they are sufficient to meet

the borrowers long term requirements.

Bank also considers the followings points while sanctioning the working

capital limit to the concern:

Turnover size of the concern: The bank normally gives working capital

limit upto 20-25 % of the turnover estimated (for the year under

review) by the concern.

Current ratio should be 1.33: 1. In case of take over case the last

three year CR average should be 1.33:1. Some relaxation may be given

but subject to approvals from Circle Head or Head Office of bank.

Total Outside Liability/ Net Worth Ratio should be in the range of 2-3

times.

As a measure to incentive to export sector while calculating the

margin i.e. 25% of current assets, export receivables are excluded

from current assets.

Additional credit needs of exporters arising out of firm order/

confirmed letter of credit (which are not taken into account while

fixing regular credit limits of borrowers) are to be met in full even if

sanction of such additional credit limit exceeds MPBF

Credit limits of the borrowing concern in the sugar industry may be

determined on the basis of a current ratio of 1:1.

Sick/weak units under rehabilitations will be exempted from the

application of 2nd method of lending.

Term loan Instalments payable within the next twelve months time are

excluded from current liabilities while calculating MPBF but included

while calculating Current Ratio.


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The Drawing Power (DP) should be equal to or more than the limit

applied for. The above margin depends on industry to industry. Some

time margins may be nil.

The inventory holding period, time taken in realization of debtors,advance to suppliers and credit availed from suppliers are also taken

into consideration. All the above factors are calculated in either days

or months. It shows the requirement of working capital in months or

days. In bank term it is called Working Capital Cycle of the concern.

It is very important factor because it shows blockage of funds and how

much time a concern takes to realize the same. It is the measure of

capability of concern to manage the liquidity in the system.

Bank compare the holding period of borrowing concern current assets with

the concern in same business and industry standards. If bank finds major

differences than it may instruct to borrowing concern, to standardize the

same with peers or industry standard, subject to necessary approvals from

higher authorities.


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CREDIT RATING MODEL

The various risks faced by any company may be broadly classified as

follows:

Industry Risk: It covers the industry characteristic, compensation, financial

data etc.

Company/ business risk: It considers the market position, operating

efficiency of the company etc.

Project risk: It includes the project cost, project implementation risk, post

project implementation, etc.

Management risk: It covers the track record of the company, their attitude

towards risk, propensity for group transaction, corporate governance etc.

Financial risk: Financial risk includes the quality of financial statements,

ability of the company to raise capital, cash flow adequacy etc.


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SECURITY

Banks need some security from the borrowers against the credit facilities

extended to them to avoid any kind of losses. securities can be created in

various ways. Banks provide credit on the basis of the following modes of

security from the borrowers.

Hypothecation: under this mode of security, the banks provide credit to

borrowers against the security of movable property, usually inventory of

goods. The goods hypothecated, however, continue to be in possession of the

owner of the goods i.e. the borrower. The rights of the banks depend upon

the terms of the contract between borrowers and the lender. Although the

bank does not have the physical possession of the goods, it has the legalright to sell the goods to realize the outstanding loans. Hypothecation facility

is normally not available to new borrowers.

Mortgage: It is the transfer f a legal / equitable interest in specific

immovable property for securing the payment of debt. It is the conveyance of

interest in the mortgaged property. This interest terminated as soon as the

debt is paid. Mortgages are taken as an additional security for working

capital credit by banks.

Pledge: The goods which are offered as security, are transferred to the

physical possession of the lender. An essential prerequisite of pledge is that

the goods are in the custody of the bank. Pledge creates some kind of

liability for the bank in the sense that Reasonable care means care, which a

prudent person would take to protect his property. In case of non-payment

by the borrower, the bank has the right to sell the goods.

Lien:The term lien refers to the right of a party to retained goods belonging

to other party until a debt due to him is paid. Lien can be of two types viz.

Particular lien i.e. A right to retain goods until a claim pertaining to these

goods are fully paid, and General lien, Which is applied till all dues of the

claimant are paid. Banks usually enjoyed general lien.


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BANKING ARRANGEMENTS

Working capital is made available to the borrower under the following

arrangements;

CONSORTIUM BANKING ARRANGEMENT:

RBI till 1997 made it obligatory for availing working capital facilities beyond

a limit (Rs 500 million in 1997), through the consortium arrangement. The

objective of the arrangement was to jointly meet the financial requirement of

big projects by banks and also share the risks involved in it.

While it consortium arrangement is no longer obligatory, some borrowerscontinue to avail working capital finance under this arrangement. The main

features of this arrangement are as follows;

Bank with maximum share of the working capital limits usually takes the

role of lead bank.

Lead bank, independently or in consultation with other banks, appraise theworking capital requirements of the company.

Banks at the consortium meeting agree on the ratio of sharing the assessed

limits.

Lead bank undertakes the joint documentation on behalf of all member

banks.

Lead bank organizes collection and dissemination of information regarding

conduct of account by borrower.


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MULTIPLE BANKING ARRANGEMENT

Multiple banking is an open arrangement in which no banks will take the

lead role.

Most borrowers are shifting their banking arrangement to multiple banking

arrangements.

The major features are

Borrower needs to approach multiple banks to tie up entire

requirement of working capital.

Banks independently assessed the working capital requirements of the

borrower.

Banks, independent of each other, do documentation, monitoring and

conduct of the account

Borrowers deals with all financing banks individually.

SYNDICATION

A syndicated credit is an agreement between two or more lenders to provide

a borrower credit facility using common loan agreement. It is internationally

practiced model for financing credit requirements, wherein banks are free to

syndicate the credit limit irrespective of quantum involved. It is similar to a

consortium arrangement in terms of dispersal of risk but consist of a fixed

repayment period.


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REGULATION OF BANK FINANCE

Introduction

Bank follows certain norms in granting working capital finance to

companies. These norms have been greatly influenced by the reconditions of

various committees appointed by the RBI from time to time. The norms of

working capital finance followed by banks are mainly based on the

recommendation of Tandon committee and Chore committee.

These committees were appointed on the presumption that the existing

system of bank lending of number of weakness industries in India havegrown rapidly in the last three decades as result of which, the industrial

system has become vary complex. The banks role has shifted from trade

financing to industrial financing during this period. However, the banks

lending practices and styles have remained the same. Industries today fail to

use bank finance efficiently. Their techniques of managing funds are

unscientific and non-professional. The industries today lack in reducing

costs, optimizing the use of inputs, conserving resources etc.

The weakness of the existing system highlighted by the Dehejia committee in1968 and identified by the tondon committee in 1974, are as follows:

It is the borrower who decides how much he would borrow ;the bankers

does not decide how much he would lend and is, therefore, not in a position

to do credit planning. The bank credit is treated as the first sources of

finance and not as supplementary to other sources of finance. The amount

of credit is extended is based on the amount of security available and not on

the level of operations of the borrower.

Security does not by itself ensure safety of bank. Funds since all bad sticky

advances are secure advances. Safety essentially lies in the efficient follow

up of the industrial operations of the borrower.


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We discuss the following committees important finding and

recommendations for bank finance: -

TANDON COMMITTEE

CHORE COMMITTEE.

TANDON COMMITTEE

Introduction:

The Tandon committee was appointed by the RBI in July 1974 and headed

by Shri. Prakash L. Tandon, the chairman of the Punjab national bank, to

suggest guidelines for rational allocation and optimum use of bank credit

taking into consideration the weakness of the leading system. Bank credit,

which had become a scare commodity, strictly rationed to meet the credit

requirement of all the sectors. The larger sector of the industry needed strict

rationing becomes. It was over relying on bank finance and pre empted most

of it while the other sectors were not getting even their due share. Therefore,

the method and criterion adopted for fixing credit ration needed to bestandardized so that there is minimum scope for miss-use or part of the

credit uses. The Tandon committee was concern exactly with this problem.

Its report laid down as to how the credit ratio of individual borrowers could

be fixed at imposed certain obligation on them for the efficient use of the

credit made available.

The recommendation of the Tandon committee based on the following

notions: The borrower should indicate the demand for credit for which heshould draw operating plans for the ensuring year and supply them to the

banker. This would facilitate credit planning at the banks level and help the

banker in evaluating the borrowers credit needs in a more realistic manner.

The banker should finance only the genuine production needs of the

borrower. The borrower maintained reasonable levels inventories and

receivables. Efficient management of resources should therefore be ensured

to eliminate slow moving and flabby inventories.


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The working capital needs of borrower cannot entirely finance by the

banker. The banker will finance only a reasonable part of it for the

remaining; the borrower should depend on his own fund. Recommendation

of Tandon committee accordingly, the Tandon committee put forth in the

following recommendations.

Inventory and receivables norms

The borrower is allowed to hold only a reasonable level of current asset,

particularly inventory and receivable. The committee suggested the

maximum level of raw material, stock in process, finished goods, which

corporate in an industry should be to hold. Only the normal inventory based

on a production plan, lead-time of supplies, economic ordering levels and

reasonable factor safety should be financed by the banker.

Lending norms:

The banker should finance only a part of the working capital gap; the other

part should be financed by the borrower form long-term sources. The

current asset will be taken on the estimate values or values as per the

Tandon committee norms, whichever is lower. The current will consist of

inventory and receivables, referred as chargeable current assets (CCA), andother current assets (OCA).


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MAXIMUM PERMISSIBLE BANK FINANCE:

The Tandon committee suggested the following three methods of

determining the permissible level of bank borrowings-

Method-I

The borrower will contribute 25 % of the working capital gap from long term

fund i.e owned fund and term borrowings; the remaining 75 % can be

financed from bank borrowings. This method gives a minimum current ratio

of 1:1. This method was considered suitable only for very small borrowers

where the requirement 0 credit was less than Rs 10 lacs.

Method-II

The borrower will contribute 25 % of the total current assets from long-term

funds i.e. owned funds and term borrowings. A certain level of credit for

purchases and other

current liabilities will be available to fund the building up of current assets

and the bank will provide the balance. Consequently, the current liabilities

inclusive of bank borrowing could not exceed 75 % of current assets. This

method gives a current ratio of 1.3:1. This method was considered for all

borrowers whose credit requirements were more than Rs.10 lacs.

It may be observed from the above that borrowers contribution from long

term funds would be 25 per cent of the working capital gap under the first

method of lending and 25 per cent of total current assets under the second

method of lending. The above minimum contribution of long-term funds is

called minimum stipulated Net Working Capital (NWC) which comes from

owned funds and term borrowings.


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Above two method of lending may be illustrated by taking the following

example of a borrowers financial position, projected as at the end of next

year

Current Liabilities Amount Current Asset Amount

Creditors for purchase 100 Raw Material 200

Other current liabilities 50 Stock in process 20

150 Finished goods 90

Bank borrowing,includingbillsdiscounted with bank

200Receivables (including billsdiscounted with bank ) 50

Other current asset10

350 370


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Calculation Of Maximum Permissible Bank Finance (MPBF)

Method 1 Method 2

Total Current Assets 370 Total Current Assets 370

Less: Current Liabilities 150 25% of above from long 92

(other than bank borrowing) term sources

Working Capital Gap 220 278

Less: 25% of above from 55 Less: Current Liabilities 150

long term sources (other than bank borrowing)

MPBF 165 MPBF 128

Excess bank borrowings 35 Excess bank borrowings 72

Current ratio 1.71:1 Current ratio 1.33:1

It may be observed from the above that in the first method, the borrower has

to provide a minimum of 25% of working capital gap from ling-term funds

and it gives a minimum current ratio 1.17:1. In the second method, the

borrower has to provide a minimum of 25% of total current assets from

long-term funds and gives a minimum current ratio of 1.33:1.

While estimating the total requirement of long-term funds for new projects,

financial institutions/banks should calculate for working capital on the

basis of norms prescribed for inventory and receivables and by applying the

second method of lending. A project may suffer from shortage of working

capital funds if sufficient margin for working capital is not provided as per

the second method of lending while funding new projects. Proper co-

ordination between banks & financial institutions is necessary to ensure

availability of sufficient working capital finance to meet the production

requirement.


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Style of credit:

The committee recommended the bifurcation of total credit limit into fixed

and fluctuating parts. The fixed component is then treated as demand loan

for the year representing minimum level of borrowing, which the borrower

expected to use through out the year. The fluctuating component is taken

care of by a demand cash credit. It could be partly used by way of bills. The

new CC limit should be placed on a quarterly budgeting reporting system.

The interest rate on the loan components should be charged lower than the

cash credit amount.


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CHORE COMMITTEE

Introduction

In April 1979, the RBI constituted a working group to review the system of

cash credit under the chairmanship of Mr. K. B. Chore, Chief Officer,DBCOD, RBI. The main terms of reference for the group were to review the

cash credit discipline and relate credit limit to production.

Recommendations by Chore Committee: -

Bank credit: -

Borrower should contribute more funds to finance their working capital

requirement and reduce their dependence on bank credit. The committee

suggested placing the second method of lendingas explain in the Tandon

committee report.

In case the borrower is unable to comply with this requirement immediately,

he would be granted excess borrowing in the form of working capital loan

(WCTL). The WCTL should be paid in seamy annual installments for a period

not exceeding 5 years and a higher rate of interest than under the cash

credit system would be charged. This procedure should apply to those

borrowers, having working capital requirements of more than Rs 1lacs.


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LEVEL OF CREDIT LIMIT

Bank should appraise and fix separate limits for the peak level and normal

non pick level credit requirements for all borrowers in excess of Rs.10 lacs

indicating the relevant periods.

With the sanctioned limits for these two periods, the borrower should

indicate in advance his need for funds during the quarter. Any deviation in

utilization of funds Beyond 10% should be considered irregular and is

subject to penalty fix by the RBI (2% p.a. over the normal rate)

Bank should discourage ad hoc or temporary credit limits. If sanction underexceptional circumstances the same should be given in the form of a

separate demand loan and additional interest of at least 1% should charged.

Lending system:

The system of three types of lending should continue i.e. cash credit loan

and bills wherever possible; the bank should replace cash credit system by

loan and bills. Bank should scrutinize the cash credit accounts of large

borrowers ones a year. Bifurcation of cash credit account into demand loan

fluctuating cash credit component, as recommended by the Tandon

committee should discontinue. Advances against books debts should be

converted to bills wherever possible and at least 50% of cash credit limit

utilize for financing purchases of raw material inventory should also be

charged to the bill system.


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DRAWING POWER OF THE BORROWER

The drawing power that a borrower enjoys at any one point depends on each

components of working capital. The bank for each component, which the

borrower must hold as his contribution to finance working capital,

prescribes margins. The drawing power of the borrower can be best

explained with the following illustration

Illustration:

Suppose a borrower has Rs 100.00 lacs as working capital limit sanctioned

to him by a bank. The security provided by the borrower to the bank is the

hypothecation of inventory.

Example 1: Suppose, the borrower needs to hold an inventory level of say

130 lacs in order to enjoy 100 lacs as his working capital limit.

The actual level of inventory with the borrower at a point is say 110 lacs.

The inventory margin prescribed by the bank is say 25 %

Therefore with this inventory level, the borrower enjoys only Rs 82.5 lacs as

his working capital limit as against Rs 100 lacs.

Inventory level (Required ) Rs 130 lacs

Drawing power of borrower Rs 100 lacs

Inventory level ( Actual ) Rs 110 lacs

Margin prescribed by bank 25 %

Drawing power of borrower 110-( 0.25110 )= Rs.82.5lacs


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Example 2: Suppose, the borrower holds Rs 150 lacs of inventory,

Inventory level (required) Rs. 150 lacs

Drawing power of borrower Rs. 100 lacs

Inventory level (actual) Rs. 150 lacs

Margin prescribed by bank 25 %

Drawing power of borrower 150( 0.25150 )= Rs.112.2 lacs

Therefore, in this case the borrower would still enjoy Rs 100 lacs as his

working capital limits as against Rs 112.5 lacs.

Therefore, the lower of the two is always considered as the working capital

limit or the drawing power of the borrower sanctioned by the bank.


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DATA ANALYSIS

&

INTERPRETATION


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CASE-STUDY ON ASSESSMENT OF WORKING CAPITAL

Background of the Company

ABC Ltd. is engaged in construction activities since July, 2008. It was

formed by a well known RTD group which are in this business since the last

15 years. The company has been dealing with big corporate firms and has

successfully completed every project so far. Their main objective is to

construct, develop, repair or remodel any civil constructions on behalf or on

contract or act as experts and consultants in civil constructions.

Performance of the company

The company was incorporated on July 17, 2008. Hence, FY 2008-09 was

the first financial year of operations of the company. Though the company

was newly established, it was able to achieve total sales of Rs.629.44 lacs as

at 31.03.2008 (within 6 months) as per Annexure I. The sales are estimated

to increase up to Rs.1625 lacs. The estimated increase will be 29%. The

company has projected a 10% increase in its sales. The actual sales

achieved by the company for 10 months are Rs.1549 lacs. The work orders

in hand are Rs.7491 lacs. So the company is confident about achieving its

estimated sales. Considering the past years performance and experience of

directors, the working results are reasonable and acceptable.

Financial Position of the company

Initially, the company has introduced Rs.62.85 lacs as capital as per

Annexure I. The Net Worth of the company is increasing every year. As

equity capital remains at the existing level, the net worth is estimated to

increase from Rs.102.27 lacs to Rs.227.02 lacs. Total reserves are 39.42 lacs

which are estimated to rise to Rs.164.17 lacs as the profit earned is retained

in the business. Current Ratio is above benchmark from the year of

inception i.e. 2.20. Due to T/L Instalments, the ratio is estimated to fall at

1.23. If these T/L instalments are excluded, then the ratio improves to 1.55

and would stabilize at 1.45 in coming years. The liquidity position of the

company is satisfactory as per past records.


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Current Assets and Current Liabilities

The company has estimated total current assets at Rs.293 lacs for currentyear as against Rs.137.80 lacs for last year. Total current liabilities (otherthan bank borrowings & T/L inst.) is Rs.62.60 lacs as on 31.03.09 and is

estimated at Rs.189 lacs for the current year.Let us see the inventory holding, debtors and creditors level.

31.03.09 31.3.10 31.3.11

Days Amt. Days Amt. Days Amt.

Inventory 09 15.98 19 83.55 19 91.68

Sundry Debtors 0 0.00 24 106.18 25 121.79

Sundry Creditors 23 35.55 17 19.55 17 21.71

i. Stock Holding Level

The company is engaged in service industry and deals with civil

constructions. Hence, stock holding level consists only stock of work-in-

process. The WIP stock is for temporary period and after finalization of bills

from the builder the same will be converted into debtors. The estimated andprojected holding period of 19days is considered reasonable.

ii. Debtors Holding Level

The first year of operations and performance was for 6 months only. Hence,

no debtors were outstanding. The debtors holding level is estimated at 24

days because the company is engaged in civil constructions of Big Projects

of Hiranandani, Lodha group, etc and contract amount is sizeable. Hencerealization period is around 24 months.

iii. Creditors Holding Level

The creditors level as on 31.03.09 is 23 days, estimated to reduce up to 17

days for current and projected years. This would be possible s the company

will avail additional bank finance and utilize it to reduce creditors.


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Financial Ratios

Financial ratios aid to know a firm's performance and financial situation.

Most ratios can be calculated from information provided by the financial

statements. These ratios can be used to analyze trends and to compare the

firm's financials to those of other firms. In some cases, ratio analysis can

predict future bankruptcy.

Current Ratio: Current Assets/Current Liabilities

The current ratio helps to know the liquidity position of a firm to measure

financial strength. Care should be taken in interpreting this ratio as, this

ratio should be used with an approach to measure liquidity, rather than a

judgment on the going concern. The seasonal character of the businessresulting in fluctuating current ratio is a disturbing factor. If current

liabilities exceed current assets, liquidity could be severely affected. The

higher the ratio, the better the liquidity position.

Debt Equity Ratio:There are three ratios under debt-equity ratio.

1. Total Term Liability/Total Net Worth (TTL/TNW:)

2. Total Outside Liability/Total Net Worth (TOL/TNW)

3. Quasi DE Ratio

Financial Leverage Ratio 31.3.09 31.3.10 31.3.11

DE Ratio TTL/TNW 0.00 0.18 0.03

DE Ratio TOL/TNW 0.61 1.14 0.66

Quasi DE Ratio 0.61 1.14 0.66

It indicates size of stake, stability and degree of solvency. Indicated what

proportion of the companys finance is represented by the tangible net

worth. The lower the ratio the greater the solvency. The ratio is usually

higher in case of SMES. The ratio should be studied at the peak level of

operations.


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Profitability Ratio

It measures the success of the firm. The returns on investment can be

checked by using this ratio. The profit of the company is as follows:

Ratio 31.3.09 31.3.10 31.3.11

NPAT to Net Sales ( % ) 6.11 7.67 6.78

Net Profit to Capital Employed 37.61 46.40 33.94

PAT / TNW 0.37 0.55 0.35


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FINDINGS

&

SUGGESTIONS


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Findings:

The Bank launched a new business process reengineering and

organizational restructuring project Navnirmaan- Baroda Next. The

project is primarily designed to optimise on available resources to

maximise business and profits and to build a next step for Bank of

Baroda, that is, Baroda Next.

For the current year, the Bank has selected the motto Leveraging

technology for augmenting business growth and profitability.

The Bank has been actively designing strategies for enhancing salesand raising brand equity through continuous market research.

Bank of Barodas long standing reputation for financial soundness,

long-term customer relationships and proactive management are

important.

Suggestions:

Bank should focus on improving credit initiation and effective credit

monitoring.

Baroda Next project can help the bank to gain more prospective

customers.

Technology has enhanced and increased the pace of credit lending

process.

Easy accessibility and short credit lending procedures will prove

beneficial to both the customers as well as the bank.


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Documents

Working Capital of Borrower-Bank of Baroda