Description
Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. It is considered as the life blood of an organization. Working capital management is the process of assessment of working capital requirements of an enterprise, appraising of proposals, follow-up and monitoring of advances on appraised loans and advances. Today, working capital loans are forming a major part in bank balance sheets. When fierce competition is the rule, the banking sector is no exception. Banks compete with each other to attract quality borrowers. In this scenario, a hasty or inadequate appraisal will result in growth of Non Performing Assets.
Working Capital Financing at
Specialised Corporate Branch Chennai
Submitted By Vipin Janardanan PGDM 2011-2013 Roll No: 175 Submitted on: 06-08-2012
A Project Report submitted in partial fulfillment of the requirement for the award of post graduate Diploma in Business Management
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ACKNOWLEDGMENT
At the completion of my Summer Internship Project, I feel obliged to express my heartfelt gratitude towards all those who have made this possible. The two months of internship has been an enriching experience in terms of learning and application of theory into practice. The real time experience that I have received is something which cannot be emulated in a class room scenario and will be highly helpful for my professional growth. The experience has helped me to understand and appreciate the dynamics existing in working capital financing, the intricacies involved in credit appraisals and also what are the parameters and approaches needed to be followed by a credit analyst in this regard. I convey my sincere gratitude to Mrs. Radha, Branch Head, of the specialized corporate branch, IDBI Bank for extending this opportunity to me, for doing my summer internship during the two months duration from May 7th to July 7th at IDBI Bank. I would also like to express my sincere gratitude to Mr. Venkateswaran N., AGM-MCG who was my coordinator and guide at IDBI for the timely suggestions and directions which were very helpful during the course of my project. I would also like to thank my mentors, M/s Siby and Mr. Mahesh who helped and guided me throughout my project work. If not for their guidance and support, this endeavour would not have been a success. Next, I definitely would like to thank Asst. Prof. Mareena Mathew, our internal guide for her keen and dedicated approach in guiding and motivating us. Very importantly, I would like to thank Prof. J Philip, President, XIME for setting out this 8-week summer internship as a part of the curriculum for the award of Post Graduate Diploma in Business Management. I also thank my parents and friends for helping me carry out this project successfully.
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Table of Contents
1. 2. 3. 4. 5. 6. 7. 8. List of Tables .............................................................................................................................. 5 List of Figures............................................................................................................................. 5 List of Abbreviations .................................................................................................................. 6 Executive Summary ................................................................................................................... 7 Objectives.................................................................................................................................. 8 Scope of study ........................................................................................................................... 8 Limitations of the study ............................................................................................................. 8 Introduction .............................................................................................................................. 9 8.1. 8.2. 8.3. 8.4. 9. Definition ........................................................................................................................... 9 Classification of Working Capital ........................................................................................ 9 Factors that can affect Working Capital ............................................................................ 10 Need and importance of Working Capital ......................................................................... 11
Assessment of Working Capital ................................................................................................ 12 9.1. Definition of Important Terms .......................................................................................... 12
Identification of current assets & current liabilities ...................................................................... 12 9.1.1. 9.1.2. 9.2. Current Assets .......................................................................................................... 12 Current Liabilities ..................................................................................................... 14
Methods of Lending in Banks ........................................................................................... 15 Operating cycle method ........................................................................................... 16 Traditional Method of Assessment of Working Capital Requirement ........................ 17 Projected Annual Turnover Method for SSI units (Nayak Committee) ....................... 17 Projected Balance Sheet Method (PBS) ..................................................................... 18 Cash- Budget Method: .............................................................................................. 19 Maximum Permissible Bank Finance Method (MPBF) ............................................... 21 Percent of Sales Method........................................................................................... 23 Regression Analysis Method ..................................................................................... 23
9.2.1. 9.2.2. 9.2.3. 9.2.4. 9.2.5. 9.2.6. 9.2.7. 9.2.8. 9.3. 10. 11.
Loan Ratings..................................................................................................................... 24 Working Capital Flowchart ................................................................................................... 28 Case Study Analysis .............................................................................................................. 29 Case Study - Background .............................................................................................. 29 About the Company and Business Profile ..................................................................... 29 Data Collection ............................................................................................................. 31 Financial Analysis and Observations ............................................................................. 32 3
11.1. 11.2. 11.3. 11.4.
11.4.1. 11.4.2. 11.4.3. 11.4.4. 11.4.5. 11.4.6. 11.4.7. 11.5. 11.5.1. 11.5.2. 11.5.3. 11.6. 12. 13.
Sales ......................................................................................................................... 32 Profitability............................................................................................................... 35 Liquidity Indicators ................................................................................................... 36 Gearing Indicators .................................................................................................... 37 Auditors Qualifications and Clarifications, if any ....................................................... 37 Contingent Liabilities ................................................................................................ 38 Peer Comparison ...................................................................................................... 39 Assessment of Proposal ................................................................................................ 40 Assessment of Working Capital Requirement ........................................................... 40 Assessment of Non - Fund Based facility ................................................................... 43 Key Risks and Mitigants ............................................................................................ 43 Recommendation for the Proposal ............................................................................... 45
Conclusion ........................................................................................................................... 46 Annexure ............................................................................................................................. 47 About IDBI .................................................................................................................... 47 Screenshots .................................................................................................................. 49 References ................................................................................................................... 54
13.1. 13.2. 13.3.
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1. List of Tables
Tables
Table 1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7 Table 8 Table 9 Table 10 Table 11 Table 12 Table 13 Table 14 Table 15 Table 16
Table Headings
Computation of working capital using cash-budget method Explanatory notes regarding rating symbols Performance/Financial Analysis of XYZ Company Sales over the years Production status of 2009 and 2010 Production wise sales of 2009 and 2010 Segment wise sales of 2009 and 2010 Profitability Index Operating profit data Liquidity Indicators Gearing Indicators Disputed statutory dues Contingent Liabilities Peer Comparison To calculate the holding period for calculating working capital To calculate the Maximum Permissible Banking Finance
Page
20 27 31 32 33 34 34 35 35 36 37 37 38 39 40 41
2. List of Figures
Figures
Figure 1. Figure 2.
Title
Operating Cycle of an Enterprise Working Capital Financing Flowchart
Page
10 27
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3. List of Abbreviations
IDBI MPBF WC NWC CMA SSI C&I CC WCDL FB NFB LC STL FY BC TOL TNW PAT PBIT PBDIT CA CL LR EPC PCFC PSCFC
Industrial Development Bank of India Maximum Permissible Bank Finance Working Capital Net Working Capital Credit Monitoring Arrangement Small Scale Industrial Commercial & Industrial Cash Credit Working Capital Demand Loan Fund Based Non-fund Based Letter of Credit Short Term Loan Financial Year Buyer's Credit Total Outside Liabilities Total Net Worth Profit After Tax Profit Before Interest and Tax Profit Before Depreciation Interest and Tax Current Assets Current Liabilities Loan Ratings Export Packing Credit Packing Credit in Foreign Currency Post-shipment Credit in Foreign Currency
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4. Executive Summary
Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. It is considered as the life blood of an organization. Working capital management is the process of assessment of working capital requirements of an enterprise, appraising of proposals, follow-up and monitoring of advances on appraised loans and advances. Today, working capital loans are forming a major part in bank balance sheets. When fierce competition is the rule, the banking sector is no exception. Banks compete with each other to attract quality borrowers. In this scenario, a hasty or inadequate appraisal will result in growth of Non Performing Assets. The problem statement of this report was to conduct a study of the Working Capital Assessment of a company in the manufacturing sector, at IDBI’s Specialised Corporate Branch, Chennai so as to gain insights about the matter of the study. These insights were used as a device for a detailed and in-depth analysis of the borrower’s financials. In this process, the technical, the marketing, the organizational, the financial, the economic and the social aspects of the borrower company were examined to ensure technical feasibility, market necessity, financial viability, economic strength and social desirability of the proposal, all of which are essential aspects to be scrutinized in a credit appraisal process. In this report I have also covered the methods applicable to the banks in appraising working capital loans and their analysis. The whole process of appraisal starts when the borrower arrives at the bank. It is followed by verification and detailed analysis of balance sheets, credit limits to be sanctioned after considering all parameters like RBI guidelines and bank internal guidelines and lastly follow-up has to be done by monitoring the cash-credit account and quarterly information system reporting. After the analysis, the bank’s internal credit rating procedure is done to rate the client before the final approval is given to the proposal. It is also recommended that IDBI maintain its conservative outlook towards lending but at the same time look for innovative ideas to beef up its market share as there is stiff competition to the Public Sector banks from the foreign banks.
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5. Objectives
? To understand and analyze the existing credit appraisal mechanism at IDBI bank and to have a practical knowledge and experience towards Working Capital financing. ? To understand the financial viability of the working capital assistance proposal by the manufacturing company which has been one of the prestigious clients (borrowers) for the specialized corporate branch of IDBI. ? To suggest any changes (if any) to IDBI that need to be brought about in its working capital financing policy. ? To understand the importance of appraisal system in sharpening the ability of the bank to identify investment opportunities of the project undertaken. ? To understand the break-up of a loan proposal and also the various risks involved in credit appraisal process
6. Scope of study
The scope of the study is limited to Credit Appraisal Department of IDBI Bank, Specialized Corporate Branch, Chennai. This study also covers ratio analysis, cash flow, risk involved in the credit appraisal and analysis of the financial statements of the company which has asked IDBI for the working capital assistance.
7. Limitations of the study
? As some of the information is not revealed being sensitive and strictly confidential, some of the suggestions are based on assumptions. ? Working capital assessment system includes various types of detailed studies for different areas of analysis. For e.g. the methods and terminologies used in the analysis for a manufacturing company will be different from that of a non-banking finance company. Therefore, due to time-constraints, I could only analyze the loan proposal of a manufacturing company that was brought to IDBI during my internship.
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8. Introduction
8.1. Definition
Working capital refers to the current asset holding of an enterprise. Simply put, it refers to a firm’s investment in short term assets, such as cash amounts receivables, Inventories etc. The term working capital is commonly used for the capital required for day-to-day working of a business concern, such as for purchasing raw material, for meeting day-to-day expenditure on salaries, wages, rents rates, advertising etc. Working capital is blood of the organization. So every finance manager must take care of working capital. Commercial banks play important role in financing working capital requirements. As per the RBI guidelines, commercial banks must follow the guidelines prescribed by them to finance working capital requirements of different sectors. The term “working capital” is often referred to “circulating capital” which is frequently used to denote those assets which are changed with relative speed from one form to another i.e., starting from cash, changing to raw materials, converting into work-in-progress and finished products, sale of finished products and ending with realization of cash from debtors. Working capital has been described as the “life blood of any business which is apt because it constitutes a cyclically flowing stream through the business”.
8.2.
Classification of Working Capital
1. Gross Working Capital: It refers to the firm’s investment in total current or circulating assets. 2. Net Working Capital: The term “Net Working Capital” has been defined in two different ways: I. It is the excess of current assets over current liabilities. This is, as a matter of fact, the most commonly accepted definition. Some people define it as only the difference between current assets and current liabilities. The former seems to be a better definition as compared to the latter. II. It is that portion of a firm’s current assets which is financed by long-term sources i.e. promoters’ stake or other long from Banks etc.). term liabilities (Equity/Preference Capital, Debentures/Bonds/ Unsecured Loans from Promoters and Associates/Corporate Loans
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3. Permanent Working Capital: This refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities. In other words, it represents the current assets required on a continuing basis over the entire year. Tandon Committee has referred to this type of working capital as “Core current assets”. Characteristics of this type of working capital: 1. Amount of permanent working capital remains in the business in one form or another. This is particularly important from the point of view of financing. The suppliers of such working capital should not expect its return during the life-time of the firm. 2. It also grows with the size of the business. In other words, greater the size of the business, greater is the amount of such working capital and vice versa. Permanent working capital is permanently needed for the business and therefore it should be financed out of long-term funds. 4. Temporary Working Capital: The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. In other words, it represents additional current assets required at different times during the operating year. For example, extra inventory has to be maintained to support sales during peak sales period. Similarly, receivables also increase and must be financed during period of high sales. On the other hand investment in inventories, receivables, etc., will decrease in periods of depression. Suppliers of temporary working capital can expect its return during off season when it is not required by the firm. Hence, temporary working capital is generally financed from short term sources of finance such as ad hoc bank credit. 5. Negative Working Capital: This situation occurs when the current liabilities exceed the current assets. It is an indication of liquidity crisis to the firm.
8.3.
Factors that can affect Working Capital
Internal factors: Nature & size of business, firm’s production policy, availability of credit, growth and expansion of business, profit margin and dividend policy, operating efficiency of the firm, co-coordinating activities in firm External factors: business fluctuations, changes in technology, import policy, taxation policy, infrastructural facilities, etc.
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8.4.
Need and importance of Working Capital
Working capital finance is essential to carry on day-to-day operations to maintain the
operating cycle of an enterprise. Fixed assets cannot generate income unless they are used with the help of working capital. Therefore working capital is considered life blood of an enterprise. Working capital is needed till a firm gets cash on sale of finished products. It depends on two factors: i. ii. Manufacturing cycle i.e. time required for converting the raw material into finished product; Credit policy i.e. credit period given to Customers and credit period allowed by creditors. Thus, the sum total of these times is called an “Operating cycle” and it consists of the following six steps: i. ii. iii. iv. v. vi. Conversion of cash into raw materials. Conversion of raw materials into work-in-process. Conversion of work-in-process into finished products. Time for sale of finished goods—cash sales and credit sales. Time for realization from debtors and Bills receivables into cash. Credit period allowed by creditors for credit purchase of raw materials, inventory and creditors for wages and overheads.
Figure 1. Operating Cycle of an Enterprise
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9. Assessment of Working Capital
9.1. Definition of Important Terms
To scrutinize the credit proposal of a unit, the bank employs a tool known as the Credit Monitoring Arrangement Form, which in short is known as CMA. It is used for measuring the credit worthiness of the customer applying for the bank loan. Also it can be used to find out the permissible bank finance that can be provided to the customer. It contains certain general parameters which reflect the unit’s performance and is required to be examined by a credit analyst. These parameters not only indicate the unit’s performance but also provide clues for examining the justification or otherwise, for credit limit sought. Before analyzing the methods adopted to measure the financials of the customer, it is important to understand certain terms as regards to Balance sheet and P&L of a company. Since my project was on working capital financing, I would be concentrating only on current assets and current liabilities which hold good for calculating the working capital requirement. Identification of current assets & current liabilities Introduction The assets and liabilities created in the operating cycle of an enterprise are called the gross working capital and the excess of current assets over current liabilities is called the Net Working Capital. While the study of gross working capital indicates the nature and extent of working capital requirements, the analysis of Net Working Capital indicates the liquidity position of an enterprise. In order to compute the Net Working Capital and the Maximum Permissible Bank Finance, it is necessary to understand current assets and current liabilities and have a proper classification of various items of current assets and current liabilities.
9.1.1.
Current Assets
Current assets are those assets expected to be realized in cash or sold or consumed or
turned over during the operating cycle of the business, normally within one year. They are assets which are acquired with the intention of converting them into cash during the normal operating cycle of the business unit, normally within one year.
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They differ from fixed assets which are normally acquired for use in the production of current assets (i.e., goods and services). These assets remain in business for a longer time than current assets and they are normally not meant for resale. The current assets would include the following: (a) Cash and Bank Balance: A business unit while operating will have to maintain a certain amount of cash and cash balances in various collection and interest bank accounts for meeting day to day disbursements in various places of operation. (b) Inventories: These consist of (i) Raw materials and stores, (ii) stock in process, (iii) Finished goods and (iv)Consumable spares. This is a very important item of current assets and forms a major component of working capital requirements. Projected inventory should be examined in relation to past trends, future outlook and inter-firm comparisons. The levels are then normally accepted if they are reasonable. Where the analysis of balance sheet reveals excess inventory the borrower should be asked to liquidate the same within a reasonable time. (c) Receivables: Receivables are dues arising out of credit sales. Where bills are raised on purchases, and then discounted with banks, some companies show the amount of receivables net of bills discounted and the amount of bills discounted as a contingent liability.
(d) Advances to suppliers for purchase of raw materials and stores, spares, etc. The
projected level of advances to supplier of raw materials and stores should be consistent with the past trends and the present market conditions. If not, inquires may be made and the amount should be tallied with the corresponding amount in funds flow sheet.
Other Current Assets are:
(e) Prepaid expenses. (f) Advances to employees and others for meeting day to day expenses of normal business operations. (g) Advance Payment of Tax. (h) Duty Draw back claims and cash incentives receivable. (i) Deposits with public bodies arising out of normal business operations. (j) Receivable on sale of fixed assets to be received within the next one year. The items in the following list should be reckoned as non-current assets: These assets are termed as non-current assets as they are not intended to be converted into cash or other similar assets or useful goods and services within a period of one year.
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(a) Investments in shares, debentures, etc., and advantages to other firms/companies not connected with the business or the borrowing firm. (b) Investments made in mutual funds (c) Investments made in associate companies/ subsidiaries/group companies, Loans extended sinter- deposits, (d) Dead inventory i.e., slow moving/obsolete items (e) Security deposits/Tender deposits made by the borrower. (f) Receivables of sticky nature e.g., debts which are the subject matter of legal/recovery proceedings and other receivables of more than six months age. (g) Advances not realizable within one year e.g., advance to inter-connected companies or firms other than in the normal course of business. (h) Dues from Directors and senior officials of the borrower Company which are not realizable within the operating cycle. (i) Prepaid expenses of long term nature and deferred charges like discount on debentures, etc.
9.1.2. Current Liabilities
Current Liabilities are liabilities whose liquidation is expected to take place within the operating cycle of the business, normally within one year. These are the obligations which are reasonably expected to be paid by liquidating current assets or by raising other current liabilities. They differ from term liabilities which are repayable after a period of one year. Term liabilities are long term borrowings or deferred liabilities which are normally created for the purpose of acquiring fixed assets etc. The current liabilities would include the following:
[a] Short term borrowings from banks: are those granted for working capital and which
repayable on demand such as pledge loan, hypothecation loan, cash-credit, overdraft, documentary bills on Sight or Usance terms, supply Bills, export Bills, advance against book debts, finance against deferred receivables, commercial papers etc. The bills discounted should be reckoned as a part of Current Liability and the underlying receivables are to be treated as Current Assets.
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Short term borrowings:
Are those from others are of substantial amount in the balance sheet, inquiry should be made as to the institution, firm or friends from which/whom they have been obtained and the relative details should be given in the balance sheet. The reason for this is that if it is from directors or friends and the company is paying interest a higher rate, then it would mean high interest burden on the company. Banks generally stipulate a condition that the rate of interest paid on such borrowings shall not be more than the rate charged by them on the Working Capital facilities.
[c]Sundry Creditors:
Only creditors for purchase of raw materials and stores should be included. Level of sundry creditors shown an increasing trend in the balance sheet should be investigated.
[d] Other statutory liabilities:
These are liabilities which the company has to meet during the year under review, viz. provision for taxation, sales tax, excise duty, gratuity dues to employees etc. While scrutinizing this item, it should be seen whether there is any gradual or sudden accumulation of statutory liabilities due to non-payment of taxes, provident funds dues of employees etc.
[e] Deposits:
Deposits from public maturing within one year should be included here.
[f] [Other current liabilities:
Include liabilities for expenses, interest accrued and due dividend paid and other nonstatutory provisions, installment of deferred payment credits due within one year.
9.2.
Methods of Lending in Banks
It is difficult to postulate a method of assessment of working capital in any business which
will be of universal application of businesses. The assessment of working capital requirements is beset with several variables. The requirement of working capital would noticeably vary with industry characteristics. The proper assessment of working capital requirements would go a long way in enabling a business to carry its operations efficiently.
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Present Position: While advising the individual banks to evolve their own methods of assessment of working capital requirements, the RBI has given the following guidelines in the matter. Working capital credit requirements are determined by the banks according to their perception of borrower and the credit needs. Transparent policy and guidelines for credit dispensation in respect of each broad category of economic activity should be formulated by the banks, with the approval of their respective board of directors. Prudential guidelines and exposures norms relating to single group borrower/s shall continue to be in force. Working capital is defined as the funds required carrying the required levels of current assets to enable the unit to carry on its operations at the expected levels uninterruptedly. Thus Working Capital required is dependent on (a) The volume of activity (viz. level of operations i.e. Production & sales) (b) The activity carried on viz. mfg process, product, production program, the materials & marketing mix.
9.2.1. Operating cycle method
Any manufacturing activity is characterized by a cycle of operations consisting of purchase of purchase of raw materials for cash, converting these into finished goods & realizing cash by sale of these finished goods. The time that lapses between cash outlay & cash realization by sale of finished goods & realization of sundry debtors is known as the length of the operating cycle. That is, the operating cycle consists of: ? ? ? ? Time taken to acquire raw materials & average period for which they are in store. Conversion process time Average period for which finished goods are in store & Average collection period of receivables (Sundry Debtors) The length of the operating cycle is different from industry to industry and from one firm to another within the same industry. For instance, the operating cycle of a pharmaceutical unit would be quite different from one engaged in the manufacture of machine tools. The operating cycle concept enables us to assess the working capital need of each enterprise keeping in view the peculiarities of the industry it is engaged in and its scale of operations. Operating cycle is an important management tool in decision-making.
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9.2.2. Traditional Method of Assessment of Working Capital Requirement The operating cycle concept serves to identify the areas requiring improvement for the purpose of control and performance review. But, as bankers, we require a more detailed analysis to assess the various components of working capital requirement viz., finance for Stocks, bills etc. Bankers provide working capital finance for holding an acceptable level of current assets, viz. raw materials, stocks-in-process, finished goods and sundry debtors for achieving a predetermined level of production and sales. Quantification of these funds required to be blocked in each of these items of current assets at any time will, therefore provide a measure of the working capital requirement (WCR) of an industry.
9.2.3. Projected Annual Turnover Method for SSI units (Nayak Committee)
For SSI units which enjoy fund based working capital limits up to Rs.5 crore, the minimum working capital limit should be fixed on the basis of projected annual turnover. 25% of the output or annual turnover value should be computed as the quantum of working capital required by such unit. The unit should be required to bring in 5% of their annual turnover as margin money and the Bank shall provide 20% of the turnover as working capital finance. Nayak committee Guidelines correspond to working capital limits as per the Operating Cycle method where the average production / processing cycle is taken to be 3 months (i.e. working capital would be turned over 4 times in a year). Projected Annual Turnover Method for C & I industrial units (limits up to Rs 5 crore) Bank has decided to extend Nayak Committee approach for assessment of limits to C & I industrial units requiring credit limits up to Rs.5 crore. That is, credit requirement up to Rs.5 crore of C&I borrowers (industrial units) may be assessed at a minimum of 20% of projected annual turnover. In other words, the working capital requirement will be assessed at 25% of projected annual turnover, of which 5% should be borne by entrepreneur as margin and 20% would be allowed as Bank Drawings. While accepting projected annual sales turnover, a cap of 25% over actual annual sales turnover in the immediately preceding year should be set, except where production capacity has been substantially increased. Projected Annual Turnover Method for Business Enterprises in Trade & Services Sector: i) For working Capital limits up to Rs. 5 crore to C & I (Trade) sector, the assessment of credit limit is to be based upon annual turnover. Thus, an across the board credit limit equal to 15% of projected annual turnover be offered to business enterprises in the T&S sector. It would be available for utilization generally as a cash credit limit. However, where needed an LC limit (as a sub-limit of total), may also be allowed. 17
ii) The credit limit would be secured by hypothecation charge on the current assets of the enterprise. Periodical stock statements are to be obtained and margin of 25% be retained. iii) Credit limits under this assessment method may be offered to established (at least 3 years old) profit making business enterprises, eligible for credit rating of SB-4 and above. Mortgage of property valued at least at 33% of the limit is to be prescribed. Further, an interest rebate of 0.50% p.a. may be given to borrowers who offer mortgage of property valued at over 75% of the credit limit. iv) While accepting projected annual sales turnover, a cap of 25% over actual annual sales turnover in the immediately preceding year should be set. When circumstances warrant its breach, reasons therefore should be recorded. v) Where borrowers indicate need for credit limits which are higher than the amount indicated above, assessment under the traditional PBS method may be resorted to.
9.2.4. Projected Balance Sheet Method (PBS)
The PBS method of assessment will be applicable to all C&I borrowers who are engaged in manufacturing, services, and trading activities, including merchant exports and who require fund based working capital finance of Rs. 25 lacs and above. In the case of SSI borrowers, who require working capital credit limit up to Rs.5 crore, the limit shall be computed on the basis of Nayak Committee formula as well as that based on production and operating cycle of the unit and the higher of the two may be sanctioned. Fund based working capital credit limits beyond Rs 5 crore for SSI units shall be computed in the same way as for C&I units. For business enterprises in Trade and Services Sector, where the projected turnover method is not applicable, PBS method shall be followed. In the Projected Balance Sheet (PBS) method, the borrower’s total business operations, financial position, management capabilities etc. are analyzed in detail to assess the working capital finance required and to evaluate the overall risk of the exposure. The following financial analysis is also to be carried out: ? Analysis of the borrower’s Profit and Loss account, Balance Sheet, Funds Flow etc. for the past periods is done to examine the trend in turnover, profitability, financial position, financial management, etc. in the business. ? Detailed scrutiny and validation of the projected income and expense in the business, and projected changes in the financial position (sources and uses of funds) are
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carried out to examine if these are acceptable from the angle of liquidity, overall gearing, efficiency of operations etc. There will not be a prescription like mandatory minimum current ratio or maximum level of a current asset (inventory and receivables holding level norms) under PBS method. Under the PBS method, assessment of WC requirement will be carried out in respect of each borrower with proper examination of all parameters relevant to the borrower and their acceptability.
9.2.5. Cash- Budget Method:
General: This method is optional to the borrowers in industry, trades and services segment as well as civil contractors/ builders engaged in construction activities and seasonal industries, with fund-based working capital limits above Rs 10 crores from banking system. Assessment of Working Capital Finance: Under this method, the working capital finance required should be quantified from the monthly/quarterly cash outflows/inflows projected and not from the projected levels of assets and liabilities. The permissible bank finance should be restricted to the peak level gap as reflected in the annual projected cash budget by the borrower. The cash method eliminates the anomaly of ‘averages’ of production sales parameters and takes into account the fluctuations in the requirement of funds within a time-frame. Further, the cash-budget system is not influenced by the normative approach in respect of inventory and receivable holdings. a) Collection/ Analysis of financial data: Besides scrutiny of cash budget, other aspects of assessments like examination of funds flow, profitability, financial parameters etc. should be carried out as per PBF method. Analysis of profit and loss account, balance sheet, funds flow etc. for the previous years to examine the profitability, financial position, financial management etc. Scrutiny and validation of the projected income & expenditure, projected balance sheet and projected funds flow to examine whether these acceptable from the angle of liquidity, overall gearing, efficiency of operation etc.
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b)
Assessment of bank finance for working capital: Monthly/ quarterly projections of cash receipts, and cash outflows should be furnished
in the cash budget statement and the cash has to arrive at which forms the basis for assessing working capital finance. On the scrutiny of data furnished under cash budget statement, the following data should be extracted for the purpose of assessment for the purpose of assessment for Working capital requirements.
Sl. No Particulars Current Year Actuals/ Projections Q1 Q2 Q3 Q4
1
Total cash outflows from business operations
2
Total Inflows to business operations
3 4
Cash gap in business operation
Less: amount brought/ Proposed to be brought in from other sources, i.e. cash surplus under non-business operations/ capital accounts/ sundry items.
5
Net cash gap for business operations[ item 3-4]
Table 1: computation of working capital using cash-budget method
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Note: The outer limit for finance, for working capital requirements, from banking system should be peak GAP among all the four quarters of the current years.
9.2.6. Maximum Permissible Bank Finance Method (MPBF)
Proper assessment of working capital requirements and computation of maximum permissible bank finance, are based on the norms for holding current assets and proper classification of current assets and proper classifications of current assets and liabilities. Norms for holding current assets (Inventories and Receivables) Bank credit for working capital requirements is linked with production requirements. As such, the working capital requirement is assessed by deciding on the reasonable level of holding current assets required for production. This depends on the rate of flow of expenditure or costs within the operating cycle and the length of the operating cycle. 1. The rate of flow of expenditure or costs within the operating cycle, in turn depends on the volume of production and sales and the costs associated with such production or sales, each of which in turn is influenced by several factors such as a) Nature of business b) Size of business c) Production process d) Stock turnover velocity e) Credit terms in the industry f) Trade credits available g) Unit cost of the product h) Seasonal fluctuations i) Business cycle fluctuations 2. The length of the operating cycle for any business, generally, consists of the following phases: a) The period for which the raw materials are held in stock (pre production phase) b) The length of the production cycle (production phase) c) The period for which finished goods are held in stock(storage phase) d) The collection period in respect of sales receivables(collection phase)
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3.
The length of the operating cycle of a business is the sum of the lengths of the above phases of the cycle. For the purpose of the assessment of working capital requirements and determining the level of current assets, in respect of a borrower where no norms are prescribed in this regard, it is necessary to compute the length of the above mentioned different phases of the operating cycle as under: a) Pre – production phase = Stock of raw material * 365
Annual cost of raw materials consumed b) Production phase = Work in process * 365 Annual cost of production c) Storage phase = Stock of finished goods * 365 Annual cost of goods sold d) Collection phase = Book debts * 365 Annual sales 4. In the case of existing units, it is possible to determine the length of the operating cycle in respect of each of the above phase by reference to the past operations in the business. Undoubtedly, any factor which are likely to alter the characteristics of the business in the future should be taken into account e.g., change in raw materials availability causing large stocks to be held, increase in competition forcing more liberal credit terms etc. For new business, bankers will have to rely on computations made for similar business and the industry norms. (i) Proper classification of various items of current assets and current liabilities In order to calculate net working capital and maximum permissible bank finance, it is necessary to have proper classification of various items of current assets and liabilities. (ii) Working capital gap After estimating the reasonable level of current assets (inventory, receivables, etc.,) required for the operation of a unit, sources of financing the same are decided. A part of the total
22
current assets can be financed by creditors for purchases and other current liabilities. The remaining part of the current assets is called the working capital gap. It is the borrower’s requirement of finance to carry current assets other than those financed out of current liabilities. Working capital gap is thus current assets minus current liabilities other than bank borrowings. This gap can be partly financed by borrower’s own sources/long term borrowings and partly by bank finance.
(iii) Maximum Permissible Bank Finance (MPBF):
For the purpose of working out the Maximum Permissible Bank Finance (MPBF) for bridging the working capital gap, three methods were recommended under Tandon Committee Recommendations. They are furnished hereunder for the purpose of understanding the concept of MPBF. In the first method, the borrower will have to contribute a minimum of 25% of the working capital gap from long term funds i.e., owned funds and term borrowings and it gives a minimum current ratio of 1.17:1. In the second method, the borrower will have to provide a minimum of 25% of the total current assets from long term funds and it gives minimum current ratios of 1.33:1. Due to this, in this method of borrower’s contribution from long terms sources is more than in the first method. In the third method, the borrower’s contribution from long term funds will be to the extent of the entire core current assets, i.e., absolute minimum level of raw materials, process stock, and stores which are in the pipeline so as to ensure continuity of production and minimum of 25% of the balance current assets. Borrower’s contribution from long term sources is the most in this method. However, the third method has not been accepted for implementation by the RBI.
9.2.7. Percent of Sales Method
Based on the past experience, some percentage of sales may be taken for determining the Quantum of working capital
9.2.8. Regression Analysis Method
The relationship between sales and working capital and its various components may be plotted on Scatter diagram and the average percentage of past 5 years may be ascertained. This average percentage of sales may be taken as working capital. Similar exercise may be carried out at the beginning of the year for assessing the working capital requirement. This method is suitable for simple as well as complex situations. 23
9.3.
Loan Ratings
Loan Ratings (LR) are opinions on the ability and willingness of a borrower to make
timely payments on the specific loan obligation, over its life.
Need for Loan Ratings
With financial market reforms, the traditional dividing lines for banks, Development Financial Institutions (DFIs), NBFC’s and other players in the financial system are gradually disappearing. The commercial banks, whose traditional forte has been working capital lending, are increasingly moving into long term financing, while the DFIs are moving into short term working capital lending. In this context, LR is aimed at providing a valuable input in assisting the decision making process in BANK. Banks and DFIs often use credit ratings on debt securities as an indicator of the borrower’s ability to honour its obligations on loans. LR directly addresses their needs by rating the loan itself and incorporating in the analysis, the specific characteristics of the loan.
Benefits of LR
LR will meet the requirements of Banks for the following purposes: a. assessing the credit worthiness of borrowers; b. serving as a simple objective indicator for the internal credit risk exposure guidelines; c. determining the risk premium to be charged; d. portfolio monitoring; e. making quick credit decisions
Rating Methodology The analytical framework for rating methodology would be divided into three interdependent segments. The first would deal with economy and industry characteristics, the second with management aspects and the third with financial characteristics. In addition to quantitative and objective factors, qualitative aspects like assessment of management capabilities would be very important factors in arriving at the rating for an instrument. Key areas considered in a rating analysis would include the following:
24
A.
Economy and Industry Outlook The upcoming risks and opportunities in the borrower’s industry would be weighed to
provide a framework for understanding the future ability of borrower to generate income. Factors considered would include:
? ? ?
Effect of economic cycles on the industry. Business cycles in the industry and their severity. Tariff structure, threat from imports, price competitiveness of the domestic industry, and pace of technological change. Basis of competition and key success factors. Structure of the industry. Entry and exit barriers. Vulnerability of industry to new technologies. Environmental factors.
? ? ? ?
B.
Management Assessment
? ? ? ? ? ? ?
Background and history of borrower. Corporate strategy Quality of management and management capabilities under stress. Organisational structure, Personnel policies including succession planning. Corporate governance. Marketing and distribution arrangements. Bargaining power of the borrower’s suppliers and customers.
C.
Financial Risk
?
Financial management philosophy and track record (capital structure, profitability, liquidity position, financial flexibility and cash flow adequacy). Working capital management. Asset cover and liquidity profile of assets. Financial projections (with particular emphasis on achievability of sales targets, the components of the cash flow and ability to meet debt obligations as and when they fall due).
? ? ?
?
Free cash flows and their sensitivity to various economic, industrial and business risks over the term of the instrument. Inter-firm comparison of the financial structure and profitability margins. Accounting policies and practices. 25
? ?
?
Track record of payments to the banks and financial institutions.
In addition, while conducting an analysis for short term loans, emphasis will be laid on:
? ? ?
Sources of alternate liquidity Access to financial markets. Quality of relationships with the lenders.
Most companies would be hard pressed to liquidate their short term working capital borrowings from current cash flows. Short term ratings will, therefore, examine the alternative sources of liquidity available to a company, including its liquid investments. D. Terms of the Loan Rating may vary according to loan covenants such as:
? ?
Maturity of loan. Nature of loan - senior or subordinated, covenants and other provisions that may reduce the amount of recovery in case of default. Repayment terms- moratorium period, repayment in installments or bullet repayment, etc. Credit Reinforcements through guarantees or the backing of financial assets. The Rating Process would normally take about three to four days, depending on the
?
?
complexity of the deal and the flow of information from the client. The Rating would be approved by a rating committee comprising of CGM (CRMG) as Chairman and GM (MRD) and GM (CFD) as members. The ratings would be kept confidential from third parties.
26
Symbols (AAA)
Definition Loans carrying this rating are considered to be of the best quality, carrying negligible investment risk. Debt service payments are protected by stable cash flows with good margin. While the underlying assumptions may change, such changes as can be visualised are most unlikely to impair the strong position of such loans.
(AA)
Loans carrying this rating are judged to be of high quality by all standards. They are also classified as high investment grade. They are rated lower than IDBI loans because of somewhat lower margins of protection. Changes in assumptions may have a greater impact or the long-term risks may be somewhat larger. Overall, the difference with IDB1 rated loans is marginal.
(A)
Loans with this rating are considered upper medium grade and have many favourable investment attributes. Safety for principal and interest are considered adequate. Assumptions that do not materialise may have a greater impact as compared to the loans rated higher.
(BBB)
Such loans are considered to be last of investment grade. However, adverse changes in assumptions are more likely to weaken the debt servicing capability compared to the higher rated loans.
(BB)
Such loans are considered to be speculative, with inadequate protection for interest and principal payments.
(B)
Loans with such rating are generally classified susceptible to default. While interest and principal payments are being met, adverse changes in business conditions are likely to lead to default.
(C)
Such loans carry high investment risk with likelihood of default in the payment of interest and principal.
(D)
Such loans are of the lowest category. They are either in default or are likely to be in default soon. Table 2. Explanatory notes regarding rating symbols
27
10. Working Capital Flowchart
Collection of financial data
Analysis of financial data
Classification of Current Assets (CA)/ Current Liabilities (CL)
Verification of projected levels of current assets/ current liabilities with special emphasis on inventory/ receivables/ sundry creditors
Evaluation of liquidity in the business operation
Validation of bank finance sought on the project balance sheet
Fixing of sub-limits
Disbursement of Working Capital Loan
Fig 2. Working Capital Flowchart
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11. Case Study Analysis
11.1. Case Study - Background
The case before me was to assess the working capital requirement of XYZ Ltd. Company who had approached IDBI Bank’s Specialised Corporate Branch in Chennai with a request for a working capital loan assistance of 45 crore. The project involved detailed and in depth analysis of the financial results of the borrower’s project over the years. Since it was against bank’s policies to disclose the financials of its customers and due to its sensitivity clause I have been asked to name the customer by a pseudo name as XYZ Ltd in the report. The promoters’ and the directors’ names were also not allowed to be disclosed to maintain confidentiality. Also wherever the data for the present scenario has not been made available the past data has been taken into account and analyzed. First of all, the company’s history and its business profile were thoroughly analyzed. After that, to scrutinize its financials I used the CMA (Credit Monitoring Arrangement) tool and weighed the credit worthiness of XYZ Ltd. Also from the tool analysis found out the maximum permissible finance that can be provided and confirmed that the request falls within the limits. Analysis based on various financial ratios was also performed. And lastly, the risks associated and the bank’s internal and external ratings were also checked and verified to give away the final approval to the proposal.
11.2. About the Company and Business Profile
XYZ Ltd., a part of XYZ group of companies was incorporated in the year 1967 is engaged in the manufacture of pressure pipe and fittings, fibre cement sheets for industrial roofings and flat sheets for interiors. It also has a textiles division, which makes cotton yarn. The XYZ group with a turnover of Rs.2000 cr has wide business interests in the areas of cement, cotton yarn, software systems, fibre cement products and wind energy. XYZ’s first asbestos cement sheet plant was set up in Tamil Nadu in 1967 and since then the production technology has been updated continuously. The second sheet plant was commissioned in 1974 followed by one more sheet plant in Madhya Pradesh in 1987. The present aggregate capacity for Fibre Cement Sheets is 5 lakh tonnes per annum and Fibre Cement Pressure Pipe is 30 lakh tonnes per annum. The building products divisions of XYZ Ltd 29
are located in various centers in 8 states including Tamil Nadu, while the textile spinning unit is located in Southern Tamil Nadu. XYZ LTD is an efficient producer of Fibre Cement Sheets in India and is the 3rd largest player in its segment. XYZ has pioneered and introduced the innovative Calcium Silicate Board, a versatile building interior product in India. XYZ is operating a modern fibre cement roofing sheets and pipe plants in India. The XYZ Group is well known for its business ethics, professional management, social awareness and philanthropic activities. XYZ Industries Ltd. (XYZ ) is a part of Rs.2000 cr. XYZ Group of Companies, having diverse business interests. The group's business interests are: Cement- XYZ Cements Ltd is the flag ship company of XYZ Group, the sixth largest cement producer in the country and the second largest in South India. Textiles- 8 Spinning Units in Southern Tamil Nadu Software systems - XYZ Systems Ltd. Fibre Cement products – XYZ Industries Ltd. Wind Energy - XYZ Wind Farm, (XYZ Industries Ltd) Biotechnology – Shri XYZ Biotech Surgical products – XYZ surgical cotton mills Ltd
The group runs various Educational institutions right from elementary educations schools to ITI & Polytechnic colleges. It runs a charity trust and a fully equipped diagnostic centre apart from contributing to the Government Hospital in its area of Operation.
30
Rs crore Year ended Net Sales Other Income PBDIT PAT Cash Profit Paid Up Capital Tangible Net Worth Net Working Capital Net Cash from Operations Contingent Liability PBDIT as a % of Sales NP as a % of Sales TOL / TNW Adjusted TOL/TNW Current Ratio Interest Coverage Ratio DSCR (for TL/CL) CFDSCR Imports Exports 2009 409.89 11.02 73.81 35.64 66.92 4.33 277.48 29.25 40 63.39 18.01 8.7 1.31 4.86 1.08 2.88 2.93 1.73 127.61 29.35 2010 480.25 12.11 89.08 53.59 79.55 8.67 329.03 39.04 42.19 93.04 18.55 11.16 1.07 2.79 1.987 4.06 2.86 1.58 150.42 11.8 2011 553.42 12.00 96.38 53.21 89.65 8.67 373.71 102.97 58.81 105.97 17.42 9.61 1.01 2.75 1.66 4.81 3.3 1.62 175.90 7.51 2012 692.97 11.20 105.90 61.34 101.93 8.67 421.68 73.49 51.04 120 15.28 8.85 0.87 1.61 1.34 4.39 1.73 0.90 219.65 7.89
Table 3. Performance/Financial Analysis of XYZ company
11.3. Data Collection
Primary Data: ? During the mentoring sessions with our project guide and other staff members at IDBI bank. Secondary Data: ? Books and magazines ? Annual Reports of XYZ Company ? Internal reports of the banks ? Library research ? Websites
31
11.4. Financial Analysis and Observations
11.4.1. Sales
(Rs in crore) Particulars Domestic Sales Export Sales Net Sales 31.03.2009 393.95 29.35 409.21
Table 4. Sales over the years
31.03.2010 490.49 11.80 480.26
31.03.2011 569.36 26.76 553.43
? ?
The company has registered net sales of 480.26 crore during 2009-10 which corresponds to a 17.16 percent increase over the previous year. The Domestic Sales has gone up by 24.50% as on 31.03.2010 compared to FY 2009. The increase in Sales is on account of ? ? ? Capacity addition of 40000 MT in the FC sheet production during the FY2010 Improved realizations. Increase in the demand for FC sheets in the country and revival in economy.
•
Regarding the export sales, the Company exports cotton Yarn to Japan and Italy. During the FY 2010, exports were executed to other European Countries like Germany. The future plans include expanding the export market to US also.
•
The Company also exported Machinery and Spares to its subsidiary Sri XYZ Lanka (Private) Ltd to the extent of Rs.0.55 crore.
32
Production Status: Year Ended 31.03.09 Particulars Installed Capacity Fibre Cement Sheets, Accessories & Fittings (MT) Fibre Cement Pressure Pipes & Pipe Accessories (MT) Calcium Silicate Board (MT) Cotton Yarn (Spindles) 43296 2618846 kg -54487 25.22% 43926 216000 3324443 Kg -105320 48.75% 40000 11887 29.72% 40000 11969 29.92% 30000 --30000 --494000 Actual Capacity Year Ended 31.03.10 Installed Actual Capacity Utilization 92.36%
Production Utilization Capacity Production 466120 94.35% 534000 493213
Cement Clinker Grinding 216000 (MT) Plastic Storage Tank 636.51L
8091135
--
636.51 L 966600
--
Table 5. Production status of 2009 and 2010
•
A new plant for manufacture of Fibre Cement Products has been commissioned in Tamil Nadu with a capacity of 1.20 lakh MT commenced its production from July, 2010. The number of plants manufacturing FC products is eight including this.
•
Further, another Plant was being set up in the State of Bihar to cater to the markets of the Eastern and North Eastern Regions. This Plant will also have an Installed Capacity of 1.20 lakh M.T and the estimated Cost of the Project is about Rs.35 crore. For this project, about 20 acres of land has been taken on lease for 90 years from Bihar Industrial Area Development authority, Patna.
•
Growth in the top line is estimated to be driven by XYZ’s expansion in capacities. However, possible overcapacity within the FC sheets industry is expected to result in increased price competition and corresponding moderation in profitability.
33
•
Product wise Sales: Product Quantity Turnover Rs in crs 2009 Fibre Cement Sheets in MT Calcium Silicate Boards in MT Cotton Yarn (Spindles) Kg Cement Clinker Grinding (MT) Plastic Storage Tank lts Export of Machinery Units from Windmill (KWH) 440362 10823 2662989 54973 7706700 -2010 466250 11216 3365727 105534 1740850 -2009 305.07 20.41 55.30 13.69 1.59 2.17 5.28 2010 348.89 22.32 71.86 24.09 0.36 0.62 5.16
33501902 36967792
Table 6. Production wise sales of 2009 and 2010
? With the arrangements for continuous supply of Clinker and sale of Cement, the CCG Plant
had reported good performance in FY10. Segment wise Sales: (Rs in cr) Division Building Products Textiles Windmill Others Total 2009 355.21 57.58 11.02 24.10 447.91 2010 404.96 77.84 12.11 25.00 519.91
Table 7: Segment wise sales of 2009 and 2010 • • The building products division contributes more than 70% of the total Sales of the Company. The textiles division is the second largest component of XYZ ’s revenues. The textiles division Turnover for FY10 was also considerably higher at Rs.77.84 cr compared to Rs.57.58 crore in FY09. With the demand for yarn picking up in the last 4 months of FY10, the Unit registered a good performance with its sale of Yarn of 33.66 Lakh Kgs in FY10 as against 26.63 Lakh Kg in FY09. Though the Cotton prices continue to be high,
34
with the expected good demand for the Yarn and higher realizations, the company expects the unit to perform better in FY11. • Apart from FC sheets and textiles, XYZ is also engaged in the manufacture and sale of building boards, clinker grinding, production of wind energy etc. At present, these lines of revenue contribute marginally to XYZ ’s overall revenues.
11.4.2.
Profitability
(Rs crore) Particulars PBIT PAT 31.03.2009 (Audited) 43.15 35.63 9.27 8.71 31.03.2010 (Audited) 60.14 53.59 10.92 11.16
Table 8: Profitability index
31.03.2011 (Audited) 66.91 53.21 11.22 9.61
31.03.2012 (Estimated) 72.51 61.34 10.75 8.852
PBIT % of net sales PAT % of net sales
? ?
The Company’s operating profit has improved by 18.37% as on FY 2010 because of increase in the volume of Sales and improved realizations. The increase in profit margin has also been contributed by reduction in interest cost by Rs.4.00 crore and admin expenses by Rs.2.00 crore (which was actually Forex losses during FY 09) Operating Profit: Division wise: (Rs in crore)
Division Building Products Textiles Windmill Others
2009 (Audited) 64.34 (4.36) 2.88 8.75
2010 (Audited) 78.59 1.30 3.68 6.23
Table 9: Operating profit data
35
?
Profitability of the Sheets Division had improved during FY10, with effective control over expenses, despite increase in cost of major Raw Materials viz., Fibre and Cement. However, continuation of these realizations would be a key factor impacting the division’s profitability particularly given the volatility of prices of key inputs like cement and asbestos fibre.
•
XYZ also generates power through windmills largely for captive consumption.
11.4.3.
Liquidity Indicators
2009 (Audited) 201.90 186.62 15.28 1.08 2010 (Audited) 234.95 195.99 38.96 1.987 2011 2012 (Audited) (Estimated) 258.65 284.27 155.68 102.97 1.66 210.78 73.49 1.34
Particulars Total Current Assets Total Current Liabilities Net Working Capital Current Ratio
Table 10. Liquidity Indicators
•
The level of current assets has gone up in tune with the increase in Sales volume. The level of current liabilities also has gone up to finance the additional requirement of Current assets. The Bank borrowings have gone up and trade creditors have come down marginally. The Company was able to negotiate for very fine pricing from the Banks and hence has substituted some of their creditors with Bank borrowings.
•
The ideal current ratio recommended by the Tandon Committee was 1.33 (100/75). But despite the low current ratio, the company has been honoring all the commitments on time and the track record is satisfactory. And as one can see in the subsequent years it has bettered its ratio towards 2012.
36
11.4.4.
Particulars
Gearing Indicators
2009 364.00 277.47 1.31 63.39 1.53 2.88 2010 352.42 329.02 1.07 93.04 1.35 4.06 2011 345.15 373.71 0.92 105.97 1.20 4.81 2012 366.57 421.68 0.87 120 1.1 4.39
Total Outside Liabilities Tangible Net worth TOL/TNW Contingent Liabilities TOL/TNW adjusted for CL Interest Coverage Ratio
Table 11: Gearing Indicators
Gearing ratio is nothing but the ratio of TOL/TNW (Total Outside Liabilities/ Tangible Net Worth). This is regarded as the second most important ratio used by a lending bank in a credit appraisal. It is an important tool in assessing the overall position of loans as compared to own funds. The Company’s gearing has been low in 2009 and has improved further Y-o-Y from 2009 to 2011 to 0.92. TNW has gone up due to ploughing back of profits which has resulted in reduction of outside liabilities, resulting in better gearing. So, as one can see the values are way below the bank’s benchmark level of 3:1, indicating satisfactory solvency position. The Tangible Net worth of the Company has increased from Rs.277.47 crore to Rs.329.02 crore as on 31.03.2010 due to retention of profits. XYZ’s market capitalization works out to be Rs.658.00 crore. The market value of its Investments (mainly in XYZ Cements, where its holds a 20.7% stake as a promoter) works out to Rs.676.00 crore. The true net worth of the Company is manifold higher than the stated value of Rs.329.02 crore. 11.4.5. Auditors Qualifications and Clarifications, if any The disputed statutory dues aggregating to Rs.0.89 crore that have not been deposited on account of matters pending before appropriate authorities are as under: S. No 1 Name of the Statute Sales-tax act Total
Table 12: Disputed statutory dues
Forum where dispute is pending High Courts
Amount(Rs in crores) 0.89 0.89
37
Clarification provided by the Company:
Sales Tax demands amounting to Rs. 0.89 crore (previous year Rs. 0.89 crore) have been disputed by the Company and necessary appeals have been filed. Based on the nature of claim disputed, no provision has been considered necessary. This has been accounted in the contingent liabilities as shown in the next page.
11.4.6.
Contingent Liabilities
(Rs in crore) 2010-11 8.31 2.55 7.91 13.00 12.00 25.00 36.29 0.89 105.97
Table 13. Contingent Liabilities
The Company’s contingent liabilities position is as follows.
No 1. 2. 3. 4. 5. 6. 7. 8. 9. Particulars Estimates amount of contracts remaining to be executed on Capital accounts Bank Guarantees Letters of Credit Corporate Guarantee furnished by the Company to AXIS Bank Ltd for XYZ Systems Ltd to support their credit facilities Corporate Guarantee furnished by the Company to IDBI Bank Ltd for XYZ Systems Ltd to support their credit facilities Corporate Guarantee furnished by the Company to Punjab & Sind Bank for XYZ Systems Ltd to support their credit facilities Corporate Guarantee furnished by the Company to AXIS Bank Ltd for XYZ Textiles Ltd to support their credit facilities Sales Tax Total
2009-10 1.19 18.20 1.47 8.00 7.00 20.00 36.29 0.89 93.04
Around 80% of the contingent liabilities have been on account of Corporate Guarantee furnished to the lenders of associate companies. This has been considered necessary for ensuring uninterrupted financing of the associates. Other Contingent liabilities have arisen under normal course of business and are considered reasonable for the level of operations of the Company.
38
11.4.7.
Peer Comparison (Rs. crore) Hyderabd Visaka Industries Industries 703.69 157.54 89.72 22.39 12.75 261.78 1.20 1.77 598.13 117.16 57.21 19.59 9.56 235.73 1.38 1.17 Everest Industries 652.53 70.03 30.01 10.73 4.60 173.70 1.06 1.37
As on 31.03.2010 Net Sales PBDIT PAT PBDIT (%) PAT (%) Total Net Worth (TNW) Current Ratio TOL/TNW
XYZ 480.26 86.07 53.59 17.92 11.16 329.02 1.13 1.07
Table 14: Peer comparison Observations /Comments • • • XYZ has a very strong TNW with better profit margins. Hyderabad industries alone have a better profit margin the XYZ. The gearing is the lowest in XYZ. The sale of top four players has grown at an average CAGR of 16.97% in past 3 years whereas the bottom line grew at 39.78% for the same period. Contribution of XYZ to the sheeting industry during the year 2009-10 has been accounted as to 40000 MT.
39
11.5. Assessment of Proposal
11.5.1. Assessment of Working Capital Requirement
Build up of Current Assets & Current Liabilities (Rs. in crore) Particulars Raw materials a. Indigenous Month’s consumption Stock in process – Amt Month’s Cost of Production Finished Goods - Amt Month’s Cost of Sales Domestic Receivables – Amt Month’s Domestic Sales Creditors for Purchases – Amt Month’s Purchases 49.08 4.9 1.11 0.04 54.72 1.92 27.24 0.70 40.25 1.87 48.64 3.94 1.36 0.04 74.42 2.27 28.77 0.63 26.72 1.06 34.99 3.12 1.84 0.05 83.90 2.39 38.60 0.78 27.03 1.04 151.18 4.56 1.36 0.03 67.23 1.57 59.69 1.06 37.77 1.14 2009 2010 2011 2012
Table 15: To calculate the holding period for calculating working capital
•
The raw material holding level has been historically at an average of around two months. However, the levels are estimated at 4.44 months and 5.40 months respectively for FY 2011 and FY 2012 since the company is growing and is on an expansion drive and it will be purchasing the raw material and stocking it for smooth operations (maintaining minimum levels at various factories).
• • •
The receivables level is at an acceptable position at 19-20 days. Stock in process is at the same level of 1-2 days. The creditor level is at 2.80 months as on 31.03.2010, which is higher than the previous years, since the Company had stocked material for commencing activity at new plants and 40
the levels are actually going up on account of stocking of Cotton and raw material. With the increasing Bank interest rates, Company wants to avail the credit from suppliers at higher levels. • Finished goods holding period was at 2.24 months as on FY 2010. The level has come down in the subsequent years since the company is planning to manage inventory at the minimum holding levels.
Calculation of Maximum Permissible Bank Finance
(Rs. in Crore) Particulars 1. Total Current Assets 2. Other Current Liabilities 3. Working Capital Gap 4. Min. Stipulated NWC 5. Actual / Projected NWC 6. Item 3 Minus Item 4 7. Item 3 Minus Item 5 8. MPBF (lower of 6 or 7) 2009 200.45 143.98 56.46 50.11 29.25 6.35 27.20 6.35 2010 235.04 128.49 106.54 58.76 39.04 47.78 67.50 47.78 2011 258.65 122.52 136.13 64.66 102.97 71.46 33.15 33.15 2012 284.27 153.54 130.7 71.06 73.49 59.66 57.24 57.24
Table 16: To calculate Maximum Permissible Bank Finance
Comments:
The MPBF has been assessed at Rs. 33.15 crore and Rs.57.24 crore for 2010-11 and 2011-12 to support the estimated increase in turnover of the company. Considering the fag end of the financial year the MPBF is recommended for both the financial years i.e. 2011 and 2012.
41
•
MPBF of Rs.57.24 crore for FY2012 has been arrived at after reckoning Sundry Creditor for goods to the extent of Rs.25.56 crore, representing outstanding under Letter of Credit/Buyer’s Credit for procurement of raw materials. As the company will decide whether to avail LC/BC or a fund based facility for procurement of raw material, based on the factors prevailing at that point of time, the company would like to have exchangeability between FB & NFB limits.
Assessment of Fund Based facilities:
Cash Credit: Rs. 15 crore The company presently enjoys a Cash Credit limit of Rs. 15 crore with the Bank which is proposed to be renewed. The proposed limits will be within the assessed MPBF for FY 2011/2012, backed by adequate drawing power. The entire exposure will be fully secured by paripassu charge on the current assets of the company. Short Term Loan/WCDL: Rs. 20 crore The company is very cost conscious and avails the Short Term Loan at competitive rates offered by the various Banks. The company presently enjoys a Short Term Loan of Rs. 20 crore to meet any urgent need of working capital which is proposed to be renewed. The tenor of each STL shall be for a maximum period of 90 days only and the limit will be within the overall assessed MPBF backed by adequate drawing power. The facilities will be backed by Demand Promissory Note and DPN Delivery Letter. EPC/PCFC/PSCFC: (Rs.5.00 crore) The Company undertakes export of cotton yarn to Japan and other countries like USA. They also export machinery to their subsidiary in SXYZ Lanka. Though the Company has conservatively estimated the Export Sales at around Rs.7.00 to 8.00 crore for FY 11and FY12, presently they have orders worth Rs.12.00 crore for export to their subsidiary Sri XYZ Lanka (Private) Ltd. The Company proposes to avail EPC/PCFC/PSCFC in order to get interest benefit (in the current rising rate regime). In view of this, we recommend an inner limit of Rs.5.00 crore of EPC/PCFC/PSCFC.
42
11.5.2.
Assessment of Non - Fund Based facility
Bank Guarantee: (Rs.5.00 crore)
The company requires bank guarantees (Bid Bond, Financial and Performance) to be given to government departments (TNEB etc.,), customs for import duty exemption etc., and for other statutory purpose periodically. We propose to have a limit of Rs. 5.00 crore as inner limit to secured fund based working capital limits.
11.5.3.
Key Risks and Mitigants
The following are some of the key risks that can affect their normal operations and which, more importantly, should be scrutinized by the lending bank. If the company can prove there are sufficient mitigants for each risk pointed by the bank/lender, then that risk can be said to be normal.
1. Business & Industry Risks
? Dependency on imported raw material Chrysotile asbestos sheets which is one of the major raw material used in manufacturing FC sheet. Mitigant: About 94% of Chrysotile asbestos produced worldwide is consumed by countries other than India. India uses barely 6 to 7% of world’s asbestos fibre production. This goes to prove that AC sheet and pipe production and usages of these products are very much prevalent in most of the world. ? Imported raw material leaves industry vulnerable to forex risks. Depreciated Indian rupee will hit industry margins. Mitigant: The company covers 50% of their imports regularly by booking forward contracts. Further, it takes forward covers as and when required for additional amount based on the volatility. ? FC sheets industry continues to face regulatory risks on account of a possible ban on the use of asbestos in India as well as the possibility of a ban on asbestos mining in major asbestos producing countries like Russia, China, Zimbabwe, Canada etc. Mitigant: In India, only the Chrysotile variety, which is considered safe, is used in AC products like sheets and pipes, and not for spraying. The Government of India has constituted various expert committees to study the asbestos industry and having been 43
satisfied that asbestos does not actually pose a health risk to the workers at the manufacturing plants so long as the work place pollution controls were in place, or to the public who use the asbestos-cement products, the Ministry of Industry, Government of India, in July 1997, has in fact de-licensed the industry, allowing any person to set up a factory without the need for an industrial license from the ministry.
2. Financial Risks ? Fluctuations in Raw Material Prices - Cement and Asbestos fibre is important raw
material for FC sheet manufacturing contributing around 45% and 30% of the total cost respectively. Any fluctuation in the cement prices is likely to affect the profit margins of the Company. Mitigant: Currently, Cement prices have corrected by 20% from its high. Rising capacity expansions in the cement industry has created medium-term supply glut in the industry thus, putting pressure on the prices. We expect cement prices to be lower for the medium term. This would benefit FC Sheet industry as the end product prices are not dependent on the raw material prices, end user being different. ? Cost Effectiveness - The efficiency of the companies in this sector is apprehended by the ability of the firm to source inputs at reasonable cost as well as the scale of operation. So the players with strong focus on rural segment and strong brands are better placed. Mitigant: The company has identified multiple sources of procurement and undertakes an elaborate exercise to arrive at the cost effective raw material mix for each year. The company also enjoys competitive rates offered by their suppliers.
3. Management Risks
The risks are nil as the company belongs to XYZ Group and has been in the industry for almost 40 years. The promoters have a proactive approach and are constantly on the lookout for innovative practices to improve the product mix, identify new product lines and improve the existing products through the best technology. The company is the first to manufacture calcium silicate board business through technical assistance with a Japanese company.
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11.6. Recommendation for the Proposal
?
The company promoters have been in this business for more than 50 years, which has a long history of ethical conduct and a track record of honoring the commitments on time. XYZ belongs to the XYZ group, which is known for its business ethics, professional management, social awareness and philanthropic activities. The company’s ratings, both internal and external, have been regarded as good for credit appraisal. XYZ Industries has an existing relationship with satisfactory track record. The company’s performance is on growth path and has been recording impressive growth. XYZ is paying dividend since inception and the company’s financial parameters for the year under review are satisfactory. The company has been availing multi product from us Short Term Loan, Letter of Credit, Bank Guarantee, Buyers Credit, CMS (Collection and Disbursements) and Current Account). In view of the above, the working capital may be sanctioned at an aggregate assistance
?
?
?
?
?
of Rs 45 crore renewal of WC limits (FB – 40 Cr and NFB – Rs 5 Cr (Inner Limit to CC/WCDL), as per the general terms and conditions applicable to sanction of such types of assistance by the Bank.
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12. Conclusion
IDBI Bank provides working capital facility to the industry to finance day-to-day production & sales. For production, funds are generally required for purchase of raw materials, stores, fuel, for payment of labour, power charges, for storing finished goods till they are sold out & for financing the sales by way of sundry debtors / receivables. Cash Credit facility is granted to the customers to bridge working capital gap. The Bank also provides short term loan facility for a period of up to 1 year for the purpose of bridging temporary cash flow mismatches arising due to various reasons like non-realization of receivables in time, etc.
The bank prefers to use the second method of lending working capital under the MPBF rather than evolving its own method. The bank has their own internal credit rating procedure to rate the clients. The specialized corporate office where I was placed for
my internship had clients that were looked upon by the MCG group of IDBI. There is stiff competition to the public sector banks from the private and other foreign banks as their lending rates are more competitive and they have brought in much more innovative and extensive marketing techniques to woo variety of corporate customers. IDBI Bank has been maintaining a conservative look towards lending which is still recommended. Having said that, IDBI has to market itself and bring in more innovative lending practices in order to stay in competition and eventually become a leader in the corporate banking sector.
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13. Annexure
13.1. About IDBI
IDBI Bank Ltd. is a Universal Bank with its operations driven by a cutting edge core Banking IT platform. The Bank offers personalized banking and financial solutions to its clients in the retail and corporate banking arena through its large network of Branches and ATMs, spread across length and breadth of India. It has also set up an overseas branch at Dubai and has plans to open representative offices in various other parts of the Globe, for encashing emerging global opportunities. Our experience of financial markets will help us to effectively cope with challenges and capitalize on the emerging opportunities by participating effectively in our country’s growth process. As on March 31, 2012, the Bank had a network of 973 Branches and 1542 ATMs. The Bank's total business, during Fy 2011-12, reached Rs. 3,91,651 Crore, Balance sheet reached Rs. 2,90,837 Crore while it earned a net profit of Rs. 2032 Crore (up by 23.15 %). The vision for the Bank is “TO BE THE MOST PREFERRED AND TRUSTED BANK ENHANCING VALUE FOR ALL STAKEHOLDERS”. Corporate Banking In its continuing endeavour to effectively meet the requirements of different Groups of Corporate Clients, IDBI Bank Ltd. has organised its Corporate Banking Wing based on client's turnover besides creating a separate specialized cell and Group each to cater to corporates in Film Sector and Infrastructure Sector respectively. Based on scale, Corporates with turnover of more than Rs. 100 crore but up to Rs. 500 crore are looked after by Mid Corporate Group (MCG) while Corporates with turnover of more than Rs. 500 crore are looked after by Large Corporate Group (LCG). However, as stated earlier, with a view to effectively manage the peculiar requirements of Film Finance, a specialised cell has been set up in LCG to cater to Corporates in Film Sector regardless of their turnover.
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Special focus for Infrastructure Financing Further, considering the significance of the infrastructure sector in the country’s development, a specialised Group, namely Infrastructure Corporate Group (ICG) has been created which deals with Corporates from infrastructure, Industries accorded infrastructure status by RBI, regardless of their turn over. Since inception in 1964 [formerly as Industrial Development Bank of India], IDBI Bank has been assigned to play a distinctive role in the promotion of industrial development of the country. It has provided financial assistance towards setting up of industrial estates. Being a prominent player in financing infrastructure projects, IDBI Bank actively participates in addressing policy-related issues in various forums including the Committees constituted by the Government of India. Finalization of model Power Purchase Agreement and Model Concession Agreement in road sector are some of the significant contributions made by IDBI Bank in the development of this sector. It has financed landmark first-of-its-kind projects in the infrastructure sector such as Independent power project, fixed and mobile telecom, port, road and airports in India. The policy makers have identified power, telecom, ports (both sea and airports), roads, transportation and urban infrastructure facilities as infrastructure sector and are providing impetus for the growth in these sectors, Reserve Bank of India has accorded infrastructure status to select sectors, credit to which is classified as financing to Infrastructure sector. These three Groups in the Bank cater to the requirement of financial assistance as also provide other services like Deposits products to clients from Corporate sector.
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13.2. Screenshots
Screenshots of the CMA Tool that was used for the analysis
Profit and Loss Account
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Current Liabilities
50
Term Liabilities
Current Assets
51
Other current assets, fixed and non-current assets
Working capital assessment
52
Calculation of MPBF
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13.3. References
Book references: 1. Dr. D.D.Mukherjee, 2012. Credit Appraisal, Risk Analysis & Decision Making. 6th ed. Mumbai: Snow White Publications Rvt. Ltd. 2. Chandra, Prasanna. 2007. Financial management. 7th ed. New Delhi: Tata McGraw Hill. 3. Pandey, I.M. 2010. Financial Management. 10th ed. New Delhi: Vikas Publishing Hose Pvt Ltd., 2010. 4. XYZ Company’s audited Annual Reports for the year 2009, 2010, 2011 and 2012. Website References: 1. www.idbi.com 2. www.rbi.org.in 3. www.investopedia.com 4. en.wikipedia.org
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doc_989153345.pdf
Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. It is considered as the life blood of an organization. Working capital management is the process of assessment of working capital requirements of an enterprise, appraising of proposals, follow-up and monitoring of advances on appraised loans and advances. Today, working capital loans are forming a major part in bank balance sheets. When fierce competition is the rule, the banking sector is no exception. Banks compete with each other to attract quality borrowers. In this scenario, a hasty or inadequate appraisal will result in growth of Non Performing Assets.
Working Capital Financing at
Specialised Corporate Branch Chennai
Submitted By Vipin Janardanan PGDM 2011-2013 Roll No: 175 Submitted on: 06-08-2012
A Project Report submitted in partial fulfillment of the requirement for the award of post graduate Diploma in Business Management
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ACKNOWLEDGMENT
At the completion of my Summer Internship Project, I feel obliged to express my heartfelt gratitude towards all those who have made this possible. The two months of internship has been an enriching experience in terms of learning and application of theory into practice. The real time experience that I have received is something which cannot be emulated in a class room scenario and will be highly helpful for my professional growth. The experience has helped me to understand and appreciate the dynamics existing in working capital financing, the intricacies involved in credit appraisals and also what are the parameters and approaches needed to be followed by a credit analyst in this regard. I convey my sincere gratitude to Mrs. Radha, Branch Head, of the specialized corporate branch, IDBI Bank for extending this opportunity to me, for doing my summer internship during the two months duration from May 7th to July 7th at IDBI Bank. I would also like to express my sincere gratitude to Mr. Venkateswaran N., AGM-MCG who was my coordinator and guide at IDBI for the timely suggestions and directions which were very helpful during the course of my project. I would also like to thank my mentors, M/s Siby and Mr. Mahesh who helped and guided me throughout my project work. If not for their guidance and support, this endeavour would not have been a success. Next, I definitely would like to thank Asst. Prof. Mareena Mathew, our internal guide for her keen and dedicated approach in guiding and motivating us. Very importantly, I would like to thank Prof. J Philip, President, XIME for setting out this 8-week summer internship as a part of the curriculum for the award of Post Graduate Diploma in Business Management. I also thank my parents and friends for helping me carry out this project successfully.
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Table of Contents
1. 2. 3. 4. 5. 6. 7. 8. List of Tables .............................................................................................................................. 5 List of Figures............................................................................................................................. 5 List of Abbreviations .................................................................................................................. 6 Executive Summary ................................................................................................................... 7 Objectives.................................................................................................................................. 8 Scope of study ........................................................................................................................... 8 Limitations of the study ............................................................................................................. 8 Introduction .............................................................................................................................. 9 8.1. 8.2. 8.3. 8.4. 9. Definition ........................................................................................................................... 9 Classification of Working Capital ........................................................................................ 9 Factors that can affect Working Capital ............................................................................ 10 Need and importance of Working Capital ......................................................................... 11
Assessment of Working Capital ................................................................................................ 12 9.1. Definition of Important Terms .......................................................................................... 12
Identification of current assets & current liabilities ...................................................................... 12 9.1.1. 9.1.2. 9.2. Current Assets .......................................................................................................... 12 Current Liabilities ..................................................................................................... 14
Methods of Lending in Banks ........................................................................................... 15 Operating cycle method ........................................................................................... 16 Traditional Method of Assessment of Working Capital Requirement ........................ 17 Projected Annual Turnover Method for SSI units (Nayak Committee) ....................... 17 Projected Balance Sheet Method (PBS) ..................................................................... 18 Cash- Budget Method: .............................................................................................. 19 Maximum Permissible Bank Finance Method (MPBF) ............................................... 21 Percent of Sales Method........................................................................................... 23 Regression Analysis Method ..................................................................................... 23
9.2.1. 9.2.2. 9.2.3. 9.2.4. 9.2.5. 9.2.6. 9.2.7. 9.2.8. 9.3. 10. 11.
Loan Ratings..................................................................................................................... 24 Working Capital Flowchart ................................................................................................... 28 Case Study Analysis .............................................................................................................. 29 Case Study - Background .............................................................................................. 29 About the Company and Business Profile ..................................................................... 29 Data Collection ............................................................................................................. 31 Financial Analysis and Observations ............................................................................. 32 3
11.1. 11.2. 11.3. 11.4.
11.4.1. 11.4.2. 11.4.3. 11.4.4. 11.4.5. 11.4.6. 11.4.7. 11.5. 11.5.1. 11.5.2. 11.5.3. 11.6. 12. 13.
Sales ......................................................................................................................... 32 Profitability............................................................................................................... 35 Liquidity Indicators ................................................................................................... 36 Gearing Indicators .................................................................................................... 37 Auditors Qualifications and Clarifications, if any ....................................................... 37 Contingent Liabilities ................................................................................................ 38 Peer Comparison ...................................................................................................... 39 Assessment of Proposal ................................................................................................ 40 Assessment of Working Capital Requirement ........................................................... 40 Assessment of Non - Fund Based facility ................................................................... 43 Key Risks and Mitigants ............................................................................................ 43 Recommendation for the Proposal ............................................................................... 45
Conclusion ........................................................................................................................... 46 Annexure ............................................................................................................................. 47 About IDBI .................................................................................................................... 47 Screenshots .................................................................................................................. 49 References ................................................................................................................... 54
13.1. 13.2. 13.3.
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1. List of Tables
Tables
Table 1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7 Table 8 Table 9 Table 10 Table 11 Table 12 Table 13 Table 14 Table 15 Table 16
Table Headings
Computation of working capital using cash-budget method Explanatory notes regarding rating symbols Performance/Financial Analysis of XYZ Company Sales over the years Production status of 2009 and 2010 Production wise sales of 2009 and 2010 Segment wise sales of 2009 and 2010 Profitability Index Operating profit data Liquidity Indicators Gearing Indicators Disputed statutory dues Contingent Liabilities Peer Comparison To calculate the holding period for calculating working capital To calculate the Maximum Permissible Banking Finance
Page
20 27 31 32 33 34 34 35 35 36 37 37 38 39 40 41
2. List of Figures
Figures
Figure 1. Figure 2.
Title
Operating Cycle of an Enterprise Working Capital Financing Flowchart
Page
10 27
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3. List of Abbreviations
IDBI MPBF WC NWC CMA SSI C&I CC WCDL FB NFB LC STL FY BC TOL TNW PAT PBIT PBDIT CA CL LR EPC PCFC PSCFC
Industrial Development Bank of India Maximum Permissible Bank Finance Working Capital Net Working Capital Credit Monitoring Arrangement Small Scale Industrial Commercial & Industrial Cash Credit Working Capital Demand Loan Fund Based Non-fund Based Letter of Credit Short Term Loan Financial Year Buyer's Credit Total Outside Liabilities Total Net Worth Profit After Tax Profit Before Interest and Tax Profit Before Depreciation Interest and Tax Current Assets Current Liabilities Loan Ratings Export Packing Credit Packing Credit in Foreign Currency Post-shipment Credit in Foreign Currency
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4. Executive Summary
Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. It is considered as the life blood of an organization. Working capital management is the process of assessment of working capital requirements of an enterprise, appraising of proposals, follow-up and monitoring of advances on appraised loans and advances. Today, working capital loans are forming a major part in bank balance sheets. When fierce competition is the rule, the banking sector is no exception. Banks compete with each other to attract quality borrowers. In this scenario, a hasty or inadequate appraisal will result in growth of Non Performing Assets. The problem statement of this report was to conduct a study of the Working Capital Assessment of a company in the manufacturing sector, at IDBI’s Specialised Corporate Branch, Chennai so as to gain insights about the matter of the study. These insights were used as a device for a detailed and in-depth analysis of the borrower’s financials. In this process, the technical, the marketing, the organizational, the financial, the economic and the social aspects of the borrower company were examined to ensure technical feasibility, market necessity, financial viability, economic strength and social desirability of the proposal, all of which are essential aspects to be scrutinized in a credit appraisal process. In this report I have also covered the methods applicable to the banks in appraising working capital loans and their analysis. The whole process of appraisal starts when the borrower arrives at the bank. It is followed by verification and detailed analysis of balance sheets, credit limits to be sanctioned after considering all parameters like RBI guidelines and bank internal guidelines and lastly follow-up has to be done by monitoring the cash-credit account and quarterly information system reporting. After the analysis, the bank’s internal credit rating procedure is done to rate the client before the final approval is given to the proposal. It is also recommended that IDBI maintain its conservative outlook towards lending but at the same time look for innovative ideas to beef up its market share as there is stiff competition to the Public Sector banks from the foreign banks.
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5. Objectives
? To understand and analyze the existing credit appraisal mechanism at IDBI bank and to have a practical knowledge and experience towards Working Capital financing. ? To understand the financial viability of the working capital assistance proposal by the manufacturing company which has been one of the prestigious clients (borrowers) for the specialized corporate branch of IDBI. ? To suggest any changes (if any) to IDBI that need to be brought about in its working capital financing policy. ? To understand the importance of appraisal system in sharpening the ability of the bank to identify investment opportunities of the project undertaken. ? To understand the break-up of a loan proposal and also the various risks involved in credit appraisal process
6. Scope of study
The scope of the study is limited to Credit Appraisal Department of IDBI Bank, Specialized Corporate Branch, Chennai. This study also covers ratio analysis, cash flow, risk involved in the credit appraisal and analysis of the financial statements of the company which has asked IDBI for the working capital assistance.
7. Limitations of the study
? As some of the information is not revealed being sensitive and strictly confidential, some of the suggestions are based on assumptions. ? Working capital assessment system includes various types of detailed studies for different areas of analysis. For e.g. the methods and terminologies used in the analysis for a manufacturing company will be different from that of a non-banking finance company. Therefore, due to time-constraints, I could only analyze the loan proposal of a manufacturing company that was brought to IDBI during my internship.
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8. Introduction
8.1. Definition
Working capital refers to the current asset holding of an enterprise. Simply put, it refers to a firm’s investment in short term assets, such as cash amounts receivables, Inventories etc. The term working capital is commonly used for the capital required for day-to-day working of a business concern, such as for purchasing raw material, for meeting day-to-day expenditure on salaries, wages, rents rates, advertising etc. Working capital is blood of the organization. So every finance manager must take care of working capital. Commercial banks play important role in financing working capital requirements. As per the RBI guidelines, commercial banks must follow the guidelines prescribed by them to finance working capital requirements of different sectors. The term “working capital” is often referred to “circulating capital” which is frequently used to denote those assets which are changed with relative speed from one form to another i.e., starting from cash, changing to raw materials, converting into work-in-progress and finished products, sale of finished products and ending with realization of cash from debtors. Working capital has been described as the “life blood of any business which is apt because it constitutes a cyclically flowing stream through the business”.
8.2.
Classification of Working Capital
1. Gross Working Capital: It refers to the firm’s investment in total current or circulating assets. 2. Net Working Capital: The term “Net Working Capital” has been defined in two different ways: I. It is the excess of current assets over current liabilities. This is, as a matter of fact, the most commonly accepted definition. Some people define it as only the difference between current assets and current liabilities. The former seems to be a better definition as compared to the latter. II. It is that portion of a firm’s current assets which is financed by long-term sources i.e. promoters’ stake or other long from Banks etc.). term liabilities (Equity/Preference Capital, Debentures/Bonds/ Unsecured Loans from Promoters and Associates/Corporate Loans
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3. Permanent Working Capital: This refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities. In other words, it represents the current assets required on a continuing basis over the entire year. Tandon Committee has referred to this type of working capital as “Core current assets”. Characteristics of this type of working capital: 1. Amount of permanent working capital remains in the business in one form or another. This is particularly important from the point of view of financing. The suppliers of such working capital should not expect its return during the life-time of the firm. 2. It also grows with the size of the business. In other words, greater the size of the business, greater is the amount of such working capital and vice versa. Permanent working capital is permanently needed for the business and therefore it should be financed out of long-term funds. 4. Temporary Working Capital: The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. In other words, it represents additional current assets required at different times during the operating year. For example, extra inventory has to be maintained to support sales during peak sales period. Similarly, receivables also increase and must be financed during period of high sales. On the other hand investment in inventories, receivables, etc., will decrease in periods of depression. Suppliers of temporary working capital can expect its return during off season when it is not required by the firm. Hence, temporary working capital is generally financed from short term sources of finance such as ad hoc bank credit. 5. Negative Working Capital: This situation occurs when the current liabilities exceed the current assets. It is an indication of liquidity crisis to the firm.
8.3.
Factors that can affect Working Capital
Internal factors: Nature & size of business, firm’s production policy, availability of credit, growth and expansion of business, profit margin and dividend policy, operating efficiency of the firm, co-coordinating activities in firm External factors: business fluctuations, changes in technology, import policy, taxation policy, infrastructural facilities, etc.
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8.4.
Need and importance of Working Capital
Working capital finance is essential to carry on day-to-day operations to maintain the
operating cycle of an enterprise. Fixed assets cannot generate income unless they are used with the help of working capital. Therefore working capital is considered life blood of an enterprise. Working capital is needed till a firm gets cash on sale of finished products. It depends on two factors: i. ii. Manufacturing cycle i.e. time required for converting the raw material into finished product; Credit policy i.e. credit period given to Customers and credit period allowed by creditors. Thus, the sum total of these times is called an “Operating cycle” and it consists of the following six steps: i. ii. iii. iv. v. vi. Conversion of cash into raw materials. Conversion of raw materials into work-in-process. Conversion of work-in-process into finished products. Time for sale of finished goods—cash sales and credit sales. Time for realization from debtors and Bills receivables into cash. Credit period allowed by creditors for credit purchase of raw materials, inventory and creditors for wages and overheads.
Figure 1. Operating Cycle of an Enterprise
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9. Assessment of Working Capital
9.1. Definition of Important Terms
To scrutinize the credit proposal of a unit, the bank employs a tool known as the Credit Monitoring Arrangement Form, which in short is known as CMA. It is used for measuring the credit worthiness of the customer applying for the bank loan. Also it can be used to find out the permissible bank finance that can be provided to the customer. It contains certain general parameters which reflect the unit’s performance and is required to be examined by a credit analyst. These parameters not only indicate the unit’s performance but also provide clues for examining the justification or otherwise, for credit limit sought. Before analyzing the methods adopted to measure the financials of the customer, it is important to understand certain terms as regards to Balance sheet and P&L of a company. Since my project was on working capital financing, I would be concentrating only on current assets and current liabilities which hold good for calculating the working capital requirement. Identification of current assets & current liabilities Introduction The assets and liabilities created in the operating cycle of an enterprise are called the gross working capital and the excess of current assets over current liabilities is called the Net Working Capital. While the study of gross working capital indicates the nature and extent of working capital requirements, the analysis of Net Working Capital indicates the liquidity position of an enterprise. In order to compute the Net Working Capital and the Maximum Permissible Bank Finance, it is necessary to understand current assets and current liabilities and have a proper classification of various items of current assets and current liabilities.
9.1.1.
Current Assets
Current assets are those assets expected to be realized in cash or sold or consumed or
turned over during the operating cycle of the business, normally within one year. They are assets which are acquired with the intention of converting them into cash during the normal operating cycle of the business unit, normally within one year.
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They differ from fixed assets which are normally acquired for use in the production of current assets (i.e., goods and services). These assets remain in business for a longer time than current assets and they are normally not meant for resale. The current assets would include the following: (a) Cash and Bank Balance: A business unit while operating will have to maintain a certain amount of cash and cash balances in various collection and interest bank accounts for meeting day to day disbursements in various places of operation. (b) Inventories: These consist of (i) Raw materials and stores, (ii) stock in process, (iii) Finished goods and (iv)Consumable spares. This is a very important item of current assets and forms a major component of working capital requirements. Projected inventory should be examined in relation to past trends, future outlook and inter-firm comparisons. The levels are then normally accepted if they are reasonable. Where the analysis of balance sheet reveals excess inventory the borrower should be asked to liquidate the same within a reasonable time. (c) Receivables: Receivables are dues arising out of credit sales. Where bills are raised on purchases, and then discounted with banks, some companies show the amount of receivables net of bills discounted and the amount of bills discounted as a contingent liability.
(d) Advances to suppliers for purchase of raw materials and stores, spares, etc. The
projected level of advances to supplier of raw materials and stores should be consistent with the past trends and the present market conditions. If not, inquires may be made and the amount should be tallied with the corresponding amount in funds flow sheet.
Other Current Assets are:
(e) Prepaid expenses. (f) Advances to employees and others for meeting day to day expenses of normal business operations. (g) Advance Payment of Tax. (h) Duty Draw back claims and cash incentives receivable. (i) Deposits with public bodies arising out of normal business operations. (j) Receivable on sale of fixed assets to be received within the next one year. The items in the following list should be reckoned as non-current assets: These assets are termed as non-current assets as they are not intended to be converted into cash or other similar assets or useful goods and services within a period of one year.
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(a) Investments in shares, debentures, etc., and advantages to other firms/companies not connected with the business or the borrowing firm. (b) Investments made in mutual funds (c) Investments made in associate companies/ subsidiaries/group companies, Loans extended sinter- deposits, (d) Dead inventory i.e., slow moving/obsolete items (e) Security deposits/Tender deposits made by the borrower. (f) Receivables of sticky nature e.g., debts which are the subject matter of legal/recovery proceedings and other receivables of more than six months age. (g) Advances not realizable within one year e.g., advance to inter-connected companies or firms other than in the normal course of business. (h) Dues from Directors and senior officials of the borrower Company which are not realizable within the operating cycle. (i) Prepaid expenses of long term nature and deferred charges like discount on debentures, etc.
9.1.2. Current Liabilities
Current Liabilities are liabilities whose liquidation is expected to take place within the operating cycle of the business, normally within one year. These are the obligations which are reasonably expected to be paid by liquidating current assets or by raising other current liabilities. They differ from term liabilities which are repayable after a period of one year. Term liabilities are long term borrowings or deferred liabilities which are normally created for the purpose of acquiring fixed assets etc. The current liabilities would include the following:
[a] Short term borrowings from banks: are those granted for working capital and which
repayable on demand such as pledge loan, hypothecation loan, cash-credit, overdraft, documentary bills on Sight or Usance terms, supply Bills, export Bills, advance against book debts, finance against deferred receivables, commercial papers etc. The bills discounted should be reckoned as a part of Current Liability and the underlying receivables are to be treated as Current Assets.
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Short term borrowings:
Are those from others are of substantial amount in the balance sheet, inquiry should be made as to the institution, firm or friends from which/whom they have been obtained and the relative details should be given in the balance sheet. The reason for this is that if it is from directors or friends and the company is paying interest a higher rate, then it would mean high interest burden on the company. Banks generally stipulate a condition that the rate of interest paid on such borrowings shall not be more than the rate charged by them on the Working Capital facilities.
[c]Sundry Creditors:
Only creditors for purchase of raw materials and stores should be included. Level of sundry creditors shown an increasing trend in the balance sheet should be investigated.
[d] Other statutory liabilities:
These are liabilities which the company has to meet during the year under review, viz. provision for taxation, sales tax, excise duty, gratuity dues to employees etc. While scrutinizing this item, it should be seen whether there is any gradual or sudden accumulation of statutory liabilities due to non-payment of taxes, provident funds dues of employees etc.
[e] Deposits:
Deposits from public maturing within one year should be included here.
[f] [Other current liabilities:
Include liabilities for expenses, interest accrued and due dividend paid and other nonstatutory provisions, installment of deferred payment credits due within one year.
9.2.
Methods of Lending in Banks
It is difficult to postulate a method of assessment of working capital in any business which
will be of universal application of businesses. The assessment of working capital requirements is beset with several variables. The requirement of working capital would noticeably vary with industry characteristics. The proper assessment of working capital requirements would go a long way in enabling a business to carry its operations efficiently.
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Present Position: While advising the individual banks to evolve their own methods of assessment of working capital requirements, the RBI has given the following guidelines in the matter. Working capital credit requirements are determined by the banks according to their perception of borrower and the credit needs. Transparent policy and guidelines for credit dispensation in respect of each broad category of economic activity should be formulated by the banks, with the approval of their respective board of directors. Prudential guidelines and exposures norms relating to single group borrower/s shall continue to be in force. Working capital is defined as the funds required carrying the required levels of current assets to enable the unit to carry on its operations at the expected levels uninterruptedly. Thus Working Capital required is dependent on (a) The volume of activity (viz. level of operations i.e. Production & sales) (b) The activity carried on viz. mfg process, product, production program, the materials & marketing mix.
9.2.1. Operating cycle method
Any manufacturing activity is characterized by a cycle of operations consisting of purchase of purchase of raw materials for cash, converting these into finished goods & realizing cash by sale of these finished goods. The time that lapses between cash outlay & cash realization by sale of finished goods & realization of sundry debtors is known as the length of the operating cycle. That is, the operating cycle consists of: ? ? ? ? Time taken to acquire raw materials & average period for which they are in store. Conversion process time Average period for which finished goods are in store & Average collection period of receivables (Sundry Debtors) The length of the operating cycle is different from industry to industry and from one firm to another within the same industry. For instance, the operating cycle of a pharmaceutical unit would be quite different from one engaged in the manufacture of machine tools. The operating cycle concept enables us to assess the working capital need of each enterprise keeping in view the peculiarities of the industry it is engaged in and its scale of operations. Operating cycle is an important management tool in decision-making.
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9.2.2. Traditional Method of Assessment of Working Capital Requirement The operating cycle concept serves to identify the areas requiring improvement for the purpose of control and performance review. But, as bankers, we require a more detailed analysis to assess the various components of working capital requirement viz., finance for Stocks, bills etc. Bankers provide working capital finance for holding an acceptable level of current assets, viz. raw materials, stocks-in-process, finished goods and sundry debtors for achieving a predetermined level of production and sales. Quantification of these funds required to be blocked in each of these items of current assets at any time will, therefore provide a measure of the working capital requirement (WCR) of an industry.
9.2.3. Projected Annual Turnover Method for SSI units (Nayak Committee)
For SSI units which enjoy fund based working capital limits up to Rs.5 crore, the minimum working capital limit should be fixed on the basis of projected annual turnover. 25% of the output or annual turnover value should be computed as the quantum of working capital required by such unit. The unit should be required to bring in 5% of their annual turnover as margin money and the Bank shall provide 20% of the turnover as working capital finance. Nayak committee Guidelines correspond to working capital limits as per the Operating Cycle method where the average production / processing cycle is taken to be 3 months (i.e. working capital would be turned over 4 times in a year). Projected Annual Turnover Method for C & I industrial units (limits up to Rs 5 crore) Bank has decided to extend Nayak Committee approach for assessment of limits to C & I industrial units requiring credit limits up to Rs.5 crore. That is, credit requirement up to Rs.5 crore of C&I borrowers (industrial units) may be assessed at a minimum of 20% of projected annual turnover. In other words, the working capital requirement will be assessed at 25% of projected annual turnover, of which 5% should be borne by entrepreneur as margin and 20% would be allowed as Bank Drawings. While accepting projected annual sales turnover, a cap of 25% over actual annual sales turnover in the immediately preceding year should be set, except where production capacity has been substantially increased. Projected Annual Turnover Method for Business Enterprises in Trade & Services Sector: i) For working Capital limits up to Rs. 5 crore to C & I (Trade) sector, the assessment of credit limit is to be based upon annual turnover. Thus, an across the board credit limit equal to 15% of projected annual turnover be offered to business enterprises in the T&S sector. It would be available for utilization generally as a cash credit limit. However, where needed an LC limit (as a sub-limit of total), may also be allowed. 17
ii) The credit limit would be secured by hypothecation charge on the current assets of the enterprise. Periodical stock statements are to be obtained and margin of 25% be retained. iii) Credit limits under this assessment method may be offered to established (at least 3 years old) profit making business enterprises, eligible for credit rating of SB-4 and above. Mortgage of property valued at least at 33% of the limit is to be prescribed. Further, an interest rebate of 0.50% p.a. may be given to borrowers who offer mortgage of property valued at over 75% of the credit limit. iv) While accepting projected annual sales turnover, a cap of 25% over actual annual sales turnover in the immediately preceding year should be set. When circumstances warrant its breach, reasons therefore should be recorded. v) Where borrowers indicate need for credit limits which are higher than the amount indicated above, assessment under the traditional PBS method may be resorted to.
9.2.4. Projected Balance Sheet Method (PBS)
The PBS method of assessment will be applicable to all C&I borrowers who are engaged in manufacturing, services, and trading activities, including merchant exports and who require fund based working capital finance of Rs. 25 lacs and above. In the case of SSI borrowers, who require working capital credit limit up to Rs.5 crore, the limit shall be computed on the basis of Nayak Committee formula as well as that based on production and operating cycle of the unit and the higher of the two may be sanctioned. Fund based working capital credit limits beyond Rs 5 crore for SSI units shall be computed in the same way as for C&I units. For business enterprises in Trade and Services Sector, where the projected turnover method is not applicable, PBS method shall be followed. In the Projected Balance Sheet (PBS) method, the borrower’s total business operations, financial position, management capabilities etc. are analyzed in detail to assess the working capital finance required and to evaluate the overall risk of the exposure. The following financial analysis is also to be carried out: ? Analysis of the borrower’s Profit and Loss account, Balance Sheet, Funds Flow etc. for the past periods is done to examine the trend in turnover, profitability, financial position, financial management, etc. in the business. ? Detailed scrutiny and validation of the projected income and expense in the business, and projected changes in the financial position (sources and uses of funds) are
18
carried out to examine if these are acceptable from the angle of liquidity, overall gearing, efficiency of operations etc. There will not be a prescription like mandatory minimum current ratio or maximum level of a current asset (inventory and receivables holding level norms) under PBS method. Under the PBS method, assessment of WC requirement will be carried out in respect of each borrower with proper examination of all parameters relevant to the borrower and their acceptability.
9.2.5. Cash- Budget Method:
General: This method is optional to the borrowers in industry, trades and services segment as well as civil contractors/ builders engaged in construction activities and seasonal industries, with fund-based working capital limits above Rs 10 crores from banking system. Assessment of Working Capital Finance: Under this method, the working capital finance required should be quantified from the monthly/quarterly cash outflows/inflows projected and not from the projected levels of assets and liabilities. The permissible bank finance should be restricted to the peak level gap as reflected in the annual projected cash budget by the borrower. The cash method eliminates the anomaly of ‘averages’ of production sales parameters and takes into account the fluctuations in the requirement of funds within a time-frame. Further, the cash-budget system is not influenced by the normative approach in respect of inventory and receivable holdings. a) Collection/ Analysis of financial data: Besides scrutiny of cash budget, other aspects of assessments like examination of funds flow, profitability, financial parameters etc. should be carried out as per PBF method. Analysis of profit and loss account, balance sheet, funds flow etc. for the previous years to examine the profitability, financial position, financial management etc. Scrutiny and validation of the projected income & expenditure, projected balance sheet and projected funds flow to examine whether these acceptable from the angle of liquidity, overall gearing, efficiency of operation etc.
19
b)
Assessment of bank finance for working capital: Monthly/ quarterly projections of cash receipts, and cash outflows should be furnished
in the cash budget statement and the cash has to arrive at which forms the basis for assessing working capital finance. On the scrutiny of data furnished under cash budget statement, the following data should be extracted for the purpose of assessment for the purpose of assessment for Working capital requirements.
Sl. No Particulars Current Year Actuals/ Projections Q1 Q2 Q3 Q4
1
Total cash outflows from business operations
2
Total Inflows to business operations
3 4
Cash gap in business operation
Less: amount brought/ Proposed to be brought in from other sources, i.e. cash surplus under non-business operations/ capital accounts/ sundry items.
5
Net cash gap for business operations[ item 3-4]
Table 1: computation of working capital using cash-budget method
20
Note: The outer limit for finance, for working capital requirements, from banking system should be peak GAP among all the four quarters of the current years.
9.2.6. Maximum Permissible Bank Finance Method (MPBF)
Proper assessment of working capital requirements and computation of maximum permissible bank finance, are based on the norms for holding current assets and proper classification of current assets and proper classifications of current assets and liabilities. Norms for holding current assets (Inventories and Receivables) Bank credit for working capital requirements is linked with production requirements. As such, the working capital requirement is assessed by deciding on the reasonable level of holding current assets required for production. This depends on the rate of flow of expenditure or costs within the operating cycle and the length of the operating cycle. 1. The rate of flow of expenditure or costs within the operating cycle, in turn depends on the volume of production and sales and the costs associated with such production or sales, each of which in turn is influenced by several factors such as a) Nature of business b) Size of business c) Production process d) Stock turnover velocity e) Credit terms in the industry f) Trade credits available g) Unit cost of the product h) Seasonal fluctuations i) Business cycle fluctuations 2. The length of the operating cycle for any business, generally, consists of the following phases: a) The period for which the raw materials are held in stock (pre production phase) b) The length of the production cycle (production phase) c) The period for which finished goods are held in stock(storage phase) d) The collection period in respect of sales receivables(collection phase)
21
3.
The length of the operating cycle of a business is the sum of the lengths of the above phases of the cycle. For the purpose of the assessment of working capital requirements and determining the level of current assets, in respect of a borrower where no norms are prescribed in this regard, it is necessary to compute the length of the above mentioned different phases of the operating cycle as under: a) Pre – production phase = Stock of raw material * 365
Annual cost of raw materials consumed b) Production phase = Work in process * 365 Annual cost of production c) Storage phase = Stock of finished goods * 365 Annual cost of goods sold d) Collection phase = Book debts * 365 Annual sales 4. In the case of existing units, it is possible to determine the length of the operating cycle in respect of each of the above phase by reference to the past operations in the business. Undoubtedly, any factor which are likely to alter the characteristics of the business in the future should be taken into account e.g., change in raw materials availability causing large stocks to be held, increase in competition forcing more liberal credit terms etc. For new business, bankers will have to rely on computations made for similar business and the industry norms. (i) Proper classification of various items of current assets and current liabilities In order to calculate net working capital and maximum permissible bank finance, it is necessary to have proper classification of various items of current assets and liabilities. (ii) Working capital gap After estimating the reasonable level of current assets (inventory, receivables, etc.,) required for the operation of a unit, sources of financing the same are decided. A part of the total
22
current assets can be financed by creditors for purchases and other current liabilities. The remaining part of the current assets is called the working capital gap. It is the borrower’s requirement of finance to carry current assets other than those financed out of current liabilities. Working capital gap is thus current assets minus current liabilities other than bank borrowings. This gap can be partly financed by borrower’s own sources/long term borrowings and partly by bank finance.
(iii) Maximum Permissible Bank Finance (MPBF):
For the purpose of working out the Maximum Permissible Bank Finance (MPBF) for bridging the working capital gap, three methods were recommended under Tandon Committee Recommendations. They are furnished hereunder for the purpose of understanding the concept of MPBF. In the first method, the borrower will have to contribute a minimum of 25% of the working capital gap from long term funds i.e., owned funds and term borrowings and it gives a minimum current ratio of 1.17:1. In the second method, the borrower will have to provide a minimum of 25% of the total current assets from long term funds and it gives minimum current ratios of 1.33:1. Due to this, in this method of borrower’s contribution from long terms sources is more than in the first method. In the third method, the borrower’s contribution from long term funds will be to the extent of the entire core current assets, i.e., absolute minimum level of raw materials, process stock, and stores which are in the pipeline so as to ensure continuity of production and minimum of 25% of the balance current assets. Borrower’s contribution from long term sources is the most in this method. However, the third method has not been accepted for implementation by the RBI.
9.2.7. Percent of Sales Method
Based on the past experience, some percentage of sales may be taken for determining the Quantum of working capital
9.2.8. Regression Analysis Method
The relationship between sales and working capital and its various components may be plotted on Scatter diagram and the average percentage of past 5 years may be ascertained. This average percentage of sales may be taken as working capital. Similar exercise may be carried out at the beginning of the year for assessing the working capital requirement. This method is suitable for simple as well as complex situations. 23
9.3.
Loan Ratings
Loan Ratings (LR) are opinions on the ability and willingness of a borrower to make
timely payments on the specific loan obligation, over its life.
Need for Loan Ratings
With financial market reforms, the traditional dividing lines for banks, Development Financial Institutions (DFIs), NBFC’s and other players in the financial system are gradually disappearing. The commercial banks, whose traditional forte has been working capital lending, are increasingly moving into long term financing, while the DFIs are moving into short term working capital lending. In this context, LR is aimed at providing a valuable input in assisting the decision making process in BANK. Banks and DFIs often use credit ratings on debt securities as an indicator of the borrower’s ability to honour its obligations on loans. LR directly addresses their needs by rating the loan itself and incorporating in the analysis, the specific characteristics of the loan.
Benefits of LR
LR will meet the requirements of Banks for the following purposes: a. assessing the credit worthiness of borrowers; b. serving as a simple objective indicator for the internal credit risk exposure guidelines; c. determining the risk premium to be charged; d. portfolio monitoring; e. making quick credit decisions
Rating Methodology The analytical framework for rating methodology would be divided into three interdependent segments. The first would deal with economy and industry characteristics, the second with management aspects and the third with financial characteristics. In addition to quantitative and objective factors, qualitative aspects like assessment of management capabilities would be very important factors in arriving at the rating for an instrument. Key areas considered in a rating analysis would include the following:
24
A.
Economy and Industry Outlook The upcoming risks and opportunities in the borrower’s industry would be weighed to
provide a framework for understanding the future ability of borrower to generate income. Factors considered would include:
? ? ?
Effect of economic cycles on the industry. Business cycles in the industry and their severity. Tariff structure, threat from imports, price competitiveness of the domestic industry, and pace of technological change. Basis of competition and key success factors. Structure of the industry. Entry and exit barriers. Vulnerability of industry to new technologies. Environmental factors.
? ? ? ?
B.
Management Assessment
? ? ? ? ? ? ?
Background and history of borrower. Corporate strategy Quality of management and management capabilities under stress. Organisational structure, Personnel policies including succession planning. Corporate governance. Marketing and distribution arrangements. Bargaining power of the borrower’s suppliers and customers.
C.
Financial Risk
?
Financial management philosophy and track record (capital structure, profitability, liquidity position, financial flexibility and cash flow adequacy). Working capital management. Asset cover and liquidity profile of assets. Financial projections (with particular emphasis on achievability of sales targets, the components of the cash flow and ability to meet debt obligations as and when they fall due).
? ? ?
?
Free cash flows and their sensitivity to various economic, industrial and business risks over the term of the instrument. Inter-firm comparison of the financial structure and profitability margins. Accounting policies and practices. 25
? ?
?
Track record of payments to the banks and financial institutions.
In addition, while conducting an analysis for short term loans, emphasis will be laid on:
? ? ?
Sources of alternate liquidity Access to financial markets. Quality of relationships with the lenders.
Most companies would be hard pressed to liquidate their short term working capital borrowings from current cash flows. Short term ratings will, therefore, examine the alternative sources of liquidity available to a company, including its liquid investments. D. Terms of the Loan Rating may vary according to loan covenants such as:
? ?
Maturity of loan. Nature of loan - senior or subordinated, covenants and other provisions that may reduce the amount of recovery in case of default. Repayment terms- moratorium period, repayment in installments or bullet repayment, etc. Credit Reinforcements through guarantees or the backing of financial assets. The Rating Process would normally take about three to four days, depending on the
?
?
complexity of the deal and the flow of information from the client. The Rating would be approved by a rating committee comprising of CGM (CRMG) as Chairman and GM (MRD) and GM (CFD) as members. The ratings would be kept confidential from third parties.
26
Symbols (AAA)
Definition Loans carrying this rating are considered to be of the best quality, carrying negligible investment risk. Debt service payments are protected by stable cash flows with good margin. While the underlying assumptions may change, such changes as can be visualised are most unlikely to impair the strong position of such loans.
(AA)
Loans carrying this rating are judged to be of high quality by all standards. They are also classified as high investment grade. They are rated lower than IDBI loans because of somewhat lower margins of protection. Changes in assumptions may have a greater impact or the long-term risks may be somewhat larger. Overall, the difference with IDB1 rated loans is marginal.
(A)
Loans with this rating are considered upper medium grade and have many favourable investment attributes. Safety for principal and interest are considered adequate. Assumptions that do not materialise may have a greater impact as compared to the loans rated higher.
(BBB)
Such loans are considered to be last of investment grade. However, adverse changes in assumptions are more likely to weaken the debt servicing capability compared to the higher rated loans.
(BB)
Such loans are considered to be speculative, with inadequate protection for interest and principal payments.
(B)
Loans with such rating are generally classified susceptible to default. While interest and principal payments are being met, adverse changes in business conditions are likely to lead to default.
(C)
Such loans carry high investment risk with likelihood of default in the payment of interest and principal.
(D)
Such loans are of the lowest category. They are either in default or are likely to be in default soon. Table 2. Explanatory notes regarding rating symbols
27
10. Working Capital Flowchart
Collection of financial data
Analysis of financial data
Classification of Current Assets (CA)/ Current Liabilities (CL)
Verification of projected levels of current assets/ current liabilities with special emphasis on inventory/ receivables/ sundry creditors
Evaluation of liquidity in the business operation
Validation of bank finance sought on the project balance sheet
Fixing of sub-limits
Disbursement of Working Capital Loan
Fig 2. Working Capital Flowchart
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11. Case Study Analysis
11.1. Case Study - Background
The case before me was to assess the working capital requirement of XYZ Ltd. Company who had approached IDBI Bank’s Specialised Corporate Branch in Chennai with a request for a working capital loan assistance of 45 crore. The project involved detailed and in depth analysis of the financial results of the borrower’s project over the years. Since it was against bank’s policies to disclose the financials of its customers and due to its sensitivity clause I have been asked to name the customer by a pseudo name as XYZ Ltd in the report. The promoters’ and the directors’ names were also not allowed to be disclosed to maintain confidentiality. Also wherever the data for the present scenario has not been made available the past data has been taken into account and analyzed. First of all, the company’s history and its business profile were thoroughly analyzed. After that, to scrutinize its financials I used the CMA (Credit Monitoring Arrangement) tool and weighed the credit worthiness of XYZ Ltd. Also from the tool analysis found out the maximum permissible finance that can be provided and confirmed that the request falls within the limits. Analysis based on various financial ratios was also performed. And lastly, the risks associated and the bank’s internal and external ratings were also checked and verified to give away the final approval to the proposal.
11.2. About the Company and Business Profile
XYZ Ltd., a part of XYZ group of companies was incorporated in the year 1967 is engaged in the manufacture of pressure pipe and fittings, fibre cement sheets for industrial roofings and flat sheets for interiors. It also has a textiles division, which makes cotton yarn. The XYZ group with a turnover of Rs.2000 cr has wide business interests in the areas of cement, cotton yarn, software systems, fibre cement products and wind energy. XYZ’s first asbestos cement sheet plant was set up in Tamil Nadu in 1967 and since then the production technology has been updated continuously. The second sheet plant was commissioned in 1974 followed by one more sheet plant in Madhya Pradesh in 1987. The present aggregate capacity for Fibre Cement Sheets is 5 lakh tonnes per annum and Fibre Cement Pressure Pipe is 30 lakh tonnes per annum. The building products divisions of XYZ Ltd 29
are located in various centers in 8 states including Tamil Nadu, while the textile spinning unit is located in Southern Tamil Nadu. XYZ LTD is an efficient producer of Fibre Cement Sheets in India and is the 3rd largest player in its segment. XYZ has pioneered and introduced the innovative Calcium Silicate Board, a versatile building interior product in India. XYZ is operating a modern fibre cement roofing sheets and pipe plants in India. The XYZ Group is well known for its business ethics, professional management, social awareness and philanthropic activities. XYZ Industries Ltd. (XYZ ) is a part of Rs.2000 cr. XYZ Group of Companies, having diverse business interests. The group's business interests are: Cement- XYZ Cements Ltd is the flag ship company of XYZ Group, the sixth largest cement producer in the country and the second largest in South India. Textiles- 8 Spinning Units in Southern Tamil Nadu Software systems - XYZ Systems Ltd. Fibre Cement products – XYZ Industries Ltd. Wind Energy - XYZ Wind Farm, (XYZ Industries Ltd) Biotechnology – Shri XYZ Biotech Surgical products – XYZ surgical cotton mills Ltd
The group runs various Educational institutions right from elementary educations schools to ITI & Polytechnic colleges. It runs a charity trust and a fully equipped diagnostic centre apart from contributing to the Government Hospital in its area of Operation.
30
Rs crore Year ended Net Sales Other Income PBDIT PAT Cash Profit Paid Up Capital Tangible Net Worth Net Working Capital Net Cash from Operations Contingent Liability PBDIT as a % of Sales NP as a % of Sales TOL / TNW Adjusted TOL/TNW Current Ratio Interest Coverage Ratio DSCR (for TL/CL) CFDSCR Imports Exports 2009 409.89 11.02 73.81 35.64 66.92 4.33 277.48 29.25 40 63.39 18.01 8.7 1.31 4.86 1.08 2.88 2.93 1.73 127.61 29.35 2010 480.25 12.11 89.08 53.59 79.55 8.67 329.03 39.04 42.19 93.04 18.55 11.16 1.07 2.79 1.987 4.06 2.86 1.58 150.42 11.8 2011 553.42 12.00 96.38 53.21 89.65 8.67 373.71 102.97 58.81 105.97 17.42 9.61 1.01 2.75 1.66 4.81 3.3 1.62 175.90 7.51 2012 692.97 11.20 105.90 61.34 101.93 8.67 421.68 73.49 51.04 120 15.28 8.85 0.87 1.61 1.34 4.39 1.73 0.90 219.65 7.89
Table 3. Performance/Financial Analysis of XYZ company
11.3. Data Collection
Primary Data: ? During the mentoring sessions with our project guide and other staff members at IDBI bank. Secondary Data: ? Books and magazines ? Annual Reports of XYZ Company ? Internal reports of the banks ? Library research ? Websites
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11.4. Financial Analysis and Observations
11.4.1. Sales
(Rs in crore) Particulars Domestic Sales Export Sales Net Sales 31.03.2009 393.95 29.35 409.21
Table 4. Sales over the years
31.03.2010 490.49 11.80 480.26
31.03.2011 569.36 26.76 553.43
? ?
The company has registered net sales of 480.26 crore during 2009-10 which corresponds to a 17.16 percent increase over the previous year. The Domestic Sales has gone up by 24.50% as on 31.03.2010 compared to FY 2009. The increase in Sales is on account of ? ? ? Capacity addition of 40000 MT in the FC sheet production during the FY2010 Improved realizations. Increase in the demand for FC sheets in the country and revival in economy.
•
Regarding the export sales, the Company exports cotton Yarn to Japan and Italy. During the FY 2010, exports were executed to other European Countries like Germany. The future plans include expanding the export market to US also.
•
The Company also exported Machinery and Spares to its subsidiary Sri XYZ Lanka (Private) Ltd to the extent of Rs.0.55 crore.
32
Production Status: Year Ended 31.03.09 Particulars Installed Capacity Fibre Cement Sheets, Accessories & Fittings (MT) Fibre Cement Pressure Pipes & Pipe Accessories (MT) Calcium Silicate Board (MT) Cotton Yarn (Spindles) 43296 2618846 kg -54487 25.22% 43926 216000 3324443 Kg -105320 48.75% 40000 11887 29.72% 40000 11969 29.92% 30000 --30000 --494000 Actual Capacity Year Ended 31.03.10 Installed Actual Capacity Utilization 92.36%
Production Utilization Capacity Production 466120 94.35% 534000 493213
Cement Clinker Grinding 216000 (MT) Plastic Storage Tank 636.51L
8091135
--
636.51 L 966600
--
Table 5. Production status of 2009 and 2010
•
A new plant for manufacture of Fibre Cement Products has been commissioned in Tamil Nadu with a capacity of 1.20 lakh MT commenced its production from July, 2010. The number of plants manufacturing FC products is eight including this.
•
Further, another Plant was being set up in the State of Bihar to cater to the markets of the Eastern and North Eastern Regions. This Plant will also have an Installed Capacity of 1.20 lakh M.T and the estimated Cost of the Project is about Rs.35 crore. For this project, about 20 acres of land has been taken on lease for 90 years from Bihar Industrial Area Development authority, Patna.
•
Growth in the top line is estimated to be driven by XYZ’s expansion in capacities. However, possible overcapacity within the FC sheets industry is expected to result in increased price competition and corresponding moderation in profitability.
33
•
Product wise Sales: Product Quantity Turnover Rs in crs 2009 Fibre Cement Sheets in MT Calcium Silicate Boards in MT Cotton Yarn (Spindles) Kg Cement Clinker Grinding (MT) Plastic Storage Tank lts Export of Machinery Units from Windmill (KWH) 440362 10823 2662989 54973 7706700 -2010 466250 11216 3365727 105534 1740850 -2009 305.07 20.41 55.30 13.69 1.59 2.17 5.28 2010 348.89 22.32 71.86 24.09 0.36 0.62 5.16
33501902 36967792
Table 6. Production wise sales of 2009 and 2010
? With the arrangements for continuous supply of Clinker and sale of Cement, the CCG Plant
had reported good performance in FY10. Segment wise Sales: (Rs in cr) Division Building Products Textiles Windmill Others Total 2009 355.21 57.58 11.02 24.10 447.91 2010 404.96 77.84 12.11 25.00 519.91
Table 7: Segment wise sales of 2009 and 2010 • • The building products division contributes more than 70% of the total Sales of the Company. The textiles division is the second largest component of XYZ ’s revenues. The textiles division Turnover for FY10 was also considerably higher at Rs.77.84 cr compared to Rs.57.58 crore in FY09. With the demand for yarn picking up in the last 4 months of FY10, the Unit registered a good performance with its sale of Yarn of 33.66 Lakh Kgs in FY10 as against 26.63 Lakh Kg in FY09. Though the Cotton prices continue to be high,
34
with the expected good demand for the Yarn and higher realizations, the company expects the unit to perform better in FY11. • Apart from FC sheets and textiles, XYZ is also engaged in the manufacture and sale of building boards, clinker grinding, production of wind energy etc. At present, these lines of revenue contribute marginally to XYZ ’s overall revenues.
11.4.2.
Profitability
(Rs crore) Particulars PBIT PAT 31.03.2009 (Audited) 43.15 35.63 9.27 8.71 31.03.2010 (Audited) 60.14 53.59 10.92 11.16
Table 8: Profitability index
31.03.2011 (Audited) 66.91 53.21 11.22 9.61
31.03.2012 (Estimated) 72.51 61.34 10.75 8.852
PBIT % of net sales PAT % of net sales
? ?
The Company’s operating profit has improved by 18.37% as on FY 2010 because of increase in the volume of Sales and improved realizations. The increase in profit margin has also been contributed by reduction in interest cost by Rs.4.00 crore and admin expenses by Rs.2.00 crore (which was actually Forex losses during FY 09) Operating Profit: Division wise: (Rs in crore)
Division Building Products Textiles Windmill Others
2009 (Audited) 64.34 (4.36) 2.88 8.75
2010 (Audited) 78.59 1.30 3.68 6.23
Table 9: Operating profit data
35
?
Profitability of the Sheets Division had improved during FY10, with effective control over expenses, despite increase in cost of major Raw Materials viz., Fibre and Cement. However, continuation of these realizations would be a key factor impacting the division’s profitability particularly given the volatility of prices of key inputs like cement and asbestos fibre.
•
XYZ also generates power through windmills largely for captive consumption.
11.4.3.
Liquidity Indicators
2009 (Audited) 201.90 186.62 15.28 1.08 2010 (Audited) 234.95 195.99 38.96 1.987 2011 2012 (Audited) (Estimated) 258.65 284.27 155.68 102.97 1.66 210.78 73.49 1.34
Particulars Total Current Assets Total Current Liabilities Net Working Capital Current Ratio
Table 10. Liquidity Indicators
•
The level of current assets has gone up in tune with the increase in Sales volume. The level of current liabilities also has gone up to finance the additional requirement of Current assets. The Bank borrowings have gone up and trade creditors have come down marginally. The Company was able to negotiate for very fine pricing from the Banks and hence has substituted some of their creditors with Bank borrowings.
•
The ideal current ratio recommended by the Tandon Committee was 1.33 (100/75). But despite the low current ratio, the company has been honoring all the commitments on time and the track record is satisfactory. And as one can see in the subsequent years it has bettered its ratio towards 2012.
36
11.4.4.
Particulars
Gearing Indicators
2009 364.00 277.47 1.31 63.39 1.53 2.88 2010 352.42 329.02 1.07 93.04 1.35 4.06 2011 345.15 373.71 0.92 105.97 1.20 4.81 2012 366.57 421.68 0.87 120 1.1 4.39
Total Outside Liabilities Tangible Net worth TOL/TNW Contingent Liabilities TOL/TNW adjusted for CL Interest Coverage Ratio
Table 11: Gearing Indicators
Gearing ratio is nothing but the ratio of TOL/TNW (Total Outside Liabilities/ Tangible Net Worth). This is regarded as the second most important ratio used by a lending bank in a credit appraisal. It is an important tool in assessing the overall position of loans as compared to own funds. The Company’s gearing has been low in 2009 and has improved further Y-o-Y from 2009 to 2011 to 0.92. TNW has gone up due to ploughing back of profits which has resulted in reduction of outside liabilities, resulting in better gearing. So, as one can see the values are way below the bank’s benchmark level of 3:1, indicating satisfactory solvency position. The Tangible Net worth of the Company has increased from Rs.277.47 crore to Rs.329.02 crore as on 31.03.2010 due to retention of profits. XYZ’s market capitalization works out to be Rs.658.00 crore. The market value of its Investments (mainly in XYZ Cements, where its holds a 20.7% stake as a promoter) works out to Rs.676.00 crore. The true net worth of the Company is manifold higher than the stated value of Rs.329.02 crore. 11.4.5. Auditors Qualifications and Clarifications, if any The disputed statutory dues aggregating to Rs.0.89 crore that have not been deposited on account of matters pending before appropriate authorities are as under: S. No 1 Name of the Statute Sales-tax act Total
Table 12: Disputed statutory dues
Forum where dispute is pending High Courts
Amount(Rs in crores) 0.89 0.89
37
Clarification provided by the Company:
Sales Tax demands amounting to Rs. 0.89 crore (previous year Rs. 0.89 crore) have been disputed by the Company and necessary appeals have been filed. Based on the nature of claim disputed, no provision has been considered necessary. This has been accounted in the contingent liabilities as shown in the next page.
11.4.6.
Contingent Liabilities
(Rs in crore) 2010-11 8.31 2.55 7.91 13.00 12.00 25.00 36.29 0.89 105.97
Table 13. Contingent Liabilities
The Company’s contingent liabilities position is as follows.
No 1. 2. 3. 4. 5. 6. 7. 8. 9. Particulars Estimates amount of contracts remaining to be executed on Capital accounts Bank Guarantees Letters of Credit Corporate Guarantee furnished by the Company to AXIS Bank Ltd for XYZ Systems Ltd to support their credit facilities Corporate Guarantee furnished by the Company to IDBI Bank Ltd for XYZ Systems Ltd to support their credit facilities Corporate Guarantee furnished by the Company to Punjab & Sind Bank for XYZ Systems Ltd to support their credit facilities Corporate Guarantee furnished by the Company to AXIS Bank Ltd for XYZ Textiles Ltd to support their credit facilities Sales Tax Total
2009-10 1.19 18.20 1.47 8.00 7.00 20.00 36.29 0.89 93.04
Around 80% of the contingent liabilities have been on account of Corporate Guarantee furnished to the lenders of associate companies. This has been considered necessary for ensuring uninterrupted financing of the associates. Other Contingent liabilities have arisen under normal course of business and are considered reasonable for the level of operations of the Company.
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11.4.7.
Peer Comparison (Rs. crore) Hyderabd Visaka Industries Industries 703.69 157.54 89.72 22.39 12.75 261.78 1.20 1.77 598.13 117.16 57.21 19.59 9.56 235.73 1.38 1.17 Everest Industries 652.53 70.03 30.01 10.73 4.60 173.70 1.06 1.37
As on 31.03.2010 Net Sales PBDIT PAT PBDIT (%) PAT (%) Total Net Worth (TNW) Current Ratio TOL/TNW
XYZ 480.26 86.07 53.59 17.92 11.16 329.02 1.13 1.07
Table 14: Peer comparison Observations /Comments • • • XYZ has a very strong TNW with better profit margins. Hyderabad industries alone have a better profit margin the XYZ. The gearing is the lowest in XYZ. The sale of top four players has grown at an average CAGR of 16.97% in past 3 years whereas the bottom line grew at 39.78% for the same period. Contribution of XYZ to the sheeting industry during the year 2009-10 has been accounted as to 40000 MT.
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11.5. Assessment of Proposal
11.5.1. Assessment of Working Capital Requirement
Build up of Current Assets & Current Liabilities (Rs. in crore) Particulars Raw materials a. Indigenous Month’s consumption Stock in process – Amt Month’s Cost of Production Finished Goods - Amt Month’s Cost of Sales Domestic Receivables – Amt Month’s Domestic Sales Creditors for Purchases – Amt Month’s Purchases 49.08 4.9 1.11 0.04 54.72 1.92 27.24 0.70 40.25 1.87 48.64 3.94 1.36 0.04 74.42 2.27 28.77 0.63 26.72 1.06 34.99 3.12 1.84 0.05 83.90 2.39 38.60 0.78 27.03 1.04 151.18 4.56 1.36 0.03 67.23 1.57 59.69 1.06 37.77 1.14 2009 2010 2011 2012
Table 15: To calculate the holding period for calculating working capital
•
The raw material holding level has been historically at an average of around two months. However, the levels are estimated at 4.44 months and 5.40 months respectively for FY 2011 and FY 2012 since the company is growing and is on an expansion drive and it will be purchasing the raw material and stocking it for smooth operations (maintaining minimum levels at various factories).
• • •
The receivables level is at an acceptable position at 19-20 days. Stock in process is at the same level of 1-2 days. The creditor level is at 2.80 months as on 31.03.2010, which is higher than the previous years, since the Company had stocked material for commencing activity at new plants and 40
the levels are actually going up on account of stocking of Cotton and raw material. With the increasing Bank interest rates, Company wants to avail the credit from suppliers at higher levels. • Finished goods holding period was at 2.24 months as on FY 2010. The level has come down in the subsequent years since the company is planning to manage inventory at the minimum holding levels.
Calculation of Maximum Permissible Bank Finance
(Rs. in Crore) Particulars 1. Total Current Assets 2. Other Current Liabilities 3. Working Capital Gap 4. Min. Stipulated NWC 5. Actual / Projected NWC 6. Item 3 Minus Item 4 7. Item 3 Minus Item 5 8. MPBF (lower of 6 or 7) 2009 200.45 143.98 56.46 50.11 29.25 6.35 27.20 6.35 2010 235.04 128.49 106.54 58.76 39.04 47.78 67.50 47.78 2011 258.65 122.52 136.13 64.66 102.97 71.46 33.15 33.15 2012 284.27 153.54 130.7 71.06 73.49 59.66 57.24 57.24
Table 16: To calculate Maximum Permissible Bank Finance
Comments:
The MPBF has been assessed at Rs. 33.15 crore and Rs.57.24 crore for 2010-11 and 2011-12 to support the estimated increase in turnover of the company. Considering the fag end of the financial year the MPBF is recommended for both the financial years i.e. 2011 and 2012.
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•
MPBF of Rs.57.24 crore for FY2012 has been arrived at after reckoning Sundry Creditor for goods to the extent of Rs.25.56 crore, representing outstanding under Letter of Credit/Buyer’s Credit for procurement of raw materials. As the company will decide whether to avail LC/BC or a fund based facility for procurement of raw material, based on the factors prevailing at that point of time, the company would like to have exchangeability between FB & NFB limits.
Assessment of Fund Based facilities:
Cash Credit: Rs. 15 crore The company presently enjoys a Cash Credit limit of Rs. 15 crore with the Bank which is proposed to be renewed. The proposed limits will be within the assessed MPBF for FY 2011/2012, backed by adequate drawing power. The entire exposure will be fully secured by paripassu charge on the current assets of the company. Short Term Loan/WCDL: Rs. 20 crore The company is very cost conscious and avails the Short Term Loan at competitive rates offered by the various Banks. The company presently enjoys a Short Term Loan of Rs. 20 crore to meet any urgent need of working capital which is proposed to be renewed. The tenor of each STL shall be for a maximum period of 90 days only and the limit will be within the overall assessed MPBF backed by adequate drawing power. The facilities will be backed by Demand Promissory Note and DPN Delivery Letter. EPC/PCFC/PSCFC: (Rs.5.00 crore) The Company undertakes export of cotton yarn to Japan and other countries like USA. They also export machinery to their subsidiary in SXYZ Lanka. Though the Company has conservatively estimated the Export Sales at around Rs.7.00 to 8.00 crore for FY 11and FY12, presently they have orders worth Rs.12.00 crore for export to their subsidiary Sri XYZ Lanka (Private) Ltd. The Company proposes to avail EPC/PCFC/PSCFC in order to get interest benefit (in the current rising rate regime). In view of this, we recommend an inner limit of Rs.5.00 crore of EPC/PCFC/PSCFC.
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11.5.2.
Assessment of Non - Fund Based facility
Bank Guarantee: (Rs.5.00 crore)
The company requires bank guarantees (Bid Bond, Financial and Performance) to be given to government departments (TNEB etc.,), customs for import duty exemption etc., and for other statutory purpose periodically. We propose to have a limit of Rs. 5.00 crore as inner limit to secured fund based working capital limits.
11.5.3.
Key Risks and Mitigants
The following are some of the key risks that can affect their normal operations and which, more importantly, should be scrutinized by the lending bank. If the company can prove there are sufficient mitigants for each risk pointed by the bank/lender, then that risk can be said to be normal.
1. Business & Industry Risks
? Dependency on imported raw material Chrysotile asbestos sheets which is one of the major raw material used in manufacturing FC sheet. Mitigant: About 94% of Chrysotile asbestos produced worldwide is consumed by countries other than India. India uses barely 6 to 7% of world’s asbestos fibre production. This goes to prove that AC sheet and pipe production and usages of these products are very much prevalent in most of the world. ? Imported raw material leaves industry vulnerable to forex risks. Depreciated Indian rupee will hit industry margins. Mitigant: The company covers 50% of their imports regularly by booking forward contracts. Further, it takes forward covers as and when required for additional amount based on the volatility. ? FC sheets industry continues to face regulatory risks on account of a possible ban on the use of asbestos in India as well as the possibility of a ban on asbestos mining in major asbestos producing countries like Russia, China, Zimbabwe, Canada etc. Mitigant: In India, only the Chrysotile variety, which is considered safe, is used in AC products like sheets and pipes, and not for spraying. The Government of India has constituted various expert committees to study the asbestos industry and having been 43
satisfied that asbestos does not actually pose a health risk to the workers at the manufacturing plants so long as the work place pollution controls were in place, or to the public who use the asbestos-cement products, the Ministry of Industry, Government of India, in July 1997, has in fact de-licensed the industry, allowing any person to set up a factory without the need for an industrial license from the ministry.
2. Financial Risks ? Fluctuations in Raw Material Prices - Cement and Asbestos fibre is important raw
material for FC sheet manufacturing contributing around 45% and 30% of the total cost respectively. Any fluctuation in the cement prices is likely to affect the profit margins of the Company. Mitigant: Currently, Cement prices have corrected by 20% from its high. Rising capacity expansions in the cement industry has created medium-term supply glut in the industry thus, putting pressure on the prices. We expect cement prices to be lower for the medium term. This would benefit FC Sheet industry as the end product prices are not dependent on the raw material prices, end user being different. ? Cost Effectiveness - The efficiency of the companies in this sector is apprehended by the ability of the firm to source inputs at reasonable cost as well as the scale of operation. So the players with strong focus on rural segment and strong brands are better placed. Mitigant: The company has identified multiple sources of procurement and undertakes an elaborate exercise to arrive at the cost effective raw material mix for each year. The company also enjoys competitive rates offered by their suppliers.
3. Management Risks
The risks are nil as the company belongs to XYZ Group and has been in the industry for almost 40 years. The promoters have a proactive approach and are constantly on the lookout for innovative practices to improve the product mix, identify new product lines and improve the existing products through the best technology. The company is the first to manufacture calcium silicate board business through technical assistance with a Japanese company.
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11.6. Recommendation for the Proposal
?
The company promoters have been in this business for more than 50 years, which has a long history of ethical conduct and a track record of honoring the commitments on time. XYZ belongs to the XYZ group, which is known for its business ethics, professional management, social awareness and philanthropic activities. The company’s ratings, both internal and external, have been regarded as good for credit appraisal. XYZ Industries has an existing relationship with satisfactory track record. The company’s performance is on growth path and has been recording impressive growth. XYZ is paying dividend since inception and the company’s financial parameters for the year under review are satisfactory. The company has been availing multi product from us Short Term Loan, Letter of Credit, Bank Guarantee, Buyers Credit, CMS (Collection and Disbursements) and Current Account). In view of the above, the working capital may be sanctioned at an aggregate assistance
?
?
?
?
?
of Rs 45 crore renewal of WC limits (FB – 40 Cr and NFB – Rs 5 Cr (Inner Limit to CC/WCDL), as per the general terms and conditions applicable to sanction of such types of assistance by the Bank.
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12. Conclusion
IDBI Bank provides working capital facility to the industry to finance day-to-day production & sales. For production, funds are generally required for purchase of raw materials, stores, fuel, for payment of labour, power charges, for storing finished goods till they are sold out & for financing the sales by way of sundry debtors / receivables. Cash Credit facility is granted to the customers to bridge working capital gap. The Bank also provides short term loan facility for a period of up to 1 year for the purpose of bridging temporary cash flow mismatches arising due to various reasons like non-realization of receivables in time, etc.
The bank prefers to use the second method of lending working capital under the MPBF rather than evolving its own method. The bank has their own internal credit rating procedure to rate the clients. The specialized corporate office where I was placed for
my internship had clients that were looked upon by the MCG group of IDBI. There is stiff competition to the public sector banks from the private and other foreign banks as their lending rates are more competitive and they have brought in much more innovative and extensive marketing techniques to woo variety of corporate customers. IDBI Bank has been maintaining a conservative look towards lending which is still recommended. Having said that, IDBI has to market itself and bring in more innovative lending practices in order to stay in competition and eventually become a leader in the corporate banking sector.
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13. Annexure
13.1. About IDBI
IDBI Bank Ltd. is a Universal Bank with its operations driven by a cutting edge core Banking IT platform. The Bank offers personalized banking and financial solutions to its clients in the retail and corporate banking arena through its large network of Branches and ATMs, spread across length and breadth of India. It has also set up an overseas branch at Dubai and has plans to open representative offices in various other parts of the Globe, for encashing emerging global opportunities. Our experience of financial markets will help us to effectively cope with challenges and capitalize on the emerging opportunities by participating effectively in our country’s growth process. As on March 31, 2012, the Bank had a network of 973 Branches and 1542 ATMs. The Bank's total business, during Fy 2011-12, reached Rs. 3,91,651 Crore, Balance sheet reached Rs. 2,90,837 Crore while it earned a net profit of Rs. 2032 Crore (up by 23.15 %). The vision for the Bank is “TO BE THE MOST PREFERRED AND TRUSTED BANK ENHANCING VALUE FOR ALL STAKEHOLDERS”. Corporate Banking In its continuing endeavour to effectively meet the requirements of different Groups of Corporate Clients, IDBI Bank Ltd. has organised its Corporate Banking Wing based on client's turnover besides creating a separate specialized cell and Group each to cater to corporates in Film Sector and Infrastructure Sector respectively. Based on scale, Corporates with turnover of more than Rs. 100 crore but up to Rs. 500 crore are looked after by Mid Corporate Group (MCG) while Corporates with turnover of more than Rs. 500 crore are looked after by Large Corporate Group (LCG). However, as stated earlier, with a view to effectively manage the peculiar requirements of Film Finance, a specialised cell has been set up in LCG to cater to Corporates in Film Sector regardless of their turnover.
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Special focus for Infrastructure Financing Further, considering the significance of the infrastructure sector in the country’s development, a specialised Group, namely Infrastructure Corporate Group (ICG) has been created which deals with Corporates from infrastructure, Industries accorded infrastructure status by RBI, regardless of their turn over. Since inception in 1964 [formerly as Industrial Development Bank of India], IDBI Bank has been assigned to play a distinctive role in the promotion of industrial development of the country. It has provided financial assistance towards setting up of industrial estates. Being a prominent player in financing infrastructure projects, IDBI Bank actively participates in addressing policy-related issues in various forums including the Committees constituted by the Government of India. Finalization of model Power Purchase Agreement and Model Concession Agreement in road sector are some of the significant contributions made by IDBI Bank in the development of this sector. It has financed landmark first-of-its-kind projects in the infrastructure sector such as Independent power project, fixed and mobile telecom, port, road and airports in India. The policy makers have identified power, telecom, ports (both sea and airports), roads, transportation and urban infrastructure facilities as infrastructure sector and are providing impetus for the growth in these sectors, Reserve Bank of India has accorded infrastructure status to select sectors, credit to which is classified as financing to Infrastructure sector. These three Groups in the Bank cater to the requirement of financial assistance as also provide other services like Deposits products to clients from Corporate sector.
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13.2. Screenshots
Screenshots of the CMA Tool that was used for the analysis
Profit and Loss Account
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Current Liabilities
50
Term Liabilities
Current Assets
51
Other current assets, fixed and non-current assets
Working capital assessment
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Calculation of MPBF
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13.3. References
Book references: 1. Dr. D.D.Mukherjee, 2012. Credit Appraisal, Risk Analysis & Decision Making. 6th ed. Mumbai: Snow White Publications Rvt. Ltd. 2. Chandra, Prasanna. 2007. Financial management. 7th ed. New Delhi: Tata McGraw Hill. 3. Pandey, I.M. 2010. Financial Management. 10th ed. New Delhi: Vikas Publishing Hose Pvt Ltd., 2010. 4. XYZ Company’s audited Annual Reports for the year 2009, 2010, 2011 and 2012. Website References: 1. www.idbi.com 2. www.rbi.org.in 3. www.investopedia.com 4. en.wikipedia.org
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