EXCECUTIVE SUMMARY

The project report is titled A study on credit appraisal mechanism of KSFC.

With the increase in social responsibility and shift from security to purpose oriented
lending, its now expected that the banks and financial institutions should assist
entrepreneurs during all phases of a project i,e., identification, selection, appraisal,
implementation and follow up.
KSFC was established by Government of Karnataka in March 1959 under the
SFCs Act 1951 for extending the financial assistance for setting up of tiny, micro, small
and medium scale industrial units in the state.
The small and medium scale sector in India lacks capital to run their business and
starving for funds in the earlier days. SFCs were started to provide funds to small and
medium scale sector and encourage first generation entrepreneurs to start business
especially in backward area throughout the country
Industrial projects are appraised by different institutions for a variety of reasons.
State financial institutions and other financial institutions appraise projects to find out
whether it is worth to make to investments in them and extend long term loans.
Since capital is a scarce resource, it should be allocated carefully for the
development of industrial units and it should be helpful to the society, KSFC has been
acting as regional development bank by providing assistance to needy entrepreneurs.
Before giving loans to any project the corporation checks the marketing, financial,
economical, social and legal viability of the project, after this appraisal procedure the
KSFC will provide term loans,. All set norms are fulfilled as per the policy
Thus the basic objective of this study is to assess the appraisal system of KSFC,
and to check its adequacy to appraise a project and to find out relationship between the
appraisal procedure and the NPA percentage of the KSFC.
Thus this project gives the information about the drawbacks in the appraisal
procedure of the KSFC, what are the changes to be done to make it more effective and
efficient and how the NPA and the amount of loan sanctioned is correlated to each other.
Finally we arrive at a conclusion that the project appraisal mechanism of KSFC is
adequate enough to appraise a project with that it also requires some changes to be done.
CHAPTER 1
Introduction
Finance is the lifeblood of all types of economic activity. It is so indispensable
that no one can neglect nor ignore the importance of finance. Finance is defined as

distribution of and purchase of liability and equity claims issued for the purpose of
generating revenue producing assets its management of monetary affairs of the company
it includes determining what has to be made for raising money on best term available and
what has to be made for allocating available funds to the best use.
Finance is the administration of economic activity it includes banking money
and Credit for different type and classes. All major business decisions made have
financial implications no matter whether an organization is small or big newly started or
existing business needs finance. If decision relating to money or funds fails it may result
in failure of the business organization.
Financing is a comprehensive activity which includes not only sources but also
cost associated with their resources, duration of requirement and proper utilization of
funds.
Global Scenario of Finance:
In recent years the financial sector in most of the countries around the world has
undergone major changes. Deregulation, liberalization and technological innovations,
allow financial institution to a larger variety of products and services, making the
traditional frontiers between banking, securities and insurances sectors merge. In practice,
the financial sector is in a process of rapid transformation. Reforms are continuing as part
of the overall structural reform aimed at improving the productivity and efficiency of the
economy. The role of an integrated financial infrastructure is to stimulate and sustain
economic growth.
The US$28 billion Indian financial sector has grown at around 15
percent and displayed stability for the last several years, even when other markets in the
Asian region were facing a crisis. This stability was ensured through the resilience that
has been built into the system over time. The financial sector has kept pace with the
growing need of corporate and other borrowers. Banks capital market participants and
insurers have developed a wide range of product and service to suit varied customer
requirements.
Indian Financial System:
The world system stands for a set of bodily organs like composition or concurring
function, a scheme of classification and a method of organization. Finance holds the key
to all human activity. Finance is the study of money, its nature, creation, behaviors,
regulation and administration. So all those activities dealing in finance are organized is
known as the financial system or financial sector.
The evolution of the financial system in India has been interlinked with the

growth of the macro economics. The financial system has travelled up and down from
barter financial system greatly influenced by the spread of urban society and above all the
advent of large-scale industrialization in the second half of the nineteenth century, altered
the expansions of the railways and especially with the revolutionalisation of information
technology.
In India, the evolution of financial system reflected its political, social and
economic need and aspiration. Government has played a large role in the creation and
broad basing of the financial system in the country. The government has exerted its
influence over the flow of credit control and direction. It is also big borrower as well as
regulator of the financial system.
The growth path of financial system can be divided into three distinct phases
the first phases are characterized by active state intervention with a view to build up the
institutional infrastructure. Developing countries are in a hurry to catch up with modern
banking and development in money and capital markets and they cant afford to wait for
the spontaneous and autonomous growth of the financial system to take place.
The financial system is closely connected or interlinked with institutions,
agents, practices, market transactions, claims and liabilities. In a financial system it is
concerned about money, audit and finance, some of the terms are related but some are
different form each other.
Money refers to current medium exchange.
Finance is monetary resources comprising debt and ownership funds of state/
company.
Credit or loan is a sum of money to be returned normally with interest.
Currency and exchange form an essential part of financial system.

Scope of the Financial Function

a) Estimation of the financial requirements
Estimating the financial requirements is the first and the foremost task
and long term financial needs of the concern. This calls for preparation of the financial
plan for present as well as for future. The amount required for purchasing fixed assets as
well as needs of funds for working capital have to be estimated.

b) Deciding the capital structure

The term capital structure refers to the kind and proportion of different
securities for raising funds. After deciding the quantum of funds required it should be

decided as to which type of securities should be raised further while deciding about the
capital structure, due consideration ??????????????????????

c) Selecting a source of finance

Once the capital structure is decided an appropriate source of finance is
selected. The various sources of finance include share capital, debenture, loans from
financial institution, commercial banks and public deposits etc.

d) Selection pattern of investment

Once the funds have been procured, the decision about investment pattern that is
to be taken. A decision has to be taken as to type of assets that are to be purchased first
funds may be invested in fixed assets and an appropriate portion may be kept for the
purpose of working capital.

e) Proper cash management

Requirement of cash at different times and then make arrangements for acquiring
cash.

f) Implementing financial control

An efficient system of financial management necessitates the various
control parameters generally such as ROI, Budgetary Control, Break Even Analysis, Cost
Control and Ratio Analysis.

g) Proper use of surpluses

The utilization of profit or surpluses is also an important factor in financial
management. A judicious use of surplus is essential for expansion and diversification
plans and also in protecting the interest of share holders.

Objective of the Financial Function:

The primary objective of the finance function is to arrange for required
funds for the business from time to time

a) Acquiring sufficient funds

The basic objective of finance function is to asses or estimates the financial
requirements of an enterprises and then finding out suitable sources for receiving them.

b) Proper utilization of funds

Though selecting the source and rising of funds is most important objective of
the finance function. The proper utilization of such funds is even more critical, the funds
should be utilized in such a way that maximum benefit is derived from them.

c) Increasing profitability

The planning and control of finance function aims at increasing profitability

of the concern. It is a fact that money generated money sufficient fund will have to be
invested in order to increases profitability.

d) Maximizing enterprise value

Finance function also aims at maximizing the value of the firm usually a
enterprise value is linked with profitability.

Pattern of Fund Requirement:

A firm basically needs three types of funds they are:
Short term finance
Medium term finance
Long term finance

Classification of Various Sources of Finance

Short Term Investment
a) Call money/ call notice
This is the barrowing and lending money for short term ranging from 1 to 14
days, if the money is lent for a day is called call money. It is called because of the money
that is lent is to repaid the next day together with agreed interest. If it is for a period of
more than a day and less than 14 days it is called as notice money.

b) Commercial paper
It is another short term instrument introduced in a domestic money
market. This was aimed towards disintermediation. It is an unsecured promissory note
issued by the company either directly or through bank or merchant bank.

c) Treasury bills
It was introduced in the year of 1986. This is the most liquid
instrument available in Indian market. Treasury Bills are issued by the central govt., to
meet its short term needs.

d) Commercial bills
One of the ways of raising working capital finance is by way of
discounting bills by the supplier on his customer in course of his routine trade activities.

The unique feature of these commercial bills is that could be subjected to further rounds
of discounting by bank holding their bills.

e) Certificate of deposits
RBI introduced this in 1989 with the objective of broad basing the money
market. It is the marketable receipt of funds deposited in bank for a period at a specified
rate of interest.

Medium and long term finance

a) Equity shares
Equity shares are commonly referred to common stock or ordinary share. It
is an instrument issued by the company to mobilize the capital. Companies issues them in
new capital issue market. The equity shareholders enjoy special powers of voting and can
become director of a company.

b) Preference shares:
The characteristics of preference shares are hybrid in nature like bonds, their
claims on the company income are ltd., and they receive the fixed dividend in event of
liquidation of company their claims on assets of firms are also fixed.

c) Debentures
The private sector companies generally issue debentures as a long term
promissory note for raising capital. The company promises to pay interest and principal
as stipulated, bond is an alternative form of debentures in India.

d) Retained earnings
Retained earnings refer to creation of reserves out of profit and the
utilization of accumulated profit or reserves for meeting the financial requirements of
business. It is also called as internal source of finance.

e) Public deposits
It is usually raised by a company from general public as means of
borrowings assuring them a fixed % interest for a specific period of time.

Recent trends in Indian financial system:

With a view to bringing the interest rates nearer to the free markets rates, the
government has taken the following steps:
The interest rate on company deposits is freed.
The interest rate on 365 days treasury bills determined by auctions and they are
expected to reflect the free markets rates.
The coupon rate on government loans been revised updates so as to be market
oriented.
The interest rate on debentures is allowed to be fixed by companies depending
upon the market rate.
The maximum rate of interest payable on bank deposits above one year.

Major players in Financial Sector:

a) Industrial Development Bank of India (IDBI):
The IDBI, which was established in 1964 under the act of parliament, is the
principal financial institution for providing credit and other facilities for development of
industry, co-ordinate working of institutions engaged in financing, promoting or
developing industrial units and assisting development of such institutions. IDBI has been
providing direct financial assistance to large and medium industrial units and helping
small and medium industrial concerns through banks and state level financial
corporations. Now it is converted into a bank.

b) Industrial Finance Corporation of India (IFCI):

The government of India has set up the IFCI in 1948 under the special act.
At the time of independence in 1947, India's capital market was relatively underdeveloped. Although there was significant demand for new capital, there was a dearth of
providers. Merchant bankers and underwriting firms were almost non-existent. And
commercial banks were not equipped to provide long-term industrial finance in any
significant manner.
It is against this backdrop that the government established The Industrial Finance
Corporation of India (IFCI) on July 1, 1948, as the first Development Financial
Institution in the country to cater to the long-term finance needs of the industrial sector.
The newly established DFI was provided access to low-cost funds through the central

bank's Statutory Liquidity Ratio which in turn enabled it to provide loans and advances to
corporate borrowers at concessional rates.

c) Small Industries Development Bank of India (SIDBI):

SIDBI has been established in 1989 to function as an apex bank for tiny
and small scale industries. It is an independent financial institution aimed to aid the
growth and development of micro, small and medium scale enterprises in India. It was
incorporated initially as a wholly owned subsidiary of Industrial Development Bank of
India. Current shareholding is widely spread among various state owned banks, insurance
companies and financial institutions. Beginning as a refinancing agency to banks and
state level financial institutions for their credit to small industries, it has expanded it's
activities, including direct credit to the SME through 100 branches in all major industrial
clusters in India. Besides, it has been playing the development role in several ways such
as support to micro-finance institutions for capacity building and on lending. Recently it
has opened 7 branches christened as Micro Finance branches, aimed especially at
dispensing loans up to Rs. 5.00 lakh.

d) Industrial Credit and Investment Corporation of India (ICICI)

The Industrial Credit and Investment Corporation of India was sponsored by
a mission from the world bank for the purpose of developing small and medium
industries in the private sector. It was registered in january1995 under the Indian
companies act. Its issued capital has been subscribed by Indian banks, insurance
companies and individuals and corporations of the Indian banks, insurance companies
and individuals and corporations of the United States, the British eastern exchange banks
and general public in India.
The Industrial Credit and Investment Corporation of India Limited (ICICI)
was incorporated at the initiative of World Bank, the Government of India and
representatives of Indian industry, with the objective of creating a development financial
institution for providing medium-term and long-term project financing to Indian
businesses. In 1994, ICICI established Banking Corporation as a banking subsidiary.
Formerly known as Industrial Credit and Investment Corporation of India, ICICI Banking
Corporation was later renamed as 'ICICI Bank Limited'. ICICI founded a separate legal
entity, ICICI Bank, to undertake normal banking operations - taking deposits, credit
cards, car loans etc.

e) State Financial Corporations (SFCs)

SFC s form a unique set of institutions established to assist and

develop industrialization in the state of India. For the purpose of assisting the financial
help to small and medium sized industries, the government of India desired to set up state
financial corporations.

Evolution of State Financial Corporation (SFC):

The Indian Financial sector today comprises an impressive network of
financial institutions and wide range of financial instruments. Functionally there are two
types of financial institutions in the Indian market, namely developmental institutions and
investment institutions.
Developmental institutions include industrial finance corporation of India (IFCI),
Industrial Reconstruction Bank of India (IRBI), State Finance and Development
Corporation.
In the category of investment institutions comes the Unit Trust of India (UTI),
Life Insurance Corporation (LIC), State Level bodies like State Industrial
Investment Corporation.
The Idea of developmental banks has its origin in the urge in the backward and under
developed countries to achieve quick economic growth. Under this urge, a developmental
bank was conceived as an instrument for promoting all round development, since they
undertake both banking function as well as developmental functions.
The establishment of Industrial Finance Corporation of India (IFCI) though
bridged serious gap in institutional finance for large-scale industrial units, the problem of
term finance for medium and small-scale units was left unsolved. The need for
establishing a similar institution at the state level was left unsolved. The need for
establishing a similar institution at the state level was initially felt as device to bridge the
gap. Hence the SFCs came into existence to look into this problem as regional
development banks over a period of years.
SFCs form a unique set of institutions established to assist and develop
industrialization in India. The activities of IFCI were statutorily restricted to large scalesector. The Indian socio-economic environment with certain under-developed feature
constantly stressed the urgent need for the development of medium and small scale
industries. Establishment of regional development banks has been important means to
meet this end.
Their sources of funds are issue of bonds and debentures in the market, fixed
deposits from the public, borrowing from RBI, IDBI, state governments etc. These funds
are deployed mostly as loans and advances to the various medium and small enterprises,

investment in government securities, corporate share, debentures etc. These bodies are to
assist in particular small-scale industries, units in backward areas. There are 18 SFCs
operating in India they are
Assam financial corporation
Bihar state financial corporation
Delhi financial corporation
Gujarat financial corporation
Haryana financial corporation
Himachal financial corporation
Jammu Kashmir financial corporation
Karnataka state financial corporation
Kerala financial corporation
Madhya Pradesh financial corporation
Maharashtra state financial corporation
Orissa state financial corporation
Punjab financial corporation
Rajasthan financial corporation
Tamil nadu industrial investment corporation limited

Objectives of SFCs
The SFCs have been authorized under section 25 of the SFC s Act to
carry on the following kinds of business.
Granting of loans or advances to or the subscribing to debentures of industrial
concern repayable within a period not exceeding 20 years from the date on which
they are granted or subscribed as the case may be.
Under writing of the issues of stocks, shares, bonds or debentures by industrial
concerns.
Guaranteeing on such terms and conditions as may be agreed upon raised by
industrial concerns that are repayable within a period not exceeding 20 years
capital are floated in the public market.

Generally doing of all such acts and things as may be incidental to or

consequential upon the exercises of their powers or the discharge of their duties
under the act.

DEFINITION of 'Appraisal'

The valuation of property (i.e. real estate, a business, an antique) by the

estimation by an authorized person. In order to be a valid appraisal, the authorized person
will have a designation from a regulatory body governing the jurisdiction the appraiser
operates within.

WHAT IS CREDIT APPRISAL?

Credit appraisal means an investigation/assessment done by the bank prior to

providing any loans & advances/project finance & also checks the commercial,
financial & technical viability of the project proposed.
Proper evaluation of the customer is preferred which measures the financial
condition & ability to repay back the loan in future
Credit appraisal is the process of appraising the credit worthiness of the loan
applicant
Factors like: Age
Income
Number of dependents
Nature of employment
Continuity of employment
Repayment capacity
Previous loans, etc. are taken into account while appraising the credit
worthiness of a person.

3 C of credit are must be kept in mind for lending funds

Character
Capacity
Collateral
If any one of these are missing in the project, the lending officer must question the
viability of credit
Th heart of a loan proposal system is, which security is given. In this aspect
basically the valid extract are taken from the report and the data enables any credit officer
to take decision regarding finalization of loan proposal. Credit appraisal system is
summary of extracted records. Regarding verification made towards the profile of the
applicant. It is presentation of report in suitable format. While easily reflect the

eligibility of loan procedure viz tenor eligibility E.M.I. (equated monthly installment)
The credit appraisal is done for different purpose they are as follows
To know the market for business.
To knows the customers financial requirement & his experience.
To know that whether he is taking the loan from other bank or non-banking
financial institution and whether he is able to pay timely to pay installment to
satisfy their loan amount.
Thus the appraisal of credit appraisal is very much important for the disbursement of
loan and advances.
Appraisal also helps to find out his integrity in this project, for which customers
takes loan. His aims and intensions in taking this loan and the purpose for which he is
taking loan for which its overall capacity is checked.
In short credit appraisal system is very important for the purpose of bank and
NBFC (non-banking financial company) and it would not be able to collect the money
which is lending to their customers. If that NBFC is not able to collect their installments
then that loan account will become NPA [non performing asset] and the goodwill and
reputation of the NBFC will be down. The officer, who will be giving sanction to that
particular proposal will also be questioned.
He must do the proper check & analysis of the documents after studying all this
aspects.

CREDIT APPRAISAL
The process by which a lender appraises the creditworthiness of the
prospective borrower is knows as credit appraisal. This normally involves appraising
the borrowers payment history and establishing the quality and sustainability of his
income. The lender satisfies himself of the good intentions of the borrower, usually
through an interview.

Credit Scoring
Credit scoring is the statistical system used by lenders to determine your
creditworthiness. Information about you and your credit experiences is collected from
your loan application and your credit report. Using a statistical program, lenders compare
this information to the credit performance of consumers with similar profiles.
A credit scoring system awards points for each factor that helps predict who
is most likely to repay a debt. A total number of points "a credit score" helps predict how

creditworthy you are, that is, how likely it is that you will repay a loan and make the
payments
when
due
The points are distributed in various aspects of your profile such as :
- personal information: age, educational qualifications, number of dependent/children,
spouses
income
- employment information : organization, designation, length of service, etc.
- income information : net income, installment of other loans, other liabilities.
- net worth information : owning a house, vehicle, credit cards, telephone, etc.
- previous relations with the lender : banking account, credit card, any other loan, etc
from the same lender
Your level of education can give an indication to the lenders whether it is a
good risk to extend credit to you. Higher the education better is the credit score. A person
with professional qualifications is given more points than a simple graduate.
Lenders prefer people who are stable. So, lenders assign more points to people
whove lived in a particular location or have worked for a single employer for many
years. If youve moved around a lot, you lose precious points. If youve moved because
of a better-paying job, you can recoup some of those points if your salary has increased,
for
example.
Lenders rate your profession and your employers too. Most of the lenders have a
list of approved companies. Credit points are allotted based on the type of company you
work for or the type of profession you are in. The rating from most favored to least
favored profession / organization may vary from lender to lender however an indicative
list is presented here under:
a) government / public sector undertakings / MNCs.
b) teaching / educational institutions.
c) Scientists / engineers.
d) Banks / financial institutions.
e) chartered accountants / company secretaries.
f) Hotels / travel organizations.
g) Media / advertising agencies
you get additional points based on whether you own a house, or have a vehicle, or
hold a valid credit card. Some lenders insist that all prospective customers must have a
phone at residence. These factors play an important role in determining your credit
eligibility.

Why is credit scoring used?

Credit scoring is based on real data and statistics, so it usually is more reliable
than subjective or judgmental methods. It treats all applicants objectively. Judgmental
methods typically rely on criteria that are not systematically tested and can vary when
applied by different individuals.
Credit scoring models are complex and often vary among creditors and for
different types of credit. If one factor changes, your score may change. The trick here is
you cant find out your score.
Companies providing loans and credit do not disclose their credit appraisal
criteria. Both the score and the statistics that go into it are top secret. The reason being
that if people understood their appraisal criteria and scorings, they could cheat by altering
their profile thereby artificially jacking-up their overall credit score. But, of course, we
will try to improve our credit scores, wont we?
In short credit appraisal system is a conclusive report, which enables
decision according to the norms and policies of the organization. It is the first tool in the
hands of credit appraisal officer. In short credit appraisal system is a vital and important
task to be done at loan and sanctioning time.

INTRODUCTION TO BANKING
As there is a origin for everything for instance an ancient mused about early of
life philosophy was born. The first roman decided to build a road instead cutting a path
through the jungle. Engineering came in to existence one day is primitive times, A human
being lend to another then passed for money and his original investment plus a little more
banking has started. Banks has business organization selling bank services bank
continuously asses and reassess how a customer view a bank services. What are new and
emerging for customer aspiration and these can be satisfied.
Which nationalization of major bank is 1969, in such serving the socio economic
objective has assume as much importance for the bank as these role of traditional
commercial banker the role and responsibility assume by the banks today are distinctly
different from those of other industries.
Owning to social commitment banks execute service to a large number of
customers without looking in to commercial viability, involvement of banks in social
fulfillment, poverty alleviation programms, and rural development. Priority sector
lending, extending banking to un banked areas and providing a plethora of services to all

segments of the population etc. has thus largely been successful in meeting the objective
of nationalization and natural.
Banks are back bone of society. A bank must meet the financial needs of a
customer by acting as a custodian of his asset. Providing credit facilities and assisting
him to speedily through out financial transaction of one type or another. Banking, when
you come to think of it, is about people it is not figure, files and ledger.
Bank services need considerable improvement on an emergent basis. And the time
has come for bank to look inward to find out what is the nature and quality of the product
they sell, what is the product is been demanded by the customer.
Banks have a social purpose. Banks have been interested with a worthy
cause.Banks belongs to the nation only through people, banks future prosperity and the
extent for its participation in the countrys economic advancement rest ultimate in
customer hands.
A banker is a dealer in money and credit. The business of banking consist of
borrowing and lending. Banks acts as an financial intermediary between saver (lender)
and investor (borrower) by accepting deposits of money from a large number of
customers and key factor will always remain customer. It would be unrealistic today to
believe that banks are mere financial institutions. Working for profit, banks essentially are
now social organization, rendering financial services to sub serving the social economic
objective of the society.
Services to the society means servile to customers present and future from the
point of view, the prime functions of banks of view, the prime functions of banks can be
defined as the creation and delivery of customers needed services in satisfying manner.
Therefore a bankers bank is to identify this customer and these needs.
Lending a major portion of a accumulated pool of money to those who wish to
barrow.
The Indian companies act defines the term banking as accepting for the sake of
lending or investment of deposits of money from the public, repayable on demand or
otherwise withdraw and able by cheque draft or otherwise.

FUNCTIONS OF BANKING
The main functions under section 5 and 6 of the act are:

Borrowing of money in the form of deposits

Lending or advancing of money in the form of different types of loans.

The drawing, making, accepting, discounting, buying and selling, collecting and
dealing in bills of exchange promissory notes coupons drafts bill of lading
railway receipts warrents debentures certificates securities both negotiable and
non negotiable.

The granting and issuing of credit travelers cheque etc.

The acquiring holding issuing on commission underwriting. Dealing in stock

funds shares debentures bonds securities of all kinds.

The purchasing and selling of bond scrips and other forms of securities on behalf
or others negotiations of loans and advances. The receiving of all kinds of bonds
or valuables on deposit or for safe custody or otherwise.

Providing safe deposits of valuable.

Collecting transmitting of money and securities.

Buying and selling of foreign exchange including foreign notes.

IMPORTANCE OF BANKING
The economic importance of banking is as follows

Banks mobilized the small scattered and idle savings of the people make them
available for productive purposes.

By accepting the savings of the people banks provide safety and security to
surplus money for depositors

By offering attractive interest on savings of the people with the banks, banks
promote the habit of thrift and saving among the people.

Banks influence the rate of interest in the money market; through the supply of
money banks exert a powerful influence on the interest rate.

Banks provide a convenient and economical means of payment, the cheque, debit
card and credit card system introduced by bank is of great help for making
payments.

Banks provide a convenient and economical means of transfer of funds from one

place to another, banks drafts and demand draft are commonly used for remittance
of funds; mail transfer and telegraphic transfer are also used for transfer of funds.

HISTORY OF MODERN BANKING IN INDIA

Pre-nationalization period: the history of modern banking in India dates back
to the last quarter of 18th century. During this period the English agency house of Bombay
and Calcutta started banking business in India. The set up the bank of Hindustan around
1770 followed by set up of quasi government banking institution like presidency bank of
Bombay is 1840. In 1921 and early 20th century, the Swadeshi movement inspired starts
banks to India. The India banks were established during this period in 1935 the reserve
bank of India was established as central bank for regulating and controlling the banking
business in the country. Soon after independence the reserve bank was nationalized in
September 1948.
Post nationalization period: On account of top sided growth of the banking system
and to bridge the gap between a few industrial houses and banks the scheme of social
control was imposed on banks with effect from Feb.1.1969 it resulted setting up of
national credit council for more equitable distributors of banks more broad based. As a
result the government resorted to more radical measures by nationalizing 14 major banks
on July 1969, later on April 1980, six more banks were nationalized to achieve the
objectives.
Present scenario of banking industry: The Indian banking can be broadly categorized into
nationalized (government oriented) private banks and specialized banking institution.
The RBI acts as a centralized body monitoring any discrepancies and short
coming is the system. Since the nationalization of the banks in 1969 the public sector
bank have acquired a place of prominence and has then seen tremendous progress.
The need to become highly customer focused the slow moving public sector banks
to adopt a fast track approach.

NEW GENERATION BANKING:

The liberalized policy of government of India permitted entry of private sector in
banking; the industry has witnessed the entry of new generation private banks. The major
parameter that distinguishes these banks from all the other banks in Indian banking is
level of services that is offered to the customer, verifying the focus has always being
centered the customer understanding his needs and delighting him with various

configurations of benefits and a wide portfolio of production and services. The population
of these banks can be gauged by the fact that is a short span of time these banks gained
considerable customer confidence.

Review of literature & research design

Introduction about the internship
The project report entitled A study on feasibility of project appraisal
mechanism of KSFC has been undertaken at Karnataka State Financial Corporation for a
duration which starts from 8-12-2014 to 14-02-2015 to find out whether the project
appraisal procedure of the KSFC is feasible enough to appraise a project and to find out
the drawbacks of the appraisal procedure.
KSFC was established by Government of Karnataka in March 1959 under the
SFCs Act 1951 for extending the financial assistance for setting up of tiny, micro small
and medium industrial units in the state.

Significance of conducting study:

Capital is a scarce resource, hence it should be optimally utilized and there of
rational allocation of this resource is very important. The available capital should be used
to achieve overall social economic objectives. Credit is the life line of business. Small
businesses fail to get access to capital and money markets. Hence, it is necessary for any
financial institute to know the feasibility of the project before lending the money. The
main objective of establishing KSFC was to provide term loan assistance to tiny, small
and medium scale enterprise mainly for purpose of acquisition of fixed assets, working
capital etc., hence, and project should be appraised using different appraisal techniques to
know the projects worth before providing financial assistance.

Introduction
Industrial projects are appraised by different institutions for a variety of reasons.
State financial institutions and other financial institutions appraise projects whether it is
worth to make to investments in them and extend long term loans. Government allied
agencies appraise projects with a view to find out whether they should be given any tax

exemptions, subsidies, guaranties or other incentive. The purpose of appraisal thus varies
from one appraising agency to another, while the objects of appraisal may differ; the
general principles of appraisal are almost always the same. Basically, project is
technically feasible and financial viable. Equally important are the marketability of the
products produced and the competence of the promoters to implement the project and
successfully sell the goods produced. This combined co-ordinate examination of a project
is familiarly known as project appraisal.
Since SFC are set up mainly to provide financial assistance on a long term basis,
their approach have to be necessarily different from those of commercial banks who
provide short
term working capital facilities. People who lend money should be prepared to lose some
of it
may be a cliche, but it is a pointer to the essentially risky nature of transaction. The
purpose of appraisal, however is not to set down a categorical statement of long range
prospects of an industrial unit but only broad guidance of the financial institutions in
forming its own judgment, regarding the future prospects of the project envisaged by the
borrowing unit and the work out the term of loan to safeguard the interest of the
institution to the maximum extent .
The factors are taken in to consideration in the security of individual
applications, the weight age given to individual factors varies from case to case bais,
important among those are type of organizational activity of the borrowing unit its size,
nature of the product, the market potential, managerial competence, resourcefulness of
promoters the financial soundness of the project, the quantum of the loan its profitability
etc.
While extending term loans it is not only sufficient to concentrate only on
commercial profitability of a project as determined by the level of profits, but also
equally necessary to determine the economic significance or importance of the project to
the development of the economy.
Therefore banks and financial institutions play an important role in the
development of country. They provide not only financial assistance to viable projects but
also assist the entrepreneurs during all phases of project viz identification, selection,
appraisal implementation and follow up. All the phases are inter-related and the
experience gained during appraisal of various projects and their constant supervision
helps the financial institutions and banks in guiding the entrepreneurs while identification
and selection of new projects.

Title of the study:

A Study on Feasibility of Project Appraisal mechanism of KSFC

Need for the study:

Investment decision forms part of development process. Amongst various
methods of making investment decisions, project appraisal occupies the most leading
position. It helps rationalize the guidelines for investment criteria at the project level.
Production is a function of specific use of inputs to derive outputs. How to decide about
the specific use of inputs which have alternative uses is an investments dilemma. In a
free market economy, prices of inputs determine their most efficient allocation. But the
market forces may not lead to achieve desirable social economic objectives such as
equitable distribution of income. In case of public sector investment, serious attention
should be given to its economic and social effects. In the case of private sector
investment, project usually centers on around financial worth ignoring the social and
economic aspect. But any investment decision, be in the public sector or private sector,
the project appraisal and its techniques play a very significant role

Statement of the problem:

Project financing is very critical in light of the fact that even potentially non
viable projects may lead to mounting industrial sickness, wastage of scarce resources and
loss for the KSFC. Credit appraisal is about determining the financial viability of a
project. Study would focus on terms and techniques of appraisal procedures.

Scope of the study:

The scope of studying the credit appraisal covers the system and operations
at KSFC. The study aims to cover how the credit are appraised by KSFC for new
business venture as well as existing enterprises and the way they assess the viability of
the project by studying the project.

Objectives of the study:

To study the various aspects of project appraisal

To study whether the project appraisal procedure of KSFC is sufficient enough to
appraise a project
To study the relationship between the changes in the project appraisal procedure

and NPA
A Study on Feasibility of Project Appraisal Mechanism of KSFC
To study various loans schemes and procedure of availing loans
To offer suggestions and recommendations.

Methodology
The proposed methodology is a descriptive research study to portray
accurately the characteristics of a particular situation involving fact-finding enquiries, in
to the state of affairs, as it exists at present. The report documents what are the current
methods & practices. Hence one time research confined to current methods & practices.
Data has been collected from following source
Primary data : From case studies, project reports and the primary information
provided by KSFC personnel
Secondary data: is collected from published materials such as published
annual reports, various broachers, circulars, periodicals, annexure and financial
publications, websites of KSFC, books on appraisal.

Analysis
Tools and Techniques used for data analysis
Project appraisal techniques such as,
1) Ratio analysis
2) Profitability and cash flow analysis
4) Internal rate of return
5) Break even analysis
The analysis of appraisal techniques would be based on actual project reports
provided
by KSFC

Literature review
According to Sunil Mishra A study in to the insight objectives of the SFCs 2013
the small and medium scale sector in India lacks capital market and starving for funds. So

the SFCs were started to provide funds to small and medium scale and encourage first
generation entrepreneurs to start business especially in backward areas
KSFC is sanctioning loans to industrial units under different schemes. KSFC is
also providing services like hire purchase, leasing and merchant banking activities etc.
KSFC is recognized as best merchant banker. KSFC is an ISO certified organization and
striving to provide better services to its customers through professional management and
teamwork. The management is taking effective measures to transform the organization to
a customer centric institution.
According to William Samuel Project appraisal procedure of KSFC-2012 the
project appraisal is efficient only when there is a proper tools and techniques are used
otherwise it will be of no use and it will be impossible to find out viability of the project
accurately.
Since capital is scarce resource it should be allocated carefully for the
development of industrial units. KSFC has been acting as regional development bank by
providing assistance to needy entrepreneurs. Before giving loans to any projects the
corporation checks the viability of the project. KSFC appraises projects to test the
viability from the technical financial marketing and managerial angles.
Thus the basic objective of this study is to assess the appraisal system of KSFC
and to know how the projects are being evaluated at KSFC before they finance them and
to make necessary recommendations for modifying the appraisal mechanism, so as to
meet their mission statement.

Limitations of the study

The collection of data for analysis is restricted to KSFC only

The comparative study is not done due to the project constraints.
One of the limitations was the time factor. The available time is utilized to
maximum extent to bring quality and accuracy in this report
There is a possibility of biased information from respondents
Findings cannot be generalized with other reports.

Profile of the industry

Industry profile Introduction:
The growth and development of an economy is one of the main objectives
of every country. These calls for a structure of industries, agriculture and banking system
and only through this , a country can gain economic status internationally to establish
strong economic system. Development banks play an important role in the economic
development of a developing nation. These banks are comparatively of recent origin,

though they did exist prior to world war II. The growth of development banking is now a
world-wide phenomenon.

Origin of development bank

The first development bank as started in 1822 in Belgium to finance commercial and
industrial ventures. Later France, Germany, Australia, Netherlands, Switzerland etc, all
saw the emergence of similar institutions in their countries, At the end of the 19th
century, these institutions were set up under both private and government ownership, to
cater to the needs of economies in different countries. By the end of 1945, world bank or
international bank for reconstruction and development as officially known came in to
being with such affiliates as international finance corporation (1956) and international
development association (1960). Subsequent to World Bank, several regional
multinational banks were established in order to compensate scarcity of capital in
member countries in their economic development programs.

Development banking in India

Development bank is defined as a promotional agency which promises,
encourages and stimulates entrepreneurs or process to usher fastest entrepreneurial and
developmental process along the dormant entrepreneurs Development banks are those
banks engaged in promotion and development of industries, agriculture and other key
sectors. These banks differ from commercial banks in one sense: they do not mobilize
savings of the people, but invest the resources in a productive manner. Additionally, these
banks provide other developmental services so as to accelerate the growth of the
economy.
In the wake of exigencies emerging out of the First World War industrial
commission (1916- 1918) was set up to study the problem of industrial sector. The
commission found scarcity of finance as a big hurdle in the way of industrial
development and recommended setting up a development bank, similar to industrial bank
of Japan (1902). Through elective intervention by the government in economic affairs.
The montage Chelmsford report on constitutional reforms resulted in certain provisional
governments passing state aid to industries legislations in 1922. The industrial finance
corporation of India was then established on 1st July 1948. Since then, good number of
development financial institutions were set up to cater to the needs of industries,
agriculture and service sector. All these institutions were aimed at accelerating the growth
of economic development of the country, as at the end of June 1995 as many as 480
development financial institutions were in operation in India.

Components of Indian financial institutions

Banking Institutions
Non banking Institutions
Commercial banks
Organized sector Development finances
Financial entities
Public
Private
RRBs
Money lenders
Indigenous bankers

State financial corporations (SFCs) An introduction

At the time the industrial finance corporation was set up, it was recognized
that it was essential to establish similar institutions with a view to assist small industries
in different states because it was not possible for a single institution to satisfy the capital
needs of the small concerns spread all over the country.
Accordingly, the SFCs Act was enacted in 1951by government of India, which
gives authorization to each state to establish a SFC. The Punjab government took the lead
in organizing a financial corporation in 1953 when Punjab financial corporation was set
up.
Gradually financial corporations were established in different states. There is 18
SFCs functioning in the country as of now. These institutions extend financial assistance
to small-scale industries. The area of operation is confined to one state.

Objectives of SFCs
The principal objective of the SFCs is to provide medium and long term
financial assistance to small and medium enterprises, particularly when there is lack of
normal banking facilities. SFCs collectively sub serve broad national objectives of
economic growth with accent on promotion of small enterprise, balanced regional growth
and widening of the entrepreneurial base through encouragement of new entrepreneurs.

Functions of SFCs
The functions of SFCs are as follows:
Granting loans or advances or subscribing to the debentures of industrial

concerns, (loans to be repayable within 20 years)

Guaranteeing the loans raised by industrial concerns on such conditions as may be
mutually agreed upon, but they should be repayable within 20 years.
Guaranteeing deferred payments of any industrial concern, which purchases
capital goods within India.
Underwriting the issue of stocks. Debenture or bonds of industrial concerns
subject to their being disposed off in the market within 7 years.
Providing for discounting of bills of exchange. Beside the SFCs can act as agents
of the central government, state government and other national level development
financial institutions.

Company profile
Background and inception of the company
Financing to the industries is an important aspect which has been
considered by the central government from very early days. To enable this various
industrial policy resolutions were passed which had a number of provisions under which
the government could give financial assistance to small. Medium and large scale
industries to aid the industries an Act was passed, this Act provides provision to state
government to give industrial credit. One season that gave birth to this SFC Act 1951,
was prior to this Act the government or states were directly giving loans to start new
industries or for expansion. This method was not effective and an alternative distinct
which could dispense credit to industries, expeditiously imperative. Karnataka state was
prior to start the State Financial Corporation KSFC (which was known as Mysore state
financial corporation MSFC) prior to 1972 was established; on 5th march 1959 on the last
but one day or financial year 1959-1960 though RBI gave an indication in the year 195556 to start financial corporation in Karnataka and SFC Act was also passed long back in
1951.

Mission, Vision, and Quality policy

Mission statement
KSFC is committed to continually nurture develop and service the SME sector through
need based product and service.

Vision statement

Vision of KSFC is to be a premier financial institution in the country by providing

effective and efficient service to all sectors of people under one roof. Its vision is all for
one and one for all.

Goals
Overall development of small scale and medium scale industries.

Quality policy
Customer satisfaction and Continual Improvement through professional
management and team work.
QUALITY OBJECTIVES
To effectively identify and assist the entrepreneurs in establishing successful
business enterprises.
To provide quality financial and related services on a continuous basis.
To continually upgrade our products and services.
To motivate and involve employees to achieve the set organizational growth
targets.
To encourage the employees to upgrade and enhance the knowledge and skills
through effective Training and Development.
To transform the organization to a customer centric Institution.

Ownership pattern
Objectives of KSFC
Some of the important objectives of KSFC are: To render financial assistance mainly to meet the long term financial needs of
small and medium enterprises (SMEs) in Karnataka.
Contribution to growth of small scale industries, backward area development and
promoting the first generation entrepreneurs.
To provide for wide ranging scope of assistance and operational flexibility.
Setting standard of performance to achieve transparent governance.
To introduce office automation.
To delivery its business in equipment leasing, working capital assistance to select
units and to support research and development activities.
To identify new projects where they can investment and assist the local people to
set up industrial units in backward areas by providing the technical inputs
required.

To provide special concessions to entrepreneurs belonging in scheduled castes and

tribes, women entrepreneurs and physically challenged.
To provide preference to local, tiny, ancillary industries.
To meet the urgent working capital needs of existing units by way of corporate
loan.
To meet financial requirements for creation of fixed assets.

Product and service profile

Credit linked capital subsidy scheme (CLCSS)
The objective of the scheme is to facilitate technology up gradation of
micro and small enterprises (MSEs) in specified products/ sub sectors by
approved under the scheme.

Technology up gradation for textile industries

To provide encouragement to textile industrial units (including units in the
cotton ginning and pressing sectors) in taking up technology up gradation and to
merchandise their production facilities.

Interest subsidy scheme for scheduled caste / tribe entrepreneurs

Interest subsidy in respect of loans availed by SC / ST entrepreneurs.

Privileged entrepreneurs scheme

To meet short term funds requirements of the existing units which
are under thrust / normal sofa sectors of lending policy of the corporation.

Assistance to construction activity (term loans)

To provide assistance to the construction activity sector. The

following are covered under the scheme:
Construction of commercial complex
Construction / buying of ready built show rooms and sales outlets
Constructions of residential apartments / group housing
Creation of infrastructure for professional educational institutions
Construction of industrial estates
Establishment of software packs
Formation of residential layouts

Assistance to construction activity (corporate loan)

To provide financial assistance to property developers, construction
companies and firms for construction of group housing, commercial complexes,
software parks and infrastructure projects like roads, flyovers, bridges etc.

corporate loan scheme

The objective of the scheme is to extend short term loans to the
existing successful units who require urgent working capital funds either to meet
the gap in the working capital requirements or funds required for executing the
rush of the orders. This loan is also considered for developing / expanding new
markets and opening LC for purchase of new equipment till a term loan is
sanctioned and released by financial institutions. The corporation also extends
corporate loan for meeting the statutory dues to the corporation also extends
corporate loan for meeting the statutory dues to the government like payment of
income tax, excise duty etc,

Assistance for construction of roads

For acquiring capital goods, equipment including road rollers,
asphalting units, concrete mixtures, tippers, excavators, surveying and other
supporting equipment towards development, maintenance and construction of
roads.

Single window scheme

The objective of the scheme is to provide timely and adequate working
capital assistance to micro, small and medium enterprises (MSME) along with
term loan for fixed assets for entrepreneurs setting up new projects by KSFC.

Working capital term loan for existing units

The objective of the scheme is to provide timely and adequate
working capital assistance to the existing micro, small and medium enterprises
(MSME) who have availed term loans earlier from corporation, having proven
track record.

Line of credit for purchase of raw materials

To provide timely and adequate working capital assistance in the form of

WCTL to MSMEs for purchase of raw materials from KSSIDC.

Assistance for marketing related activities

To provide financial assistance to small and medium scale units to
undertake various activities necessary

Acquisition of existing assets and enterprises

To extend financial assistance for taking over of existing assets /
enterprises.

Assistance to entertainment industry

The objective of the scheme is to provide financial assistance for the
construction / purchase of cinema halls, multiplexes, production of short TV
serials, software for visual media publicity and feature films.

Assistance to tourism related activities

To provide financial assistance for setting up of amusement parks,
convention centers, restaurants, travel and transport and tourist services agencies.

Assistance to health care services:

Assistance to doctors / qualified medical practitioners:

For purchase of the premises / renovation of the existing premises, acquiring fixed
assets like furniture, computers, office automation, ambulance, car / van, interiors
and Medicare related equipment required for a clinic.
Assistance to nursing home / hospitals:
For establishment of new and expansion / modernization of existing nursing
homes and hospitals. Loan available for land, building and equipment for
diagnostic, monitoring the therapeutic use, air conditioners, ambulance, etc.
Assistance for acquiring electro medical equipment:
A Study on Feasibility of Project Appraisal Mechanism of KSFC
Department of MBA, PESIT Page 18
For procurement of new electro medical and related equipment with accessories
like
CT scanners, endoscopy, gastro copy, X-ray etc.., loan is also available for
establishing diagnosis laboratories.

Areas of operations
KSFCs area of operation covers the entire state of Karnataka. KSFC has branch
offices in each district headquarters that is total 32 branches categorized as super A grade,
A grade and B grade branches monitored by four circles offices. It extends loans to
industrial undertakings established or to be established in the state of Karnataka. Each
branch office in the district has adequate power relating to sanctions and disbursements.
Term loan up to Rs. 20 crs are sanctioned at branch offices with the approval of
competent authorities as per the delegation made by the board of KSFC are sanctioned at
head office. Industrial undertaking which are having registered office outside the state of
Karnataka can also avail financial assistance provided the place of business is in
Karnataka and they agree to shift their registered office to the state to Karnataka.
Branch Offices

Super A Grade Branch Offices

1. Bangalore, M G Road
2. Bangalore, Jayanagar
3. Dharwad

A Grade Branches
1. Ballari
2. Bangalore, Rajajinagar
3. Bangalore Rural
4. Belagavi
5. Hassan
6. Kalaburagi
7. Kolar
8. Mandya
9. Mangalore
10. Mysuru
11. Ramanagar
12. Tumkur
13. Udupi

B Grade Branches
1. Bagalkot
2. Bidar
3. Chamarajnagar

4. Chickballapur
5. Chitradurga
6. Chikkamagalore
7. Davangere
8. Gadag
9. Haveri
10. Karwar
11. Koppal
12. Raichur
13. Madikeri
14. Shivamogga
15. Vijayapura
16. Yadgir

Infrastructural facilities
Infrastructural facilities mean the basic requirements the company should look after in
order to ensure free flow of activities. The company contains good infrastructure with all
basic facilities as well as the welfare of employees.
It is being equipped with all kinds of modern facilities that are required.
The KSFC office is being redesigned according to the modern requirement with
cabinets, office furniture, systems, fans, air conditions and stationeries etc.
It maintains a very good communication system internal and external as it is
facilitated or equipped with telephones, computers and the internet services.
KSFC also has a very good canteen service for its employees where they are
served with good and nutritious food.
KSFC has also got a very good library facility for its employees.

Competitors information
KSFC has been playing a pivotal role in the development of small and medium scale
enterprise (SMEs) in the state of Karnataka

Following are the main competitors of KSFC

Public sector banks and financial institutions

1. State bank of India and its 7 associates banks
2. Canara bank
3. Syndicate bank
4. Vijaya bank
5. Corporation bank
6. IDBI bank
7. SIDBI

Private sector banks and financial institutions:

1. ICICI bank
2. Axis bank
3. ING-Vysya bank
4. City financial bank
5. Federal bank

Future growth and prospects

KSFC is one of the fast track term lending financial institutions in the country,
which has assisted more than 1,63,645 units amounting to nearly Rs.10,465 cr over the
last 55 years in the state of Karnataka. It is one of the robust and professionally managed
financial corporations.
KSFC has got branches all over the Karnataka and due to this it is in opposition
to provide service to all micro, small, medium scale, industries and other service like
hotel, hospitals etc. Karnataka has become one of the fastest industrial growing states and
KSFC played a crucial role in providing finance to industries
KSFC is supported by government of Karnataka along with SIDBI, KSFC
entered in to tri party agreement with government SIDBI, KSFC has planned to reduce
interest rate in future to meet the competition and to attract firms to avail their financial
assistance. The corporation has many priorities for the coming years. The foremost is to
be more competitive by offering attractive interest rates, tackling NPAs by setting up
appropriate mechanism avoiding slippage of assets thereby improving the corporation is
of great importance.
The SME sector is showing great potential in the global market and with the
advantage of competitive interests rates, the corporation is expected to garner sizeable
business in the coming years.
The corporation is proposing to improve its income from fee-based activities

apart from increasing business from insurance activity with its tie-up with united India
insurance company. It is has entered into a MOU with Unit trust of India for marketing of
their products. Concerned efforts will be made to achieve the targets and to improve the
working results of the corporation.

MEANING OF FINANCIAL ANALYSIS

Financial Statements Analysis is an analysis which critically examines the
relationship between various elements of the Financial Statements. It focuses on the
evaluation of past operations as revealed by the analysis of basic statements. It is a
process of scanning Financial Statements for evaluating the relationship between the
items as disclosed in these. It is an important means of assessing past performance and
forecasting and planning future performance. The analysis simplifies, summarizes and
systematizes the monotonous figures.

MEANING OF RATIO ANALYSIS

Analysis of Financial Statements with the help of Ratio is termed as Ratio
Analysis. Ratio Analysis is a widely used tool of Financial Analysis. It can be used to
compare the risk and return relationships of firms of different sizes. It is defined as the
systematic use of ratio to interpret the Financial Statements so that the strengths and
weaknesses of a firm as well as its historical performance and current financial condition
can be determined.

OBJECTIVES OF RATIO ANALYSIS

Following are the important objectives of Ratio Analysis

To provide the necessary basis for Inter-period and Inter-firm Comparison.

To help in providing a part of information needed in the process of decision-making.

To focus on facts on a comparative basis and facilitate drawing of conclusions

relating to the performance of a firm.

To evaluate the performance of a firm in determining the important aspects of a

business such as liquidity, solvency, operational efficiency, overall profitability
capital gearing, etc.

To throw light on the degree of efficiency in the management and the effectiveness
in the utilization of its assets.

To provide the way for effective control of the enterprise in the matter of achieving
the physical and monetary targets.

To help management in discharging its basic functions like forecasting, planning, coordination, communication, control, etc.

To promote co-ordination among the departments and the staff by the study of
performance and efficiency of each department.

To point out the financial condition of business whether it is strong, questionable, or

poor and enables the management to take necessary steps.

To act as an index of the efficiency of an enterprise.

CLASSIFICATION OF RATIOS
Accounting Ratios may be classified as under
Traditional Ratios
Functional Ratios

Traditional Ratios
Traditional Accounting Ratios are classified on the basis of the origin of the
figures used in the accounting ratios, i.e. on the basis of the Financial Statements from
which ratios are derived. The following ratios are usually included in this type of
classification.

Balance Sheet Ratios or Financial Ratios

Ratios calculated from the different items as appearing in the Balance Sheet of a
concern are called Balance Sheet Ratios, e.g. Current Ratio, Liquid Ratio, Debt-equity
Ratio, and so on.

Profit & Loss Account Ratios or Operating Ratios

Ratios calculated from the different items as appearing in the Profit & Loss Account
of a concern are called Profit & Loss Account Ratios or operating Ratio, e.g. Gross Profit
Ratio, Net Profit Ratio, Operating Ratio.

Mixed Ratios or Composite Ratios

Ratios calculated, taking some items as appearing in the Balance Sheet and taking
some items as appearing in Profit & Loss Account, are called Mixed Ratios or Composite
Ratios, e.g. Return on Net Worth, Return on Investment (ROI), Capital Turnover Ratio,
etc.

FUNCTIONAL RATIOS
The other way of classifying the ratios in on the basis of functions they perform,
what they indicate, symptoms or characteristics, namely, liquidity, profitability, financial
stability and turnover relationship, etc. This classification assumes greater significance
because it distinctly the different aspects of business performance and helps the various
users of Financial Statements to take guard of their interest. For instance, short-term
creditors are interested to evaluate the liquidity position by analyzing the liquidity ratios,
while long-term creditors and investors are interested in the solvency and profitability
position of the organization and as such they study the solvency and profitability ratios.
The following ratios are included in this classification.

Liquidity Ratios

Leverage Ratios

Profitability Ratios

Activity/Efficiency Ratios

Liquidity Ratios
Liquidity Ratios are those ratios which are computed to evaluate the capacity of the
company to pay off its short-term liabilities. These ratios indicate the short-term financial
position of the company by relating short-term resources with short-term obligations.
These ratios are basically used by the short-term creditors, viz. suppliers, bankers,
lenders, employees and all others who are interested in the recovery of money due to

them. Short-term creditors focus their attention on the liquidity of the company.
The most common ratios which indicate the extent of liquidity or lack of it are as follows:

Current Ratio
This ratio is also called Working Capital Ratio. It is used to assess the short-term
financial position of the business concern. In other words, it is a measure of the
companys short-term solvency, i.e. its ability to meet its short-term obligations. It
matches the total current assets of the company against its current liabilities.
As a measure of short-term solvency, it indicates each rupees of current assets
available for each rupee of current liability. Apparently, the higher the current ratio, the
more protected are the short-term creditors and vice -versa. Conventionally, a current
ratio of 2:1 (current assets twice of current liabilities) is satisfactory. The Formula for
computation of current ratio is given below:

Current Assets
Where,
Current Assets

= Cash in Hand + Cash at Bank + Short-term Investments + Bills

Receivable + Debtors + Short-term Loans & Advances +
Inventory + Prepaid Expenses.

Current Liabilities = Creditors + Bills Payable + Bank Overdraft + Provision for

Taxation
+ Proposed Dividend + Unclaimed Dividend +
Payment Received in Advance + Outstanding Expenses + Other
Liabilities Payable within One Year.
Super Quick Ratio:
This ratio is also called, Cash Position Ratio or Cash Ratio or Absolute
Liquidity Ratio. This ratio establishes the relationship between super quick assets and
current liabilities. It may be used by banks and financial institutions who are very much
interested in lending short-term loans to companies for a period of not more than three
months. Generally, an absolute liquid ratio of 0.5:1 is considered as an ideal ratio. This
ratio is computed with the help of the following formula.

Super-Quick Ratio
Where,
Super Quick Assets = Cash in Hand + Cash at Bank + Marketable Securities

Leverage/Solvency/Capital Structure Ratios

The second category of financial ratios is Leverage or Capital Structure Ratios. The
long-term lenders/creditors would judge the soundness of a firm on the basis of the longterm financial strength measured in terms of its ability to assure the long-term lenders
with regard to a) periodic payment of interest during the period of the loan and
b) repayment of principal on maturity or in predetermined installments at due dates.
There are, thus, two aspects of the long-term solvency of a firm:
a) Ability to repay the principal when due and
b) Regular payment of the interest. Accordingly, there are two different, but mutually
dependent and interrelated, types of leverage ratios. First, ratios are based on the
relationship between borrowed funds and owners capital. These ratios are computed
from the Balance Sheet and reflect the relative / stake of owners and creditors in
financing the assets of the firm. In other words, such ratios reflect the safety margin to the
long-term creditors. The second category of such ratios is based on the Income Statement
and shows the number of times the fixed obligations are covered by earnings before
interest and taxes. In other words, they indicate the extent to which a fall in operating
profits is tolerable in that the ability to repay would not be adversely affected.
Following are some important leverage ratios

Debt to Equity Ratio

The relationship between borrowed funds and owners capital is a popular measure
of the long-term financial solvency of a firm. This relationship is shown by the DebtEquity Ratio. This ratio indicates the relative proportions of debt and equity in financing
the assets of a firm. It reveals the extent to which debt financing has been used in the
business. It discloses to the creditors the extent of their in interest being covered by the
net worth by the company. It can be computed by using the following formula.

Debt-Equity Ratio
Where,
Total Debt Debentures + Term Loans + Loans on Mortgage + Loans from Financial
= Institutions + Other Long-Term Loans + Redeemable Preference Share
Capital + All Current Liabilities.

Shareholders Funds

Equity Share Capital + Irredeemable Preference Share Capital +

= Capital Reserves + Retained Earnings + Any Earmarked Surplus
Like Provision for Contingencies etc. Fictitious Assets
(Goodwill, Preliminary Expenses).

Debt to Total Tangible Assets Ratio

The Debt-Total Tangible Assets Ratio indicates the proportion of total tangible
assets financed by total debt. Symbolically, it is equal to:

Debt-Total Assets Ratio

Where,
Total Tangible Assets = Total Assets (Goodwill + Preliminary Expenses +
Accumulated Losses)

Proprietary Ratio
This ratio is called Equity Ratio or Owners Fund Ratio or Shareholders
Equity Ratio. This ratio points out the relationship between the shareholders funds and
total tangible assets. In other words, it indicates the proportion of total assets financed by
owners. The formula for this ratio may be written as follows:
Fixed Assets to Proprietors Funds Ratio
This is also known as Fixed Assets to Net Worth Ratio. It establishes the
relationship between fixed assets and shareholders funds. The main object of calculating
this ratio is to ascertain the percentage of owners funds invested in fixed assets. This is
an indicator of the efficiency of the management regarding formulation of financial
planning. It can be calculated as follows:

Fixed Assets to Proprietors funds Ratio

Where,
Fixed Assets = Total Fixed Assets - Depreciation
Capital Gearing Ratio

This ratio is also known as Capital Structure Ratio or Leverage Ratio. It is used to
analyze capital structure of the company. It establishes the relationship between fixed
interest, dividend bearing securities and equity shareholders funds. It is an indicator of
the degree of risk involved in the total capital employed in the business. It can be
calculated as follows:

Capital Gearing Ratio =

Where,
Fixed Interest and Dividend bearing Funds = Preference Share Capital + Debentures +
Long-Term Loans
Equity Shareholders Funds = Equity Share Capital + Reserves and Surplus {Goodwill
+ Preliminary Expenses + Profit and Loss A/c (Dr.)}.
Interest Coverage Ratio
This ratio establishes the relationship between the amount of net profits or
earnings before the deduction of interest, taxes and fixed interest charges. This ratio is
used as a yardstick for the lenders to know whether the business concern is able to pay its
fixed interest charges on long-term loans periodically. Interest Coverage Ratio is
calculated with the help of the following formula:

Interest Coverage Ratio =

Where,
EBIT or PBIT = Earnings or Profits before Interest and Taxes

PROFITABILITY RATIOS
Profit is the difference between revenue and expenditure over a period of time. It
refers to the absolute quantum of profits, whereas profitability refers to the ability to earn
profits. Profitability ratios are the ratios which are computed to evaluate the performance
and efficiency of the business concern. Profitability Ratios are used by the management,
owners, creditors and employees. Equity shareholders employ these ratios because they
are very much interested in knowing capital appreciation of their investment and dividend
per share. Management employs profitability ratios to assess the operational performance

of the business concern. They are used by the creditors to ascertain the margin of safety
available to them. Profitability ratios are the test of wages and fringe benefits to the
employees. Following are the important profitability ratios:

Return on Assets (ROA)

Here, the profitability ratio is measured in terms of the relationship of between
net profits and assets. The ROA may also be called profit to assets ratio. It is calculated
to measure the productivity of total assets. It is calculated using the following formula:

Return on Assets =

The term fictitious assets include preliminary expenses, deferred revenue expenditure,
discount on issue of shares and debentures, debit balance of Profit and Loss Account and
other losses shown on the assets side of the Balance Sheet.
Return on Investment
Return on Investment is also known as Return on Capital Employed or Overall
Profitability Ratio. It is calculated by establishing the relationship between the operating
profit earned and capital employed. It is an indicator of the earning capacity of the capital
invested in the business. It shows efficiency of the business as a whole. This ratio is
calculated by using the following formula:
Return on Investment =
Where,

Capital Employed = Equity Share Capital + Preference Share Capital + Reserves and
Surplus + Debentures and Long-Term Loans (Fictitious Assets +
Intangible Assets + Investments outside the Business).

(Or)

Capital Employed = Proprietors Funds + long-Term Loans.

Return on Ordinary Shareholders Equity

While there is no doubt that the preference shareholders are also owners of a firm, the
real owners are the ordinary shareholders who bear all the risk, participate in
management and are entitled to all the profits remaining after all outside claims including
preference dividends are met in full. The profitability of a firm from the owners point of
view should, therefore, be assessed in fitness of things, in terms of the return to the
ordinary shareholders. The ratio under reference serves this purpose. It relates net profit,
finally available to equity shareholders, to the capital employed by them. It is calculated
as follows:

Return on Ordinary Shareholders Equity

=

Ordinary Shareholders Equity = Equity Share Capital + Reserves and Surplus

(Miscellaneous Expenses + Debit Balance of Profit and
Loss Account).
Earnings Per Share (EPS)

Earnings per Share (EPS) measures the profit available to the equity shareholders on a
per share basis, that is, the amount they can get on every share held. It is calculated by
dividing the profits available to the equity shareholders by number of outstanding shares.
The profits available to the ordinary shareholders are represented by net profits after tax
and preference dividend. Thus,

EPS =

4.4.2.4 Activity/Efficiency Ratios

Activity ratios make use of purchases and sales while calculating various ratios. But,
KSFC is neither a trading company nor a manufacturing company. Hence, the question of
purchases and sales does not arise in the case of KSFC. Therefore, the activity/efficiency
ratios cannot be calculated for KSFC.
jyothi1719@gmail.com