2010

A PROJECT REPORT ON

WORKING CAPITAL FINANCE

ACTIVITY OF

THE JAMMU & KASHMIR BANK LTD.

SUBMITTED BY: SYED MISBAH-UL-HASSAN ANDRABI MBA ( FINANCE) Under Guidance of: Mr. Faiz Akmali Manager Advances J & k Bank

INDEX
CHAPTER 1: INTRODUCTION TO THE BANK PAGE NO. 1.1 INCEPTION .6 1.2 COMPANY PROFILE .7 1.2.1 CORPORATE GOVERNANCE . 8 1.2.2 VISION 10 1.2.3 MISSION ..10 1.2.4 BOARD OF DIRECTORS 10 1.2.5 COMPOSITION 10 1.3 UNIQUE CHARACTERISTICS AND SERVICES ..11 1.3.1 FINANCIAL SERVICES PORTFOLIO: ONE STEP FOR ALL FINANCIAL NEEDS.11 1.3.2 PRODUCTS AND SERVICES .11 1.3.2.1 SUPPORT SERVICES . 11 1.3.2.2 DEPOSITIRY SERVICES 12 1.3.2.3 THIRD PARTY SERVICES . ..12 1.3.2.4 CASH MANAGEMENT SERVICES . 12 1.4 REGISTERED OFFICE AND CORPORATE HEADQUARTERS . .12 CHAPTER 2: CREDIT POLICY 2.1 BACKGROUND 2.2 MAIN OBJECTIVES 2.2.1 CREDIT RISK MANAGEMENT 2.2.2 EFFICIENT CREDIT DELIVERY SYSTEM CHAPTER 3: LOANS AND ADVANCES 3.1 POLICIES, PRIORITIES AND PRINCIPLES 3.2 FUNDS FOR LENDING 3.3 STRATEGY FOR LENDING 3.4 LENDING PRINCIPLES .. . . ..19 ..19 ...20 .22 . .. . ..14 .14 16 16

INDEX
CHAPTER 4: CLASSIFICATION OF ADVANCES 4.1 SECTOR-WISE 4.2 PERIOD-WISE 4.3 SECURITY-WISE CHAPTER 5: CREDIT APPRAISAL 5.1 STUDY OF BORROWER AND PROCESS OF PROPOSAL . ..30 5.2 MANAGEMENT . .30 5.3 NATURE OF INDUSTRIES AND ITS STATUS IN THE ECONOMY AND FUTURE PROPOSAL30 5.4 OPERATIONS . ..31 5.5 FINANCIAL . 31 5.6 CREDIT REQUIREMENT , ...31 5.7 STUDY OF BORROWER , .31 5.7.1 CHARACTER , 32 5.7.2 CAPACITY , .33 5.7.3 CAPITAL , .33 CHAPTER 6: FINANCIAL STATEMENTS; ANALYSIS AND INTERPRETATION 6.1 BALANCE SHEET , 36 6.2 PROFIT AND LOSS ACCCOUNT , 37 6.3 FINANCIAL ANALYSIS AND INTERPRETATION ..38 6.4 CLASSIFICATION PROCESS ..38 6.5 NEED FOR SEPARATE CLASSIFICATION AND ANALYSIS OF BALANCE SHEET 38 6.5.1 CLASSIFICATION AND ANALYSIS OF ASSETS . ..39 6.5.2 CLASSIFICATION AND ANALYSIS OF LIABILITIES .. .47 6.6 CLASSIFICATION AND ANALYSIS OF PROFIT AND LOSS ACCOUNT .. .57 6.6.1 SALES .. .57 6.6.2 COST OF SALES .. 57 6.6.3 GROSS PROFIT .. .58 PAGE NO. .................................................................25 . .27 .. 27

INDEX
6.6.4 OTHER INDIRECT COSTS 6.6.5 OPERATING COSTS 6.6.6 NON-OPERATING INCOMES AND EXPENSES 6.6.7 PROFIT BEFORE TAX 6.6.8 PROFIT AFTER TAX 6.6.9 RETAINED PROFIT CHAPTER7: WORKING CAPITAL FINANCE 7.1 WORKING CAPITAL CONCEPTS . 7.1.1 GROSS WORKING CAPITAL .. 7.1.2 NET WORKING CAPITAL 7.1.3 WORKING CAPITAL GAP 7.1.4 OPERATING CYCLE . 7.2 ASSESSMENT OF WORKING CAPITAL REQUIREMENT . 7.2.1 QUANTUM OF WORKING CAPITAL .. . 7.2.2 VIABILITY OF THE PROJECT . 7.2.3 ACCEPTABLE BUSINESS PLAN .. . 7.2.4 CURRENT ASSET BUILDUP . 7.2.5 CALCULATION OF PERIOD OF HOLDING .. 7.2.6 OTHER CURRENT ASSETS . 7.2.7 SOURCES OF WORKING CAPITAL FUNDS 7.2.7.1 CURRENT LIABILITIES . 7.2.7.2 BANK BORROWINGS 7.2.7.3 SUNDRY CREDITORS .. 7.2.7.4 OTHER CURRENT LIABILITIES .. 7.3 WORKING CAPITAL GAP .. 7.4 NET WORKING CAPITAL 7.5 MARGIN 7.6 PERMISSIBLE BANK FINANCE ..62 .63 63 ..63 64 ..........65 .66 ..66 .67 69 70 ..72 ..74 74 .74 ..74 ..75 75 75 75 77 .. .. PAGE NO. ..58 ..58 59 59 59 .59

INDEX
PAGE NO. 7.7 FIXATION OF LIMITS 78 7.8 RBI GUIDELINES FOR BANK LENDING FOR WORKING CAPITAL PURPOSE ..79 7.9 METHODS OF LENDING (FINANCIAL NORMS) .. .79 7.10 WORKING CAPITAL LIMITS .81 Conclusion Recommendations.. Annexure References 82 ..83 ..84 92

1. INCEPTION OF THE BANK: Entire banking in the state of Jammu and Kashmir was performed by traditional lenders till 1920 -30 and that too at exorbitant interest rates .At the same time some banks functioned at a very limited scale, such as Punjab National Bank Limited, Grindlay s Bank and Imperial Bank of India. The role of these banks was reduced to the acceptance of deposits, as they could not grant loans and advances to the people of the state owing to the statutory limitations. Under this scenario banks could not ameliorate the financial and social position of the people of the state. To overcome this critical situation the then Maharaja of the state conceived an idea of setting up of a state bank in the state. After a prolonged exercise and deliberations the assignment for establishment of The Jammu and Kashmir Bank Limited was given to the late Sir Sorabji N Pochkhanwala, the then Managing Director of the Central Bank of India. Mr. Pochkhawala formulated a scheme on 24-09-1930, suggesting establishment of a semi state Bank with participation in capital by state and the public under the control of state Government. Thus the bank was formally incorporated on the 1st of October 1938 and commenced business from 4th of July 1939 at its Registered Office Residency Road Srinagar, Kashmir. The Jammu & Kashmir Bank Limited has been the first of its nature and composition as a State owned bank in the country .The state Govt. besides contributing half of the issued capital also appointed it as its bankers for general banking and treasury business .In its formative years, the bank had to encounter several serious problems, particularly around the time of independence, when out of its total of ten branches two branches of Muzaffarabad and Mirpur fell to the other side of the line of control(now Pak Administered Kashmir) along with cash and other assets ;in 1947. However the State Govt. came to its rescue with the assistance of Rs.6.00 Lac to meet the claims; however the bank steadfastly overcame its difficulties and kept growing. Following the extension of Central laws to the state of Jammu & Kashmir, the bank was defined as a govt. company as per the provisions of Indian companies act 1956 .The bank had its first full time chairman in 1971, following social Central measures in banks .The year 1971 was a turning point for the bank on conferment of scheduled bank status and witnessed remarkable progress in all the vital fields of operations .The bank was declared 6

as "A" Class Bank by Reserve Bank of India in 1976 .In recognition of dominant role and exalted performance , Reserve bank of India appointed the bank as its agent for performing the general banking business of the Central Govt. especially in maintaining currency chests and collection of taxes. 1.2 COMPANY PROFILE: ORGANISATIONAL BACKGROUND

The Jammu & Kashmir Bank is today one of the fastest growing banks in India with a network of more than 500 branches/offices spread across the country offering world class banking products/services to its customers. Today, the Bank has a status of value driven organization and is always working towards building trust with Shareholders, Employees, Customers, Borrowers, Regulators and other diverse Stakeholders, for which it has adopted a strategy directed to developing a sound foundation of relationship and trust aimed at achieving excellence, which of course, comes from the womb of good Corporate Governance. Good Governance is a source of competitive advantage and a critical input for achieving excellence in all pursuits. J&K Bank considers good Corporate Governance as the sine qua non of a good banking system and has adopted a policy based on all the four pillars of good governance transparency, disclosures, accountability and value, enabling it to practice trusteeship, transparency, fairness and control, leading to stakeholders delight, enhanced shareholder value and ethical corporate citizenship. It also ensures that bank is managed by an independent and highly qualified Board following best globally accepted practices, transparent disclosures and empowerment of shareholders, besides ensuring to meet shareholders aspirations and societal expectations following the principles of management's executive freedom to drive the bank forward without undue restraints but within the framework of effective accountability. The excellence achieved by the bank in its operations stemming from the roots of voluntary good Governance has not gone unrecognized and Bank has recently bagged three very prestigious awards for following fair business practices and commitment to social obligations. Currently more than 90.5% of the banks business is computerized. The J&K Bank is the first bank to launch ATM cum debit card in Kashmir. The bank launched ATM cum Debit card J&K Bank global access card in collaboration with the master card international. The bank has grown the number of ATMs to 182 at the end of March 2006. 7

The bank has launched the three variant types of credit cards with different limits with an interest free credit facility for 20 to 50 days at accept at 125000 mercantile establishments across the globe. The customers have the access to their money for all the 365 days of a year and 24 hours per day. The credit and debit cards of the bank are accept of cash with draws at 7000 ATMs in India and 1 million ATMs across the globe. To maximize value to its customers, the innovation in products and improving the quality and speed of the services in the Hall Mark of banks business strategy. The bank has launched several unique financial and deposit products like education loans, car loans, consumer loans, flexi deposit recurring plus and Mehandi deposits schemes to meet the needs of customers. the bank has recently won the prestigious Asian banking awards 2004 for customer convenience program. The awards is given each to recognize and honor the bank in Asia pacific region for outstanding innovating and world-class products services, projects and programmers. J&K Bank has embarked on brand strategy exercise and engaged removed consultants to work on business development possibility and engaged over all processes that could be improved in the future to enhance the overall profitability of the bank. This would increase branding of the banks products in order to increase the value for its customers. And now with the right kind of leadership efforts of dedicated employees and State of art technology, the J&K Bank is on the path of growth and success building trust profit, peace and property. 1.2.1 CORPORATE GOVERNANCE J&K Bank has been committed to all the basic tenets of good Corporate Governance well before the Securities and Exchange Board of India and the Stock Exchanges pursuant to Clause 49 of the Listing Agreement mandated these. Now, it is endeavor to go beyond the letter of Corporate Governance codes and apply it innovatively in a more meaningful manner, thereby making it relevant to the organization that is operating in a specific environment, which is different from the generic Anglo-Saxon one. In line with the vision, J&K Bank wants to use Corporate Governance innovatively in a transitional economy like Jammu and Kashmir. The Bank wants to use Corporate Governance as an instrument of economic and social transformation. In due course, the bank would set self-targets of social and economic reporting as a part of annual disclosures. This will help to conceptualize and contextualize the form and content of 8

Corporate Governance in a developing state. Given the fact that J&K Bank is and is seen as a great success of public-private partnership , Bank as a business is expected to play a role in social transformation of the economy. This lends urgency to implementation of good governance practices which go beyond the Corporate Governance code. Operating in an environment that is emerging from a situation of civil strife, the issue of Corporate Governance assumes a different and greater relevance. The Bank, as the prime corporation of Jammu and Kashmir, has a vested interest in making the state a safe place for business. J&K Bank has a key role to play in providing public and private services, financial infrastructure and employment. As such, the efficiency and accountability of the corporation is a matter of both private and public interest and governance, therefore, comes at the top of the agenda. The fact that the bank is state owned but professionally managed, having a large size of international investors, governance is critical. For the Bank, Corporate Governance is concerned with the systems of laws, regulations and practices, which will promote enterprise, ensure accountability and trigger performance. The J&K Bank, for one, stands for being more accountable, practice self-policing and make financial transactions transparent and constitutional. The Bank wants to be partners in the economic and social transformation of the nation. In its context there is a need to redefine the role of its directors to make J&K Bank an engine of social transformation. As an eminent corporate jurist (Chancellor William T. Allen) from US says, A corporate director has civic responsibility. The people, who accept this responsibility, do it conscientiously and well deserve our respect as they are serving a nation. But those who as directors are passive and view their role as mere advisers, are pliable and pleasant but do not insist on a real monitor s role, do small service to anyone and deserve little respect . J&K Bank s directors belong to the former category.

1.2.2 VISION To catalyze economic transformation and capitalize on growth . The Bank s vision is to engender and catalyze economic transformation of Jammu and Kashmir and capitalize from the growth induced financial prosperity thus engineered. The Bank aspires to make 9

Jammu and Kashmir the most prosperous state in the country, by helping create a new financial architecture for the J&K economy, at the center of which will be the J&K Bank. 1.2.3 MISSION The J&K Bank s mission is two-fold: To provide the people of J&K international quality financial service and solutions and to be a super specialist bank in the rest of the country. The two together will make it the most profitable Bank in the country. 1.2.4 BOARD OF DIRECTORS The responsibility for good governance rests on the Corporate Board which has the primary duty of ensuring that the principles of Corporate Governance, both as imbibed in law and regulations and those expected by stakeholders, are religiously and voluntarily complied with and the stake holder s interests are kept at utmost high level. 1.2.5 COMPOSITION The Bank s Board of Directors comprises a judicious mix of executive, non-executive and independent Directors as per Corporate Governance requirements. Appreciating the fact that Board Composition is key to Corporate Governance, the Board of Directors of the Bank consists of eminent persons with considerable professional experience and expertise in Banking, Finance, Economics, Industry, Law etc., combining their wide ranging experiences to impart values and provide direction to Bank s development. The Board is professional and an active Board which meets frequently during the year to chart out policies and practices. The present strength of the Board is seven comprising of Chairman, two Executive Directors and four Non Executive Directors. Consequent upon the resignation of Mr. Umar Khurshid Tramboo from the directorship of the Bank w.e.f 3rd June, 2008, steps are being taken to co-opt an independent Director on the Board of the Bank at the ensuing Annual General Meeting scheduled to be held on 19th July, 2008. 1.3 UNIQUE CHARACTERISTICS & SERVICES

y y

J&K Bank carries out banking business of the Central Government In-spite of a government equity holding of 53 per cent, Jammu & Kashmir Bank (J&K Bank) is regarded as a private sector bank. 10

J&K Bank is the one and only banker and lender of last resort to the Government of J&K

y y

Plan and non-plan funds, taxes and non-tax revenues are routed through the J&K Bank J&K Bank claims the distinction of being the only private sector bank that has been designated as agent of RBI for banking

The services of J&K Bank are utilized for the purposes of disbursing the salaries of Government officials

J&K Bank collects taxes pertaining to Central Board of Direct Taxes, in Jammu & Kashmir

1.3.1 Financial Services Portfolio: One stop for all financial needs. y y y y y y Insurance joint venture with MetLife international. Distributor of : Life Insurance products of MetLife (India) Pvt. Ltd. Non-life insurance products of Bajaj Allianz, General Insurance Co. Ltd. Providing depository Services. Offering Stocks Barking Service. Collection Agent for utility Services provided by State and private sector 1.3.2 Products & Services 1.3.2.1 Support Services Anywhere Banking Internet Banking SMS Banking ATM Services Debit Cards Credit Cards Merchant Acquiring

y y y y y y y

11

1.3.2.2 Depository Services Dematerialization Account (Demat A/c) Other Services

y y

1.3.2.3 Third Party Services Mutual Funds Insurance Services - Life & Non Life Remittance Services

y y y

1.3.2.4 Cash Management Services Real Time Gross Settlement (RTGS) National Electronic Fund Transfer (NEFT)

y y

1.4 REGISTERED OFFICE & CORPORATE HEADQUARTERS

The Jammu And Kashmir Bank M A Road, Srinagar 190001 Jammu & Kashmir Phone: (+91- 0194) 2481930 -2481935

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CREDIT POLICY

13

CREDIT POLICY:
As the bulk of funds for lending come from deposits which may be repayable on demand or after fixed maturity periods. Credit policy is devised so as to avoid mismatch on this account. It is necessary to have knowledge of various developments in business and industry and an insight into trends and conditions likely to affect these, before indentifying the fields of business to which lending is mostly directed. The bank is regularly updating its credit policy and the policy approved by the Board is given hereunder. Any changes from time to time shall be conveyed separately to the branches.

2.1 BACKGROUND:
Consequently upon announcement of Reserve Bank of India in 1997-98, the extant prescriptions with regard to the assessment of Working Capital Finance based on the concept of Maximum Permissible Bank Finance (MPBF) were withdrawn and full operational freedom was granted to banks in the matter of the assessment of working capital needs of borrowers. The Banks were advised to evolve appropriate systems for assessing the working capital needs of their borrowers, within the prudential guidelines and exposure norms already prescribed. The Reserve Bank of India also advised banks to lay down transparent policies and guidelines for credit dispensation. Keeping in view the withdrawal of RBI guidelines the CREDIT POLICY of the Bank was prepared and the same was approved by the Board of Directors in its meeting held on September 7, 1998, and detailed guidelines thereof were advised to the operative levels. The credit policy was subsequently revised in the year 2001-02 and circulated.

2.2 MAIN OBJECTIVES:

The main objectives of the LOAN POLICY of the Bank would be to continue to ensure a strong, robust and healthy growth of the loan portfolio while scattering the associated risks through adopting of comprehensive risk management module/policy and improve the yield from the portfolio subsequently and make it the major contributor to the Bank s bottomline. The main thrust of the policy shall remain on achieving the following objectives:

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a) Improvement in the quality of loan assets with emphasis on safety, security and recycling of funds. b) To put in place a comprehensive Credit Risk Management System and have an efficient system for credit delivery. c) To ensure deployment of funds in profitable and upcoming potential areas/sectors with the stress on Asset Liability and funds recycling. d) To ensure compliance of various regulatory norms/instructions/guidelines. e) To improve the Credit Deposit Ratio further through proper planning over the next 3 to 4 years. f) Increase lending to the productive sectors of the economy g) Attract prestigious Corporates through intense marketing. h) According priority to social commitments. i) New product development.

In order to achieve objectives underlined herein above the Bank shall follow two-pronged strategy. In respect of Corporate Sector focus of credit management will be on identification, measurement and mitigation of associated risks through a comprehensive Risk Management System besides through Close-Supervision and follow-up of the corporate advance. Credit dispensation under the Retail Segment will be based on the policies and guidelines laid down in these special credit schemes designed by the Bank. THE CREDIT POLICY SHALL PURSUE THE FOLLOWING MAJOR ISSUES/AREAS FOR ACHIEVING THE ABOVE STATED OBJECTIVES: a) b) c) d) e) Set up a comprehensive Credit Risk Management Module/System. Set up an efficient credit delivery system. Increase flow of credit to Priority Sectors and Export Credit. Set up annual targets for credit deposit ratio and yield on advances. Set up system for post Disbursement Monitoring of loan accounts with emphasis on monitoring of weak accounts/potential NPA s f) Fixes rate of interest loans and sub PLR lending. g) Non-fund bases business.

15

2.2.1 I) CREDIT RISK MANAGEMENT SYSTEM:

In order to asses and evaluate the risk bearing capacity of the bank and to implement the guidelines/instructions of Reserve Bank of India on the Risk Management, the bank in consultation with National Institute of Bank Management (NIBM) Pune has already initiated the process to put in place a comprehensive mechanism/structure for measuring/quantifying and managing/mitigating the risk associated with the Credit Portfolio.

2.2.2 II) EFFICIENT CREDIT DELIVERY SYSTEM: a) Corporate/SSI Finance Branches:

To give focused attention, corporate customers and SSI s would be serviced through specialized Corporate/SSI branches. Two Corporate Finance Branches have already been established in Delhi (Ansal Plaza) and Mumbai (Worli). Besides one more specialized Branch for financing of the SSI has been established in Srinagar taking their number to six. The setting up of these branches shall facilitate faster decision making for delivery of credit.

b) New Business Group:

A New Business Group (NBG) comprising of Chief General Manager, General Manager(Credit & Investment), General Manager (Retail Credit) was constituted at Corporate Headquarters in order to eliminate delays in the process of decision making on new references so as to garner the business of high rated Corporate. Under this system all fresh credit proposals which envisage total exposure (Fund based + Non-Fund based) of Rs. 10 crores and above are to be transferred to the Central Office (Central Advances Department) for placing before the NBG. CAD on receipt of the communication has to place it before the NBG within two days. The NBG would arrive at a consensus about whether the proposal is support worthy or not on the basis of preliminary information.

c) Credit Committees:
In order to streamline the process of credit dispensation, the Bank has constituted two committees called Credit Committees . One committee is headed by Deputy General Manager (Credit) with the following executives as its members 1) DGM (Credit) 2) DGM (Investment) 3) Assistant General Manager (Credit)

16

All proposals received at Corporate Headquarters processed and recommended by CAD for sanction of Credit Limits up to Rs. 10 crores but exceeding the loan powers of DGM (Credit) are examined by this committee and submitted to the Competent authority with their recommendations. Second Committee is headed by Chief General Manager and has the following executives as its members; 1) CGM 2) General Manager (C&I) 3) GM (Retail Credit) The Committee examines the credit proposals duly processed and recommended by CAD for sanction of credit limits exceeding Rs. 10 crores and submits them to the Competent Authority with their recommendations. The above committees meet frequently as required by the exigencies of the business.

17

LOANS AND ADVANCES

18

3.1 LOANS AND ADVANCE:-POLICIES, PRIORITIES AND PRINCIPLES

Lending is considered the principle activity of commercial bank. Advances made by the bank constitute the bulk of its assets and form the backbone of banks structure. A sizeable portion of the income of the Bank is derived through lending activities. The strength of a Bank is primarily judged by the quality of its advances. It is necessary that the bank s lending activities are handled with utmost prudence. Errors made while lending may place the bank in a difficult situation. The judicious dispensation of funds is in fact all the most important to ensure a fair index of success. Advances not only play an important part in earnings of the bank but also promote the economic development. Bank credit plays a pivotal role in industry, agriculture, trade and exports, poverty alleviation, creating new employment avenues and removing regional economic imbalance.

3.2 FUNDS FOR LENDING:

Main source from which funds become available for lending are:a) Owned funds of the bank i.e, it s paid up capital, reserves and surplus b) Deposits of all types (from public and others) c) Call loans and borrowing including refinance and bill rediscounting facilities from the banks and financial institutions Viz. Reserve Bank of India (RBI), Industrial Development Bank of India (IDBI), Small Industries Development Bank of India (SIDBI), National Bank for Agriculture and Rural Development (NABARD), Export Bank of India (EXIM Bank), National Housing Bank (NHB), Discount and Finance House of India Ltd. (DFHI), etc.

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3.3 STRATEGY FOR LENDING:

a) Improving the Pre-sanction Appraisal (Credit Risk Analysis): The banks shall continue to accord special attention to pre-sanction appraisal. While considering a credit proposal the following aspects about the management/activity will be analyzed in detail; y Good track record and market reputation (CHARACTER) y Adequate Net Worth/Credit Worthiness of the Borrower. (CAPITAL) y Market and economic viability of the activity. (CAPACITY) The appraisal skills are being strengthened through conducting of special training programs for loans/credit officers.

b) Adherence to Prudential Exposure Norms in order to reduce Credit Concentration: In order or scatter the risks associated with the credit portfolio and also to have it well diversified, the primary objective would be to progressively reduce the credit concentration in high risk industries/sectors. The Bank shall fix various credit concentration limits, above which our exposure shall not exceed. c) Diversified Credit Portfolio: Keeping in view the bank s existing exposures and level of NPA s, uncertain prospects for future and high risks associated with these sectors, financing of the following sectors will be accorded low priority; y Iron and Steel y Textiles y Engineering y Automobiles y Paper y Solvent Oil Extraction y NBFC s y Real Estate/Construction y Entertainment/Film Production y Advances against Shares and Debentures

d) Focussed attention towards flow of credit to Corporate and Retail Segments:

20

Keeping in view the present economic conditions, the slow/sluggish growth/performance of various sectors of the industry, it is felt expedient to have an increased flow of credit and deployment of funds in retail segments. The sector offers vvery good potential for credit deployment, which is corroborated by the growth registered by this segment over the last few years. However, it still offers immense potential for boosting the Bank s Credit portfolio. The policy to be pursued is to improve/increase the Bank s credit deployment to this sector to the range of 15% to 20% of Bank s total credit by the year 2005.

e) To identify thrust areas for credit deployment and increasing the CD ratio: The following areas of the retail segment shall be the thrust areas for accelerating the Bank s credit growth during 2001-2002 y Financing Retail Traders y Financing Small Transporters y Housing Finance y Car Loan/Consumer Loans y Education Loans y Loans to Professionals (falling under priority sector) y Personal consumption Loan(General Public/Pensioners) Besides this, efforts shall be made to increase our exposure/deployment of credit in good corporate and public sector enterprises with at least A+ (or equivalent) credit rating in the loan term.

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3.4 LENDING PRINCIPLES

The strength of the Bank is judged by the quality of its advances. Unwise and unsound lending policies may lead the bank into a difficult situation. Lending involves some degree of risk, utmost prudence and expertise in handling the lending activities is, therefore, required so as to identify the risks associated and managing them. Lending is bases mainly on the principles of safety, liquidity and profitability. Safety of an advance is directly related to the basis on which decisions to lend is taken, the type and amount of credit to be provided and the terms and conditions on which the advance is sanctioned. The bank consequently adopts a two pronged approach to ensure the safety and soundness of every loan and advance; a) Pre-sanction appraisal- to measure the risk involved and determine the bankability of each loan proposal, and; b) Post-sanction control- to ensure proper management of risks through proper documentation, monitoring, follow up and supervision of every loan and advance. The conventional guiding principles of sound lending with the help of which every credit proposal can be evaluated, include; y The borrower should be acceptable to the bank, that is, the bank must have confidence in the borrower s integrity and ability to run his business. The borrower must have adequate financial stake in the business, he should neither bfe overtrading nor should he be indulging in speculative activities. The advance should not be subjected to any unusual risk. The Bank must satisfy beyond any shades of doubt that the advance is safe not only at the time of lending but will remain so throughout its term and that the money lent will be repaid by the borrower on the due date. The advance should be remunerative for the Bank. The business of the borrower should be acceptable to the Bank, that is, it should be in line with the approved purposes laid down in the Bank s credit policy and directives of RBI and the Government. 22

y y

Advances for non-productive purposes should be discouraged excepting of course small consumption/consumer loans, which need to be encouraged. Advances for purpose of hoarding, overtrading and profiteering or for speculative purposes must be discouraged. The borrower s business must be viable, that is, it must be earning reasonable profits so as to ensure repayment of loan as per program prescribed by the Bank. It is always advisable to grant loans of small amount to large number of borrowers rather that grant large loans to a few. This will scatter/spread the risk Concentration of advances to a particular trade, industry, activity or section of a community should be avoided. The security offered by the borrower must be acceptable to the Bank. This will serve as an insurance against untoward happenings like depression or failure of borrower s business or even intentional default by the borrower.

Post-sanction supervision to a large extent depends upon the findings of pre-sanction appraisal. If the borrower is considered to be first class risk, the bank may be prepared to relax some of the requirements of security. If the business is below a satisfactory risk, the bank may not lend at all or it has to impose stringent follow-up and control measures. The successful lending depends upon careful selection of the borrower, proper appraisal of his credit needs and adequate control to ensure that his dealings with the Bank remain satisfactory and that he is complying with the terms and conditions on which credit has been sanctioned to him.

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CLASSIFICATION OF ADVANCES

24

CLASSIFICATION OF ADVANCES
Advances are classified on the basis of various parameters discussed in the following paragraphs;

4.1 I) SECTOR-WISE CLASSIFICATION:

Advances to various sectors of the economy, are classified as under:Agriculture and Allied activities:- Allied activities include dairying and animal husbandry, fishery, piggery, poultry, bee-keeping, horticulture, forestry, stud farms, cold storage, biogas plants, sericulture, pesciculture, agricultural services like forestry and logging, ocean, sea and coastal fishing, inland water fishing, collection of pearls, conches, shells and sponges etc. Industry- large, medium, small and tiny sector industries. Trade, transport, public utilities and finance. Services: setting up of industrial estates, educational purposes, professional services, hotel and restaurant, recreation services, custom service units, rental and leasing services etc. Export Finance. Miscellaneous Advances: such as rural infrastructure projects, agro industries, loans for purchase of consumer durable goods, loans for housing, personal loans, Professional and Self-employed etc. PRIORITY SECTOR: Advances granted to the following sectors are classified under the priority sector; a. b. c. d. e. f. g. h. Agriculture- Direct and Indirect Finance Small Scale Industries Small Road and Water Transport Operators Industrial Estates Retail Traders Small Business Professional and Self-employed Education, Housing and Consumption Loans 25

i. State Sponsored Organisations for Scheduled Castes/Scheduled Tribes j. Funds provided to RRB s k. Loans to Self Help Groups (SHG s/Non-Govt. Organisations (NGO s)) PRESENT NORMS FOR PRIORITY SECTOR LENDING: The norms presently applicable to Indian Commercial Banks (Including Private Sector Banks) for increasing the flow of credit to certain important/identified segments of the economy and weaker sections of the society (Priority Sectors) are as under: Priority sector Advances are required to be maintained at 40% of the net Bank Credit (total advances). In case of Indian Commercial Banks, export finance is no to be included in determining the target/achievements under the priority sector lending.  Within the 40% target for priority sector, a sub-target of 18% is prescribed for direct and indirect finance to agriculture (including allied activities). However agricultural lendings under the Indirect category should not exceed 1/4th (25%) of the subtarget of 18%, that is, 4.5% of the net Bank Credit. Advances under the Indirect category in excess of 4.5% of the Bank Credit is not be reckoned for computing achievements under the sub-target of 18%. However, all agricultural advances (direct & indirect) are to be reckoned for computing the achievements under the overall priority sector target of 40% of net bank credit.  Within the overall target of 40% for the Priority Sector, the advances to weaker sections should constitute 25% of the Priority Sector Advances, that is, 10% net bank credit.  Lending under Differential Rate of Interest (DRI) Scheme should constitute at least 1% of the net bank credit as at the end of previous year. At least 40% of DRI advances should go to Scheduled Castes/Tribes and at least two-third of such advances should be made through rural/semi urban branches.  Credit Deposit Ratio should be at least 60% in rural and semi-urban branches.  Net funds provided by sponsor banks to RRB s are also to be treated as Priority Sector Advances by the Sponsor Bank.

4.2II) PERIOD-WISE CLASSIFICATION:

On the basis of their period, advances are categorized into the following categories:-

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Short-Term Advances: advances repayable on demand or within a period not exceeding 12 months. All working capital advances viz. cash credits, overdrafts, demand loans, bills limits, crop loans etc. are short-term advances. Term Loans: Advances repayable beyond one year, in agreed installments, over a fixed period of time. These may be either: Medium Term Loans- repayable within 3 to 7 years. Or Long Term Loans- repayable beyond 7 years.

4.3 III) SECURITY-WISE CLASSIFICATIONS: On the basis of security the loans and advances are broadly classified as:a) Secured b) Partly secured c) Unsecured or Clean Secured loans or advances are defined under section 5(n) of the Banking Regulation Act, 1949, as a Loan or advance made on the security of assets, the market value of which is not less than the amount of such loan or advance at any time. An unsecured loan or advance is a loan or advance not so secured . Banks are required to limit their commitments by way of unsecured guarantees in such a manner that 20% of the outstanding unsecured guarantees plus the total outstanding unsecured advances should not exceed 15% of the total outstanding advances. Various kinds of securities are available to the branches for the advances made. The securities can be classified as primary and collateral.

PRIMARY SECURITY:
it is the principal security or main cover for an advance. Primary security may be either personal security or impersonal (Tangible) security or both, provided by the borrower.

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 Personal Security:- Means the personal security of the borrower given by way of a duly executed demand promissory note, bond, acceptance/endorsement on a bill of exchange and the personal convenants in mortgage deeds or loan agreements.  Impersonal Security:- This is the tangible security given by the borrower in some physical form that can be realized by sale or transfer and provides the main cover for the advance. This may either be acquired with bank finance or the borrower may give his existing assets. Impersonal security is obtained by creating a charge by way of pledge/hypothecation/mortgage/assignment over borrowers assets such as goods, book debts and bills receivable, life insurance policies, bank deposits, marketable shares, Govt. securities and other movable assets, fixed assets such as land, buildings, plant and machinery and other immovables etc.

COLLATERAL SECURITY:
It means an additional security that is, in addition to primary security. This is obtained by way of charge (Hypothecation/pledge/mortgage etc.) over some tangible assets or a personal security by way of guarantee from a person other than the borrower (a third party).

DIRECT AND INDIRECT SECURITIES:

Securities furnished by the borrower himself are called direct securities and those furnished by a third party to cover the borrower s liability are termed indirect.

SPECIFIC AND CONTINUING SECURITIES:

A security which covers only a specific debt (a demand or term loan) is called a specific security, and the security which covers the existing as well as the future liability or the ultimate liability (advance in the form of cash credit or overdraft) of the borrower is called a continuing security.

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CREDIT APPRAISAL

29

CREDIT APPRAISAL- STUDY OF BORROWER AND PROCESS OF PROPOSAL Credit appraisal is the basic requirement for determining the merits of a proposal before sanctioning financial assistance. While appraising the proposal, the Branch Manager should carefully study the applicant (borrower), his integrity, nature of activity and future prospects of the business. With regard to financing credit proposal, the following aspects are to be carefully analyzed.

5.2 MANAGEMENT:
The simple meaning of the word management is- a person or a group of persons managing a business or an enterprise. Man behind the project is very important. Management is both a key to success as also a common reason for the failure of an enterprise. Proper evaluation of management is highly essential part of appraisal of a project/business activity. Branches may receive request for financial assistance either from new entrepreneurs for establishing a new project or from existing entrepreneurs for an expansion/diversification/modernization of their existing units. While appraising existing entrepreneurs, their past record is always available. A judgment can be made on the basis of past balance sheet, and profit and loss account statements, credit records with the bankers, dividend policy followed in the past, adherence to sound business policies and evidence of professionalism in management. While appraising expansion/diversification/modernization, of projects, it should be ensured whether the present management is flexible enough to change itself according to the new changes. In case of new projects, the past record may not be available with the branches. They can obtain information regarding background of the new entrepreneurs and try to judge the character on the basis of the performance of other units managed by them. Efforts should be made to get as much as information as possible about the past record of the promoters. A through understanding of what a man has done in the past in very helpful in predicting his future potential.

5.3 NATURE OF INDUSTRY AND ITS STATUS IN THE ECONOMY AND FUTURE PROSPECTS:
Various aspects of the particular industry/activity should be judiciously evaluated before selecting a project. The following points have to be examined; y Examination of market study report; 30

y y y y y y y y y y

Demand-Supply gap; Type of the product; Future demand; Product differentiation; Availability of other competitive products; Consumer preference; Distribution arrangements; Government policy regarding the industry in general and the product in particular; Manufacturing process; Availability of various inputs required for production.

5.4 OPERATIONS:
Constraints in the availability of infrastructural facilities, power, utilities, manpower etc., availability or raw materials and other inputs required in the day to day operations.

5.5 FINANCIAL:
Planning and management, past record, net worth, debt equity mix etc.

5.6 CREDIT REQUIREMENT:

Purpose and need, repayment program and probability of fulfillment as scheduled, security and other terms.

5.7 STUDY OF THE BORROWER:

The first and most important aspect to be evaluated, while appraising a loan proposal is to study/know the borrower i.e. his integrity and honesty and whether it is safe to entrust the bank s money to the applicant or applicants. Even when the bank has a proper security, it is the borrower to whom the lending is primarily made and an honest borrower is our best security. The selection of a right type of a borrower is therefore necessary. The Branch Manager should have confidence in his customer before deciding to make an advance i.e. he should feel fully assured that the borrower can be relied on to adhere to the bank s requirements and norms. This ordinary necessitates a credit 31

investigation of the character and credit worthiness of the borrower. The degree of investigation will among other things depend on the size of advance and whether it is unsecured or secured. The following points may be noted in the appraisal of the borrower in order to make an assessment of his standing, respectability and credit worthiness.

5.7.1 CHARACTER:
Character is the greatest single asset, any individual can have. It is the essential/primary ingredient underlying the granting of credit. Men deficient in character cannot be trusted. An applicant for credit should be of proven ability and integrity and always willing and determined to meet his obligations. In case the honesty and integrity of the prospective customers in questionable, no loan should be granted to him irrespective of the security offered. It is unwise to believe that a person previously found to be untrustworthy would change his character when coming afresh to the bank for an advance. The assessment of a person s character is not easy. The following points may prove useful in this regard; y Extent and nature of education y State of his heath. His energy and capacity for hard work y General reputation among social and business circles, acquaintances, associates, employees and competitors. y Personal habits such as drinking, gambling, sex morals, welfare and civic activities. y Antecedent family history, existing family relationships and influences. y Antecedent business record. y His behavior and dealings with bank and others; y Is the borrower straight forward? What is his recpectability and reputation viz-a-viz commercial integrity? Does he meet his commitments in time. y Would he consult the bank about his future plans or would he act first and them come to the bank for further help. The branch manager should investigate every aspect of the character and convince himself that despite adverse conditions, the borrower will still repay the dues and adhere to bank s norms and terms.

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5.7.2 CAPACITY:
The branch manager must assertian the capacity of the borrower i.e. his ability and experience to run the business in a profitable manner. The earning capacity of the borrower will depend on efficient managerial ability and is the guiding factor for determining whether to lend and how much to lend. Past business results and income and expenses of the borrower are extremely important in appraising his capacity. Other guiding factors include; Qualification and technical expertise of the borrower/management; Study of business performance. Is a surplus being built up. Paying habits of the borrower; Whether the borrower is prepared to put in sufficient time and hard work in the business; Past record of the management. How long associated with this business? Has it established a record of successful operation? Are the plans of the borrower on sound and realistic line?

5.7.3 CAPITAL:
Capital or financial strength of the borrower as measured by equity or net worth of the business should be enquired into so as to assess his credit worthiness, ability to repay and the quantum of credit that may be granted. The capacity contribution and its efficient use measures the capacity of the borrower. The capital can be assessed from the financial statements of the borrower. In the case of a new business, the source for required capital contribution must be clearly identifiable. The amount of advance must bear a reasonable and acceptable relationship with the borrower s own stake or contribution in the business/project. The lending should be disproportionate to borrower s own capital and his sake must at least conform to the minimum margin requirements stipulated by the bank. It the borrower has a reasonable amount of his own investment in the project, he will have the incentive to make it a success.

The Character, Capacity and Capital of a borrower are three main factors in assessment of a borrower. The most important, however, is the character. The relative significance of the three factors can be summarized with the following figure;

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The figure can be explained by the following table;

Character Good Good Good Impaired Good Impaired Good Impaired Good Impaired

Capacity Sufficient Sufficient Insufficient Insufficient Sufficient Sufficient Nill Nill Nill Sufficient

Capital Sufficient Insufficient Sufficient Sufficient Not Available Sufficient Sufficient Sufficient Nill Nill

Inference Safety in Credit Limit Fair credit risk Fair credit risk Doubtful credit risk Limited success High risk Inferior credit risk Distinctly poor risk Inferior credit risk Fraudulent credit risk

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FINANCIAL STATEMENTS- ANALYSIS AND INTERPRETATION

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FINANCIAL STATEMENTS- ANALYSIS AND INTERPRETATION:

Besides the in-depth study of the borrower/management, credit appraisal, involves a detailed study and analysis of past and projected financials that is, estimating the operational efficiency and financial stability of the borrower concern. The objective of such an analysis by a banker is to assess financial soundness and credit worthiness of a business concern. Financial analysis is a useful tool for determining the strengths and weakness of the business of a borrowing concern and for judging the elements of risk associated with the loan proposals. It is not only useful in taking the initial decision to lend money but also in monitoring the progress of the concern and utilization of funds after the loan has been disbursed. The basic source of data in respect of the financial position and working results of a business enterprise are the financial statements. The financial statements, generally consist of two account statements viz. Balance Sheet and Profit and Loss Account Statements, which a business concern prepares periodically (on annual basis), with the objective of finding out at a glance its financial position and working during that particular period.

6.1 BALANCE SHEET:

Balance sheet is a statement of what a business entity owns and what is owes as on a particular date. In other words, it is the statement of Assets and Liabilities of a business and is a snap short picture of the financial position at a given point of time. Thus it is a statement of assets and liabilities that can be given value in terms of money. Assets include land, buildings, plant and machinery, stocks in trade or inventory, debtors and such other things that can be given value in terms of money. To acquire these assets, the business concern needs money and the concern obtains it from different sources. Such as financial institutions, banks, suppliers and owners. Money brought in by the owners is in the form of capital and is different from the money received from other sources mentioned above, as capital is repaid only when the business is wound up. However, it is a liability to the business concern, because, in accounting, the business concern is treated as distinct and separate from its owners. Thus in a balance sheet, liabilities reflect the funds that have been made available to the business concern and assets show how the funds have been used or deployed.

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6.2 PROFIT AND LOSS ACCOUNT:

This statement summarizes the net results of the business operations for a particular period of time. The statement actually consists of two parts viz. a trading account and profit and loss account. It is also known as operating statements. The profit and loss account consists of the items of income on one hand and items of expenses/costs on the other. The difference between the two represents the profit or loss for the period. The same statement is called as income and expenditure statement in the case of non-profit organisations like clubs, charitable institutions etc. A profit and loss account is an integral part of the balance sheet. Balance Sheet and Profit and loss account are inter-related and both reveal the financial conditions of a unit. Balance sheet is a point statement and it provides a snap short view of the financial position of the concern at a particular point of time, whereas the Profit and loss account is a period statement and provides operational results during a specific period of time. In other words while the profit and loss account reflects operational health of a concern during a particular period, the balance sheet reflects the financial health as on a particular date and reflects the strength of the business concern to weather storms. The operational health of a business concern is more important from lenders point of view as the banker normally expects repayment of the dues out of profits and nor from the disposal of assets created by the loan. In any meaningful analysis both the statements need to be examined together to measure profitability, liquidity or solvency of a concern and establish a relationship between profits made and total funds employed and to determine adequacy of returns on funds employed.

6.3 TWO APPROACHES IN BALANCE SHEET STUDY:

There are two basic methods for the analysis of a balance sheet from the bankers point of view. These are known as Going concern approach and Gone concern approach. Usually both methods are used since they are regarded as complementary. In the going concern approach it is assumed that the business concern will continue to be in existence for an indefinite period, whereas in gone concern approach it is assumed that the business concern is being wound up on the day the final accounts are prepared. Under both the concepts liabilities are taken at the balance sheet value and are more or less definite. As regards the assets the going concern concept recognizes that the assets of the business as valued in the balance sheet are worth the figures quoted therein, but as per the 37

gone concern concept the value of each asset known in the balance sheet is assessed realistically on a forced sale basis according to the condition and sale-ability of asset and marketability to be available.

6.4 FINANCIAL ANALYSIS AND INTERPRETATION

For comprehensive analysis, balance sheet and profit and loss account for the past 2-3 years and current and next year should be called for and examined. The data contained in the financial statements should be compiled in the proper formats. Financial analysis is done on the basis of information compiled in these formats

6.5 CLASSIFICATION PROCESS:

The first step in analysis of financial statements is to classify or regroup the various items of balance sheet and profit and loss account, so that it is easier to analyze them also to facilitate a meaningful comparative analysis by adopting a uniform procedure for classification. The classification of assets and liabilities as per the balance sheet drawn under the provisions of the Companies Act-1956 or by other concerns differs in many respects from the usually accepted approach of bankers, based on the guidelines prescribed by Reserve Bank of India.

6.5 NEED FOR SEPARATE CLASSIFICATION AND ANALYSIS OF BALANCE SHEET:

Bankers should study previous two year s actual, current year s estimates and following year s projections. While the balance sheet gives previous one year s position, it does not indicate future projections. The Companies Act which has prescribed the balance sheet format looks at the classification of the assets and liabilities from the shareholders point of view and Government, whereas the bankers has a different perspective. The balance sheet form alongwith other forms as prescribed by the Reserve Bank of India (RBI), popularly known as CAS forms, are designed to serve the following main purposes; y y y y y To verify whether the projections are in accordance with the past trends and current working, subject to technological and other developments. To work out the basis (i.e, cost of raw material, cost of production, cost of sales) to which the inventory and receivable norms are related. To verify whether the projected levels conform to the prescribed norms; To verify whether the various accounting ratios projected are realistic; and To fix the need base limits.

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CLASSIFICATOIN AND ANALYSIS OF ASSETS:

Assets are what the business concern owns. The assets side of a balance sheet is examined by the bankers from the gone concern approach. It is assumed that the business concern has gone into liquidation or dissolution on the date of the balance sheet, which in under scrutiny. In this manner assets are segregated into two major components; viz; Tangible assets: i.e., those assets which have reasonable value on the date of the assumed liquidation. Intangible assets: i.e., those assets which have negligible of no reasonable value on that date. Tangible assets are of several types. Some of these like raw material and finished goods are purchased and/or manufactured for sale and are short term in nature. Such assets generally have a high turnover and can be converted into (or realized in) cash easily. They are, therefore, more liquid. Other tangible assets like land and building, plant and machinery, furniture and fixture etc. are purchased/acquired for purpose of productive or long term use and are generally not for sale. Such assets have a permanent characteristic as they do not vary from day to day. They are, therefore, least liquid. Still some other tangible assets like investments in sister concerns, deferred and overdue receivables, advances for capital goods, etc. are slow moving assets and have semi permanent characteristics. They get converted into cash buy very slowly and may not be directly related to main business activity of the business concern. They are, therefore, less liquid. For analysis purpose, the assets are thus classified by banks, into four broad heads depending on their use, degree of liquidity and their realizable value. These four groups are: y y y y Current Assets Fixed Assets Other non-Current Assets Intangible Assets Tangible Tangible Tangible (Patents, goodwill, preliminary and formation expenses bad/doubtful debts not provided for etc.)

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CURRENT ASSETS:
Current and other assets which can be realized in cash or sold or consumed or turned over during the operating cycle of the business usually not exceeding one year are defined as Current Assets. Such assets represent employment of funds on short term; they vary from day to day and are easily converted into cash and such more liquid. They are also called as liquid assets or circulating assets. The operating cycle refers to the time period from the purchase of raw material, and realization of sale proceeds. This varies from business to business. Any asset, which assists or aids in reducing the duration of operating cycle, could be considered to be a current asset. Further the quality of these assets should be such that at least book values are realizable i.e. the items can be realized or are realizable without loss. It losses are anticipated, for example, doubtful debts, then they must be suitably provided for.

LIST OF CURRENT ASSETS:

y y y y y Cash and Bank Balance Investments (Other than long term investments)/ Govt. and other trustees securities/fixed deposits with banks; Receivables (excluding deferred receivables) Inventory Other current assets (e.g. loans and advances etc.)

CASH AND BANK BALANCE:

Cash and Bank Balance are the two most liquid assets. Though larger amount of cash and bank balance will ensure quicker paying capacity and highly liquid position, yet at the same time it might affect the profitability of the concern (as cash is non-earning asset). It should, therefore, be seen that cash balances are not maintained beyond the normal requirements of the concern.

INVESTMENTS(OTHER THAN LONG TERM INVESTMETS)

A business concern may invest its surplus cash/funds in fixed deposits with banks, in government and other trustee securities, in shares/debentures of other companies with the purpose to earn profit on such funds which are not required immediately for normal trade investments. It may also invest the reserves or provisions made out of profit for specific purpose 40

(like future expansion, etc.). The investments should be liquid and temporary and should not assume permanency, more especially if there are more productive avenues (e.g. expansion, diversification etc.) for investment. As per the companies Act all investments whether long term or short term are included under the head Investments . Marketable means that it can be readily sold. Following points may be noted regarding classification of investments; a) Fixes deposits with the bank even though maturing after one year may be treated as current assets, because they can be encashed before the due date. Interest on term deposits with the bank will be treated as current assets. However, if the investments in the fixed deposits are made for specific purpose or long term purpose (like sinking fund, gratuity funds etc.) these are treated as non-current assets. Similarly deposits representing or earmarked for margin money for issuing bank guarantees or opening letters of credit are usually classified as non-current assets. If they are included in current assets, the borrowers permissible level of finance goes up (75% thereof under the second method of lending). b) Invest in Govt. and trustee securities, which are easily marketable are treated as current assets. If the investments in these securities are made for long term purpose (sinking funds, gratuity funds etc.) then these are treated as non-current assets. c) Investments in shared, debentures or bonds of subsidiaries and other companies under the same management should not be treated as current assets, even if these are quoted and readily marketable, because bank finance is meant for deployment of in borrower s line of activity and not in inter-corporate locking of funds. d) Investment in shares of other companies and advances to other firms/companies, not connected with the business of the borrowing firm, should also be excluded from current assets and treated as non-current assets. e) Amounts representing interconnected company transactions should be treated as current assets only after examining the nature of transactions and merits of the case. For example, advance paid to suppliers for a period of more than normal trade practice should not be considered as current asset. The market value of investments should be ascertained and fall in the value should be provided for. They should be valued at cost or market value whichever is lower. RECEIVABLES: Receivables or debtors or book-debts represents the money owed to the firm by its customers who have not yet paid for goods sold or services rendered by the firm. In the balance sheet drawn as per the provisions of the Companies Act, debtors are required to be classified as 41

Debts outstanding for a period exceeding six months and other debts . Also, particulars are required to be provided relating to debts considered good and secured, debts considered good for which there is no security other than debtor s personal security and debts considered doubtful or bad. Also the bills purchased/discounted by banks are not shown as liabilities/assets in the balance sheet but as contingent liability or indicated in the foot note to the balance sheet. Receivables realized within 12 months may be classified as current assets, though the usual tendency among banks is to exclude receivables outstanding for more than 6 months from current assets. Deferred receivables (i.e. receivables on account of sales made on deferred payment terms) due within one year are treated as current assets and those maturing after one year are excluded. Receivables from subsidiaries/sister/associate concern will form part of current assets, provided these receivables arise in the normal course of business and represent dues for sales made to them in the ordinary course of business on usual credit terms. Exports receivables (other than deferred receivables maturing after one year) are to be shown separately under current assets. As per the extant instructions, export receivables are to be deducted from the total current assets while calculating the MPBF for arriving at the minimum stipulated net working capital. The book debts of the firm should be thoroughly scrutinized because they carry value only if they are realizable. The value of book debts depends upon the sale-ability of the product/goods, the debt collection policy of the firm and soundness of the debtors. If a firm has large number of small debtors, its risks are well spread. The default of a few debtors will not pose a liquidity problem. But if there are 5-6 large debtors only, the firm can face tough situation even if one of the debtors were to default. The amount of the debtors should not be unduly large as compared to credit sales. The period of credit granted by the firm should not be longer than the normal credit period in that trade or industry.

STOCKS/INVENTORY:
In the case of trading concern, stocks mainly comprise of raw material and/or finished goods. In a manufacturing concern stocks, also known as Inventory, comprise of raw materials including stores and other items used in the manufacturing process (like coal, fuel, packing materials, labels etc.), stocks in process (i.e. goods in various stages of manufacture), stocks of finished goods and stocks of other consumable spares. Normally loose tools and spares for machinery are not included. Only such consumable spares, which do not exceed 9 months consumption, (if indigenous) or 12 months consumption (if imported) are treated as current assets. Beyond this level they should be treated as non-current assets and shown under non-current assets. 42

Dead inventory i.e. slow moving or obsolete items should not be classified as current assets. In certain industries where the operating cycle is beyond 12 months, inventories held during such long operating cycle will be treated as current assets. It should be ascertained that the levels of stocks/inventories are adequate to enable the unit to operate successfully and are not disproportionate viz-a-viz the sale turnover. Excessive levels of inventory could be due to inefficient management or for speculative purpose to make profits on expected rise in prices. As the excess stock is usually unproductive, such a tendency should be discouraged and finance against unproductive assets has to be avoided. The stock sale ratio should be compared with other concerns in the same trade or industry. The figure (or value) of stocks should be examined item-wise keeping in view the following cretaria; a) Note the shifts in the values of each item year to year. For example, a progressive increasing sales turnover may justify in holding of stocks from one year to another. But a declining trend in sales should not support a trend of increasing stock holding. The following two examples explain it;

i)

Acceptable Sales (Thousand Rs.) Stocks (Thousand Rs.) Stock turnover (sales/stocks)

Year 1 100 10 10 times

Year 2 150 15 10 times

Year 3 200 20 10 time

ii)

Acceptable Sales (Thousand Rs.) Stocks (Thousand Rs.) Stock turnover (sales/stocks)

Year 1 100 10 10 times

Year 2 75 15 5 times

Year 3 60 20 3 time

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b) The period of holding of each item should conform to its demand and supply position in the market, production requirement etc. c) The stocks should be readily realizable, having active turnover and their quality should satisfy the requirements of a good security. Stock losses on account of obsolescence etc. should be provided for. d) the basis of valuation of each item should be as per laid down guidelines (invoice/cost or market value whichever is less). Changes, if any, in the basis of valuation should be carefully watched as this may distort the profit figure, considerably. In a healthy profitable business, the tendency will be to under value the stocks, thus reducing the profit figure, limiting the tax liability and in the process creating potential hidden reserves. On the other hand over valuation of stocks will lead to inflation of profits, a higher dividend than justified and also resulting in unsound lending and the risk of bad debt. Both these extremes need to be monitored carefully.

OTHER CURRENT ASSETS:

These include prepared expenses, normal trade investments and loans and advances. Advances to suppliers of goods/raw materials and stores/consumable spares are treated as current assets and advances to suppliers of goods (e.g. machinery suppliers, etc.) are not treated as current but non-current assets. Normal trade investments by way of advances to other companies/firms are treated as current assets because these may directly or indirectly help in reducing the duration of the operating cycle. Advance payment of income tax is treated as current assets. Advance tax paid and provision thereof should be netted. Advances to employees/directors etc. are treated as non-current assets. Security and tender deposits, irrespective of whether they mature within normal operating cycle of one year or not should be classified as non-current assets.

QUICK ASSETS:
Among the current assets there are certain assets which can be converted into cash more quickly than others. They are know as quick assets. These include cash and bank balances, fixed deposits with banks, marketable securities, debtors etc. Inventories on the other hand cannot be directly converted into cash. It is not possible to find buyers at a short notice. Therefore inventories are not treated as quick assets except where cash sales are effected. They are, however, part of current assets. An informative balance sheet from the banker s point of view should list assets in order of liquidity i.e. the order in which they could easily be converted into cash. Most liquid asset obviously being cash and the least liquid asset is being the fixed assets. 44

FIXED ASSETS:
Fixes assets represent assets of a permanent nature, which are acquired for a productive use. These assets are sold only when the replacement becomes necessary due to wear and tear or obsolescence or when the business goes into liquidation or changes hands. Sale of these assets may realize values lower than their book value on account of depreciation, obsolescence etc. An exception is the case of land (or factory building) which if sold may realize a value more than the book value. However, the purpose of acquiring land or building is not to make profit but to house the project on a permanent basis. Therefore, these assets form part of the fixed assets. Examples of fixed assets are:y y y y y y Land (free hold/lease hold). Building (factory, office etc.) including constructions in progress. Plant and Machinery (Immovable/movable). Test equipments, dies, tools, fixture, etc. Furniture and Fixture (installations, office equipments, etc.); Motor Vehicle etc.

Since the fixed assets are acquired for long term use, most of these are gradually worm out, that is, they depreciate or decrease in value. The original cost of the fixed assets (except land) is, therefore, reduced by a certain amount every year over the useful economic life of that asset. This amount known as depreciation, is charged as an expense in the profit and loss account. As charging of deprerciation affects the profit before tax and payment of tax to the Govt. through tax laws. In the balance sheet, fixed assets are shown at their original cost and as well as net value (book-value) with details of depreciation charged upto date. Historically, the true value of land and buildings tends to increase, over the years. At times, therefore, these assets are revalued to show the current value. The process of revaluation increases the book value of the fixed assets and results in creation of revaluation reserve on the liability side. While analyzing the balance sheet this fact should be studied and if the assets have been revalued, the increase in the value due to revaluation may be ignored by deducting the revaluation reserve from the value of fixed assets on the assets side and Reserve and Surplus A/c on liabilities side of the Balance Sheet.

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OTHER NON-CURRENT ASSETS:

These are slow moving assets, which are converted into cash slowly. Such assets have a semipermanent characteristics and are usually not connected with the main activity of the firm. From the view point of liquidity Non-Current Assets are not as liquid as the Current Assets. Those tangible assets, which can neither be classified as current assets nor fixed assets are put under this head. In the company s balance sheet such assets are either shown under the Miscellaneous Assets or included under the Fixed Assets, Investments or current assets. For example: 1. Investments/ book-debts/ advances/ deposits, which are non-current assets. 1.1. Investments in subsidiary companies/affiliates 1.2. Others (Investments by way of advances to companies/firms not concerned with business of borrowing concern) 1.3. Advances to suppliers of capital goods/spares and contractors for capital expenditure. 1.4. Deferred receivables maturing after one year. 1.5. Security deposits/tender deposits (irrespective of their period); 2. Obsolete stocks; 3. Non-consumable store and spares; 4. Other miscellaneous assets including dues from directors, partners/employees.

INTANGIBLE ASSETS:
Intangible assets are those assets which (on the date of assumed liquidation of the business concern) have negligible or no realizable value. These assets are as such not available for payment of debts. Goodwill is an intangible asset and there is nothing concrete to show in respect of the same. Goodwill means the advantage, benefit etc., that comes from a business organization s reputation (earned by brand name, from its good relations with customers and so on). It is, therefore, difficult to value goodwill. Intangible assets are included in the balance sheet when they are purchased and may be shown separately or as part of fixes assets in the company balance sheet. If a business concern changes hand i.e. it is purchased by somebody as a going concern, price paid in respect of the purchase may include a certain amount as goodwill and this will be shown in the balance at cost. When present business is dissolved for the purpose of liquidation, the value of goodwill has hardly any realizable value. Sinking business cannot have a good reputation. Also the value of goodwill fluctuates in direct proportion to the fortune of the business firm from time to time and therefore, it is not possible for affix a stable value to this item. Example of intangible assets are goodwill, patent rights, trade marks, 46

preliminary expenses, deferred revenue expenditure, bad and doubtful debts not provided for debit balance in the profit and loss account. All intangible asset have one quality in common, they have to be written off as early as possible. For working out the tangible net worth of a borrowing unit, intangible assets are deducted from its net worth.

CLASSIFICATION AND ANALYSIS OF LIABILITIES:

Liabilities are what the business concern owes to others on a particular date. A balance sheet records actual liabilities only. It does not record financial commitments made by the business concern to outsiders. Thus, for example, if a business concern has entered into a contract for, say purchase of articles from somebody for the next 10 years, this financial fact will not be appearing in the balance sheet. However, such financial facts may find a place in the notes to the balance sheet. Liabilities are of varying maturity. Some liabilities (like bank overdraft, trade creditors, etc.) are short term in nature i.e. they are payable within a short period or on demand. While others (like term loans from the bank/others) are long term in nature i.e. they are payable over longer periods. The liability towards the owner i.e. the owners equity or fund is payable by the business only when it goes into liquidation or changes hands. Normally owners equity is payable from the sale of residual assets (if any) after all other liabilities have been settled. The classification of liabilities in the Companies Act format of the Balance Sheet does not meet fully the banker s requirements. Therefore, for the purpose of analysis the liabilities in the balance sheet are classified by banker s into three major groups depending on their nature. These are: Outside Liabilities: (a) Current Liabilities (b) Term Liabilities Owners Funds: (c) Net worth (Owners Capital) : ( Long term Liabilities) : : (Short term Liabilities) (Deferred/Fixed Liabilities)

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CURRENT LIABILITIES: Current liabilities (short term) are those liabilities or obligations which are repayable with one year. The main headings under current liabilities as per the classification followed by bankers are as under: y y y y y y y y y Short term borrowings from the banks and others (including bills purchased and discounted and excess borrowings placed on repayment basis i.e. WCTL ). Deposits (Maturing within one year). Sundry creditors (trade). Unsecured loans (unsecured loans taken from Directors of the borrowing company, where no period is mentioned are to be treated as current liabilities). Advances/progress payments from customers. Installments due on long term borrowing within one year. Accrued expenses (charges/interests) etc. Statutory liabilities. Miscellaneous Liabilities.

SHORT TERM BORROWINGS:

These include all types of (secured or unsecured) working capital finance from banks (overdrafts, cash credits, bills purchased/discounted, demand laons, excess borrowings on repayment basis, etc.) and other types of bank borrowings from any other sources (secured or unsecured) are also treated as current liabilities. Unsecured loans from directors/partners/others are treated as current liability if no definite period is mentioned. However, if an undertaking to the effect that these will not be repaid without bank s prior consent is obtained, these may be treated as long term liability. Enquiries regarding terms and conditions of the borrowings, rate of interest, period of repayment, security etc. on which these borrowings have been raised, will be helpful in the analysis. Bills purchased/discounted, though shown as contingent liability in the company balance sheet should not be included under this item with corresponding increase in receivables on asset side.

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TEADE CREDITORS:
This includes creditors for purchase of goods traded in/raw materials and consumable stores and spares. Creditors for expenses and others, if any, should be shown separately. Trade creditors are expected to be paid in the ordinary course of business within the period stipulated in the transactions or as per particular trade practice. It met within the specific time, they do not involve payment of interest and these are as such non-interest bearing. Trade creditors should bear a proper relationship with the level or purchases. Unusually large outstanding credits disproportionate to total purchases may signify inability of the borrower to pay off the creditors in time and these may be pressing creditors. Age wise list of creditors(especially with bigger amounts) would be helpful during the analysis. Outstanding liabilities in respect of credit purchases under usance letters or credit/coacceptance facility from the banks should be shown under trade creditors.

ADVANCES/PROGRESS PAYMENTS FROM CUSTOMERS:

All advances/deposits from customers (buyers) will be treated as current liability. Where deposits are required (in terms of regulations framed by the Govt.) to be invested in a specified manner (e.g. advances for booking of vehicles), the benefit of netting may be allowed to the extent of such investments in approved securities and only the balance amount need be classified as current liability. Progress payments may be set of f against work in process where progress payments are shown on the liability side, without deduction from work in process. Advance payments received are also adjusted progressively from the value of work completed, as agreed in the contract. Outstanding advances payments are to be reckoned as current liability or otherwise, depending upon whether they are adjustable within one year, or later.

DEPOSITS FROM DEALERS, SELLING AGENTS:

The deposits from dealer and selling agents may be treated as term liability irrespective of their tenure if such deposits are accepted to be repayable only when the dealership/agency is terminated. This condition should be verified from the terms of the agreements between the borrower and the dealer/selling agents. The deposits, which do not satisfy the above condition should be classified as current liabilities.

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INSTALMENTS PAYABLE ON LONG TERM BORROWINGS/LIABILITIES:

Installments of term loans/deferred payment credits/debentures/redeemable preference shares (due within one year) from the date of balance sheet are treated as current liability although borrowing concerns classify these as term liabilities in their balance sheets. It may be noted that although term loan installments falling due for payment in the next 12 months are treated as current liability for calculation of current ratio etc. these should be treated as an item of current liability for the purpose of calculation of maximum permissible bank finance and net working capital. Overdue installments shall, however, continue to be treated as current liability. Deposits from family members/friends and relatives should be treated as a current liability in the absence of an understanding from the borrower and the depositors, that these deposits will not be withdrawn from the business without the prior permission of the bank in writing. If such an undertaking is obtained these may be classified under term liability.

ACCRUED EXPENSES:
All accrued expenses due like interest, wages and salaries and other expenses due for payment should be treated as current liability.

STATUTORY LIABILITIES:
This includes provident fund dues, provisions for tax payable, sales tax, excise duty, etc., obligations towards workers which are payable within one year have to be classified undercurrent liabilities. When a business concern has made sufficient profits during a particular a particular year, it has to pay income tax on such profits. However, the tax liability often crystallizes on a later date, after the date of balance sheet. Therefore, the business concern generally makes a provision for payment of tax. As and when the tax liability is known, this is paid by the business concern. Therefore, provisions made for tax payable is classified as current liability. Advance payment of tax is also made pending crystallization of actual liability. In such cases advances tax paid and provision therefore should be netted and the net position may be shown but netting should be made uniformly for all the years under consideration. When provision for excise duty is made it should be classified as current liability. The disputed excise liabilities shown as contingent liability or by way of notes to the balance sheet need not be treated as current liability unless it has been collected or provided for in the accounts of the 50

borrower. Provisions for disputed excise duty may be classified under current liability unless the amount is payable in installments, spread over a period exceeding one year as per the orders of competent authority like the Excise Deptt., or in terms of directions of a competent court. In such cases installments payable after one year may be classified as long term liability. Where the provision made for disputed excise duty is invested separately, say, in fixed deposits with banks, such provisions may be set off against the relative investment. Disputed liabilities in respect of income tax, sales tax, customs and electricity charges need to be treated as current liability except to the extent provided for in the books of the borrower.

MISCELLANEOUS LIABILITIES:
This would include Dividend payable, liabilities for expenses, gratuity payable within one year, other provisions and any other payments due within next 12 months. If dividend is only recommended and not appropriated from profits pending approval of the shareholders in the Annual General Meeting, the amount may be shown as current liability after deducting it from general reserves and/or surplus in profit and loss account. The concept of current liabilities would include estimated or accrued amounts, which are anticipated to cover expenditure within the year for known obligations, for example, dividend payable, tax payable etc. In cases where specific provisions have not been made for these liabilities or other known statutory liabilities estimates thereof should be made for eventual payment during the year and the amounts, though not provided, should be shown as current liabilities. Since the current liabilities are payable within a short period (one year) ideally, therefore, these funds should be invested in short term assets i.e. current assets only. Use of these funds in long term assets in always fraught with dangers, since repayment on due dates will not be possible unless, of course, the business concern sells off its fixed assets etc., which in effect means that the borrower is not serious about continuing in business. A well manage concern should have more current assets to cover the current liabilities. Difficulty in meeting the current liabilities as and when they fall due is considered a symptom of or overtrading i.e. trading beyond the available financial resources.

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TREM LIABILITIES:
Term liabilities are those liabilities, which are repayable after one year from the balance sheet date. These represent the long term finance (secured or unsecured) obtained by the business organisations from financial institutions, banks and other agencies. Examples of term liabilities are: Debentures (not maturing within one year). Redeemable Preference Shares (not maturing within one year but maturity not exceeding 12 months). y Term Loans (exclusive of installments payable within one year). y Deferred payment credits (exclusive of installments payable within one year). y Term Deposits (repayable after one year). y Other term liabilities (maturing after one year). Installments/repayments due within next 12 months from the date of balance sheet are excluded from the term liabilities and treated as current liabilities. Overdue installments/repayments, if any, are also excluded from term liabilities and treated as current liabilities. Repayment program for term liabilities should be called for and looked into to ensure proper classification thereof. y y

NET WORTH:
Net worth represents the investment of the owner in the business, in the form of capital, which can be proprietor s capital, partner s capital or shareholders capital. Undistributed profit for the year is added to the capital funds (to the reserves in the case of companies). Net worth represents the investment on a long term basis and unlike outside liabilities the net worth is repaid only when the business is wound up. It is as such a permanent source of finance to the business. A successful and well-run business should reflect an increasing net worth. In the case of proprietorship and partnership firm, capital and funds will consist of only the capital account or the capital account and the drawing account. Drawings account, if maintained are used for the purpose of setting distribution of surplus/profits among the partners etc. The drawings account can show a credit balance, which means the firm owes the outstanding balance to the partner(s) or a debt balance, which indicates the partners owe the outstanding balance to the firm. The aggregate of capital, credit balance (undistributed profit) in the drawing account and surplus (if any) constitutes, the net worth of the business concern. Debit balance in

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drawing account (if any) and accumulated losses will be deducted from capital to arrive at the net worth of the business. Net worth in respect of the limited companies comprises of: y y y y y y Ordinary Share Capital (Paid Up); Preference Share Capital (maturing after 12 years); General Reserve (excluding provisions); Development rebate reserve; Other reserves (excluding provisions); Surplus or Deficit in profit and loss account.

Share Capital are the funds actually paid by the shareholder for buying shared in the company. This money is known as owner s equity. Capital may be raised in the form of ordinary (or Equity share capital and/or Preference Share Capital). Preference shares have a preference as to payment of dividends (also arrears of dividends if the shares are cumulative preference shares) and preference as to their redemption. For the purpose of analysis, the preference share capital, which is redeemable after a period of 12 years from the balance sheet date, is treated as a part of net worth. The preference capital redeemable within 12 years but after one year is excluded from Net Worth and treated as term liability. The same is classified as a current liability in case the redemption is due within 12 months. Non-refundable subsidy received from the Central/State Govt. is treated as a part of the Net Worth. The share-holders capital represents investment on a long-term basis. Although interest in not paid on such money invested, the shareholders expect returns when the company prospers and makes sizeable profits from its normal operations. These returns are paid in the form of dividends by the company. In other words, the shareholders have right to share the profits earned by the business. Dividend payment depends on size of profit. Very often a cautious or prudent management does not distribute the entire profits among the shareholders as dividends. They distribute only a portion and balance is retained in the business and transferred to the balance sheet as reserve and surplus. Sometimes a cautious management makes it a corporate policy to transfer percentage of profits to reserves as a cushion against some future setback or for some specific purpose like future expansion, etc. Reserves are of two types: y General Reserve or Revenue Reserve: this reserve is created out of profits (surplus) arising out of normal business activities (operations) of the business and is usually available for payment of dividends. 53

Capital Reserve: it is the reserve created from the surpluses arising out of activities not usually connected with the normal business of the concern such as revaluation of fixed assets, profit on capital transaction such as sale of fixed assets. These reserves are not usually available for payment of dividends. Reserve may be either free reserves i.e. not created for any specific purpose or tied up reserves i.e. created for a specific purpose. Free reserves can be used freely for any purpose including payment of dividends. Capital Reserves created on account of revaluation of fixed assets/property are ignored for calculating Net Worth. Consequently increase in fixed assets as such is also ignored during analysis. Reserves in the nature of provisions for future payments of liabilities etc. (viz. provisions for taxation/dividends/gratuity/bad debts/depreciation etc.) are not considered part of net worth but treated as part of outside liabilities (Term/Current Liabilities). The surplus balance, if any, left in profit and loss account after creation of reserves, payment of dividends/tax etc. is carried over to balance sheet and forms part of the net worth. Any deficit in P&L Account is deducted from capital and reserves to arrive at net worth. y

CONTINGENT LIABILITIES:
These are shown as a foot note to balance sheet, as these are not actual liabilities. A cotingent liability is a possible liability, which may or may not crystallize. On the happening of a certain event a contingent liability may become an actual liability.examples are guarantee and endorsements on bills, liability on bills discounted, arrears of cumulative dividends, charge on assets to secure the liabilities like provident fund etc. not provided for, any claim against the company not acknowledges as, debt etc. The contingent commitments should not be unduly large, as they may make the business concern vulnerable to a risk beyond its resources. Each item of contingent liability should be examines viz-a-viz its effect on the financial position of the company if and when the same materializes and if so, to what extent. Satisfactory explanations should be sought from the company s management as to how they propose to liquidate the contingent liability(contingent liability on materialization may create asset of equal value and may not adversely affect the financial set up on the company).

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OVERALL BALANCE SHEET:

To understand the complications of the financial structure of a business concern it is necessary to know how assets are financed by owners/shareholders funds and outside liabilities. It would be necessary to understand the relationship between different groups of liabilities and assets to determine the solvency and liquidity of a business concern, which are of prime importance for a banker.

TANGIBLE NET WORTH:

This is the real net worth of the business concern. Net worth minus intangible asset gives the tangible net worth of a concern.

SOLVENCY:
This refers to the ability of the business to repay its outside liabilities from the assets. Thus if tangible assets are more than outside liabilities the business concern is said to be solvent. Continuous losses in a firm will cause erosion of its net worth and make it solvent.

LIQUIDITY:
This refers to the ability of the business concern to pay off the maturing current liabilities from the amounts realized out of the current assets. Liquidity means the short-term solvency. A business concern will not have to meet its entire outside liabilities in the short term. It may have to meet its current liabilities in the short term from short-term assets. If it has enough current assets to meet current liabilities, its position is said to be liquid i.e. its current assets should be more than its current liabilities. The degree of liquidity depends upon the size of current assets and current liabilities, the quality of current assets and maturity dates of current liabilities. It has to be ensured that current liabilities are raised to finance current assets only and that current assets when sold or realized are employed to reduce maturing current obligations. Any deviation from this important principle of liquidity will bring liquidity crises for the business organisation. For example working capital bank finance (current liability) if invested in purchase of a machine (long term asset) will cause liquidity problems because the bank borrowings will remain outstanding/overdrawn for long, since the funds have been blocked in an asset not intended for sale. Similarly, if a business concern employs the sale proceeds of stocks in long 55

term investments in a sister concern, it will face liquidity problems, since the cash which should have been allowed to liquidate maturing claims, say trade creditors has been invested on a long term basis.

NET WORKING CAPITAL (N.W.C.):

The long term funds which are used to finance current assets are known as Net Working Capital of liquid surplus. Net Working Capital is the surplus available after the long term assets (uses) are financed out of the long-term liabilities (resources). The concept of NWC can be displayed in the form of an equation as under; NWC NWC = Current Assets - (minus) Current Liabilities OR = Long Term Liabilities - (minus) Long Term Assets (Net worth + Term Liabilities ) (Fixed + Non-Current + intangible)

The Net Working Capital is thus the measure of liquidity of a concern. The higher the NWC the more liquid the business concern is. If long term liabilities are not adequate to meet long term assets, the business will have to seek recourse to additional current liabilities. In other words, in such a situation current assets will be less than current liabilities and net working capital would be negative. A negative NWC would reflect lack of liquidity and diversion of current liabilities for financing of the long term assets.

6.5.2 CLASSIFICATION AND ANALYSIS OF PROFIT AND LOSS ACCOUNT:

Profit and Loss Account gives the summarized position of sales and other incomes and other expenses and the amount of profit/loss made at a given level of operations. Detailed break up of various incomes and expenditures should be noted from the schedules/notes attached to the statement during analysis and classification. Profitability is the most useful measure of financial position of a business concern. Comparative quantity and cost analysis of various items in this statement should be made to find out whether return on sales, return on capital employed, et., and overall performance of the concern is satisfactory and progressive. Items in the profit and loss account are classified under the following major heads: 56

SALES:
Sales represent the cause at which the goods/products have been billed/sold. If this includes the excise duty it is known as Gross Sales. The net sales can be computed by deducting the excise duty and returns from Gross Sales. Net sales represent the effective volume of business on which profit is earned or loss is sustained. Break up of Gross Sales i.e. Domestic Sales and Export Sales should be given, preferably a break up of the sales into cash sales and credit sales should be provided. Percentage increase/decrease in value of sales and the quantity sold should be studied. Such aspects like quantity sold, rebates, returns and allowances and the amount paid by way of commission and discount to dealers and selling agents need to be examined. For example a higher allowance for returns and discounts means that there is something wrong with the goods produced or handled while a large commission to dealers implies that a more than normal effort is needed to effect the sales of the goods manufactured by the concern.

COST OF SALES:
The profit comes primarily from the sales of goods and services. However, all sales proceeds are not profits for a business concern. it costs some money to make of produce the goods. Further it is likely that some of the goods produced during a particular year are not be sold during that year. Such goods do not contribute to the profit although they form a part of the asset. The amount of money spent on producing the goods for sale is known as cost of sales or cost of goods sold. It takes into account the following costs:a) Cost of raw material consumed (incuding stores and other items used in the process of manufacture); b) Cost of other spare consumed; c) Power and fuel charges; d) Direct labour charges (i.e. factory wages and salaries); e) Other direct manufacturing expenses (like repairs and maintenance expenses of plant and machinery, factory rent, etc.); f) Depreciation (on factory land/building, machinery, etc.).

GROSS PROFIT:
The figure of net sales minus the cost of sales in the gross profit made during the current year. In the trading account, the firm will record the sales realized, cost of goods sold and gross profit 57

earned. If we know the sales and correct gross profit, the cost of goods sold can be calculated by deducting the gross profit from the sales.

OTHER INDIRECT COSTS:

Cost of production and cost of goods sold represent direct costs which are identified with the products manufactured and the goods sold. These costs are what are known as product costs i.e. costs, which can be directly related to the products manufactured. Such costs can also be matched with the sales or revenue earned. Apart from these costs, the business concern would have incurred expenses/costs (like salaries to office staff, sales personnel and relative expenses on stationary, telephone, postage etc.) in keeping its day to day operations going. Such costs are known as indirect costs. These costs cannot be assigned to the product but can be assigned as expired costs to the period covered by the financial statements. All indirect costs are to be met out of gross profit.

OPERATING PROFIT:
This is the profit from operations after deducting all operative expenses or costs (i.e. direct and indirect costs) from the sales. In other words Gross Profit minus indirect expenses (selling, general and administrative expenses) will give the operating profit of a business. Interest on loans and advances or other finances available to a business concern is also an indirect cost. Operating profit before interest. After interest is charged, this will be known as operating profit after interest.

NON-OPERATING INCOMES AND EXPENSES:

Besides the operating expenses (both direct and indirect), a business concern would usually incur some more expenditure like Provision for bad and doubtful debts, legal expenses, write off of goodwill and other intangible assets, loss on sale of old/obsolete stocks, machinery, investments, etc. these expenses are not directly linked with normal operations of a business and are known as non-operating expenses. Similarly a business may derive income other than sales and income from normal operations like Dividends from investments, interest on bank/other deposits, recovery of doubtful debts/bad investments, etc. tax and other refunds, profit on sale of old stocks/machinery/investments etc., such incomes, not derived from normal operations, are called Non-operating income.

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PROFIT BEFORE TAX:

Operating profit minus non-operating expenses and plus non-operating incomes give the profit before tax. In other words, profit before tax can be arrived at by deducting from sales and other incomes (operating and non-operating) all expenses i.e. operating expenses (cost of sales and other indirect costs) and non-operating expenses.

PROFIT AFTER TAX:

Business concern has to pay taxes on profits they earn during a particular year, at a prescribed rate. The rates vary from time to time. This tax is paid sometimes after the end of the year and therefore a provision for tax from the profits of the year is made. Profit after tax will be equal to profit before tax minus tax or provision for tax.

RETAINED PROFIT:
The profit after tax (net profit) can be used for distribution under various heads like write offs, adjustments, payment of dividend or drawings by partners/proprietors. The undistributed profit, which is retained in the business, in the shape of reserves or surplus profit is known as retained profit.

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WORKING CAPITAL FINANCE

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WORKING CAPITAL FINANCE

When any activity is started, whether manufacturing or trading, it requires funds or capital for creation or producing assets. The producing or fixed assets (also known as long term assets) such as building, plant and machinery etc., are needed for creation of a capacity, these assets remain in the business more or less permanently and are not meant for sale. The funds used for acquiring these assets are known as fixed capital or long term capital. These long term funds may be contributed by the owners by way of capital or equity; reserves and surpluses (if the concern is in the existence and has ploughed back profits) and by term lending financial institution/banks, by way of term loan. When producing capacity is created, the concern need funds or capital for creation of circulating assets to operate within the capacity created. These also known as current assets, like raw materials, stock in progress, finished goods, receivables, cash etc., go through the production cycle and meant for eventual sale. Funds required for financing current assets are called working capital funds. Its main sources are short term or working capital limits from bank or sundry creditors and other current liabilities and contribution from net worth and other long term liabilities, etc. Bank provide the working capital finance in the form of cash credits, overdrafts, demand loans (for working capital purpose), bills purchased discounted limits and pre-shipment and post shipment etc. Working capital finance considered by the banks is subject to guidelines issued by the Reserve Bank Of India (RBI) from time to time. The RBI has brought about major changes in the lending system for working capital finance in the last two decades. In terms of guidelines issued by RBI, banks consider production oriented and need based finance to the borrowing concerns. Therefore, it is necessary to make proper assessment of the total requirements of the working capital funds by a unit according to its production requirements. Inadequate levels of working capital may result in under utilization of capacity and serious financial difficulties. Similarly excessive levels may lead to unproductive use and unnecessary interest burden on the unit.

7.1 WORKING CAPITAL CONCEPTS:

Working capital represents finance or funds needed by the business concerns for their day to day operations. Working Capital mainly consists of investments in raw material, work-inprogress, finished goods and receivables. These assets form bulk of current assets and are termed as chargeable assets.

7.1.1 GROSS WORKING CAPITAL (GWC):

The term gross working capital refers to the funds required for financing the total current assets (TCA). In other words it means the funds invested by a business concern in current assets. 61

Current assets are those assets which can be realized in cash or sold or turned over during the operating cycle of the business usually not exceeding one year. Current assets represent uses of funds. The sources of funds for investment in current assets are provided partly from current liabilities and partly from surplus, long term funds or net working capital in the form of owned funds (net worth) and other long term/liabilities. Current liabilities are those liabilities which are repayable within 12 months from the date Balance Sheet.

7.1.2 NET WORKING CAPITAL (NWC)

Net working capital represents the long term funds invested in current assets after meeting the investment in long term assets NCW can be calculated by working out the difference between current assets and current liabilities. It also arrived at by working out the difference between long term funds or liabilities or long term uses or assets. An important concept of working capital is the funds borrowed short should not be invested long. This is because the long. This is because the current liabilities (being payable within a short period of time) if blocked as a permanent (or long term) investment in fixed assets and other long term assets, cannot be repaid when due. However, surplus long term funds can and should be invested in current or short term assets in the form Net Working Capital. Since the current assets are porn to price fluctuations and also in order to have the owners stack in current assets or gross working capital, it is desirable to have AWC as positive i.e., the current assets should be more than current liabilities or the current ratio should be 1:1. this would mean availability of working funds or liquidity. For the financing banker this would be the safety caution for funds lent. NWC assumes vital importance in the management of working capital finance of the business concern. An essential feature of efficient working capital is availability of positive and adequate NWC. A positive but inadequate NWC entails liquidity constraints on the part of business concern where as negative or adverse NWC is an obvious symptom of sickness of business concern.

7.1.3 WORKING CAPITAL GAP (WCG):

WCG represents the difference between total current assets (TCA) and current liabilities excluding bank borrowing i.e., other current liabilities (OCL):

7.1.4 OPERATING CYCLE:

The basic need of every manufacturing concern is procure raw materials for the purpose of production. In the process of production, the business incurs cost in the form of wages for labor, power and fuel charges, and deprecation on machinery and other manufacturing expenses. Raw material ultimately converted it to finished goods remains in the form of stock awaiting to be 62

sold in the market. As per the trend in the market the goods are sold against cash or credit. The goods sold against credit or receivables/debtors. Receivables are ultimately paid in cash. The total time spend with which business activity rotates is called an operating cycle or production/working cycle. The operating cycle of any manufacturing concern consists, therefore, of following stages of conversion:

i) ii) iii) iv) v)

Conversion of cash into raw material raw material may be procured either on payment by cash or on credit. Even if purchased on credit, cash may have to be paid after certain period; Conversion of raw materials in stock in process; Conversion of stocks in process into finished goods. Conversion of finished goods into cash or receivables/debtors/bills; Conversion of receivables/debtors/bills into cash. A non manufacturing trading concern may not require funds for purchase of raw materials and there processing but it also needs finance for storing goods and providing credit to its customers on sales. Similarly a concern engaged in providing services may not have to keep inventories, but it may have to provide credit facilities to its customers. Thus all enterprises engaged in manufacturing or trading or providing services require finance for their day to day operations and each one of these has a peculiar operating cycle. Constituents of operating cycle namely cash, raw materials, stock in process, finished goods and receivables represent a portion of total current assets. Thus, investment in operating cycle represents a part of Working Capital Finance. The finance in terms of operating cycle approach is considered as production oriented and need based working capital in the normal course. Trading concerns have the quickest turnover of current assets and therefore a shorter operating cycle. At the other end of the scale, the turnover of current assets of heavy engineering units is very slow and is in some cases (ship building units etc) not even once a year they have, therefore, longer operating cycle. The duration of the operating cycle depends upon several variables:-

i) ii) iii) iv) v) vi)

Average ordering period for raw materials. Period of processing. Average, period required for packing and forwarding. Average collection period. Economic forces of demand and supply. The policy of the business concern in the matter. The process of conversion of cash to cash through the operating cycle cannot be instantaneous. Depending on the business conditions, delays are inherent in the cycle. For instance where the 63

raw material is scarce or is a quota item, more raw material is required to be held which implies blocking up of funds. The delay in work in process is a gain dependent on the nature of process, e.g., in a chemical processing unit, the entire process of conversion may be completed in less than a day while in an engineering unit it may extent over a few months. A gain if the manufacturing is carried out specific orders, the finished products may be dispatched as and when completed, thus avoiding the need for storing the finished goods. However, if the products are manufactured to stock before subsequent sales, stocking of finished goods will be governed by market conditions. Items under short supply lifted fast while others are held for long. Delays in the last stage that ids the conversion of receivables into cash depends on trade practices, economic factors etc. Thus depending on the environment, product and process delays occur in the various stage of the operating cycle. Goods are held in between the different stages and these goods represent money value. The investment in operating cycle indicates the money blocked up in the form of working capital by business. Apparently, therefore, in order to keep investment in operating cycle/current assets to a minimum level the operating cycle should be as short as possible. Every business, as a part of efficient working capital management should work out a system by which the time span of operating cycle is reduced and as result investment in operating cycle is minimized. However, the business must ensure educate investment in operating cycle through out to prevent production laws which might ultimately affected profitability of the business. The ascertainment of the length of the operating cycle is, therefore, essential for proper assessment of working capital requirements and for deciding the extent of working capital facilities.

7.2 ASSESSMENT OF WORKING CAPITAL REQUIRMENTS

Before the actual, assessment of working capital is taken up, it would be advantageous to get an idea about the various terms used in context.

7.2.1 QUANTUM OF WORKING CAPITAL

The quantum of working capital requirements (Gross Working Capital) depends on nature of activities of an enterprise. In addition to this it depend on two main factors. i. ii. Level of activity or operations. Duration or length of operating cycle. The level of activity refers to the level of production or sales. An increased sales turnover would normally require increased working capital for its achievement. For instance if a unit producing 64

1000 units per month desires to produce 1200 units in the coming months then it requires more working funds to attain the increased production target. On the other hand if for the same production level of 1000 units per month, the raw material availability changes from 10 to 15 days. Then more raw material is to be stored which means requirement of additional working funds. Similar situations might arise in respect of work in process, finished goods and receivables. For estimation of gross working capital requirements we must also know the level of operating expenses required for attaining projected level of sales. E.g., if the sales forecast a unit for next year are Rs. 800000, its operating expenses are Rs 600000 and the estimated length of its operating cycle is 4months(120days).what shall be total working capital requirements achieve the sales target ?since each rupee of W.C. employed during year will be turned over 3times (360 days 120 days).the total working capital required by the unit on an average will be Rs2.00 lacks(Rs 6lacs 3).Any reduction in the length of operating cycle will improve the W.C. turnover ratio. Thus if the same unit is able to reduce the length of operating cycle from 120 days to 90 days ,its W.C. turnover ratio will improve from 3times to 4 times per year (360 90 days).Accordingly the gross working capital requirements will be Rs 1.50 lacks (Rs 6 lacks 4) instead of Rs 2.00 lac. This means better utilization of resources on account of better management of one or more phases of operating cycle. It has to be ensured that the unit will have regular supply of raw materials to facilitate uninterrupted production. The unit should also be able to maintain adequate stock of finished goods for smooth sales operations. The requirement of trade credit facilities to be given by the unit to its customers should also be assessed on the basis of practice prevailing in the particular industry / trade.

7.2.2 VIABILITY OF THE PROJECT

Before agreeing to provide working capital to a unit, viability of the project is to examined a detailed study is usually done by financial institutions and banks while providing term loans finance to unit for acquisition of fixed assets so as to ensure that the project will generate sufficient returns on resources invested in it. The viability of a project depends on technical fusibility and marketability of the products at profitable price availability of financial recourses in time and proper management of the unit in brief a project should satisfy the tests of technical, commercial, financial and managerial feasibilities. Proper co-ordination amongst banks and financial institutions is necessary to judge the viability of the project and to provide working capital at appropriate time without any delay. If a unit approaches the bank only for working capital requirements and no viability study has been done which is generally done at the time of providing term loans, a detailed viability study is necessary before agreeing to provide working capital finance. It must be emphasized that assessment of working capital requirements of a concern must be preceded by a detailed appraisal of the past and future financial viability of the concerns planning, operations and financial position. The past and future viability can be ascertained by examine the financial statements for the past 2-3 years as well as the estimated/projected 65

statements for current and next year. It is implicit that the concern will have to submit an acceptable business plan or forecasts in the form of estimated /projected statements to the bank. Thereafter assessment of working capital needs is based on past trends and end-use of funds and estimated requirement of additional funds as revealed by the business plan of the concern (or the cash budget in the cases of those concerns with seasonal operations)

7.2.3 ACCEPTABLE BUSINESS PLAN:

Based on the acceptable business plan submitted by the customer, acceptable(projected) level of production and sales for the current level of production and sales for the current /next year will have been determined .This will to a large extent depend on past trend in operations of the unit and will be the basic factor for assessing the total working capital requirements .The projection of production /sales level depends on 6 major factors;

A. Does the concern have any utilized capacity in hand? B. Is it embarking on an expansion or diversification program, which will affect current/years production and sales? C. What are the expected market conditions and what kind of sales promotion campaign has the decided upon? D. Are the good marketed by the concern covered under standard quality control specification (say ISI specification).

E. What is the volume of pending orders on hand vis--vis the position in the previous year for the same period? F. Are the essential inputs(raw material/labour, etc)likely to be adequate to meet the projected production and demand? The projected production /sales volume should be based on actual current price and not on anticipated increase in prices in future. For this purpose it is important to ascertain in the increase in production /sales both value wise and quality wise .A higher sales figure estimated for the current /next year as compared to the actual sales figure for the previous year can be accepted provided there is scope for increasing capacity utilization or capacity is in the course of being ague anted by virtue of an expansion /diversification/ modernization program. A higher sales production which is expected to be the result of higher selling prices stimulated by higher cost of inputs but without any increase in production /sales in real terms should not be supported by the bank. In short the production /sales targets should be reasonable, realistic and achievable and not ambitious and optimistic ones assumptions underlying the targets should be studied. Once the production /sales estimates have been finalized, the next steps is to analyze the cost figures in the projected profit and loss statement .Consumption cost of raw materials /stores, 66

cost of production and cost of sales and other indirect expenses should have a reasonable relationship with the increased level of sales .Sudden and unreasonable increase or decrease in various cost components can be noted by trend analysis that is comparing projected figures with past years actual. In short it has to be ensured that various cost/ expenses and resultant profit has been projected on a realistic and reasonable basis and there is no over estimation of profits . Projected sales and cost figures can be related to past figures as illustrated in the following examples: (Rs in thousands)
Sales/production factors Sales Increase in sales (%) Consumption of raw materials Consumption of stores/Spares Cost of Production Cost of goods sold Gross profit Year I Actuals 160 % to sales Year-II Projected 200 25% % to sales

96

60%

120

60%

5%

10

5%

136

85%

170

85%

128

80%

160

80%

32

20%

40

20%

Projected sales and cost figures, which compare favorably with past trends will obviously be accepted. Major variations with past trends will have to be explained and if the explanations are unsatisfactory, the forecast /plans will have to be got suitably revised to make them acceptable. After the operational plan is finalized, next step is to analyze the projected balance sheets which will reveal the projected level of long term and short term liabilities (including bank borrowings) and the long term and short term assets and the position of the NWC. Any major additions projected in fixed assets and sources of financing the same shall have to be studied .We have already seen that working capital has three important components i.e. current assets ,current liabilities, and net working capital and that the current assets (or gross working capital) should be partly financed by current liabilities and partly from NWC. It is therefore essential that the identification of the current assets and liabilities are properly made both for ascertaining the NWC correctly as well as correct assessment of total or gross working capital finance that the bank can grant to the customer .It is important to note that customer may try to include more 67

items under current assets and exclude some items from current liabilities in order to jack up his liquidity and get more and more finance from the bank.

7.2.4 CURRENT ASSESTS BUILD-UP:

The projected level of current assets will determine the gross working capital requirements. The components of current assets or gross working capital are:A. B. C. D. E. Raw material and consumable stores; Stocks in process; Finished goods; Receivables; Other current assets (like cash, investment, advances to suppliers of raw material/stores and other advances etc).

Assessments of funds required to build up current assets at any time provide a measure of the total working capital required by a unit at any time .The holding of current assets will depend on following factors:F. Duration of the operating cycle: G. Demand and supply position for each item. For example, if the market for raw material is depressed or the raw material is easily available , the concern can buy these items off the shelf and need not to go in for heavy stocking: H. Cost factor will determine how much the concern stocks at a time: I. Seasonality of operations will obviously dictate the amount of current assets to be had: J. Past trends in the form of past activity ratios can determine the reasonableness or other wise of the projected current assets holding: K. The future prospects of the concern will also help in determining how much to invest in current assets: L. Selective credit control directives issued by RBI in respect of certain sensitive commodities prescribe over ceilings on limits ,margins and interest rate of banks and these control the holding of current assets: M. Central/State Governments stipulate the norms especially in respect of agricultural commodities like stocks of rice/ wheat ,raw cotton, etc. That the rice sellers ,cotton mills etc. Can hold.

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7.2.5 CALCULATION OF PERIOD OF HOLDING:

Period of holdings of current assets are calculated as under:-

A. RAW MATERIALS AND CONSUMABLE: Stock holding period of raw material and consumables is calculated in relation to annual consumption cost of raw materials and stores .Funds requirement for holding raw materials, etc. Will thus depend on:a. Average consumption of raw materials: b. Fluctuations in the raw material availability: c. Fluctuations in the raw materials consumption depends on whether the items are regularly consumed or bulk quantities are required at a time: d. Minimum quantities supplied by the market: e. Storage facility availability: f. Criticality of an item (i.e. how important is the item in order to maintain production).

B. STOCKS IN PROCESS: Level of stock in process to be held will be calculated in relation to annual cost of production. The funds blocked up in stock process depend on the following factors: a) time required for conversion of raw materials to finished goods: b) number of products handled at a time in the process: c) Average quantities of each product processed at each time (batch quantity ). d) The process i.e. the manners in which raw materials are added in the process. To illustrate, the major raw materials in the case of grey iron foundry are added in the initial stage itself, while in an assembly unit, like TV industry the major raw materials and components are added at the last stage of the process. C. FINISHED GOODS: The holding period of stock of finished goods is expressed in relation to annual cost of sales. Goods may be manufactured against firm orders or against anticipated orders. In the former case the quantum of finished goods depends on; a) Delays due to inspection of the finished goods especially were an external agency is involved. 69

b) Delays in preparation and dispatch of documents. c) Delay in shipment. d) Delay due to non availability of wagons. e) Minimum quality that can be dispatched (e.g. full track load). In the pace of goods manufactured to stock against anticipated order, the quantum of finished goods held depends on. a) b) c) d) Average dispatch quantity of finished goods; Variation due sudden requirements or slump in the market; Minimum quantity that can be dispatched; Delays due to non availability of truck, wagon etc.

D.

RECEIVABLES: Sales may be affected under three different methods.

a) Against advances received In this case no funds are blocked up in bills and hence no funds are needed. More over the advance received itself goes to meet the working capital needs. b) Against cash in the case of cash sales again no funds are blocked up and hence no funds needed. c) On credit In the case of credit sales working funds are required to meet the delays in sales realizations. The quantum of working funds required depends on period of credit given and efficiency of management of debit collection. The holding level of receivables is computed in relation to gross sales (or gross credit sales if this figure is available. Thus the past activity ratios, norms (if any) and other factors discussed earlier, will determine the period of holding of major current assets viz. Inventory and receivables also known as chargeable current assets. When the period of holding has been established, they have to be converted in terms of monitory value to determine the working funds blocked in each item. For e.g., if on basis of trend analysis and other factors, it is decided that the customer should hold one month s requirements of raw materials at peak level. What should be the volume of this level of raw material? In the previous example, total consumption of raw materials projected for year second is Rs 1,20,000 /= one month s stock of raw material will be equivalent to one month s consumption that is the customer can hold raw material at any time upto Rs 10,000 /= (1,20,000 12 ). Similarly the value of other current assets can be calculated as illustrated below (based of previous example).

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Current Assets

Period of holding (say)

Sales/Production cost per annum

Value of current assets

Raw materials Consumable stores/spares

1 month

120 (Consumption of R.M) 10 (Consumption of stores/spares).

10(12012)

1 month

1(1012) (Approx Value)

Stock in process

1 week

170 (cost of production.)

3(17052) Approx. Value

Finished goods. Receivables

15 days

160 (Cost of sales ).

7 (16024 ) (Approx. Value)

45 days

200 (Sales)

25(2008)

7.2.6 OTHER CURRENT ASSETS

The projected level of other current assets viz. cash and bank balance, investment, advances to supplies of raw material, advance taxes, prepaid expenses etc, should be in tune with the past trends and projected level of working. It is generally expected that 15 to 30 days cash expenses is required to be kept in the form of cash for meeting out contingencies like fluctuation in material prices, delay in sales realization etc. or for payment of various cash expenses like wages and salaries, power, fuel, rent etc. the quantum of such cash retention for meeting working capital requirements depends upon the process time. For activities having long processing time like in ship building, higher quantum of such cash balances have to be retained. 15 to 30 level of cash are suggested for small sale and medium scale units. Large units can and should manage with 7 to 10 days cash in hand. Cash expenses will include; wages and salaries, power, fuel and water charges, factory and office rent, repairs, and maintenance charges, selling general and administrative expenses. The buildup of current assets will now assume the format given on the next page:

Current Assets

Period of Holding

Value in Rs. A

a) Raw material

Months consumption

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b) Consumable stores/ spares. C) Stocks in process d) Finished goods e) Receivables f) Other current assets. i) Cash and bank balance} ii) Advance to suppliers } iii) Others (specify) }

Months consumption months C.O.P months C.O.S months G. Sales

B C D E

Peak build-up current assets (i.e. gross W.C requirement) = A-B-C+D+E+F

The purpose of assessing the total working capital requirement (and merely the investment in inventory and receivables alone) is to determine how this total requirement of funds will be meant. E.g., if part of the raw material is available on credit, bank finance will be required only for that portion of raw materials, which represents cash purchases. Similarly if advance payments against orders are expected to be received, only part of the finished goods not covered by the advance payment received will reacquire bank credit.

7.2.7 SOURCES OF WORKING CAPITAL FUNDS:

After estimating the projected level of current assets the next step is to apply all the funds that are/ will be available to finance the current asset. Two major sources of working capital funds to finance the gross working capital requirement are:a) Current liabilities. b) Own Funds or net working capital

7.2.7.1 CURRENT LIBILITIES:

Major current liabilities are:i. Bank borrowings. ii. Sundry creditors. iii. Other current liabilities. a) Advances from buyers. 72

b) Short term borrowings. c) Other including provisions.

7.2.7.2 BANK BORROWINGS

By and large, a major portion of the working funds are finance by the banks because of the following reasons:i. ii. iii. Within a prescribed limit, working capital finance can be availed as per requirements. The limit itself can be altered depending on the activity level. The rate of interest is reasonable compared to other borrowings.

It must be stressed that the bank is a lender of last resort. When a concern has razed all other forms of funds and laid out its own share in the form NWC then is the time to approach a bank for short term finance. Banks lend on the bases of landing and other norms discussed later in this chapter.

7.2.7.3 SUNDRY CREDITORS:

Credits available against purchase of materials/stocks etc go to meet the working capital needs. e.g., SSI unit is engaged in cloth printing on a job work bases where the customer himself gives the cloth to be printed. The unit gets about one month credit on purchase of dyes and chemicals for printing, while many a time the printing charges are collected within 15 days. Thus the unit is able to effectively finance the entire working capital needs from sundry creditors itself. Trade credit is usually a cheap source of finance so long as discounts are not offered and /or overdue interest is not charged. If discounts are available but utilized, trade credits as a source of working capital finance can generally be more expensive than other sources of funds. E.g. assume that a supplier offers a normal credit period of 60 days with the option that payments within 30 days are entitled to a trade discount of 2%. If the purchasing firm decides not avail of the discount, it will lose 2% for 30 days on all its purchase from this particular supplier. This loss works out to effective interest ratio of 24% per annum, which costlier than the existing banks lending rates. Sundry creditors form a major source for meeting working capital needs. It is as such essential to assess the projected level of creditors properly. Trade parties and past trends (in case of existing units) can help in assessing the level of creditors properly. It may be noted that many a time parties lend to project a lower of creditors compared to past trends and this aspect should be fully studied.

73

7.2.7.4 OTHER CURRENT LIBILITIES:

Advance from buyers is a source of working funds especially if sales are made against firm orders. Industries in general also get credit on some of the expenses on a continuous basis. About 45 days credit is available on power bills, about 15 days in the case of wages paid monthly. This is a type of short term finance available. Short term borrowings by way of unsecured loans/ deposits are other source of working funds. Working capital requirements fluctuate on a day to day basis depending on exigencies. Therefore, occasion do arise, when the unit has to resort to short term borrowings from friends or other market sources. Provision for income tax and similar provisions made for meeting certain liabilities could be another source until the liabilities crystallize. The projected levels of other current liabilities should be assessed properly and these should be in tune with the increased working and past actual levels maintained by the unit.

7.3 WORKING CAPITAL GAP:

After assessing the projected level of current assets and current liabilities, the working capital gap will be calculated as under: I) II) Projected current assets Less: Projected current liabilities (Other than bank borrowings) W.C. GAP {A - B} : : A B

III)

Working capital gap so arrived at should partly financed from NWC and partly from Bank finance.

7.4 NET WORKING CAPITAL AND MARGIN:

NWC is contribution from long term sources (owned funds and long term liability) towards financing current assets. How much NWC a borrowing concern should have depends upon the margin money stipulated by the bank. While providing working capital finance bank stipulates a certain stake of the borrower to ensure proper management of funds. This stake of the owner otherwise termed Margin Money is what comes out of the equity or own funds and other long term funds. The actual and estimated position of NWC needs to be properly assessed before determining the level of permissible bank finance.

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7.5 MARGINS:
Margins required to be maintained on current assets determine the requirements NWC. The %age margin charged will depend upon the quality, marketability and price stability of each current assets. Evidently margin against stocks-in-process will be higher than that charged on raw materials or finished goods. The question of margins arises for several reasons. Firstly, the owners of the enterprise must have an adequate financial stake in current assets. Secondly, current assets are normally subject to price fluctuations. If prices are highly volatile financing of current assets can be a risky proportion. In such circumstances high margins ensure that the risk is born by the owner and not by the bank/creditors. It has also to be considered that a forced sale may realize values for lower than market prices. In the event of enforcement of security, the bank has to realize not only the principle amount lent but also interest outstanding and other charges. Adequate margins therefore, provide a cushion of safety in lending against current assets. The level of margin to be maintained will differ not only from security to security but also one type of borrower to another. A borrower having strong liquid position can afford higher margins. A sick unit may need relief from high margin for a temporary period for revival. Large borrowers are required to contribute minimum NWC equivalent to 25% of current assets as per lending norms. Banks generally levy concessionary margins while financing the W.C requirements of small scale units. Sensitive commodities like food grains, oil and oil seeds, cotton and sugar etc are subject to margins prescribed under Selective Credit Control directives.

7.6 PERMISSIBLE BANK FINANCE (PBF)

In the case of large borrowers PBF is calculated by computing WC GAP and deducting the margin requirements or NWC as required under the lending methods. These lending methods stipulate the minimum NWC requirements to be contributed by the borrower. Another way of computing the level of bank finance is to apply all the funds that are available to finance the current assets. Therefore, from each item of the balance current assets, margins are deducted (which represented the firm s own contribution in the form of NWC), the residual portion of current assets will represent the amount of credit that can be provided by the bank. The bank credit figures arrived at in this manner is known as Advance value or Drawing Limit\Power . This method is usually applied to small borrowers (that is those not covered by lending norms). Here is an illustration.

75

Current Assets

Value

Less Value

Margins (%)

Advance value or drawing power or bank finance Permissible Rs____

i) Raw material less Credit Available ii) Consumable stores less Credit Available iii) Stock-in-process Iv) Finished Goods less advance from Buyers v) Receivables

Rs____ Rs____ Rs____ Rs____ Rs____ Rs____

Rs____ (say 25%)

Rs____

Rs____ Rs____

(say 50%) (say 50%)

Rs____ Rs____

Rs____ Rs____ Rs____

(say 25%) (say 10% to 50%)

Rs____ Rs____

vi) Other current Assets (cash, Advance to Suppliers Others etc.) less other Current liabilities ( including Provisions) Total Funds Required

Rs____

Rs____

Rs____

(say 100%)

Rs____

Rs____ (A)

Rs____ (B)

Rs____ (A - B)

=( C ) =

In the above table represents the total margin requirements to be contributed by the borrower. The actual \estimated NWC of the borrowing concern should be adequate to meet the margin requirement (B) in full. In case there is a short fall in the NWC, the concern will be required to raise long term funds in the form of capital, long term unsecured loans\deposits etc to the extent of short fall. If the NWC is surplus [that is more than margin required (B)], to that extend the bank finance (C) will be reduced. For instance, if the margin requirement is around the level of two lacks, and the NWC is also Rs 2 lacks, there is a proper balance and the bank finance computed can be realized as a limit to the borrower. If the NWC is say Rs 1.50 lacks, the concern has a short fall of Rs 0.50 lacks and before the limit is realized, the concern shall have to raise Rs 0.50 lacks by way of long term funds. But if the NWC is Rs 2.25 lacks, the concern has a surplus NWC and therefore, the bank finance computed will obviously have to be reduced by 25000/= 76

so that only the genuine and need based requirements are met from the bank finance and there is no over financing. Under-financing a concern is as dangers as over financing it. Proper assessment has therefore to be made so that real productive needs of the concern are financed adequately.

7.7 FIXATION OF LIMITS

Within the overall permissible bank finance and depending on drawing power against stocks and receivables, separate limits for drawing against stocks and receivables/book debts should be fixed. Accordingly cash credit limits may sanction against stocks hypothecations or pledge of goods and bills purchase/discount limit may be sanctioned against receivables. Bill finance is more liquid than advances against book debits because (I. bills either have fixed maturity dates or payable on demand II. Drawees are bound to pay on time otherwise they risk their reputations if the bank notes and protests the dishonored). The assessment of working capital requirements of business concerns havening more than one line of activity can be made in two ways. The activity wise or division wise assessment can be made and separate credit limits sanctioned for each activity/division or alternatively an overall assessment made for the company and wherever necessary, sub limits could be allocated for use of a particular activity or division.

7.8 RBI GUIDELINES FOR BANK LENDING FOR WORKING CAPITAL PURPOSES:
With a view to bringing about reforms in the bank credit system and evolving a systematic and uniform approach to assessment of working capital finance by banks, RBI constituted a study group popularly known as Tandon Study Group, in 1974. The study group s main recommendations covered quantities norms for inventory and receivables built up: financial norms or lending methods for computing permissible bank finance or working capital and norms for financial follow-up and related matters. In 1979 RBI appointed another working group known as Chore Committee to revive the cash credit system in detail in the light of Tandon Committee norms. This committee extended the recommendations of the Tandon Committee with some modification. Following the acceptance of Tandon/ Core Committee norms by RBI, all borrowers having working capital limits of Rs 10 Lack and above from the banking system where brought under the new lending system. Over the years, RBI has made certain changes in the system with the liberation of Indian economy since 1991, need was felt to further review the lending system to make it more flexible in the changing economic scenario. RBI accordingly constituted an In-House Group under the chairmanship of Miss I.T. Waz in January 1993. In terms of the report of the group borrowers enjoying working capital limits less than Rs 100 lacks have been exempted from the application of inventory/Receivable norms and lending methods. In the year 1997-98 Reserve Bank of India announced withdrawal of their extent prescriptions with regard to the assessment of the working capital finance based on the concept of 77

Maximum permissible Bank Finance (MPBF),enunciated by the Tandon Working Group ,on the basis of minimum current ratio of1:33:1.Full operational freedom was granted to banks in the assessment of working capital needs of borrowers. The Apex Bank further advised the banks that the turnover method as already prevalent for computation of the working capital needs of the SSI borrowers upto Rs 2.00crore, should be used for assessing the working capital requirements of this segment of borrowers ,banks have been given the freedom of follow cash budget system for assessing the working capital finance or even retaining the present system of MPBF with necessary modification or any other method/system as would be found appropriate by the individual banks. The banks were advised to evolve appropriate system for assessing the working capital needs of their borrowers, within the prudential guidelines and exposure norms already prescribed. The Reserve Bank of India also advised the bank to lay down transparent policy and guidelines for credit dispensation in respect of each category of economic activities.

7.9 METHODS OF LENDING (FINANCIAL NORMS):After estimating the reasonable level of current assets based on norms/past trends, required for operations of a unit,, sources of financing the same are decided .The total current assets will be financed partly by the creditors for purchases and other current liabilities (excluding bank borrowing). The remaining current assets called the working capital (i.e. from owned funds and long term borrowings) and partly by bank borrowing can be assessed as per the two suggested methods of lending: Method 1: Borrow is required to contribute a minimum of 25% of the working capital gap from long sources (i.e. owned funds +term borrowing) and the balance 75% of the working capital gap will be the maximum bank finance. Method2: Borrower is required to contribute a minimum of 25% of total current assets from long term sources and the maximum permissible bank finance will be equal to W.C. Gap less by this minimum contribution .In the method total current liabilities inclusive of bank borrowing will not exceed 75% of current assets. The 1st method will give a minimum current ratio of 1:1, whereas the minimum current ratio under the 2nd method will be 1:33:1. Minimum NWC at 25% of total current assets under method 2nd ensures the basic financial discipline the borrower must observe if the WC finance is required from the bank. The availability of stipulated NWC accompanied by satisfactory current ratio assures the bank about the short term financial solvency of the borrower.

ILLUSTRATION FOR CALCULATION OF MAXIMUM PERMISSIBLE BANK FINANCE (MPBF)

The project level of the current assets and current liabilities other than bank borrowings as indicated by the borrowers financial position for the next year is as under:78

Current Liabilities (excluding Bank Borrowing) Creditors for purchases other current liabilities

Amount 100 40

Current Assets Raw Material Stock-in-process Finished goods Receivables other current assets

Amount 200 20 80 50

10 360

140

The total current assets as per norms/past trend and in relation to the projected sales/production for the next year. Creditors and other current liabilities also confirm to the past trend. MAXIMUM PERMISSIBLE BANK FINANCE (MPBF):

First method 1. Total current assets 2. less : Current liabilities other than bank borrowings 3. Working capital Gap (WCG) 4. Minimum stipulated NWC-25% of WCG 5. M.P.B.F Current Ratio

Amount 360

Second method 1. Total current assets (TCA)

Amount 360

140

2. less : Current liabilities other than bank borrowings 3. Working capital (WCG) Gap

140

220

220

55 165 1.18:1

4. Minimum stipulated NWC- 25% of TCA 5. M.P.B.F Current Ratio

90 165 1.33:1

79

Method second ensures higher contribution of barrower by way of NWC. The total current assets may include export receivables. These should be taken in to account for the purpose of calculating W.C.GAP but for the purpose of calculating minimum required NWC export receivables should be excluded under both the methods.

7.10 WORKING CAPITAL LIMITS:

With the object of liberalizing the flow of bank credit and simplifying the procedure for assessment of working capital requirements, the Bank/Branches should adopt the turnover method for assessment of credit requirements of the borrowers based on the following thresh hold limits: _ For assessing the fund based working capital finance upto the limit of Rs 5.00 crores for village industries and other SSI units (new as well as existing). For assessing the fund based working capital finance upto the limit of Rs 2.00 crores for borrowers engaged in information Technology and Software Industry. For assessing the funds based working capital finance upto the limit of Rs 1.00 crore for non-SSI borrowers engaged in the service /trade including merchant exporters. The above working capital limits have been exempted from the application of 1st and 2nd method of lending as well as norms for inventories receivables and a simplified formula , for assessment of their W.C. requirements has been prescribed .As per the new formula ,the working capital limits of all such borrowers (new as well as existing) will be computed on the basis of a minimum of 20% of their projected annual turnover .The borrower will be required to bring in 5% of the annual turnover as margin money .In other words 25%of the output value (turnover) would be computed as total working.

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CONCLUSION:
Since the J&K Bank Ltd. was the first state owned bank in the state, which obviously has helped it to dig its roots very much deep. The bank from its very beginning has proved itself. It is working hard and is improving itself day-by-day. Its market share is very high in the state which indicated its dedication towards its customers. The most important thing is that the bank is showing progress. The bank has also achieved excellence in many respects. The policies and strategies are being formulated by the elite personalities, which are discharging their duties and responsibilities in the right perspective. From the entire project work it can be concluded that the bank is really discharging its responsibilities and duties and is making efforts to help the state to become the most prosperous in the country.

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RECOMMENDATIONS/SUGGESTIONS: 1. The bank has got a great image particularly in J&K state so it should take such initiatives so as to make the state a self-sustained and financially independent. 2. Since our state in monopoly in various products, the bank should finance those activities which are associated with these products such as saffron, almond, handicrafts etc. 3. Our state is bestowed with so many natural resources especially water resources. Those projects which involve the utilization of water resource such as hydroelectricity, irrigation etc should be financially assisted. 4. Bank should encourage such project which will involve the employment generation. 5. Such loan schemes should be introduced which will include flexible rate of interest on the borrowings. For the initial some period of time the rate of interest on the lending should be less than the normal. On one hand this will result in the less interest burden on the borrower and also made him to pay the loans as early as possible. 6. The drive should be started by the bank to restore the sick industries in the state, it will help the bank as well as generate employment opportunities for the youth of the state. 7. The Bank should help to make business activities safe in the state by providing schemes which are least risky. 8. The bank should also provide financial assistance to all those projects which are associated with the environmental activities such as protection of lakes, aforestation etc. thereby performing its corporate social responsibility.

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PRESENT DAY SCENARIO OF J&K BANK

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PRESENT DAY SCENARIO OF J&K BANK

Having being ranked at the 26th slot by D&B among the Indian corporate, the Jammu & Kashmir Bank is today one of the fastest growing banks in India with a network of more than 500 branches/offices spread across the country offering world class banking products/services to its customers. Today, the Bank has a status of value driven organization and is always working towards building trust with Shareholders, Employees, Customers, Borrowers, Regulators and other diverse Stakeholders, for which it has adopted a strategy directed to developing a sound foundation of relationship and trust aimed at achieving excellence, which of course, comes from the womb of good Corporate Governance. Good Governance is a source of competitive advantage and a critical input for achieving excellence in all pursuits. J&K Bank considers good Corporate Governance as the sine qua non of a good banking system and has adopted a policy based on all the four pillars of good governance transparency, disclosures, accountability and value, enabling it to practice trusteeship, transparency, fairness and control, leading to stakeholders delight, enhanced shareholder value and ethical corporate citizenship. It also ensures that bank is managed by an independent and highly qualified Board following best globally accepted practices, transparent disclosures and empowerment of shareholders, besides ensuring to meet shareholders aspirations and societal expectations following the principles of management's executive freedom to drive the bank forward without undue restraints but within the framework of effective accountability. The excellence achieved by the bank in its operations stemming from the roots of voluntary good Governance has not gone unrecognized and Bank has recently bagged three very prestigious awards for following fair business practices and commitment to social obligations.

Main highlights of the Bank as on 31st March, 2010:

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CAPITAL AND RESERVES

The bank s net worth as at 31st March 2010 was Rs 2962.8 crores comprising of paid up capital of Rs 48.49 crores, share warrants of Rs 28.10 crores and reserves of Rs 2232.34 crores.

CAPITAL & RESERVES

3500 3000 2500 2000 1500 1000 500 0 2005 Amount 1665.4 2006 1799.47 2007 2008.73 2008 2308.92 2009 2574.37

Amount(Crores)

2010 2962.8

PROFIT
The Bank posted a net profit of Rs 512 crores for the year, which 24.8% higher than410 crores in the previous year.

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PROFIT
600 500 400 300 200 100 0 2005 Amount 115.07 2006 176.84 2007 274.49 2008 360

Amount (Crores)

2009 410

2010 512

NET INTEREST INCOME

During the year the Bank s NII increased to Rs 1119 registering a growth of 11.9%.

NET INTEREST INCOME

1200 1000 800 600 400 200 0 2006 Amount 663.72 2007 767.84 2008 810.44 2009 1000

Amount (Crores)

2010 1119

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DIVIDEND
The policy of rewarding the shareholders with high dividends continued this year as well. In view of appreciable performance of the Bank, the Directors are pleased to recommend a dividend of 220% (free of tax) for the year ended March 31, 2010.

DIVIDEND
250 200 150 100 50 0 2005 Amount 80 2006 80 2007 115 2008 155

(Percentage)

2009 170

2010 220

CURRENT DEPOSITS
During the year the Bank s current deposits increased to Rs 4892.39 registering a growth of 5.78%.

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CURRENT DEPOSITS
6000 5000 4000 3000 2000 1000 0 2006 Amount 3011.4 2007 3479.18 2008 4294.96

Amount (Crores)

2009 4625.18

2010 4892.39

SAVINGS BANK DEPOSITS

During the year the Bank s saving deposits increased to Rs 10260.81 registering a growth of 29%.

SAVINGS BANK DEPOSITS

12000 10000 8000 6000 4000 2000 0 2006 Amount 5013.51 2007 5848.83 2008 6902.54 2009 7953.49

Amount (Crores)

2010 10260.81

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TERM DEPOSITS
During the year the Bank s term deposits increased to Rs 22083.96 registering a growth of 7.51%.

TERM DEPOSITS
25000 20000 15000 10000 5000 0 2006 Amount 15459.73 2007 15866.28 2008 17395.76

Amount (Crores)

2009 20425.44

2010 22083.96

TOTAL DEPOSITS
During the year the Bank s total deposits increased to Rs 37237.16 registering a growth of 12.83%.

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TOTAL DEPOSITS
40000 35000 30000 25000 20000 15000 10000 5000 0 2005 Amount 21644.97 2006 23484.64 2007 25194.29 2008 28593.26

Amount (Crores)

2009 33004.1

2010 37237.16

ADVANCES
During the year the Bank s advances increased to Rs 23057.25 registering a growth of 10.16%.

ADVANCES
25000 20000 15000 10000 5000 0 2006 Amount 14483.11 2007 17079.94 2008 18882.61 2009 20930.41

Amount (Crores)

2010 23057.25

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INVESTMENTS
During the year the Bank s investments increased to Rs 13956.47 registering a growth of 30%. The increase in investments has been mainly in SLR securities in true with the regulatory requirements.

INVESTMENTS
16000 14000 12000 10000 8000 6000 4000 2000 0 2005 Amount 9089.23 2006 9002.34 2007 7392.19 2008 8756.66

Amount (Crores)

2009 10736.23

2010 13956.47

009

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REFERENCES

Financial Management By M. Y. Khan Financial Management By I.M. Panday J&K Bank Website www.jkbankt.net Manual of Instruction regarding Loans and Advances of the Bank (The J&K Bank Ltd.) Annual Reports of the Bank

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