General

• Understanding the background of the borrower and the business model

• Analysis of Financial Statements and understanding the operating cash flows
• Analysing the Credit Monitoring Arrangement (CMA) data to understand the
financial health of the borrower
• Site Visit and Due Diligence (including verification of Primary Security and
Collateral Security sites and through CERSAI)
• Third party valuation of assets and legal Verification/ Due Diligence
• Rating of the borrower based on bank’s internal rating model/ exernal model,
exposure and pricing of the loan
• Sanction of Loan - Setting covenants of the loan – Pre disbursement conditions
• Setting up of Escrow Account for disbursement of loan wherever required
• Post disbursement compliances and verifications
The 5 Cs of lending
• Character
• Capacity
• Capital
• Collateral
• Conditions
Cash flow from operations

• Cash flows are generated from 3 activities – operating, investing &

financing
• There are two methods of arriving at cash flow from operations- Direct and
Indirect.
• Under the Direct method you prepare the receipts and payments account
• Under Indirect method, you start with net income and proceed adding the
non cash expenses and deducting non cash income and adding or
deducting the net increase/ decrease in current assets or liabilities
Ratio Analysis

• Return on investments
• Net worth ( financial strength)
• Current ratio / quick ratio ( short term liquidity )
• Debt equity ratio ( leverage & long term solvency)
• Debt service coverage ratio ( ability to repay)
• Turnover ratio
• Free cash flows = net cash flow from operations- capital expenditure
(this indicates how much free cash is available for the company to grow)
Some insights into current ratio
• Current ratio is a key ratio for the assessment of working capital limits. It is the
measurement of the borrower’s liquidity. The following common myths about the
ratio are worth discussing
✓Current ratio is low because the company sells for cash and buys on credit (where
does it invest the cash)
✓Non current items, such as dealer deposits distort current ratios ( should not be
treated as current even if short term.
✓High current ratio implies large obsolete inventory and irrecoverable debtors (not
always true, quality to be checked independent of ratio)
✓Current ratio is low because of large current portion of long term debt (maybe
but it indicates a funding mismatch)
✓Beyond a point high current ratio does not indicate superior liquidity ( true, it can
affect the earnings)
Sensitivity Analysis
• All types of alternative choice problems involve making assumptions
and estimates about the future. Eg : assume that the GDP will grow
by ‘x’ percentage and so on
• At that point of time, you are worried if you have made the correct
assumptions.
• After doing the first set of assumptions, it is always a good idea to
redo the analysis several times, each time using different set of
assumptions.
Break Even Point analysis

• At the break even volume, total costs equal total revenue

• The profit region is above the break even volumes
• Total revenue = price/ unit * volume
• Total cost = total fixed cost + (variable cost per unit * volume)
• Break even volume is the volume where price/ unit * volume =total
fixed cost + (variable cost per unit * volume)
Working capital loans
Credit Monitoring Arrangement Data (CMA
data)
• The RBI requires banks to submit CMA data for availing any type of
loan (Project Loans, Term Loans and Working Capital Limits).
CMA data is a systematic analysis of working capital management of
a borrower and the objective of this statement is to ensure the usage
of long term and short term funds for the purpose they were given.
Banks evaluate the eligibility of funding based on a careful evaluation
of CMA data.
CMA Data contains 7 statements which help bankers in the evaluation:
1. Balance sheet that will show the financial position of the company. CMA Data
will have 2 years audited balance sheet and 3 years projected balance sheet.
2. Particulars about the present limits & proposed limits. It will show both Fund
and Non-fund based limits of the borrower.
3. Operating Statement / Profit and loss account statement
4. Cash flow statement that will help to evaluate the liquidity of the company.
5. Changes in working capital — This report helps in understanding the changes in
current assets and current liabilities and will also help assess the short term
solvency of any company.
6. Ratio analysis
7. Calculation of maximum permissible bank finance (MPBF).
Working Capital Loan
• It is a loan taken to finance a company’s operating cycle. It provides
liquidity to cover day to day operations. It is given in the form of a
cash credit ( against stock of inventory), bill finance ( against
receivables) or an overdraft in the current account ( for a short period
against collaterals)
• Many organisations have cyclical revenue streams, hence the need for
working capital finance.
• The firm’s operating cycle typically consists of three primary activities:
purchasing resources, producing products and distributing (selling
products.
• These activities create fund flow which is both uncertain and
unsynchronised.
• Payment for resources usually takes place before receipts from sale
• Receipts from sales cannot also be predicted with complete accuracy
 Operating Cycle
(Service Provider)

Cash

Debtors/
Receivables
30 days

Operating Cycle= 30 days or 1 month.

Operating Cycle (Trader)

Cash

Operating Cycle
(Trader)

Debtors/
Receivables
35 days Stock
25 days

Operating Cycle= 35+25= 60 days or 2 months

 Operating Cycle
(Manufacturer)

Cash

Debtors/ Raw
Receivables Materials
60
30 days 60 days

Finished
Goods Work in
20 days Progress
10 days

Operating Cycle= 60+10+20+30= 120 days or 4 months

• Identify the operating cycle of the following :

• Bus operator
• A person who runs his vehicle on contract basis
• A software company
• A dealer in goods
• A Kirana/ grocery shop owner
• There can be variations in the WC cycle.
1. A bus operator with specific route permit is a service provider. He may
start his day by taking diesel from the nearby petrol bunk on credit,
which he will repay at the day end after completing that day’s work. He,
in other words, starts his day not with cash but with creditors. He will
not be having any debtors as nobody after entering in the bus request for
ticket on credit basis for his journey.
2. A Person who runs his vehicle on contract basis will be having debtors as
he will be receiving payment from his client only at the beginning of the
succeeding month.
3. Similarly, a Trader may or may not have receivables depending upon his
credit policy or the nature of the goods he deals with.
Factors affecting working capital
Loan proposal should cover each of these areas
• Length of operating cycle
• Nature of business/ Type of product manufactured
• Sales volume
• Terms of credit extended to customers ( Accounts receivables)
• Seasonality of business
• Scale of operations
• Technology and production style
• Operational efficiency
• Level of competition in the industry
• Gross Working Capital (GWC) is the total of current assets

• Net Working Capital (NWC) is the net of current assets and current
liabilities

• Working Capital Gap (WCG) - while NWC is the difference between

Total Current Assets (TCA) and Total Current Liabilities (TCL) ,WCG is
the difference between Total Current Assets (TCA) and Other Current
Liabilities (OCL) which is Total Current Liabilities excluding Bank
borrowings
Working capital measures

Help calculate the velocity in which funds move through the operating cycle

Days cash cash balance cash expenses per day

Days receivable Accounts receivable credit sales per day

Days inventory Inventory cost of sales per day

Working capital turnover sales revenue working capital
Current ratio current assets current liabilities

monetary current
Acid test ratio assets current liabilities
Sales

Gross sales
Less Discount
sales returns
Net sales
Cost of goods sold
Opening stock of raw materials
Net cost of Purchases ( Purchases - (returns and discounts)+ frieght charges
Raw materials available for use
Less closing stock of raw materials
Raw materials consumed
Add Direct Labour
Add manufacturing costs ( indirect labour, factory supplies, supervisors
salaries, power and fuel etc
Total manufacturing cost
Add work in progress ( opening stock)
Less working in progress ( closing stock)
Cost of goods manufactured
Add opening stock of finished goods
Cost of goods available for sale
Less closing stock of finished goods
Cost of goods sold
Gross margin

Net sales
Less Cost of goods sold/ cost of sales
Gross Margin
Operating Income or Profit

Gross margin
Less: selling expenses, general, administrative
Research and development expenses
Operating profit (Earnings before Depreciation Interest and Tax)
Less: Depreciation
Earnings before Interest and tax
Less : Interest expenses
Earnings before Tax
Less : Taxes
Net profit or Profit after tax
Inventory turnover :

• Raw materials holding period = raw materials/cost of raw material

consumed
• Stock in process holding period = Stock in process/ cost of goods
manufactured
• Finished goods holding period = Finished goods / cost of goods sold
(or cost of sales)
Cash conversion cycle

• Day’s receivable + day’s inventory = operating cycle

• Operating cycle – day’s payables = cash conversion cycle

• It measures liquidity and indicates the time interval for which

additional short term financing is needed to support a spurt in sales
Net working capital
▪ Current assets less current liabilities.

Current liabilities include bank borrowings including short term loans,

trade creditors, advance from customers and deposits / loans falling
due in less than 12 months

Current assets include cash, inventories and receivables

Before 1974, Security Oriented Lending, was in practice and working
capital finance by a bank was considered as an advance against some
current assets ( mainly finished stock in the godown / warehouse) and
hence only those borrowers having an asset in possession were
considered for bank advance. Many a times the credit limits were very
high and were not fully utilised, but banks had to fully set aside the
amount sanctioned, which led to blocking of lendable resources. To
overcome this the concept of need based finance was introduced.
MAXIMUM PERMISSIBLE BANK FINANCE
(MPBF)
• MPBF is mainly a method of working capital assessment. As per the
recommendations of Tandon Committee, the corporates are
discouraged from accumulating too much of stocks of current assets
and are recommended to move towards very lean inventories and
receivable levels. This is where MPBF comes into picture.
• For the computation the banks use a set of six forms (CMA)-
Assessment of working capital; Operating statement; Analysis of
balance sheet; Comparative statement of Current assets and Current
liabilities; Computation of MPBF for working capital and funds flow
statement
There are 5 methods for MPBF calculation.

✓Tandon Committee Method I (WCG Method I)

✓Tandon Committee Method II(WCG Method II)
✓ Nayak Committee Method (Turn Over Method)
✓ Expenditure Method
✓ Funds Flow or Cash Budget Method
Initially there was one more method of lending under Tandon Committee ( Method III)
which required the segregation of current assets into core and fluctuating. As this was
difficult for implementation, this method was never implemented
• Tandon Committee - Method 1: In the case of borrowers whose
working capital requirement is less than Rs.10 lakhs, the banks are
permitted to fund the net working capital gap ( which is the
difference of total current assets and current liabilities other than
bank borrowings) after deducting the margin amount.
• Tandon Committee - Method II: This method is used in the case of
borrowers with credit requirement of more than Rs.10 lakhs. In this
method, the borrower brings in as margin, a minimum of 25% of its
total current assets, and the balance is funded by the bank.
 Case : Given below is the balance sheet of a company . Calculate MPBF under method I
and II (Rs. in lakhs)
Cash with the Bank 3.06
Fixed Deposit with the Bank (maturing within 3 months) 2.64
Fixed Deposit with the Bank (maturing within 9 months) 1.01
Book debts older than 1 year 4.46
Book debts below 6 months 36.01
Stock of raw materials 28.22
Stock in process 1.01
Finished Goods 20.48
Advance given to Suppliers 25.08
Advances to Associates 12.01
Outstanding Overdraft (HYP) 21.07
Outstanding Overdraft (Book Debts) 14.01
Advances received from buyers 6.97
Sundry creditors for goods 12.51
Other Creditors 16.63
Interest accrued but not due for payment 4.85
Provision for dividend 2.81
Other short term liabilities 1.29
TOTAL CURRENT LIABILITIES TOTAL CURRENT ASSETS
Advance received 6.97 Cash at Bank 3.06
Sundry Creditors 12.51 Fixed Deposit 2.64
Other Creditors 16.63 Fixed Deposit 1.01
Interest Accrued 4.85 Book Debts Less than 6 months 36.01
Provision for dividend 2.81 Raw Materials 28.22
Other Short Term Loans 1.29 Stock in Process 1.01
Overdraft - HYP 21.07 Finished Goods 20.48
Overdraft - Book debts 14.01 Advance to Suppliers 25.08

80.14 117.51

Short term Bank Borrowings : 21.07+14.01=35.08

Other Current Liabilities (OCL) : 80.14-35.08=45.06
 Method 1. Method 2.

A. Total Current Assets 117.51 A. Total Current Assets 117.51

B. OCL 45.06 B. OCL 45.06
C. WCG 72.45 C. WCG 72.45
D. 25% of C(WCG) 18.11 D. 25% of CA 29.38
E. Actual NWC (117.51-80.14) 37.37 E. Actual NWC 37.37
F. C-D 54.34 F. C-D 43.07
G. C-E 35.08 G. C-E 35.08
H. PBF (F or G whichever is less) 35.08 H. PBF (F or G whichever is less) 35.08

(Required Margin 18.11 (Required Margin 29.38

Available Margin 37.37 Available Margin 37.37
Excess borrowing Nil Excess borrowing Nil
Current Ratio 117/80.14 1.47:1 Current Ratio 117/80.14 1.47:1
The PBF is the same both in I and II method.
What is the Reason?

This firm is having a higher Margin in the system - The Current Ratio is
117.51 / 80.14 = 1.47
The conclusion is that when the CR is more than 1.33, the PBF will be
the same both under I and II methods of calculation, because the Bank
is filling the gap after deducting the margin available subject to
minimum.
 Tandon Method 1 Audited Audited Provisional Projected
1Total current assets 51639 47578 46340 49700
2a.Bank borrowings 7680 6700 13000 13000
2b. OCL 34054 39300 21870 24270
2Total Current liabilities
3Net Working capital gap
4Minimum stipulated NWC

5NWC
6(3-4)
7(3-5)
8Maximum Permissble Bank Finance
(lower of 6 and 7 )
9Actual Borrowing
10Excess borrowing
11Current ratio
 Tandon Method 1 Audited Audited Provisional Projected
1Total current assets 51639 47578 46340 49700
2a.Bank borrowings 7680 6700 13000 13000
2b. OCL 34054 39300 21870 24270
2Total Current liabilities 41734 46000 34870 37270
3Net Working capital gap 17585 8278 24470 25430
4Minimum stipulated NWC (Net 4396.25 2069.5 6117.5 6357.5
Working Capital Gap )* 25%
5NWC 9905 1578 11470 12430
6(3-4) 13188.75 6208.5 18352.5 19072.5
7(3-5) 7680 6700 13000 13000
8Maximum Permissble Bank Finance 7680 6208.5 13000 13000
(lower of 6 and 7 )
9Actual Borrowing 7680 6700 13000 13000
10Excess borrowing 0 491.5 0 0
11Current ratio 1.237336 1.034304 1.328936048 1.333512
 TANDON COMMITTEE (2nd method) 2017-18 2018-19 2019-20 2020-21
Audited Audited Provisional Projected
1Total current assets 51639 47578 46340 49700
2a.Bank borrowings 7680 6700 13000 13000
2b. OCL 34054 39300 21870 24270
2Total Current liabilities 41734 46000 34870 37270
3Net Working capital gap 17585 8278 24470 25430
4Minimum stipulated NWC

5NWC
6(3-4)
7(3-5)
8Maximum Permissble Bank Finance
(lower of 6 and 7 )
9Actual Borrowing
10Excess borrowing
11Current ratio
 TANDON COMMITTEE (2nd method) 2017-18 2018-19 2019-20 2020-21
Audited Audited Provisional Projected
1Total current assets 51639 47578 46340 49700
2a.Bank borrowings 7680 6700 13000 13000
2b. OCL 34054 39300 21870 24270
2Total Current liabilities 41734 46000 34870 37270
3Net Working capital gap 17585 8278 24470 25430
4Minimum stipulated NWC (Net Working 12909.75 11894.5 11585 12425
Capital Gap )* 25%
5NWC 9905 1578 11470 12430
6(3-4) 4675.25 -3616.5 12885 13005
7(3-5) 7680 6700 13000 13000
8Maximum Permissble Bank Finance 4675.25 -3616.5 12885 13000
(lower of 6 and 7 )
9Actual Borrowing 7680 6700 13000 13000
10Excess borrowing 3004.75 10316.5 115 0
11Current ratio 1.237336 1.034304 1.328936048 1.333512
• In method 1, the minimum current ratio expected is 1.25 while in
method 2 it is 1.33.
• If current ratio is 1.33 and more, then the permissible finance is the
same under both methods.
• If current ratio is below 1.25 and 1.33 under the methods
respectively, the calculation will indicate an excess borrowing
TURN OVER METHOD - NAYAK COMMITTEE METHOD)

• A committee headed by P R Nayak, the then DG of RBI came out with these
recommendations :
• Working Capital requirement at 25% of the gross sales (not net sales)
turnover
• Out of 25% of working capital requirement, 5% of total turnover will be
brought by the borrower as Margin and the remaining 20% will be Bank
borrowing.
• If the borrower is having a Margin of more than 5% of projected Turnover
in the system, Bank borrowings can be correspondingly reduced as it is a
need based finance.
• If the borrower is having a Margin of less than 5%, he may be sanctioned a
limit @ 20% of the projected turnover but the DP should have to be
monitored properly.
• Suppose projected and agreed sales turn over of a unit is Rs.100.00
lacs. The working capital requirement as per Turn Over method is
Rs.25.00 lacs. The borrower will bring margin of Rs. 5.00 lacs . So the
bank borrowing will be 20 lakhs.
• Now suppose the borrower shows a projected margin of Rs. 7.00
lakhs, then the bank borrowing will be Rs. 18 lakhs. (25-7)
• Again if the borrower shows a projected margin of Rs. 4 lakhs, bank
borrowing (sanctioned) will be Rs. 20 lakhs. However the drawing
power will need to be regulated
• A. Projected sales/turnover = 200 lakhs
• B. Minimum WC requirement (25% of the T/O ) = 50
• C. Minimum Margin of 5% of T/O or 20% of WC requirement = 10
• D. Eligible finance (B)-(C) = 40
• E- Margin available in the system NWC = 8 (say)
– (NWC as per last audited balance sheet)
• F Eligible Bank Finance(B-E)or D whichever is less = 40
• G- Eligible Bank Finance as per actual availability of Margin ( E x 4) = 32
• H Permissible Bank Finance (F or G whichever is less) = 32
• I Limit recommended (Limit sought or H whichever is less)
• The projected Turnover should be acceptable to the Bank.
• Reasons for accepting the turnover projected by the borrower.

❖ Past trend – Industry trend

❖ Quarterly/Half yearly financial statements
❖ Monthly VAT returns
❖ Credit turnover in the account
❖ Fresh orders
❖ Achievement against previous years projections
Expenditure Method
• This method is used for assessing working capital requirement of
Hotels, Restaurants, Educational Institutions, Hospitals, Travel agents
etc.
• 60 to 90 day’s expenses like salary, electricity, consumables,
telephone, maintenance etc. is projected.
• 75% of the projected expenses is given as a working capital.
• 25% to be brought as margin by the borrower.
Cash Budget Method
• Working capital limits are assessed on the basis of projected cash gap or cash
deficit on the basis of monthly/ quarterly/ half yearly and yearly projections of
cash receipts and payments
• This method is used for assessing working capital requirement of Large
Contractors and Infrastructure Projects, IT sector etc.
• Monthly projections on each items in the assets & liabilities are made.
✓ Sources increased = Inflow of Funds
✓ Sources decreased = Outflow of Funds
✓ Uses Increased = Outflow of Funds
✓ Uses Decreased = Inflow of Funds
• Difference between INFLOW & OUTFLOW will be either surplus or deficit. Deficit
needs to be financed.
• 25% of Deficit to be the margin & 75% will be the Bank finance.
• This method is a major customer – friendly method and well suited
for borrowers who are dealing with seasonal products and
construction and other order based activities.
• Banks however stand the risk of heavy dependency on projected cash
flows which cannot be accurately verified and lack transparency.
Banks have to ensure end use only by verifying the cash flows as
there is no need for stock statements. Instead borrowers have to
submit actual receipts and payment account.
Project Loan
Assessment of Term loan
Cost of the Project
• Land site development and building construction
• Plant and Machinery & Equipment
• Working capital Margin
• Pre operative expenses
Sources of Finance
Share capital, reserves and surplus ( Promoters contribution)
Unsecured loans
Term loan from Bank
Assessment of a Term Loan
• Term loan appraisal covers the appraisal of the borrower and appraisal of
the project. The characteristics of a term loan are that term loan
commitments are for a long term. The banks and financial institutions
normally offer term loans repayable in 10-15 years and beyond that period
in exceptional cases like housing loans. The repayment would be made out
of cash generated from business activities.
• Appraisal of the borrower covers honesty and integrity of the borrower,
standing of the borrower, business capacity, managerial competence,
financial resources in relation to the size of the project. The sources of
information for the above are the personal interview, credit investigation,
trade circle enquiries, market report, existing bank’s report, CIBIL report,
assets and liabilities statements submitted by the borrowers, Income Tax
assessment orders and wealth tax assessment orders of promoters.
Assessment of a Term Loan
Appraisal of project covers the following details.
• Commercial Viability of the project:
• Line of business, demand-supply, profit margin, imports, exports, list
of important customers and suppliers, extent of competition, costing
and pricing, mechanism of the product, dependence on single or few
customers or suppliers, prevailing Government policies, embargo etc.
are to be evaluated
• Production Arrangement: Power, water supply, transport,
infrastructure facilities like Proximity to the source of raw materials,
stores and other production facilities, workforce etc.
Assessment of a Term Loan
• The Manager has to visit the place of the factory to see that the
business exists at the address furnished and also to ascertain the
infrastructure available, the level of activity and make a preliminary
report on his/her visit which includes inspection report on prime and
collateral security offered.
• The Manager has to familiarise with borrower’s business,
form opinion about adequate labour strength, maintenance of the
factory, godown etc.
Assessment of a Term Loan
Techno Economic Viability (TEV)
• Assessment of the practicality of the project
• It refers to estimation of the potential demand and choice of optimal technology
It contains:
✓background of the industry & of the enterprise submitting the report
✓the product characteristics, market positions and trends,
✓raw material requirement and manufacturing processes,
✓required land area, building specifications and construction schedules, plant and
machinery requirements,
✓ Financial implications, marketing channels, requirement of labor and personnel.
Assessment of a Term Loan
• Market conditions & marketing arrangements:
✓ Demand, supply, pricing etc.,
✓Names of the main buyers, names of major competitors and their total
market shares.
• Financial appraisal:
✓ Past financial statement like profit and loss accounts, balance sheets.
✓The correlation between fixed assets and under charging of depreciation,
✓Operating loss position, contribution of other income to net profit,
✓valuation of closing stock, borrowings and interest cost,
✓extent of reserve created by revaluation of assets,
Assessment of a Term Loan
✓unsecured loan shown as quasi-equity,
✓movement of unsecured loans over the years,
✓borrower’s stake in the business,
✓ investment in intangible assets, other non-current assets.
✓ Acceptability of projection and assumption considered for the
assessment,
✓profitability estimate, solvency ratio i.e. ability to service outside
liabilities like TOL/TNW, Funded Debt/TNW etc.
✓Liquidity position like networking capital and current ratio.
Assessment of a Term Loan

• The major problems concerning term finance is maturity mismatch, funding risk,
Interest rate risk (IRR).
• These aspects are to be carefully looked into while fixing loan amount and
repayment instalments.

• Clearance from appropriate government agencies: Consents, approvals &

environment clearance aspects.
• Non-fund based facilities: Apart from the term loan, a project may also require
non –fund based facilities like Deferred Payment Guarantee, Co-acceptance,
Buyers credit etc. Assessment of non-fund based limits in such cases.
• SWOT analysis (Strength, Weakness, Opportunity and Threat)
Amortisation Schedule

• An amortization schedule is a complete table of periodic loan

payments, showing the amount of principal and the amount of
interest that comprise each payment until the loan is paid off at the
end of its term.

• The amortization schedule is important when we are considering

repayments other than EMIs
Loan to the real estate sector
Appraisal of a Loan for the real estate sector
• Understand the Real Estate (Regulation and Development) Act, 2016
(RERA) guidelines to check the required due diligence
• Understand the Techno Economic Viability (TEV) evaluating the
technical and financial information about the project.
• Analyse the Credit Monitoring Arrangement (CMA) showing the past
& projected performance of a business in financial terms, to ascertain
the financial health of a business.
The Real Estate (Regulation and Development)
Act, 2016
• Seeks to protect home-buyers as well as help boost investments in the real estate
industry. The Act establishes a Real Estate Regulatory Authority (RERA) in each
state for regulation of the real estate sector and also acts as an adjudicating body
for speedy dispute resolution.
• The Real Estate Act makes it mandatory for all commercial and residential real
estate projects where the land is over 500 square metres, or eight apartments, to
register with the Real Estate Regulatory (RERA) for launching a project, in order to
provide greater transparency in project-marketing and execution.
• The Act prohibits unaccounted money from being pumped into the sector and as
of now 70 per cent of the money has to be deposited in bank accounts through
cheques. A major benefit for consumers included in the Act is that builders will
have to quote prices based on carpet area not super built-up area, while carpet
area has been clearly defined in the Act to include only usable spaces. Under
RERA, its mandatory for the builders to disclose the carpet area.