CONTENTS

II.

CORPORATE FINANCE PRODUCTS & DELIVERY PROCESS

A. Long Term Finance

1.
2.

Project Financing / Term Loan

Takeover of Existing T.L.

B. Medium Term Finance

1.
2.

Liquirent Loan
Mortgage Loan / Loan Against Property

C. Short Term Finance

1.
2.
3.
4.
5.

Cash Credit / Working Capital Loan

Takeover of Existing C.C./ W.C.L.
Pre-shipment Finance
a. Packing Credit (in Rs./FC)
Post-shipment Finance :
a. Purchase / Discounting of Export Documents (in Rs. /FC)
Opening of Import L/C

EXTERNAL PROCEDURE TO DELIVER U.M.C. PRODUCTS

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A. LONG TERM FINANCE

1. Project Financing/ Term Loan - Introduction
1.1 Application and Preliminary Scrutiny

1.2 Appraisal and Sanction

1.2.1 Market Appraisal
1.2.2 Technical Appraisal
1.2.3 Financial Appraisal
1.2.4 Managerial Appraisal
1.3 Sanction
1.3.1 Post Sanction Documentation
1.4 Disbursement and Monitoring
1.4.1 Tips to an entrepreneur seeking project financing
1.5 Post Implementation Review

1. Project Financing/ Term Loan - Introduction

Term loans refer to instrument of financing where a loan is availed by a borrower with
repayment in periodic installments over a pre-specified period. Such term loans could
either be for a project or for purchase of an asset. Project financing largely follows the
pattern of project loans from Financial Institutions with the tenure being between 7-10
years including a moratorium of upto 2 years.
However, banks do not generally extend project loans in case of SMEs except in case of
longstanding clients with a good track record. The interest rate in case of the term loans
from banks depend upon the credit rating of the client but tend to be lower than that of
the state financial institutions on account of lower cost of funds.
Loans for purchase of assets (vehicle, equipment) are of a medium term nature with loan
periods extending from 3-5 years. In case of these loans, the main competition to banks
arises from the non-banking financial institutions (NBFCs). The NBFCs compete primarily
on response time while interest rates tend to be higher. In recent times, banks are also
facing competition from a new quarter in these loans that of Packaged Financing where
the manufacturer (either on its own or through a tie-up with a preferred financier)
arranges financing of its products.
1.1 Application and Preliminary Scrutiny
During this stage, the entrepreneur seeking financing from the financial institution,
approaches the institution with his project. The Business Development division holds
informal discussions with the promoter to assess the eligibility of the project for financing.
In case of state financial institutions, there are typically various schemes under which
these projects could be taken up and financed. The institution ascertains the applicability
of the scheme under one or the other of these projects at this stage.
Only the prima facie suitability of the project is ascertained at this stage without any
detailed analysis being taken up. Apart from the eligibility of the project, the capability of
the promoter in bringing in his share of equity capital and ability to provide suitable
collateral of the nature required.

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The Application and Preliminary Scrutiny stage assumes significance in that in case of
small projects, which are largely promoter and location dependent. Detailed analysis in
case of these projects at best provides indicators and cannot generally be of as rigorous
nature as in case of larger projects. Hence in case of small projects, projects that are
found prima facie eligible for lending also by and large cross the detailed appraisal stage
and are sanctioned financing. Subject to prima facie suitability of the project at the stage
of preliminary scrutiny, the proposal is taken up for Detailed Appraisal is taken up.
1.2

Appraisal and Sanction

Term lending institutions have a standardized way of appraisal. Each project is appraised
under various criteria from different viewpoints like marketing, technical, financial,
economic and managerial angles. A brief description of these viewpoints and the criteria
employed are given below.
1.2.1 Market Appraisal

The reasonableness of the demand projections supplied by the promoters are

verified by utilizing the findings of available reports/ surveys, industry association/
planning commission/ DGTD projections, and independent market surveys
(sometimes commissioned with the expense borne by the promoters).

Assess the adequacy of the marketing infrastructure planned in terms of

promotional effort, distribution network, transport facilities, stock levels, etc.

Judge the knowledge, experience and competence of the key marketing personnel.
In case of appraisal for projects of SMEs, the market appraisal generally tends to be
accorded low importance. The localized/regional nature of these businesses often makes
success in marketing more a function of the entrepreneurs attributes or contacts rather
than a fundamental demand-supply mismatch in the product (currently met by expensive
imports or near substitutes).
However, over the past few years most financial institutions, based on their experience of
past lending drawn up categories of industries where new projects would be restricted /
prohibited. These are clearly stated in the lending policies of the financial institutions.
When the lending policy of an FI categorises an industry in the prohibited category, it
actually means that the risk of financing such projects (in its opinion) is high making such
projects an unacceptable risk from the point of a lender. In the event of your project being
classified under the Prohibited Category, it would be prudent to review its viability before
taking it up for implementation. Also such projects might have to be completely selffinanced.
1.2.2

Technical Appraisal

The technical appraisal is done by qualified & experienced personnel (internal or external)
and focuses is mainly on the following aspects:

Product mix
Capacity
Process of manufacture
Engineering know-how and technical collaboration
Raw materials and consumables
Location, site and building
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Plant and equipment

Manpower requirements
Break-even point

Normally SME projects do not involve breakthrough technology. As a result, the

technology aspect is fairly simple to appraise. However, substandard equipment resulting
in unsuccessful pilot runs and prolonged rectification process is often a major problem
leading to a unit turning sick even prior to commercial operations. What is accorded
maximum importance by the FIs is the reputation of the suppliers and the necessity of 23 quotes for the key equipment to judge reasonableness of quality and price. Some of the
FIs maintain lists of approved suppliers from among whom such equipment will have to
be sourced (if available). However such lists also tend to have problems since they are
not updated on a regular basis. Consequently, some delays and minor problems are
unavoidable in most cases on this count.
1.2.3

Financial Appraisal

Term lending institutions try to assess the following in their financial appraisal of a project
proposal:
a. Estimate of capital cost
b. Estimate of working results
c. Rate of return
d. Financing pattern
a. Estimate of capital cost:
The assessment of capital cost involves a vigorous check of the financial projections
provided by the promoter on the following aspects:

Padding or under-estimation of costs

Proper specification of machinery

Credibility of various suppliers

Allowances for contingencies

Inflation factors
b.

Estimate of working results :

The projections supplied by the promoters regarding the sales, realizations and profits are
assessed by checking whether:

A realistic market demand forecast has been given

Price computations for inputs and outputs are based on current quotations and
inflationary factors
An appropriate time schedule for capacity utilization is given
The cost projections are distinguished between fixed and variable costs
appropriately

c. Rate of return: The norms for the financial viability are generally in the
range of :

Internal Rate of Return (IRR) 15-20%

Return on Investment (ROI) 20-25%

Debt-service coverage ratio (DSCR) 1.5 to 2

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The above mentioned figures are not mandatory and a certain degree of flexibility is
shown on the basis of the nature of the project, risks inherent in the project, and the
status of the promoter.
d.

Financing pattern :

A general debt-equity ratio norm of 1.5:1

Minimum Promoters contribution 20-25% of the project cost

Stock-exchange listing requirements in cases part of the equity is proposed to be
raised from the public
The financial capability of the promoter

In case of sectors involving standard technologies and having seen numerous projects,
norms are readily available for most of the parameters such as the gestation period,
build-up of capacity utilization, the unit project cost, cost structure etc. However, in case
of other projects, such financial analysis often tends to be based on an aggregation of
reasonable assumptions! FIs rework these projections based on the 2-3 parameters
where they have standardized assumptions. These could be build-up in capacity
utilization, power tariff per unit, etc.
The beauty of Financial Analysis is that the viability of projects can be established by
effecting minor changes in assumptions such as growth rates, cost structure, residual
value, etc (often at the second or third decimal!). So, achieving the cut-off IRR or
coverage may not prove difficult to a person well versed with the various facilities
available on spreadsheets! However, Financial Analysis remains an extremely important
step, as it is the standard that influences decision of the financiers. (especially of the
public sector). Secondly, the sensitivity analysis conducted as part of such studies forms
the basis for identifying the crucial parameters for the success of the project. Financiers
tend to monitor the project progress through these milestones and parameters. In dayto-day practice the financial institutions have their own independent criteria and credit
rating methodology for arriving at the credit rating of each project. Financial institutions
calculate the Internal Rate of Return (IRR). The Internal Rate of Return refers to the
rate of return that the project is expected to generate based on its projected cash flows
accruing over its expected lifespan. Institutions have a threshold IRR that the project
needs to surpass to assess its viability. Various financial ratios are calculated for the past
and future data provided to them by the promoters after checking the veracity of the
same. The various ratios, which are frequently calculated include :

Current ratio:
[(Receivables + material and finished good inventory)/ (creditors for goods and
expenses)]
Long term debt-equity ratio
[Long Term Debt/ Networth]
Interest coverage ratio
[(Profit Before Interest Provision for Tax)]/(Interest payments due for the year]
Fixed assets coverage ratio
[Fixed Assets/ (Term loan and other long term debt obligations)]
Debt-service coverage ratio
[{(Profit before interest- Provision for taxes)+Depreciation}/ {Interest repayments
+ (Principle Repayments*(1-effective tax rate))}]
Profit after tax/sales

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The minimum or maximum values for some of the ratios are as follows:
Long-term debt-equity ratio (Maximum allowable)
2
Current ratio (Minimum)
1.33
Interest cover ratio (Minimum)
2
Fixed asset coverage ratio (Minimum)
1.25
The above values are taken as standard though a certain amount of flexibility is exercised
depending on the perception and personal judgment of the appraising officer. A rating is
assigned to the project based on the scores of the different ratios. A cut-off rating
determines financing decision (whether the project would financed or not). Above the
rating, the projects maybe categorized into excellent, good and average. Based on this
and the project characteristics, the final terms and conditions of financial assistance are
decided upon like:

Moratorium
Repayment period
Availability period
Security (like pari-passu charge, first charge, personal guarantee, corporate
guarantee etc.)
Interest rate

All the expenses like service fee, processing fee, document fee and other expenses like
inspection of site, factory, etc. are charged to the applicant and is a source of income for
the lending institution.
1.2.4 Managerial Appraisal
Managerial competence and integrity is an extremely important pre-requisite to translate
a project viable on paper into a real life success. Capital markets across the world (and
even Indian investors in recent times) factor in the company management in company
valuations (in other words share prices).
The following criteria tend to be looked at by the FIs to form a judgement regarding the
managerial competence and resourcefulness.

Track record in earlier projects

Resourcefulness of the promoter
Understanding of the business
Commitment to the project and
Integrity

1.3 Sanction
In the event of the project being assessed as viable, Sanction is accorded for financing to
the proposal. The Sanction is an in-principle decision for financing the project and is
generally subject to fulfillment of certain terms and conditions. Some of these conditions
could be standard ones such as:

In-principle approval from a bank for working capital

No Objection certificate from the Pollution Control Board

Sanction for power from the Electricity Board

Completion of all documentation formalities creating a charge in favour of the

financial institution on all the relevant assets.

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Disbursement shall commence only when the First Investment Clause has been
satisfied. First Investment Clause requires the entrepreneur to invest his contribution
before approaching the Financial Institutions for disbursement.

Additionally, in the event of the Financial Institution being dissatisfied with any particular
aspect of the project, then a condition stipulating the fulfillment of the desired change
may be made for disbursement to commence.
1.3.1 Post Sanction Documentation
Post Sanction Documentation involves formulating legally binding documents on the
following:

Loan agreement conveying the terms and conditions of the loan

Documents conveying equitable mortgage on the primary security i.e. the fixed
assets pertaining to the project and on the additional security (collateral).
Personal Guarantee of the borrower and guarantor (if any).
Search report from an Advocate indicating a clear title for the last fifteen years as
per the land records; and
Approved building plans in case of constructed property.

This would involve submission of the relevant documents by the enterprise. The legal
department in the Financial Institution would scrutinize these documents for their validity
and completeness. Subsequent to this the documentation formalities would be completed
with the agreements being finalized and signed. On completion of the post-sanction
documentation the Disbursement procedure would commence subject to the other predisbursement conditions (mentioned above) being fulfilled.
Time taken at the Documentation Stage
The time taken at different stages of the Credit decision could be on delays on the part of
the promoter and/or in-efficiencies on the part of the financial institution. However, the
delays during the Post-Sanction Documentation are generally on account of poor
homework by the entrepreneur.
In case of SMEs, quite often the documentation process requires 4-6 months for
completion. This is mainly because of delay on the part of the entrepreneur in furnishing
relevant documents and satisfying queries arising during scrutiny. In case of financing
through the state financial institutions, in certain cases, the institution is also partly
responsible, as these requirements are made known to the prospective borrower only
subsequent to the Sanction as part of the Sanction conditions.
Time taken during the Documentation stage is clearly unproductive and if excessive could
lead to the project assumptions undergoing a change affecting the viability of the project
(and requiring a review prior to disbursement).
1.4 Disbursement and Monitoring
Appraisal looks at the project at a point in time and when such project is only on paper.
Monitoring on the other hand is a continual check on the project as it materializes from an
idea on paper into a facility capable of meeting its stated purpose. Thus, monitoring acts
as a means of a regular check on the timely implementation along the committed course
of action.

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Need for Monitoring

Given the rapid changes in regulations enhancing the level of competition, fluctuations in
commodity prices and evolving technology, monitoring a project implementation has
become extremely important. This enables the FIs to judge the seriousness of the
implementation effort and stop any/further disbursement to a non-serious (or incapable)
promoter rather than throw good money after bad.
Monitoring also assumes tremendous importance in the Indian context due to a number
of reasons:

Projects especially those of a conventional nature face a number of procedures

involving clearances by public authorities that take time.
Projects especially in the small and medium sector also get bogged down on
account of poor prior planning especially in meeting pre-disbursement conditions
such as documentation related to the primary assets and collateral, sanction of
working capital and power connection.
Promoters (small, medium as well as large) often lose interest on the project and
deploy the money in financial assets or flavour of the month projects with an eye on
short-term wealth.

The importance of monitoring or following up on the projects which are financed by the
term lending institutions after due appraisal has gained importance in recent years due to
many unethical practices which have come to light regarding the mis-utilisation of funds
sanctioned. Other than this monitoring also became important due to the rising incidence
of sickness in the corporate sector and the amounts that have been blocked in the
process.
This has led to many financial institutions coming to the conclusion that prevention is
better than cure, since many of them are now raising resources from the market and any
lack of efficiency on their part will be detrimental to their survival.
Monitoring Process during Disbursement :
Monitoring is usually inbuilt during the Disbursement process in the following ways:

In case of large projects the disbursal of funds is generally through periodic credits
to a No Lien Account from where the payments are met as and when required.
Monitoring here is generally through a review of the implementation generally
conducted on completion of key milestones.
In case of small and medium enterprises, the disbursement is on reimbursement
basis where the promoter initiates implementation through his own funds and
periodically seeks reimbursement from the FI. The monitoring is effected each time
a request for reimbursement is initiated by the promoter. This involves scrutinizing
the documents indicating various expenses on the project and ascertaining the
reasons for any deviations. In case of first time promoters, this may also involve
visits to the site and inspection of key machineries prior to erection at the site.

Problems during Disbursement

Problems during Disbursement occur on account of the following broad reasons:

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Significant change in the Project Parameters. This includes change in state

capacity, location (on account of litigation, environment, local opposition,
technology, etc.)
Non-fulfillment of the Pre-Disbursement Conditions such as the First
Investment Clause, sanction of Working Capital from bank, non-receipt of power
connection and non-receipt of No-Objection Certificate from the Pollution Control
Board.
Lack of subsequent interest/commitment from the entrepreneur subsequent to
the Sanction of financing.
Sudden change in the economic environment recession, downturn in the
capital markets, war, natural calamity, etc.

In case of larger projects delays in implementation generally happen on account of

formalities pertaining to acquisition of land (incl. delays caused by litigation), changes in
the economic environment, etc. In case of SMEs, problems during Disbursement
predominantly arise on account of non-fulfillment of the Pre-Disbursement conditions
imposed at the time of Sanction. These include:
1. Non-submission of In-Principle Approval for Working Capital from the
commercial bank
An application for working capital is made to the bank at the same time while the process
for project financing with the Financial Institution is initiated. On accepting an application,
the bank provides an acknowledgement that the application has been received and is
being processed. An In-principle approval from the bank is the next stage. In case of
applicants who do not have prior business contacts with the bank, there is often a delay
in the receipt of such In-Principle Sanctions. Part of the reason is the reluctance of the
banks to lend any longer to new projects by promoters without prior track record (or long
standing relationship with the bank). Delays are often witnessed in the receipt of the InPrinciple Approval as well as final approval subsequently.
2. Fulfillment of the First Investment Clause
The First Investment Clause requires the promoter to invest his equity contribution prior
to availing disbursement from the financial institution. Often, the promoter is unable to
mobilize his share of funds leading to delays in obtaining disbursement from the State
Financing Institution.
3. Receipt of Power Connection from the Electricity Board and Pollution Control
Board
The receipt of Power Connection from the Electricity Board could get delayed due to
bureaucratic tangles or in cases where incremental infrastructure has to be laid
specifically for the connection.
4. Changes in key machinery suppliers for the project
In the event of a change in the suppliers of key machinery, the entrepreneur would have
to convince the financing institution about the necessity for the change. Major changes or
persistent changes in machinery could lead to delays in disbursement and project
implementation.
The nature of problems (indicated above) during disbursement especially in case of SMEs
is primarily on account of inadequate planning by the entrepreneur at earlier stages.
Problems relating to First Investment Clause and changes in key machinery are typical
examples of this. Problems in availing working capital and power connection refer to
issues, which are to some extent outside his control. Financing Institutions due allow
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initial disbursements if these conditions are partially met, but require that these be
fulfilled by the time of the last disbursement.
In the past few years, delays in disbursement are also occurring in some cases on
account of delays in the state financial institutions disbursing the funds. This has
particularly been in case of those State Financial institutions, which are suffering from
severe financial problems resulting in default on commitments to refinancing institutions.
This has caused cessation of fresh refinance support as a result of which these state
institutions are finding problems of meeting disbursement commitments.
1.4.1 Tips to an entrepreneur seeking project financing
Prior preparation on the project

The entrepreneur would need to finalize the kind of project and the requirements in
terms of civil infrastructure, equipment and utilities. Additionally, groundwork is also
required in assessing the market potential and marketing channel to be adopted for
marketing the products.

In case of medium size projects, the entrepreneur may decide to engage the services of
an expert consultant for conducting market surveys and for lending a professional touch
to the report. It is however essential to engage a reputed consultant for this purpose.
Interaction with financing agencies
Choose the financing institution that you would want to approach.

Institution with which you (or a close relative) have a prior dealings (or track record)
The institution must be financially sound
Pricing and service quality of the institutions

Understand the formalities and procedures beforehand

A number of formalities and procedures are involved in availing project finance and
working capital finance from banks and Financial Institutions. It is essential to be aware of
the same before hand. This would provide the entrepreneur with an assessment of the
time frame for such availing finance. In the event of his likely inability to fulfill any of the
conditions such as furnishing collateral security, etc. this would also indicate the futility of
persisting with the particular financing institution.

Budget adequately for promoter contribution

The promoter would have to contribute both for financing the project (in the form of
equity). However the project cost as assessed by the financing institution and the working
capital requirement as assessed by the bank often tend to be lower side. The excess over
such assessment would have to be fully incurred by the promoter.
For instance,
The project cost for a particular project may have been pegged at Rs. 100 lakh
comprising the following:

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Project cost
Components Financed by
Land and building
Rs. 25 lakh
Promoters equity
Rs.
40 lakh
Machinery
Rs. 50 lakh
Loan from FIs
Rs. 60 lakh
Margin money for w.c.
Rs. 15 lakh
Pre-operative expenses
Rs. 5 lakh
Contingencies for escalation
Rs. 5 lakh
Total
Rs. 100 lakh
Rs. 100 lakh
However, conservative assumptions by institutions may result in the following deviations
in actuals:

Additional expenditure on civil works: Rs. 5 lakh

Additional expenditure in pre-operative expenses by Rs. 3 lakh for securing speedy
clearances
Additional expenditure due to escalation of equipment costs and costs incurred in
installation of machinery and commissioning: Rs. 5 lakh
Actual requirement of working capital Rs. 80 lakh; Working capital requirement
assessed as per bank norms Rs. 60 lakh. Excess contribution towards working
capital Rs. 20 lakh.

Total escalation in project costs Rs. 13 lakh (Rs. 8 lakh after utilizing the Provision for
contingencies). Increased Promoter Contribution for Working Capital Rs. 20 lakh.
Additional funds required to be brought in: Rs. 28 lakh (assuming Working Capital is fully
required upfront). Such situations could lead to the entrepreneur being required to invest
often even 50% higher amounts that his contribution as per the assessed cost of projects.
Evidently, it is better to anticipate these in advance!
1.5

Post Implementation Review

Periodical Reviews
Post implementation, reviews are normally conducted by FIs to seek information for
compilation of statistics and internal studies. This is done largely by the All India Financial
Institutions in case of the large companies. The State Financial Institutions, which cater to
the small and medium businesses generally, do not review cases that are regular. Only in
cases where the loan becomes non-performing, efforts are initiated to address the
problem either by providing adequate breathing time through formal/ informal
reschedulement or by other intensive recovery measures.
Corporate Governance
In case of medium and large businesses the Financial Institutions have nominees on the
Board of Directors. Earlier these nominees used to involve themselves only in matters
pertaining to the dealings with Financial Institutions. The need to protect the interests of
the institutions and other stakeholders, such as small shareholders in ensuring that the
promoters manage the business in a responsible manner, has led to these directors
playing a more effective role on the aspect of Corporate Governance.
These businesses would also need to adhere to the code of corporate governance set by
these institutions. Nominee directors are appointed on corporate boards by these
institutions to monitor compliance. The guidelines address most of the concerns voiced
by the minority and majority shareholders of the Indian corporate sector and seek to
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prevent a wide range of practices. Some of these practices while being legal under the
law have not always served investor interests.
Guidelines on Corporate Governance
The institutions have defined corporate governance as a philosophy by which owners and
managers are expected to be perennially responsible to other stakeholders such as
minority shareholders, promoters, institutional shareholders, deposit-holders, creditors,
consumers and the institutional lenders. The areas where the nominee directors are
expected to play an effective role include crucial pre-defined areas such as investments
in subsidiaries and loans, awards of contracts, mergers and acquisitions, expansion and
diversification, dividend, accounting policy, subsidiarisation and desubsidiarisation.

Well defined dividend policies

According to the guidelines, companies should have well defined and declared longterm dividend policies with deviations immediately being brought to the notice of
the boards.

Consistent and transparent accounting policies

Accounting policies of a company, particularly relating to the methods of charging
depreciation, should be examined by the nominees, as also any changes in them.

Investment in subsidiaries
Cracking down on investments in non-productive assets by business houses, the
guidelines say that if subsidiaries are to be carved out by investment of funds, the
rationale behind its creation ought to be carefully examined.

Loans and Investments to Unlisted companies

Investments in the form of loans at concessional rates of interest must be examined.
Likewise, investments in unlisted companies in which promoters of companies are
interested ought to be carefully examined. The guidelines also put a check on
reckless resource raising in the form of equity or loans unless required for expansion
and long-term working capital needs.

Expansions, Diversifications & Corporate Restructuring

Expansions and diversifications will now come under examination. Expansions of
capacities through subsidiary company or joint ventures should be carefully
examined too. Transfers or hiving of profitable divisions and transfer of nonprofitable divisions should be allowed after detailed examination of valuation reports
by the nominees. Recognizing the uniqueness of brand-driven companies, the
guidelines say that in transfer of divisions relating to consumer durables, proper
value ought to be assigned to brand name and distribution networks. When a
corporate merges into another or follows the acquisition route, institutions will have
to examine the impact of merger on the equity shareholding pattern as well as the
impact on promoter holdings.
Diligence in expenditures
For the first time, perhaps, CEOs will have to account for their luxury expenditure.
Companies should not indulge in avoidable and extravagant, which is detrimental to
shareholders.

Managerial Remuneration & Award of Contracts

The guidelines require changes in managerial remuneration and commissions
payable to directors to be carefully examined and increases related to the financial
position of the company. Utilization of properties should be examined carefully, while
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contracts awarded to companies in which directors of the company are interested

ought to be examined in detail. In other words, no more sea-face properties or plum
contracts to nephews! Terms of the contracts should be examined and it should not
be detrimental to the companys interests. Equity dilutions to promoters on
preferential basis should be within institutional guidelines, while at the same time,
offerings should not be made only for increasing equity of promoters directly or
indirectly, unless warranted. Audit review committee reports, tender award
committees and concurrent audit reports should be closely scrutinized by
institutional nominees while the action taken or compliance with reports should be
examined.
Acquisitions & Sale of Investments
Finally, acquisitions of shares for the purpose of acquiring management control of
companies are to be examined. Nominees should ensure that the cost of acquisition
is not detrimental to the company. Likewise, disposing of investments consisting of
equity should be carefully effected.

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B. MEDIUM TERM FINANCE

1. Liquirent Loan
Liquirent Scheme is the scheme under which the loan can be borrowed against
receivable rent from rented out commercial or residential property.
a. Eligibility to apply for the "Liquirent" Scheme

The applicant / borrower own commercial or residential property

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b.

The property has been rented out to individuals, banks, MNCs, PSUs, Government
Institutions including landlords of IOB's branch/office premises and officers'
quarters

The Lease agreement for letting out/leasing of your property required

The receivable rent has not been charged to any other loan

The applicant/ borrower and the tenant to whom the property is rented out are
credit-worthy

The said property is not under dispute or under legal action for any building
violation If the receivable rent is partly charged, the balance should be sufficient to
cover the repayment for the proposed loan.

Estimation / Computation of Liquirent

The Loan Amount would be 75% (maximum) of the receivable rent for the
unexpired period of lease or tenancy after deductions for TDS and the advance
rent received

But the loan is subject to a maximum of 60 months rent

In exceptional cases, the loan amount can be arrived at based on the unexpired
portion of the current lease and future renewal, where such clause is incorporated
in the current lease

In such cases the maximum number of months rent to be financed may be

increased to 84, on a case to case basis, depending on the location of property,
value of connection, investment made by lessee in the leased premises such as
interior decoration, air-conditioning etc

The unexpired portion of the lease, however, should not be less than 36 months

The loan can be repaid in equated monthly installments for a maximum period of
60/84 months as the case may be but the repayment period should not exceed the
number of months taken into account for arriving at the loan amount.

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C. SHORT TERM FINANCE

a. Cash Credit / Working Capital Loan
1. Introduction

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2. Application for Working Capital

2.1 List of Documents accompanying the application
3. In-Principle Sanction for Working Capital
3.1 Appraisal and Final Sanction
3.2 Post Sanction Requirements
4. Monitoring and follow-up
5. Estimation of Working Capital Requirement
5.1 Introduction
5.2 Main Factors Considered in the estimation of working capital requirement
5.3 Steps involved in arriving at the level of Working Capital Requirement
5.4 Standard Formulae for determination of Working Capital
5.5 Working Capital assessment on the formula prescribed by the Tandon Committee
5.6 Working Capital & Small Scale Industries
5.7 Eligibility and Norms for bank financing of SSIs as per Nayak Committee

1. Introduction
Banks exercise extreme caution in lending to first time applicants starting up their
business. A first time applicant would be asked for collateral in the form of land, building
or residential property. This would be in addition to a second charge on the fixed assets of
the enterprise.
2. Application for the working capital
Most of the large commercial banks are moving towards the trend of specialized SSI
branches near the industrial concentrations. The applications for working capital are
generally accepted and processed at these branches.
2.1 List of Documents accompanying the application
The application for working capital would need to have a covering letter containing a
request for sanction of working capital limits. The following documents would need to be
enclosed alongwith:

Detailed Project Report containing the detailed financials at projected levels of

operations for the next 5 years
Memorandum and Articles of Association
Copies of Incorporation documents (relating to formalities with the Registrar of
Companies in case of corporates)
Statutory approvals obtained/ applied for such as for power, water, pollution control,
environment clearance, clearances from other agencies/ departments with purview
over the business.
Other relevant documents Letters of intent/ confirmed orders from prospective
buyers.
Networth statement of promoters.

In case of the larger loans (above Rs. 5 crore in case of most banks), the projections are
generally submitted in the CMA format prescribed by Reserve Bank of India (earlier
mandatory).

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3. In- Principle Sanction for Working Capital

The timeframe for in-principle sanction depends upon two factors:

Time taken for submission of necessary documents

The decision structure at the bank

Most of the large banks have specialized SSI branches at the industrial concentrations in
the country. These branches are headed by senior executives often with sanctioning
power of Rs. 5-6 crores at the branch. In such instances, delays for processing the
applications at the bank are limited. Infact the stage of in-principle sanction maybe
dispensed with and final sanction accorded on full appraisal.
In other cases, such processing may take 30-45 days for according In-Principle Sanction
to the project. The newer private sector banks are generally faster in according such
approval. The significance of the in-principle sanction of working capital is that such
sanction is necessary for obtaining term funding from the financial institutions. While
these financial institutions accord sanction to a industry,
3.1 Appraisal and Final Sanction
The appraisal and final sanction of the request for working capital is based on a thorough
appraisal of the Detailed Project Report (DPR). The traditional banks generally have
specified formats for submission of the DPR. The usual coverage of the DPR includes:

Overview of the business

Background of promoters

Details of products to be manufactured manufacturing process and raw material

Market overview and competition Sensitivity Analysis What if on Finished Goods

prices, raw material costs and so on

Detailed financial projections covering the Balance Sheet, Profit and Loss Account,
Funds Flow and the Financial Ratios.
The timeframe for a Final Sanction in cases where all the requirements have already been
submitted by the borrowing unit is 90 days from the submission of the application.
3.2 Post Sanction Requirements
Post sanction requirements involve completion of documentation creating a charge in
favour of the bank. This could include a charge on assets related to the business and
charge on collateral offered (if any). In case of the assets of the business already being
mortgaged with the term lending institution, a second or third charge maybe created in
favour of the bank.
The financing facilities sanctioned can thereafter be availed by the borrower.
4. Monitoring and follow-up
Working capital financing is extended for the current asset build up of a business, which is
linked to its activity level. These assets are mobile (in case of inventory) and also easily
convertible into cash. At best, the banks have a second charge on the fixed assets of the
enterprise and without the power of Seizure (u/s Sec 29 as available to the state financial
institutions) realizing money from the security is time consuming. Hence, banks pay
extremely high importance to the monitoring and follow-up of the loan.

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The system of a current account through which all the transactions are routed acts as an
in-built check on the operations of the borrower. By studying the current account
transactions in detail, the banker is able to make an assessment of the business. In
addition to this, the banks also undertake other forms of monitoring.
These include :

Stock Statements collected on a monthly basis from the borrower

Quarterly Operating Statement giving details of the operations for the quarter

In addition to these checks, banks often employ methods such as :

Stock Audit by independent firms of chartered accountants

This would involve a visit to the storage areas of the borrower, visual inspection and
scrutiny
of the stock statements at the spot. Cross-checking these with the statements given by
the
client would provide a means of check.
Branch Inspection conducted by the internal audit/ bank staff
In case of larger loans, Consortium meetings where the operations of the unit are jointly
reviewed are also undertaken.
Review, enhancement of limits and adhoc limits
Review of limits is usually undertaken on an annual basis. In cases where a request for
enhancement of limits is made by the borrower during the course of the year, such a
request is processed based on the stock statements and QoS submitted. In case of
temporary need, an adhoc limit of upto 25% of the existing limits could be granted on
request.
5. Estimation of Working Capital Requirement
5.1 Introduction
Lack of adequate working capital is often stated as one of the major reasons for sickness
in industry (especially in case of SMEs). The counter arguments from the banks have
been that most firms face problems of inadequate working capital due to credit
indiscipline (diversion of working capital to meet long term requirements or to acquire
other assets). In this context it would be pertinent to understand the method adopted by
banks in computing the working capital requirement of the business and the quantum of
bank financing to be provided by the bank.
5.2 Main factors considered in the estimation of working capital requirement

The nature of business and sector-wise norms

Factors such as seasonality of raw materials or of demand may require a high level
of inventory being maintained by the company. Similarly, industry norms of credit
allowed to buyers determine the level of debtors of the company in the normal
course of business.

The level of activity of the business

Inventories and receivables are normally expressed as a multiple of a days
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production or sale. Hence, higher the level of activity, higher the quantum of
inventory, receivables and thereby working capital requirement of the business. So
in order to arrive at the working capital requirement of the business for the year, it
is essential to determine the level of production that the business would achieve. In
case of well-established businesses, the previous years actuals and the
management projections for the year provide good indicators. The problems arise
mainly in the case of determining the limit for the first time or in the initial few years
of the business. Banks often adopt industry standard norms for capacity utilization
in the initial years.
5.3 Steps involved in arriving at the level of Working Capital Requirement

Based on the level of activity decided and the unit cost and sales price projections,
the banks calculate at the annual sales and cost of production.

The quantum of current assets (CA) in the form of Raw Materials, Work-in-progress,
Finished goods and Receivables is estimated as a multiple of the average daily
turnover. The multiple for each of the current assets is determined generally based
on the industry norms.

The current liabilities (CL) in the form of credit availed by the business from its
creditors or on its manufacturing expenses are deducted from the current assets
(CA) to arrive at the Working Capital Requirement (WCR).
5.4 Standard Formulae for determination of Working Capital
The issue of computation of working capital requirement has aroused considerable debate
and attention in this country over the past few decades. A directed credit approach was
adopted by the Reserve Bank of ensuring the flow of credit to the priority sectors for
fulfillment of the growth objectives laid down by the planners. Consequently, the
quantum of bank credit required for achieving the requisite growth in Industry was to be
assessed. Various committees such as the Tandon Committee and the Chore Committee
were constituted and studied the problem at length.
Norms were fixed regarding the quantum of various current assets for different industries
(as multiples of the average daily output) and the Maximum Permissible Bank Financing
(MPBF) was capped at a certain percentage of the working capital requirement thus
arrived at.
5.5 Working Capital assessment on the formula prescribed by the Tandon
Committee
Working Capital Requirement (WCR)= [Current assets i.e. CA (as per industry norms)
Current Liabilities i.e. CL]
Permissible Bank Financing [PBF} = WCR Promoters Margin Money i.e. PMM (to be
brought in by the promoter)
As per Formula 1 : PMM = 25% of [CA CL] and thereby PBF = 75% of [CA CL]
As per Formula 2 : PMM = 25% of CA and thereby PBF = 75%[CA] CL
As is apparent Formula 2 requires a higher level of PMM as compared to Formula 1.
Formula 2 is generally adopted in case of bank financing. In cases of sick units where the
promoter is unable to bring in PMM to the extent required under Formula 2, the difference
in PMM between Formulae 1 and 2 may be provided as a Working Capital Term Loan
repayable in installments over a period of time.
5.6 Working Capital and Small Scale Industries
Small scale industries have a distinct set of characteristics such as low bargaining power
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leading to problems of receivables and lower credit on purchases, poor financial strength,
high level of variability due to dependence on local factors, etc. Consequently, it has been
rightly argued that the industry norms on different current assets cannot be adopted.
The PR Nayak Committee that was appointed to devise norms for assessing the working
capital requirement of small-scale industries arrived at simplified norm pegging the
Working Capital bank financing at 20% of the projected annual turnover. However, in case
of units which are non-capital intensive such as hotels, etc. banks often assess
requirements both on the Nayak Committee norms as well as the working cycle norms
and take the lower of the two figures.
5.7 Eligibility and Norms for bank financing of SSIs as per Nayak Committee
a. Applicability : In case of SSIs, with working capital requirement of less than Rs. 5
crores
In case of other industries, with working capital requirement of less than Rs. 1 crore
b. Quantum of Working Capital bank financing : 20% of the projected annual
turnover
c. Subject to a Promoter bringing in a margin of : 5% of the projected annual
turnover (i.e. 20% of the total fund requirement that has been estimated at 25% of the
projected annual turnover)

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