Credit Analysis - Purpose and Factors to be

considered: An Overview

SUBMITTED BY

Name: Mr. Ninad Gupte

DPGD/AP11/0024

Welingkar Institute of Management

Development & Research
Year of Submission: 2013

ACKNOWLEDGEMENT

First and foremost, I thank the Almighty God for sustaining the enthusiasm with which plunged
into this endeavor.

I avail this opportunity to express my profound sense of sincere and deep gratitude to many
people who are responsible for the knowledge and experience I have gained during the project
work.

In the first place, I thank Welingkar Institute of Management Development and Research for
given me this opportunity to this project

I extend my overwhelming gratitude to my teachers for their valuable guidance and meticulous
supervision during the preparation of this Project Report.

My hearty and inevitable thanks to my company and central Bank of India who helped me to
bring out the project in a successful manner. I would be failing in my duty if I do not
acknowledge a deep sense of gratitude to my parents and friends who have helped me in
completing project work successfully.

CERTIFICATE

This is to certify that project titled Credit Analysis - Purpose and Factors to be considered:
An Overview has been submitted by Mr. Ninad Gupte seat no. DPGD/AP11/0024 a
candidate for the Post Graduate Diploma examination of

Welingkar Institute of Management

under my guidance and direction.

The matter presented in this report has not been submitted for any other purpose in this Institute.

_______________________
Guide:
Place: Mumbai
Date :

TABLE of CONTENTS
Particular
s

Serial
Number

Topic

Executive Summary
1.1

Page
Numbe
r
5

1.2

Introduction
Definition

1.3

Basic Types of Credit

1.4

Credit Analysis Process

Chapter 2

2.1
2.2

Purpose of Credit Analysis

Dimensions of Credit Appraisal

14
16

Chapter 3

3.1

Factors to be considered in Credit

analysis
Significance of Financial Tools
Components of Credit Cycle
Credit risk
Approaches to Evaluating Credit Risk
Importance of Credit Risk Assessment

18

Credit Analysis Report

Case Study

42
52

Format of term loan sheet

Bibliography

66
69

Chapter 1

3.2
3.3
3.4
3.5
3.6
Chapter 4

4.1
4.2

Annexure

6
7

8
9

20
29
31
35
38

EXECUTIVE SUMMARY

The financial crises have become the main cause for recession which was started in 2006
from US and was spread across the world. The world economy has been majorly affected from
the crisis. The securities in stock exchange have fallen down drastically which has become the
root cause of bankruptcy of many financial institutions and individuals. The root cause of the
economic and financial crisis is credit default of big companies and individuals which has badly
impacted the world economy. So in the present scenario analyzing ones credit worthiness has
become very important for any financial institution before providing any form of credit facility
so that such situation doesnt arise in near future again.
The project involved the complete study of overview of credit analysis to understand the
importance of credit analysis and credit analysis system followed by the banks in India. The
Credit Appraisal is a holistic exercise which starts from the time a prospective borrower walks
into the branch and culminates in credit delivery and monitoring with the objective of ensuring
and maintaining the quality of lending and managing credit risk.
The results of the project have been an outcome of a detailed analysis of collected
secondary data and well supported by analysis of primary data collected through an informal
interview with banker of Central Bank of India (CBI). The project contains case study on SME
sector of CBI to elaborate on the explanations.

The project contains various financial

information (balance sheet, Income sheet, ratios and cash flows) and graphs to the further.
Finally we concluded the results of the project by combining both the primary and the secondary
data analyses that credit analysis helps us give an overall picture about the industry as a whole
and the firms position and to assess whether it would be able to repay the credit or run into
crisis.

CHAPTER - I
Introduction (I.1)
Credit analysis is the method by which one calculates the creditworthiness of a business
or organization. In other words, it is the evaluation of the ability of a company to honor its
financial commitments. The audited financial statements of public limited companies might be
analyzed when it issues or has issued bonds or shares. Or, a Bank may analyze the financial
statements of a small business before making or renewing a commercial loan. The term refers
to either case, whether the business is large or small.
Credit analysis involves a wide variety of financial analysis techniques, including ratio
and trend analysis as well as the creation of projections and a detailed analysis of cash flows.
Credit analysis also includes an examination of collateral and other sources of repayment as well
as credit history and management ability.
Traditionally, bankers have faced credit risk in the form of default by borrowers
(individual/ organization). To this date, credit risk remains major concern for lenders worldwide.
The more they know about the creditworthiness of a potential borrower, the greater the chance
they can maximize profits, increase market share, minimize risk, and reduce the financial
provision that must be made for bad debt.
Credit risk is a risk related to non-repayment of the credit obtained by the customer of a
bank. Thus it is necessary to appraise the credibility of the customer in order to mitigate the
credit risk. Proper evaluation of the customer is performed this measures the financial condition
and the ability of the customer to repay back the Loan in future. Generally the credits facilities
are extended against the security know as collateral. But even though the Loans are backed by
the collateral, banks are normally interested in the actual Loan amount to be repaid along with
the interest. Thus, the customer's cash flows are ascertained to ensure the timely payment of
principal and the interest.

Definition (I.2)
Credit: The amount of money available to be borrowed by an individual or a company is
referred to as credit because it must be paid back to the lender at some point in the future.
For example, on a company's balance sheet, a debit will increase the inventory account (an
asset). On the other hand, a credit will increase the company's accounts payable (a liability).
Credit Risk: The risk of loss of principal or loss of a Interest on principal slowing from a
borrower's failure to repay a loan or otherwise meet a contractual obligation.
Credit risk arises whenever a borrower is expecting to use future cash flows to pay a
current debt.

Credit Analysis: A type of analysis an investor or bond portfolio manager performs on

companies or other debt issuing entities encompassing the entity's ability to meet its debt
obligations. The credit analysis seeks to identify the appropriate level of default risk
associated with investing in that particular entity.

Credit Analyst: A financial professional who has expertise in evaluating the creditworthiness
of corporate and small enterprises. Credit analysts determine the likelihood that a borrower
will be able to meet financial obligations and pay back a loan, often by reviewing the
borrower's financial history and determining whether market conditions will be favorable to
repayment.
Credit analysts are typically employed by commercial and investment banks credit card
issuing institutions, credit rating agencies and investment companies.

Basic Types of Credit (I.3)

There are four basic types of credit. By understanding how each works, you will be able to get
the most for your money and avoid paying unnecessary charges.
1. Service credit is monthly payments for utilities such as telephone, gas, electricity, and
water. You often have to pay a deposit, and you may pay a late charge if your payment is
not on time.
2. Loans let you borrow cash. Loans can be for small or large amounts and for a few days
or several years. Money can be repaid in one lump sum or in several regular payments
until the amount you borrowed and the finance charges are paid in full. Loans can be
secured or unsecured.
3. Installment credit may be described as buying on time, financing through the store or
the easy payment plan. The borrower takes the goods home in exchange for a promise to
pay later. Cars, major appliances, and furniture are often purchased this way. You usually
sign a contract, make a down payment, and agree to pay the balance with a specified
number of equal payments called installments. The finance charges are included in the
payments. The item you purchase may be used as security for the Loan.
4. Credit cards are issued by individual retail stores, banks, or businesses. Using a credit
card can be the equivalent of an interest-free Loan- end of each month.-if you pay for the
use.
BRIEF OVERVIEW OF LOANS:
Bank can provide credit of two types fund based & non-fund based:
Fund Based includes: Working Capital and Term Loan
Non-Fund Based includes: Letter of Credit and Bank Guarantee

Credit Analysis Process (I.4)

FLOW OF CREDIT ANALYSIS

Receipt of application from applicant

Receipt of documents
(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA,
and properties documents

Pre-sanction visit by bank officers

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC,
Caution list etc
Title clearance reports of the properties to be obtained from
empanelled

Valuation reports of the properties to be obtained from empanelled

valuer/engineers
Preparation of financial data
Proposal preparation
Assessment of proposal
Sanction/approval of proposal by appropriate sanctioning authority

Documentations, agreements, mortgages

Disbursement of Loan
Post sanction activities

10

STAGES IN CREDIT ANALYSIS:

The credit process begins with a thorough analysis of the borrowers creditworthiness, or
capacity and willingness to repay the loan.
The examiner should find an assessment by the credit officer of:
The borrowers current and expected financial condition.
The borrowers ability to withstand adverse conditions or stress. The borrowers credit
history and a positive correlation between historical and projected repayment capacity.
The optimal loan structure, including loan amortization, covenants, reporting
requirements the underwriting elements.
Collateral pledged by the borrower amount, quality and liquidity; bank ability to realize
the collateral under the worst case scenario. And,
Qualitative factors, such as management, the industry and the state of the economy.

The credit policy and standards should define acceptable loan purposes, types of loans and
loan structures, and industries to which the bank is willing to lend, as well as the types of
information the lender is required to obtain and analyze. The policy and standards help to create
the framework, requirements and tolerance limits for lending in which all bank credit personnel
will engage. The lender must understand the banks credit risk management system and his/her
role in it, as s/he engages in lending activities analysis, underwriting and monitoring

11

The Second stage is to Analysis of risks associated with any borrower should focus on the four
foundations of creditworthiness, shown below:

Industry involves the industry dynamics and the companys position within the industry.
Weakness in the industry itself can significantly impact loan repayment ability and the
companys position within the industry is an important issue.

Financial Condition focuses on the borrowers ability to generate sufficient cash, the
first source of loan repayment, or to draw on existing resources, e.g., capital or assets, to
repay bank borrowings. The credit analyst examines the income statement, the balance
sheet and the cash flow statement to evaluate this foundation of creditworthiness,
focusing on profitability, efficiency, liquidity, a

nd leverage, in particular.

Management Quality entails the competence, integrity and alliances of the key
individuals running the company. Management weakness or dishonesty can have an
impact on both repayment capacity and security realization. Depth of management is
always a concern, especially in smaller, family run organizations.

Security Realization determines the level of the banks control over collateral and the
likely liquidation value, factoring in time, i.e., net present value. Weakness in security
realization threatens the second source of loan repayment.
In third and fourth stage At the stage when the credit risk is evaluated it is important to

provide a clear and substantiated assessment of the general political and economic risk in the
country, the risk at micro level for the industry where the company performs, as well as the
specific risk related to the specific loan applicant and his ability to adapt to the changes in the
economic environment.

The analysis of the cash flow is of great importance to the credit

risk evaluation. The amount of the credit resource that is actually needed is determined with
the help of this analysis. As it was already stated, for the company to perform effectively, it is
very important that the extended loan should correspond exactly to the cash resource needed.
Its insufficiency or excess leads to lowering the profitability of the credited undertaking and
respectively to a number of unfavorable effects on the financial situation of the borrower and
his capacity to service the credit in accordance with the negotiated terms.

12

The stage when the credit risk evaluation is prepared involves both an assessment of the
reliability of the loan applicant and of the general economic risk for the period as well as a
number of forecasts for the tendencies in their future development. From this analysis one
can get a clear idea about the assessment of the credited undertaking, the correspondence
between the amount of the required loan and the results from the cash flow analysis about the
real need for credit resources and its capacity to generate income. An evaluation should be
made of the credit security or guarantee.
The analysis of the credit risk is a prerequisite for taking an adequate credit decision and
setting the credit terms. Therefore, if the decision is to approve and accept the credit, the
credit bank carefully determines the type of credit, its maturity and the terms for repayment
of the principal, the interest rates and the charges. It is extremely important that these
conditions meet the needs and the credit risk. It might happen that the conditions of the
commercial bank turn out to be unacceptable for the loan applicant. That is why it is
recommended to work out trade-offs, which will satisfy both parties to the credit deal.
Once the credit has been agreed, the next step is preparing the paperwork and its actual
extension.

13

CHAPTER - II
Purpose of Credit Analysis (II.1)

Lending has always been the primary function of banking, and accurately assessing a
borrowers creditworthiness has always been the only method of lending successfully. The
purpose of the credit analysis is to identify the risks to which a bank may be exposed over the
life of a project financed by the bank, and to evaluate if the transaction is structured in a way that
makes those risks acceptable by the parties involved. Whenever an individual or a company uses
a credit that means they are borrowing money that they promise to repay with in a pre-decided
period. In order to assess the repaying capability i.e. to evaluate their credit worthiness banks use
various techniques that differ with the different types of credit facilities provided by the bank. In
the current scenario where it is seen that big companies and financial institutions have been
bankrupted just because of credit default so Credit Appraisal has become an important aspect in
the banking sector and is gaining prime importance.
. Since exposure to credit risk continues to be the leading source of problems in banks worldwide, banks and their supervisors should be able to draw useful lessons from past experiences.
Banks should now have a keen awareness of the need to identify, measure, monitor and control
credit risk as well as to determine that they hold adequate capital against these risks and that they
are adequately compensated for risks incurred. The Basel Committee is issuing this document in
order to encourage banking supervisors globally to promote sound practices for managing credit
risk. Although the principles contained in this paper are most clearly applicable to the business of
lending, they should be applied to all activities where credit risk is present.
Importance of Credit Analysis of Individual Borrowers
In case of the individual borrowers the system of credit analysis is used in order to measure the
economic capability. This is done in the context of repayment of debt. The system tries to find
out if the borrower would be able to pay his debts at the proper time. With the help of credit
analysis the lenders can also find out if the debtor would at all be able to pay back the debt.
14

Importance of Credit Analysis of Corporate Entities

The system of credit analysis is also applicable for reviewing the financial capacities of a certain
issuer who is dealing in debt instruments. This process is thus extremely crucial for those who
put their money in these debt instruments as their investment decisions are guided by the
financial capacity of the issuer.
Credit analysis requires the Funding Institution to assess the risks and rewards of
extending a loan. Credit risk is a risk related to non-repayment of the credit obtained by the
customer of a bank. Thus it is necessary to appraise the credibility of the borrower in order to
mitigate the credit risk. Given the risks inherent in lending, all lenders conduct their credit
analysis with the following principles in mind.
Credit analysis supports the work of marketing officers by evaluating companies before
lending money to them. The analysis must also determine whether the information submitted is
adequate for decision-making purposes, or if additional information is required.
The Major Purpose of Credit analysis is to:
1. Examine the nature of the borrowers business in the context of its industry
2. Identify and quantify the business risks in lending situation
3. Analyze cash flow to estimate future sources and uses of cash to make conclusion with
respect to likelihood of repayment as per the proposed and agreed terms and
4. Make recommendations to the proper type and structure of loan facility in the light of the
perceived financing needs and risks.

15

5. The end result is to enable the lenders to maximize risk return.Dimensions

of Credit Appraisal (II.2)

Management Appraisal
A lot of attention has to be paid to this area, for this is one of the long term factors affecting the
business of the concern. Does the management have enough experience in the line? What is its
track record? What are the antecedents? Introduced to us by whom? These are some of the
questions that need to be answered before we can take up any kind of exposure.
Commercial Appraisal
The business has to be commercially viable for us to proceed further. Is there enough demand in
the market? Is the product accepted in the market? How many substitute products are there?
What about entry and exit barriers? Is there scope for further growth? The nature of the product
demand for the same, the existing and perceived. In the segment, ability of the proponents to
withstand the same, government policies governing the industry, etc. need to be taken into
consideration.
Financial Appraisal
Does the promoter has the capacity to raise finance- both own equity and debt? What are the
sources of margin? Will the business generate sufficient funds to service the debt and other
stakeholders? Is the capital structure optimal?
Thorough scrutiny of the financial aspects of the request needs to be carried out. Apart from
ascertaining the need based character of the limits requested for, the financial health of the
proponents, ability to absorb unanticipated financial costs need to be looked into. Where higher
limits are considered, detailed analysis of the financial health would be made and the following
ratios computed:
Current ratio
Total outside liabilities/equity ratio
Profit before interest and taxes/interest ratio
16

 Profit before tax/Net sales ratio

Inventory + receivables/Sales ratio
DSCR if the borrower enjoys any term loan with any bank/FI even if no TL is being
considered by our bank.
Assessment of working capital credit requirements hinges normally on the projected sales and
other financial figures. All the above ratios would be compiled for the past two/three years
including the latest audited balance sheet. As the ratios would vary from industry to industry,
services, trade, etc.

Economic Appraisal
What is the breakeven level? Will the business post positive net present value through its
economic life? What is the level of cost /benefit? What is the Internal Rate of Return (IRR)? Will
the cost of funding and operations be well below the IRR?

17

CHAPTER - III
Factors to be considered in Credit analysis
(III.1)
In order to obtain a credit, the prospective borrower has to apply through a request for credit
limit form in the format provided by commercial banks and financial institutions. This form, in
effect, serves as a credit analysis report.
The given information is analyzed in detail by the commercial banks and financial
institutions to measure the viability of the project. It covers the following aspects of the project:
1. Identification of the Project and the Promoters:

Name and brief introduction of the project.

Name, address, background, educational qualification, technical qualification and

business experience of project promoters and sponsors.

Asset-liability position of promoters and of sister concerns.

2. Project Organization and Management:

Legal form of project organization.

Organizational structure and management set-up.

Authority distribution and reporting relationships.

Shareholding distribution among promoters and sponsors.

Memorandum of Association and Articles of Association of the project.

3. Technical Aspects of the Project:

Land and location of the project.

18

Building, structures, and fixture requirement.

Machinery, equipment, and vehicles requirement.

Raw materials and other inputs requirement.

4. Marketing Aspects of the Project:

Proposed product mix and product line.

Pricing strategy.

Mode and Channels of distribution.

Promotional strategy.

Local and global market outlook.

5. Project costs and Financial Aspects of the Project:

Detailed break-up of project costs: fixed, variable, and semi-variable.

Working capital needs.

Proposed debt-equity structure of the project.

Proposed sources of financing.

Proposed primary and collateral securities for loan with valuation.

Proposed loan repayment schedule with desired moratorium period.

6. Socio-economic Aspects of the Project:

Employment generation.

Use of advanced technology.

Contribution to GDP.

Foreign exchange savings

19

The documentation of the factors to be considered in these categories should contain clear and
unambiguous statements describing their potential impact on credit standing. The design of the
forms should already be apt to prevent or reduce longwinded descriptions of the factors and
unclear assessments with regard to the impact on credit standing. This can be achieved by using
standardized text modules and limited field sizes

20

Significance of Financial Tools (III.2)

21

The following document has to be reviewed for credit analysis is as follows:

Income statement
Balance sheet
Cash Flow statement
Key Financial ratios
Financial Projections

Income Statement:
The income statement gives an important perspective of the health of a business.
It reports the selling activities of a company over a certain period of time.
It shows the profit of the company
Borrower should provide three years of actual results, showing that:

He has generated sufficient operating income.

Sales growth is consistent with market share and market size assumptions.

The operating margins are consistent over time.

The Balance Sheet

The balance sheet is the snapshot of the borrowers financial condition at a specific point in time.
It presents:
What the company has today (Assets).
How much does the company owe today (Liabilities)
What is the company worth today (Net worth/Equity)
The borrower should provide three years of historical balance sheets in order for the
bank:

To generate, analyze and compare the ratios.

To identify the trends.

22

Cash Flow Statement

The importance of cash flow analysis lies in the fact that cash flow is the first source of loan
repayment. The task of the credit analyst/officer is to satisfy him/her that the borrower has
demonstrated the capacity in the past, and is likely to continue to have the capacity in the future,
to generate sufficient cash flow to repay the proposed loan plus interest.
Cash flow analysis involves the use of the balance sheet and the income statement to identify the
sources and uses of cash for the operating needs of the business. By analyzing the changes in
cash, a lender gains insight, not only into the effects of past management decisions, but also into
the companys direction. Changes in working capital and capital expenditures are quantified and
highlighted. The analysis highlights cash needs directly, thereby showing the competing uses of
cash to repay the banks debt. The management of a company has many choices for the use of its
cash. Each day, decisions are made concerning the investment, financing and operations needs of
the company. The following represent some of those decisions covering each of the three key
areas:

Operations flows
Cash inflows:
Cash receipts for sale of goods and services
Cash income from investments
All other cash receipts not classified as financing or investing activities
Cash outflows:
Cash payments to acquire goods and services
Cash payments for administrative expenses such as salaries, rent and utilities
Cash payments to lenders or taxes

Financing flows
Cash inflows:
Cash proceeds from new equity
Cash proceeds of issuing new debt
Cash outflows:
Cash payments of dividends
Cash payments to reacquire equity
Cash payment to creditors

Investing flows
23

Cash inflows:
Cash receipts from the sale of investments
Cash receipts from the sale of assets
Cash outflows:
Cash disbursements to buy investments
Cash disbursements to acquire assets

Financial Ratios
Ratios are used to better understand trends in the borrowers financial condition and operations.
They reflect how the balance sheet and income statement intersect.
There are four types of ratios such as Liquidity, Efficiency, Profitability, and Leverage.

Liquidity: There are two types of liquidity ratios:

Current ratio: A broad measure of liquidity which indicates the amount of current assets

available to repay the current liabilities over the next 12 months. Acceptable current ratios
vary from industry to industry and are generally between 1.5 and 3 for healthy businesses. If
a company's current ratio is in this range, then it indicates good short-term financial strength.
If it is below 1 (current liabilities exceed current assets), then the company may have
problems paying its bills on time. However, low values do not indicate a critical problem but
should concern the management
It is expressed as follows: Current ratio = Current assets/current liabilities.

Quick Ratio/ Acid Test: is used to test the ability of a business to pay its short-term
debts. Liquid assets are equal to total current assets minus inventories and prepaid expenses.
The acid test ratio should be 1:1 or higher, however this varies widely by industry. In general,
the higher the ratio, the greater the company's liquidity.
It is expressed as follows:
Quick ratio = Cash+ Mkt. Securities + Account Recv./Current liabilities

24

Efficiency Ratio:

Ratios that are typically used to analyze how well a company uses
its assets and liabilities internally. There are 4 types of ratio which as follows:
a. Fixed asset turnover ratio: This ratio measures the utilization of business is obtaining
form its investment in fixed assets i.e. how effectively it uses its fixed assets. A high figure
indicates efficient use of asset, the company is getting high sales revenue from each fixed
assets. A low figure will indicate that managers are not using fixed assets to their full
potential.
It is expressed as: Sales revenue / net book value of fixed assets

b. Stock Turnover/inventory Turnover: This ratio is a relationship between the cost of goods
sold and the cost of average inventory during a particular period. It is expressed in number of
times. Ratio indicates the number of time the stock has been turned over during the period and
evaluates the efficiency with which a firm is able to manage its inventory. Usually a high
inventory turnover/stock velocity indicates efficient management of inventory A low inventory
turnover ratio indicates an inefficient management of inventory.
It is expressed as: cost of goods sold / average stock

d. Debtors/Receivable Turnover Ratio: This ratio shows how efficient the firm is at collecting
its debt. The higher the value of debtors turnover the more efficient is the management of
debtors or more liquid the debtors are. Similarly, low debtors turnover ratio implies inefficient
management of debtors or less liquid debtors. It is the reliable measure of the time of cash flow
from credit sales. There is no rule of thumb which may be used as a norm to interpret the ratio as
it may be different from firm to firm
It is expressed as: (Debtors/Credit net sales) * 365

e. Accounts Payable Days on Hand: It is the average number of days it takes to pay payables
in cash. This ratio gives insight into a companys pattern of payments. If the number is higher
than the terms offered by suppliers, it may be a cause for concern because suppliers may require
25

cash on delivery. It is worth noting that a low number is not necessarily a good thing. Accounts
payable provides a source of spontaneous financing.
It is expressed as: (Accounts Payable / Cost of goods Sold) * 365

f. Return on assets: This ratio indicates how profitable a company is relative to its total
assets. ROA gives an idea as to how efficient management is at using its assets to generate
earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is
displayed as a percentage. Sometimes this is referred to as "return on investment"
It is expressed as: Net profit after taxes/Total assets (Use net profit before taxes to eliminate the
effect of taxes).

g. Return on Equity:
This ratio measures the return on owners equity (Net worth). The amount of net income returned
as a percentage of shareholders equity. Return on equity measures a corporation's profitability by
revealing how much profit a company generates with the money shareholders have invested.
This ratio is more meaningful to the equity shareholders who are interested to know profits
earned by the company and those profits which can be made available to pay dividends to them.
Interpretation of the ratio is similar to the interpretation of return on shareholder's investments
and higher the ratio better is
1
Return on Equity=[Net Income (net profit after tax preference dividend) / Shareholder's
Equity]*100

26

 Profitability :
a. Gross profit margin: The gross profit margin looks at cost of goods sold as a
percentage of sales. It reflects efficiency with which a firm produces its products. As the
gross profit is found by deducting cost of goods sold from net sales, higher the gross
profit better it is. There is no standard GP ratio for evaluation. However, the gross profit
earned should be sufficient to recover all operating expenses and to build up reserves
after paying all fixed interest charges and dividends
Gross Profit margin = [(Gross Profit/Net Sales) *100] = ____%.

b. Net profit ratio : NP ratio is used to measure the overall profitability and hence it is very
useful to proprietors. The ratio is very useful as if the net profit is not sufficient, the firm shall
not be able to achieve a satisfactory return on its investment. Obviously, higher the ratio the
better is the profitability.
Net profit ratio = (Net profit / Net sales) *100 = ____%.

c. Return on capital employed: is a measure of the returns that a business is achieving from the
capital employed, usually expressed in percentage terms. ROCE indicates the efficiency and
profitability of a company's capital investments. ROCE should always be higher than the rate at
which the company borrows otherwise any increase in borrowing will reduce shareholders'
earnings, and vice versa; a good ROCE is one that is greater than the rate at which the company
borrows.

ROCE = EBIT / Capital Employed = EBIT / (Equity + Non-current Liabilities) = EBIT / (Total
Assets Current Liabilities)

27

 Leverage
Total Debts to Total Assets Ratio : Extent to which the borrowed funds have been used to
finance a companys investments
Total Debt to Total Asset = Shirt term Debt + Long term Debt / Total Asset

Debt to Equity ratio = Debt-to-Equity ratio indicates the relationship between the external
equities or outsiders funds and the internal equities or shareholders funds. However, the
interpretation of the ratio depends upon the financial and business policy of the company.
The. A ratio of 1:1 is usually considered to be satisfactory ratio although there cannot be rule
of thumb or standard norm for all types of businesses. Theoretically if the owners interests
are greater than that of creditors, the financial position is highly solvent. In analysis of the
long-term financial position it enjoys the same importance as the current ratio in the analysis
of the short-term financial position.

Debt Equity Ratio = External Equities / Internal Equities]

Or
[Outsiders funds / Shareholders funds]

As a long term financial ratio it may be calculated as follows:

28

[Total Long Term Debts / Total Long Term Funds]

Or
[Total Long Term Debts / Shareholders Funds]

29

Interest Coverage: This ratio relates the fixed interest charges to the income earned by the
business. It indicates whether the business has earned sufficient profits to pay periodically
the interest charges. Interest coverage ratio is very important from the lender's point of view.
It indicates the number of times interest is covered by the profits available to pay interest
charges. A high debt service ratio or interest coverage ratio assures the lenders a regular and
periodical interest income. But the weakness of the ratio may create some problems to the
financial manager in raising funds from debt sources.
Interest Coverage Ratio= Net Profit Before Interest and Tax / Fixed Interest Charges

Debt ratio: A high debt ratio is unfavorable because it indicates that the company is already
overburdened with debt
Debt Ratio = liabilities / assets

30

Components of Credit Cycle (III.3):

Regardless of where you seek funding - from a bank, a local development corporation or a
relative - a prospective lender will review your creditworthiness. A complete and thoroughly
documented loan request (including a business plan) will help the lender understand you and
your business. The "Five C's" are the basic components of credit analysis. They are described
here to help you understand what the lender looks for.
Capacity: to repay is the most critical of the five factors, it is the primary source of
repayment - cash. The prospective lender will want to know exactly how you intend to repay
the loan. The lender will consider the cash flow from the business, the timing of the
repayment, and the probability of successful repayment of the loan. Payment history on
existing credit relationships - personal or commercial- is considered an indicator of future
payment performance. Potential lenders also will want to know about other possible sources
of repayment.
Capital : is the money you personally have invested in the business and is an indication of
how much you have at risk should the business fail. Interested lenders and investors will
expect you to have contributed from your own assets and to have undertaken personal
financial risk to establish the business before asking them to commit any funding.
Collateral: or guarantees are additional forms of security you can provide the lender. Giving
a lender collateral means that you pledge an asset you own, such as your home, to the lender
with the agreement that it will be the repayment source in case you can't repay the loan. A
guarantee, on the other hand, is just that - someone else signs a guarantee document
promising to repay the loan if you can't. Some lenders may require such a guarantee in
addition to collateral as security for a loan.
Conditions: describe the intended purpose of the loan. Will the money be used for working
capital, additional equipment or inventory? The lender will also consider local economic

31

conditions and the overall climate, both within your industry and in other industries that
could affect your business.
Character: is the general impression you make on the prospective lender or investor. The
lender will form a subjective opinion as to whether or not you are sufficiently trustworthy to
repay the loan or generate a return on funds invested in your company. Your educational
background and experience in business and in your industry will be considered. The quality
of your references and the background and experience levels of your employees will also be
reviewed.

32

CREDIT RISK(III.4)

Default risk
Components of Credit risk
Credit spread risk

Downgrade risk

The credit risk includes:

The rst risk is referred to as default risk in which borrower does not repay obligation (assessed
by credit rating). The second risk is labeled based on the reason for the adverse or inferior
performance. The risk attributable to an increase in the spread, or more specically the credit
spread, is referred to as credit spread risk. The risk attributable to a lowering of the credit
rating (i.e., a downgrading) is referred to as downgrade risk.
Credit analysis of any entitya corporation, a municipality, or a sovereign government
involves the analysis of a multitude of quantitative and qualitative factors over the past, present,
and future. There are four general approaches to evaluating credit risk:

FOR A BANK, WHAT IS RISK?

Risk is inability or unwillingness of borrower-customer or counter-party to meet their
repayment obligations/ honor their commitments, as per the stipulated terms.

LENDER TASK

Identify the risk factors, and

Mitigate the risk

33

HOW DOES RISK ARISE IN CREDIT?

In the business world, Risk arises out of

Deficiencies / lapses on the part of the management (Internal factor)

Uncertainties in the business environment (External factor)

Uncertainties in the industrial environment (External factor)

Weakness in the financial position (Internal factor)

To put in another way, success factors behind a business are:

Managerial ability

Favorable business environment

Favorable industrial environment

Adequate financial strength

As such, these are the broad risk categories or risk factors built into our CRA models. CRA takes
into account the above types of risks associated with the borrower unit. The eventual CRA rating
awarded to a unit (based on a score of 100) is a single-point risk indicator of an individual credit
exposure, & is used to identify, to measure & to monitor the credit risk of an individual proposal.
At the corporate level, CRA is also used to track the quality of Banks credit portfolio.

34

CREDIT & RISK

Go hand in hand.

They are like twin brothers.

They can be compared to two sides of the same coin.

All credit proposals have some inherent risks, excepting the almost negligible volume of
lending against liquid collaterals with adequate margin.

LENDING DESPITE RISKS:

So, risk should not deter a Banker from lending.

A bankers task is to identify/ assess the risk factors/ parameters & manage / mitigate
them on a continuous basis.

But its always prudent to have some idea about the degree of risk associated with any
credit proposal.

The banker has to take a calculated risk, based on risk-absorption/ risk-hedging capacity
& risk-mitigation techniques of the Bank.

35

Approaches to Evaluating Credit Risk (III.5):

Credit Ratings: Credit rating is the process of assigning a letter rating to borrowers
indicating the creditworthiness of the borrower. Rating is assigned based on the ability of
the borrower (company) to repay the debt and his willingness to do so. The higher the
rating of a company, the lower the probability of its default. The companies assigned with
the same credit rating have similar probability of default.

Credit rating helps the bank in making several key decisions regarding credit including:

Whether to lend to a particular borrower or not; what price to charge

What are the products to be offered to the borrower and for what tenor?
At what level should sanctioning be done?
What should be the frequency of renewal and monitoring?

Special Feature of Rating Tool:

Extensive data requirement and Centralized data base.
Mix of subjective and objective parameters.
Includes trend analysis.
13 parameters are benchmarked against other players in the segment. The tool contains
the latest available audited data/ratios of other players in the segment. The data is updated
at intervals.
Captures industry outlook.
Easy accessibility and faster computation of scores.
Adequate security system and provision of audit trails for confidentiality.
Maintaining of past rating records in the system for collection of empirical data on rating
migrations. This will enable the bank to arrive at PDs (Probability of Default) factor.

36

Traditional Credit Analysis: The traditional approach to credit analysis calls for
assessing a prospective customer in the terms of five Cs of credit.
Character The willingness of the customer to honour his obligations. It reflects
integrity, a moral attribute that is considered very important by credit managers. Capacity
The ability of the customer to meet credit obligations from the operating cash flows.
Capital The financial reserves of the customer. If the customer has difficulty in meeting
his credit obligations from its operating cash flow, the focus shifts to its capital.
Collateral The security offered by the customer in the form of pledged assets.
Conditions The general economic conditions that affect the customer.
To get information on the five Cs, a firm may rely on the following:
1. Financial Statements Financial statements contain a wealth of information 2. Bank
References The banker of the prospective customer may be another source of
information. To ensure a higher degree of candor, the customers banker maybe
approached indirectly through the bank of the firm granting credit 3. Experience of the
Firm Consulting ones own experience is very important. If the firm has previous
dealings with the customer, then it is worth asking how prompt has the customer been in
making payments? How well has the customer honoured his word in the past? 4. Prices
and Yields on Securities For listed companies, valuable inferences can be derived from
stock market data. Higher the price-earnings multiple and lower the yield on bonds, other
things being equal, lower will be the credit risk

37

Credit scoring models: A credit score is a numerical expression based on a statistical

analysis of a person's credit files, to represent the creditworthiness of that person. A credit
score is primarily based on credit report information typically sourced from credit
bureaus.
In India, there are four credit information companies licensed by Reserve Bank of
India. The Credit Information Bureau (India) Limited (CIBIL) has been functioning
as a Credit Information Company from January 2001. Subsequently in 2010, Experian,
Equifax and Highmark were given licenses by Reserve Bank of India to operate as
Credit Information Companies in India.
Although all the four credit information companies have developed their individual credit
score, the most popular is CIBIL credit score. The CIBIL credit score is a three digit
number that acts like a summary of individual's credit history and credit rating. This score
ranges from 300 to 900 with 900 being the best score. Individuals with no credit history
will have a score of -1. If the credit history is less than six months then score will be 0.
CIBIL credit score takes time to build up and usually it takes between 18 and 36 months
of credit usage before a decent credit score.

38

Importance of Credit Risk Assessment

(III.6)
Credit is a core activity of banks & an important source of their earnings, which go to pay
interest to depositors, salaries to employees & dividend to shareholders. In credit, it is not
enough that we have sizable growth in quantity/ volume, it is also necessary to ensure that we
have only good quality growth.
To ensure asset quality, proper risk assessment right at the beginning, that is, at the time of taking
an exposure, is extremely important.
Moreover, with the implementation of Basle-II accord4, capital has to be allocated for loan assets
depending on the risk perception/ rating of respective assets. It is, therefore, extremely important
for every bank to have a clear assessment of risks of the loan assets it creates, to become Basle-II
compliant.
That is why Credit Risk Assessment (CRA) system is an essential ingredient of the Credit
Appraisal exercise.

INDIAN SCENARIO:

In Indian banks, there was no systematic method of Credit Risk Assessment till late
1980s/ early 1990s.

Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems,
not CRA systems.

RBI came out with its guidelines on Risk Management Systems in Banks in 1999 &
Guidance Note on Management of Credit in October, 2002.

39

CREDIT RISK ASSESSMENT (CRA) MINIMUM SCORES / HURDLE

RATES
1. The CRA models adopted by the Bank take into account all possible factors which go
into appraising the risks associated with a loan. These have been categorized broadly into
financial, business, industrial & management risks and are rated separately. To arrive at
the overall risk rating, the factors duly weighted are aggregated & calibrated to arrive at a
single point indicator of risk associated with the credit decision.
2. Financial parameters: The assessment of financial risk involves appraisal of the
financial strength of the borrower based on performance & financial indicators. The
overall financial risk is assessed in terms of static ratios, future prospects & risk
mitigation (collateral security / financial standing).
3. Industry parameters: The following characteristics of an industry which pose varying
degrees of risk are built into Banks CRA model:

Competition

Industry outlook

Regulatory risk

Contemporary issues like WTO etc.

4. Management parameters: The management of an enterprise / group is rated on the

following parameters:

Integrity (corporate governance)

Track record

Managerial competence / commitment

Expertise

Structure & systems

40

Experience in the industry

Credibility : ability to meet sales projections

Credibility : ability to meet profit (PAT) projections

Payment record

Strategic initiatives

Length of relationship with the Bank

5. The risk parameters as mentioned above are individually scored to arrive at an aggregate
score of 100 (subject to qualitative factors negative parameters). The overall score thus
obtained (out of a max. of 100) is rated on a 8 point scale from SB1/SBTL1 to SB 8
/SBTL8.

SALIENT FEATURES OF CRA MODELS:

(a) Type of Models
S.
No.
(i)
(ii)

Exposure Level (FB + NFB

Limits )
Over Rs. 5.00 crore
Rs 0.25 crore to Rs. 5.00 crore

Non Trading Sector

(C&I , SSI , AGL)
Regular Model
Simplified Model

Trading Sector
( Trade & Services)
Regular Model
Simplified Model

(b) Type of Ratings

S. No.
(i)

Model
Regular Model

(ii)

Simplified Model

Type of Rating
Borrower Rating
Facility Rating
Borrower Rating

New Rating Scales Borrower Rating: 16 Rating Grades

There is different rating given to the different banks. For example
S.
No.

Borrower
Rating

Range of
scores

Risk level

Comfort Level

CB1

94-100

Virtually Zero risk

Virtually Absolute safety

41

2
3
4
5

CB2
CB3
CB4
CB5

90-93
86-89
81-85
76-80

6
7
8
9
10

CB6
CB7
CB8
CB9
CB10

70-75
64-69
57-63
50-56
45-49

11
12
13
14
15

CB11
CB12
CB13
CB14
CB15

40-44
35-39
30-34
25-29
<24

16

CB16

Lowest Risk
Lower Risk
Low Risk
Moderate Risk with
Adequate Cushion
Moderate Risk

Highest safety
Higher safety
High safety
Adequate safety
Moderate Safety

Average risk

Above Safety Threshold

Acceptable Risk
(Risk Tolerance Threshold)
Borderline risk
High Risk
Higher risk
Substantial risk
Pre-Default Risk (extremely
Vulnerable to default)
Default Grade

Safety Threshold
Inadequate safety
Low safety
Lower safety
Lowest safety
Nil

Bank has introduced New Rating Scales for borrower for giving loans. Rating is given on the
basis of scores out of 100. Bank gives loans to the borrower as per their rating like CBI gives
loans to the borrower up to CB8 rating as it has average risk till CB8 rating. From CB9 rating the
risk increases. So banks do not give loans after CB8 rating.

42

Chapter IV
Case Study - CREDIT ANALYSIS REPORT
(IV.1)
Research Methodology:
To study the Credit Appraisal System, We have taken a study of Central Bank of India, in SME
sector, Mumbai. This study will help in understanding the credit appraisal system in banks & to
reduce various risk parameters, which are broadly categorized into financial risk, business risk,
industrial risk & management risk associated in providing project finance.
OBJECTIVES:
To study the Credit Analysis at Central Bank of India, SME Sector
To check the commercial, financial & technical viability of the project proposed & its
funding pattern
To check the primary & collateral security cover available for recovery of such funds
To study the credit rating methods followed by the bank for different credit ranges.
To study a credit appraisal report of a firm.
Towards this end the preliminary appraisal will examine the following aspects of a
proposal. Banks lending policy and other relevant guidelines/RBI guidelines:

RESEARCH METHODOLOGY:
The success of the analysis mostly depends on the methodology on which it is carried out. The
appropriate methodology will improve the validity of the findings.
Title:
To determine

43

RESEARCH DESIGN:

Type of research design: Analytical Research.

Data collection : Primary and Secondary data

Research approach : observation, individual depth interview

Data Source : The study is based on the data collected through primary and secondary
sources

RESEARCH PROCESS
Data Collection:
Primary Data:
1) Depth Interview from analytical department of credit analysis and loan department
3) Data explaining the working of process
Secondary Data:
1) Audited financials of company
2) Newspapers
4) Database at CBI
5) Internet
7) E- Circulars of Central Bank of India
8) Brochures of bank, RBI, CIBIL
Sampling design & sample size;
A tool used by individuals to conduct a quantitative analysis of information in a company's
financial statements. Ratios are calculated from current year numbers and are then compared to
previous years, other companies, the industry, or even the economy to judge the performance of
the company. Ratio analysis is predominately used by proponents of fundamental analysis.
LIMITATION OF THE STUDY:
Due to the time constraint limited study on the project has been done
The period is five year. Hence the data cannot be compared to the longer life of the bank.
44

 As the credit appraisal is one of the crucial areas for any bank, some of the technicalities
are not revealed which may cause destruction to the information
In a rapidly changing industry, analysis on one day or in one segment can change very
quickly. The environmental changes are vital to be considered in order to assimilate the
findings.

45

Central Bank of India

Central Bank of India, a government-owned bank, is one of the oldest and largest commercial
banks in India. It is based in Mumbai. The bank has 4100 branches and 270 extension counters
across 27 Indian states and three Union Territories. At present, Central Bank of India has one
overseas office, which is a joint venture with Bank of India, Bank of Baroda, and the Zambian
government. The Zambian government holds 40 per cent stake and each of the banks has 20 per
cent. Central bank of India is one of 18 Public Sector banks in India to get
recapitalization finance from the government over the next 24 months.
As on 31 March 2011, the bank's reserves and surplus stood at

business at the end of the last fiscal amounted to

6,868.85 crore. Its total

2,09,757.33 crore.

A number of innovative and unique banking activities have been launched by Central Bank of
India and a brief mention of some of its pioneering services are as under:
1921 Introduction to the Home Savings Safe Deposit Schemeto build saving/thrift habits in
all sections of the society.
1924 An Exclusive Ladies Department to cater to the Bank's women clientele.
1926 Safe Deposit Locker facility and Rupee Travellers' Cheques.
1929 Setting up of the Executor and Trustee Department.
1932 Deposit Insurance Benefit Scheme.
1962 Recurring Deposit Scheme.
Subsequently, even after the nationalization of the Bank in the year 1969, Central Bank
continued to introduce a number of innovative banking services as under:
1976
1980
1986
1989
1994

The Merchant Banking Cell was established.

Centralcard, the credit card of the Bank was introduced.
'Platinum Jubilee Money Back Deposit Scheme' was launched.
The housing subsidiary Cent Bank Home Finance Ltd. was started with its headquarters at
Bhopal in Madhya Pradesh.
Quick Cheque Collection Service (QCC) & Express Service was set up to enable speedy
collection of outstation cheques.

46

Further in line with the guidelines from Reserve Bank of India as also the Government of India,
Central Bank has been playing an increasingly active role in promoting the key thrust areas of
agriculture, small scale industries as also medium and large industries. The Bank also
introduced a number of Self Employment Schemes to promote employment among the educated
youth.
MSME SECTOR :
In the Indian context, the Micro, small and medium enterprises (MSME) sector is broadly a
Term used for small scale industrial (SSI) units and medium-scale industrial units.
Micro-enterprise is one where the investment in plant and machinery (their original cost
excluding land, building and items specified by the Ministry of Small Scale Industries in
its notification No. S.O. 1722(E) dated October 5, 2006) does not exceed Rs.25 lakh.

Small enterprise one where the investment in plant and machinery (see above) is more
than Rs.25 lakh but does not exceed Rs.5 crore.

Medium enterprise is one where the investment in plant and machinery (see above) is
more than Rs.5 crore but does not exceed Rs.10 crore.
Assessment of Credit for MSME Units
In tune with the liberalized environment, our Bank has adopted the following system for
assessment of working capital requirements of the borrower.
Turnover Method: This method should be used for assessing fund based working
capital requirements enjoyed from the banking system up to Rs.5.00 crore.
Traditional Method: Fund based working capital requirements under this method
should be assessed under Method II of Tandon Committee for borrowers enjoying fund
based working capital limits of above Rs.5.00 crore but less than Rs.50.00 crore.
47

Cash Budget Method:

This method would be applicable to borrowers who are
i. Falling under Cyclical Industries like Tea, Sugar etc.
ii. Borrowers availing Fund Based Working Capital limits of Rs.50 crore and above from the
banking system.
CBI NORMS FOR SME - CREDIT APPRAISAL

Credit appraisal means an investigation/assessment done by the bank prior before providing any
loans & advances/project finance & also checks the commercial, financial & technical viability
of the project proposed its funding pattern & further checks the primary & collateral security
cover available for recovery of such funds.

Benchmark of ratios is as follows:

Ratio

Benchmark

Current Ratio

1.10

Debt-Equity Ratio

3:1

Debt Service Coverage Ratio (Average):

1.25

Interest Coverage Ratio

1.50:1

Asset Coverage Ratio

1.33:1

Normally Net Worth to Bank Borrowings ratio shall be 1:4. However, deviation up to 1:6
can be allowed by next higher authority not below the rank of Zonal Manager in case of
Manufacturing & Trading accounts.

For Working Capital and Term Loan Upto One Year

48

LIMITS

Rate
Base Rate % (a)

Spread Rate % (b)

Effective Rate %
(a+b)=(c)

10.75

0.50

11.25

Above Rs. 10 lacs 10.75

and & up to Rs.
100 Lacs

1.00

11.75

Up to Rs 10 lacs

For term loans above 1 year:

Tenor premium : Tenor of the loan
(including Moratorium period)

PREMIUM

>1 Year and up to 3 Years

0.25%

> 3Years

0.50%

Rating: As per Reserve Bank of India, in case of advances up to Rs.2 crore to Micro and
Small Enterprises (MSE) sector Bank should implement scoring model and information
required for the scoring model should be incorporated in the application form itself.
Accordingly Bank has formulated two separate scoring models, (MSE-I and MSE-II
attached as Annexure III and IV) for all advances up to Rs.2 crore falling under MSE sector.
i. Scoring Model MSE-I is to be utilized for existing units and Scoring Model MSE-II is to
be used for new units.ii. For advances above Rs.2 crore and up to Rs.5 crore scoring model
similar to CART of SIDBI is to be utilized iii. For advances above Rs.5 crore LCRT of our
Bank is to be utilized. The total number of weightage marks obtained by the concerned
borrower, the borrower would be rated as under.

49

Rating Agencies: Bank has entered into an MOU for Performance and Credit Rating
Mechanism of National Small Industries Corporation (NSICs) with following rating
agencies.
1. CARE
2. CRISIL
3. FITCH
4. ICRA
5. SMERA
If borrower opts for credit rating with any of the above agencies, bank will consider
following concessions.
Concession of 50% in Processing Charges
Interest Concession of 0.25% for the following rating scale.

Performance Capabilities

Financial Strength

Interest Concession

High
Highest

SE 1A

High

SE 2A

0.25%
0.25%

Bank is adopting the ratings assigned by the external rating agencies for the purpose of
pricing only and not as a substitute for Banks internal Credit Rating exercise.Bank has also
approved following agencies (empanelled with NSCIs) for Performance and Credit Rating.
(MOU to be signed)Based on the present indications, following exposure levels are
prescribed:

50

Individuals as borrowers

Maximum aggregate credit facilities of

Rs. 20 crores
( Fund based & non-fund based )

Non-corporates

Maximum aggregate credit facilities of

Rs. 80 crores
( Fund based & non-fund based )

( e.g. Partnerships, JHF, Associations )

Corporates

Maximum aggregate credit facilities as

per prudential norms of RBI on exposures

Appraisal:
The budget must be scrutinized vis--vis the financial statements to satisfy that the forecasts are
reasonable. Once the forecasts are found acceptable, the credit limit required by the borrower is
to be determined as the peak level of cash deficit as shown in the budget. The sanctioning of the
limit will be subject to the observance of the following:
a. Maintenance of Current Ratiodesired level is 1.10
b. The Debt: Equity Ratio (TOL: TNW) normally not to exceed 2:1
c. Borrower / Group exposure to be within norms determined by the Bank internally, but within
the Reserve of India parameters;
d. The appraisal will also include assessment of the Company profile and Industry Profile
e. There has to be an evaluation of risks at the time of fixing lending limits and if felt expedient,
the level of operations and cash budget projections will be pruned down by the bank at the time
of discussions before finalizing credit limits.
f. The disbursal of credit facilities will be by way of Loan and Cash Credit components as per
stipulation of Loan Delivery System. Flexibility will be allowed in fixing maturity periods of the
loans which can correspond to the quarterly budgets if the borrowers so choose. Once the
51

maturity period is fixed, prepayment of the loan component if required shall be subject to RBI
guidelines and also payment of a penalty upto 2% of the repaid loan amount for the unexpired
period, as may be decided by sanctioning authority at his discretion.
g. Credit facilities on preferential terms like export credit should be assessed and disbursed in
terms of existing procedure. However, the total of such facilities and all other fund based
facilities availed should be within the limits under the Cash Budget.

52

CASE STUDY (IV.2)

FACT SHEET
Name

Flexi Polymers Private Limited company

Constitution

Private Limited Company

Registered Office
Address

B- 301, city light road , Athawagate

Surat-395 003, Gujarat

Line of Activity

Manufacturing of HDPP woven sacks

Sector

Manufacturing

Dealing with us

New Connection

Incorporation

15th June 2004

Name of Directors

Mr. Atulbhai Prahladbhai Patel

Mr. Rameshbhai Bhagwanbhai Patel
Mr. Hitendra Hargovinddas Patel

Group

Not a recognized group

Rating

SME 3 (ABS 31.03.2013)

Associate Concern

Dynamic Overseas (India) Private Limited

No. Of Employees

Permanent : 22
Contractual : 468
Total : 490

Proposed Credit
requirement

FBWC limits of Rs.2.25 crores

Fresh Term Loan of Rs.2.00 crores

53

BRIEF BACKGROUND:
The Company was incorporated on 15th June 2004 as Private Limited Company. The Company
was promoted with the objective of carrying for manufacturing and selling of HDPP woven
sacks to be manufactured from HDPP granules.
The promoters have sufficient experience in the line of activity. The promoters had already made
negotiations of the some of the industries as detailed under for selling the HDPP woven sacks:

Indian Farmers Fertilizers Company Limited

Gujaco masol
Birla cement
Sanghi Cement
Ambuja cement
Various grain & Food Export units of Gujarat, etc.

The firm has also started marketing activity for their products by making personnel contacts &
writing introductory letters to potential customers & as the promoters are in the same line of
business activity for the last 15 years they are having very good market contacts for the sales of
the Finished Goods.
The orders worth Rs.2.50 crores is expected to be finalized by end of August, 2013 and before
commissioning of the plant as advised

54

QUALITATIVE FACTORS:
The Company has a pro-active Management and Promoters who have hands on
experience in sacks.
Profit making Company since last 5 years.
The company was awarded with trophy for export performance of more than Rs. 6.00 &
8.00 Crore for Self.

Raw Material The major raw material for this plant is HDPP in the form of
granules. This raw material is available locally by sales & distribution network of the major
suppliers as under:

Reliance Industries Limited

Nand Agencies

Labdhi International

Hadlia petrochemicals Ltd.

Sharada Polymers

IPCL

The raw materials are purchased from the suppliers against the advance payment only and cash
discounts are offered resulting in the increase in profitability. Any variation in the cost of raw
material is proposed to be passed on to the finished products and will not affect the profitability.

Marketing Strategy/Marketing arrangement : Strong and experience people are

leading companys marketing department. Companys total turnover is divided into:
Exports Sales
Local Sales
Exports Sales:

Companys 70% turnover is generated by way of exports sales. Company has its own
presence in all most all countries. The company is exporting HDPP in Latin America,

55

African countries, Middle East, Far East, US and Europe. Almost all export customers are
dealing with company for many years.

Out of total exports turnover 60 to 70% percentage orders are repeated orders and rest of
the orders are new orders.

The Company has region wise Export Managers who can cater the need of customers
individually. Due to the quality and timely delivery of the material the company have less
competition from these countries.

Local Sales:

In Local Market Company is doing marketing its Sacks to the end customers.

The company is the largest manufacturer of S.P.C.P in India which generating repeated
order from the local customers.

Proposed Credit Limit

Proposal:
Sanction for;
i)
FBWC limits of Rs.2.25 crores
ii) Fresh Term Loan of Rs.2.00 crores
Approval for:
i)
CRA rating of SB- 6 (71 marks) based on projected financials as on
31.03.2013
ii) Pricing for WC facilities @1.00% above SBAR as applicable for SB-5
minimum @13.75and for TL 1.50% above SBAR minimum @14.25%

56

QUANTITATIVE FACTORS:
Performance & Financial Indicators:
(Rs. in Crores)

Year
Installed cap Qty.

2013

2014

2009
2520

2010
2520

2011
2520

2012
2520

(unaudited)
2520

(projected)
2520

1029

2016

2091

2142
21.0

2217

2268

9.26
0.00
0.44
0.43

19.77
0.00
1.18
1.17

20.58
0.00
1.19
1.18

9
0.00
1.23
1.22

21.82
0.00
1.31
1.30

22.34
0.00
1.33
1.32

4.64
0.29
0.66
1.20
0.95

5.92
0.78
1.10
2.04
0.95

5.73
0.79
1.09
1.96
0.95

5.78
0.82
1.15
1.97
0.95

5.96
0.87
1.24
2.02
0.95

5.91
0.88
1.32
2.05
0.95

1.23
1.73
4.11
2.64
1.34
1.01

2.01
2.51
2.50
1.80
1.52
1.71

2.80
3.30
1.67
1.27
1.53
2.40

3.62
4.12
1.19
0.92
1.53
2.57

4.49
4.99
0.88
0.81
1.57
2.74

5.38
5.88
0.66
0.62
1.81
3.28

(MT/pa.)
Net Sales Qty.
(approx) (MT)
Net Sales (Value)
(Export)
Operating profit
Profit before tax
PBT/Net sales (%)
Profit after tax
Cash accruals
PBDIT
Paid up capital
Tangible net worth
Adjusted TNW
TOL/TNW
TOL/Adjusted TNW
Current ratio (times)
NWC

57

Audited Balance Sheet: (Rs. In crores)

Sources of funds
Share Capital
Reserves and Surplus
Secured Loans : Short term CC
: Long term TL
Unsecured Loans
Deferred Tax Liability
Total
Application of Funds
Fixed Assets (Gross Block)
Less Depreciation
Net Block
Capital Work in Progress
Investments
Inventories
Sundry debtors
Cash & bank balances
Loans & advances to suppliers of
Raw material / spares
Advance tax
( Less : Current liabilities )
(Less : Provisions )
Net Current Assets
Misc. Expenditure
(To the extent not written off or adjusted )
Non-Current Assets/ Deposits
Total

31.03.2011
0.95
0.29
2.25
2.00
0.50

31.03.2012
0.95
1.07
2.25
1.60
0.50

5.99

6.37

2.67
0.37
2.30

2.67
0.69
1.98

1.73
1.85
0.15
0.14

2.13
2.40
0.15
0.12

0.10
0.31

0.23
0.67

3.66

4.36

0.03
5.99

0.03
6.37

Movement in TNW:Movement in TNW

Opening TNW
+ PAT
+ Inc. in Equity / Premium
+/- Change in Int. Assets
+/- Adj. of prior year exp.
- Dividend payment
Closing in TNW

Projected
31.03.2012
0.00
0.29
0.95
-0.01
1.23

58

31.03.2013
1.23
0.78

31.03.2014
2.01
0.79

2.01

2.80

Bank Income Analysis

(Rs. in crores)

From

Projection
31.03.2011
0.16
0.14
0.03
0.33

WC Int.
TL Int.
LC
BG
Bill
Others loan processing
Total

Projection
31.03.2012
0.27
0.29
0.01
0.57

Deviations in Loan Policy:

Parameters

Liquidity
TOL/TNW
TOL/Adj. TNW
Average gross DSCR (TL)
Debt / equity
Debt/Quasi equity
Any others

Indicative Min/Max level

as per loan policy
1.33
3.00
1.75
2:1
-

Company's
level as on
31.03.2011 @
1.34
4.11
2.64
2.54
2.01:1
1.15:1
-

Company's level as
on 31.03.2012
1.52
2.50
1.80
2.54
1.03:1
0.64:1
-

Defaulters List:Whether names of promoters, directors, company, group concerns figure in :

RBI defaulters list dated 30.09.2010
No
Wilful defaulters list dated 31.12.2007
No
ECGC caution list
No
Warning signals / Major irregularities in
Credit audit:
inspection report :
Not applicable new unit
Other audit reports :
Adverse observations in Balance sheet
Not applicable new unit
Adverse observations in Auditors report

Nil.

Any NPAs among associate concerns

None

Commercial viability :

(Rs.in crores)
59

Year ending

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

31st March
Net Sales
Net Profit
Cash Accruals
Interest on TLs
Sub Total (A)
Total repayment
Interest on TL
Sub Total (B)
DSCR (Gross)
Net DSCR
Average Gross

9.26
0.29
0.66
0.16
0.82
0.00
0.16
0.16
5.13
2.54

19.77
0.78
1.10
0.27
1.37
0.40
0.27
0.67
2.04
2.75

20.58
0.79
1.09
0.22
1.31
0.40
0.22
0.62
2.11
2.73

21.09
0.82
1.15
0.16
1.31
0.40
0.16
0.56
2.34
2.88

21.82
0.87
1.24
0.11
1.35
0.40
0.11
0.51
2.65
3.10

(Projected)
22.34
0.88
1.32
0.05
1.37
0.40
0.05
0.45
3.04
3.30

DSCR
Average Net

3.28

Total

6.56
0.97
7.53
2.00
0.97
2.97

DSCR

Break-even and sensitivity analysis and whether acceptable: (Rs. in crores)

Break even analysis
Capacity Utilization
Net Sales (A)
Variable costs
Raw material
Consumable spares
Power and Fuel
Other operating Exp.
Stock Changes
Total Variable Cost(B)
Fixed Costs
Direct Labour
Selling, Admin. & General

31/03/09
70%
9.26

31-Mar-10 31-Mar-11 30-Mar-12 31-Mar-13 31-Mar-14

80%
83%
85%
88%
90%
19.77
20.58
21.09
21.82
22.34

8.74
0.00
0.26
0.09
0.73
8.36

17.13
0.00
0.47
0.13
0.39
17.34

17.77
0.00
0.50
0.15
0.06
18.36

18.20
0.00
0.53
0.16
0.03
18.86

18.84
0.00
0.56
0.17
0.04
19.53

19.27
0.00
0.59
0.18
0.04
20.00

0.08

0.13

0.14

0.15

0.16

0.17

Expenses
Interest Expenses
Depreciation
Total Fixed Cost ( C)
Contribution (D=A-B)
Contribution ratio (E=D/A)
BE sales (F=C/E)
BE sales as % of Net

0.06
0.40
0.37
0.91
0.90
0.10
9.10

0.10
0.55
0.32
1.10
2.43
0.12
9.17

0.11
0.48
0.30
1.03
2.22
0.11
9.36

0.12
0.42
0.33
1.02
2.23
0.11
9.27

0.13
0.35
0.37
1.01
2.29
0.10
10.10

0.14
0.29
0.44
1.04
2.34
0.10
10.40

Sales

98.27

46.38

45.48

43.95

46.29

46.55

60

Interfirm Comparison: (To be given only where data from comparable units is available.)
(Amt in Cr)
Name of Company

FBL

NFBL

Year

Sales

PBT /
Sales
%

TOL /
TNW

CR

Ahmedabad Packaging
Industries Ltd.

3.30

1.20

2007

23.11

2.16

1.47

1.16

Singhal Industries Pvt. Ltd

6.70

--

2010

15.19

6.52

2.90

Asia Woven Sacks Pvt.

Ltd.

7.44

1.00

2008

22.98

4.53

3.14

Akshat Polymers

4.25

--

2010

19.77

5.92

2.50

61

1.90
1.08
1.52

Graphs

Analysis:

The firm is into manufacturing of HDPP woven sacks which are widely used as
packaging material in cement, fertilizer, etc.

As per ICRA report, grading and research services Flexible packaging sector is expected
to grow at the rate of 12.40%.

The companys borrower rating is SME-3 based on projected financials as on 31.03.2013

(the first full year of operations).

62

Projected financials are in line with the financials of the some of the unit in similar line of
activity and production level.

The promoters are having experience of more than 15 years in the line of the activity.

The affairs of the firm are expected to be managed on professional lines based on their
past experience.

The conduct of accounts of associate with the existing bankers has been satisfactory.

The short and medium term outlook for the industry is stable

Availability of collateral security reflected in collateral coverage of 50.566%.

Gross average DSCR of 2.54.

Average security margin of 48%.

The company has adequate management skills and production/marketing infrastructure in

place to achieve the projected trajectory. There is steady demand for the product.

Particulars

Rating

Overall Scoring

SME-3

Financial scoring

SME-4

Business scoring

SME-3

Management scoring

SME-3

Industry scoring

SME-3

63

Findings
Credit appraisal is done to check the commercial, financial & technical viability of the
project proposed its funding pattern & further checks the primary or collateral security
cover available for the recovery of such funds
CBI loan policy contains various norms for sanction of different types of loans
These all norms does not apply to each & every case
CBI norms for providing loans are flexible & it may differ from case to case

The CRA models adopted by the bank take into account all possible factors which go into
appraising the risk associated with a loan

These have been categorized broadly into financial, business, industrial, management
risks & are rated separately

The assessment of financial risk involves appraisal of the financial strength of the
borrower based on performance & financial indicators

After case study we found that in some cases, loan is sanctioned due to strong financial
parameters

64

Recommendation
All the documents required to appraise the project should be asked at the time of
application only rather than later by the bank
The bank must bring more transparency in appraisal of the project there should be
explanation for an appraisal of the project that was sanctioned by higher authority.
The bank must not rely on software or information provided by the client the bank should
dig in for other sources in order to draw a real picture for the company.
Credit scoring allows lenders to determine whether or not you fill the profile of the type
of customers they are looking for.
Banks concerned should continuously monitor loans to identify accounts that have
potential to become non-performing.
At the time of projections due to lack of documents, the projections are done.

CONCLUSION
In bank the Credit Appraisal is not simply a quantitative exercise of numbers crunching.
Borrowers operate in a dynamic environment, and their ability to repay is rarely the result of
static conditions reflected in periodic financial statements. The recent era of volatile social,
political, and economic change across the globe is only one example of the unpredictable forces
at work. Therefore, a sound credit rating system requires an analysis of broader credit risk
management issues as well.
The case study gave a vast learning experience to me and has helped to enhance my knowledge.
During the study I learnt how the theoretical financial analysis aspects are used in practice during
the finance assessment. I have realized during my project that a credit analyst must own multidisciplinary talents like financial, technical as well as legal know-how. The credit appraisal for
working capital finance system has been devised in a systematic way. There are clear guidelines
on how the credit analyst or lending officer has to analyze a loan proposal.
65

Annexure 1: Format of Term Sheet

Central Bank OF India

SME Finance Branch, Mumbai

Approval of Broad Terms Of The Proposal
IFB:ADV::

Dated

Name of the
account

Account with
Group
Existing
connection or
new connection
Credit Rating
Background of
promoters

(Rs. In Crores)
Brief Financials
Year (Aud.)
Net Sales
PAT(Loss)
TNW*
Current Ratio
TOL/TNW
RATIO
66

Year (Aud.)

Year (Prov.)

(Rs. In Crores)
Nature of Project

Cost of Project

tal
MEANS OF FINANCE
Nature of Facility
Amount

Rs.

Crores

Margin
Interest/Commission
Interest reset
Purpose

Period of the facility

Moratorium
Door To Door Tenor
Repayment terms
Security Prime
Collateral security
Upfront fees

Prepayment terms

67

% of

Whether conforms to Loan

Policy
Customer profitability, (in
case of existing accounts)
1.
2.
3.
4.
5.

Commission earned
on bills
purchased/discounted.
Processing charges
Commission on LC/LG
Credit balances in
SB
CD
Term deposits
a.
Through own
sources
b.
Through third
party

68

Bibliography
Websites:
http://www.rbi.org.in/home.aspx
https://www.centralbankofindia.co.in/site/indexcbi.aspx
http://crisil.com/index.jsp

www.scribd.com/

Books /Journals:
1. CBI Journals & News Letter
2. E- Circulars of Central Bank of India and RBI
3. Credit Risk Management - Andrew Fight
4. Credit process and Credit Risk management - Gunther Thonabauer, Secretariat of the
Governing Board and Public Relations
5. Credit and banking By: K. C. Nanda
6. Analysis of The Creditworthiness of bank loan applicants - Daniela Feschijan

69