Cases in Bank management

CASE FOR DISCUSSION KRISHNA STEELS Murali Krishna, proprietor of Krishna Steels, was in deep thought. He was convinced that there would be substantial increase in sales of his firm over the next couple of years. However, he had to look for borrowed funds, since he seemed to be perpetually short of cash, in spite of good profits. At the end of the first quarter of 2009, his borrowings from Smaller Bank stood at Rs 3.99 crore, and he was doubtful if the bank would agree to a significant increase in the present credit limit of Rs 4 crore. Krishna was just managing to stay within the credit limit granted by the bank by relying heavily on credit from his suppliers. Krishna had discussed his problem with Mr Jai, who headed the city branch of Larger Bank. Jai had tentatively agreed to raise the credit limit to a maximum of Rs 7.5 crore. Krishna thought that a credit limit of this size would improve his firms cash position and profitability. However, Jai made it clear that the sanction of credit limit by his bank would be based on investigation and appraisal by his team of credit officers, and that Murali would sever his relationship with Smaller Bank in case his loan was sanctioned by Larger Bank. The following points are excerpts from the credit officers report to Jai: 1. Krishna Steels was founded in 1995 as a partnership between Murali Krishna and his father, Hari Krishna. The business was located on land owned by the firm, in the growing suburbs of a large city in South India. The firm also owned four large storage buildings erected on this land. 2. The firm, which operated largely in South India, was involved in distribution of steel and steel products. 3. In 2007, Murali bought out his fathers interest in the business for Rs 2 crore. In order to give time to Murali to arrange for financing, Hari agreed to take the payment in semi annual instalments beginning March 31, 2007, with annual interest of 11%. 4. In addition to owning the steel business, Murali owned a house in an upscale locality, jointly with his father. The house was mortgaged to Smaller bank. Apart from the house and a life insurance policy, Murali had no sizable assets in his name. 5. Murali, an energetic man in his early fifties, was well known in the trade for his integrity and business acumen. 6. Sales and profits were growing year after year. In 2009-10, sales were expected to touch Rs 55 crore. There was a ready market for the firms products and the prospects of future sales were favourable, since construction activity was increasing rapidly.

Prepared by Padmalatha Suresh for class discussion only.

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Cases in Bank management

7.

The firm employed 20 people, of which half the number worked in the steel yard, 2 drove the firms trucks, and the remaining employees assisted in the office and in sales. Almost 80% of the employees had been working with the firm since inception.

8. All the sales were not cash sales. Similarly, suppliers gave credit for purchases. The usual terms of purchase in the trade provided for a discount of 2% for payments made within 10 days of the invoice date. In other cases, payment for purchases had to be made within 30 days of purchase at the total invoice price. Over the last two years, Mr Murali seemed to have hardly availed of the purchase discount, since he always seemed to be short of funds. The financial statements for Krishna Steels are given in Exhibits 1 and 2 The credit officer also commented on the key aspects of the firms financial performance, particularly the growth in sales, current assets and current liabilities, and paid attention to key financial ratios. -------------------------------------------------------------------------------------------------------------QUESTIONS: 1. WHY WAS KRISHNA STEELS SHORT OF FUNDS DESPITE PROFITABLE OPERATIONS? 2. SHOULD LARGER BANK LEND TO KRISHNA STEELS? 3. IF THE BANK DECIDES TO LEND, HOW MUCH SHOULD IT LEND? SHOULD IT IMPOSE ANY CONDITIONS FOR LENDING?

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Cases in Bank management

EXHIBIT 1: Krishna Steels Balance sheet 2007-2009 [Rs in Lakhs] Description LIABILITIES Net worth Term loan from bank Payable to Hari Krishna Trade creditors Accrued expenses Working capital loan from bank Term loan current portion payable to bank TOTAL LIABILITIES ASSETS Cash Receivables Inventory Net Fixed assets TOTAL ASSETS 43 306 337 243 929 52 411 432 262 1157 56 606 587 388 1637 504 140 213 42 372 120 200 340 45 60 449 100 100 503 75 390 FY 2007 FY 2008 FY 2009

20

20

20

929

1157

1637

NOTES: 1. The bank loan for working capital has been availed at an interest of about 11% [floating rate] 2. Interest on term loan fixed at 10% on outstanding balance. 3. Both loans are secured by Krishna Steels fixed and current assets

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Cases in Bank management

EXHIBIT 2: Krishna Steels Income statement [FY 2007- FY 2009] [Rs in lakhs] Description Net sales Cost of goods sold Opening inventory Purchases Closing inventory Total COGS Gross profit 330 2209 337 2202 719 337 2729 432 2634 843 717 432 3579 587 3424 1095 940 2007 2921 2008 3477 2009 4519

Overheads [including 622 Muralis salary] Interest PBT Tax PAT 23 74 14 60

42 84 16 68

56 99 22 77

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