OBJECTIVE

1. To study & understand the different appraisal methods of working

capital financing.
2. To understand the components and format of CAM of the bank.

3. Development of new model of appraisal in Working Capital Financing

which may applicable in Financial Sector.

4. To make a critical analysis of Different committees recommendations

constituted by The RBI on Working Capital Finance

5.How to determine the maximum permissible amount of bank finance

provided towards the borrowing unit according to their credit worthiness.
 Chapter 1
• Project Appraisal-a Basic Idea.
• Methodology Of Project Appraisal
• How to carry effective appraisal

2
 Overview
Project appraisal
Summary
Project appraisal is an essential tool in regeneration and neighbourhood renewal, but audits of
appraisal practice have found significant weaknesses. Effective project appraisal offers
significant benefits to partnerships and, most importantly, to local communities. A good
appraisal justifies spending money on a project. It is an important tool in decision making and
lays the foundation for delivery and evaluation. Getting the design and operation of appraisal
systems right is important. The proper consideration of each of the key components of project
appraisal is essential. These are
• need, targeting and objectives
• context and connections
• consultation
• options
• inputs
• outputs and outcomes

PROJECT APPRAISAL - A METHODOLOGY

Appraisal involves a careful checking of the basic data, assumptions and
methodology used in project preparation, an in-depth review of the work plan, cost
estimates and proposed financing, an assessment of the project's organizational
and management aspects, and finally the viability of project .
It is mandatory for the Project Authorities to undertake project appraisal or atleast
give details of financial, economic and social benefits and suitably incorporate it in
the PC-I. These projects are examined in the Planning and Development Division
from the technical, institutional/organizational/managerial, financial and economic
point of view depending on nature of the project. On the basis of such an
assessment, a judgement is reached as to whether the project is technically sound,
financially justified and viable from the point of view of the economy as a whole.
In the Planning and Development Division, there is a division of labour in the
appraisal of projects prepared by the concerned Executing Agencies. The
concerned Technical Section in consultation with other technical sections i.e;
Physical Planning & Housing, Manpower, Governance and Environment
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sections undertake the technical appraisal, wherever necessary. This covers
engineering, commercial, organizational and managerial aspects, while the
Economic Appraisal Section carries out the pre-sanction appraisal of the
development projects from the financial and economic points of view.
Economic appraisal of a project is concerned with the desirability of carrying
out the project from the standpoint of its contribution to the development of the
national economy. Whereas financial analysis deals with only costs and returns
to project participants, economic analysis deals with costs and returns to society
as a whole. The rationale behind the project appraisal is to provide the decision-
makers with financial and economic yardsticks for the selection/rejection of
projects from among competing alternative proposals for investment.

The techniques of project appraisal can be divided under two heads viz (i)
undiscounted and (ii) discounted. Undiscounted techniques include (a) Pay back
period, and (b) Profit & Loss account. Discounted techniques take into account
the time value of money and include (a) Net Present Value (NPV), (b) Benefit
Cost Ratio (BCR), (c) Internal Rate of Return (IRR) (d) Sensitivity Analysis
(treatment of uncertainty) (e) and Domestic Resource Cost (Modified Bruno
Ratio). Different investment appraisal criteria are given at Appendix-I.

Economic viability of the project is invariably judged at 12 percent discount

rate/opportunity cost of capital. However, in case of financial analysis, the
actual rate of interest i.e. the rate at which capital is obtained is used. For the
government-funded projects, the discount rate is fixed by the Budget Wing of
the Finance Division for development loans and advances on yearly basis. The
provisional rate of mark-up fixed by the Finance Division for the current year
(2005-06) is 8.22%. In case the project is funded by more than one source, the
financial analysis is carried out on the weighted average cost of capital (WACC)
for each project. If the project is financed through foreign grants, the financial
analysis is undertaken at zero discount rate. However, the economic analysis is
undertaken at 12% discount rate.

Many investment projects are addition to existing facilities/activities and thus

benefits and costs relevant to the new project are those that are incremental to
what would have occurred if the new project had not been added. During the
operating life of a project, it is very important to measure all costs and benefits

4
 as the difference between what these variables would be if no project (without
project) were undertaken and what they will be should the project be
implemented (with project). It is very common error to assume that all costs and
benefits are incremental to the new project when, in fact, they are not. Hence,
considerable care must be taken in defining a “ base case” which realistically
sets out the profile of costs and benefits expected if no additional investment is
undertaken.

Although project What’s the Problem?

appraisal has been a
requirement before Project appraisal - the process of assessing and questioning proposals before
regeneration funding resources are committed - is an essential tool for effective action in
is given, it has been a regeneration and neighbourhood renewal. It’s a means by which
source of confusion partnerships can choose the best projects to help them achieve what they
and difficulty for want for their neighbourhood.
partnerships. But appraisal has been a source of confusion and difficulty for partnerships
in the past. Audits of the operation of Single Regeneration Budget schemes
have highlighted concerns about the design and operation of project
appraisal systems, including:
• mechanistic, inflexible systems
• a lack of independence and objectivity
• a lack of clear definition of the stages of appraisal and of responsibility
for these stages
• a lack of documentary evidence
It’s no surprise that these audits weren’t impressed with the quality of
appraisals, and specifically found:
• individual appraisals which did not cover the necessary information or
provided only a superficial analysis of the project
• particular problems in dealing with risk, options and value for money
• appraisals which were considered too onerous for smaller projects
• rushed appraisals
Project appraisal is a requirement of regeneration funding programmes. But
tackling problems like those outlined above is about more than getting the
systems right on paper. Experience in partnerships emphasises the
importance of developing an ‘appraisal culture’ which involves developing
the right system for local circumstances and ensuring that everyone involved
recognises the value of project appraisal and has the knowledge and skills
necessary to play their part in it.

What can Project Appraisal Deliver?

Project appraisal helps a partnership to
• be consistent and objective in choosing projects
• make sure its programme benefits all sections of the community,

5
 including those from ethnic groups who have been left out in the past
• provide documentation to meet financial and audit requirements and to
explain decisions to local people.
Appraisal justifies spending money on a project.
Appraisal asks fundamental questions about whether funding is required and
whether a project offers good value for money. It can give confidence that
public money is being put to good use, and help identify other funding to
support a project. Getting it right may help a partnership make its resources
go further in meeting local need.
Appraisal is an important decision making tool.
Appraisal involves the comprehensive analysis of a wide range of data,
judgements and assumptions, all of which need adequate evidence. This
helps ensure that projects selected for funding:
• will help a partnership achieve its objectives for its area
• are deliverable
• involve local people and take proper account of the needs of people from
ethnic minorities and other minority groups
• are sustainable
• have sensible ways of managing risk.
Appraisal lays the foundations for delivery.
Appraisal helps ensure that projects will be properly managed, by ensuring
appropriate financial and monitoring systems are in place, that there are
contingency plans to deal with risks and setting milestones against which
progress can be judged.

How to carry out effective appraisal

Government guidance.
Guidance on project appraisal continues to develop and exactly what is
required of a partnership depends on which government funding programme
is providing the funding. Current guidance includes:
• New Deal for Communities and Single Regeneration Budget Guidance
on Project Appraisal and Approval, issued in October 2000 and often
referred to as the unified guidance. This now applies only to SRB
schemes
• New Deal for Communities Project Appraisal and Approval Guidance,
revised version, April 2002. This now applies to NDC programmes
• Single Programme Appraisal Guidance, issued by the Department of
Trade and Industry in September 2001. Within this general guidance
each Regional Development Agency can develop its own appraisal
system for the RDA’s single programme
There are some significant variations between these guidance documents,
particularly in relation to option appraisal and value for money assessments.
Overall, although the stated aim of changes in guidance has generally been to
improve and simplify matters, it can add up to a confused and rather
daunting picture - and partnerships will certainly need to check with RDA
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and/or Government Office on current, local, requirements.
However, in spite of these changes, certain core components continue to be
essential in project appraisal.
Getting the system right
The process of project development, appraisal and delivery is complex and
partnerships need systems which suit local circumstances and organisation.
Good appraisal systems should ensure that:
• project application, appraisal and approval functions are separate
• all the necessary information is gathered for appraisal, often as part of
project development in which projects will need support
• race equality and other equality issues are given proper consideration
• those involved in appraisal have appropriate information and training
and make appropriate use of technical and other expertise
• there are realistic allowances for time involved in project development
and appraisal
• decisions are within a partnership’s powers, with ‘non-delegated’
projects referred to others for approval where necessary
• there are appropriate arrangements for very small projects
• there are appropriate arrangements for dealing with novel, contentious or
particularly risky projects.
Appraising a project
Key issues in appraising projects include the following.
Need, targeting and objectives
The starting point for appraisal: applicants should provide a detailed
description of the project, identifying the local need it aims to meet.
Appraisal helps show if the project is the right response, and highlight what
the project is supposed to do and for whom.
Context and connections
Appraisal should help show that a project is consistent with the objectives of
the relevant funding programme and with the aims of the local partnership.
Are there links between the project and other local programmes and projects
– does it add something, or compete?
Consultation
Local consultation may help determine priorities and secure community
consent and ownership. More targeted consultation, with potential project
users, may help ensure that project plans are viable. A key question in
appraisal will be whether there has been appropriate consultation and how it
has shaped the project
Options
Options analysis is concerned with establishing whether there are different
ways of achieving objectives. This is a particularly complex part of project
appraisal, and one where guidance varies. It is vital though to review
different ways of meeting local need and key objectives.
Inputs
It’s important to ensure that all the necessary people and resources are in

7
place to deliver the project. This may mean thinking about funding from
various sources and other inputs, such as volunteer help or premises.
Appraisal should include the examination of appropriately detailed budgets.
Outputs and outcomes
Detailed consideration must be given in appraisal to what a project does and
achieves: its outputs and more importantly its longer-term outcomes.
Benefits to neighbourhoods and their residents are reflected in the improved
quality of life outcomes (jobs, better housing, safety, health and so on), and
appraisals consider if these are realistic. But projects also produce outputs,
and we need a more realistic view of output forecasts than in the past.
Value for money
This is one of the key criteria against which projects are appraised. A major
concern for government, it is also important for local partnerships and it may
be necessary to take local factors, which may affect costs, into account.
Implementation
Appraisal will need to scrutinise the practical plans for delivering the project,
asking whether staffing will be adequate, the timetable for the work is a
realistic one and if the organisation delivering the project seems capable of
doing so.
Risk and uncertainty
You can’t avoid risk – but you need to make sure you identify risk (is there a
risk and if so what is it?), estimate the scale of risk (if there is a risk, is it a
big one?) and evaluate the risk (how much does the risk matter to the
project.) There should also be contingency plans in place to minimise the
risk of project failure or of a major gap between what’s promised and what’s
delivered.
Forward strategies
The appraisal of forward strategies can be particularly difficult, given
inevitable uncertainties about how projects will develop. But is never too
soon to start thinking about whether a project should have a fixed life span
or, if it is to continue beyond a period of regeneration funding, what support
it will need to do so. This is often thought about in terms of other funding
but, with an increasing emphasis on mainstream services in neighbourhood
renewal, appraisal should also consider mainstream links and implications
from the first.
Sustainability
In regeneration, sustainability has often been talked about simply in terms of
whether a project can be sustained once regeneration funding stops but
sustainability has a wider meaning and, under this heading, appraisal should
include an assessment of a project’s environmental, social and economic
impact, its positive and negative effects.
While appraisal will focus detailed attention on each of these areas, none of
them can be considered in isolation. Some of them must be clearly be linked
– for example, a realistic assessment of outputs may be essential to a
calculation of value for money. No project will score highly against all these
tests and considerations. The final judgement must depend on a balanced
consideration of all these important factors.

Checklist

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Whether you are involved in a partnership with an appraisal system in place,
or starting to design one from scratch, these questions are worth asking.
• Are appraisals systematic and disciplined with a clear sequence of
activities and operating rules?
• Is there an independent assessment of the project by someone who has
not been involved with the development of the project?
• Does the appraisal process culminate in clear recommendations that
inform approval (or rejection) of the project?
• Is the approval stage clearly separate?
• Is the appraisal process well documented, with key documents signed,
showing ownership and agreement, and allowing the appraisal
documentation to act as a basis for future management, monitoring and
evaluation?
• Does the appraisal system comply with any relevant government
guidance (See the information section for further details)?
• Are the right people involved at various stages of the process and, if
necessary, how can you widen involvement? (Here, you may also want
to look at other topics, such as building a partnership, or community
involvement.)
• Does your system enable the key components of successful project
appraisal (summarised above) to be considered within a balanced
appraisal of a project as a whole?
If you are involved in the appraisal of projects receiving government
funding, you will need to be aware of the relevant guidance. Currently, this
is includes separate guidance for
• New Deal for Communities
• Single Regeneration Budget
• Single Programme.
These are summarised above and full details can be found elsewhere on
renewal.net

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 CHAPTER 2
• -What is Credit?
• -Cost Of Credit.
• -Importance of Credit.
• -Principles Of Good Lending.
• -Working Capital Loan.
• -Factors to be taken while determining Working Capital
Requirement.
- Introduction Of Credit Risk.
• -Credit Appraisal and Credit Appraisal with the help of
financial Ratio/Statement.

10
* What Is Credit?
Credit allows you to buy goods or commodities now, and pay for them later.
We use credit to buy things with an agreement to repay the loans over a period
of time. The most common way to avail credit is by the use of Credit cards.
Other credit plans include personal loans, home loans, vehicle loans, student
loans, small business loans, trade financing, etc.

* What Is The Cost Of Credit?

Interest Rate is charged on the credit amount that you take. Banks and other
lenders will give credit and charge interest on the amount that is borrowed.
There are two types of loans:-
Secured loans are loans such as home loan and vehicle loans. They are backed
by your assets in order to minimise the risk assumed by the lender. The assets
may be forfeited in case there is a failure to make the necessary payments.
Unsecured loans are loans such as personal loans and credit cards, where the
lender has no entitlement to any of the borrower's assets in case borrowers fail
to repay the loan. Such a loan normally carries a higher interest rate than a
secured loan.
Repayment plans of loans vary based on each type of loans. Home loan
repayment plans can be as high as 20 years or more, whereas vehicle loans can
be repaid in 3, 5 or 10 years, and the credit period for credit cards is around 50
days.

* Importance of credit
Suppose you are planning to start your business, It is well known that capital is
the blood of business, no matter what the nature of your business is and how it
is organized; you will have to address the following questions-
- How will you raise the money to pay for proposed capital investment?
- How will you handle day to day financial activities?
When you are planning for a big venture, then it may happen that you don’t
have sufficient amount of fund with you. For solving out this problem you will
approach to banks, Apex institutions, Primary Lending Institutions etc for
getting capital from them. This capital is provided by them in form of credit.
Same is in case of credit to an individual. After some times, you will have to
pay that debt with some interest.

11
* Modes of Bank Finance
A firm can draw funds from its bank within the maximum credit limit
sanctioned. It can draw fund in the following forms:
Overdraft
Under the overdraft facility, the borrower is allowed to withdraw funds in
excess of the balance in his current account up to a certain specified limit during
a stipulated period.
Cash Credit
It is the most popular method of bank finance for working capital in India.
Under this method a borrower is allowed to withdraw funds from the bank up to
the sanctioned credit limit.
Purchase of Discounting Bills
Under the purchase or discounting of bills, a borrower can obtain credit from
bank against its bills. The bank purchases or discounts the borrower’s bills. The
provided under this agreement is covered within the overall cash credit or
overdraft limit.
Letter of Credit
Suppliers, particularly the foreign suppliers, insist that the buyer should ensure
that his bank will make the payment if he fails to honor its obligation. This is
ensured through a letter of credit arrangement. A Bank opens a Letter of Credit
in favor of a customer to facilitate his purchase goods.
Bank Guarantee
A Bank Guarantee is a guarantee made by a bank on behalf of a customer
(usually an established corporate customer) should it fail to deliver the payment,
essentially making the bank a co-signer for one of its customer's purchases.

Principles of good lending

A prudent lender shall lend only after evaluating the following factors
1. Safety
2. Liquidity
3. Profitability
4. Spread
5. Purpose
6. End use
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 7. Need based finance
8. Viability oriented rather than security oriented lending
9. Own stake
10. National priorities

The decision of whether or not to give credit facility to an applicant will be

arrived using financial & accounting tools especially, the analysis of financial
ratios. Financial ratios are defined as the numerical expression of the
relationship between two variables drawn from basic financial statements .i.e.
the profit & loss account & the balance sheet

Working Capital Loan/Term Loan or Mortgage loan for

Trade & Service Sector
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Banks are the main institutional sources of working capital finance in India.
After trade credit, bank credit is the most important source of financing working
capital requirements. A bank considers a firm’s sales and production plans and
the desirable levels of current assets in determining its working capital
requirements. The amount approved by the bank for the firm’s working capital
requirements is called credit limit. Credit limit is the maximum funds which a
firm can obtain from the banking system.
In case of firms with seasonal businesses, banks may fix separate limits for the
peak level credit requirements indicating the periods during which the separate
limits will be utilized by the borrower. In practice, banks do not lend 100% of
the credit limit; they deduct margin money. A margin requirement is based on
the principle of conservatism and is meant to ensure security. If the margin
requirement is 30%, bank will lend only up to 70% of the value of the asset.
This implies that security of bank’s lending should be maintained even if the
asset’s value falls by 30%.
A borrower may sometimes require ad hoc or temporary accommodation in
excess of sanctioned credit limit to meet unforeseen contingencies. Banks
provide such accommodation through a demand loan account or a separate non
operable cash credit account. The borrower is required to pay a higher rate of
interest above the normal rate of interest on such additional credit.
The purpose of such loan is to provide hassle free working capital finance to the
borrower. The nature of this loan can be cash credit, overdraft or a term
loan. The borrower should have a good track record of 3 years.
The security in this case goes as follows: Primary Hypothecation of stocks and
book-debts Collateral Mortgage of Unencumbered residential house/flat,
commercial or industrial property with a clear marketable title in the name and
possession of the borrower/Proprietor/ Partner/s/Director/s either self occupied
or vacant.
The Rate of interest is PLR+1% with monthly rests. The term loan (against
mortgage of immovable property) from a minimum Rs. 0.50 lacs to maximum
Rs. 50 lacs or 30 times net monthly income whichever is lower. The security is
the Mortgage of the unencumbered residential house/flat, commercial or
Industrial property with a clear marketable title in the name and possession of
borrower/proprietor or partner/s/Director/s either self occupied or vacant with a

14
security cover of 1.5 times the amount of loan. The Rate of Interest is
PLR+2.5% with a repayment period of 60 months.

Factors to be taken into consideration while determining

requirements for working capital:

Production Policies
A sugar factory which belongs to a seasonal industry would obviously have its
working capital need affected by the length of the crushing season. The
production schedule i.e. the plan for production, has great influence on the level
of inventories. In some cases raw material can be procured only in a particular
season and have to be stocked for the production of the whole year. In many
others, the production cycle is limited to a part of the year and raw materials
have to be accumulated throughout the year. In all such cases the need for
working capital will vary according to the production plans. Similarly, the
decision of the management regarding automation, etc, also affects working
capital requirements. In a labor- intensive process, the requirements of working
capital will be higher. In the case of highly automatic plant, the requirements of
long-term funds would be greater.

Nature of the business

The shorter the manufacturing process, the lower is the requirements of working
capital. This is because, in such a case, inventories have to be maintained at a
low level. Longer the manufacturing process, higher will be the requirements of
working capital. This is the reason why highly capital-intensive industries
require large amount of working capital to run their sophisticated and long
production process. Similarly, a trading concern requires lower working capital
than a manufacturing concern.

Credit policy
The credit policy of the company also determines the requirements of working
capital. A company, which allows liberal credit to its customers, may have
higher sales but consequently will have large amount of funds tied up in sundry
debtors. Similarly a company, which has very efficient debt collection

15
machinery and offers strict credit terms, may require lesser amount of working
capital than the one where debt collection system is not so efficient or where the
credit terms are liberal. The credibility of a company in the market also has an
effect on the working capital requirements. Reputed and established concerns
can purchase raw material on credit and enjoy many other services also like
door delivery, after sales service etc. This would mean that they could easily
have large current liabilities; therefore the required working capital may not be
very high.

Inventory policy
The inventory policy of a company also has an impact on the working capital
requirements since a large amount of funds is normally locked up in inventories.
An efficient firm may stock material for a smaller period and may, therefore,
require lesser amount of working capital.

Abnormal factors
Abnormal factors like strikes and lockouts also require additional working
capital. Recessionary conditions necessitate a higher amount of stock of finished
goods remaining in stock. Similarly, inflationary conditions necessitate more
funds for working capital to maintain same amount of current assets.

Market conditions
Working capital requirements are also affected by market conditions like degree
of competition. Large inventory is essential as delivery has to be off the shelf or
credit has to be extended on liberal terms when market competition is fierce or
market is not very strong is a buyer’s market.
Conditions of supply
If prompt and adequate supply of raw materials, spares, stores etc. is available it
is possible to manage with small investments in inventory or work on the just in
time (JIT) principle. However if the supply is erratic, scant seasonal, channel
zed through government agencies etc., it is essential to keep large stocks
increasing working capital requirements.

Business Cycle

16
Business fluctuations lead to cyclical and seasonal changes in production and
sales and affect the working capital requirements.
Growth and expansion
The growth in volume and growth in working capital go hand in hand.
However, the change may not be proportionate and the increased need for
working capital is felt right from the initial stages of growth.
Level of taxes
The amount of taxes paid depends on taxation laws. These amount usually have
to be paid in advance. Thus need for working capital varies with tax rates and
advance tax provisions.
Dividend policy
Payment of dividend utilizes cash while retaining profits acts as a source of
working capital. Thus working capital gets affected by dividend policies.
Price level changes
Inflationary trends in the economy necessitate more working capital to maintain
the same level of activity.
Operating efficiency
Efficient and coordinated utilization of capital reduces the amount required to
be invested in working capital

* What is credit risk?

A credit risk is the amount of potential for default that is inherent in a given debt
investment or extension of credit. A lender or an investor in various types of
bonds carries a degree of credit risk on any transaction conducted. Assessing the
degree of risk involved is essential before completing any type of lending or
investment transaction.
In the case of lending money, the entity that provides the loan carries the credit
risk. For this reason, a lender will want to know pertinent information regarding
the ability of the borrower to repay the amount of the loan, including all finance
charges and related fees. If the lender is unable to determine that the borrower
will be able to repay the loan, the borrower may be considered a poor credit risk
and be denied.
With the purchase of bond issues, it is the buyer who assumes a degree of credit
risk. Bonds generally carry a commitment on the part of the bond issuer to
provide the buyer with full repayment of the purchase price of the bond at some

17
future point. As part of the transaction, the buyer also anticipates some type of
dividend or interest payment in exchange for the purchase of the bond. If the
bond issuer is not likely to be able to repay the principal or provide interest
payments as outlined in the terms of the bond, the issuer is understood to be a
poor credit risk.
Just about any type of transaction that involves the extension of credit in some
form carries a degree of credit risk. In many cases, the level of risk is very low
and thus considered acceptable. At the same time, it is important to explore all
relevant factors before assuming any degree of credit risk. Failure to do so can
result in a loss to a lender or bond investor that may be significant.

Lenders will trade off the cost/benefits of a loan according to its risks and the
interest charged. But interest rates are not the only method to compensate for
risk. Protective covenants are written into loan agreements that allow the lender
some controls. These covenants may:

• Limit the borrower's ability to weaken their balance sheet voluntarily

e.g., by buying back shares, or paying dividends, or borrowing further.
• Allow for monitoring the debt requiring audits, and monthly reports
• Allow the lender to decide when he can recall the loan based on specific
events or when financial ratios like debt/equity or interest coverage
deteriorate.

A recent innovation to protect lenders and bond holders from the danger of
default are credit derivatives, most commonly in the form of a credit default
swap. These financial contracts allow companies to buy protection against
defaults, from a third party, the protection seller. The protection seller receives
a periodic fee (the credit spread) as compensation for the risk it takes, and in
return it agrees to buy the debt should a credit event ("default") occur.

Credit scoring models also form part of the framework used by banks or
lending institutions grant credit to clients. For corporate and commercial
borrowers, these models generally have qualitative and quantitative sections
outlining various aspects of the risk including, but not limited to, operating
experience, management expertise, asset quality, and leverage and liquidity
ratios, respectively. Once this information has been fully reviewed by credit

18
officers and credit committees, the lender provides the funds subject to the
terms and conditions presented within the contact (as outlined above).

Credit analysis is the method by which one calculates the creditworthiness of

a business or organization. The audited financial statements of a large company
might be analyzed when it issues or has issued bonds. 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.

Before approving a commercial loan, a bank will look at all of these factors
with the primary emphasis being the cash flow of the borrower. A typical
measurement of repayment ability is the debt service coverage ratio. A credit
analyst at a bank will measure the cash generated by a business (before interest
expense and excluding depreciation and any other non-cash or extraordinary
expenses). The debt service coverage ratio divides this cash flow amount by the
debt service (both principal and interest payments on all loans) that will be
required to be met. Bankers like to see debt service coverage of at least 120
percent. In other words, the debt service coverage ratio should be 1.2 or higher
to show that an extra cushion exists and that the business can afford its debt
requirements.

* CREDIT EVALUATION/ IMPORTANCE OF CREDIT APPRAISAL

Credit evaluation means determination of the type of customers who are going
to qualify for credit. Several costs are associated with extending credit to less
credit worthy customers. As the probability of default increases, it becomes
more crucial to identify which clients are risky. When more time is spent on
investigating the credit worthiness of clients, the cost of credit investigation
rises. Default costs vary directly with the client quality. Collection costs
increase as the client quality falls.

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Client evaluation is based on 3 Cs
1. Character: willingness of the client to repay, honesty, integrity, sincerity
& reputation in the market
2. Capacity: ability to make payments depending on client’s financial
position determined from the final accounts, financial ratios & other
books of accounts
3. Condition: refers to the economic factors which can affect the client’s
ability to make repayments. For example: recession, poor demand, poor
liquidity etc.

* Credit Appraisal
Credit Appraisal is a process to ascertain the risks associated with the
extension of the credit facility. It is generally carried by the financial
institutions which are involved in providing financial funding to its
customers. It is the process by which the lender appraises the credit
worthiness of a prospective borrower. This involves analyzing the
borrower’s financial strength, fund requirement, repayment capability,
borrowing power, payment history etc. It helps the banker in identifying,
measuring and hedging the credit risk involved in lending to particular
borrower and also understanding the way-out involved in case of default

The debt service coverage ratio (DSCR), is the ratio of cash available for debt
servicing to interest, principal and lease payments. It is a popular benchmark
used in the measurement of an entity's (person or corporation) ability to
produce enough cash to cover its debt (including lease) payments. The higher
this ratio is, the easier it is to obtain a loan. The phrase is also used in
commercial banking and may be expressed as a minimum ratio that is
acceptable to a lender; it may be a loan condition or covenant. Breaching a
DSCR covenant can, in some circumstances, be an act of default.

* Uses
In corporate finance, DSCR refers to the amount of cash flow available to meet
annual interest and principal payments on debt, including sinking fund
payments.

20
 In personal finance, DSCR refers to a ratio used by bank loan officers in
determining debt servicing ability.

In commercial real estate finance, DSCR is the primary measure to determine if

a property will be able to sustain its debt based on cash flow. In the late 1990s
and early 2000s banks typically required a DSCR of at least 1.2, but more
aggressive banks would accept lower ratios, a risky practice that contributed to
the financial crisis of 2007–2009. A DSCR over 1 means that (in theory, as
calculated to bank standards and assumptions) the entity generates sufficient
cash flow to pay its debt obligations. A DSCR below 1.0 indicates that there is
not enough cash flow to cover loan payments.

Calculation
In general, it is calculated by: DSCR =
Annual Net Income + Amortization/Depreciation + other non-cash and
discretionary items (such as non-contractual management bonuses)
Principal Repayment + Interest payments + Lease payments

Major financial ratios relevant for the lender

LIQUIDITY

RATIO CALCULATION DEFINITION

Working Current Assets / Current Liabilities It helps determine the amount of

Capital cushion that the company has. As in to
what extent the current assets are
sufficient to cover current liabilities.

Quick Ratio (Current Assets-Inventory) / Measures the coverage of current

Current Liabilities assets minus inventory over current
liabilities.

Current Ratio Current Assets / Current Liabilities Measures the coverage of current
assets over current liabilities.

PROFITABILITY

21
RATIO CALCULATION DEFINITION

Return on Assets Profit After Tax / Total Assets Measures the effectiveness of
(ROA) management at making a profit and
using the assets efficiently.

Return on Equity Profit After Tax / Net Worth Measures profitability as a percentage
(ROE) of net worth.

Net Operating Net Operating Profit / Net Measures profitability after Cost of
Profit Margin Sales Goods Sold and Operating expenses.

Gross Profit Gross Profit / Net Sales Measures profitability accounting only
Margin for Cost of Goods Sold.

LEVERAGE AND COVERAGE

RATIO CALCULATION DEFINITION

Net Worth Total Assets – Total Liabilities This is the Owner’s equity in the
company.

Tangible Net Net Worth – Intangible Assets This is the Owner’s equity in the
Worth company adjusted by taking out
intangible assets.

Debt to Worth Total Liabilities / Net Worth Very important ratio determines
the relationship between leverage
and equity. The lower the number
the better.

Interest Coverage Operating Profit / Interest Expense Reflects the capability of the
borrower to meet financing
obligations. The higher the better.

EBIDA Net Income + Interest Expense + Earnings before Interest,

Depreciation + Amortization. Depreciation and Amortization.

22
ACTIVITY

RATIO CALCULATION DEFINITION

Accounts (Accounts Receivable / Sales) x 365 Number of days that it takes

Receivable the company on average to
Turnover Days collect its receivables

Inventory (Inventory / Cost of Goods Sold) x 365 Number of days it takes the
Turnover Days company on average to sell
its inventory.

Accounts (Accounts Payable / Cost of Goods Sold) Number of days it takes the
Payable x 365 company on average to pay
Turnover Days its payables.

23
Research Methodology
Chapter 3
(a) Problem and Research Objective.
(b) Data collection.

Research Methodology
Methodology is one of the most important parts in survey to collect information
and knowledge. The word ‘methodology’ means a particular way of doing
something. A research should have a defined systematic design, data collection

24
technique, analysis and reporting of data and finding relevant to a specific
situation facing the company.

Problem and research objective-

The main objective of study was to analyse the topic “Analysis of an appraisal
system of a bankable project”. The most difficult part of this study was to
identify the factors which create risk due to which need of appraisal occurs and
nitty-gritty of the activities related to the topic. This research report has been
prepared
The main things to be known was –
(1) Process of credit
(2) Credit appraisal in Working Capital Finance.
(3) Risks before bank
(4) Techniques to overcome risks

(a) Research approach-

Descriptive research approach has been adopted to carry out this project.

(b) Data collection:-

Here all the data are secondary and collected from different sources like book,
internet, Journal and library.

25
 Chapter 4
(a) A Critical Analysis of Different Committee constituted by
RBI namely Tandon Committee,Nayak Committee,Dahejia
Committee,Marathe Committee,K.S Chore Committee and
K.Kannan Committee.
(b) Case Study Analysis.
(c) Finding/Development of a new Model in Working Capital
Financing.
(d) Limitation of Study.
(e) Conclusion
(f) Bibliography.

26
 Case Studies
Assessment of Working Capital /Cash Credit
Facility/Term Loan

M/S Quality Crafts Store

M/S Quality Crafts Store Proprietor Mr. Shah Alam Mateen 256-D 1st floor,
Green Towers, established in the year 2002, is engaged in retail business of
Kashmiri shawls particularly trading of Pashmina and woolen shawls and allied
items. The party has been in connection with and dealing with the J&K Bank
Lajpat Nagar branch since year 2006 with satisfactory dealings and good
conduct. The turnover of account is encouraging. The party has established
good trade connections and is involved in related trade. No negative complaints
27
has been registered or found against the party ever since the opening of account
with the bank branch. The amount is frequently routed through the account and
the performance of account is good.

Borrower’s Information

Name of Applicant Borrower : Mr. Shah Alam Mateen

Address of the Head/Regd. Office : 256-D 1st floor, Green
Towers
Constitution : Individual
Date of Establishment : Year 2002
Period since dealing with branch : Year 2006
Net worth as on 31.10.2007 : Rs. 9.00 lacs

General Information of the Proposal

Existing Banking Arrangements : Sole Banking

Proposed Banking Arrangements : Sole Banking
Sanction Comes Under Powers of : Branch Head
Activity : Trading of Pashmina,
woolen
shawls etc.
Sector : Trading
Present Facilities by the Applicant : Nil
Facility Requested by the Applicant : Cash Credit
Purpose of Borrowing : For Expansion of Existing
Business
Amount Requested : Rs. 5.00 Lacs.

Securities Proposed for the Facility

Primary Security
Hypothecation of stocks and Book Debts

Collateral Security

28
 Third Party Guarantee of two persons:
1. Mr. Azam Ahmad S/o Mr. Naseeruddin Ahamad
2. Mr Shoeb Tak S/o Mr. Younis Tak

Both the guarantors are dealing with the J&K Bank Branches. As reported Both
are availing cash credit facility with their respective branches and with a
satisfactory performance.

Financials of the Firm (Amt. in Rs. Lacs)

Particulars 31/03/2007 31/03/2008

Projected
Sales 6.12 19.00
Purchases 4.12 17.53
% of Sales Growth 325.00
Net Profit 1.42 2.23

Liabilities

Share Capital 2.64 3.30

Total Term Liabilities 2.64 3.30
29
Current Liabilities

Working Capital 0.00 8.00

Sundry Creditors 0.38 1.20
Expenses Payable 0.23 0.65
Borrowings 0.00 0.00
Other liabilities 0.00 0.00

Total Current Liabilities 0.61 9.85

Tolal Liabilities 3.25 13.15

Assets

Investments 0.00 0.00

Fixed Assets 0.24 0.72
Total Fixed Assets 0.24 0.72

Current Assets

Stocks 1.24 8.50

Sundry Debtors 0.52 3.16
Cash in hand/Bank Balance 1.25 0.77
Loans/Advances 0.00 0.00

Total Current Assets 3.01 12.43

Total Assets 3.25 13.15

Financial Indicators
Particulars 31/03/2007 31/03/2008
Net Working Capital (In Rs. Lacs) 2.40 2.58
Current Ratio 4.93 1.26
Stocking Velocity ( Days) 108 175
Debtors Velocity (Days) 31 60
Creditors Velocity (Days) 33 25

Apart from the above financials of the party, the account statement reveals the
following transactions of the party with the Bank Branch (Amt. in Rs. Lacs) :

Debit Summation Credit

Summation
From 01/04/2006 to 31/03/2007 (1 6.52 6.50

30
year)
From 01/04/2007 to 31/10/2007 (7 11.62 11.10
months)
Comments and Observations:
Financial Indicators has been calculated as follows:
a) Net Working Capital: Total Current Assets less Total Current
Liabilities.
b) Current Ratio: Total Current Assets divided by Total Current
Liablities.
c) Stocking Velocity: Stock for the year divided by Cost of Goods Sold or
Credit Purchase during the year multiplied by 360 days.
d) Debtors Velocity: Average Receivables or Debtors for the year divided
by Credit Sales during the year multiplied by 360 days.
e) Creditors Velocity: Average Payables or Creditors for the year divided
by Credit Purchase during the year multiplied by 360 days.
Other Comments and observations:
f) The party has projected to achieve a sales target of Rs. 19.00 Lacs over
previous year achievement of Rs. 6.12 Lacs. The projected sales target
seems to be achievable owing to the fact that up to 31/10/2007 (7
months) the party has a sales turnover of Rs. 11.62 lacs through the
account.
g) Stock Velocity reveals the part of sales always invested in stock during
the year or in other words it refers to the period of sales sans obstacles
out of the current stock in case the production halts due to strike or other
reason.
The stocking period of 175 days is on higher side hence its been
accepted at 90 days level.
h) Debtors Velocity reveals the duration within the debtors are expected to
be realized. The projected debtors’ period seems reasonable hence
accepted for assessment as projected.
i) Creditors Velocity reveals the duration within the creditors are expected
to be paid. Lesser the days better is the position of the firm. The
projected creditors velocity is at a lower level, keeping the kind of stocks
in trade into consideration, the velocity has been accepted at 50 days
level.

31
 Assessment of MPBF (Amt. in Rs. Lacs)

Particulars Amount
Accepted Sales 19.00
Accepted Purchase 17.53

Current Assets
Stock (17.53*19÷360) 90 days 4.38
Debtors (19*60÷360 60 days 3.16
Cash in hand 0.54
Loans & advances 0.00
Total Current Assets (a) 8.08

Current Liabilities
Creditors (17.53*50÷360) 50 days 2.50
Other liabilities 0.00
Total Current liabilities (b) 2.50

Working Capital Gap (a-b) 5.58

Margin (as projected by the party) 2.58
MPBF 3.00

Recommendations of Bank Branch

In view of above, it is proposed, if agreed, to allow Cash Credit Facility of Rs. 3

Lacs (Rupees three lacs only) in favor of M/S Quality Crafts Store Prop. Mr.
Shah Alam Mateen for a period of one year subject to renewal after review
against securities as discussed.

Rate of Interest : PLR presently 13 % with monthly rests or any

other rate
This may be prescribed by the Bank from time to
time.

Margin : 40% on Stocks

50% on Book-Debts (excluding book debts older
than
6 months).
32
 .

M/S Healthy Heart Hospital

M/S Healthy Heart Hospital (Popularly known as 3H) South Extension New
Delhi is headed by eminent cardiologist of the country Dr. Nasir. Dr. Nasir is
the recipient of various prestigious awards and has a rich expertise in treating
heart ailments. The hospital run with the specialization of treating heart ailments
with all kinds of modern equipment and infrastructure. There are four stake
holders of the hospital one being Dr. Nasir himself, apart from him, out of three
stacke holders, two are doctors by profession and both are the daughters of Dr.
Nasir. The fourth partner Mrs. Zainab Kareem is teacher by profession and is
part of the family. All the three partner have 2% stake each in the Hospital rest
is lying with Dr. Nasir.
Dr. Nasir presently enjoying the facilities of Car Loan, and Housing Loan and
he has requested for sanction of mortgage loan of Rs. 100.00 lacs. The conduct
of all the loan accounts of Dr. Nasir is satisfactory.

Borrower’s Information

Name of Applicant Borrower : Healthy Heart Hospital (3H)

Address of the Head/Regd. Office
Constitution
Date of Incorporation
Period since dealing with branch
Net worth
: South Extension, New Delhi.
: Partnership
: Year 1995
: Year 2002
: Rs.600.00 lacs. Approx.

33
General Information of the Proposal

Existing Banking Arrangements : 1. Working Capital Limit of Rs.

25.00 Lacs. Presently Adhoc
Facility of Rs. 25.00 lacs over
and above the Regular limit of Rs.
25.00 Lac.
2. Term Loan Facility of Rs. 396.00
Lac with
Outstanding Balance of Rs. 50.41
Lac as on
Date.
3 Term Loan facility of Rs. 15.00 lac
for
Purchase of Machinery with O/S
Balance
Of Rs. 3.99 lacs as on date of
proposal.
4 Term Loan facility of Rs. 9.00 Lac
with O/S
Balance of Rs. 7.13 lacs
Proposed Banking Arrangements : Enhancement in working capital
limit of Rs.
25.00 lacs to Rs. 100.00 Lacs as
Cash Credit
Limit under “Mortgage Loan under
Trade
And Service sector”.
Sanction Comes Under Powers of : Zonal Office
Activity : Running Hospital with
specialization in
Treating heart ailments.
34
Sector : Professionals
Present Facilities by the Applicant : Detailed above at the head Existing
Banking
Arrangements
Facility Requested by the Applicant : Cash Credit limit under “Mortgage
Loan
Under Trade and Service Sector”.
Purpose of Borrowing : For Expansion and growth of
Business
Amount Requested : Rs. 100.00 Lacs.
Securities Existing/Proposed for the Facility
Primary
Hypothecation of stocks of medicine, machinery and receivables/Book debts.
Collateral
The property is commercial in nature and is one of the reputed hospitals of
metropolis. The property secured is none other than Healthy Heart Hospital
itself. The full description of property is :
Plot No-1 South Extension New Delhi with four storied building and basement.
The property has been valued to the tune of Rs. 889.58 Lacs as per recent
valuation report prepared by Mr. P Kumar, registered valuer on approved panel
of the Bank. In view of the fact that real estate has witnessed enormous price
escalation particularly in preceding years and the present property is enjoying
placement at prime location the assessed value seems reasonable.
Apart from above mentioned securities there is also personal guarantee of
partners.
Details of Credit Facilities Enjoyed By Dr. Nasir Partner M/S Healthy
Heart Hospitals (3H):
Serial Nature of Limit Balance Security
No. Credit Facility O/S
1. Car Loan 2.26 1.70 Hypothecation of Car
2. Housing Loan 15.00 9.90 Mortgage of Flat Purchased
for Rs. 56.33 Lacs
3. Housing Loan 102.00 60.00 Mortgage of House valued
Rs. 154.00 Lacs

35
 Financials of the Firm (Amt. in Rs. Lacs)

Particulars 31/03/2006 31/03/2007 31/03/2008

Audited Provisional Projected
Income 335.38 339.16 424.55
Net Profit 12.36 10.31 25.68
% of growth in sales

Liabilities

Share Capital 50.96 66.21 91.64

Term Loan-J&K Bank 84.57 54.21 38.21
Term Loan-Other Banks 39.15 41.19 32.24
Unsecured Loans 76.41 70.43 73.18
Total Term Liabilities 251.09 232.04 235.27

Current Liabilities

Working Capital 20.82 15.89 18.39

Sundry Creditors 73.88 70.30 84.37
Expenses Payable
Other liabilities 17.06 16.51 16.21

Total Current Liabilities 111.76 102.70 118.97

Total Liabilities 362.85 334.74 354.24

Assets

Fixed Assets 346.53 321.88 297.26

Total Fixed Assets 346.53 321.88 297.26

Current Assets

Receivables 5.40 3.48 3.20

Cash in hand/Bank Balance 4.39 3.29 3.35
Loans/Advances 6.53 9.39 6.10
Others 44.33

Total Current Assets 16.32 16.16 56.98

Total Assets 362.85 338.04 354.24

Financial Indicators
36
Particulars 31/03/2006 31/03/2007 31/03/2008
Tangible Net worth (In Rs. Lacs) 251.09 232.04 235.27
Current Ratio 0.14 0.15 0.48

Comments and Observations:

a) The Hospital income has shown marginal increase over previous years
income (from 335.38 lacs to 339.16). However projected income (Rs.
424.55 Lacs) seems achievable owing to proposed expansion program.
b) The current ratio has remained below bench mark, however keeping into
account the nature of engagement present level seems justified..

CRITICAL ANALYSIS OF DIFFERENT

COMMITTEE

Methods of lending: P.L Tandon Committee:

Like many other activities of the banks, method and quantum of
short-term finance that can be granted to a corporate was
mandated by the Reserve Bank of India till 1994. This control was
exercised on the lines suggested by the recommendations of a
study group headed by Shri Prakash Tandon.
The study group headed by Shri Prakash Tandon, the then
Chairman of Punjab National Bank, was constituted by the RBI in
July 1974 with eminent personalities drawn from leading banks,
financial institutions and a wide cross-section of the Industry with
a view to study the entire gamut of Bank's finance for working
capital and suggest ways for optimum utilisation of Bank credit.
This was the first elaborate attempt by the central bank to organise
the Bank credit. The report of this group is widely known as
Tandon Committee report. Most banks in India even today
37
 continue to look at the needs of the corporates in the light of
methodology recommended by the Group.
As per the recommendations of Tandon Committee, the corporates
should be discouraged from accumulating too much of stocks of
current assets and should move towards very lean inventories and
receivable levels. The committee even suggested the maximum
levels of Raw Material, Stock-in-process and Finished Goods
which a corporate operating in an industry should be allowed to
accumulate These levels were termed as inventory and receivable
norms. Depending on the size of credit required, the funding of
these current assets (working capital needs) of the corporates could
be met by one of the following methods:

• First Method of Lending:

Banks can work out the working capital gap, i.e. total
current assets less current liabilities other than bank
borrowings (called Maximum Permissible Bank Finance or
MPBF) and finance a maximum of 75 per cent of the gap;
the balance to come out of long-term funds, i.e., owned
funds and term borrowings. This approach was considered
suitable only for very small borrowers i.e. where the
requirements of credit were less than Rs.10 lacs
• Second Method of Lending:
Under this method, it was thought that the borrower should
provide for a minimum of 25% of total current assets out of
long-term funds i.e., owned funds plus term borrowings. A
certain level of credit for purchases and other current
liabilities will be available to fund the build up of current
assets and the bank will provide the balance (MPBF).
Consequently, total current liabilities inclusive of bank
borrowings could not exceed 75% of current assets. RBI
stipulated that the working capital needs of all borrowers
enjoying fund based credit facilities of more than Rs. 10
lacs should be appraised (calculated) under this method.

Third Method of Lending: Under this method, the borrower's contribution

from long term funds will be to the extent of the entire CORE CURRENT
ASSETS, which has been defined by the Study Group as representing the
absolute minimum level of raw materials, process stock, finished goods and
stores which are in the pipeline to ensure continuity of production and a
minimum of 25% of the balance current assets should be financed out of th
Maximum Permissible Bank Finance (MPBF)

Current Assets ( All Current Assets)

Less: Current Liabilities ( Crs. + Other Current
Liabilities)
Working Capital Gap
Less: 25% of the Total Current Assets or NWC
whichever is higher of the two amounts
38
MPBF

Assessment Of Working Capital Fund Based : under Mortgage

Loan Scheme

Sales for last financial year

Projected Sales for next financial year
Accepted Sales
(Maximum 125% of the achieved turnover)
Permissible Limit A
(20% of the accepted sales)
Forced Sale value of Property
Permissible Limit B
(75% of the forced Sale Value)
Maximum Permissible Limit C
(Lower of A or B)
Available Limit
Limit Recommended by the branch

Nayak Committee ( Turnover Method)

Considering the contribution of the SSI sector to the overall industrial

production, exports and employment and also recognising the need to
give fillip to this sector, a special package of measures was devised by
RBI (during April 1993) to ensure adequate and timely credit to this
sector. While doing so the recommendations of the PR Nayak committee
were taken into account. Examination of bank finance profile of working
capital to the small scale sector by the committee has revealed that this
sector as a whole received a level of working capital which was only
8.1% of the its output. The village industries and the smaller tiny
industries among them could get working capital finance to the extent of
only about 2.7% of their output.

The salient features of the package are set out below:

• Banks have been advised to give preference to village industries, tiny

industries and other small scale units in that order, while meeting the
credit requirements of small scale sector.
• The banks should step up the credit flow to meet the legitimate
requirements of the SSI sector in full during the 8th 5-year plan. For this
purpose the banks should draw up annual credit budget for the SSI
sector on a bottom-up basis. Each branch of the banks should prepare an
annual budget in respect of working capital requirements of all SSIs
39
 before the commencement of the year. Such budgeting should cover (a)
functioning units which already have borrowing limits with the branch
(b) new units and units whose proposals are under appraisal and (c) sick
units under nursing and also sick units found viable after discussion/
feedback received from the borrowing units. The budget should take into
account, among other relevant aspects, normal sale growth, price rise
during the past year, anticipated spurt in business etc.
• It is desirable that a single financing agency meets both the requirement
of the working capital and term credit for small scale units. The Single
Window Scheme of SIDBI enables the same agency SFC or commercial
bank, as the case may be, to provide term loans and working capital to
SSI units having a project outlay upto Rs. 20 lac and working capital
requirement upto Rs. 10 lac. The banks have been advised to adopt this
approach.
• At present norms for inventory and receivable are applicable to all units
enjoying aggregate fund based working capital credit limits of Rs. 10 lac
and above from the banking system. Units enjoying limit of Rs. 10 lac
and above but upto Rs. 50 lac are subject to the 1st method of lending.
Henceforth for the credit requirements of village industries, tiny
industries and other SSI units having aggregate fund-based working
capital credit limits upto Rs. 50 lac (subsequently raised to Rs. 1 crore
and Rs. 200 lac during April 1997, to Rs.400 lac during August 1998
and further to Rs.500 lac during May 1999) from the banking system,
the norms for inventory and receivables and also the 1st method of
lending will not apply. Instead such units may be provided working
capital limits computed on the basis of a minimum of 20% of their
projected annual turnover for new as well as existing units.
• The banks may satisfy themselves about the reasonableness of the
projected annual turnover of the applicant on the basis of annual
statements of account or any other documents such as returns filed with
sales-tax/revenue authorities and also ensure that the estimated growth
during the year is realistic. These SSI units would be required to bring in
5% of their annual turnover as margin money. In cases where output
exceeds the projections or where the initial assessment of working
capital is found inadequate, suitable enhancement in the working capital
limits should be considered by the competent authority as and when this
is deemed necessary. Drawals against the limits should be allowed
against the usual safeguards so as to ensure that the same are used for the
purpose intended. Banks will have to ensure regular and timely
submission of monthly statements of stocks, receivables etc. and also
periodical verification of such statements vis-a-vis physical stocks.
• The banks can lend on the basis of 1st method of lending to those units
(companies/ organisations) which are engaged in marketing/trading of
products of SSI, village and cottage and tiny sector units. This would be
subject to the condition that 100% dealing is with the above mentioned
products. If there are dealings with other products also, then the
relaxation of application of 1st method of lending will be only to that
portion of the marketing business relating to products manufactured by
above category of units. It is also a condition that dues of such units are
settled by such borrowers within a maximum period of 30 days from
date of supply and it is to be certified by the statutory auditors of the
borrowing units on a quarterly basis.

40
 Action on Nayak Committee recommendations by RBI:
• Banks should take immediate steps to ensure full adherence in letter and
spirit by all their branches and controlling offices to the RBI guidelines.
With a view to ascertaining the position regarding implementation of
these guidelines by the branches, banks themselves should carry out
special studies on an annual basis on as large a sample or branches, as
possible. The findings of the these studies should be reported to RBI
periodically indicating among others, the steps taken for rectifying the
deficiencies, if any, observed in the process.
• The procedure and time frame laid down for disposal of loan application
received from SSI borrowers should be strictly enforced. Whenever
application for fresh limits/enhancement of existing limits was not
considered favourably by the sanctioning official or where the limits
applied for are proposed to be curtailed, the same should be referred to
the next higher authority with all relevant particulars, to ensure scrutiny
by any independent authority and the latter should confirm the decision
of the sanctioning official or otherwise dispose of the same, within a
time bound manner. Another alternative which would also help eliminate
delays inherent in the consideration of the proposal by the successive
tiers in the hierarchy and facilitate timely decisions on credit proposals it
would be for banks to adopt a system of Committee approach, in which
decisions are taken by the competent authority after a structured
discussions with the branch managers and also the authorities at the
intervening levels.
• Problems faced by the SSI sector in regard to bank finance, to a large
extent could be solved if the branch level officials have the right
aptitude, skills and orientation. In understanding their role, the branch
managers/officials at the branches should be made aware of the
importance of small scale sector from the point of view of creation of
additional employment opportunities, exports etc. A healthy growth of
the sector will facilitate smooth loan recovery in the SSI borrowal
accounts. Further, timely assistance will prevent these accounts from
becoming sticky. The aforesaid aspects should therefore, form part of the
inputs in the training imparted to the banks’ staff. There should an
interaction between the banks’ staff and the SSI borrowers as part of the
training programmes. Banks may also consider awarding trophies to
branches for the outstanding performance in financing SSI units as a
mark of public recognition.
• One of the complaints frequently voiced by the SSI units pertains to
insistence by some banks on compulsory deposit mobilisation as a quid
pro quo for the sanction of credit facilities to the units. While enlisting
the cooperation of banks’ customers for deposit mobilisation cannot be
faulted, insisting on deposit mobilisation of stipulated amounts as a
precondition to the sanction of credit or otherwise, has no justification.
• The 2nd All India Census of SSI (1988) carried out by the Development
Commissioner(SSI), Govt. of India, has revealed that there were 85
district in the county each with more than 2000 registered SSI units with
Industries Deptt. of the State Govt. and another 110 districts each having
between 1000 to 2000 registered SSI units. RBI decided during July
1993 that while SFCs would act as the principal financing agency for
SSIs in 40 out of the 85 districts referred to above to take care of both

41
 the term loan and working capital requirements of all new SSI units
which can be financed under Single Window Scheme (SWS) of SIDBI,
the commercial banks should act as the principal financing agency under
the SWS in the remaining 45 districts, as well as in rest of the country.
Banks should also consider converting such of the branches as having a
fairly large number of SSI borrowal accounts, into specialised branches.

Important banking operational clarification on Nayak Committee

Recommendations

The implementation of recommendations of Nayak Committee, relating

particularly to the assessment of working capital, gave rise to certain
operational problems. Reserve Bank has clarified these issues on the
following lines:
• The assessment of credit limits for all borrowers enjoying aggregate
fund based working capital limits of less than Rs. 1 crore from the
banking system, is to be done both as per the traditional method and on
the turnover basis and the higher of the two limits is to be fixed as the
permissible bank finance. However, the neither the inventory norms
stipulated under Tandon Committee apply nor the PBF is subject to
ceiling as per the first method of lending. In cases where the limits
determined by the traditional method are less than 20% of the turnover,
the assessment will have to be re-examined. Nayak Committee has
stated that the working capital below the minimum level of 20% may be
justified under special circumstances in which the requirement is
demonstratively lower than the minimum level as in the case of ancillary
units.
• Where the working capital cycle is shorter than 3 months, the working
capital required would be less than 25% of the projected turnover. In
such case it is not required to still give PBF at 20% of the turnover.
• If the liquid surplus available with the borrower is higher than 5% of the
turnover, as stipulated under the recommendations, the limits can be
fixed at a lower level than 20% of the turnover keeping in view that the
genuine requirements of the unit are met adequately. If a unit has been
managing its working capital efficiently, the limits can be set at a lower
level.
• The units having longer operating cycle for working capital than three
months, should be provided proper limits to operate at a viable level
taking into account the recommendation that 20% of the turnover is the
minimum stipulation and not the maximum.
• In case of seasonal industries the distinction between the peak and non-
peak level of turnover has to be considered instead of annual turnover.
• The creditors and other current liabilities are among the sources of funds
required for building up the current assets and will be treated in the same
manner as in the traditional method.
• The borrower’s contribution (margin) will be 5% of the turnover in all
cases except where the working capital cycle is not taken at three
months. The margin will proportionately increase with the increase in
the period of operating cycle. Care is to be taken that the proportion of
margin to bank finance should be maintained in the ratio of 1:4 or even
higher in case of availability of higher liquid surplus. If the borrower is
not able to bring in minimum contribution of 5%, as a general rule, no

42
 dilution should be allowed except in special circumstance like sick units
or when permitted being desirable due to peculiar circumstances in the
sanction.
• The sub-limits against the various components of stocks and receivables
should be fixed taking into account the existing norms of inventory and
receivables as bench mark and bankers should adopt flexible approach
on case to case basis in a realistic manner while assessing the credit
needs. While allowing deviations, the sanctioning authority must ensure
that proper justification is available and given.
• With regard to the aspects like allowing drawing power on the basis of
stocks and receivables’ statements or calling data on actual turnover on a
monthly basis or calling of certificate from auditor’s every 6 months in
respect of actual sales, it has been clarified that calling for sales data on
monthly basis and comparing with the drawings in the account would be
helpful particularly in the matter of arriving at effective operational
limits as also in the monitoring the borrowal accounts. The drawing
power in any case is to be allowed on the basis of monthly stock
statement.
• In order to check the validity of projections for turnover, in case of
existing units sales data pertaining to actuals of last five years, estimates
for the current year and projections for the next year together with the
true analysis of the industry to which the borrowing unit belongs would
also be useful. Other relevant information i.e modernisation or
expansion of the existing manufacturing capacity, Govt. policy on
taxation and other relevant internal and external factors also need to be
taken into account.

K.Kannan Committee:

Kannan Committee A committee constituted by the Indian Banks' Association

to examine the relevance of the concept of Maximum Permissible Bank Finance
(MPBF) as a method of assessing the requirements of bank credit for
WORKING CAPITAL, and to suggest alternative methods. The committee was
headed by K. Kannan, Chairman, Bank of Baroda and its report submitted in
1997, includes the following recommendations :

• The MPBF prescription is not to be enforced and banks may use their
discretion to determine the credit limits of corporates.
• The CREDIT MONITORING ARRANGEMENT and QIS may cease
to be regulatory requirements.
• The financing bank may use its discretion to determine the level of
stocks and receivables as security for working capital assistance.
• The mechanism for verifying the end-use of bank credit should be
strengthened.
• A credit Information Bureau may be floated independently by banks.

Since April 1997, banks have been given the freedom to assess working capital
requirement within prudential guidelines and exposure norms. Banks may
evolve their methods to assess the working capital needs of borrowers – the

43
Turnover Method or the Cash Budget Method or the MPBF System with
necessary modifications or any other system.

Financing of working capital had always been an exclusive domain of

commercial banks. Too much emphasis on security by the banks
directed the flow of credit to affluent section of society with the result
that economic resources of the country were concentrated in a few
hands. Projects promoted by technically qualified entrepreneurs with no
tangible security to offer found it difficult to raise finance for the
working capital required by them from banks. With the nationalisation
of the banks an entirely new breed of entrepreneurs made a demand on
bank credit. Small sector and other segments of priority sector were to
be the major beneficiary of nationalisation and were preferred claimants
of credit. This resulted in an unexpected demand on lendable funds of
banks and naturally called for a reform in the policies of banks to orient
them to the new developmental role assigned to the banking industry.

Another important factor which called for reforms was the inbuilt
weakness in the cash credit system linked with emphasis on security.
The limits were directly fixed on the basis of security available in the
account which in many cases resulted in double finance. Banks also had
no control over the level of advances at any particular time. It was not
related to how much a bank can lend at a particular time but was linked
to the decision of the borrower to borrow at that time. A major part of
credit limits sanctioned by the bank remained unutilised and there was a
strong tendency within the banks to oversell the credit. It was noted as at
the end of June, 1974 that total limits sanctioned by the banking industry
was far in excess of its total deposits. Bank could afford this overselling
as 43% of the limits sanctioned by them remained unutilised. Any
unexpected demand within the sanctioned limits could prove disastrous
and had the capacity to put the entire banking industry out of gear. The
fear was proved true in late 1973 when a sudden demand on bank credit
was made due to unprecedented rate of inflation and the banks had to
arbitrarily freeze the credit limits of their borrowers.

Dehajia Committee
For over a decade the RBI has been making sustained efforts to come to grips
with the financial indiscipline in the corporate sector. The Dehejia Committee,
in particular, pointed out three aspects of it: (1) There has been a general
increase in borrowing from the banks both in relation to production and
inventory. Even financing by other sources, such as trade credit, has shown a
marked increase, (2) the period of credit was unduly lengthened and the
quantum of bank credit tended to stabilize at higher levels, and (3) in some
cases, the misuse in acquiring long term assets even spilled over into financing
fixed capital assets.

Both the Dehejia Committee and the Tandon Committee (which gave
operational expression to the norms) suggested that the demand for bank credit
be reduced partly by trimming the inventory levels and secondly by insisting
that the enterprises raise adequate funds to finance net working capital from
retained earnings or other long term sources.

44
The response from the corporate sector was essentially that the Tandon
Committee norms lack the flexibility to account for the practical exigencies that
individual firms are confronted with.
The present study has four primary purposes: (1) To establish theoretically the
possibility of developing micro level norms for the components of physical
inventory based on the operating cycle concept,
(2) to empirically demonstrate the plausibility of the approach by offering
specific calculations for twelve firms, based on the stock exchange directory, (3)
to develop a norm for bank credit starting from the inventory norms, and (4)
examine the differences of the approach with that of the Tandon Committee and
their implications.

The major findings of the study can be summed up as follows: (1) some firms
do have excess inventory of raw materials. But more importantly, for many
firms, including those where the inventory problem is not prominent, there have
been chronic difficulties in the collection of receivables. In some cases the
Tandon Committee norms appear inadequate relative to our micro level norms.
(2) The general trend in the case of bank borrowings is that, from the Tandon
Committee vantage point, many of them have inflated drawings of bank credit.
But the micro level norms of the present study suggest that in most of these
cases the reasonable level of bank credit requirements was in excess of the
actual being made available after 1968 though the reverse was the case earlier.
Of course, some firms are excess users even on our norms and some firms have
always shown restraint. (3) On the whole, it appears that the Dehejia Committee
created an excessive reverse momentum so much so that the corporate sector is
now-a-days justified in its complaint regarding credit granting policies. The
Tandon Committee sought to carry credit policy in the same restrictive direction
rather than consider the objective reality of the situation at hand.

The anti-inflationary measures may have been the source of recessionary trends
in certain sectors. The firms were compelled to liberalize credit terms and in
many cases simultaneously increase the stocks of finished goods and
receivables. But the finances necessary to sustain this activity were not
forthcoming. Given these observations we cannot say that the financial
indiscipline is exclusively a result of the corporate decision making process.
Instead the low ebb of demand and tight credit conditions left them high and
dry.

When the question of macro credit policy is resolved in the appropriate spirit we
can return to the much neglected domain of cost effectiveness and
systematically improve the situation by using the micro level norms based on
concepts such as the operating cycle. The chief merit of the disaggregated
approach consists in the efforts to assess working capital needs keeping the
technical features and trading conventions in perspective. The micro level
norms developed in this study can be invaluable guides both to the firm and the
banker in their long term efforts to brings about efficient resources utilization.
That is the major contribution of the present study.

45
 Marathe Committee
3.2 The Committee observes that there are no quantifiable, objective criteria for determining the
need for an UCB in a given area. The Committee has also noted the recommendations of the
Marathe Committee, which felt that "the Reserve Bank may address itself to the task of prescribing
quantitative definitions for the key indicators like `need', `potential' and `adequacy' or otherwise of
the `banking cover'. The Marathe Committee was of the view that while "need" for the organisation
of a new UCB refers to concepts such as population coverage, spatial and geographical spread of
existing banks etc., the "potential" criterion relates to an assessment whether, in the area of
operation proposed, the new entity would be able to achieve the norms of viability within a
reasonable period of time. Marathe Committee also felt that the determining basis for such an
assessment should be the `credit gap' in the functional area and suggested the following guidelines
for assessing the same.

i) Industrial activity present and proposed; setting up of new industrial estates etc;

ii) Level of trading activity; emerging markets and market yards;

iii) Sub-urban areas - existing and proposed;

iv) Existing banking network, deposits, advances, credit-deposit ratio;

v) Average population served by existing bank offices.

46
3.3 The Committee has examined these factors in the context of a substantially deregulated regime
and policy posture of RBI with reference to organisation of new Private Sector Banks and Local
Area Banks (LABs). The Committee is of the view that in a market driven regime, focus of the
regulator should be on strong start-up capital, compliance to prudential norms, adherence to CRAR
ab initio and professional character and integrity of management. If these factors are given due
weightage before granting licence for a banking entity, there may not be any need to prescribe other
parameters.

3.4 While responding to the questionnaire on this issue, a section of urban cooperative banks, their
federations, and state cooperative banks have suggested that ‘credit gap' criterion should be a
determining factor to establish the need for a bank, in a given locale specific. The Committee has
examined this aspect and in its view, ‘credit gap' in a given area cannot be determined on
unidentifiable parameters. The concept has to be well defined, structured and universally acceptable.
Hence, in the absence of precise, measurable and scientific tools to determine exact quantum of
credit gap, prescription of ‘credit gap' criterion for assessing the need, will only result in a laborious
exercise without any tangible results. The suggestion that the credit gap may be determined on the
basis of Potential Linked Credit Plan (PLP) of NABARD has also been examined by the
Committee. The objective behind the preparation of Potential Linked Credit Plan is to bring to the
notice of the planners, government, developmental agencies, bankers, farmers, private sector
agencies etc, the need for infusion of specific infrastructure and non credit inputs to facilitate
planned development of the district. The focus of PLP is essentially on rural development with the
thrust on district as a whole. Since UCBs initially start at an urban centre, it is difficult to arrive at
credit gap of an exclusive urban locale from PLP. Given the weak conceptual relevance of ‘credit
gap', the Committee is not inclined to agree with this criterion for determining the need for a new
urban cooperative bank at a given centre.

3.5 Yet another suggestion put forth by respondents to the questionnaire circulated by the
Committee is, that the adequacy or otherwise of banking network at a given centre can be
determined by the conventional arithmetical formula viz., Average Population Per Bank Office
(APPBO). The APPBO is arrived at by application of following formula :

47
 FINDINGS/DEVELOPING A NEW MODEL
Bank Finance for working Capital has been based on the Tandon Committee
norms introducing 25 years ago by RBI.These norms ration scarce Bank credit
to needy borrowers,on the basis of end use principle and purpose
orientation.Evaluation is on the basis of Working Capital operating cycle and
follow up is on the basis of component of gross current Asset and Current
liabilities.Current Ratio is the key of these norms.During the period 1997 RBI
has accorded operational freedom to banks in assessing the working capital
requirement of borrowers.It is hoped that Banks will come out with innovative
models of Working Capital Financing as a consequence.

Cash Flow method of financing and finance based on security,beside balance

sheet method of financing though not entirely novel are the new model that
emerged recently.Still many banks follow Tandon Committee norms for high
value limits I n view of their soundness.

Nayak Committee norms introduced in 1993 to provide hassle free finance to

SSI borrowers,Stipulate that banks should fix as credit limit,a minimum of 20%
of the projected gross sales,with a margin of five percent on sales.

As banks appear to be reluctant to reduce the margin while computing drawing

power to 20% as envisaged in this model,SSI borrower often complain that this
new model is not of much help to them.Any credit appraisal system will be
successful only when there is real time follow up based on ledger and financial
data.

We Can Make a new Working Capital lending model with the help of two
financial tool namely (1)Working Capital Cycle and (2)Value Addition
Concept.The basic concept and framework of the model works in following
way:

(1)Determination of Operating cycle and find out the time period of each
working capital component namely Sundry Debtors, Bills Receivables,
WIP,Finished Goods,Cash and Cheque Collection etc in WC Cycle.

(2)Determination of amount of value addition from companies income

statements.

(3)Computation of total amount of working capital of each component as per

Operating cycle period.For eg if Raw material stay for 2 month in cycle then

48
determine the amount for only 2 months.These way accurately we can find the
exact portion of Working Capital. we can add up amount of all the components
and exact portion of Total Amount of Working Capital we can find.For
computation of cost of SIP it is assumed to give half portion of Value addition
to it.

(4)Separate a particular portion of margin requirement for borrower stake and

rest of the portion for Working Capital financing by bank.

For Better understanding we can take a hypothetical Example:

Trading and P&L Account(Rs In Crore)

To Opening Stock 10 By Sales 120
T Purchase of RM 10 ByClosing Stock 20
To Wages 10
To Power and Fuel 15
To Raw material 70
To Direct Expenses 5
To Gross Profit C/D 20
14
0 140
To General Admn By Gross Profit
Expenses 8 B/D 20
To Net Profit 12
16
0 160
Operating Cycle Period
RM 1
SIP 0.5
FG 2
Receivables 2

Operating Cycle inmonth

RM
SIP
FG
Receivables

49
Calculation of Monthly Cost
Monthly Raw Material
Cost(Rs in Crore) 80/12 Apprx 7
Monthly Cost of SIP(Rs RM+1/2 Value
in Cr) Addition 7+1/2 of 3=8.5
Monthly Cost of FG(Rs
in Cr) RM+Value Added 10
Monthly Sales (Rs in
Cr) 120/12 10
Value Addition
(Monthly Exp) (Rs in
Cr) Sales-RM Cost 3
Monthly Total Cost (Rs
in Cr) 140-20/12 10
Determination of Working Cap provided by Bank:
Total
WC
Inentory For
Period that % Working Cap limit gien
Item month period Margin Amt(RS) by bank
RM 2 14 25 3.5 10.5
SIP 0-Jan 4.25 25 1.0625 3.188
FG 1 10 25 2.5 7.5
Debtors 2 20 25 5 15
Petty
Ex 1 3 100 3
Gross WC Limit
36.19

The main purpose of this model is to lend only that portion of working Capital
which is remain in operating cycle.In this way we can find out what is the exact
portion of WC Requirement in each of the component .The advantage in Banks
point of view is that they are not lending the Working Cap as a whole rather
they need to give it separately as per the time period of Working Capital ,so the
idea is that The portion of Working Capital used to purchase of RM is spend
only to R.M Purchase,not spend in other purpose,So effective utilization of
Working Capital is made possible.For borrower’s point of view the basic
advantage is they can have all time working capital fund in their business.So
this gives psychological assistance to borrower.

50
 LIMITATION OF THE STUDY:
Project carries certain limitations. The research is based on present available
theories and standards, therefore it is limited to present market condition and
further research and findings can be done.

• Time Constraints:
There is very limited time to complete the study.If more time is allotted then
the study may be more specific.

• Based On Only Secondary Data:

The project is completed on the basis of secondary data only.Primary data is
not available here.

• Limited Secondary Data:

The source of secondary data or published data are too limited.

• Lack of co-operation of borrowers:

For collecting data borrowers are not co-operating properly.

• Practical Approach of Developed Model:

The finding working capital Model is not tested practically,it is just a
recommendation.If practically it is tested then there is possibility of any
limitations.

51
 CONCLUSION
This Project Finance manual provides managers of public-private partnership
(PPP) projects with a broad understanding of the process around project
financing. Although the respon-sibility for arranging project financing lies with
the private sector participant(s), all stake-holders must understand the process
when evaluating the value for money conditions set out in the Treasury
Regulations on PPP projects. Understanding the process will also assist depart-
mental managers to manage transaction advisors and in negotiating with private
sector par-ties. Finally, it is important to understand that the processes and
structures used in the financ-ing of projects are dynamic and continue to
evolve. All stakeholders will therefore need to be flexible.

PPPs are often funded through the department’s budget, but may also be
partially or com-pletely funded by the users of the service (e.g. a toll road or
port). PPP projects vary significantly in term and in structure. Every project
requires a certain level of financing, but this Project Finance manual primarily
addresses the financing of longer-term PPP projects in which the pri-vate sector
provider is required to raise funds for capital investment. Most of these PPPs
pro-vide social services to the public.

The objective of using project financing to raise capital is to create a structure

that is bank-able (of interest to investors) and to limit the stakeholders’ risk by
diverting some risks to par-ties that can better manage them. In project
financing, an independent legal vehicle is creat-ed to raise the funds required
for the project. Payment of principal, interest, dividends and oper-ating
expenses is derived from the project’s revenues and assets. The investors, in
both debt and equity, require certain basic legal, regulatory and economic
conditions throughout the life of the project.

The project’s revenues are obtained from the government and/or fees (tariffs)
charged to the users of the service. In some projects, the private sector provider
also pays concession fees to the government or to another designated authority,
in return for the use of the government’s assets and/or the rights to provide the
service, which is often a monopoly. In toll roads and ports projects, for

52
example, the concession fee is based on the use of the service or the net
income, giving the government a vested interest in the success of the project. In
this case, the govern-ment’s interests are comparable to those of an equity
investor.

The rest of this Project Finance manual addresses the general structure of a
project, fund-ing alternatives, investor profiles, and the criteria investors will
consider before and during the implementation and operation of the project.
This is followed by a discussion of the terms and conditions often required by
investors, and of the various financing (equity and debt) strate-gies to be
considered by the sponsors of the project. This manual uses examples of
existing PPP projects in South Africa, frequently referring to Trans African
Concessions (Pty) Limited (TRAC), which was awarded the 30-year build-
operate-transfer (BOT) concession for the N4 toll road between Witbank,
South Africa and Maputo, Mozambique. This concession is discussed in more
detail in Annexure 1. Annexure 2 outlines the various ratios used in project
financ-ing,while Annexure 3 defines the risks inherent to PPP projects.
Annexure 4 provides a glos-sary of terms.

53
 54

BIBLIOGRAPHY
• Websites:
www.google.co.in

www.rbi.co.in

www.banknetindia.com

www.iibf.edu

www.sidbi.co.in

• Books:
Shekhar K.C and Shekhar Laxmi, VIKASH PUBLICATION……………

Banking Theory and Practices.

Rao Katuri Nageswara, The ICFAI University Press…………….. Bank

Credit ;Emerging trends.

Bagchi,S.K , Jaico Publishing House……………………..Bank Finance for

SME’s.

• Jornal,Magazine and Newspaper:

Easpuniani,A.K –“The Introducery Module Of Project Finance”…..The ICFAI
JOURNAL OF BANK MANAGEMENT,Mach 2007 Vol-ii,Page No-28 to 34.

Bhasin,Narendra Kumar-“Building Indian Infrastructure: Financing of PPP

Project”………………..Bank Quest Journal of IIBF,Jan 2009

The Economic Times.

The Finance India Journal Of Indian Institute Of Finance.

54