Credit Appraisal Methods

Why SMEs need credit?

Financing gap is all the more important in a fast-changing
knowledge-based economy because of the speed of innovation.
Innovative SMEs with high growthpotential, many of them in high-
technology sectors, have played a pivotal role in raisingproductivity
and maintaining competitiveness in recent years.
If SMEs cannotfind the financing they need, brilliant ideas may fall
by the wayside and this represents a loss in potential growth for the
economy.
The creditproposal is prepared to indicate the need based
requirement and the rationale for its recommendation
These proposals analyze various risks associated with bank lending
i.e. business risks, financial risks,management risks, etc. and clarify
the processby which such risks will be managed on an
ongoingbasis
Credit Appraisal Methods
Assessment of credit need
Financial statement analysis
Financial ratios of the company
Risk Assessment & Credit rating
Working capital requirement
Term loan analysis
Submission of documents
Monitoring Mechanism
NPA classification and recovery
Assessment of credit need

The need for credit to theborrower

Type of credit
Fund-based
Non-Fund based
Asset based
FINANCIAL STATEMENT ANALYSIS

Type of statement: Examine weather financial statement is

audited orunaudited. If the report is audited study the auditor
certificate.
Nature of activity: Engaged in trading ormanufacturing activity
or services, what kind of the products the company deals in.
Series of statement: Examine thefinancial statements.
Examine balance sheets (audited, provisional and projected) and
profit and lossaccount. Important factor to note the trendis to
observe statements of the last 3to 5years to know about the
trend in the performance ofthe firm. Prepareyearwise break up
of statements for observing trend. Compare between
theprojected and actual statements. Check the gap and reason
forgap.
Financial ratios of the company
1) CURRENT RATIO
Current ratio should be at least 1.33:1 according to bank norms.
2) DEBT EQUITY RATIO (DER)
Fresh term loan- D.E.R should not normally be above 3:1, for capital intensive
industries it may be up to 5.00:1, in case of loans to PSU, it may be 7.00:1.
In case of term loan, minimum average DSCR of 1.30:1 will be considered for any
new project.

3) DEBT SERVICE COVERAGE RATIO (DSCR)

This ratio indicates the capacity of a unit to repay the term loan and a unit can repay
the loan only when the unit generates profits. Repayment of term loan without
generation of surplus will lead to reduction in working capital, tight liquidity position and
further deterioration in the working of the unit. It is calculated as- DSCR= PAT+
Depreciation+ Interest on term/ loans Interest on term loans+ Installments of term
loans
Risk Assessment &Credit Rating
(A) EVALUATION OF FINANCIAL RISK
Current ratio
Debt Equity ratio
Sales performance (actual V/S projected).
Net profit margin (net profit tosales)v.
Return on capital employed (Profit After Tax/ Capital Employed)
Debt Service Coverage Ratio (for termloans)

(B) MANAGEMENT RISK

Experience of management andpromoters
Composition of management (qualification)
Succession planning for key positions
Labor relations (w.r.t strikes, disputes etc)
Honoring financial commitment( to banks/ financialinstitutions/ creditors/ government
etc)
EVALUATION OF MARKET OR INDUSTRY
RISK

Market potential
Competitive situation (no. of competitors,
big competitors etc)
Raw material availability and procurement.
Selling and distribution arrangement.
Technology advantage
RATING OF FACILITY & BUSINESS ASPECTS

FACILITY:
Submission of stock statement
Submission of audited balance sheet, P & L and financial data
Repayment schedule (only for term loans)
Margin given on term loan.
Operation in account
Payment of loan and interest( timely orirregular)

BUSINESS ASPECTS
Length of satisfactory relationship with Bank and
Income value to the bank ( interest,commission, exchange etc)
RATING & RISK CATEGORY

RATING SCORE RISK CATEGORY

CR-1 >90 LOWEST RISK
CR-2 81-90 MINIMALRISK
CR-3 76-80 MODERATERISK
CR-4 71-75 SATISFACTORYRISK
CR-5 66-70 ACCEPTABLERISK
CR-6 61-65 WATCHRISK
CR-7 56-60 RISK PRONE
CR-8 <55 HIGHRISK
CR-9 DEFAULT NPA- SUB-STANDARD
INTEREST RATES FOR SMALL
INDUSTRIES CREDITRATING
CREDIT RATING WORKING CAP TERM LOAN
CR1 BPLR-.25 BPLR+.25
CR2 BPLR BPLR+.5
CR3 BPLR+.25 BPLR+.75
CR4 BPLR+.75 BPLR+1.25
CR5 BPLR+1 BPLR+1.50
CR6 BPLR+1.5 BPLR+2
CR7 BPLR+2 BPLR+3
CR8 BPLR+2 BPLR+3
CR9 BPLR+2 BPLR+3
*Current BPLR 10%
Working capital requirement
Type of Working Capital Loan
Bank Overdraft Facility or Credit Line
Short-Term Loans
Accounts Receivable Loans
Factoring or Advances
Term Loan Analysis
It denotes evaluating the proposal of the loan to find out repayment
capacity of the borrower.
The primary objective is to ensure the safety of the money of the bank
and its customers. The process involves an appraisal of market,
management, technical, and financial.
Bank analyses the loan proposal from all angles in order to ensure that
the capital and interest income of the bank is relatively secured.
While appraising a term loan, financial institutions focus on evaluating
the credit-worthiness of the company and future expected stream of
cash flow with the amount of risk attached to them.
Credit worthiness is assessed with parameters such as the willingness
of promoters to pay the money back and repayment capacity of the
borrower.
Submission of Documents
1) Loan application form duly filled in all respects, along with following Annexures-
Profile of the Company
Salient features of Memorandum & article of Association
Details of Board of Directors
Share Holding Pattern / Ownership structure
Details of the Project, Plant Capacity etc.
Cost of the Project & Means of finance (with details of comparison for similar project)
Present Banking Arrangement
Present Financial Performance of the company - ( it should be supported by financial
statements for last three years and projections for next two years)
Highlights & Performance of the Group Companies
Manufacturing Process
Plant Machinery Arrangement / Origin / Price etc.
Operation & Management
Industry Scenario
Cash Flow Statement
Risk Analysis
Projected Profitability, BEP, DSCR, FACR and Sensitivity Analysis etc.. ( to be submitted
additionally in case of Term Loan)
Cont.
2) Copy of latest stock statement and book debt
statement.

3) A detailed project report covering marketability and

Techno-economic feasibility in case of new
projects/expansion/modernization.

4) Credit declaration form (ADV-80) duly filled in,

applicable to prop./partners/ guarantors/ directors/
companies.
Monitoring Mechanism
Submission of Monitoring Report by Credit Officer as per different format
such as
Report- E1 by HO and copy to ZO on monthly basis and loan amount should be Rs
5 cr. & above)
Report- E2 - Zonal Office (Copy to be sent to Credit Monitoring Dept, HO on
quarterly basis and amount of loan should be Rs.1.00 crore and above but below Rs
5.00 crores)
Report- E3 by ZO on quarterly basis (Rs.10.00 lacs and above but below
Rs.100.00 lacs)
Monitoring of potential NPA
Periodical visit by bank officials
Stock audit
Security register
Renewal of limits