reading material officers ii[1]

8/10/2019 Reading Material OFFIcers II[1]

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Staff Training Centre, Bhopal

Credit Program for Officers Level II

10.11.2014 15.11.2014

Coordinators: Mr. Pushkar K Sinha

MR K L Batra

AIM i ASPIRE i ACHIVE


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Index

Sl No Topic Page No

1 Scrutiny of Financial Statements 3

2 Formatting of Profit & Loss a/c 8

3 Ratio analysis 10

4 Cash & Fund flow statements 17

5 Working Capital Assessment FBF Method 29

6 Working Capital Assessment Cash Budget Method 34

7 Commercial Real Estate 35

8 Term Loan assessment Project finance 38

9 Consortium & Multiple banking 47

10 Debt Restructuring 50

11 Forex advances, LC mechanism, ECGC guidelines 65

12 Financial Derivatives 91

13 Treasury Management 94

14 CBS MENU OPTIONS :- ADVANCES 101

Disclaimer- This reading material has been prepared with utmost care. However the

participants are advised to refer to the Circulars and guidelines issued from time to time byCentral office and Administrative offices.


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CLASSIFICATION OF CURRENT ASSETS & LIABILITIES

ASSETS:Classified into 4 groups:

1. Current Assets2. Other Non-current assets/Misc. Assets3. Fixed Assets4. Intangible Assets

Current Assets: Also called Liquid Assets/Circulating Assets/Floating Assets/GrossWorking Capital

Definition: Those assets which are reasonably expected to be converted into cashduring the operating cycle of the business. Assets however liquid which do notform a part of operating cycle are not classified as current assets by bankers..

Three Categories:

Inventories (Stock-in-Trade)

Receivables (Trade Debts)

Other Current Assets

Examples:

Inventory:

a) Stock of rawmaterials on hand- indigenous, imported.

b) Stock of work-in-process (Semi finished goods)

c) Stock of finished goods on hand

d) Goods at stores and spares indigenous and imported

Receivables:

a) Sundry Debtors. (Trade Debts/Book Debts)

b) Bills Receivables (Bills accepted by Sundry Debtors.)

- Inland Bills upto 6 months, including deferred receivables maturingwithin one year (less reserve, for doubtful debts, less receivableoutstanding over six months, less due from sister concerns.

c) ExportOther Current Assets

a) Cash & Bank Balanceb) Investment

In Govt. & Trustee Securities (however, when investment in suchsecurities are made for long term purposes like Gratuity Fund,Sinking Fund, they should be treated as ONCA)


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Investment in Fixed Deposits with Banks/MMFS/CPS/CD etc. (otherthan long term) if they are encumbered/earmarked for knownliabilities they cannot be treated as CA)

Investment in quoted securities (if the investment is required for/related to the business and is liquid or the securities are easilymarketable.

c) Advance given to suppliers. for purchase of raw materials, stores, sparesand consumables items.

d) Advance Tax payment (I.T) after adjusting reserves for taxation.e) Advance recoverable in cash or kind.f) Advance accrued on investments.g) Pre-paid expensesh) Cash margin on LG/LC

Other Non-Current Assets ( Miscellaneous Assets)

These assets cannot be included in Current assets as (i) as they are slow moving(not readily realisable in cash) or as (ii) they are not acquired for normalbusiness purpose.

Examples:

i. Dead Inventory slow moving inventory obsolete items/slow-movingitems not readily realisable.

ii. Deferred Receivables other than those maturing beyond/after oneyear.

iii. Amounts due from Associates/Subsidiaries/affiliatesiv. Other loans and advancesv. Security Deposits Balance/Deposit with Govt.Dept./Statutory

Bodies/Tender Deposit irrespective of their maturity period.vi. Receivables not related to trade

a) Advance given to Staff members.b) Advances given to directors, partners.c) Advances given to companies not connected with businessd) Advance for purchase of fixed assets or advance to

supplier/contractor for capital expenses.e) Investment in companies not related to trade.

vii. Unquoted investments/Gratuity Fund/Sinking Fund for long termpurposes.

viii. Other miscellaneous assets/CD etc.


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iv. Trade Markv. Franchise (Amount paid towards getting exclusive right for using a brand)vi. Preliminary expenses (Company formation expenses capitalised)vii. Deferred Revenue Expenditureviii. Debit Balance in profit and loss account (adverse profit & loss account)ix. Drawings by partners. (withdrawal of capital) in partnership firmx. Bad & Doubtful debts not provided forxi. Pre-operative expenses/development expenses etc. to the extent not written

off.Nature of these assets

A banker presumes that these assets are a drain on the capital. These assetsare not available for payment of debts as long as the business runs and they are notrealisable at the time of liquidation (as they hardly fetch any value in case of forcedsale).

LIABILITIES

Reclassified into 3 groups1. Networth2. Term Liability3. Current LiabilityNetworth - Also known as Share holders. funds or owners. equity.

Items are almost permanent source of fund (need not be paid back as long as thebusiness runs)

Items represent the amount of funds (resources) given (or not drawn) by the owner(share holders.) of the business.

They are permanent source of fund. They represent the owners. stake in the business They do not carry any fixed charge by way of interest. They are not outside liabilities.

Networth are three categories:

Paid up capital ( Equity & Preference)

Free Reserves

Surplus

Examples:

- Ordinary share capital (paid up)- General Reserves

- Revaluation reserves

- Share premium amount

- Balance of profit

- Preference share capital maturity after 12 years.


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- Other reserves.

Term Liability - Also known as long term liability or Deferred Liability

Definition: Liabilities which mature for payment after a period of one year from thedate of balance sheet are called term/deferred liabilities.

Examples:

- Term Loan from Financial Institutions, Banks (excluding instalment payablewithin one year)

- Debentures payable after one year (not maturing within one year butmaturing within 12 years.)

- Deferred payment credits (excluding instalments payable within one year).

- Term Deposits payable after one year.

- Preference shares redeemable after one year but before 12 years..

- Working Capital Term Loan

- Deposits from dealers. Which are refundable only on termination ofdealership are to be treated as term liability.

- Other term liability (including ECB/ADR/GDR/FCNR (B) loans etc.

Debentures:

Current Liability:

Definition: Liabilities payable in short term (within a year) from the date of balancesheet are classified as current liabilities. They represent short term source of fund andshould be utilised for financing current assets.

Examples:

- Short term Bank Borrowing against stock, stores etc. ( cash credits,overdrafts)

- Sundry Creditors. for Trade (Creditors. on account of supply of rawmaterials)

- Advance/progress payment from customers. For supply of finished goods.

- Sundry Creditors. For expenses.- Bills payable (bill accepted on account of sundry Creditors.)

- Outstanding/Accrued expenses (expenses like rent, insurance due/accruedbut not paid)

- Provisions (made towards payment of taxed, bonus etc.)

- Dividend payable within one year of provision.


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- Deposits from Dealers. (not accepted with a condition to be repayable oncancellation of dealership or agency)

- Other statutory liability like PF dues etc.

- Instalment of term loan, debentures, deferred payment, deposits orpreference share capital, DPG/DEB/RP (Redeemable preference)shares/ECB/ADR/GDR due within one year.

- Working capital term loan - Term liability ( for calculating MPBF, TermLoan instalments falling due on next 12 months need not be treated ascurrent liability, but for calculating CR it will be treated as currentliability)

- Unsecured borrowings (including ICDS etc.) from the bank including billsdiscounted.

- Unsecured borrowings from others, where no period of repayment ismentioned. Deposits maturing within one year.

- Interest and other charges accrued but not due for payment.

- Other current liability/provision, such as gratuity liability due within oneyear of provision.

Total Outside liabilities = Current liabilities (+) Long Term liabilities

Total Tangible Assets = Current Assets (+) fixed assets (+) other non-current assets

Net Working Capital = Current Assets (-) Current liabilities

Tangible Net Worth = Net worth (-) Intangible Assets.

Formatting Trading & Profit/Loss Account

TERMS EXPLAINED

Net sales = gross sales [total sales] - excise duty Raw material consumed = opening stock of raw materials + purchases during the year -

closing stock of raw material Cost of production = raw materials consumed + manufacturing expenses including

depreciation + opening stock of stock in process - closing stock of stock in process Cost of sales = [ cost of production + opening stock of finished goods ] - closing stock of

finished goods

Gross profit =net sales - cost of sales Operating profit = gross profit - operating expenses Net profit = [ operating profit + non operating incomes ] - non operating expenses

PROFIT AND LOSS ACCOUNT & TRADING ACCOUNT The profit and loss statement is submitted for the relevant period as per the balance

sheet Date. Proper format of operating Statement is used


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Add returns on sales

Closing stocks

Details of purchases and sales of Individual items are given Confirm that separate details are given for manufacturing sales and trading sales for

comparison with the previous year The projected sales are in conformity with past trend they are justified/ reasonable and

achievable If there is a fall reasons for the fall and plans of achieving the estimates for the current

year The pricing/costing system followed by the concern is uniform at all stages

Ratio Analysis

Ratio is the relationship between two variables. It can be expresses as a ration (2:3) or as a percentage(e.g.25%) or so many times (e.g.2.3 times). The purpose of ratio analysis is to facilitate comparisons withreference to time periods or with the average of industry. An investor who is intending to invest money ina company may like to know the risk and returns associated with the investment. As this involves futureactivity, a doubt may arise as to how the analysis of the statements based on past performance will beuseful. However, past performance and trend do play a part, rather a significant part in the future

performance also.

The various ratios may be grouped under the following categories:

a) Liquidity Ratios b) Activity or Efficiency ratioc) Leverage or Stability ratiod) Profitability ratioe) Although it is possible to calculate a number of ratios under each category, we shall discuss only some ofthe important ratios both from the viewpoint of the management and bankers..

a) LIQUIDITY RATIOS : (a.1) Current Ratio(a.2) Quick or Acid Test Ratio

A.1 Current ratio of Working Capital Ratio

Current Asset

Current Liabilities

Since the ratio is the relationship between current assets and current liabilities, it is essential that thecurrent assets and current liabilities be correctly identified in the balance sheet. It is necessary that currentassets should be sufficient to meet the current liabilities. Another question is whether a current ratio of 1:1is adequate. Here it is to be seen that the value given to the assets in the balance sheet is matter ofestimate. Although the current assets are valued at the releasable cost unlike fixed assets, it is possiblethat the estimates may go wrong and the realisable value may be less than the estimated one. It istherefore, desirable that CA are more than CL to keep a good margin of safety for the current Creditors..Another question may arise, namely, what is the need to have more CA in relation CL as long as total


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assets are more than the total outside liabilities. This can be easily answered considering the fact thatfixed assets are intended for long term use in business and if companies were to pay its current Creditors.from the sale proceeds of fixed assets, it will be virtually in a state of bankruptcy liquidation.Commercial solvency of the company depends upon the adequacy of current assets in relation to currentliabilities. To what extent CA should exceed CL depends on the operating cycle of the company. If it hasa faster turnover (short operating cycle), it may be able to manage with a relatively low current ratio. Onthe contrary, if the operating cycle is longer, it will require a high margin of safety. Bankers now insistthat Current Ratio should be at least 1.33:1. However, a very high current ratio also does not indicate avery healthy management pattern.

Ways of improving current ration

a) Sale of Fixed Assets to pay CL b) Sale of Fixed Assets for investment in CAc) Long term borrowing to pay CLd) Long term borrowing to invest in CA

A.2 QUICK RATIO OR ACID TEST RATIO

It is calculated as follows:(CA-Inventory)/ (CL-Short term bank borrowing). It has to be recognised that some assets are more liquidthan others. Inventory is the most illiquid of the CA because it might have to be firstly converted intoreceivables. It is therefore, deducted from the CA. Similarly, short term bank borrowings though legally

payable on demand, are generally renewed if the company is doing alright and hence is treated as longterm liability. The acid test ratio will indicate whether liquid current assets are adequate to meet currentliabilities. Here again, the duration of the operation cycle is a crucial factor to examine the magnitude ofthe ration. Normal/Standard 1:1

b) ACTIVITY RATIOS :Inventory Turnover ratio

Debtors Turnover ratio

Accounts payable or Creditors. Turnover ratio

Assets turnover ratio

Expenses ratio

Inventory Turnover Ratio:

Cost of goods sold/Average Inventory.Inventory comprises of raw material, work-in-progress, finished goods and consumable stores and

packing materials, Inventory turnover ratio indicates how fast production cycle operates. If the ratio ishigh, it indicates higher volume of sales per rupee invested in inventory. If for example, this ratio is goingdown, it means that the company s production operation is being lengthened and inventory is gettingaccumulate. In such a situation, it is necessary to examine the portfolio further. If there is accumulation offinished goods, it required a careful analysis of the reasons for this build-up. It may be the result of a


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decline in the demand for the product of the firm resulting from price, competition, availability ofsubstitute or changes in tastes, fashions, etc. The situation may not be so alarming if lit is arising from the

build-up of raw materials inventory unless it is obsolete.

Inventory build-up entails several costs-interest, rent, insurance, salaries, and loss due to obsolescenceand pilferage. All these costs can be avoided if there is no inventory. However, business cannot runwithout a minimum of inventory. To ensure uninterrupted production and sales, a reasonable amount ofinventory has to be maintained. The inventory turnover further be sub-divided into the three followingcategories with a different pattern.

RAW MATERIAL STORAGE PERIOD:

Average inventory of R.M./R.M. consumption x 365

This will indicate, on an average, how many days consumption of raw material is held by the company.

ii) Work-in-progress period :iii)

Average work-in-progress/cost of production* 365

This will indicate the amount of money involved in the semi finished goods by giving the numberof days inventory is held in the form of semi-finished goods.

iv) Finished goods storage period:

= Average inventory of finished goods/cost of sales x 365

This ratio may be used to find out the period for which the company before sale holds finished goods.

ACCOUNTS RECEIVABLE (DEBTORS.) TURNOVER RATIO:

= Total Sundry Debtor + Bills receivable + Bills discounted outstanding/Credit

Sales X 365

The accounts receivable turnover ratio indicates at what interval the Debtors. of the company pay theamounts due by them to the company. If a company is extending credit for sixty days against the industryaverage of 30 days, it may imply anyone of the following:

a) The company has liberal credit policies to increase it sales. b) Its customers. are not having high credit rating and hence are not prompt in meeting their

obligations.c) The realisation department of the company is not efficient to realise the debts in time.d) The company s products are inferior so that they are forced to extend credit to buyers.. e) The company is facing customers. who can dictate terms to the company.


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The age of the debts is also a significant consideration. The older the age of the debt, farther it will befrom being realised and hence the profits of the company may be eroded.

PAYABLES OR CREDITORS TURNOVER RATIO:

= Bills payable + Sundry Creditors for purchases x 365

Credit Purchases

This ratio indicates the time taken by the company to pay off the Creditors.. If the credit period increasesit means that the company is taking longer time to pay the Creditors. It may be strength of the company. Ifit is a strong and reputed company, many may be willing to extend credit longer and therefore, thecompany is enjoying the cost free finance for a longer period.

On the other hand, it may be a weakness of company. The longer period of credit may be owing to theinability of the company to meet its obligations at the appropriate time because of liquidity problems.Specially, if the current ratio is poor and the Debtors. and inventory period is declining. This situationmay arise following the investment of current funds for acquisition of fixed and non-current assets.

Assets Turnover Ratio:

Sales/Net operating assets

The assets turnover ratio will indicate the efficiency with which the assets are used. If the ratio isincreasing, it will mean increasing efficiency and vice versa. An enterprise invests in assets with a view toincrease the turnover. In case of growth of turnover to less than marginal increase in assets, the ratio willcome down which will indicate that the performance has been less than budgeted.

Expense Ratio:

Another measure for efficiency of an enterprise may be the way various expenses are behaving. Thefollowing may be more pertinent:

a) Raw Material to cost of Production: This will indicate the efficiency of raw material usage. If it isincreasing it may either be because of more wastage, rejections etc., or because of a rise in rawmaterial price. In the former case, there is a decline in efficiency.

b) Cost of production to sales: This will indicate the overall production efficiency.c) Selling and distribution expenses to Sales: This will indicate the efficiency of the selling and

marketing wing of the enterprise.

d) Administrative expenses to sales: This will indicate the efficiency of general administration.

C. LEVERAGE RATIOS :

Debt/Equity Ratio:


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Debt represents the long-term liabilities and preference share capital due for payment within the next 12years. Another concept of debt is both short term and long term debt. Equity on the other hand, refers tothe tangible net worth. It is calculated as follows:

Debt/Tangible Net worth

The ratio indicates the proportion in which the financing of the company has been done. If it works to 2:1,it means that the long-term Creditors have provided Rs.200/- for every Rs.100/- of the owner scontribution. If a company has more of debt and less of capital, it may be problems with regard torepayment of installments and payment of interest when it does not have enough profits. On the otherhand, if the entire amount is in the form of equity the return (dividend) to shareholders will be on the

basis of profits. However, by borrowing a part of the funds, the shareholders stand to gain if the rate ofreturn in the business is higher than the rate of interest on borrowings as will be clear from the followingexample:

Suppose income i.e. PBIT is Rs.50/-. If the company is paying 60% tax, then ROE= 20/500 i.e. 4% Now,let us assume that the company borrows Rs..200/- and pays interest at 4% (which is the rate of return onfunds employed). In this case, the return to the shareholders i.e. ROE = (50-8)=42 (60x42/100)-25.2=16.8/300=5.6%. This increase in ROE is the result of operation of Financial Leverage. Financialleverage is measured as:

DFL = Assets x Net operating income after interest

Equity X Net Operating income before interest

= 500 x 42 = 1.4

300 50

It means the rate of earning of equity holders. will increase by 1.4 times if borrowed funds are substitutedfor owners funds.

Fixed Assets Coverage Ratio:

= Net Fixed Assets

Long Term debt secured by Fixed Assets

The fixed assets coverage ratio indicates to what extent the funds of the long-term Creditors secured byfixed assets. If it is 2:1, it means that even if the fixed assets are sold for half their book value.

Debt Service Coverage Ratio :

= Interest + PAT + Depreciation + Other non-cash expenses


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Interest + Instalment of term loan

If an enterprise has borrowed funds, it is required to repay the same and also pay the interest. For this, thecompany has the operating profits; in addition, it also has the funds from depreciation and other non-cashexpenses, which are not cash outflows. Some authorities exclude depreciation from the numerator arguingthat, after all, it is an expense for fixed assets and should not be included here. The above formula is

based on the concept the while interest is an admissible deduction, principal repayment will be done onlyafter payment of taxed. The ratio therefore shows to what extent the profits of the company will beadequate to meet the fixed charges of the interest and repayment of the borrowed funds. If this ratio worksout to 2:1, it will mean the even if there is 50% fall in profits, the company will still be able to meet itscommitments. However, if it were very near to 1:1, then even a slight fall in profits may result in theinability of the company to meet the obligations.

D. PROFITABILITY RATIOS :1. Gross Profit Ratio

2. Operating Ratio

3. Return on investment

GROSS PROFIT RATIO = GROSS PLROFIT/SALES * 100

It is an indicator of the production efficiency as discussed earlier with slight difference. In the productionefficiency, we had taken the percentage of cost of production to sales whereas share we have deductedfrom sales the cost of sales to arrive to gross profit. A low ratio may indicate high manufacturingexpenses, low price of inability to push up sales. An increasing ratio, on the other hand may indicate ahigher sales volume, low manufacturing expenses or ability to increase the selling price.

OPERATING RATIO (NET SALES MARGIN

Profit before interest and taxes x 100

Net Sales

This ratio indicates the net margin on sales after taking into account all expenses, except financialexpenses (interest) and taxes. A higher margin will indicate that the company has higher percentage of

profit on sales to meet the payment of interest, dividends and other corporate needs.

RETURN ON INVESTMENT (ROI):

This is the most widely used ratio to measure the profitability of a company specially by the managementand Creditors..

The ratio can be worked out as under: -

A. Return on total capital employed:


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Return/Investment x 100

Where the return is not profit before tax, interest on term loan and interest on debenture andinvestment means net worth of the shareholders. and term liabilities.

B. Return on Tangible Net worth : (Return on owners. fund [ROE])

Net Profit after taxes/Net worth of share holders funds x 100

FORMULAE FOR COMPUTATION OF RATIO

CURRENT RATIO CURRENT ASSETS

CURRENT LIABILITIES

DEBTORS. / RECEIVABLES TURNOVERRATIO

GROSS SALES

RECEIVABLES

DEBT-COLLECTION PERIOD

(DAYS OF SALES )

365

DEBTORS. TURNOVER RATIO

INVENTORY TURNOVER RATIO NET SALES

AVERAGE INVENTORY

INVENTORY HOLDING PERIOD (DAYSOF SALES )

365

INVENTORY TURNOVER RATIO

CREDITORS. TURNOVER RATIO

Holding Period

PURCHASES

CREDITORS.

____365___

Creditors turnover ratio


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DEBT-EQUITY RATIO

RATIO OF TOTAL OUTSIDELIABILITIES / TANGIBLE NET WORTH.

TOTAL OUTSIDE LIABILITIES

TANGIBLE NET WORTH

(IE. TOTAL DEBT= SHORT TERM + LONG TERMDEBTORS. )

GROSS PROFIT RATIO GROSS PROFIT x 100

NET SALES

OPERATING PROFIT RATIO OPERATING PROFIT x 100

NET SALES

NET PROFIT RATIO NET PROFIT x 100

NET SALES

RETURN ON ASSETS OPERATING PROFIT

TOTAL ASSETS - INTANGIBLE ASSETS

FUND FLOW ANALYSIS

Funds flow analysis is a technique of financial analysis used to study the resourcesdeployment of business. This technique is based on the concept of business operation as aseries of resource deployment for profit, based on management decisions. The businessoperation of any industrial or business unit consist of -

(a) Investment of resources

(b) Financing to provide these resources and

(c) Operation of the business with the help of these resources with the objective of profit.


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As is know, the balance-sheet presents a snap-shot picture of the financial position ata given point of time and the income statement shows a summary of revenues and expensesduring the accounting period. The funds flow statement also referred to a Statement ofchanges in financial position or the statement of sources or uses of funds drawing on theinformation contained in the basic financial statements shows the sources and application of

funds during the period. The funds flow analysis provides insight into the movement of fundsand helps in understanding the changes in the structure of assets, liabiliti es and owner sequity.

Funds flow analysis presents a decisional view of the business and helps in answeringquestions like:

Have capital investments been supported by long-term financing? Have short-term sources of financing been used to support capital investments? How much funds have been generated from the operations of the business? How much has the firm relied on external source of financing What major commitments of funds have been made during the year? Has the liquidity position of the fund improved?

What are funds?

Very broadly, funds are defined as total resources. However, most commonly fundsare defined as working capital or cash. The word Working Capital here refers. to networking capital (NWC) which is defined as current assets minus current liabilities. As suchfunds flow statement can be prepared on the basis of these three measures: Total resources,Working Capital and Cash.

Funds Flow Statement - Total Resources BasisThe preparation of the funds flow statement on total resources basis is fairly simple.

The successive balance-sheets are compared and changes in each of the balance sheet itemsare noted and classiied as sources of funds or as use of funds as follows:

Sources Uses

Increase in owners. equity Decrease in owners. equity

Increase in a liability Decrease in a liability

Decrease in an asset Increase in an assetFunds flow on total resources basis is prepared on two parts - Part A shows the changes undervarious balance-sheet items & Part B classifies these changes into sources of funds and uses offunds. It may be noted that when funds are defined as total resources, the sources of fundsare equal to the use of funds due to the double entry principle of book keeping. It may alsobe appreciated that under the total resources method, only the successive balance sheets areused and the income statements/profit and loss account are not put to use.


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Amplified Funds Flow Statement

The amplification consists of providing details underlying changes in (I) reserves andsurplus and (ii) net fixed assets. This is done as follows:

I) Changes in reserves and surplus is essentially out of retained earnings and is shown as:- Profit before Tax and Interest

- Interest

- Taxes

- Dividends

Profit before tax and interest is shown as a source of funds while taxes, interest anddividends are shown as uses of funds.

The depreciation for the year is shown as a source and increase of fixed assets isshown as use of funds.

Funds Flow Statement - Working Capital Basis

The funds flow statement on a working capital basis presents

I) Sources of working capital

ii) Uses of working capital and

iii) The net change in working capital (Working capital is defined here as current assetsminus current liabilities)

What are the sources and uses of Working Capital?

These can be depicted as under:

Sources Uses

Operations Dividend Payment Tax,Interest

Issue of share capital WORKING POOL Repayment of long-termborrowings

Long - Term BorrowingsPurchase of non-current

assets

Sale of non- currentassets


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iii) Purchase of Non-Current Assets

When a firm purchases fixed assets, long-term investments or othernon-current assets; it pays cash or incurs. a short-term debt. Hence, workingcapital decreases.

The funds flow statement - on working capital basis for Bharat Ltd. isshown at Table V Part A shows the sources, uses and net change in workingcapital and Part B shows the changes in the internal content of working capital.

Funds Flow Statement: Cash Basis

Funds flow statement on cash basis shows

(I) Sources of cash

(ii) Uses of cash and

(iii) Net change in cash.

The sources of cash are the sources of working capital plus changes within the working capitalaccount which augment the cash resources of the business. The change in working capitalwhich augment the cash flow of the business are accounted for by decrease in current assetsother than cash. The use of cash is changes which use working capital plus changes withinthe working capital account which deplete the cash resources of the business. These latterchanges are simply increase in current assets other than cash.

The sources and uses of cash are illustrated below :

Sources of Cash

- Operations-Net Income, Depreciation

- Issue of share capital

- Long-term Borrowings

- Sale of non-current asset

- Increase in current liabilities

- Decrease in Current assets other than cashUses of Cash

- Payment of dividend

- Purchase of non-current assets

- Repayment of long - term borrowings


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- Decrease in current liabilities

- Increase in current assets other than cash

The net effect of the movement of funds is easily discernible in each of the threemethods under which funds flow statements have been prepared. The funds flow system in abusiness is often likened to a hydraulic system. The concept of flow implies an inflow, anoutflow and storage where the level is determined by the rate of inflow and outflow.

To summarise, the funds flow statement we observe, is very closely related to the financialstatements, the balance-sheets and profit and loss accounts, the funds flow statement isrelated to a time span say one year or six months as the case may be. Thirdly, the funds flowanalysis is very closely related to the normal decision making process in the business -decisions relating to investment, operations and finance as stated at para 1 above.

Projected Fund Flow Statement

A fund flow statement can be prepared either on the basis of past data or for a futureperiod of time provided the time span is specified. All the questions to which answers aresought on the basis of past data can also be answered for future period of time provided theprojections are based on realistic assumptions. In fact, projected funds flow statement is ofgreat practical relevance to bankers. as some of the important questions pertaining to thefinancial position, profitability and servicing of working capital/term loans etc. extended bybanks can be answered with a fair degree of reliability. This to a great extent relieves thebanker of his anxiety as to whether a credit decision to be taken at present is worthwhilefrom a commercial point of view.

As bankers funds flow analysis is used mainly to find answers to:

a) How the long term and short term resources will be raised and used?b) When and how much finance the unit would require?c) When and how the business will repay the loan/s?d) Are the financial policies followed by the unit proper and financial planning acceptable?e) What is the dividend policy of the company?f) What is the contribution of funds provided by internal sources to the growth of business?

(In the past and in Future)

A funds flow statement as a third financial statement in addition to the balance-sheetand profit and loss account has a distinct role to play in evaluating the use of resources andthe pattern of financing them.

Cash Flow Statements


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Cash equivalents are short term, highly liquid investments that are readily convertible intoknown amounts of cash and which are subject to insignificant risk of changes in value.

Cash flows are inflows and outflows of cash and cash equivalents.

Operating activities are the principal revenue-producing activities of the enterprises andother activities that are not investing or financing activities.

Investing activities are the acquisition and disposal of long-term assets and other investmentsnot included in ach equivalents.

Financing activities are activities that result in changes in the size and composition of theowners capital (including preference share capital in the case of a company) and borrowingsof the enterprise.

Cash and Cash Equivalents

Cash equivalents are held for the purpose of meeting short-term cash commitments ratherthan for investment or other purposes. For an investment to qualify as a cash equivalent, itmust be readily convertible to a known amount of cash and be subject to an insignificant riskof changes in value. Therefore, an investment normally qualifies as a date of acquisition.Investments in shares are excluded from cash equivalents unless they are, in substance, cashequivalents; for example, preference shares of a company acquired shortly before theirspecified redemption date (provided there is only an insignificant risk of failure of thecompany to repay the amount at maturity).

Cash flows exclude movements between items that constitute cash or cash equivalentsbecause these components are part of the cash management of an enterprise rather than part

of its operating, investing and financing activities. Cash management included theinvestments of excess cash in cash equivalents.

Presentation of a Cash Flow Statement

The cash flow statement should report cash flows during the period classified by operating,investing and financing activities.

An enterprise presents its cash flows from operating, investing and financing activities in amanner which is most appropriate to its business. Classification by activity providesinformation that allows users to assess the impact of those activities on the financial positionof the enterprise and the amount of its cash and cash equivalents. This information may alsobe used to evaluate the relationships among those activities.

A single transaction my include cash flows that are classified differently. For example, whenthe installment paid in respect of a fixed asset acquired on deferred payment basis includesboth interest and loan, the interest element is classified under financing activities and theloan element is classified under investing activities.

Operating Activities


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The amount of cash flows arising from operating activities is a key indicator of the extent towhich the operations of the enterprises have generated sufficient cash flows to maintain theoperating capability of the enterprise, pays dividends, repay loans and make new investmentwithout recourse to external sources of financing. Information about the specific componentsof historical operating cash flows is useful, in conjunction with other information, in

forecasting future operating cash flows.

Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the enterprises. Therefore, they generally result from the transactionand other events that enter into the determination of net profit or loss. Examples of cashflows from operating activities are:

cash receipts from the sale of goods and the rendering of services;

cash receipts from royalties, fees, commissions and other revenue;

cash payments to suppliers for goods and services;

cash payments to and on behalf of employees

cash receipts and cash payments of an insurance enterprise for premiums and claims,annuities, and other policy benefits;

cash payments or refunds of income taxes unless they can be specifically identified withfinancing and investing activities; and

cash receipts and payments relating to futures contract, forward contracts, option contractsand swap contracts when the contracts are held for dealing or trading purposes.

Some transactions, such as the sale of an item of plant, may give rise to a gain or loss whichis included in the determination of net profit or loss. However, the cash flows relating to suchtransactions are cash flows from investing activities.

An enterprise may hold securities and loans for dealing or trading purposes, in which cashthey are similar to inventory acquired specifically for resale. Therefore, cash flows arisingfrom the purchase and sale of dealing or trading securities are classified as operatingactivities. Similarly, cash advances and loans may by financial enterprises are usuallyclassified as operating activities since they relate to the main revenue-producing activity ofthat enterprise.

Investing Activities

The separate disclosure of cash flows arising from investing activities is important becausethe cash flows represent the extent klto which expenditures have been made for resourcesintended to generate future income and cash flows. Examples of cash flows arising frominvesting activities are:


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accounting records of the enterprise; or by adjusting sales, cost of sales, (interest and similarincome and interest expense and similar charges for a financial enterprise) and other items inthe statement of profit and loss for; changes during the period in inventories and operatingreceivables and payables; other non-cash items; and other items for which the cash effectsare investing or financing cash flows.

Under the indirect method, the net cash flow from operating activities is determined byadjusting net profit or loss for the effects of changes during the period in inventories andoperating receivables and payables; non-cash items such as depreciation, provisions, deferredtaxed, and unrealized foreign exchange gains and losses; and all other items for which thecash effects are investing or financing cash flows.

Alternatively, the net cash flow from operating activities may be presented under the indirectmethod by showing the operating revenues and expenses excluding non-cash items disclosedin the statement of profit and loss and the changes during the period in inventories andoperating receivables and payables.

Reporting Cash Flows from Investing and Financing Activities

An enterprise should report separately major classes of gross cash receipts and gross cashpayments arising from investing and financing activities, except to the extent that cash flowsdescribed in paragraphs 22 and 24 are reported on a net basis.

Reporting Cash Flows on a Net Basis

Cash Flows arising from the following operating, investing or financing activities may be

reported on a net basis: cash receipts and payments on behalf of customers when the cashflows reflect the activities of the customer rather than those of the enterprise; and cashreceipts and payments for items in which the turnover is quick, the amounts are large, andthe maturities are short.

Examples of cash receipts and payments referred to in paragraph 22(a) are:

the acceptance and repayment of demand deposits by a bank;

funds held for customers by an investment enterprise; and

rents collected on behalf of, and paid over to, the owners of properties

Examples of cash receipts and payments referred to in paragraph 22(b) are advances madefor, and the repayments of :

principal amounts relating to credit card customers;

the purchase and sale of investments; and


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The separate disclosure of cash flows that represent increases in operating capacityand cash flows that are required to maintain operating capacity is useful in enablingthe user to determine whether the enterprise is investing adequately in themaintenance of its operating capacity may be prejudicing future profitability for thesake of current liquidity and distributions to owners.

CONCEPTS FOR WORKING CAPITAL ASSESSMENT

WORKING CAPITAL:

Funds required acquiring the Current Assets for any Servicing, Trading or Manufacturingconcern for the day to day operations.

GROSS WORKING CAPITAL [GWC]:

Total of Current Assets [TCA]

NET WORKING CAPITAL [NWC]

Difference between Total Current Assets and Total Current Liabilities [ NWC = CA CL ] Also it can be measured as total long term sources less Fixed Assets and otherMiscellaneous / intangible Assets [NWC = LTS { FA + MA}]

MARGIN:It is the amount contributed by the borrower from the Long Term Sources to Finance theCurrent Assets. [It is also the net Working Capital available in the system]

WORKING CAPITAL GAP [WCG]:

It is measured by the difference between the Current Assets and Current Liabilities excludingthe Short Term Bank borrowings. [WCG = CA CL {Excl STBB}]

PERMISSIBLE BANK FINANCE [PBF]: It is arrived by deducting the stipulated Net Working Capital or available NWC in the system,whichever is higher from the Working Capital Gap arrived.

PBF = WCG [Higher of stipulated NWC or available NWC]

WORKING CAPITAL ASSESSMENT

For assessment of working capital needs, the projections submitted for the following year arerelevant. This first step in assessing the quantum of working capital finance is to find outwhether the projections given by the borrower are reasonable. The reasonableness ofborrower s projections can be determined as under:


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(1) The bank can use with advantage the past data given by the borrower as well asthe data available with it. What has been the bank s past experience in dealingwith that particular borrower? To what extent the earlier projections have cometrue? Did they compare favourably with the actual when the results werecompiled? If the earlier projections had compared favourably with the actual, inthat case it will increase the bank s faith in that particular borrower and the bankcan presume that the borrower is following sound practices and he is having arealistic view of the future. The borrower is also not trying to get higher bankfinance by inflating the figures. If in the past the projections did not comparefavourably with the results, the bank needs to be careful. The bank in such asituation will also be required to look into the gap between the projections andactual. Particularly, the aspect to be looked into is whether the gap betweenactual is narrowing or widening over a period of time. If the gap is widening, this isnecessarily a cause of concern. Still greater care needs to be exercised inaccepting the projections in such cases.

(2) The projections should be studied in close conjunction with past data. How theunit has fared in the past? What has been the rate of growth? What relationship thedifferent items of past bear to sales and cost of production? What has been thelevel of current assets or the current liabilities, other current liabilities and networking capital (NWC) etc.? the comparison has to be made between the pastperformance and the future projections. If the future projections are markedlydifferent from the past trend in relation to projected rate of growth, the reasonsfor the same have to be ascertained before accepting the various projections.

(3) The borrower bases his projections on certain assumptions as to various factorsaffecting his operations, e.g. market demand, cost of raw materials, price,availability of inputs and other environmental factors. The bank has to assess howfar these assumptions are likely to materialise.

(4) How the limits already sanctioned by the bank have been utilised by the borrowerin the past? Have the accounts been particularly conducted as per terms ofsanction or these have been frequently violated. Is the borrower particular inhonouring his commitments? What is the position of the various accounts? Did hesubmit the required data for follow-up and renewal of his facilities in time?

(5) There is a limit upto which the operations of the unit can be efficiently carriedout. Beyond this the operations will start giving negative results. This level has tobe identified. There may be one single factor which may restrict further expansionin operations notwithstanding the fact that all the facilities in other areas exist.This factor inhibiting further growth has to be identified. While accepting theborrower s projections, it has to be ensured that the projections do not go beyondthis factor w hich may be termed as the Choking Factor as this will choke furtherexpansion.

(6) In determining the quantum of bank finance, the projections relating to thefollowing have direct relevance:

a. Salesb. Productionc. Cost of productiond. Cost of salese. Current assetsf. Current liabilitiesg. Net working capital


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The most important area to be looked into is Sales. All other aspects are directlyrelated to the projected level of sales. Therefore, determining the projected level of sales isfirst step in assessing the working capital needs of a borrower. Once the level of sales hasbeen determined, the other data can be easily determined in relation to sales. The projectedlevel of sales depends upon:

a) What is the installed and licensed capacity? Does it have any idle capacity whichcan now be utilised?

b) Is the unit undertaking any expansion, modernisation or diversification program?Have any funds been earmarked for the same in the projections? Are they going toaffect the quantum of production for the following year and to what extent? Thiswill be very relevant where the borrower is projecting more than normal rate ofgrowth in respect of production and sales.

c) Are essential inputs available to take care of projected production figure?d) How the increase in production is going to affect the quality and cost of

production? Are the goods manufactured have quality certification or coveredunder ISI specifications?

e) What are the present market conditions and terms of sales? What plans are thereto boost sales. Will the sales in future be on more favorable terms to the buyers? Ifthe period of credit is going to be extended is holding of increased levels ofreceivables proposed to be financed? Will it be within the lower of past trends ornorms?

f) Is the unit proposing to launch an expert drive to capture international markets?g) Are there any pending orders in hand? What has been the position in the previous

years? Was the unit forced to launch any distress sales in the past?h) From what sources increase in NWC will be met?A higher than normal sales estimate for the following year can be accepted only after

the bank is satisfied on the basis of the above scrutiny that the projected level of sales can beachieved and the available past data and future plans give positive indications in this regard.The bank has also to ensure that the borrower is willing to create the necessary support toachieve the sales target.

(7) The bank having satisfied itself as to the projected level of sales can determine theother data in relation to sales. The following steps can be taken for finalising other data:

a) The relationship between different items constituting cost of production can bestudied in relation to sales and cost of sales. It is to be ensured that the projectedincrease in respect of any item is not out of proportion to the past relationship.Preferably the projected increase in costs under the various heads should be looserso as to reflect the benefits arising out of better capacity utilisation and economicsof scale.

b) After the projections relating the items constituting cost of production, the levelof production and sales have been finalised, the holding period of items of currentassets is to be determined. The holding period of chargeable current assets can bedetermined based on the rule that the projected holding should be the lower ofnorms or past practice. the borrower should confirm to this rule in his projectionof chargeable current assets.

c) Since the holding level of chargeable current assets is already governed by a ruleunder TCR, there is a tendency on the part of some borrowers to inflate theirfigures of other current assets to get higher bank finance as the quantum of bankfinance is depending to a great extent, on the levels of current assets and currentliabilities. The levels of other current assets can also be estimated on the basis of


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the borrower s past practice. The linkage with projected increase in sales can alsobe established.

d) The bank is to bridge the gap between current assets and current liabilities afterensuring the borrow er s contribution. Therefore, the quantum of bank finance isvery much depending upon availability of short term credit from other sources.This we have earlier termed as other current liabilities . What some borrowers doin order to get more bank finance is to project the level of other current liabilitiesat a lower level so that the gap between current assets and other current liabilitiesis more. The bank should ensure that the level of other current liabilities isprojected properly. The projected level of other current liabilities should showincrease keeping in tune with sales.

e) The projected level of NWC should at least be 25% of total current aspects undersecond method of lending and 25% of working capital gap under first method oflending. Further, the level of NWC should also be maintained in absolute terms,i.e. it should not show any decrease in real terms compared to the previousposition excepting where expressly permitted by the bank.

(8) Once the borrower s overall projections for the follo wing year have been acceptedby the Bank, the actual requirement of working capital and bank finance can beworked out on the basis of steps given in CAS Form II (Part C). The steps broadly are :a) The actual requirement of working capital can be arrived at on the basis of

position of current assets/other current liabilities .b) The bank is to partly meet the difference between current assets and other

current liabilities depending upon under which method of lending the borrower iscovered.

c) If the available NWC is more than the minimum stipulated working capital underthe first or second method of lending, the available NWC is to be taken intoaccount for arriving at the permissible level of bank finance.

DANGERS OF INADEQUATE WORKING CAPITAL

IT STAGNATES GROWTH FIXED ASSETS UNDERUTILISED OPERATING INEFFICIENCY CREEPS IN DIFFICULT TO ACHIEVE TARGETS OF BUSINESS FOR PRODUCTION AND PROFIT BUSINESS REPUTATION AT STAKE SITUATION OF TIGHT CREDIT TERMS DIFFICULT TO MEET PAYMENT COMMITMENTS

DANGERS OF EXCESSIVE WORKING CAPITAL ACCUMULATION OF UNNECESSARY INVENTORY RISK OF LOSS BY THEFT, AND WASTAGE MAKES MANAGEMENT COMPLACENT AND INEFFECTIVE. RESULTS IN SPECULATIVE TREND SCOPE FOR DIVERSION OF FUNDS INDICATION OF DEFECTIVE CREDIT POLICY SLACK COLLECTION OF RECEIVABLE LEADS TO HIGHER INCIDENCE OF BAD DEBTS


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OPERATING CYCLE

1. Operating cycle is influenced by four key events Purchase of raw materials Payment for raw materials Sale of finished goods Collection of cash for sales

Time that elapses between the Purchase of raw material and Collection of cash for sales Is called OPERATING CYCLE 3. Time length between

Payment for raw material and Collection of cash for sales Is referred as CASH CYCLE

Operating cycle is calculated by adding up the Inventory period and Debt collectionperiod.

Inventory period = Avg. Inventory Annual Cost of Goods sold/365 Debt collection period = Avg. Debtors Annual Sales / 365 Cash cycle = Operating cycle - Account payable (Sy. Cr.) period

Account payable period = Avg. Sy. Cr. Annual cost of goods sold /365

ASSESSMENT OF WORKING CAPITAL BY Flexible Bank Finance Method

Example

Particulars Yearprevious

(audited)

2012

Currentyear 2013 (prov )

2014

(proj)

2015

(proj)


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Total current Assets (A) 455.43 559.06 602.45 650.36

Less : current liability(other than

bank borrowing)(B)166.94 24.85 31.51 38.22

Working capital Gap=(A-B)=C 288.49 534.21 570.94 612.14

NWC Available in the system (D) 80.64 99.67 136.40 178.53

Flexible Finance Method

(C)- (D)

207.85 434.54 434.54 433.61

Net sales 1098.81 1300.00 2907.40 3153.07

NWC to TCA % 17.70% 17.83% 22.64% 27.45%

FBF to TCA% 45.63% 77.73% 72.13% 66.67%

Normally, when CMA data is obtained for the total exposure of more than Rs.1.00 crores,eligible amount of CC limit is arrived at in Form V of the VMA data, which is as above.

Further to ensure minimum margin (NWC) in the system, the percentage of NWC to TCA is tobe analysed and if it is less than 25% then, in terms and conditions, it is to be stipulated thatthe borrower has to infuse additional capital.

FBF method is also known as holding period method of assessment of working capital. Theholding period of inventory , debtors and creditors are calculated and compared with thepast/actuals to ensure that the holding level for the projections is also acceptable. Thenbased on the projections, the above table is used to arrive at the CC limit. In the proposal,the holding period is to be justified very elaborately.

ASSESSMENT OF WORKING CAPITAL UNDER CASH BUDGET METHOD

Cash Budget is usually a forecast of receipts and payments of an enterprise drawn at smallintervals of time. It is a projection into future as against a cash flow statement that is usuallyhistorical in nature. It is drawn for a specific period in near future in order to ascertain theliquidity position of an enterprise at prescribed intervals . The position of liquidity isdetermined by the level of closing cash at each prescribed intervals.


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In the following cased, cash budget method is used:

A business enterprises requests for a short term loan Before issuing LC, the bank has to ensure that a comfortable liquidity position exists

when the bills against LC are presented for payment. When adhoc working capital is sanctioned, the banker has to ensure that adequate

cash surplus is likely to accrue during the period of repayment of the adhoc facility. For financing construction activities Peak and non-peak levels of working capital requirements, in case of activities like

firecracker manufacturing, printing & publication of text books, agricultural activities,etc. limits may go high during the peak activity period of the year and may go downduring the non peak period.

Financing of software development activities as it is essentially financing of cash gaps.

Though the permissible level of bank finance is determined by the peak level of deficit in thecash budget, the availability of finance is limited to the extent of deficit in the cash budget

for the respective months.

Commercial Real Estate:

Real Estat e Sector is one which is always playing a crucial role in a nation s economy.

Unimaginable upside potential during boom period and disastrous downslide risks wheneconomy slows down.

Due to significant growth in the sector, RBI has instructed all commercial banks to come out

with a policy of their own for this sector.In our Bank the policy was implemented from the year 2006-07

Definition:

Real Estate is an immovable assets and the permanently attached improvements to it.

Commercial Real Estate is one where the repayments are out of the cash flows generated bythe asset financed by bank.

Commercial Real Estate is different from exposure to collateralized Real Estate properties.

Exposure is both credit and investment, also sanctioned limits or outstanding whichever ishigher.

Direct Exposure like Residential mortgage, Commercial Real Estate, Investment exposure.

Indirect exposure like NFB limits to NHB, HFCs Housing Boards and other Public Housingagencies.


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Collateral Security:

Collaterals of minimum 25% to be obtained from CRE. Where primary security is more than200% no collateral insisted but the land cost should be at cost price if it is bought less than 1year or fair value if more than 1 year.

Cost price of land is more than 10 crores or Project cost is more than Rs.25 crores then twovaluation from approved valuer and the lower value to be taken into account. The valuation isonly for asset coverage and not for project cost.

Unexpired lease in case of leasehold should be minimum 30 years.

Margin:

Minimum 35% excluding soft cost like IDC, Administrative cost, Vacancy creation cost, whereno tangible securities are created. Soft cost finance due to value addition should be amaximum 10% of project cost.

For public sectors levies for conversion of land usage can be treated as project cost.

Advance money received to be received from the customers / buyers are also to be taken intoaccount.

Relaxation of margin in exceptional cases by CMD with ratification from Board subsequently

Tenor of Repayment:

CRE : 3 years for single construction and 7 years for multiple construction

Under sale or lease model repayment within 2 years from completion date and securitizationloan for lease model may be considered separately.

In securitization where the repayment is less than lock in period then, it is not CRE andappropriate pricing.

For residential loans as per Loan Policy.

Personal guarantee is must and its waiver should be informed to the Board and ratified.

Group risk to be studied.

FACR min.1.50:1Minimum DSCR 1.50, DER 2:1Escrow stipulation where it is possible.

Thorough vetting of project cost by chartered engineers.

Any deviation should be ratified by the Board.


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Constitution of company, authorised capital, MOA and AOA of the SPV and the sponsors.Compliance under section 293(1)(d) of the Companies Act.In case ECBs are envisaged, the relevant ECB Guidelines / RBI approval conditions.FDI compliance mattersProcedural compliances such as Board Resolutions, shareholders resolutions etc.

VALIDATION OF KEY PROJECT ELEMENTS

Financial assessment of the Project Consortium. In projects under competitive bidding, theproject is awarded to the consortium that qualifies in the technical and financial bid before itcomes for fund raising.Assessment of Shareholders Agreement and major financial clauses in the ConcessionAgreement and other important agreements.Assessment of licence fee and other parameters in PPP model.Evaluation of financial parameters in project logistics.

VALIDATION OF KEY PROJECT ELEMENTS

Assessment of Financing Mix and Promoters Contribution in line with institutional norms.Assessment of Project Contracts with suitability for financial risk mitigation and allocation soas to increase bankability of the project.Extent of recourse required from project developers (Sponsor Support Agreement). Thenormal recourse is through direct equity, contingent equity support and stipulation of lock-inperiod for promoters equity.

QUANTITATIVE ASSESSMENT OF THE PROPOSAL

Critical assessment of key financial assumptions based on qualitative analysisConstruction of a financial forecasting model that projects a base case of achievable financialparameters.Consideration of tax aspects and incentives if any for the proposed investment plan.Viability analysison a stand alone basis both in full recourse and in a SPV structure.Overall viability in full recourse model.Proposing financial risk mitigation mechanisms.

FINANCIAL MODELLING

Fixation of Assumptions underlying Financial Model Capacity Utilisation and assessment of ramp up phaseSelling PricesKey raw material / contracted costsDirect Conversion / other input costsIndirect Production / operating costsAdministrative Costs


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Selling and distribution costsDepreciation rates Under Straight Line method as per the rates prescribed under Schedule XIV of the CompaniesAct.Under WDV method as per the IT Act.

FINANCIAL MODELLING

Assessment of Working capital Requirements Inventory and Receivable holding periodCredit period for key raw materialsInterest rates For term borrowingsFor working capital borrowingsCorporate Tax estimations for the Project Stand-alone in the case of SPV projectsFor the company as a whole in full recourse projectsTax incentives / holidayOther assumptions /estimations such as Exchange ratesImplementation periodDraw down of term loansRaising of Equity Finance

FINANCIAL MODELLING

Identification of Revenue Streams Main revenueAuxiliary revenueOther IncomeValue Addition and Product MixBreak-down of Operating Costs Direct Production CostsIndirect Production CostsAdministrative CostsSelling and Distribution Costs

FINANCIAL MODELLING

Main Computation Schedules Project Cost StatementMeans of Finance StatementTerm Loans Draw Down Schedule and computation of Interest during ConstructionCapitalisation Schedule


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Term loans amortisation ScheduleInterest and Financial Cost Schedule for Operating Phase.Working Capital ScheduleDepreciation scheduleAmortisation of deferred expenditure.Tax Computation Statement

FINANCIAL MODELLING

Statements of Financial Forecast Projected Operating Statement (P&L)Projected cash Flow StatementProjected Balance SheetAdditional Statements for Full Recourse Projects Divisional GP Statements for Project and Existing Operations separatelyCombined Profitability Statement for the companyCombined Cash Flow StatementCombined Balance Sheet

VIABILITY ANALYSIS

KEY APPRAISAL RATIOS

Return on Capital Employed (ROCE)Debt Service Coverage Ratio (DSCR)Internal Rate of Return (IRR)Weighted Average Cost of Capital (WACC)Overall Debt Equity Ratio(For Full Recourse Projects. For the computation of this ratio, interest overdue andinstalments falling due in the next 12 months are not included. Preference Capital repayablewithin 3 years is included as debt.) Fixed Asset Coverage Ratio (FACR) (For Full Recourse Model) Break Even Point / Cash Break-even(Computed in terms of Capacity Utilisation) Loan Life Coverage Ratio

DSCR

Profit after tax + Depreciation +/-Non- Cash items +Interest on LT Borrowings---------------------------------------------Interest on LT Borowings + Annual Repayment

DER and DSCR


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Presently DER around 1.5-2.33DSCR to be measured for tenor of DebtAverage DSCR is actually Composite DSCRAverage DSCR to be about 1.5Adjusted DSCRDER and DSCR seen together

IRR

IRR obviates the need for adopting a Discount Rate. IRR is that discounting rate which equatesfuture cash flows from the project to the initial investment.IRR is the overall capacity of the Project to generate a combined discounted cash flow returnfor all capital providers to the project.IRR for Total Funds is the Benchmark Rate to be compared to the WACC.IRR measures the maximum external rate the Project can bear. The WACC has to fall withinthe IRRTo be measured for 12-15 years in non BOT ProjectsTo be measured for the Concession Period for BOT ProjectsNo salvage assumed for BOT ProjectsPeriodic maintenance Costs for Infrastructure Projects to be considered

Cost of Capital

Post tax WACCCost of Debt Funds influenced by tax sheltersEffective Rate of Tax to be consideredCost of Equity and Quasi Equity at 20%

Debt Servicing Reserve

Created for servicing debt obligations during the currency of the loans out of the free cashflow (FCF) .To cover both interest and principal repayment.DSR to be sufficient to service two quarters of dues at any point of time.The Cash Flow Statement to show allocation to DSR.

Project Life Ratio

Calculated as the NPV of the Cash Flows from the Project before interest and debt servicingdiscounted at the Cost of Debt / Total Loan outstanding

Loan Life Ratio

Calculated as the NPV of the Cash Flows to the providers of Long Term Debt from the Projectthrough interest and debt servicing discounted at the Cost of Debt / Total Loan outstanding.

PLR / LLR = Loan Life Coverage Ratio (LLCR) = should be around 1.50 or abovePLR LLR = Residual Life Ratio (RLR) = should be above 0.50


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VIABILITY MATRIX

Average DSCR to be a minimum of 1.50 to 1.75. In infrastructure projects this can be relaxedto a minimum of 1.33 since additional cash flow safeguards are provided.Minimum DSCR in any year to be atleast 1.33. In infrastructure projects, this can be relaxedto 1.20Minimum IRR to be 15%IRR-WACC to be atleast 4-5%BEP not more than 65 to 70%RLR to be atleast 0.50FACR to be 1.25 (not in limited recourse projects with cash flow based appraisal)

SENSITIVITY MATRIX

CASH FLOW BASED LENDING AND CASH LOCK BOXES

NEED FOR CASH FLOW BASED CREDIT APPRAISAL

Cash flow based credit is becoming more accepted due to the following reasons With universal banking becoming more popular, there is a need to integrate the creditapproach for short-term and long term lending.Long term financing is becoming riskier due to globalisation (increase in business risk) andbanking becoming market-oriented (capital raising and recovery management). Cash flowapproach helps in addressing debt servicing risk better.With structured financing catching on at least in bigger financing deals, cash flow approach isrequired for deal structuring, pricing and addressing debt servicing risk.

CONCEPT OF FUND FLOW / CASH FLOW

Fund Flow Is the total incremental or decremental flow of capital (resources) to thecompany in a given period either as cash resources or as receivables and payables.Cash flow Is the total incremental or decremental flow of capital (resources) to thecompany in a given period in cash resources (Bank and cash balances and cash equivalents).

PRESENTATION OF CASH FLOW STATEMENT

Direct Method Under this method, the Cash Flow from Operations is arrived at fromindividual components such as Collections from Debtors and Payments to Creditors andEmployees.Indirect Method Under this method, the Cash Flow from Operations is arrived at from NetProfit as adjusted for non-cash items in the P&L Account.CASH FLOW BASED APPRAISAL - UNDERSTANDING THE FINANCING SITUATIONIs it a full recourse or limited recourse financing model?Assessment of the generation and quality of cash flow. This would depend on the type of


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business, payment mechanisms and receivable management.Understanding the operating cash inflow and outflow and changes in working capital.Estimation of cash flow generating capacity based on the above.Assessment of cash flow gap if any (Should be distinguished from viability gap).

CASH FLOW BASED LENDING MECHANISMS

Project is financed on cash flow assessment as the primary security for debt servicing andviability is determined on the basis of cash flow parameters.Use of Cash Flow based ratios for viability analysis DSCR / Overall DSCRIRR and WACCLoan Life Coverage RatioFuture Cash flow gap is generally financed through equity. In larger projects it may befinanced in the same project. For e.g initial cash losses are included in project cost forfinancing.

Risk analysis is done to identify cash flow risks in the project that could impair the generationof expected cash flow.

Suitable cash lock boxes are provided by way of Debt Service Reserve, Escrow of cash flowthrough Trust and Retention Account, Lien on cash flow through creation of charge ondesignated receivables, assignment of escrow to ensure that control on escrowed cash flow isavailable.

PAYMENT MECHANISMSRevolving Letter of Credit mechanism for the Off-take of finished product / service.The revolving L/C has to be replenished every time it is invoked.Usually used in power projects where the SEB is the buyer.Can be used in cases where the Off- taker s credit -worthiness is not satisfactory.The Escrow Account mechanism A special purpose accountUsed for tracking and control of project revenues / cash flowHas to be in place before attaining financial closure (where escrow is through a State agencysuch as SEB).In other cases, creation of escrow is part of financing documentation.State Government Guarantee Used very selectively especially where a Government undertaking is the project developer.Government support Revenue Shortfall loansShadow tolling

ESCROW MECHANISM

Escrow accounts are used to capture cash flows during project implementation and / or in theoperative stage.The escrow account is used under a Trust and Retention (TRA) mechanism with a Waterfall


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approach.The amount that goes into escrow could be the receivable itself or the free cash flow.If receivables are to be escrowed, these are identified and pooled.The working capital bankers issue Letter of Ceding first charge on the designatedreceivables.The off-taker bears the servicing cost of the escrow banker.The number of escrow accounts would depend on the size and complexity of the project.

OVERVIEW OF SECURITY PACKAGE AND FINANCIAL CONTRACTSSECURITY PACKAGE

For large sized Limited Recourse SPV Projects First charge on project assets - (Fixed and Movable, both present and future). Not availablein road projects.Assignment of project contracts /licences / documents / insurance policies to provide Step -in rights to lenders.Project Completion Support from Sponsors.Pledge/ non disposal of shares For shares held by sponsors / sponsoring companiesThe Trust and Retention Account mechanism - For Escrow of Recivables, Cash Flow.Charge on Designated ReceivablesCreation of Debt Service ReserveRevolving Letter of CreditOther Credit enhancements as may be found necessary such as limited corporate guarantee,letters of comfort, Government Guarantee etc.

SECURITY PACKAGEFor Full Recourse Projects Pari Passu Charge on all assets including project assets - (Fixed and Movable, both presentand future).Pledge/ non disposal of shares For shares held by sponsors.The Trust and Retention Account mechanism - OptionalCreation of Debt Service Reserve OptionalPersonal Guarantees of all Core PromotersAsset Collaterals of PromotersOther Credit enhancements as may be found necessary.

FINANCIAL CONTRACTSLoan Agreement Could be a common loan documentation (Club Loan).Deposit of title deeds - for creation of equitable mortgage on fixed assets.Deed of Hypothecation For creation of charge on movable assets.Substitution Agreement / Contract of Novation - Sometimes there are tripartite agreementsinvolving the Licensor, Licencee and the lenders.Sponsor Support Agreement For project completion supportDeed of Pledge/ Non-disposal undertaking For shares held by sponsors / sponsoringcompaniesEscrow and Disbursement Agreement for creation of TRA.


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Security and Hypothecation Agreement - for creating charge on the designated receivablesRevolving Letter of Credit.

RBI GUIDELINES ON FINANCING OF INFRASTRUCTURE PROJECTSThe amount sanctioned should be within the overall ceiling of the prudential exposure normsprescribed by RBI for infrastructure financing.Banks/ FIs should have the requisite expertise for appraising technical feasibility, financialviability and bankability of projects, with particular reference to the risk analysis andsensitivity analysis.Banks may lend to SPVs in the private sector, registered under Companies Act for directlyundertaking infrastructure projects which are financially viable and not for acting as merefinancial intermediaries. Banks may ensure that the bankruptcy or financial difficulties of theparent/ sponsor should not affect the financial health of the SPV.

RBI GUIDELINES ON FINANCING OF INFRASTRUCTURE PROJECTSIn order to meet financial requirements of infrastructure projects, banks may extend creditfacility by way of working capital finance, term loan, project loan, subscription to bonds anddebentures/ preference shares/ equity shares acquired as a part of the project financepackage which is treated as "deemed advance and any other form of funded or non -fundedfacility.Banks are precluded from issuing guarantees favouring other banks/lending institutions forthe loans extended by the latter. This does not apply to FIs. However, for infrastructureprojects, banks are permitted to issue guarantees favouring other lending institutions,provided the bank issuing the guarantee takes a funded share in the project at least to theextent of 5 per cent of the project cost and undertakes normal credit appraisal, monitoringand follow up of the project.Under the current ECB policy, guarantees cannot be provided by Indian banks to foreignlenders.

RBI GUIDELINES ON FINANCING OF SPV PROJECTSInfrastructure projects are often financed through Special Purpose Vehicles. Financing ofthese projects would, therefore, call for special appraisal skills on the part of lendingagencies. Identification of various project risks, evaluation of risk mitigation throughappraisal of project contracts and evaluation of creditworthiness of the contracting entitiesand their abilities to fulfil contractual obligations will be an integral part of the appraisalexercise.Often, the size of the funding requirement would necessitate joint financing by banks/FIs orfinancing by more than one bank under consortium or syndication arrangements. In suchcases, participating banks/ FIs may, for the purpose of their own assessment, refer to theappraisal report prepared by the lead bank/FI or have the project appraised jointly.The long - term financing of infrastructure projects may lead to asset liability mismatches,particularly when such financing is not in conformity wit h the maturity profile of a bank sliabilities. Banks would, therefore, need to exercise due vigil on their asset-liability positionto ensure that they do not run into liquidity mismatches on account of lending to suchprojects.


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CCOONNSSOORRT T II UUMM AADDVVAANNCCEESS MEANING:Banks join together to finance the Working Capital requirements of a borrowing concern.As of now,formation of consortium is not mandatory. It is voluntary.

WHY ?Limitation in resources due to preemption of funds.Spreading of risks.Pooling of expertise.Pooling of experiencePooling of resources.Threshold credit limit of Rs.50 crores is removed.Exposure ceiling determined by prudential exposure norms will necessitate addition of oneor more Banks to finance the requirements of a borrowing company.

NORMS OF CONSORTIUM:Membership Minimum 2

_ Maximum No ceilingMinimum share: 5% of FB limit orRs.5.00 crore whichever

is more.Maximum share: Generally 40%. If it exceeds40%,endeavour to be made tobring it down to 40%.

LEAD BANK:Bank with maximum exposure.Bank with second largest share is the Second Lead Bank.Makes overall supervision of the A/c.

FUNCTIONS OF THE LEAD BANK:Preparation of the appraisal note and its circulation.Conduct quarterly meetings.Joint documentation.Joint inspections.Exchange of information.


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BENEFITS TO THE LEAD BANK:

Lead Bank charges.Proportionate share of business.As the borrowing company normally approaches the Lead Bank for adhocs/ one-oftransactions, the advances level can be increased.

EXIT ROUTE:Minimum Two years for exit.If one member bank cannot take the enhanced share, other willing bank/s can take theadditional share either partially or fully.If none of the existing Banks come forward then,a new member can be admitted.If no Bank takes the additional share in the event of one Bank quitting,it can after givingan undertaking that the repayment of its dues will be deferred till the dues of otherBanks are repaid in full.A member Bank can also sell its share at a discount. Benefits available to the Borrower:If the time frame for sanction is not adhered, they can approach a new Bank/consortiumfor the limit.The new Bank intending to sanction the limit should apply for NOC.If NOC is not received within 10 days they can go ahead with the sanction/disbursement.One off term loan can also be considered by a Bank who is not a member of theconsortium,if NOC is not received within 20 days.

JOINT DOCUMENTATION:It has to conform to the SWCL (Single Window Concept of Lending) as prescribed by IBA.Alternatively , the Banks can go in for individual documentation.Paripassu letters have to be exchanged.

CONSORTIUM MEETINGS:

To be held quarterly.To discuss about:Performance of the company as per MSOD and QPR.Availement of limits.Expansion/diversification plans.Details of funds raised,deployed,investments made during the quarter.Joint inspection report.


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Operational deficiencies observed.Routing of proportionate share of business.Schedule of Joint inspection.

PROBLEMS FACED:Everybodys responsibility becomes nobodys responsibility. Indifference in monitoring.Conflicts and misunderstanding.Pooling of skills do not take place.Delay in taking decisions.Unholy alliance sometimes with the borrower to stall the recovery efforts of memberbank/s.

MULTIPLE BANKING ARRANGEMENT (MBA)IC.NO7806 DT.26.10.2002

More than one Bank finance a borrower simultaneously & independently.No Common Assessment of Limits.The Borrower under MBA is free to approach any Bank of his choice to avail creditfacilities.No joint DocumentationThe Term & Conditions such as Intt.rate, Margin Security, Documents etc are bilateralissues.

No Lead Bank for taking decision on MPBF.

Structure of MBADecision making is fasterRisk of not sharing information is high.Unscrupulous borrowers manipulate and Defraud the Banks.No other formal arrangements to share the information.No common Approach to assessment of limits

RBI GuidelinesWith a view to introduce flexibility in credit delivery system & to facilitate smooth flow ofcredit, RBI in Oct,1996 had withdrawn various regulatory prescriptions regarding conductof Consortium/ Multiple Banking/ Syndicate Arrangements.In order to mitigate the Credit Risk and to ensure effective monitoring of Advance, Banksadopt the IBA guidelines


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IBA Panel Recommendation- Aug 2001

Bank with largest loan exposure will assess creditworthiness of the borrower.Banks will be free to stipulate margin limits and interest rates.

Lenders must keep others informed about the developments.Documentation to be done by the Banks individually.Borrowers to furnish financial details on quarterly basis, duly certified by the CompanysAuditors.All Banks to have paripassu charge over current Assets.Coordination in Appraisal/Assessment Process in Information Sharing

RESTRUCTURING

Meaning of a restructured account

A restructured account is one where the bank, for economic or legal reasons relating tothe borrower s financial difficulty, grants to the borrower concessions that the bankwould not otherwise consider.

Restructuring would normally involve : Modification of terms of the advances/ securities, (which would generally include, among

others) Alteration of repayment period Repayable amount The amount of installments

Rate of interest (due to reasons other than competitive reasons).

The guidelines on restructuring are divided into the following 4 categories:

1. Restructuring of advances extended to industrial units.2. Restructuring of advances extended to industrial units under the CDR Mechanism3. Restructuring of advances extended to Small and Medium Enterprises.4. Restructuring of all other advances.

In these four sets of restructuring of advances, the major difference in the prudentialregulations lies in the stipulation that subject to certain conditions the accounts ofborrowers engaged in industrial activities (under CDR Mechanism, SME Debt restructuringMechanism) continue to be classified in the existing asset classification category uponrestructuring. The benefit of retention of asset classification on restructuring is notavailable to the accounts of borrowers engaged in non-industrial activities except to SMEborrowers. (IC No. 8160 dated 06.11.2008)

When restructuring is to be undertaken


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The following are the normal grounds when an account requires restructuring:

Cost / time overrun resulting in increase in Project cost Failure to reach break-even levels Inability to service interest / installments Frequent excesses / return of cheques Decline /stoppage of production Decline in sales / profits Rising levels of inventories with large portion of non moving items. Failure to pay statutory dues or wages Internal diversion of funds Devolved LCs / invoked BGs.

Gains of Restructuring

Preservation of economic value of an asset Employment generated by unit is retained.

Borrowers Gains

Comes out of financial mess (Inability to service the debts on existing terms) Gets some soft terms Gets additional funds Gets some financial concession Keeps the unit / business going. Re-assesses business fortunes based on past experience which has led to the situation.

Bankers Gains

Retention of Asset Classification Status on certain conditions Avoid extreme recovery measures Prescribes revised repayment schedule, re-negotiate the terms and attempts to minimize the

losses, if any. Wins customer s goodwill It is a win - win situation for the borrower, for the Bank and for the nation, if done systematically.

Eligibility criteria

The guidelines would be applicable to the following entities, which are viable or potentiallyviable:

All the accounts classified under standard , sub-standard and doubtful categories. All non-corporate SMEs irrespective of the level of dues to banks.


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All corporate SMEs, which are enjoying banking facilities from a single bank, irrespective of thelevel of dues to the bank.

All corporate SMEs that have funded and non-funded outstanding up to Rs.10 crores undermultiple/consortium banking arrangement. The bank with maximum outstanding may work out therestructuring package, along with the bank having the second largest share.

SME Debt Restructuring Mechanism will be available to all borrowers engaged in any type ofactivity.

Accounts involving, fraud and malfeasance will not be eligible for restructuring under theseguidelines.

In case of wilful defaulters, the reasons for classification of the borrowers as wilful defaultersspecially in old cases where the manner of classification of a borrower as a wilful defaulter was nottransparent, are to be ascertained and if the borrower is in a position to rectify the wilful default,restructuring of such accounts may be done with Board s approval.

Accounts classified as loss assets will not be eligible for restructuring. In respect BIFR cases, restructuring is not permissible without their express approval.

Other RBI Guidelines

Banks cannot reschedule / restructure / renegotiate borrowal accounts with retrospectiveeffect.

Delay in sanctioning of the scheme shall not be permitted and if the Asset Classification statusof the account undergoes deterioration in the meantime, it would be a matter of concern.

Any Restructuring done without looking into a) cash flows of the borrow