taking credit decisions

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21 Taking Credit Decisions To start off any business, certain requirements are to be fulfilled which can be broadly classified into two as: 1) Mandatory Requirements 2) Statutory Requirements The Mandatory Requirements and the Documentary evidences needed for each are: - Mandatory Requirements Documentary Evidences 1) A suitable premise in a suitable place to Copy of rent agreement in case of operate from leased properties and copy of title deed in case of owned premises along with land tax and building tax paid receipts. 2) Power Allocation Power Allocation letter from the Electricity board/ Electricity Bill. 3) Water Connection Water connection letter from the water authority/ Water Bill. 4) Amenities for the Staff Unit Visits 5) Nature of Association: - a) Proprietorship Declaration b) Partnership Copy of Partnership Deed c) Joint Venture Joint Venture Agreement d) Private Ltd Company Memorandum and Articles of

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About Bank Credit

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Page 1: Taking Credit Decisions

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Taking Credit Decisions

To start off any business, certain requirements are to be fulfilled which can be broadly classified into two as:

1) Mandatory Requirements2) Statutory Requirements

The Mandatory Requirements and the Documentary evidences needed for each are: -

Mandatory Requirements Documentary Evidences

1) A suitable premise in a suitable place to Copy of rent agreement in case of operate from leased properties and copy of title deed

in case of owned premises along with land tax and building tax paid receipts.

2) Power Allocation Power Allocation letter from the Electricity board/ Electricity Bill.

3) Water Connection Water connection letter from the waterauthority/ Water Bill.

4) Amenities for the Staff Unit Visits

5) Nature of Association: - a) Proprietorship Declaration b) Partnership Copy of Partnership Deed c) Joint Venture Joint Venture Agreement d) Private Ltd Company Memorandum and Articles of e) Public Ltd Company association

Certificate of Commencement of Business (Not applicable to Pvt Ltd Co)

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The Statutory requirements and the documentary evidences needed for each are: -

Statutory Requirements Documentary Evidences

1) State Government Licenses Copy of Sales tax registration certificate Ex. Sales Tax registration certificate.

2) Central Government license Copies of Central Sales Tax/VAT Ex. Central Sales Tax registration/ VAT registration certificate

3) Local Body License Copies of Shop Establishment/Factory Ex. Shop Establishment Act, Factory registration certificate License etc.

4) Department specific licenses such asLicenses from : -a) Drug Controller in the case of Copy of licensePharmaceutical connected activitiesIncluding the medical shops

b) Forest department in the case of Copy of licenseTimber-based industries includingFurniture

c) Pollution control board in case of Copy of licenseManufacturing industries

d) Excise Department in case of Copy of licensedistilleries, manufacturing processeswhere alcohol contents are involved

e) Explosives department in case of Copy of licenseQuarries and firework related business

f) Geological survey in case of service Copy of licenseIndustries, job works and excisable items

g) Central excise in case of service Copy of licenseIndustries, job works and excisable items

h) Approved plan and construction Approved Plan, Permission letterPermission from the competent authority Estimates.In case of Building/ housing finance Along with the estimates

i) Land Tax, Building tax, approved plan Tax paid receiptsAnd completion certificate in case ofExisting constructions

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j) Prospectus, Application/ Approval Prospectus used by the institution, courseOf the course from Ministry of HRD in approval from ministry of HRD’s websiteCase of Educational loan for Indian www.education.nic.inCourses and Prospectus with

_______________________________________________________________________Educational Institutions:_______________________________________________________________________ Loans to Requirements

1) Higher Secondary School - Affiliation from State Government/ CBSE/ ICSE.

2) Professional Colleges other than - Approval from All India Council for

Medical - Technical Education(AICTE)/ Affiliation to the University of the State.

- Government Approval

3) Medical and Pharmacy - Affiliation to the university of the state- Approval from Indian Medical Council

(IMC)- Ayurveda_Central council of Indian

Medicines (CCIM)

4) Nursing - Approval from government and affiliation to the university

- Approval from the Indian Nursing council (INC)

- Educational Loan prospectus

What to read from the documents?

1) Evidence of association and activity2) Legality of association and activity3) Names and addresses of institutions4) Names and addresses of persons behind the show.

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Taking – Credit Decisions - Pre-Balance sheet Appraisal Exercises

1. Applicant should have a place to operate from. It can be either own premises or rented one. As a documentary proof towards having a place to operate from, photocopy of title deed/building tax paid receipt in case of own building or copy of the lease deed in case of rented building is to be obtained and verified with the building number and location.

Needless to mention that there should be power and water connection which are basics to run the show.

Benefits of the exercise - By looking at the deed, we can find out whether it is an own premises or a rented one, in case of rented one, how long the applicant can function from the premises. An access letter/approval from the owner would be additional safeguard.

2. Legality of the Activity In order to ensure that the activity proposed is an approved one by the law of the land, license from Local body of Administration like Panchayat/Municipality/Corporation is a must.

Benefits of the Exercises - Apart from the confirmation that the activity is an approved one by the Local authority, we can check the name of the applicant, the constitution, Address, activity permitted and the period, from the license.

3. Statutory Requirements

a) Every activity/ resulting in sale has to be registered with the Sales tax and Central Sales tax authorities, such copy of the ST/CST registration has to be obtained as applicable.

b) In case of Timber/ Wooden Furniture Industries/Business, a permission/NOC is necessary from the Forest Dept. in addition to the ST/CST and the local body license.

c) In case of manufacturing of medicines, Licenses from Drug Controller and Excise Dept. are required. Drug license is also required for sales.

d) In case of food, License from food Inspector of the local body is a must.

e) In case of Manufacturing industries, the pollution control Board is the only authority to decide which is the polluting and which is the non-polluting activity. As such, all manufacturing industry should have the NOC /License from the pollution control Board.

There are Export processing zones, District Industrial Areas, autonomous bodies like Noida and Okhala where there is a separate pollution control licensing authority, NOC is to be taken from the pollution Board of the industrial areas/autonomous bodies too.

f) In case of the number of employees are more than ……., Provident fund contribution and Employees State Insurance (ESI) are compulsory.

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Benefit of the exercises - It can be found out that how long the unit is functioning, the name, address, constitution and the activity.

General :

In addition, copies of partnership, memorandum and articles of Association, Certificate of incorporation, certificate of commencement of business, SSI registration etc. are to be obtained wherever applicable.

If it is a running concern, financials for the last 3 years, audited one in case of turnover is above 40 lakhs, along with the sales tax assessment order, if not available, copies of annual S.T. return filed to be obtained. If the profit shown in the P&L a/c is more than taxable level, copies of IT returns filed also to be obtained.

While the ST assessment/copies of returns would confirm the sales turnover, the IT return will confirm the profit. Only after obtaining these documents and making a market study of the proposed activity and its feasibility one should venture into the analysis of balance sheet leading to credit decision.

Simple Analysis of Balance sheet - A statement showing sources and uses of fund on a given date

Source/Liabilities :

1) Current Liability/Working capital Apart from the equity and long term source of fund, there is another component in source of fund which is demand in nature, to be repaid as and when demanded, like loans from friends, loans from Banks, cost of goods purchased on credit, the salary to be paid, the audit fee payable and tax collected but not remitted at the Treasury etc. These are the sources out of which current assets are created, so as a whole can call these as working capital, not the Bank finance alone.

2) Deffered Liability - Loans from close relatives, and financial Institutions which are repayable not in the near future, say not earlier than one year can be classified under this. This is also known as debt. The owner’s fund together with the debt known as long-term source of fund.

As per the credit policy of the Bank, the proportion of debt and equity which is Technically called as debt equity ratio is to be 2:1 i. e. the debt can be 2 times of the equity/capital/own fund.

Chartered Accountants treat a threefold debt position as satisfactory wherein the debt equity ratio is 3:1 i.e. the debt can be 3 times of equity/capital/own funds.

3) Total Outside Liabilities: Excluding capital, all other liabilities like current and deferred put together is known as Total outside liabilities which should not exceed 4:1 is outside liabilities. Can be 4 times of owned funds.

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4) Own fund - Which is also known as owner’s fund or equity or capital which is ideally 20% of the balance sheet size in case of lending under turnover method and 25% under second method..

Summary

To sum up, the left hand side of the balance sheet, known as the Liability side, is the sources of fund. Since all these amounts including the capital is payable by the unit either on demand on or later date., these are called liabilities.

Uses/Assets The other side of the Balance sheet i. e. the right hand side shows how the liabilities are used for the conduct of the activity. When the unit holds anything in its name, it is known as their Assets which can be divided into three categories current assets, fixed assets and intangible assets.

1) Current Assets / Working Capital

All the current assets are uses of working capital i.e. current liabilities. The current assets consist of cash and bank balances, stock, book debts, advance paid towards supply etc. which are recycled in the day to day activities of the business keeping the business active, continuing and capable of meeting the current liabilities at any time by disposal of the Assets. In a healthy/ideal situation, the current assets creations has to be from the current liability, along with the margin from long-term sources of fund.

2) Fixed Assets

Consist of that assets which are not meant for sale/not recycled in the normal course, it facilitates the activity/recycling. It may be the Land and Building from where the unit is operating, may be the furnitures and fixtures which facilitate to function the Office/show room, may be machineries which facilitates the production, may be the vehicles which facilitates the movement of products, business canvassing and official use of the owners etc. etc. In any case, these are “fixed” with the unit, not offered for sale or not recycled in the ordinary course of business.

3) Intangible assets - are the assets of which presence cannot be counted, felt or can be taken out and liquidated. These are the amounts which are not written off or adjusted to the profit and loss a/c fully in the concerned financial year at a stretch because of the constrains on profitability but would be adjusted over years according to the profitability. The examples are the preliminary and pre-operative expenses incurred, heavy advertisement expenses in the first year of operation, goodwill paid while taking over a good company, accumulated loss etc., But while calculating the net worth, these are to be set off/deducted from the equity.

Current ratio/Liquidity Ratio : When current liabilities are used for creation of current assets, Naturally the current assets equal to current liabilities. Hence, in arithmetical terms, when we divide current assets by current liabilities, the answer would be 1:1. The satisfactory current ratio is 1.25:1 under turnover method, 1.33:1 in second method indicative of flow of funds from long term sources to current asset creation.

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Working Capital

Working capital is reflected in the balance sheet by items of CURRENT ASSETS and CURRENT LIABILITIES, the items which are constantly changing their forms – cash to raw material, raw material to semi finished goods, semi finished goods to finished goods, finished goods to cash or receivables and receivable to cash, Bank finance/ cash for payment of Trade creditors, loan creditors etc. To sum up, working capital is component in the Balance Sheet which cycles and cycles continuously to keep the activity alive, just like the blood circulate in human body.

One school of thought identify current assets along with the current Liabilities as working capital where as other school of thought identify the excess of current assets over the current liabilities as working capital.

We may call the identification of Ist school of thought as GROSS WORKING CAPITAL and the other school’s identification as NET WORKING CAPITAL.

Why the Net working capital cannot be called as capital

The Net working capital is the excess of the Current Assets over the Current Liability which is the result of a flow of fund from a source other than the current liability. It can be by way of term loans, loans from close relatives, future liability in Kuries which need not be repaid within the current year, say 12 months; or loans from partners/Directors etc. It also can be from the own fund which is called capital or equity. We call these source as long term source. In other words, long term source of fund can be from kuri auction, loans from close relatives/Directors/Partners/term loans/ capital.

As per the norms, nowhere it stipulates that the margin/net working capital should be from capital. The only stipulation is that it should be from the long term source of fund repayable on a phased manner preferably from the internal generation of fund i.e, is repayable from profit, not from disposal of current assets. The long term source of funds other than the own fund is known as DEBT.

Since the networking capital/margin can be either/or both from long term source of fund as well as from the capital, the source to be identified, and to be confirmed that there isminimum contribution from capital/equity and the debt equity ratio is within the permitted level of 2:1.

Why the Capital : In order to ensure party’s stake in the business which would be the driving force to conduct the activity in a responsible and profitable way, from time immemorial, capital is insisted.

Apart from that current liabilities are expected to be met out from the disposal of current assets, in ideal situation. But in an adverse situation, the current assets may fetch a lesser value and it may not be possible to meet the current liabilities out of current assets alone wherein the capital acts as a margin or cushion to support, and hence the compulsion for capital.

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While debt is the long term source of fund which is an outside liability which need not repay currently or immediately, generally to be met out of profit. Capital is a liability to self which is the last one to be met out.

DEBT EQUITY RATIO : Though the margin/net working capital is suggested from long term source, to ensure a healthy contribution from the party, as per the credit policy, the debt equity ratio is stipulated at 2:1 which means the debt can be two fold of the equity or when the debt is divided by equity, result should not be more than 2, which means capital should be of a minimum of 6.66% and long term source should be 13.34% out of 20% under turn over method whereas minimum capital requirements under second method is at 8.33% and 16.67% out of 25%.

2:1 of 20% - Turn over method ! 2 :1 of 25% - Second method!

20% x 1 : 6.66% ! 25% x 1 = 8.33% 3 ! 3

!20% x 2 : 13.34% ! 25% x 2 = 16.67%

3 ! 3 ------------ ! ----------

Total 20.00% ! 25.% ======= ! =======

Methods followed for credit decisions on Working Capital

As per our loan policy, loans upto 2 crores in case of General finance and upto 5 crores in case of SSI advance, TURNOVER METHOD is followed to take credit decisions out of various methods mentioned below.

Ist Method

In the early stage, in order to assess the requirement of Bank finance, a system was evolved which was the Ist system or method evolved which was name as Ist method where in the components of balance sheet were well categorized into current liabilities and current assets. The method advocates that current/Demand sources along with current assets are to be identified as gross working capital, the difference between the assets and liabilities other than the Bank finance is called working capital gap. The method suggests that 75% of the Gap is to be met out of Bank finance where 25% of the gap to be brought in from long term source.

Illustration

Current Liabilities Current Assets----------------------- ------------------ Trade creditors 100 Stock 310Loan creditors 50 Receivable 50Bank Borrowing 165 Other C.A. 10 ---------- -------- 315 370

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Capital 55 ------- Grand Total 370 370 ===== ======25% of the working capital gap = 370 – [315-165]x 25 : 55

100 ==Current ratio = 370 = 1.17:1 315

The margin in percentage terms 55 x 100 : 14.86% 370 =====

IInd method

Since the stake of the Borrower is too meager in the Ist method and too low to absorb the shock in case of a depressed situation, another method was suggested, which was the second in line, known as second method where the stake of the borrower has increased.

Instead of 25% of the working capital gap as capital/Long-Term source, it was suggested to have 25% of the current assets as capital/ Long-Term source. :

Illustration

Current Liabilities Current Assets----------------------- ------------------- Trade creditors - 100.00 Stock in Trade : 310.00Loan credits 50.00 Receivable 50.00Bank finance 127.50 Other C.A. 10.00

277.50 370.00 --------- --------

Capital 92.50 --------- Grand Total 370.00 370.00 ====== ======

25% of the current assets as capital/Long-Term source = 370 x 25 = 92.50. 100 The bank finance is suggested at arriving the difference between the current assets – [current liabilities + capital ] i.e. 370 – [100+50 +92.50] = 127.50

It can be seen that with higher capital position of 92.50, outside liability was reduced to 277.50 from 315 where the current ratio is at a higher side = 370.00 = 1.33:1 277.50

Margin in percentage terms 92.50 x 100 = 25% . 370

IIIrd method

Then came another suggestion recommending a still higher margin, the method was known as 3rd method, wherein it was suggested that the core current asset is to be created out of capital/ Long Term source of fund.

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Ex: The stock in Trade which is the core assets, is to be met out of the capital. Since this is not at all practical, the method was not at all accepted.

Turn over method : The scarcity of capital compelled the borrowers to represent against the second method and as a via media between the second method and Ist method, a new method was suggested based on the turnover of the business which is named as Turnover Method.

Taking the normal business cycle at 4 times, ¼ th of the total turnover or 25% of the total turnover is assumed as the working capital requirement under this method. Out of which 5% of the requirement or 1/5th to be met out of capital, 20% of the requirement or 4/5 th to be met out of current Liabilities including Bank finance.

IllustrationFor a unit with a turn over of Rs. 1,480/-. The working capital requirement works out to Rs.370/- being the 25% or ¼ th of the total turnover. Out of which 5% of Rs.1480 [or 1/5 th ] i.e. Rs. 74/- should be brought in as capital and 20% of or 4/5 th Rs.1,480/- i.e. Rs.296/- is to be met out of current liabilities including Bank finance.

Current Liabilities Current Assets Trade creditors 100.00 Stock in Trade 310.00Loan credits 50.00 Receivable 50.00Bank finance 146.00 Other C.A. 10.00

296.00 370.00 Capital 74.00

Grand Total 370.00 370.00 ====== ====== Current Ratio 370 : 1.25:1

296 Margin in percentage terms : 74 x 100 = 20% 370 ==== Permitted flow of funds

The normal flow of the funds between the sources and uses is from current Liability to current Assets, differed liability to fixed assets, capital being the supporter for margin requirements. Any flow of fund from current to fixed is not favoured and will end up in negative working capital. Customer is at the liberty to choose the full 20% from the Bank or to choose a mix of liabilities based on the cost of fund and availability of fund.

How can be Negative Working Capital

1) When the current source of fund is utilized for creation of fixed assets,

2) When there is no capital to support the working capital which may be because of no capital infusion or because of the Eroding of capital because of loss.

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Correcting the position

In case of a flow of fund from the current liability to fixed assets, in a most required/justifiable situation, after making sure that the end utilisation was for the better future of the unit, a prudent banker need not be panic at the negative working capital, instead may help the unit to liquidate the fixed assets by granting permitted level of Term loan against fixed asset and crediting back the proceeds either to reduce current liabilities or to create current assets if required so that the current asset and current liability position can set right. [ Ref. Annexure No. 1, Pre correction stage and Annexure No. 2, Corrected stage].

If the capital erosion is because of the early stages of teething problems of a unit which is otherwise viable and picking up, a support can be given for augmenting/replenishing the capital position by granting a term loan. These sort of adjustments are known as working capital term loan, but to be considered only if there is adequate profit to repay the monthly instalments.

The working capital term loan is also granted to augment capital for good entrepreneurs who do not have the capacity to bring in required level of capital.

How to look at the Creditors [ Refer Annexure No. 3 and 4]To find out the average Trade creditors period, the accepted method is as follows :

Trade Creditors outstanding as on year end x 365 = Average Trade Creditors period Purchases for the year

If the credit period is over and above the average trade creditors’ period for the similar activity in the market, may be an indicator towards

i) a poor pay mastership ii) the product dealt may be of inferior quality or of a poor demand, hence the

supplier is not demanding for payment for fear of loosing business.

On a contrary it may because of the strong market hold of the party, extra ordinary reputation of the party, suppliers dare not to ask the payment as in the case of normal supplies. But this is very rare; if the party is so strong, he will bargain for the cash discount and pay less instead of doing credit purchase.

But what extent this result is transparent ?

Since the Balance sheet being a day’s statement, the formula may not give a transparent result. When you get a result contradictory to market trend, you may call for a monthly

Break up of purchases. Some times the sales target compulsions make the party to have compulsory year end purchases, and this can be very well find out from the breakups.

Ex : If the Balancesheet shows a trade credit of Rs.593.77 lakhs as on 31-03-04 against an yearly purchase of Rs.2744.19 lakhs where the party is a white goods dealer where the

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purchases are said to be cash and carry basis, as per formula the average creditors’ period is arrived at as follows:

Trade Creditors - 593.77 x 365 = 78.97 daysPurchases – 2744.19 ========

Against an average trade creditors’ period of 82 days, the party claims it is cash and carry. When we look at monthly purchases, we can see that during the month of March there was an abnormal purchase of Rs.572.49 lakhs. In order to arrive the actual possible average, we may have to deduct the March purchase both from total purchases [ 2744.19 – 572.49 = 2171.70] and Trade Creditors [ 593.77 – 572.49 = 21.28], and deduct the number of days in March from the 365 days [ 365-31 = 334] and apply the formula i.e.

Trade Creditors 21.28 x 334 = 3.27 days 11 month Purchases 2171.70

the exercise confirm the party’s stand that Trade creditors are at an average of one week.

How to look at debtors [ Refer Annexure No. 3 and 4] To find out the average Trade debtor period, the accepted method is as follows :

Trade debtors outstanding as on year end x 365 days Sales for the year

If the debtor’s period is over and above the average debtors period for the similar activity in the market, may be indicative of

i) Poor collection mechanism ii) Inferior quality of goods or no demand for the goods so that the party is

hesitant to demand for the payment with in average market credit period.

On the contrary, it may also happens that because of the strong market control of the debtor, the party may be hesitant to ask for early payments for fear of loosing the business, which is very rare.

But what extent the result is transparent ?

Again, as in the case of creditors, since the balance sheet being a day’s statement, the formula may not give a transparent result. When you get a result contradictory to the market trend or against the claims of the party, you may call for a monthly breakup of sales. The purchase compulsions ends up with sales compulsions too which results in high credit sales during the month of March.

Ex : If the balance sheet shows a debtor’s position of Rs.560.10 lakhs against the yearly sales of Rs.2607.73 lakhs, as per the formula, the average debtors period is arrived as follows :

Trade debtors 560.10 x 365 : 78.39 days.Sales 2607.73 ========

Against an average debtors’ period of 78 days, market survey indicates a maximum debtors’ period of 15 days, hence further analysis is required. When look at the monthly sales, we see

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that there was abnormal sales during the month of March. In order to arrive the possible average, we may have to deduct the March sales from both the total sales [ 2607.73 – 501.42 = 2106.31 ] and Trade debtors [ 560.10 – 501.42 = 58.68] and also to deduct the number of days of March from 365 [365-31 = 334] and apply the formula i.e.

Trade debtors 58.68 x 334 = 9.30 days Eleven month Sales 2106.31 =======

This exercise confirm that Trade debtors are in the permitted level.

Substitution of Trade Creditors by Bank finance – How to look at it.

The Sundry/Trade Creditors can be at a cost or free. Creditors are said to be free when there is no cash discount or interest on the supplies irrespective of the fact that whether the purchases are made on cash or credit. Likewise loan creditors are said to be free of cost when the funds are available without interest.

Generally the cash purchase do attract attractive cash discount and loan creditors do charge interest.

When the cash discount offered is higher than the rate of interest, naturally, substitution of trade creditors can be permitted to have a cheaper purchase so that either the profit can be improved or selling price can be reduced to compete in the market.

Likewise, when the loan creditors’ interest is higher than the bank interest, it is better to avail bank finance rather than going for private borrowing.

To illustrate the substitution, in the given case, from the yearly purchases the average monthly purchase can be worked out by dividing the total purchase by 12 i.e. Rs.27,44,19,700.33/12 = Rs.2,28,68,300/- The average weekly sales can be ascertained by dividing the yearly sales by 54 weeks i.e. Rs.26,07,73,855.00 = Rs. 48,29,145/-

54 ===========

If cash discount @ 2.5% is offered for cash purchase, in this case, on an average monthly purchase of Rs. 2,28,68,300/- the cash discount @ 2.5% works out to Rs.5,71,707/-. On the other hand, interest @13% for an advance of Rs.2,28,68,300/- which can be repaid @ Rs.48,29,145/- per week out of the sales proceeds, works out as follows :

Ist of the month To Debit Rs 2,28,68,300.00 (Dr.)7th of the month By sales Rs. 48,29,145.00 (Cr.) 1,80,39,155.00 14thof the month By sales 48,29,145.00 “ 1,32,10,010.0021st of the month By sales 48,29,145.00 “ 83,80,865.0028thof the month By sales 48,29,145.00 “ 35,51,720.005th 35,51,720.00 “ Nil------------------------------------------------------------------------------------------------------------

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Interest @ 13% From Ist of the month till closure = Rs. 1,59,983.00 ============= ------------------------------------------------------------------------------------------------------------

Even at a constant loan of Rs.2,28,68,300/- which is the average monthly purchase the interest @ 13% for one month = Rs.2,47,739.00Whereas cash discount @ 2.5% for the month = Rs.5,71,707.00 ------------------- Benefit is Rs.3,23,968.00 ===========

When we compare the interest of Rs. 1,59,983/- with the cash discount offered the profit is Rs. 5,71,707/- - Rs.1,59,983/- = Rs. 4,11,724/-. It can be seen that an additional profit of Rs. 4,11,724/- is available on utilizing Bank finance instead of falling back on trade creditors. In such cases, Trade creditors can be substituted by Bank finance, customer is to be advised suitably. (Refer Annexure –5).

Looking at the stock position and turnover

Stock position to be looked upon from the following point of views:

a) How long it will take to get the stock replenished i. e. the distance between the partys’ place and principal’s Depo from where despatch is done.

b) Size, colour, varieties and number of manufacturer etc., compels to have a minimum number of each items to satisfy the consumers which ends up with apparently high stock.

c) While the Edible oils, Rice, wheat, Sugar, Steel, Cement etc. will have minimum stock with high turnover, but have minimal profit margin, the white goods will have a high stock, lower turnover, but better profit margin.

How to look at stock turnover As noted, stock is created out of current liabilities which mainly consist of Bank finance along with the support from capital/long term source. If the profit in the activity is 2% as an average, to service the interest @ 13% the stock should rotate a minimum of 6 ½ times. This method can be taken as a thump rule in all cases provided the average profit of an activity is arrived at taking the performances of a number of similar units.

To sum up one should not look at the turnover alone to judge a unit and it’s requirement, but to look at the nature of goods dealt with and its profit margin.

Understanding certain Technical Terms/Names :1) Net sales - Total sales minus sales return.

2) Trading Expenses - Cartage paid to bring the good, labour charges paid for unloading etc. directly connected to reach the goods at the premises for onward sales.

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3) Selling Expenses - Comes under profit and loss a/c, like sales man’s salary, commission, advertisement, publicity, etc.

4) Administration and Gen. Expenses - Salaries, postage, rent for the Office, Electric, Water Bills of the Office, Telephone Bill etc.

5) Operating Profit - Profit from the Core operation. Ex : If a Timber depot has a lorry running on hire, the income from the hire is not treated as an income from the Timber Trade. Only the income from core activity i.e. trade activity is to be taken as operating profit.

6) Manufacturing Expenses – Power, fuel, wages to labours etc. which are directly connected to the manufacturing.

7) Raw materials consumed – Opening stock of raw materials plus net purchases during the year minus closing stock of raw materials.

8) Cash Profit – Profit/plus depreciation in case of profit, loss minus depreciation in case of loss.

9) Fixed cost - Cost which is of fixed in nature irrespective of volume of production or sale. Ex : Building rent, Depreciation, interest on capital, salaries to permanent staff, Electricity bill etc.

10) Variable cost - Cost which have a direct relationship with the volume of production/sales. Ex : Raw material, cartage inward, power and fuel consumption for factory, wages to labours, etc.

Mr. N.V Ignatius(General Manager)

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Annexure - 1

A CASE FOR CORRECTING THE LIQUIDITY POSITION BY GRANTING WORKING CAPITAL TERM LOAN (WCTL)

PRE CORRECTION STAGEFinancial Position a s on ……………….31-03-04 ……. (Rs.in lacs)

CAPITAL & LIABILITIES

ASSETS

CURRENT LIABILITYTo our BankTo other Banks Trade Creditors Private Loans Loans from close relativesExpenses payable

Rs.231.77..593.77.... 12.93

CURRENT ASSETSCash on Hand Cash with banks Stock Trade debtorsAdvances/Deposits

Rs. 8.36 .. 223.94 560.10 40.76

838.47 833.16DEFERRED LIABILITY Term Loan from banks Long term deposits………………………………

..

..….….

FIXED ASSETSLand & BuildingsFurniture & equipmentPlant & MachineryVehicles

115.00 80.00 … 33.45

228.45CAPITAL & RESERVESCapital Reserves & unappropriated} Profit }Current Account (*)

178.96 44.18

INTANGIBLE ASSETSAccumulated loss Drawing Account (*)……………..

… … …

223.14 TOTAL 1061.61 TOTAL 1061.61

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Current Ratio : 0.99:1 (Negative)

Working Results for last three years :(In case of new business, give estimates)

(Rs. In lacs) 2001-02 2002-03 2003-04 SALES/BUSINESS TURNOVER 848.30 1156.22 2607.73 NET PROFIT 14.90 23.12 48.14 Income Tax paid 0.48 2.70 4.23 Sales tax paid Not applicable; Second sales

Any arrears in Income tax & Sales tax Copies of ST returns attached.

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Annexure - 2 THE POSITION AFTER CORRECTING THE LIQUIDITY AFTER GRANTING

WORKING CAPITAL TERM LOAN (WCTL)

CORRECTED STAGEFinancial Position as on ……………….31-03-04 ……. (Rs.in lacs)

CAPITAL & LIABILITIES

ASSETS

CURRENT LIABILITYTo our BankTo other Banks Trade Creditors 422.44Private Loans Loans from close relativesExpenses payable

Rs.231.77..593.77.... 12.93

CURRENT ASSETSCash on Hand Cash with banks Stock Trade debtorsAdvances/Deposits

Rs. 8.36 .. 223.94 560.10 40.76

667.14

838.47 833.16

DEFERRED LIABILITY Term Loan from banks 171.33Long term deposits………………………………

Nil..….….

FIXED ASSETSLand & BuildingsFurniture & equipmentPlant & MachineryVehicles

115.00 80.00 … 33.45

228.45CAPITAL & RESERVESCapital Reserves & unappropriated} Profit }Current Account (*)

178.96 44.18

INTANGIBLE ASSETSAccumulated loss Drawing Account (*)……………..

… … …

223.14 TOTAL 1061.61 TOTAL 1061.61Current Ratio : 1.25:1

Positive after granting WCTL of Rs.171.33 lacs. Repayment : 84 monthly instalments of Rs.3,10,449/- including interest @ 13% yearly Repayment obligation Rs. 37,25,399/- - Profit – Rs.48,14,000/-

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Working Results for last three years :(In case of new business, give estimates) Debt Equity Ratio : 0.76:1 (Rs. In lacs) 2001-02 2002-03 2003-04 SALES/BUSINESS TURNOVER 848.30 1156.22 2607.73 NET PROFIT 14.90 23.12 48.14 Income Tax paid 0.48 2.70 4.23 Sales tax paid Not applicable; Second sales

Any arrears in Income tax & Sales tax Copies of ST returns attached.

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Annexure - 5

CASE FOR PERMITTING SUBSTITUTION OF SUNDRY CREDITORS TRADE

Financial Position as on ……………….31-03-04 ……. (Rs.in lacs)

CAPITAL & LIABILITIES

ASSETS

CURRENT LIABILITYTo our BankTo other Banks Trade Creditors Private Loans Loans from close relativesExpenses payable

Rs.231.77..593.77.... 12.93

CURRENT ASSETSCash on Hand Cash with banks Stock Trade debtorsAdvances/Deposits

Rs. 8.36 .. 223.94 560.10 40.76

838.47 833.16DEFERRED LIABILITY Term Loan from banks Long term deposits………………………………

..

..….….

FIXED ASSETSLand & BuildingsFurniture & equipmentPlant & MachineryVehicles

115.00 80.00 … 33.45

228.45CAPITAL & RESERVESCapital Reserves & unappropriated} Profit }Current Account (*)

178.96 44.18

INTANGIBLE ASSETSAccumulated loss Drawing Account (*)……………..

… … …

223.14 TOTAL 1061.61 TOTAL 1061.61

Working Results for last three years :(In case of new business, give estimates)

(Rs. In lacs) 2001-02 2002-03 2003-04 SALES/BUSINESS TURNOVER 848.30 1156.22 2607.73 NET PROFIT 14.90 23.12 48.14

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Income Tax paid 0.48 2.70 4.23 Sales tax paid Second sales; S.T. Not applicable

Any arrears in Income tax & Sales tax Copies of annual return attached.

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Annexure - 3

TO WHAT EXTENT THE TRADE CREDITORS/TRADE DEBTORS FORMULASARE CORRECT? HOW TO CHECK IT

Financial Position as on ……………….31-03-04 ……. (Rs.in lacs)

CAPITAL & LIABILITIES

ASSETS

CURRENT LIABILITYTo our BankTo other Banks Trade Creditors Private Loans Loans from close relativesExpenses payable

Rs.231.77..593.77.... 12.93

CURRENT ASSETSCash on Hand Cash with banks Stock Trade debtorsAdvances/Deposits

Rs. 8.36 .. 223.94 560.10 40.76

838.47 833.16DEFERRED LIABILITY Term Loan from banks Long term deposits………………………………

..

..….….

FIXED ASSETSLand & BuildingsFurniture & equipmentPlant & MachineryVehicles

115.00 80.00 … 33.45

228.45CAPITAL & RESERVESCapital Reserves & unappropriated} Profit }Current Account (*)

178.96 44.18

INTANGIBLE ASSETSAccumulated loss Drawing Account (*)……………..

… … …

223.14 TOTAL 1061.61 TOTAL 1061.61

Working Results for last three years :(In case of new business, give estimates)

(Rs. In lacs) 2001-02 2002-03 2003-04

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SALES/BUSINESS TURNOVER 848.30 1156.22 2607.73 NET PROFIT 14.90 23.12 48.14 Income Tax paid 0.48 2.70 4.23 Sales tax paid Second sales ; S.T. not applicable Any arrears in Income tax & Sales tax Copies of Annual returns filed attached.

Annexure - 4

BIFURCATION OF ANNUAL SALES & PURCHASE – 2003-2004

Month Sales -2003-04 Purchase - 2003-04

April 12457912.00 4991768.02

May 14476325.00 15478421.67

June 16403325.00 16527487.79

July 14621876.00 14524393.41

August 18639212.00 20024616.42

September 47200031.00 45021209.64

October 14708656.00 17644742.96

November 15061757.00 18272554.39

December 26679418.00 22321409.51

January 16744809.00 19714445.18

February 13637843.00 22648935.73

March 50142691.00 57249715.61

TOTAL 260773855.00 274419700.33

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Mr. N.V Ignatius(General Manager)