Post on 03-Jun-2018
transcript
8/11/2019 Techniques of Financial Appraisal
1/35
TECHNIQUES OF FINANCIAL APPRAISAL
FOR BANK LENDING
SLIDE11
8/11/2019 Techniques of Financial Appraisal
2/35
TECHNIQUES OF FINANCIAL APPRAISAL
Let us imagine you have been recruited by a new generationBank or a PSU Bank or an Asset Financing NBFC into one of
the following positions/roles :
ManagerCredit Appraisal
ManagerCredit Analyst
ManagerCorporate Banking
ManagerSME Banking
Then what are your role expectations ?
You should have, inter-alia, the basic knowledge of
Techniquesof Financial Appraisal for Bank Lending
8/11/2019 Techniques of Financial Appraisal
3/35
OUTLINES/LEARNING OBJECTIVES
INTRODUCTION
Balance Sheet (Statement of Assets and Liabilities)
Profit & Loss A/C ( Operating or Income Statement)
REQUIREMENT OF AUDITED FINANCIALSTATEMENTS
REARRANGEMENT OF BALANCE SHEET ITEMS AS
PER RBI GUIDELINES
REARRANGEMENT OF PROFIT & LOSS ACCOUNT
FINANCIAL /RATIO ANALYSIS OF A BUSINESS ENTITY
8/11/2019 Techniques of Financial Appraisal
4/35
INTRODUCTION - 1
Whenever a bank considers a loan proposal,apart from integrity and KYC aspects, bankskeenly find out the financial details of theprospective borrower. The extent of details
depends on the type of loan, type of theborrower, purpose of loan etc.
Financial details are collected with a view to
assess the followings :
8/11/2019 Techniques of Financial Appraisal
5/35
INTRODUCTION - 2
Net Worth of the Applicant :Helps the bankin deciding the level of activity which may bedesirable by that applicant and the amount ofmoney which can be lent to him.
Repayment Capacity : Helps the bank toassess the surplus available for repayment ofinstalment and interest on banksloan.
Net Worth of the Guarantor :
8/11/2019 Techniques of Financial Appraisal
6/35
INTRODUCTION - 3
Viability/Bankability : A scrutiny of thefinancial records/statements of the existingand proposed business activity helps bank inassessing whether the proposed bank loan will
result in a viable increase in operations andprofit.
Availability of Unencumbered Securities :
Such information is normally available fromthe financial statements of a businessenterprise. For individuals weve to call forsuch information.
8/11/2019 Techniques of Financial Appraisal
7/35
BASIC FINANCIAL STATEMENTS
BALANCE SHEET
INCOME STATETEMENT (PROFIT & LOSS A/C)
DIRECTORS AND AUDITORS REPORT,
EXPLANATORY SCHEDULES AND NOTES ONACCOUNTS
CASH FLOW STATEMENT
BASIC DIFFRENCE B/W BALANCE SHEET &INCOME STATEMENT
8/11/2019 Techniques of Financial Appraisal
8/35
BASIC FINANCIAL STATEMENTS
ITEMS OF BALANCE SHEET : ASSETS ANDLIABILITIES & EQUITY OR CAPITAL
CONCEPTS OF ASSETS AND LIABILITIES (DEBT)
AND EQUITY CLASSIFICATION OF ASSETS (CA & FA) :
CONCEPTUAL DISTINCTION
CLASSIFICATION OF LIABILITIES (CL & FL OR TL): CONCEPTUAL DISTINCTION
REQUIREMENTS FOR AUDITED FINANCIAL
STATEMENTS
8/11/2019 Techniques of Financial Appraisal
9/35
AUDITED FINANCIAL STATEMENTS - 1
Companies : All Limited Companies have tosubmit audited financials.
Turnover above Rs.60 lakh/Gross Receipt
exceeding Rs.15 lakh : Non-Corporateborrowers other than Professional & Self-employed persons with annual sales turnoverof above Rs.60 lakh and Professional & Self-
employed persons with annual gross receiptsof above Rs.15 lakh are required to submitaudited financials to banks for loan proposalsas per sec. 44AB of IT act.
8/11/2019 Techniques of Financial Appraisal
10/35
AUDITED FINANCIAL STATEMENTS - 2
RBI Guidelines : Non-Corporate borrowerswith aggregate fund-based working capitallimit of Rs.25 lakh and above are required tosubmit audited financials to banks as per RBI
guidelines.
Format for Financial Statements : A companyis required to prepare its B/S as per or similar
to the format given in Schedule VI of theCompanies Act. No format is prescribed forProfit & Loss A/c.
8/11/2019 Techniques of Financial Appraisal
11/35
PUBLISHED BALANCE SHEET
Liabilities Amount Assets Amount
Capital , Reserves & Surplus
(Net Worth)
Fixed Assets (Net)
Term Liabilities
(Secured Loans +
Unsecured Loans)
Investments
Current Liabilities & Provisions Current Assets, Loans &
Advances
Misc. Exp. & losses not yet
Written-off
Total Liabilities Total Assets
8/11/2019 Techniques of Financial Appraisal
12/35
REARRANGED BALANCE SHEET
Liabilities Amount Assets Amount
Capital , Reserves & Surplus
(Net Worth)
Fixed Assets
Intangible Assets
Term Liabilities Other Non-Current Assets
Current Liabilities
(OCL + STBB)
Current Assets
(Inventory + Receivables+
OCA)
Total Liabilities Total Assets
8/11/2019 Techniques of Financial Appraisal
13/35
REASONS FOR REARRANGEMENT
OF BALANCE SHEET ITEMS - 1
Liabilities Side : As per Companys published Balance Sheet,liabilities are grouped on the basis of Security and Liquidity.
The objective of a banker in analysing the B/S is to find outthe liabilities which are payable in short term and to
compare the same with the short term assets for ensuringthat all short term liabilities are covered by sufficient shortterm assets because Banks traditionally provide Short Termloans/Working Capital Loans. The classification like Securedand Unsecured Loans does not serve this purpose.
The Banker wants to reclassify the liabilities strictly on thebasis of theirtime for payment.
8/11/2019 Techniques of Financial Appraisal
14/35
REASONS FOR REARRANGEMENT
OF BALANCE SHEET ITEMS - 2
Asset Side : As per Companys published Balance Sheet,assets are grouped on the basis of Purpose or use ofresources.
A Banker for the purpose already stated wants to reclassify
the assets strictly on the basis of comparative liquidity (shortterm assets) and realisability (convertibility to cash).
For example in the companysB/S, items like patents, goodwilletc. find place u/r FA but a banker likes to classify them as IA
on the conservative assumption that they would realisenothing in case of forced sale, for payment of bank debts.Similarly certain items classified as CA may not be liquid andbanker likes to classify them as Non-Current assets.
8/11/2019 Techniques of Financial Appraisal
15/35
REARRANGEMENT OF BALANCE SHEET ITEMS
AS PER RBI GUIDELINES
Liabilities Side : A. Net Worth : Representing contribution ofthe promoters/owners of the concern towards business. Itconsists of Paid-upCapital, Free Reserves and Surplus. It isalso known as the ShareholdersFunds or OwnersEquity.
B. Term or Deferred Liabilities : Representing thoseliabilities which are payable after one year from the balancesheet date. They represent long term sources of funds for thebusiness and should be utilised for financing Fixed Assets.Examples : (i) Term Loan from Fis/Banks excluding Instalments
payable within 1 year, (ii) Debentures payable after 1 year, (iii)Deferred Payment Credits excluding Instalments payablewithin 1 year, (iv) Term Deposits payable after 1 year. Theportion of such liabilities which are payable within a year isclassified as Current Liability.
8/11/2019 Techniques of Financial Appraisal
16/35
REARRANGEMENT OF BALANCE SHEET ITEMS
AS PER RBI GUIDELINES
C. Current Liabilities : Representing those liabilitieswhich are generally payable within one year from thebalance sheet date. They represent short termsources of funds for the business and should be
utilised for financing Current Assets.
Examples :(a) Trade Creditors including Bills Payable(Credit available on purchases of Raw Materials,Consumables & Spares), (b) Creditors for Expenses(Rent payable, wages payable and otheroutstanding/accrued expenses)
8/11/2019 Techniques of Financial Appraisal
17/35
REARRANGEMENT OF BALANCE SHEET ITEMS
AS PER RBI GUIDELINES
C. Current Liabilities (.. Contd..) : (c) Short Term BankBorrowings for Working Capital (in short STBB) likeCash Credit (CC), Overdraft (OD) or Working CapitalDemand Loan (WCDL), Bill Finance, (d) Provisions for
payment of taxes, dividends, bonus and otherstatutory dues, (e) Advance payment fromCustomers for supply of Finished Goods and (f)Instalments of Term Loan, Debentures, Deferred
Credits and Deposits etc. falling due within 1 year. All Items except (c) are collectively known as Non-
Banking /Spontaneous CL or Other Current Liabilities(OCL or CLOTSTBB).
8/11/2019 Techniques of Financial Appraisal
18/35
REARRANGEMENT OF BALANCE SHEET ITEMS
AS PER RBI GUIDELINES
Asset Side : A. Fixed Assets : Representing assets of fixednature such as land, building, plant and machinery etc. (for aManufacturing Concern) permanently required by theconcern to carry out its business, aka Capital/Block Assets.
Net Fixed Asset or Net Block = Gross Fixed Asset or GrossBlockAccumulated Depreciation
B. Intangible Assets : Representing assets which have nophysical existence or certain fictitious assets which are in fact
capitalised expenses/accumulated losses such as goodwill,patents, preliminary expenses and Miscellaneousexpenditures and losses not yet written off etc.
8/11/2019 Techniques of Financial Appraisal
19/35
REARRANGEMENT OF BALANCE SHEET ITEMS
AS PER RBI GUIDELINES
C. Current Assets : Representing those assets which are likelyto be converted to cash or used up in the business within oneoperating cycle (working capital cycle) of the business or amaximum period of 12 months. The main constituents areInventory and Receivables. These two items are combinedly
known as Chargeable Current Assets. Current Assets alsoincludes items like Cash and bank balance, short term liquidinvestments, fixed deposits with banks, advance tax paid,prepaid expenses and advance payment to suppliers of rawmaterials etc. These miscellaneous items are known as Other
Current Assets (OCA) or Non-Chargeable Current Assets.
Current Assets are also known as Liquid Assets, CirculatingAssets or Floating Assets or Gross Working Capital.
8/11/2019 Techniques of Financial Appraisal
20/35
REARRANGEMENT OF BALANCE SHEET ITEMS
AS PER RBI GUIDELINES
D. Other Non-Current Assets : Which represent miscellaneousassets not realisable during the current operating periodsuch as non-consumable stores and spares, investments,loans and advances etc. to other group concerns/employeesor for activities not directly related to the business of the unit.
It also includes debtors outstanding for more than 6 months,dead/non-moving inventory, Security deposit, Advances tosuppliers of Capital goods and Fixed deposits with banks heldas margin for LC/LG etc.
8/11/2019 Techniques of Financial Appraisal
21/35
REARRANGEMENT OF P & L ACCOUNT 1. Gross Sales (Net of Returns)
2. Less Excise duty
3. Net Sales
4. Cost of goods Sold or Cost of Sales
(i) Raw Materials consumed
(II) Other Spares
(iii) Power Fuel
(iv) Direct Labour
(v) Repairs Maintenance
(vi) Other manufacturing expenses
(vii) Depreciation
(viii) Sub-Total of (i) to (vii) i.e., Factory Cost
(ix) Add Opening stock of Work in Process (WIP)
(x) Deduct Closing stock of WIP
(xi) Sub-Total/ Cost of Production of goods available for Sale (COP)
(xii) Add Opening stock of finished goods (FG)
(xiii) Deduct Closing stock of FG
(xiv) Sub-Total/Cost of goods Sold (COGS)
8/11/2019 Techniques of Financial Appraisal
22/35
REARRANGEMENT OF P & L ACCOUNT- Contd :
5. Gross Profit (34)
6. Less Operating Expenses
(i) Office/General & Administrative Overheads
(ii) Selling & Distribution Overhead
7. Operating Profit Before Interest & Tax (OPBIT)
8. Add/Deduct Non-Operating or Other Income/Expenses
9. Profit or Earning Before Interest & Tax (PBIT or EBIT)
10. Financing or Interest Expenses (both for Working Capital & Term Loan)
11. Profit or Earning Before Tax (PBT or EBT)
12. Tax paid/provision
13. Net Profit/Profit After Tax (PAT)
Rearrangement of Balance Sheet and P&L a/c is to be done for a number ofoperating years and also on the basis of estimates for the current year followed
by projections for the next year. This enables the banks to study the trend anddraw conclusions regarding the operations of the concern on year to year basis.
8/11/2019 Techniques of Financial Appraisal
23/35
OBJECTIVES OF STUDYING
FINANCIAL STATEMENTS Study of financial statements involves study of the following five major
aspects of the business enterprise :
- SOLVENCY
- LIQUIDITY
- LEVERAGE
- PROFITABILITY
- ACTIVITY (TURNOVER/UTILISATION/EFFICIENCY)
- COVERAGE Ratios
TREND ANALYSIS/TIME SERIES ANALYSIS
INTRA-FIRM COMPARISION
INTER-FIRM COMPARISION`
8/11/2019 Techniques of Financial Appraisal
24/35
FINANCIAL & RATIO ANALYSIS
OF A BUSINESS ENTITY - 1(A) Financial Stake of the Promoters/Owners and Solvency of the Concern :
Solvency Ratios measure ability of the firm to meet its longterm obligations
Tangible Net Worth (TNW) : TNW = NW IA. Also, TNW =
Total Tangible Assets (TTA) Total Outside Liabilities (TOL).Positive TNW i.e., when total tangible assets exceed totaloutside liabilities, would mean the concern is solvent.
Asset Coverage Ratio : (a) Total Asset Coverage Ratio (TACR)
or Solvency Ratio = [Total Tangible Assets (TTA)/Total Loansor TOL], (b) Fixed Asset Coverage Ratio: FACR (Tangible FixedAssets/Long Term Loans). It measures the solvency/ability ofthe firm to pay for the loans by disposing of its assets, in caseof need. Generally used by Term Lenders/Project Financiers
to judge the Solvency of the borrowing firm.
8/11/2019 Techniques of Financial Appraisal
25/35
FINANCIAL & RATIO ANALYSIS
OF A BUSINESS ENTITY - 1(B) FINANCIAL LEVERAGE
Debt Equity Ratio (DER) : DER = Long TermDebt/Equity ; or, Debt to Assets Ratio, High DERalso known as Trading on (Thin) Equity.
Total Indebtedness Ratio (aka Total Debt to Equity)(TOL : TNW), TOL = CL + TL, TNW= NWIA
Asset to Equity (A/E) = EM is called Financial
Leverage Ratio
8/11/2019 Techniques of Financial Appraisal
26/35
FINANCIAL & RATIO ANALYSIS
OF A BUSINESS ENTITY - 2 (B) Liquidity : Liquidity ratios measure the ability of the firm
to meet its short term obligations, the solvency of the firm inshort term. Fixed assets are required by any going concern forlong-term use and are not available to meet its obligations forshort-term or immediate liabilities. These liabilities are to be
met from Current assets. The value and realisability of currentassets into cash is thus an important indicator of the capacityof the concern to meet its current liabilities to ensure smoothday to day functioning of the unit. The most important aspectof financial appraisal by banks is to study the liquidity position
of the concern which is very relevant for assessment ofworking capital requirements of a firm. The following tworatios are important in this regard.
(a) Current Ratio (b) Liquid/Quick/Acid Test Ratio
&
8/11/2019 Techniques of Financial Appraisal
27/35
FINANCIAL & RATIO ANALYSIS
OF A BUSINESS ENTITY - 3Current Ratio : It is the ratio of Current Assets to CurrentLiabilities. From lenderspoint of view, a higher current ratiois preferable. In other words, the larger the excess of currentassets over current liabilities, the better. This is because, thecompany could then ward off even a drastic fall in the value
of current assets, without defaulting on its commitment tocreditors. On the contrary, if the ratio falls below 1, thecompany would be in serious liquidity problems, finding itdifficult to meet the financial commitments in time. Aminimum current ratio of 1:1 indicates that CL are just
matched by CA. In India, the benchmark for CRadopted bybanks is 1.33, pursuant to the recommendations of theTondon and Chore committees. This means that the CLshould Not exceed 75% of CA.
C & O S S
8/11/2019 Techniques of Financial Appraisal
28/35
FINANCIAL & RATIO ANALYSIS
OF A BUSINESS ENTITY - 4Current Ratio (CR) : It needs to be added that an unduly highCR need not be an unmixed blessing. A very high CR wouldindicate that the company is unable or unwilling to raiseadequate CL to finance a part of the CA. Excluding theprospect of inability to raise funds/CL, even unwillingness to
do so would, in many cases, point to faulty financial planning (a) conservative CA management policy leading to excessholding of Inventory and/or very liberal credit policy/poordebt collection policy resulting in high Receivables; both thefactors leading to higher level of CA and hence high CR; (b)
conservative CA financing policy by using higher proportionof long term funds instead of short term sources/CL infunding the CA which increases the cost and reduce theprofitability. For, CL are usually less costlier than TL and NWand every trading/manufacturing concern should raise
adequate quantum of CL.
FINANCIAL & RATIO ANALYSIS
8/11/2019 Techniques of Financial Appraisal
29/35
FINANCIAL & RATIO ANALYSIS
OF A BUSINESS ENTITY - 5Current Ratio (CR) : Also a very high CR of 2:1 or 3:1 doesnot necessarily signify a very high liquidity position of thefirm, instead a firm with a CR of even 1:1 may have acomfortable liquidity condition. The moot point here is thatone should be aware of the limitation of ratios and one
should not be guided by the quantity of CR alone, oneshould see and analyse the quantity as well as the qualityof the CA/each component of CA to ensure that nodead/non-moving/ obsolete inventory or no baddebtors/receivables are included in the CA which results in
higher level of CA/CR and therby giving false impression ofhigh liquidity.
8/11/2019 Techniques of Financial Appraisal
30/35
FINANCIAL & RATIO APPRAISAL
Liquid/Quick/Acid Test Ratio : The CR refers to firmsability to meet itsshort term obligations within one year. However, it does Not precisely
indicate the firms ability or otherwise in meeting the immediatelypressing liabilities. Inventory and prepaid expenses are not quicklyrealisable and thus may not be available to meet the current dues of thefirm. To ascertain a firms preparedness for meeting the immediatedemands on its liquidity, current assets of such nature are thus excludedto find the real liquidity position of the concern on a very short term basis,
i.e., another ratio called the liquid/quick/acid test ratio is computed bycomparing the relationship b/w current liabilities and immediatelyrealisable current assets (quick/liquid assets) such as cash, receivables andhighly liquid marketable investments.
Quick/Liquid Ratio = (CA (Inventory + Prepaid Exp.))/CL = (Cash +
Receivables + Investments)/CL
A quick ratio of 1:1 is considered desirable.
8/11/2019 Techniques of Financial Appraisal
31/35
FINANCIAL & RATIO APPRAISAL
(C) Profitability Ratios : The important ratios are Gross Profit Margin(GPM), Operating Profit Margin (OPM), Net Profit Margin (NPM), Return
on Net Worth (RONW) and Return on Investments (ROI), Return on assets(ROA) and Du Pont Analysis of ROE (5 Factor Analysis).
ROE = PAT/E = PAT/PBT x PBT/EBIT x EBIT/S x S/A x A/E = Tax MgmtEfficiency x Interest Mgmt Efficiency x Operating Efficiency x AssetUtilisation x Equity Multiplier or Financial Leverage
(D) Coverage Ratios: Interest Coverage Ratios like I/EBIT, EBIT/I andI/EBITDA and EBITDA/I.
Debt Service Coverage Ratio (DSCR): Wellstudy in Term Loan and ProjectAppraisal, = Cash Flow available to service LT Debt/LT Debt Service
Commitment or Burden.
8/11/2019 Techniques of Financial Appraisal
32/35
FINANCIAL & RATIO APPRAISAL
(E) Activity Aspects : Activity or Turnover/Utilisation/Efficiency ratioscome under this category; such as Fixed Asset TO (NS/FA), Inventory TO
(COGS/Inv), DebtorsTO (Total Cr. Sales/Avg. Debtors), CreditorsTO ( TotalCr. Purchase/Avg. Creditors). Also following holding periods are usuallycomputed over successive years for the unit itself (intra-firm comparison)and with that of similar units (inter-firm comparison) for assessment ofWorking Capital Requirement of the Business Unit. They are RM holdingPeriod = (Avg. stock of RM/Avg. daily consumption of RM during the year),
WIP holding Period=(Avg. stock of WIP/Avg. daily Cost of Production (COP)of goods produced during the year), FG holding Period=(Avg. stock ofFG/Avg. daily Cost of goods sold (COGS)during the year), Debtors orReceivables holding Period=(Avg. Debtors and Receivables/Avg. daily Cr.Sales during the year) - this is Avg, Credit period extended or Avg. debtcollection period, Creditors or Payables holding Period=(Avg. Creditorsand Payables/Avg. daily Cr. Purchases during the year) this is Avg. Creditperiod enjoyed or Avg. Credit payment period.
8/11/2019 Techniques of Financial Appraisal
33/35
KEY WORDS/TERMINOLOGIES/GLOSSARY
CA, CL, FA, FL or TL, Net Worth, Tangible Net Worth(TNW), Tangible -vs- Intangible Asset, Chargeable
CA, TOL, Current Ratio, Liquid/Quick/Acid Test
Ratio, Debt Equity Ratio, TOL : TNW ratio or Total
Indebtedness Ratio, RM, WIP, FG, Receivables &Payables Holding Period, Other CL or Spontaneous
or Non-Bank CL, Avg. Debt Collection Period, Avg.
Credit Period Enjoyed.
8/11/2019 Techniques of Financial Appraisal
34/35
Home Task for Next Class
Activity : Collect the latest annual report of aManufacturing Company and rearrange the
Balance Sheet as per Bankers Requirement
and calculate the following ratios etc. Current Ratio, Liquid/Quick/Acid Test Ratio,
Debt Equity Ratio, TOL : TNW ratio or Total
Indebtedness Ratio, RM, WIP, FG,Receivables & Payables Holding Period, Other
CL or Spontaneous or Non-Bank CL, Avg. Debt
Collection Period, Avg. Credit Period Enjoyed.
8/11/2019 Techniques of Financial Appraisal
35/35