PROJECT ON WORKING CAPITAL ASSESSMENTOF SMEs IN MUMBAI

BYAAKASH KAKKADPGDBM

A REPORT ON WORKING CAPITAL ASSESSMENTOF SMEs IN MUMBAI

BY AAKASH KAKKADA REPORT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS OF MBA OF N.L DALMIA INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH

CERTIFICATEThis is to certify that the project titled Credit Assessment & Market Scoping of SMEs in Mumbai submitted by Mr. Aakash Kakkad in partial fulfillment of Post Graduate Diploma in Management (N. L. Dalmia Institute of Management Studies and Research) is a bona-fide record of work carried out by him under my guidance and supervision during his final year.

Chetana Asbe(Faculty Incharge - NLDIMSR)

DECLARATIONI hereby solemnly declare that the project entitled Credit Assessment & Market Scoping of SMEs submitted by me is a genuine and bonafide work based on my own understanding. This project is done in partial fulfillment for the award of Post Graduate Diploma in Management at N. L. Dalmia Institute of Management Studies and Research Mumbai

Aakash Kakkad PGDBM(N.L. Dalmia Institute Of Management Studies And Research)

ACKNOWLEDGEMENT

Achievement is finding out what you would be doing rather than what you have to do. The higher the summit the harder is the climb.It has been rightly said that we are built on the shoulders of others. For everything I have achieved, the credit goes to all those who had helped me to complete this project successfully.I take this opportunity to express my profound gratitude to the management of N. L. DALMIA INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH for giving me the opportunity to accomplish this project work.I am very thankful to MS. NEHA GOENKA for her kind co-operation in the completion of my project.Finally, I wish to thank all my friends who directly or indirectly helped me in the completion of the project and to my family without whose support, motivation and encouragement this would not have been possible.

INDEXSr.noContentPage no.

1.Scope of the Study7

2.Objective 9

3.Research Methodology10

4.ING VYSYA BANK11

5.Introduction 14

6.Nature of Finance Demand in the MSME Sector17

7.Definition of SMEs in India18

8.Wish List of SME21

9.Growth and Performance of SMEs22

10.Government Initiatives26

11.Opportunities in SME Sector in India29

12.Budget 2014 & MSME31

12.Problems faced by SMEs33

13.Working Capital34

14.Basic Principles of Lending36

15.Problems in Lending38

16.Products Offered to SMEs41

17.Credit Parameters48

18.Process of SME Financing51

19.Servicing60

20.Credit Proposal for SME62

21.Case Study67

22.SWOT of Textile Industry87

23.Market Scoping89

24. Conclusion90

25.Bibliography91

SCOPE OF THE STUDYThe Micro, Small and Medium Enterprises (MSME) contribute nearly 8 percent of the countrys GDP, 45 percent of the manufacturing output and 40 percent of the exports. They provide the largest share of employment after agriculture. They are the nurseries for entrepreneurship and innovation. They are widely dispersed across the country and produce a diverse range of products and services to meet the needs of the local markets, the global market and the national and international value chains.

BROAD CLASSIFICATION OF SMEs IN INDIA

There is a total finance requirement of INR 32.5 trillion ($650 billion) in the MSME sector, which comprises of 26 trillion ($ 520 Billion) of debt demand and INR 6.5 trillion ($130 Billion) of equity demand. The three main pillars of the enabling environment Growth of Finance in the MSME Sector are (a) legal and regulatory framework (b) government support (c) financial infrastructure support. MSMEs function in a highly competitive environment and require an enabling environment to sustain growth. Well-rounded fiscal support, a strong policy framework, and incentives promoting innovation by financial institutions can significantly increase the penetration of formal financial services to the MSME sector.Within the formal financial sector, banks account for nearly 85 percent of debt supply to the MSME sector, with Scheduled Commercial Banks comprising INR 5.9 Trillion (USD 118 Billion). Non-Banking Finance Companies and smaller banks such as Regional Rural Banks (RRBs), Urban Cooperative Banks (UCBs) and government financial institutions (including State Financial Corporation and State Industrial Development Corporations) constitute the rest of the formal MSME debt flow.

Given the size and scope of this market, the financial sector has a significant role to play in expanding their reach to this segment in an enabling environment and facilitating sustainable growth.Thus the scope of this study is extensive and financial institutions such as banks have a very crucial role to play.

OBJECTIVE

1) To understand the definition and classification of Small Medium Enterprise.

2) To understand the importance and significance of SME to the banking sector.

3) To study the business model of Bank in terms of SME financing.4) To study the credit appraisal methods used by Bank for SMEs.

5) To comprehend reasons behind rejection of bank finance to an SME.

6) To understand the problems faced by SMEs in getting bank finance.

7) To understand people skills and interaction with clients and customers.

RESEARCH METHODOLOGYResearch methodology is systematic process which consists of series of action or steps necessary to effectively carry out research and the desired sequencing of these steps. The above project has been conducted through the use of both primary as well as secondary data and experience that I have gained in these two months of valuable internship. The research involved:1) In-depth analysis of the balance sheets, income statements and cash flow statements as done by the Relationship Manager.2) Reading through the previous proposals for the various corporate credit products and services offered by the bank and understanding the method of assessment and appraisal. 3) Comprehensive study of the various types of products and services offered by the bank to SMEs and their need and requirement for bank finance.4) Understanding financial risk analysis and management risk analysis and industry risk of the client as well as the sector as a whole.5) Interaction with the various customers and clients of the bank and understanding the insightful view of the industry experts on the sectoral growth and the business model.6) Interacting with different employees at Bank and using the internal circulation of the banks intranet for extracting the necessary secondary data.

In the process of completing this study, I have referred to several credible sources of data, including existing research literature and industry publications. The data collected has proven to be extremely valuable in coming to conclusions and developing inferences.

INTRODUCTION

Micro, Small and Medium Enterprises (MSME) sector has emerged as a highly vibrant and dynamic sector of the Indian economy over the last five decades. MSMEs not only play crucial role in providing large employment opportunities at comparatively lower capital cost than large industries but also help in industrialization of rural & backward areas, thereby, reducing regional imbalances, assuring more equitable distribution of national income and wealth. MSMEs are complementary to large industries as ancillary units and this sector contributes enormously to the socioeconomic development of the country.

Small and medium enterprises are central to economic development, particularly in emerging markets. They are the backbone of a country which wants to project itself as a fully developed nation with equitable socio-economic growth. Interestingly,95% of all registered firms across the world are SMEs, and the number is as high as 99% for regions like Europe.SMEs therefore play an integral role in fueling the progress of any country, especially in developing economies.

The fact that enterprises which are generally low capitalized and which use localized resources can impact the employment scenario in such a significant manner, is truly outstanding .The strongest differentiator for SMEs is the competitive business model, which emphasizes the use of cost-effective and local resources, capital, processes and labor, ensuring an effective ROI.To fuel this competitive edge and ensure that SMEs fully optimize their resources and opportunities, SMEs need timely and unrestricted access to financial services, which has historically been severely constrained.

Banks are demonstrating that the MSME segment can be served profitably, provided it is properly understood. But banks alone cannot be the savior of the MSME sector. They too need a strong system to lean upon. RBI must ease the lending and NPA accounting norms for banks who lend to the MSME sector. Such strong directives and support would have a very positive impact on the morale of the MSMEs.Recognizing the importance of the SME sector, RBI has issued the following guidelines:

1. Ensuring credit to the MSME sector as part of the priority sector lending by banks.2. Earmarking credit for micro enterprises within overall lending to micro and small enterprises.3. Opening specialized SME branches.4. Enhancing the limit for computation of the aggregate working capital requirements on the basis of minimum 20% of the projected annual turnover.5. Adopting a cluster-based approach for SME financing by banks.6. Reviewing the progress in achieving at least 20% YoY growth in credit to SMEs by the boards of banks.

MSME credit also allows banks to build a granular diversified portfolio, which helps in risk mitigation and de-bulking.Continuing to be earnest in its endeavors, the government has undertaken measures to support SME access to finance. These measures include reforming existing legal/ regulatory barriers. This may involve streamlining accounting requirements or formalizing processes for SMEs. It could also mean reducing capital requirements in BASEL norms for SME portfolios. The government helps in developing financial markets for SMEs and intervening in the market directly to jumpstart lending to SMEs. Direct government intervention in the banking markets includes direct lending through government-owned institutions and directed credit programs, where the government provides capital to banks specifically for lending to SMEs. This has also strongly motivated banks to lend more. The government also guarantees SME loans for which the government shares a portion of the credit risk. The government operates through NABARD and SIDBI.

Ministry of Micro, Small & Medium Enterprises (M/o MSME) envision a vibrant MSME sector by promoting growth and development of the MSME Sector, including Khadi, Village and Coir Industries , in cooperation with concerned Ministries/Departments, State Governments and other Stakeholders, through providing support to existing enterprises and encouraging creation of new enterprises.

SMEs always represented the model of socio-economic policies of Government of India which emphasized judicious use of foreign exchange for import of capital goods and inputs, labor intensive mode of production, employment generation, non concentration of diffusion of economic power in the hands of few (as in the case of big houses), discouraging monopolistic practices of production and marketing and finally effective contribution to foreign exchange earning of the nation with low import-intensive operations.

SMEs developed in a manner, which made it possible for them to achieve the following objectives:1. High contribution to domestic production2. Significant export earnings3. Low investment requirements4. Operational flexibility5. Location wise mobility6. Low intensive imports7. Capacities to develop appropriate indigenous technology8. Import substitution9. Contribution towards defense production10. Technology oriented industries11. Competitiveness in domestic and export markets

NATURE OF FINANCE DEMAND IN THE MSME SECTORMicro enterprises are also characterized with limited access to both immovable and movable collateral, while the majority of financial institutions prefer collateral-based financing as risk mitigation. These enterprises are mostly centered around entrepreneurs alone, which makes them vulnerable because micro-entrepreneurs have often had limited training in resource planning and are not always aware of all the potential financing avenues available.

The average credit requirement of a small enterprise across manufacturing and services industries is estimated to be approximately INR 4 million. With limited access to immovable collateral or assets, small enterprises especially in knowledge-based industries, are handicapped in their ability to access adequate debt from formal financial institutions.Although mature small enterprises (particularly knowledge-based enterprises) tend to use bank instruments for most of their business transactions, cash continues to be preferred across the overall small segment as entrepreneurs have limited incentive to maintain financial records. Lack of financial documentation further increases the challenge of accessing finance from formal financial institutions.Small enterprises access finance from both formal and informal sources, but in case of formal sources, these units tend to have relationships with 1-2 financial institutions.

DEFINITION OF SMEs IN INDIAIntroductionSME sector of India is considered as the backbone of economy contributing to 45% of the industrial output, 40% of Indias exports, employing 60 million people, create 1.3 million jobs every year and produce more than 8000 quality products for the Indian and international markets. With approximately 30 million SMEs in India, 12 million people expected to join the workforce in next 3 years and the sector growing at a rate of 8% per year, Government of India is taking different measures so as to increase their competitiveness in the international market.There are several factors that have contributed towards the growth of Indian SMEs. Few of these include; funding of SMEs by local and foreign investors, the new technology that is used in the market is assisting SMEs add considerable value to their business, various trade directories and trade portals help facilitate trade between buyer and supplier and thus reducing the barrier to tradeWith this huge potential, backed up by strong government support; Indian SMEs continue to post their growth stories. Despite of this strong growth, there is huge potential amongst Indian SMEs that still remains untapped. Once this untapped potential becomes the source for growth of these units, there would be no stopping to India posting a GDP higher than that of US and China and becoming the worlds economic powerhouse.MICRO, SMALL & MEDIUM ENTERPRISES DEVELOPMENT (MSMED) ACT,2006.The Government of India has enacted the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 on June 16, 2006 which was notified on October 2, 2006. With the enactment of MSMED Act 2006, the paradigm shift that has taken place is the inclusion of the services sector in the definition of Micro, Small & Medium Enterprises, apart from extending the scope to medium enterprises. The MSMED Act, 2006 has modified the definition of micro, small and medium enterprises engaged in manufacturing or production and providing or rendering of services. The Reserve Bank as notified the changes to all scheduled commercial banks. Further, the definition, as per the Act, has been adopted for purposes of bank credit vide RBI circular ref.RPCD.PLNFS. BC.No.63/ 06.02.31/ 200607 dated April 4, 2007.SMEs can be classified into the following two categories:

MSME

MANUFACTURINGSERVICE

DEFINITION OF MICRO, SMALL AND MEDIUM ENTERPRISES

(a) Enterprises engaged in the manufacture or production, processing or preservation of goods as specified below:i. A micro enterprise is an enterprise where investment in plant and machinery does not exceed Rs. 25 lakh;ii. A small enterprise is an enterprise where the investment in plant and machinery is more than Rs. 25 lakh but does not exceed Rs. 5 crore;ANDiii. A medium enterprise is an enterprise where the investment in plant and machinery is more than Rs.5 crore but does not exceed Rs.10 crore.In case of the above enterprises, investment in plant and machinery is the original cost excluding land and building and the items specified by the Ministry of Small Scale Industries vide its notification No.S.O. 1722(E) dated October 5, 2006.

(b) Enterprises engaged in providing or rendering of services and whose investment in equipment (original cost excluding land and building and furniture, fittings and other items not directly related to the service rendered or as may be notified under the MSMED Act, 2006) are specified below:i. A micro enterprise is an enterprise where the investment in equipment does not exceed Rs. 10 lakh;ii. A small enterprise is an enterprise where the investment in equipment is more than Rs.10 lakh but does not exceed Rs. 2 crore; andiii. A medium enterprise is an enterprise where the investment in equipment is more than Rs. 2 crore but does not exceed Rs. 5 crore.

These will include small road & water transport operators, small business, retail trade, professional & selfemployed persons and other service enterprises.Lending by banks to medium enterprises will not be included for the purpose of reckoning of advances under the priority sector.

iv. Since the MSMED Act, 2006 does not provide for clubbing of investments of different enterprises set up by same person / company for the purpose of classification as Micro, Small and Medium enterprises, the Gazette Notification No. S.O.2 (E) dated January 1, 1993 on clubbing of investments of two or more enterprises under the same ownership for the purpose of classification of industrial undertakings as SSI has been exscinded vide GOI Notification No. S.O. 563 (E) dated February 27, 2009.

Manufacturing Enterprises Investment in Plant & Machinery

DescriptionINRUSD($)

Micro Enterprisesupto Rs. 25Lakhsupto $ 62,500

Small Enterprisesabove Rs. 25 Lakhs & upto Rs. 5 Croresabove $ 62,500 & upto $ 1.25 million

Medium Enterprisesabove Rs. 5 Crores & upto Rs. 10 Croresabove $ 1.25 million & upto $ 2.5 million

Service Enterprises Investment in Equipments

DescriptionINRUSD($)

Micro Enterprisesupto Rs. 10Lakhsupto $ 25,000

Small Enterprisesabove Rs. 10 Lakhs & upto Rs. 2 Croresabove $ 25,000 & upto $ 0.5 million

Medium Enterprisesabove Rs. 2 Crores & upto Rs. 5 Croresabove $ 0.5 million & upto $ 1.5 million

WISH LIST OF SME

Despite the governments best efforts to patronize the MSME sector, there is scope for improvement. The suggestions from the MSME beneficiaries resemble wish lists encompassing tax benefits from RBI policies. Some of the common suggested schemes and measures propagated by the SMEs are:

1) Tax Benefits Differential taxation for SMEs:Categorizing SMEs in the same bracket as large multinational corporations often leads to SMEs under reporting profits to save tax, which in turn affects their ability to avail finance. Collateral requirement of banks would reduce with better reporting, and bridging the information asymmetry. It would also mean faster turnaround time for SME loans, as the requirements are seasonal and erratic. Decrease in number of taxes:SMEs today have the same number of taxes as large corporates which include Sales Tax, VAT, MAT, Excise and Income Tax. Since SMEs' operations are run mainly by promoters themselves with little professional help, tax planning as a business activity takes most of the time.

2) Credit GuaranteesCGTMSE/ECGC, routed through SIDBI and other nodal agencies, with an 18-month cooling period, makes it impossible for banks to finance the scheme (as banks according to RBI norms have to declare their NPAs in 90 days). Reduction in the cooling period could incentivize banks to lend more. Along the same lines, easing claim formalities could also lead to more lending.Credit Rating Subsidy is again routed through NSIC which makes it cumbersome for SMEs to claim. The same could be routed through banks which could make the subsidy much more meaningful.

3) RBI policies to boost financingThe RBI should categorize SME lending as Direct Priority Sector Lending instead of Indirect Priority Sector Lending. Better rating mechanism needs to be formulated jointly by RBI, banks and credit rating agencies BASEL II does not recognize the difference in SME and large corporate lending. Hence, SME rating takes a beating in banks. The Small and Medium Enterprises Rating Agency (SMERA) rating is currently unacceptable in BASEL. SME rating should include collateral, promoter net worth and vintage, since sole dependence on the balance sheet for rating gives a lopsided view of the company.

4) Tax SopsThe government seeks to encourage entrepreneurship ventures by offering tax sops. There is General Excise Exemption Scheme of the Central Excise Department wherein specified goods are exempted from excise for SMEs. The government also offers tax holidays on Export Oriented Units (EOU). SMEs are offered exemptions from Custom and Central Excise duties on import and local procurement of capital goods, raw materials, consumables, spares and packing material, among others. Tax holidays are also given for various small scale industries and other IT, food processing, pharmaceuticals and energy. Tax holidays for MSME are also given in specific under developed states and North Eastern region.87

GROWTH AND PERFORMANCE OF SMEs

INTRODUCTIONPerformance of Micro, Small & Medium Enterprises (MSME) sector is assessed by conduct of periodic All India Census of the Sector. The latest census conducted was Fourth All India Census of MSME. The Census was conducted with reference year 2006-07, wherein the data was collected till 2009 and results published in 2011-12. Fourth All India Census of MSME is the first census conducted post implementation of Micro, Small and Medium Enterprises Development (MSMED) Act, 2006. Prior to implementation of MSMED Act, 2006, the sector was defined, as per the provision of Industries Development and Regulation Act 1951, as Small Scale Industries (SSI) sector and its constituent tiny and auxiliary units as per periodic revision of criteria for defining such units. Third All India Census of SSI was conducted with coverage and concepts as prevailing during 2001-02.

The scope and coverage of the MSME sector was broadened significantly under the MSMED Act, 2006, which recognized the concept of enterprise and to include both manufacturing and services sector, besides defining the medium enterprises under MSME sector. Thus the entire non-agricultural sector of economy was brought under the coverage of MSME sector subject to the revised criteria prescribed for defining Micro, Small and Medium Enterprises separately for manufacturing and service sector.

There are over 6000 products ranging from traditional to high-tech items, which are being manufactured by the MSME sector in addition to provide wide range of services. The leading industries with their respective shares are as depicted below.

LEADING MSME SECTORS

It is well known that the MSME provide the maximum opportunities for both self-employment and jobs after agriculture sector. Some of the striking features of the MSME sector in the last few years can be observed as follows:

A) Number of Enterprises in the MSME Sector:There has been a gradual increase in the number of enterprises adding to the list of number of SMEs. There has been a gradual increase in the number of working enterprises from 361.76 lakhs in 2007 to 447.73 lakhs in 2012.

B) Employment in MSME SectorThe gradual increase in the number of enterprises has had a positive effect on the employment generated over the years. This has certainly given a boost to the number of employment generated over the years. As per the research the employment rose from 805.23 lakhs in 2007 to 1012.59 lakhs in 2013.

C) FIXED INVESTMENT IN MSME SECTORThe investment in fixed income in the MSME sector has increased drastically. An evident growth has been observed from 868543.79 crore in 2006 to 1776939.36 crore in 2012.

D) Gross OutputWith an overall increase in the number of enterprises, employment and investment in fixed income the gross output has increased from 1351383.45 crore in 2006 to 1834332.05 crore in 2012.

GOVERNMENT INITIATIVESTowards the development of the SME sector, Government of India has been extremely alert and proactive. The Government's policy initiatives like enactment of the new Micro Small and Medium Enterprises Development Act, 2006, pruning of reserved SSI list, advising FIs to increase their flow of credit to the SME sector, are all initiatives towards boosting entrepreneurship, investment and growth. The schemes comprise of bank credit facilitation, Export credit Insurance, SME Credit Rating, Bill discounting schemes, Government stores purchase programmes, infomediary services, facilitating marketing support, technology support and other support services. The schemes have been formulated at both national as well as International level.There are certain schemes which National Small Industries Corporation carries forward to assist small enterprises with a set of specially tailored schemes designed to put them in a competitive and advantageous position. Besides NSIC the crucial role of the Confederation of Indian Industry (CII) has been involved with the promotion of SME sector since inception. CII strongly believes that employment will be best served by promotion of the small sector.CII sets up special exhibition platforms at all its leading high-profile trade fairs such as International Engineering and Technology Fair, DefExpo for defense industry, Auto Expo for the automobile and components industry and many others throughout the year.Besides these schemes, the Government of India also runs an International Cooperation Scheme for Technology infusion and/or up gradation of Indian MSMEs, their modernisation and promotion of their exports are the principal objectives of assistance under the International Cooperation Scheme.Among instruments of SME Financing, SIBDI, is the principal financial institution for the promotion, financing and development of industry in the SME sector in the country. SIDBI also provides appropriate support in the form of promotional and developmental services. In order to improve the credit flow to the SME sector, it has tied-up with eight public sector banks in the country. With these tie-ups, it has covered 150 SME clusters, out of the total 388 clusters identified across the country. Some of the major initiatives introduced to tackle the problems faced by SMEs include:

Credit Guarantee Fund Trust for Small Industries-Government of India, in association with SIDBI, has set up a Credit Guarantee Fund Trust for Small Industries (CGTSI) to implement the guarantee scheme.

Venture Capital Funding- SIDBI, along with some other institutions, has taken a lead in promoting venture capital funding in the country.Micro Credit- Realising the potential of micro finance in stimulating economic growth, SIDBI, has laid emphasis on increasing the capacity of the sector to handle credit and growth in the disbursements of micro finance. SIDBI Foundation for Micro Credit has been established.Small and Medium Enterprises Fund-The most important amongst the sectoral initiatives taken by the Government of India and SIDBI is an SME Fund, with a view to giving impetus to the fund flow to the SME sector. Under the Fund, assistance is being provided to SMEs at an interest rate of 200 basis points below the Bank's PLR. Direct assistance is being extended to SMEs through SIDBI's own offices at 9.5 per cent rate of interest as also by way of providing refinance tothe primary lending institutions.Udayami Helpline- Besides this, the Government has also set up the Udayami Helpline which will provide all the relevant information and details to the interested entrepreneurs regarding the scope of the business operations they may want to venture into, loan facilities, government schemes and other modalities of setting small units. This will further strengthen the reach of the government all across the country.IPR Facilitation Center- Apex industry chamber, FICCI, launched an IPR facilitation centre in association with the ministry of Micro-Small and Medium Enterprises (MSME). In addition to providing general advisory about IPRs, such as, patents, trademarks, designs and copyrights, these centres will also provide services related to patent searches, patent drafting, patent prosecution, facilitation in commercialisation of inventions, prosecution matters etc.Marketing Intelligence cell- The National Small Industries Corporation (NSIC) has set up the MSME Marketing Intelligence cell for the assistance of micro, small and medium enterprises in the country. This Marketing Intelligence cell will collect and circulate domestic as well as international marketing intelligence to MSMEs which would improve their market capabilities and further boost their competitiveness.SMERA-To help the SMEs grow better, the government has started the Small and Medium Enterprise Rating Agency (SMERA), a joint venture between SIDBI, Dun & Bradstreet and 11 leading banks operating in SME segment. SMERA is the first rating agency in India which focuses on the Indian SME Segment, providing ratings that are independent, comprehensive and transparent. SMERA is the country's first rating agency that focuses primarily on the Indian SME segment. SMERA's primary objective is to provide ratings that are comprehensive, transparent and reliable. This would facilitate greater and easier flow of credit from the banking sector to SMEs.

SMERA offers the following: 1) SMERA Credit Ratings provides a comprehensive and independent third-party evaluation of the overall condition of the applicant. Currently, SMERA offers Obligor Ratings which takes into account the financial and non-financial factors that have bearing on the credit worthiness of the applicant. 2) At present, SMERA offers following products: 1. MSME Rating 2. Greenfield & Brownfield Grading 3. Microfinance Institutions (MFI) Rating 4. Green Rating 5. Risk Management Solutions 6. Maritime Training Institutions (MTI) Rating 3) SMERA Rating endeavors to enhance the market standing of the applicant amongst lenders, trading partners and prospective customers.

Various Schemes-The Ministry of Micro, Small and Medium Enterprises (MSME) is implementing the promotional schemes for the development of micro, small and medium enterprises. The schemes and programmes generally focus on capacity building in states and regions; nevertheless, there are a few schemes and programmes, which are individual beneficiary-oriented. Scheme of Surveys, Studies and Policy Research Entrepreneurship Development Institution Scheme Scheme of Fund for Regeneration of Traditional Industries (SFURTI) Rajiv Gandhi Udyami Mitra Yojana (RGUMY) Marketing Assistance Scheme (Implemented through NSIC) Performance and Credit Rating Scheme (Implemented through NSIC) Prime Minister's Employment Generation Programme (PMEGP) (Implemented through KVIC) Product Development, Design Intervention and Packaging (PRODIP) (Implemented through KVIC) KhadiKarigarJanashreeBima Yojana for Khadi Artisans (Implemented through KVIC) Interest Subsidy Eligibility Certification (ISEC).

OPPORTUNITIES IN SME SECTOR IN INDIAINTRODUCTIONSmall industry has been one of the major planks of Indias economic development strategy since independence. India accorded high priority to SMEs right from independence and pursued support policies to make these enterprises viable and vibrant and over time, these have become a major contributor to the GDP of the nation. Despite numerous protections and policy measures, SMEs remained mostly small, technologically backward and lacked competiveness.The decade of 1990 was characterized by policy changes, nationally as well as internationally. These policy changes took place at the three levels global, national and sectoral, which had the major implication on the functioning of small industry of India as well as their performance. The policy marked: 1) the beginning of end of protective measures for small industry and 2) promotion of competitiveness by addressing the basic concerns of the sector; namely technology, finance and marketing. These resulted in the decline of number of items reserved exclusively for small industry, to be brought down from 842 in 1991 to 239 in 2007. These policy changes led to the radical change in the environment for the functioning of small industry.In the recent past the SMEs have performed better than their larger counterpart. Between 2001 and 2006, net companies with the net-turnover of Rs 1 Crore 50 Crore had a higher growth rate of 701% as compared to 169% for large companies with turnover of over Rs. 1000 Crore. After a steep fall in the production between 1991 and 2000, there are has been a continuous growth in number of units, production, employment as well as the exports of the sector.Today the scenario of Indian SMEs has changed completely. Some of the SMEs are acquiring companies abroad as part of the globalization process. The SME sector has transformed themselves to the need of large local manufacturers and suppliers to global manufacturers. SMEs have also started investing in R&D activities in order to compete in the global market.SMEs now occupy a position of strategic importance in the Indian economic structure due to its significant contribution in terms of output, exports and employment. The small scale industry accounts for over 40% of gross industrial value addition and over 50% of the total manufacturing exports. Further, there are approximately 30 million SME units, that are spread all over the country and account for production of over 8000 different types of the products, right from very basic to highly sophisticated. They have also become the biggest employment generating engine in the country, providing employment to over 60 million and adding over 1.3 million jobs each year.With the positive outlook of Indian economy, Indian SMEs plan to increase their capital expenditure and hire more staff in the coming months. To add to this there is an increasing number of SMEs that are eyeing offshore expansion for their businesses.Research findings indicate that number of Indian SMEs conducing international business activities is expected to rise from 31% to 56% by 2013. The increase is driven by the domestic SMEs, 24% of which plan to go international by 2013. With the initiatives that are being taken by the government and other SME organizations, the future definitely looks bright for Indian SMEs. India is among the three most attractive FDI destinations in the world India has evolved as one of worlds leading technology centers India has highest return on foreign investment in the world By 2032, India will be among the three largest economies in the world India is a developed country as far as Intellectual Property is concerned The Indian market has two core advantages an increasing presence of multinationals and an upswing in the IT exports.These factors indicate the current the outlook of the world economy towards the investments in India. The Government of India has always given top priority to the Indian SMEs, leading to their growth and has contributed heavily to the growth of the Indian economy. The government too has introduced incentives for the SMEs in order to make them competitive in the international markets. In order to enable SMEs get easy access to the finance, government has also introduced priority sector lending and has made mandatory on the domestic and foreign banks to lend 40% and 32% of their Net Bank Credit (NBC) to the SMEs.The opportunities exists for foreign SMEs looking to expand in the Indian market in the field of technology transfer, setting up the new business in the country, obtaining the sub-contracting rights, out-sourcing to their Indian partners etc

BUDGET 2014-15 & MSME

Industry body CII today said the Budget proposals are likely to provide a major impetus to the development of micro, small & medium enterprises (MSME) sector and create jobs.

"The Finance Minister has duly recognized that SMEs form the backbone of the country's industrial output and employment and rightly underscored the importance of promoting entrepreneurship and start-up enterprises," Co-Chairman of CII National MSME Council T T Ashok said. "The focus of Budget on providing infrastructural support like power and land for the MSMEs under various schemes in rural India, is going to spur the growth of the sector, create a large number of jobs and revive the economy," he added.

Finance Minister Arun Jaitley yesterday unveiled a slew of measures to revitalise the micro, small and medium enterprises sector, laying special thrust on promotion of start-ups. Presenting the Budget 2014-15 proposals in Parliament, he said a Rs 10,000 crore venture capital fund will be set up for the sector. "CII welcomes the proposal to set up a Rs 10,000 crore fund that will act as a catalyst to private capital by way quasi-equity, soft loan, and other risk capital for start-up companies," the chamber said.

Jaitley also announced that the definition of MSME will be reviewed to provide for a higher capital ceiling. "The decision to revisit definition of MSME by providing for a higher capital ceiling was most awaited which has been our recommendation for the last five years," CII said. Jaitley also said a programme to facilitate forward and backward linkages with multiple value chain of manufacturing and service delivery will be put in place.

Moreover, the Finance Minister said an entrepreneur-friendly legal bankruptcy framework will be developed for SMEs to enable easy exit. Besides, he said, a nationwide "District level Incubation and Accelerator Programme" would be taken up for incubation of new ideas and providing necessary support for accelerating entrepreneurship.

"The proposal of the Finance Minister to set up a trade facilitation centre and a craft centre and a museum with an outlay of Rs 50 crore to develop and promote handloom products is a welcome step for the development of the micro enterprises in India and is going to help them showcase at a global scale," Ashok said. "Setting up of a committee to examine the financial architecture for MSME Sector, remove bottlenecks and create new rules and structures and give concrete suggestions in three months is a step forward to address financing problem of MSMEs," he added. Moreover, he said, the amendment of the Apprenticeship Act will encourage MSMEs to avail of the benefits under the scheme and help in getting skilled manpower for the sector.

PROBLEMS FACED BY SMEs

Some of these hurdles comprise of inefficacy of SMEs to access continued development and success. Lack of Finance:It has emerged as the most critical barrier for perfect capacity utilization and competing in the market. SMEs are not able to raise adequate funds from banks, especially for high risk projects. Insufficient basic infrastructure facilities like irregular power and water supply, bad road and railway connectivity etc. are some of the factors that are hampering the growth of SMEs in India.

Lack of Technology: One of the crucial factors that prompts in the success or failure of enterprise is technology. The best use of technology no doubt enables enterprise in reducing cost of production, maintain consistency in quality, improve productivity and finally develop the competitiveness of the enterprise.

Lack of Planning: Another problem that is mainly faced by SME sector is the proper division of time, which is usually the outcome of improper planning and strategy. Moreover, if you are in debt then you have to be careful from your bankers and suppliers and off course your employees who will be on your nerves on the salary day.

Lack of Marketing Assistance: One of the chief problems that they do not have marketing expertise or not in a position to hire someone who can jazz up their sales. Paucity of marketing support and limitation of the resources is a characteristic of all SMEs. When it comes to marketing of products or services internationally, any small or medium company is always constrained by its scarcity of budgets, which in turn limits its growth. A B2B marketplace not only solves companies problem of reach to the buyers worldwide, the online marketplace also support their communication needs and help them display an array of products.

Lack of Knowledge:Lack of knowledge and information about the various schemes announced by the government.

Lack of Right Staff: Last but not the least SMEs are largely dependent on their staffs, if you fail in the recruitment process, you fail indeed. SMEs must hire right employees, who give their best and support the enterprise through their performances.

WORKING CAPITALINTRODUCTIONWorking capital is the fund invested in current assets and is needed for meeting day to day expenses. Working capital is the fund invested in current assets. It occupies an important place in a firms Balance Sheet. Working capital financing is a specialized area and is designed to meet the working requirements of a business. The main sources of working capital financing are trade credit, bank credit, factoring and commercial paper.

The firms generally enjoy easy access to the bank finance for meeting their working capital needs. But from time to time, Reserve Bank of India has been issuing guidelines and directives to the banks to strengthen the procedures and norms for working capital financing. It is important to assess the role of bank credit in financing working capital needs of firms.

Working capital is that portion of a firms capital which is employed in short term operations. Current assets represent Gross Working Capital. The excess of current assets over current liabilities is Net Working Capital. Current assets consists of all stocks including finished goods, work in progress, raw material, cash, marketable securities, accounts receivables, inventories, short term investments, etc. These assets can be converted into cash within an accounting year. Current liabilities represent the total amount of short term debt which must be settled within one year. They represent creditors, bills payable, bank overdraft, outstanding expenses, short term loans, etc.

The working capital is the finance required to meet the costs involved during the operating cycle or business cycle. Operating cycle is the period involved from the time raw materials are purchased to the time they are converted into finished goods and the same are finally sold and realized. The need for current assets arises because of operating cycle. The operating cycle is a continuous process and therefore the need for current assets is felt constantly. Each and every current asset is nothing but blockage of funds. Therefore, these current assets need to be financed which is done through Working Capital Financing.

There is always a minimum level of current assets or working capital which is continuously required by the firm to carry on its business operations. This minimum level of current assets is known as permanent or fixed working capital. It is permanent in the same way as the firms fixed assets are. This portion of working capital has to be financed by permanent sources of funds such as; share capital, reserves, debentures and other forms of long term borrowings. The extra working capital needed to support the changing production and sales is called fluctuating or variable or temporary working capital. This has to be financed on short term basis. The main sources for financing this portion are trade credit, bank credit, factoring and commercial paper. It is in this context that bank financing assumes significance in the working capital financing of industrial concerns.

WORKING CAPITAL FINANCING BY BANKSA commercial bank is a business organization which deals in money i.e. lending and borrowing of money. They perform all types of functions like accepting deposits, advancing loans, credit creation and agency functions. Besides these usual functions, one of the most important functions of banks is to finance working capital requirement of firms. Working capital advances forms major part of advance portfolio of banks. In determining working capital requirements of a firm, the bank takes into account its sales and production plans and desirable level of current assets. The amount approved by the bank for the firms working capital requirement is called credit limit. Thus, it is maximum fund which a firm can obtain from the bank. In the case of firms with seasonal businesses, the bank may approve separate limits for peak season and non-peak season. These advances were usually given against the security of the current assets of the borrowing firm.

BASIC PRINCIPLES OF LENDINGCredit Appraisal is the process by which a lender appraises the technical feasibility, economic viability and bankability including creditworthiness of the prospective borrower. Credit appraisal process of a customer lies in assessing if that customer is liable to repay the loan amount in the stipulated time, or not. Here bank has their own methodology to determine if a borrower is creditworthy or not. It is determined in terms of the norms and standards set by the banks. Being a very crucial step in the sanctioning of a loan, the borrower needs to be very careful in planning his financing modes. However, the borrower alone doesnt have to do all the hard work. The banks need to be cautious, lest they end up increasing their risk exposure. All banks employ their own unique objective, subjective, financial and non-financial techniques to evaluate the creditworthiness of their customers. In the credit appraisal process, the decision maker attempts to find answers to two questions. First, whether the entrepreneur requires funds and also what are his credentials. If the answer to the first question is positive, the second question is all about the extent of his requirement and the ways and means to fund the requirements.

The bank assesses credit risk of any borrower based on the 5 "C's" of Credit:

1. Capacity:Capacity to repay is the most significant of the five factors. The lender will have to determine the sources of income that the applicant possesses to repay the loan. The main consideration will be cash flow generated from the business. The lender will also consider contingency sources of income i.e., marketable securities, money market accounts and other assets that can be quickly liquidated into cash.2. Capital:Capital is the money that has been invested by the business owner into his/her business. The amount of invested capital by the owner is indicative of the owner's stake and confidence in the viability of his/her business.3. Collateral:Collateral is pledged assets to guarantee the security of a loan. Collateral is deemed as a second source of income in the event that the borrower cannot repay the loan. Assets that are typically accepted as collateral are fixed assets of a business i.e., equipment, plant and property. Banks typically will file a UCC (Uniform Commercial Code) lien on collateralized assets. Banks also consider working capital like accounts receivable and inventory, to be feasible sources of collateral. But, typically banks will usually discount the value of working capital (being that the market value is neither fixed nor certain) at a certain percentage of estimated market value.

4. Conditions:Conditions focus on the intended purpose of the loan. How will the proceeds from the loan be utilized i.e. to purchase equipment, working capital? Will the use of the loan contribute to the future economic growth of the business? Also banks consider the local market and economic conditions both within your industry and other industries that affect your business e.g., your suppliers and customers5. Character:Character is the personal impression that a prospective borrower makes to a potential lender or investor. This is the more subjective of the five credit factors. A person's educational background, industrial experience and credit history with other creditors will be considered.

PROBLEMS IN LENDINGBanks have to ensure that the lending process is extremely foolproof and safe. Any default in payment of the loan amount will result in increasing Non Performing Assets. Banks are very concerned about adding credit risk exposures to commercial loan portfolios. A recession creates enormous market challenges for SMEs. Bankers need to develop an enhanced sense of confidence in the management and business prospects of an SME before it will extend credit. Bankers actively seek SMEs that are run by focused and capable managers. SMEs that can demonstrate effective risk management skills and an awareness of the challenges and opportunities present in their market will find that bankers are more than willing to extend new credit facilities to them. Bankers will have greater confidence in these SMEs if they understand and believe in the SME business model. Bankers lend with confidence when they understand how businesses can generate sufficient cash flow and profits to pay back loans. Bankers need confidence that credit risk is being mitigated. SMEs enhance banker confidence that they are a good credit risk by demonstrating a strong risk management and corporate governance culture.These obstacles are as follows:a. Informational AsymmetriesInformational asymmetries are always present in enterprise financing transactions. Entrepreneurs typically possess privileged information on their businesses that cannot be easily accessedor cannot be accessed at allby prospective lenders or outside investors. This leads to two problems. First, the lender/investor may not be able to differentiate adequately between high quality and low quality companies and projects. In that case, price variables (i.e. interest rates) may not work well as a screening device, because high interests may lead to an excessively risky portfolio. Second, once the lenders/investors have supplied the funding, they may not be able to assess whether the enterprise is utilizing the funds in an appropriate way. To mitigate these problems, bankers and outside investors may adopt precautionary measures, such as requiring that financing be collateralized. Ultimately, they may simply turn down the request for financing. Informational asymmetries tend to pose more severe problems for SME, than for larger business. The information that SME can realistically provide to external financiers (in the form of financial accounts, business plans, feasibility studies, etc.) often lacks detail and rigor. This problem is often aggravated by the low level of education of small entrepreneurs, who may not be in the position to adequately articulate their case. This problem is particularly acute in developing countries. The information supplied to bankers and outside investors by family-owned SME is often not fully accurate and realistic, and opaque behavior may prevail. Under these conditions, outside financiers tend to adopt a very cautious attitude towards SME, and either reduce the amount of financing sought or refuse it altogether.

b. Risk ProfileAnother approach ascribes the difficulties faced by SME in accessing finance to their higher risk profile. Bankers regard SME as riskier enterprises for a number of reasons. First, SME face a more uncertain competitive environment than larger companiesthey experience more variable rates of return and higher rates of failure. Second, SME are comparatively less equipped in terms of both human and capital resources to withstand economic adversities. Third, there is the problem of inadequate accounting systems, which undermines the accessibility and reliability of information concerning profitability and repayment capacity. In developing countries, there is the added problem of a more volatile operating environment, which has a negative impact on the security of transactions. There is a greater risk that lenders/investors will not get paid, or that assets will not be properly registered.

c. Transaction CostsIrrespective of risk profile considerations, the handling of SME financing is an expensive business. The cost of appraising a loan applicationor of conducting a due diligence exercise in view of a possible equity investmentis largely independent from the size of the financing under consideration. For all practical purposes, the following costs are fixed: (i) administrative costs; (ii) legal fees; and (ii) costs related to the acquisition of information, such as the purchase of a credit profile from a specialized agency. In the case of smaller loans or investments, it is more difficult to recoup these costs. Similar considerations apply to the costs that outside financiers must incur after disbursement, when conducting field inspections, or attending board meetings. Again, the problem is more severe in developing countries for the following reasons: (i) the lack of adequate management information systems in financial institutions; (ii) the undeveloped state of the economic information industry; and (iii) the poor state of certain public services, such as the registration of property titles and collaterals. To some extent, the problem can be solved by raising the cost of financing through a higher interest rate or closing fee. This is indeed the approach adopted by many micro lending schemes, but it is possible only up to a certain point.

d. Lack of Collateral In the case of debt financing, lenders typically request collateral in order to mitigate the risks associated with the moral hazard. The lack of collateral is probably the most widely cited obstacle encountered by SME in accessing finance. The amount of collateral required in relation to the loan size is a measure frequently adopted to empirically assess the severity of the financing gap. In some cases, the enterprise may be unable to provide sufficient collateral because it is too newbecause it is not firmly enough established. In some cases, the lender may deem the collateral insufficient in view of the size of the loan requested. In other words, the proposed expansion project may be too large in comparison with the current size of the firm. In other cases, the collateral may be insufficient simply because the managers-owners tend to siphon off resources from the company for personal or other purposes.

Demand-side ConsiderationsThe behavior of financial institutions is not the only reason that SME have problems accessing financing. Constraints on the demand side also have an impact. Indeed, while SME advocates loudly lament the inaccessibility of external finance, bankers and venture capitalists often decry the shortage of bankable or investable firms. In this connection, the following three factors play a significant role:a. Poor Quality of ProjectsOne demand side constraint has to do with the quality of projects submitted for financing, which is often well below minimum standards. The poor quality of projects is frequently invoked as an excuse by conservative bankers, but the problem is often acknowledged also by independent parties, such as members of the scientific community. b. Inability to Exploit Existing OpportunitiesA second constraint is that promoters are often unable to make the best use of available opportunities, irrespective of the intrinsic quality of the projects. This relates not only to their limited ability to convincingly articulate business ideas, but also to the unwillingness of many small entrepreneurs to waste time in dealing with financial institutions. Certainly, there are examples of promoters who have been able to cultivate a strong relationship with venture capitalists or business angels, and who have been able to gradually build a relationship of trust and familiarity that could compensate for other factors. However, in many cases, high tech promoters tend to concentrate exclusively on technical aspects and are not inclined to invest time in creating financing opportunities. Even in the case of well-established businesses, there are indications that knowledge of financial instruments is limited6. Business associations and incubators can sometimes help in overcoming this attitude, but so far, this has not always been the case.c. Negative Attitude towards Outside InvestorsA third problem has to do specifically with equity financing and relates to the unwillingness of enterprises to relinquish control over the company to outsiders.

PRODUCTS OFFERED TO SMEs

For running an establishment two types of capital are required: 1. Fixed Capital: Money for acquiring fixed assets such as land, building, equipment, etc. 2. Working Capital: Money for purchasing/Stocking raw materials, payment of salary, power etc. and for financing the interval between the supply of goods and receipt of payment post sales i.e. finance to meet the costs involved during the operating cycle or working capital cycle.

The following are the PRODUCTS with the company to fund the SMEs. A. Fund Based B. Non-Fund based.

WORKING CAPITAL

FUND BASED

NON FUND BASED

FUND BASED: The lending of funds can be by way of Demand Loan repayable on demand or Term Loan repayable over a period of time at agreed intervals. It can also be by the way of Overdraft where credit limit up to the amount to be lent is set in the current account or a Cash Credit account, where against the security of stocks or receivables a limit up to sanctioned level of lending is made available to the borrower in the form of running account allowing withdrawals up to the limit as per his requirement. Lending can also take the form of Bill Discounting where the bank lends against bill of exchange drawn in favour of the borrower but payable at a future date by placing the amount of the bill less discount charges at the disposal of the borrower by discounting the bill.

Overdraft When a customer maintaining a current a/c is allowed to more than the credit balance in the account, such facility is called as an overdraft facility. At the request and requirement of the customer temporary overdrafts are allowed. However against securities, regular overdraft limits are sanctioned. Salient features of this type of account are as under:

a) Overdraft is a running account and hence debits and credits are freely allowed. b) Interest is applied on daily product basis and debited to the account on monthly basis. c) Overdrafts are generally granted against the security of government securities, shares & debentures, LIC policies and bank's own deposits etc. and also on unsecured basis. d) Temporary overdrafts should be allowed only on written request of the customer. A letter of recording should be obtained from a customer when a temporary overdraft is granted to him. However, temporary overdrafts should be granted sparingly to meet the short term requirements of customers. e) In case it is decided to withdraw/reduce overdraft facility to the customer, sufficient notice of the same should be given to the customer.

Cash Credit A cash credit is an arrangement to extend short term working capital facility under which bank establishes a credit limit and allows the customer to borrow the money upto a certain limit. The bank sanctions the limit called cash credit limit to each borrower upto which he is allowed to borrow against the security of stipulated tangible assets i.e. stocks, book debts, etc. The customer need not draw at once the whole of the credit limit sanctioned but can withdraw from his CC account as and when he needs the fund and deposit the surplus funds from the sales proceeds, etc into the account. Besides this the facility of frequent and unrestricted transactions is available. Interest is calculated on daily product basis and for the credit balance lying in the cash credit account, no interest is payable. Salient features of cash-credit system are as under:

a) Sanction of limit: Cash-Credit limit is sanctioned after taking into account several factors detailed later in the product note. The drawings are restricted up to the sanctioned limits or available Drawing Power (whichever is lower) and should be only for the purposes for which the limit has been sanctioned.

b) Running account: A cash-credit account is an active running account. There are no restrictions as regards number of debit and/or credit transactions in the account. It is expected that all sales/ purchase/other transactions of the borrower should be routed through this account. In fact a healthy chum rate in the account to be encouraged, the account may move freely between debit and credit balances as well.

c) Repayment: Cash-credit facility is technically repayable on demand and there is no specific date of repayment. Quarterly behavior scoring shall indicate the health of the account and a annual review to be conducted to decide on account renewal.

d) Application of interest and service charges: i. Interest is calculated on daily product basis, applied on calendar monthly basis ii. For credit balance lying in cash-credit account, no interest is payable as cash-credit account is in nature of current account. iii. Service charges as per current account rules are to be levied.

e) Calculation of drawing power: Based on the value of security charged to the bank and other applicable factors, the stipulated margin is reduced and the advance value is calculated subject to overall limits. No drawings in cash-credit accounts beyond the drawing power should be allowed. However, interest and other charges may be force debited exceeding drawing power. Changes in drawing power are done on a monthly basis based on the stock/debtors statements submitted by the borrower.

Demand Loan A demand loan is a loan sanctioned for the period upto 35 months repayable on demand. The loan is disbursed by way of single debit to the account. The amount needs to be repaid in installments. Salient features of demand loan are as follows:

a) Further debits: Demand loan is not a running account and as such no further debits to an account are made subsequent to the initial advance except for interest, cheque bounce charges and other sundry/ incidental charges.

b) Further credits: No restrictions on credits in the account as they would go towards repayment of the demand loan outstanding.

c) Repayment: Although all demand loans are payable on demand, repayment schedule is fixed by way of Equated Monthly Installments. Lump sum payments are also allowed.

d) Interest: Interest is calculated on debit products on daily product basis and applied on calendar monthly basis.

e) Granting of additional loan: i. A fresh loan account should be opened for every new advance sanctioned and a new DP Note be taken. ii. When a further loan/facility is proposed to be sanctioned against the same security or to the same borrower, the existing facility nature and the behaviour thereof must be documented in the CAM (Credit Approval Memo).

Term Loan A term loan is an advance allowed for a fixed period either in lump sum or in installments and which is repayable according to a schedule of repayment as against on demand and at a time. a) Period: A term loan is granted for a period exceeding 3 years but not exceeding 5 years. b) Purpose: Term loans are generally granted to meet the need of capital expenditure i.e. acquiring of fixed assets like land, building, plant & machinery etc. for the purpose of setting up of new units or expansion, modernization, renovation, replacement of existing units, adding more bays in the service station, more floors in a departmental store etc.

c) Repayment: A monthly repayment schedule is fixed and accordingly loans repaid in installments. Interest: Interest is as per the EMI schedule calculations.

d) Security: Term loans are granted against the security of immovable properties, plant & machinery, vehicles, acceptable liquid securities, etc.

Bill Purchase/Discounting This represents advances against the bills of exchange drawn by the customers on their clients. Bills are either purchased or discounted. Demand bills are purchased and usance bills are discounted. Bills may be clean or documentary. Bills accompanied by the title of the goods are called documentary bills and bills without such documents are called clean bills. The seller of the goods draws the bill lf exchange on buyer, as per payment terms of the goods supplied. Such bills can be routed through the banker of the seller to the banker of the buyer for effective control. Demand bills: When the bill of exchange is made payable on demand or sight, such a bill is called Demand bill. The buyer is expected to pay the amount of the bill immediately at sight. Usance Bills: When the bill is drawn payable after certain period or on a specified date, the bill is called Usance bill. The bill is presented to the buyer once for acceptance, when he accepts to pay the bill on due date and on due date the bill is presented again for payment. Bill Purchase facility is extended against the clean demand bills whereby the bank lends money to the payee of the cheque or the draft and to the drawer of the bills by purchasing the same against tendering of such bills by the payee or drawer. The bank in turn sends the bills for collection, preferably to its own branch at the place of drawee or its correspondent bank or to the buyers bank.

Bills discounting facility is extended against the Usance bills. In such cases, the seller tenders the usance bill drawn by him usually along with documents to title to goods, to his banker who discounts the bill i.e. levies discount charges for the unexpired portion of the duration of the bill to collecting bank at the centre of the drawee either to its own branch or drawees bank, with instructions to release the documents to the title against acceptance and thereafter, to recover the bill amount on due date. Sometimes the accepted Usance bills are also tendered and discounted by the bank.

Export Finance Export finance is broadly classified into: 1. Pre-shipment finance and 2. Post-shipment finance

Pre-shipment finance: Financial assistance extended prior to the shipment of goods shall fall under pre shipment finance. Post-shipment finance: Financial assistance extended subsequent to the shipment of goods shall fall under the purview of post shipment finance.

NON FUND BASED: There are certain types of advances which do not involve deployment of funds at least in the initial stage. These are called Non-Fund Based Credit. A Performance Guarantee issued by the bank on behalf of a customer to third party for fulfillment of terms of contract, Letter of Credit issued by the Bank on behalf of its customer favouring the third party in India or abroad is some of the examples of this type of finance. Even though funds are not involved at the initial stage, bank is taking risk, and on failure of its client to fulfill terms of guarantee or letter of credit, we will have to pay out funds to the beneficiary on behalf of the customer and recover it later from him.

Bank Guarantee We come across a guarantee in two capacities. One as a beneficiary when somebody guarantees the payment of debt of banks borrower in case of default and the other as a guarantor when the bank itself promises to pay the dues or discharges the liabilities of its customers in favor of a third party. While in former case bank is a creditor and in the latter case bank is the debtor.

Types of Guarantees: Guarantees issued can be broadly classified into two categories viz. Advance and Performance Bank Guarantee A. Advance Guarantee: The bank takes the guarantee on behalf of the customer that, the customer will execute the contract. If the customer fails then the bank is responsible for making the payment under the guarantee. B. Performance Guarantee: Performance guarantees are issued on behalf of constituents guaranteeing their performance as per the contracts entered into. Hence in the event of the default of the customer to perform the obligations undertaken by him, the bank will make payment under the guarantee.

Letter of Credit Ideally any seller of goods/services would like to receive payment before the delivery of goods / services to a buyer. Similarly the buyer would also like to ensure that the goods/services bought are as per his specifications and deliveries are affected in time, before parting with the money. If the buyer and seller are at two different, far away stations, both the factors cannot be satisfied simultaneously. As a compromise, services of third party as an intermediary are utilized. This intermediary is usually a bank who issues a letter of assurance to a seller at the request of a buyer for payment of cost of goods / services sold on certain terms and conditions. Such an assurance letter is named as a "Letter of Credit". A letter of credit is a written instrument issued by a banker at the request of a buyer (applicant) in favor of the seller (beneficiary) undertaking to honor the documents or drafts drawn by the seller in accordance with the terms and conditions specified in the credit, within a specified time.

Parties to a letter of credit Following are the parties to the letter of credit:

ApplicantThe buyer of the goods / services (borrower)

Opening Bank

The Bank / Branch which lends its name / credit

Advising Bank

Opening bank's branch or another bank at beneficiary's place to whom the Letter of Credit is sent for onward transmission to the beneficiary

Seller/Beneficiary

The party to whom the credit is addressed (seller or supplier of the goods / services)

Negotiating Bank

Opening bank's branch or another bank who negotiates the documents

Confirming BankThe bank adding confirmation to the letter of credit

KINDS OF CREDITS

The letters of credits which banks generally issue are: 1. Inland L/C: An L/C where all the parties to an L/C are located within the country. 2. Foreign L/C: An L/C where either the opener or the beneficiary is located outside the country of issue and arising out of export or import of goods/services out of/into the country of issue.

Other types of letter of credits are as follows: 3. Revocable Credit: A credit that can be cancelled or amended at any time without the prior knowledge of the beneficiary. 4. Irrevocable Bank: It is a definite undertaking of the issuing bank to honour documents strictly drawn as per terms and conditions of credit which cannot be amended or cancelled without the agreement of all the parties to the credit, in particular the beneficiary. In practice, LCs is almost always irrevocable.5. Confirmed Credits: Where credits carry the confirmation of the advising bank. It constitutes a definite undertaking of such confirming bank in addition to that of the opening bank. 6. Transferable Credits: A transferable credit is a credit under which the beneficiary (first beneficiary) may request the bank authorised to pay, incur a deferred payment undertaking, accept or negotiate (the "Transferring Bank"), or in the case of a freely negotiable credit, the bank specifically authorised in the credit as transferring bank, to make the credit available in whole or in part to beneficiary (ies) second beneficiary/beneficiaries7. Acceptance Credits: Where the payment is to be made on the maturity date in terms of the credit. 8. Revolving Credits: Which provide that the amount of drawings made there under would be reinstated and made available to the beneficiary again and again for further drawings during the currency of credit, up to a certain sum subject to certain conditions specified therein.

CREDIT PARAMETERSBusiness banking department at Bank considers the following credit parameters: A) Financial Stability: It analysis the balance sheet of the particular SME. It looks at the profit and loss statement. The relationship manager works out different ratios to find out the progress of the SME. The ratios that are important in this business is as follows:

1) Gross margin ratio: It helps us to find out the efficiency of the company. It enables us to know the impact of the rising cost on the gross profit. 2) Net profit ratio: It enables us to know the profit earning capacity of the firm. If this is rising year on year basis (Y-O-Y), it means that the firm is performing well and so we are less hesitant to give the loan. 3) Current ratio: It helps us to know the liquidity position of the SME. 4) Interest coverage ratio: It enables us to know the interest paying capacity of the SME. If it is good as per industry averages then we are confident in giving loan to such customer as they would be capable enough in paying our interest. It is one of the most important ratios considered by us before giving working capital loan to any SME. 5) Debt Service Coverage Ratio (DSCR): It helps us in knowing the capability of the firm in repaying its principal amount. It is another most important ratio considered by us before giving loan to any of the SME. 6) Debt to Equity ratio: It enables us to know the ratio in which the firm uses debt and equity. 7) Leverage: It enables us to know the level of debt w.r.t the equity. 8) Debtor Days: It enables us to know the debtors collection period. Banks only consider the debtors of less than 90 days. 9) Creditor days: It helps us in knowing the days within which the SME can make payment to its customer. 10) Inventory days: It helps us to know their stock holding period. Bank Considers only the stock of less than 180 days. 11) Return on capital employed: It enables us to know the returns earned by the SME on the total capital employed by them. 12) Current assets to sales ratio: If this ratio is high then it means that the inventory or debtor days have increased and if it is low then it means that the inventory or debtor days have decreased, which is good for the bank.

B) Security: The next important thing the bank looks for is the security that the SME is willing to give. There is primary security and collateral security. The primary security includes hypothecation of stock and book debts and the collateral security includes mortgage of the property. Both these securities are of necessity for any kind of facility that has been availed for. Apart from these securities personal guarantee (PG) by the directors and the promoter is also mandatory. Clients have to be convinced so as to give the personal guarantee as some of them are unwilling to give as they are already giving us the guarantee in the form of primary and collateral security. But personal guarantee is taken so as to be sure that the people applying for the loan have the intention to carry out the business. This is because if the person gives PG then he has the intention to carry out the business and repay the money back to the bank but if he is unwilling to give the PG then even if he may be willing to repay the money back to the bank but bank is not assured that the customer will repay the money back and so bank carries out all the due diligence to be on the safer side. In case of the collateral security the fixed assets is of the SME is mortgaged. The valuation report of the mortgaged property has to be submitted by the SME to the bank. The mortgage property provided could be residential, commercial or industrial property. The value of the hypothecation and mortgage could higher or lower than the value of the facility provided.

C) Banking Details: This is another important aspect that has to be considered by the bank for giving credit. This enables the bank to know following based on the existing facility that the SME have with the XYZ bank: Churning percentage: This helps the bank to know the receipts that the SME routes through the bank. Bank expects minimum churning percentage of 80-90%. For example: MONTHS CREDIT TOTAL OF BANKSTATEMENTSALESCHURNING (%)

MARCH 2013850100085%

Churning= (Credit Total/ Sales)*100 Overdrawing: It means the amount overdrawn by the SME over and above the facility granted by the bank. For example, if the facility provided was RS. 500 lacs and money utilized is Rs. 501 lacs then the amount overdrawn is Rs. 1 lacs. Repayment Track: It enables the bank to know the repayment track record of the bank. Bank expects it to be prompt. LC devolvement: LC is devolved when the SME fails to repay the amount to the bank on maturity. Bank expects that the devolvement should be Nil. Cheque conditions: It enables the bank to find out whether any of the cheque issued by the SME has ever bounced.

D) Debtors and Creditors: It forms very important part in deciding about the credit that has to be given to the SME. If the debtors of the SME is reputed and the value to be received from that debtor is a huge amount then bank is not hesitant in giving loan to that particular SME and in the same way if the suppliers are big and reputed firms giving credit to the SME then bank is sure about the credibility of the SME and are not hesitant in sanctioning the loan amount. Bank prefers to have top five suppliers and customers list from that particular SME.

E) Business Model: It gives details about the business carried out by the firm, the technology used by them, turnover achieved by them, etc. It also gives details about the employee strength of the firm along with the composition of the skilled and unskilled employees. It gives details about the process followed by the firm in giving the final output. Most importantly it gives information about the operational factors such as availability of raw materials, price fluctuations in raw material, product range, power availability and skilled staff. This is considered to be important because it reflects the profitability of the firm. For instance if the prices of the raw material increases then the margins of the business is expected to be impacted if there are large number of competitors in the market and thus will have an impact on the interest coverage ratio.

F) Industry Analysis: It enables the bank to know the growth prospect available in the particular industry.

PROCESS OF SME FINANCINGSOURCING

MEETING THE CUSTOMER

INITIAL DOCUMENT COLLECTION

PRINCIPAL APPROVAL

DOCUMENT COLLECTION AS PER LOGIN CHECKLIST

PROPOSING TO CREDIT DEPARTMENT WITH BUSINESS APPROVAL

JOINT MEETING BETWEEN RM, CUSTOMER AND CREDIT DEPARTMTNET

CREDIT DECISION

SANCTION

DISBURESMENT IN LIASON WITH OPERATION DEPARTMENT

PROCESS OF SME FINANCING1) SOURCING:LEAD GENERATION is the most important function of Business Banking. It is the preliminary stage of SME financing. The process of sourcing is carried out in four ways at bank.

a) Branch Networks:Every RM is tagged to a few branches. The RM is based out of these branches. The RM interacts with the branch staff (Branch Manager, Sales Manager, Trade and Forex RM, Business Development staff) and explains to them the various business banking products. The best way to source customers is to tap the existing relationships of the branch i.e customers who already hold savings or current accounts with the bank or is taking any other banking services. Cross Selling techniques are used under this method. These customers could also be all together a new client who approaches the banks for the needs of working capital or walk in customers.

b) Cold Calling:Cold Calling is the art of approaching someone, professionally, openly and meaningfully, with a sensible proposition. Cold calling typically refers to the first telephone call made to a prospective customer.Also a popular method used by many RMs. An authentic data base is made and calls are made to prospective clients. Another method of cold calling includes sourcing clients on fields. A RM would visit a company and ask for working capital requirement arbitrarily to source clients. This is an indirect method of sourcing clients.

c) Existing Client References: Each Relationship Manager (RM) is given their own territory wherein they have to tap the SMEs. Once they are well established in their sector they start to form a chain of client in the same industry with reference of an existing client. This method of sourcing clients is called Referencing. The RM networks through the existing client to get information about new clients. The positive aspect of this method is that the RM gets primary information about the new client and he is well informed about the credibility of the client due to the intense network. The negative aspect of this method is that the client base of the RM gets restricted to a particular sector. Any macro impact on the sector therefore affects the overall client base of the RM.

d) Consultants: Another popular method used by the RMs are through Consultants. There are various consultants in the market mostly known as Direct Selling Agents who help the clients who are in need of working capital financing get in touch with the Relation Manager. These Direct Selling Agents are mostly reputed Chartered Accountants who offer consultancy services to the clients and help the bank generate new business. These consultants are aware of the market conditions and help in the smooth process of SME financing.

2) MEETING THE CUSTOMER:After the Relationship Manager gets the leads through various methods of sourcing they conduct an initial meeting with the client. At this stage only the Relationship Manager meets the client. The Relationship Manager understands the history of the business, product line and the business model from inception. A detailed review of the background of the business, promoter etc is undertaken. The RM also understands the current position of the business, the profitability and the future growth prospects of the client. By conducting a comprehensive analysis of the business model of the client the RM also guides the client on the best mix of products and services that the bank offers and is ideal for the client. The RM also strives to understand the problems the customer is facing with the existing banker.Initial talks about the current bankers if any are also undertaken and the process of loan takeover is discussed. The security cover, collaterals obtainable from the client and the percentage of collaterals against the limits are also understood by the RM and the client. Typically the following aspects are covered in the first meeting with the client: History of Business History of Promoter Current Position of Business Problem with existing bank Reasons and Need of Working Capital requirements Security Cover Collaterals Banking Takeover from existing banker

3) INITIAL DOCUMENT COLLECTIONThe following documents are collected and analyzed by the RM to understand the financial position of the client. KYC Documents Latest Sanction letter of existing bank Last three years audited balance sheet and profit and loss A/c Bank statements for last six months

Reference Checks: At this stage the RM also conducts a reference check of the client in order to understand the credibility and goodwill of the customer in the market.

4) PRINCIPAL APPROVALThis stage of approval is the initial or the preliminary approval. Once the RM conducts the meeting and collects the documents RM will analyze the case as to whether the particular case is doable or not. This case is discussed by the RM with his superiors and team to analyze its feasibility. If he finds the case to be doable based on its financials and other criteria the he starts working on the preparation of the Credit Assessment Monitoring (CAM).

5) DOCUMENT COLLECTION AS PER LOGIN CHECKLISTOnce the RM is convinced about the proposal and finds the case to be feasible he further asks for the following documents to take the proposal to the next stage. The RM prepares an entire file for that one particular case ensuring all the following documents. The following lists of documents are collected: Company Profile including details of product, shops, business model. Background on promoters & directors of the company. Duly filled and signed copies of Net worth Statements of all Directors and Guarantors in banks Format. Month wise Sales and Purchase figures. Last 6 months Stock statements. Last 12 months VAT Returns copies along with VAT audit report. List of Fixed Asset with Written Down Value (WDV). List of Directors and Shareholders along with Shareholding pattern on companys letter head. (Duly stamped and signed by Director or authorized signatory). Stock and property insurance copies. Top 10 debtors and creditors along with company name, contact person name and contact numbers and Sales and Purchase amount. Export Import code certificate copy. (If Applicable) CRISIL Report, Export house etc certification copy (if any with the company). Pollution control board certificate if applicable. (Latest copy). Details about strength of Staff bifurcated into Marketing, Finance, Accounts, and Factory in charges etc. List of Countries where company is exporting and also countries list from where company is importing. (If Applicable). Photocopies of property documents along with Share certificates, Latest Tax paid receipts, Latest Maintenance receipts, Approval Plan Copy, CC copy and OC copy etc. Photocopies of all the chain agreements copies.

6) PROPOSING TO CREDIT DEPARTMENT WITH BUSINESS APPROVAL

At this stage the RM prepares the Finspread, understands financial ratios and finalizes the CAM note. The RM fills in various financial and numerical details of the company in the Finspread and rolls out various ratios and policy compliance parameters of the client. The RM also prepares a CRR Calculation Sheet wherein the RM rates aspects such as:1) Suppliers 2) Customers3) Liquidity4) Leverage5) Sales Growth6) PBDIT/Sales7) DSCR8) Integrity9) Family standing/History10) Financial Standing11) Management Competence12) Management Standing13) Employee Quality etc.CREDIT ASSESSMENT MONITORING (CAM) After analyzing all these aspects, the CAM is prepared for the particular case. CAM is a very crucial document for the risk analysis since it provides comprehensive details of the case.

PROPERTY ESTIMATORThe role of estimator is also crucial at this stage. He gives his valuation of the proposed collateral. This helps the bank evaluate the appropriate value of the collateral provided by the customer. The CAM is sent to the credit department who goes through the proposal made by the RMs.

RISK ANALYSIS A bank faces different types of risk while lending to a customer.LENDING RISKS FOR BANK1) Credit RiskCredit risk refers to the probability where the counterparty or the borrower may fail to fulfill its obligations as per the agreed terms. It involves inability or unwillingness of a borrower or counter party to meet commitments in relation to lending, trading, hedging, settlement and other financial transactions.Credit risk faced by the bank depends on both external and internal factors. External factors are those which are out of the control of banks and internal factors are those which can be easily controlled by the bank. In case if the loans have to be given to the client who is into the manufacturing of the chemicals, then we will have to consider the raw materials included in manufacturing the final product. This is because if the prices of the raw materials are facing lot of volatility then this will affect the margin of our client and may have the impact on the amount the interest and principal repayment of the client. Such a risk is known as external risk and the banks have to mitigate for the same.

SOURCES OF CREDIT RISK1. Direct lending risk: It lies in the products like loans and advances, overdrafts, bills discounted, etc. It is the risk that the dues will not be paid on time.2. Contingent lending risk: It lies in products like letters of credit, guarantees, etc. It is the risk that contingent exposures get converted into actual obligations and that these obligations may not be repaid on time.3. Issuer risk: It is the risk of financ