Working Capital Management
Working Capital Management
Working Capital Management
Working Capital
Management
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Working Capital
ACKNOWLEDGEMENT
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PREFACE
To start any business, First of all we need finance and the success
of that business entirely depends on the proper management of
day-to-day finance and the management of this short-term capital
or finance of the business is called Working Capital Management.
Working Capital is the money used to pay for the everyday trading
activities carried out by the business - stationery needs, staff
salaries and wages, rent, energy bills, payments for supplies and
so on.
I have tried to put my best effort to complete this task on the basis
of skill that I have achieved during the last one year study in the
institute.
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1.4.1 INTRODUCTION:
Research methodology is a way to systematically solve the research
problem. It may be understood as a science of studying now research is
done systematically. In that various steps, those are generally adopted
by a researcher in studying his problem along with the logic behind
them.
It is important for research to know not only the research method but
also know methodology. The procedures by which researcher go about
their work of describing, explaining and predicting phenomenon are
called methodology. Methods comprise the procedures used for
generating, collecting and evaluating data. All this means that it is
necessary for the researcher to design his methodology for his problem
as the same may differ from problem to problem. Data collection is
important step in any project and success of any project will be largely
depend upon now much accurate you will be able to collect and how
much time, money and effort will be required to collect that necessary
data, this is also important step. Data collection plays an important role
in research work. Without proper data available for analysis you cannot
do the research work accurately.
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The primary data is that data which is collected fresh or first hand, and
for first time which is original in nature. Primary data can collect through
personal interview, questionnaire etc. to support the secondary data.
The secondary data are those which have already collected and stored.
Secondary data easily get those secondary data from records, journals,
annual reports of the company etc. It will save the time, money and
efforts to collect the data. Secondary data also made available through
trade magazines, balance sheets, books etc.
This project is based on primary data collected through personal
interview of head of account department, head of SQC department and
other concerned staff member of finance department. But primary data
collection had limitations such as matter confidential information thus
project is based on secondary information collected through five years
annual report of the company, supported by various books and internet
sides. The data collection was aimed at study of working capital
management of the company.
Project is based on
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The scope of the study is identified after and during the study is
conducted. The Study of working capital is based on tools like trend
Analysis, Ratio Analysis, Working capital leverage, operating cycle etc.
Further the study is based on last 5 years Annual Reports of Jain
Irrigation Systems Ltd. And even factors like Competitor’s analysis,
industry analysis were not considered while preparing this project.
This project has completed with annual reports; it just constitutes one
part of Data collection i.e. Secondary. There were limitations for primary
data Collection because of confidentiality.
Also it was difficult to collect the data regarding the competitors and their
Financial information. Industry figures were also difficult to get.
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2.0 Introduction:
It's a fact of any business; company needs capital to conduct business. Of course
the best way to obtain it is through sales. Sometimes, however, companies need
other, more immediate sources. Different sources may be appropriate for different
stages of growth. Start-ups often rely on family members, friends, venture capitalist
or local associates. Once companies have achieved a financial track record,
companies can turn to other sources such as Asset Based Lending or Commercial
Loans.
Broadly funding classified in to two categories i.e. Equity base funding and debt
funding. Following chart will explain about the types of funding.
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Working Capital
Another type of asset based lending rapidly gaining popularity is factoring. Factoring
is defined as the purchasing of a company's accounts receivable on a non-recourse
basis. Asset based lending may be the best source for working capital for companies
in turnaround where traditional bank loans may not be available or for new and
rapidly growing companies where high levels of growth cause the business cycle to
outpace the collection of receivables.
Long term debt is one of the initial financing avenues a company should pursue.
Most long term debt takes on the form of a loan where the interest and part of the
principal are paid back in equal installments over the life of the loan. Some of the
sources for business loans include the following:
commercial banks
government sponsored loan programs
small business investment companies
private lenders
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Working Capital
Thus the need for working capital arises from the prevalence of credit in business
transactions, need to fund manufacturing and support and to account for the
variations in the supply of raw material and demand for finished goods.
Gross working capital refers to the firm’s investments in current assets. Current
assets are the assets which can be converted into cash within an accounting year
and include cash, short-term securities, debtors, bills receivable and stock
(inventory).
Net working capital refers to the difference between current assets and current
liabilities. Current liabilities are those claims of outsiders which are expected to
mature for payment within an accounting year and include creditors, bills payable
and outstanding expenses.
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Working Capital
Net working capital can be positive or negative. A positive net working capital would
arise when current assets exceed current liabilities. A negative net working capital
occurs when current liabilities are in excess of current assets.
The above characteristics render limit based financing from banks ideal for working
capital financing. This is because the client is charged interest only on the average
outstanding utilized and is saved with the bother of reinvesting short term surpluses
arising out of low working capital utilization at a point in time.
Further since the transactions of the business are generally routed through a current
account with a bank, availing a credit limit from the same bank is really convenient.
Thus, working capital requirements are generally financed through limit based
financing by banks.
The appraisal of bank finance for working capital involves the following steps:
For a systematic and proper estimation of the gross working capital requirements of
a firm, it is essential to identify its various components and analyze them in detail
and for that it is important to understand the operating cycle.
electricity, water, rent. Etc. are also incurred during the period of processing. All this
requires funds/capital.
Once the goods are produced, it may not be sold immediately and it may have to be
stored in a go down for some days before they are sold. Storing of such finished
goods involves cost of material used in such finished products, labour and other
manufacturing expenses incurred in producing them, etc. It is not necessary that all
the goods will be sold in cash.
Some goods will be sold on credit. Till such time sale proceeds are not realized,
funds are blocked in such receivables. Finally, when the sales proceeds are realized,
the funds are again used to procure material, etc. as above and the whole
process/cycle starts all over again. The total time taken from the purchase of
material, till realization of sale proceeds is called the operating cycle and the amount
of capital/funds required to sustain this cycle is called the gross working capital.
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OPERATING CYCLE
Here the total operating cycle will be the summation of the entire period, for trading
house procurement of raw materials and production process would not be included
in to the operating cycle.
For a trading house as well as a producer is very important to understand as to how
many times the operating cycle repeats it self, this is quiet important while calculating
the Limit for raising finance especially working capital finance.
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= (L + T + U) C.
365
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Costs of carrying too much inventory Costs of carrying too little inventory
Opportunity cost of Stock Our Costs
foregone interest;
Warehousing costs; Lost Sales
Damage and pilferage; Delayed Service
Obsolescence; Ordering Costs
Insurance. Loss to Quantity discounts.
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Debtors (Accounts Receivable) are customers who have not yet made payment for
goods or services which the department has provided. The objective of debtor
management is to minimize the time-lapse between completion of sales and receipt
of payment. The costs of having debtors are:
opportunity costs (cash is not available for other purposes);
Bad debts.
Debtor management includes both pre-sale and debt collection strategies.
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Good cash management can have a major impact on overall working capital
management.
Cash Forecasting
Good cash management requires regular forecasts in order for these to be materially
accurate; they must be based on information provided by those managers
responsible for the amounts and timing of expenditure. Capital expenditure and
operating expenditure must be taken into account. It is also necessary to collect
information about impending cash transactions from other financial systems, such as
creditors and payroll
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Working Capital gap, can either be financed from own resources or by banks, for any
financial institution it is an issue of key importance to allocate resources in such a
manner that maximum returns can be fetched, also to acquire adequate and
lucrative resources is an issue of prominent concern.
These working capital requirements of Adani Exports are financed mainly by banks.
Banks and financial institutions fund this working capital gap at AEL through two
broad modes:
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1. Term Loans:
Term Loans are generally taken to acquire capital assets. The repayment is in the
form of either installments (Actual + Interest) or EMI. Repayment of Term Loan is
through future earnings from the Capital Asset acquired. The purpose of the term
loan is defined well in advance.
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Cash Credit Facility is generally granted under the running account facility. Availed
for maintenance of inventory and day to day business activities;
Cash Credit Facility, or CC limit is generally used to meet a major part of working
capital requirement. Cash Credit Facility can broadly be bifurcated in two segments.
1. Cash Credit – Pledge
2. Cash Credit – Hypothecation
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4. Discounting Of Bills:
A borrower obtains credit from banks against the bills he possesses. The bank here
discounts the bill i.e. purchases the bill after analyzing the credit worthiness of the
drawer. The borrower gets discounted amount of the bill.
(Full amount of bill – Discount charges of bank) = Discounted amount of bill.
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ECGC Guarantee
Most of the banks cover their packing credit advances under 'Packing Credit
Guarantee' of Export Credit Guarantee Corporation of India Ltd. (ECGC). ECGC
issues packing credit guarantees on each exporter individually and also has the
system of issuing a guarantee in favor of the bank on whole turnover basis. Premium
on the guarantee is generally recovered from the exporter. The rates of premium on
individual guarantees are higher in comparison to rates on 'Whole Turnover Packing
Credit guarantee' issued to banks.
It is necessary to obtain this information from the bank as cost of additional premium
for individual guarantee may sometimes be quite heavy depending upon the turnover
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Credit facilities, which do not involve actual deployment of funds by banks but help
the obligations to obtain certain facilities from third parties, are termed as non-fund
based facilities. Non Fund Based Facilities are a sort of written under taking given
by the bank on behalf of the purchaser.
The Non Fund Based limit facilities include two modes of finance.
1. Letter of Credit
2. Bank Guarantee
1. Letter Of Credit:
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The LC transaction occurs between two parties at a time: buyer and seller, buyer
and issuing bank (which authenticates the credit & manages the LC process on
behalf of the seller), advising bank & seller.
Letter of Credit are used for risk control, various protections availed because of LC
are
1. To Protect Against Seller Risk
2. To Protect Against Buyer Risk
3. To Protect Against Country Risk
4. Exchange Control Regimes
5. Import Control Regimes
2. Bank Guarantee:
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Applicant (A) and beneficiary (B) have a business contract. This is the primary
contract. ‘B’ wants to cover against the risk of any non-performance of the
contract by ‘A’. So ‘B’ can ask for a monetary deposit as a cover.
‘A’ is not willing to block his money. So, ‘A’ approaches his Bank with a request to
issue a B.G. in favor of ‘B’. Thus there arises the need for a bank guarantee.
Types of Guarantees
1. Ordinary Guarantee
Financial: Guarantee the customer’s financial worth, creditworthiness,
and his capacity to take up financial risks.
Performance: The guarantee obligations relate to the technical,
managerial, administrative experience and capacity of the customer
(applicant).
The financing limits are granted based on assessment of the working capital
requirement. The assessment factors include various characteristics such as the
nature of industry, industry norms, actual level of activity for the previous year and
the projected level of activity for the subsequent year to arrive at the working capital
requirement. The bank financing limit is thereafter decided on the base of factoring in
margins on the different types of current assets forming part of the working capital.
The Bank Financing Limit is fixed on an annual basis. However, since such limit is
provided to meet specific requirements, utilizing the limits is subjected to the Drawing
Power, which is decided on a monthly/ quarterly basis.
The effective bank financing is therefore to the extent of the lower of:
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Banks exercise extreme caution in lending to first time applicants starting their
business. A first time applicant would be asked for collateral in the form of
land, building or residential property. This would be in addition to a second
charge on the fixed assets of the enterprise. Sequence of steps to avail
working capital
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In case of the larger loans (above Rs. 5 crore in case of most banks), the projections
are generally submitted in the CMA format prescribed by Reserve Bank of India
(earlier mandatory).
Most of the large banks have specialized SSI branches at the industrial
concentrations in the country. These branches are headed by senior executives
often with sanctioning power of Rs. 5-6 crores at the branch. In such instances,
delays for processing the applications at the bank are limited. In fact the stage of in-
principle sanction maybe dispensed with and final sanction accorded on full
appraisal.
In other cases, such processing may take 30-45 days for according In-Principle
Sanction to the project. The newer private sector banks are generally faster in
according such approval. The significance of the in-principle sanction of working
capital is that such sanction is necessary for obtaining term funding from the financial
institutions. While these financial institutions accord sanction to a industry,
The appraisal and final sanction of the request for working capital is based on a
thorough appraisal of the Detailed Project Report (DPR). The traditional banks
generally have specified formats for submission of the DPR. The usual coverage of
the DPR includes:
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The timeframe for a Final Sanction in cases where all the requirements have already
been submitted by the borrowing unit is 90 days from the submission of the
application.
Working capital financing is extended for the current asset build up of a business,
which is linked to its activity level. These assets are mobile (in case of inventory) and
also easily convertible into cash. At best, the banks have a second charge on the
fixed assets of the enterprise and without the power of Seizure (u/s Sec 29 as
available to the state financial institutions) realizing money from the security is time
consuming. Hence, banks pay extremely high importance to the monitoring and
follow-up of the loan.
The system of a current account through which all the transactions are routed acts
as an in-built check on the operations of the borrower. By studying the current
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These include:
This would involve a visit to the storage areas of the borrower, visual inspection
and scrutiny of the stock statements at the spot. Cross-checking these with the
statements given by the client would provide a means of check.
In case of larger loans, Consortium meetings where the operations of the unit are
jointly reviewed are also undertaken.
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Norms were fixed regarding the quantum of various current assets for
different industries (as multiples of the average daily output) and the Maximum
Permissible Bank Financing (MPBF) was capped at a certain percentage of the
working capital requirement thus arrived at.
Working Capital Requirement (WCR)= [Current assets i.e. CA (as per industry
norms) – Current Liabilities i.e. CL] Permissible Bank Financing [PBF} = WCR –
Promoter’s Margin Money i.e. PMM (to be brought in by the promoter)
As per Formula 1: PMM = 25% of [CA – CL] and thereby PBF = 75% of [CA – CL]
As per Formula 2: PMM = 25% of CA and thereby PBF = 75%[CA] – CL
Illustrative Example:
Turnover of a manufacturing unit: Rs. 750 lakh p.a (assumed uniform across the
year)
Assumed value addition norm: 50% (i.e. cost of raw material = 50% of Realisation)
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Promoter Projections
- Work in progress 25
- Finished Goods 60
- Receivables 125
Working Capital
171.82 225.0 171.82
Requirement
Notes:
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Applicable norm (d) is the more conservative of (b) or (c) from the bank’s
point of view.
Formula 1
PMM (Promoter Margin Money) as per formula 1 = 25% of 171.82 lakh = Rs. 42.95
lakh ~ Rs. 43 lakh
Hence, Permissible Bank Finance 1 = Rs. 129 lakh
Formula 2
PMM as per formula 2 = 25% of Rs. 190.6 lakh = Rs. 47.65 lakh
Permissible Bank Financing as per formula 2 = [75% of 190.6 lakh – Rs. 18.8 lakh ]
= Rs. 124.1 lakh
The difference between the 2 methods is Rs. 4.90 lakh (which maybe extended as a
Working Capital Term Loan in case of sick units.
Thus the PMM while being at 25% of the Working Capital requirement 1 could
actually translate to as high as Rs. 225 lakh – Rs. 124 lakh i.e. Rs. 101 lakh
assuming that the promoter projections really reflect his genuine need for working
capital. It should however be understood by the entrepreneur that he ought to keep
his working capital requirements to the minimum (whether or not bank financing is
available) to ensure that his interest burden and capital blocked is kept to the
minimum.
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The Bank Financing Limit arrived above is the Overall limit for the year. The
actual quantum of bank financing that could be availed by the unit at a given
point in time depends upon its drawing power based on its periodical returns
filed to the banker.
When more than one bank joins hands to finance the credit requirements under
participation arrangement to a corporate borrower, it is called Consortium Advance.
The participation of banks enable them to pool their talent and resources to take
credit risk on large scale and to apply uniform standards, terms and conditions etc. in
regard to a credit proposal.
Here, one bank acts as the lead bank or the leader of the consortium, while other
banks are the participating members. Guide lines and rules for governing the
consortium and activities of the same are framed by RBI as well as the member
banks of the consortium. The requirement of the borrower is generally so huge that
one bank individually cannot meet it, thus, various banks come together to fulfill
these requirements. It is upon the borrower and member banks to decide up on
banks entering or leaving the consortium. Banks finance the borrower as per the %
sanctioned to them by the consortium, minimum being 1.50% although the same can
be decided by the consortium.
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Certain key aspects of financing working capital through consortium banks are:
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Sales
Net Working Capital Turnover Ratio:
Net current asset
10
10 9
9 8
8 7
7 6
6 5
5 4
4 3
3
2
2
1
1
0
0 2000-01 2001-02 2002-03 2003-04 2004-05
2000-01 2001-02 2002-03 2003-04 2004-05
The above ratio shows net working capital turnover from the year 2001-2005, the
year 2001 had the net working capital ratio 3.09 times, actual working capital means
combination of net working assets and investment from the total Assets turnover
during the year. Than the company used next year total working capital has
increased 3.43 times but in 2003 the total turnover of company reduced than and
that why the working capital was reduced 3.27 and than in the year 2004 the total
working capital increased due to increased in the efficiency of sales turnover as
same way the total sales turnover still increased in the year 2005 but as we show
from sources total fixed capital increased for purpose of expansion, the working
capital was only 9.54 times.
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360 days
Creditor’s Ratio:
Creditor’s turnover
Creditors Ratio
100
90
80
70
60
50
40
30
20
10
0
2000-01 2001-02 2002-03 2003-04 2004-05
The ratio above shows the credit period days allowed to the creditors by the
company, in the year 2001 the creditor’s ratio was for 74 days this is a high rate and
may result in to impending certain financial burdens on the company maintaining the
credit period. In the next as well the period is considerably high at 86 days. In the
year 2004 the company’s business expanded and company preferred lesser day to
for creditors because payments came regularly against given credit. In the year 2005
it was only 41 days so as good for MNC company concern.
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360 days
Debtor’s ratio :
Debtor’s turnover
Debtors Ratio
140
120
100
80
60
40
20
0
2000-01 2001-02 2002-03 2003-04 2004-05
The debtors ratio is of a very keen importance for an organization as debt receivable
is a main constitute for completion of the operating cycle, and payment made by the
organization. Although there has been a steep increase in the debtors ratio till year
2002-03, with the increased standardization and smoothening of policies, the debtors
ratio has come considerably down and low to a low of 44 from a high of 133 in a
shorter span, this shows the company’s stand on its debts receivable management.
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360 days
Inventory Turn over Ratio :
Inventory turnover
Inventory Ratio
18
16
14
12
10
8
6
4
2
0
2000-01 2001-02 2002-03 2003-04 2004-05
Above chart shows the inventory in hand of company for a particular period of time,
in the year 2001 the company had 17 days for inventory handling ratio, it means
company’s transaction was very fast and company was good at its core business
trading, that have less inventory on hand, than in the year 2002 9 days was ratio of
inventory in that particular year the total turnover was much lower that is why
company could not perform good trading in the year 2002, in 2004 the company
expanded its business and did record trading so some how inventory days increased
to 8 days in the next year even company made double turnover than the previous
years so just increased days 7 of handling inventory on hand .
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1.4
1.2
0.8
0.6
0.4
0.2
0
2000-01 2001-02 2002-03 2003-04 2004-05
This ratio indicates the portion as debt compared to equity. The general or standard
debt-equity ratio is 2:1 equity; maximum Rs. 2 debt fund can be raised against equity
of Re. 1/-.
From the above chart it can be visualized that the company has maintained a
reputed as well as healthy debt-equity ratio. In all these years it never exceeds the
said limit, but here in beginning the ratio was just 1.25 in 2001, than in 2002 it
reduced to 1 moreover in the next year it reduced at its bottom level due to poor
financial position of company just 0.29 in the year 2003, then in the year 2004 it
increased to 0.47, and at finally in 2005 it gains handsomely towards positively 0.96.
This clearly shows the developing trend coming back to the company.
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Operating Cycle
70
63
60
50 50 51
40
30
23
20
10 10
0
2000-01 2001-02 2002-03 2003-04 2004-05
Operating cycle means the difference between the debtor’s payment period, creditor
period, and inventory days; that is the period of payment between all of them. This
ratio is very important for any organization as this clearly shows the days required by
any organization to complete its trading cycle and also gives intuitions about
commencing the new cycle
Here in the year 2001 the operating cycle was for 63 days it means that company
had made all payment and have to receive the same payments as per terms with in
that 63 days, than it seems long terms for the payment of the transaction, in the next
year it reduced to 50 days but in next year when trading was lowest that company
had the cycle of 51 days it shows the typical situation , but the company became
aware at higher stage of that trading level when business expand company had only
23 days period for operate payment of business, than in 2005 on large scale of turn
over the company
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Banks use credit rating to analyze the credit worthiness of any proposed customers
(borrower). And then based up on the credit rating and the risk appraisal the bank
decides up on the rate on interest or the charge to be levied up on a particular
finance. Thus, it is an issue of key concern for any organization to understand the
norms based up on which the banks frame this credit rating policy. Credit Rating
agencies both internal as well as external, pay keen interest and base to certain
macro as well micro environmental elements, this is basically because of the fact
that not just the financials but also the economic and non economic environmental
factors determine the over all credit worthiness of any financial organization, a few of
these most crucial elements are:
Management
Institutional Arrangement
Capital Adequacy and Asset Quality
Resources
Operational Effectiveness
Scalability and Sustainability
Transparency & disclosure
Value Creation and distribution
Banking organizations also look in to various risk and credit policies before framing
their policies. The main concern of any bank before framing the credit ratings is to
analyze and achieve a perfect customer (borrower) whose credit worthiness would
be sound enough to avoid the NPA or risk coherence of the lending. Credit Ratings
most of give ranks or grades to institutions and organizations based up on their
financial and economic feasibility, thus for any organization it is an issue of keen
consideration to understand the credit rating policy of any banking organization.
Other than this key issues considered while framing a credit rating policy for any
banking organization contain the following details:
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Ratio Analysis
1. Current Ratio
2. Debt Equity ratio
3. Return on Net Worth
4. IRR
Statements and Financials
1. Quarterly Information Statements
2. Financial Data as asked for
3. Renewal note and data
4. Projects of Sales and Profits
Suppose that we were trying to determine whether a small company was a good
credit risk and computed the following ratios:
market equity
=. 9 48
book debt
Working Capital
If the Altman Z score cut off for a credit worthy business is 2.7 or higher, would we
accept the following client?
Firm's Z Score
(3.3 x.12) (1.0 x1.4) (.6 x.9) (1.4 x.4) (1.2 x.12) 3.04
All throughout this project, there were several learning experiences, both on floor
and off floor, based up on those learning experiences, certain findings and
suggestions have been laid. It is not possible to list all those valuable information
and knowledge gained from the project, but some of the corporeal knowledge
acquired is listed below:
Findings:
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Learning Outcomes
The two month internship spent at Adani Exports Ltd. has been very informative.
It has given me a very good idea about the corporate culture which is very
different from the student culture. This would help me to get adjusted to the
corporate culture easily in the future.
Important lessons I leant from this two months internship are, importance of
communication skills, punctuality and integrity in the corporate world. Being a
part of big organization for two months, it has given me lot of self confidence. I
have understood the meaning of patience and understood how it helps to build
one’s career. I have tried my best to understand technicalities and mechanism of
various types of Financing in Imports-Exports business.
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5) Suggestions:
Adani Exports Ltd. is going on the right direction from its date of establishment. It has
achieved many milestones in the shorter span of business. Also company have
strong future plan of diversified the business as well as product mix. As the there is
no such problem is given for the study, so there is no special suggestions. Following
suggestions are on the base of observations made during the course of internship
which may help AEL for better governance.
The company should use packing credit in foreign currency instead of Indian
currency loans. In comparison to Indian currency bills, the company should
discount foreign currency bills quickly to restrict itself from the foreign
currency exposure
Regular and diligent meetings with lenders and especially bankers can
increase the understanding of both the parties, and can reduce
misconceptions as well both the parties can easily understand each other’s
demands and requirements.
Application of international rules for accounting and analysis should be
adapted, adhering to credit ratings and formulating requirements in line with
the Basel II rules can reduce the gap between banks assessment and the
company’s assessment.
Company should use correct mixtures of Fund base and Non-Fund base
finance to meet up its working capital requirement. Thus company can reduce
its interest expenditure.
The company should make the operating cycle more effective, this can be
done by reducing the stand on time, or the holding period of goods, because
of this, the remittance of cash and cash receivables can be increased
resulting in to lesser debtors and a smooth cash cycle.
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7) Conclusions:
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Bibliography
• www.economictimes.com
• www.businessstandards.com
• www.moneycontrol.com
• www.wikipedia.com
• www.realmarket.com
• www.google.com
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Glossary:
TL - Term Loan
FB - Fund Based
Fx - Foreign Exchange
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